Hollywood and the Insurance Industry

Once upon a time in a country far, far away, a few visionaries
(and, yes, a few con artists) laid the foundations of the multi-billion- dollar motion picture industry. It required taking considerable risks then, and it still does today. Since its beginning, Hollywood has relied on the insurance industry to help manage those risks.

“Modern entertainment” now includes an extremely large number of related activities: musical performances, stage plays, radio and television programs, sporting events and beauty contests, as well as motion pictures. Insurers are involved in all of them, but “The Movies” remain special, perhaps due to their legendary ability to fascinate the public.

Somewhere over the rainbow
Whatever the reason, they also fascinate the insurance industry. According to the Insurance Information Network of California (IINC), film production-related premiums exceeded $100 million in 1998, the majority for feature films. Although it may qualify as a “niche business,” the major players aren’t small—they include AIG, Chubb, CNA, Fireman’s Fund and St. Paul among the most prominent, as well as Lloyd’s.

The IINC describes four basic film insurance products. They’re designed to “protect filmmakers from possible business interruption from everything from weather-related filming delays to the loss of a cast member or other film personnel.”

In a bulletin issued last year it described them as follows:

• Cast insurance covers any additional costs that can arise if a production loses a cast member, director or any personnel and often represent the largest film insurance claims. In March of 1994, the producers of “Wagons East” collected $14.5 million when actor John Candy died of heart failure with 20 percent of production remaining.

• Errors and omissions policies protect production companies from lawsuits involving violation of personal rights, libel or slander. These policies usually require filmmakers to consult with attorneys prior to a film’s release to check for anything that might spur a lawsuit.

• General production insurance packages provide the standard insurance needed by any business, such as workers’ compensation, general liability and commercial auto insurance. It also includes costs for delays and re-shooting due to inclement weather, equipment failure and set damage.

• Completion bonding guarantees that a film will be finished. Without completion bonds, some of the Academy Award-nominated independent films such as “Cider House Rules,” “The English Patient” and “Leaving Las Vegas” might never have made it to Oscar night. Without the backing of a major studio, independent producers need the guarantee that they have the financial means to complete a film.

The name’s ‘Bonds,’ ‘Completion Bonds’
Completion bonding and its offshoots, gap financing and income stream securitization guarantees, are more complicated, and therefore more likely to lead to disputes and litigation.

“In the simplest case, a completion guarantee or bond assures whoever is financing the production, whether it’s a bank or an individual, that the film will be made and delivered within the time period specified; that it won’t cost them any more than the original investment; and that in a worst case scenario—production is shut down—it’s a guarantee that they can get their money back,” said Steve Mangel, the head of International Film Guarantors (IFG) in Hollywood.

IFG is a very specialized type of insurance broker which arranges completion bonds. It’s a limited partnership between Near North National Group and Fireman’s Fund, and, as Mangel indicated, “you can’t just write a policy and sit back and hope there isn’t a loss. A completion guarantee gives you very broad powers, and an obligation to mitigate. You can even take over the production, but it’s very rare to do it.”

IFG specialists are experienced in every aspect of movie making and follow a film’s progress from day one. “That way,” Mangel continued, “if there’s anything off-kilter we can bring people together and try to work out the problems. Knowing what goes on, on a daily basis, is the key to monitoring. You have to break down all the components in the schedule.”

A completion bond is only issued at the request of the third party investor, and until fairly recently, mainly for independent productions, according to Mangel. Typically, the producer or his agents will “pre-sell” the rights to distribute the film before it has been made. When enough of these contracts have been concluded to make the project viable, the producer seeks financing from banks, movie studios and private investors.

The investors contract with a broker such as IFG to guarantee that the film will be completed. While the producer may have obtained distribution contracts, no guarantee is given that the film will actually be distributed, sold, or make any money. It simply assures investors they’ll get their money back, or that the guarantor will pay for cost overruns, which are recoverable by the guarantor after the principal amount has been repaid.

IFG normally writes more than 40 guarantees a year for up to $100 million. It’s written more than $2 billion for such films as “Braveheart,” “Evita,” “Four Weddings and a Funeral,” “Fargo,” “Lara Croft—Tomb Raider,” “The Score,” and Woody Allen’s “The Curse of the Jade Scorpion.” It’s currently awaiting post-production and/or the release of the first episode of “The Lord of the Rings,” Robert Altman’s “Gosford Park” and Harrison Ford’s latest film, “We Were Soldiers Once and Young.”

Completion bonding is a mature industry. Most of the essential contract wording has long been established, and services like IFG’s are an integral part of filmmaking. There are still changes going on, however. “Until five or six years ago most studio projects were ‘self-bonded,'” Mangel said, “but recently there have been more co-productions, where guarantees are required. There’s also a desire to take cash investments off the balance sheet by borrowing the money to finance a film rather than advancing it directly, which increases the demand for policies guaranteeing completion and delivery.” Nevertheless, they’re all essentially classic film guarantees.

Frankly, my dear…
Some newer types of financial protection policies, however, have strayed into income protection, which goes beyond completion bonding and carries higher risks.

AXA crossed the line in 1993 when it began writing policies covering “gap financing.” Production costs are usually advanced on the basis of the existence of underlying contracts for distribution rights. In some cases these aren’t enough to cover the cost of finishing the film, which creates a “gap” between the amount the investor provides, covered by a classic completion bond, and the total amount required. To finance the gap, the producer assigns future (i.e., as yet unrealized) revenue to the lender, who then seeks to protect his investment by obtaining a policy that will guarantee to repay the difference between the amount actually lent, and the amount the lender actually receives over a finite period of time.

If you’re financing Spielberg or Lucas, the investment is extremely safe, but they don’t need it; their distribution rights are quite sufficient. “It’s a large part of independent productions,” according to Mangel, but he confirmed that classic completion guarantees don’t normally cover it. As the risks increase, so do the premiums, and eventually funds are advanced for a film or a TV series that never gets distributed or even produced.

AXA found this out when a number of claims were presented on gap financing policies it had written. According to Stephanie Binet of AXA Corporate Solutions, they wouldn’t have provided coverage for the loans if the banks or the producers involved had fully disclosed all the facts concerning the production companies and the films they intended to produce. Many of these cases are still in the courts.

Go ahead, make my day
While insurers frequently contest insurance claims, financial guarantees are sacrosanct. Unless there has been verifiable fraud or the guarantor is insolvent, the bondholders are paid. They underpin too many financial transactions, and are relied on by too many people to make it otherwise. That’s why AIG created such a controversy when it refused to pay claims on bonds issued in the U.K. by Credit Suisse First Boston (CSFB), which had been rated “AAA” by Standard & Poor’s.

A very brief summary begins with Flashpoint, a U.K. company, which arranged financing, eventually totaling $250 million, to fund the making of several television series in 1997-98. The six separate deals, called appropriately “Hollywood 1, 2, etc.” were funded by securitizing the future revenues which the films were expected to provide. CSFB advanced the money, and insured the first three with the U.K. subsidiary of Australia’s HIH, which went into liquidation last March. HIH in turn reinsured the notes; one of the reinsurers was New Hampshire, an AIG subsidiary. The primary insurer on Hollywood #’s 4, 5 and 6 was Lexington Insurance Co., also an AIG subsidiary.

Although Flashpoint made some of the episodes, none of the revenues they generated were sufficient to pay off the notes; a number of them were never completed, and production never began on the rest.

HIH paid out around $50 million and asked its reinsurers, New Hampshire included, to reimburse it, but they refused on the grounds that HIH shouldn’t have paid the claims in the first place as they were insurance policies, and thus subject to the defenses of breach of warranty, non-disclosure of material facts and bad faith.

When Lexington refused to pay on the primary policies, CSFB accused AIG of defaulting on its unconditional financial guarantees.

AIG’s reaction was swift and angry. Chairman Maurice “Hank” Greenberg, who’s never been known to back away from a fight, accused CFSB of “bad-mouthing” his company, and adamantly denied that any financial guarantees were involved. AIG issued a statement and a position paper explaining its view that: “the securities underwriter and the purchasers of the insurance backed notes assumed that the insurance policies were absolute and unconditional guarantees of due and timely payment of the notes, whereas the insurers understood themselves simply to be insuring a stream of revenues from a defined set of motion pictures.”

And, as the sun sinks slowly in the West…

Topics Market AIG