The insurer that blew its cover: Paul Durman on the ambitious policy that has led MMI to the brink of failure

SHORTLY before 5pm on Wednesday, the Independent was assured by someone at UBS Phillips & Drew, financial advisers to Municipal Mutual Insurance, that there would be no further news from the troubled insurer that day. As the journalist came off the phone, he was passed a fax announcing that MMI had stopped accepting new business from 5pm and had suspended the payment of claims.

The anecdote illustrates the confused and farcical manner in which MMI played out its penultimate act. The Department of Trade and Industry, in the days immediately before it forced MMI to suspend trading, maintained it was keeping close tabs on the insurer's rescue talks with a potential European partner.

The problem was, it was not even clear that MMI was closely in touch with the talks. For three days after the Independent on Sunday first reported that the European insurance group Eurosafe was no longer interested in a rescue, Brian Wright, MMI's chief executive, was maintaining that talks were continuing.

Yet anyone calling La Garantie Mutuelle des Fonctionnaires (Groupe GMF), the French municipal insurer leading the Eurosafe negotiations, would have learnt immediately that it was quite simply not interested. At first, an MMI spokesman suggested this was due to a breakdown in internal communications at GMF. But GMF staff supposedly involved in the negotiations displayed the same lack of enthusiasm as the press office.

Nevertheless, MMI claims Mr Wright spoke to senior GMF management in Paris and was assured that meetings would proceed as planned, on the basis that GMF was still interested in a deal.

The collapse of the talks threatens to provide Britain's largest and most high-profile insurance company failure since the early Seventies. MMI is Britain's ninth-biggest general insurer, writing nearly pounds 800m of premiums last year. It insures around 90 per cent of the country's 500-plus local authorities.

The company still has substantial assets, measured at pounds 1.4bn at the end of last year. The fear is that it may face claims substantially greater.

The first casualties on Thursday were the minority of councils leaving rubbish uncollected as they were forced to take dustcarts and other vehicles off the roads. Exeter City Council appeared to be worst-hit. It was forced to close its civic centre and leisure facilities as it sought to arrange alternative insurance cover.

Councils provide the overwhelming bulk of MMI's business, but in recent years the company has built up a book of about a million personal customers. Most of these came to MMI through block policies, notably those with the Cheltenham & Gloucester Building Society and the Automobile Association. Although these policy-holders may face delays in settling their claims, they are ultimately safeguarded by the Policyholders' Protection Board, which will ensure they receive 90 per cent of agreed claims.

Cheltenham & Gloucester promptly switched 216,000 of its borrowers insured with MMI to General Accident. Remarkably, GA has agreed to meet claims payable by MMI.

Other leading intermediaries have also put contingency measures in place. The AA has offered to meet the shortfall its 380,000 customers covered by MMI would face after a payout from the Policyholders' Protection Board.

It was MMI's attempt to expand beyond its core council business that sowed the seeds of its downfall. Between 1986 and 1991, the company's premium income leapt from pounds 221m to pounds 785m. It was winning business by quoting premium rates often substantially below those of its competitors.

At first, rising profits kept pace with premium income. But the dry summers of 1989 and 1990, the storms of early 1990 and the onset of recession pushed the whole insurance industry deep into loss. MMI's slack underwriting caught up with it and in 1990 the company slumped to a pounds 64.8m loss.

However, the annual statement from Maurice Stonefrost, MMI's new chairman, failed to acknowledge the problems. 'The benefit of the group's strong financial position is that policyholders can be confident in our continuing quality of customer service in such difficult times,' Mr Stonefrost wrote in April 1991.

As the leading insurer of schools - a prime target for arson - MMI bore the brunt of the increasing incidence of malicious fires. The company also had to contend with the escalating cost of both public and employers' liability claims.

Along with the increasing damages awarded against local authorities, MMI faced claims arising from the Hillsborough football disaster and the 'pin-down' child abuse scandal.

By March this year, MMI's finances had deteriorated significantly, and it was apparent that the insurer had insufficient assets to meet the DTI's solvency requirements.

Speculation about the company's problems mounted rapidly, though one of MMI's senior managers claimed there was 'no suggestion that we are technically insolvent', and denied the company faced severe financial difficulties, when questioned by the Independent in April.

MMI told the DTI of the extent of its problems towards the end of March. In defending its own role in allowing the insurer to trade for a further six months, the department claims it kept a close watch on MMI thereafter. It was involved in the appointment of Mr Wright, who replaced Andrew Maclean as chief executive in May.

Mr Wright had recently retired as a senior executive director of Sun Alliance, the insurer. His arrival coincided with MMI's announcement that it was to seek a new owner for its business. The company also attempted to staunch the worst of its losses by pulling out of commercial insurance.

The extent of MMI's problems did not become public until July, when it announced its planned deal with GMF and Eurosafe. It reported a loss for 1991 of pounds 238.6m. After provisions for future claims and property write- downs, net assets fell from pounds 287.9m to pounds 4.9m.

The company's accounts were heavily qualified by its auditors, Coopers & Lybrand. A 'going concern' report on Municipal General Insurance, a key MMI subsidiary, queried the adequacy of a pounds 43.4m provision against the poor-quality commercial insurance business written in 1990 and 1991.

Since these dismal figures accompanied news of the rescue deal, it seemed that GMF/Eurosafe knew the worst. However, GMF has clearly been put off by the insight into MMI that it has gained over the past 10 weeks.

Recently, associations representing local authorities commissioned their own report on the company from Touche Ross. The accountants warned: 'There is a strong possibility that MMI will cease trading in the very near future and be placed in some form of insolvency proceedings. In the event of insolvency, member authorities are unlikely to receive settlement of their claims in full; a significant proportion of the settlement will be deferred and the figure ultimately payable will not be determined for many years.'

MMI is seeking to sell or transfer its personal lines business to other insurers, and to refocus on its core business of insuring councils. Without fresh capital, it is difficult to see how it could open again to new business.

Its council customers are already looking elsewhere, using brokers to arrange invariably more expensive cover at Lloyd's. Richard Edgar, a director of Jardine Insurance Brokers, said his firm had received calls from more than 100 councils.

The council associations favour placing MMI under a creditors' scheme of arrangement. This would allow it to resume paying claims while avoiding the costs of a liquidation.

The finance union MSF, which has 1,500 members among MMI's 2,500 staff, still hopes for a rescue. After a meeting with management on Thursday, Tony Whiteley, MSF's national officer, said MMI still contends that a number of insurers are interested in buying the company as a whole.

MSF was not offered any guarantees on jobs. Mr Whiteley said: 'If there was a liquidation, our members would be in severe difficulty as far as jobs and their mortgages were concerned. If we are not careful, 2,000 people could be out of work.'

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