A Bermuda reinsurance company is at the centre of an international controversy that has caused the collapse of one Japanese insurer and sparked a $2.5 billion legal battle.

The Wall Street Journal reported on Monday that North Carolina insurance company Fortress Re ceded hundreds of millions in insurance premiums to its Bermuda subsidiary Carolina Re, which went into liquidation last December.

Carolina Re then paid more than $400 million in dividends to its owners - who were also the principals of Fortress Re.

But when the Japanese insurers on whose behalf Fortress Re had written insurance policies sought to recover claims stemming from a series of aviation disasters culminating in the September 11 terror attacks, they found that both Fortress and Carolina were insolvent.

Carolina Re, which should have paid out an estimated $600 million, had just $62 million in assets.

The Wall Street Journal reported that Japanese insurer Nissan Fire & Marine Insurance Co. believes that some $406 million in profits from Carolina Re were instead paid out in dividends to Carolina and Fortress' owners.

And Carolina Re liquidator John McKenna of Ernst & Young is now investigating the company to see if any Bermuda insurance regulations have been broken. Mr. McKenna could not be reached for comment yesterday.

Nissan Fire has also claimed in a North Carolina court that the owners, Maurice D. Sabbahand Kenneth H. Kornfeld, skimmed millions of dollars more from Fortress.

"Fortress, telling its Japanese clients it wanted to take the same risks they did, established a reinsurer of its own in the 1980s to share in the pool's losses and profits," The Wall Street Journal article said. "It was called Carolina Re and based in Bermuda.

"Fortress paid Carolina Re 25 cents of every dollar of premiums collected. In return, Carolina Re was on the hook for 25 percent of claims. "But with the pool now facing what Nissan Fire calculates are $2.5 billion in losses from September 11 and earlier air disasters, Carolina Re can't come close to paying its share of $600 million or so.

Nissan Fire estimates that Carolina Re - using (a) profit formula Nissan considers bogus - has recorded $470 million in profits since 1984. But Carolina Re's most recent balance sheet showed it had just $62 million in capital and surplus.

"Nissan Fire estimates that the outstanding $408 million was paid in dividends to Carolina Re's shareholders - Mr. Kornfeld and various interests of Mr. Sabbah and his family.

"A liquidator of Carolina Re appointed by a Bermuda court, John McKenna, says that estimate is pretty accurate.

"Nissan alleges that these dividends were paid improperly, `without regard to Carolina Re's growing financial obligations'."

The newspaper said Fortress's attorney said the payments were proper because Carolina Re was "clearly solvent" when they were paid. He added that Carolina Re complied with all Bermuda regulations.

"Mr. McKenna, the liquidator, says he's reviewing financial statements to see if the dividends were legal under Bermuda law.

"The Fortress case has left a tangled web of financial arrangements that will take years to unravel.

"Some companies that dealt with the agency, including insurers that bought policies from it as well as financial reinsurers, may be saddled with losses or may be unable to collect for months or years.

"One big unknown is the extent to which Taisei Fire, the Japanese company now in bankruptcy court, will cover its share of the pool's losses.

And the Japanese insurers are piling up fresh losses on Fortress policies still in effect. The $2.5 billion figure doesn't include what are expected to be substantial losses for the insurers from last fall's American Airlines crash near Kennedy Airport and last month's China Air disaster near Taiwan."

Nissan Fire and the other insurers claim that the Carolina Re insolvency is part of a bigger fraud involving Fortress, according to the Wall Street Journal article.

It said Fortress Re acted as an agent for three large Japanese reinsurers and was a leading seller of policies that covered big chunks of the losses in many aviation catastrophes.

"For 24 years, Fortress reported to the Japanese insurers that the business it oversaw for them was profitable," the newspaper said.

"But following September 11, the Japanese insurers became worried about their exposure and sent in their own auditors to look at Fortress's books which triggered a financial meltdown and pushed one of the insurers into bankruptcy court and prompted Fortress to halt new business.

"It has also spawned an international legal battle over who will ultimately pay an estimated $2.5 billion in claims from September 11 and many other air disasters dating to 1998."

Nissan Fire & Marine Insurance Co., contends it has uncovered a massive fraud in which Fortress hid some losses by, in effect, borrowing the money to cover the claims.

"While the Japanese insurers were incurring a giant bill, a Nissan Fire lawyer alleged in a hearing in federal court in Greensboro, North Carolina, Fortress's owners were `skimming off' hundreds of million of dollars, in part via a Bermuda firm they owned," the newspaper said. Fortress denies any fraud.

But the Wall Street Journal said the "debacle" has already resulted in Taisei Fire & Marine Insurance Co., one of the three big insurers that worked with Fortress, becoming only the second casualty insurer to file for bankruptcy since the Second World War. "It and the other two that dealt with Fortress, Nissan Fire and Aioi Insurance Co., have booked losses or charges against earnings of about $2.6 billion in connection with Fortress dealings," it said.

Nissan Fire's suit against Fortress and its principals , Mr. Sabbah, 73, and Mr. Kornfeld, 55, is on hold while the parties pursue arbitration, the newspaper said.

The newspaper said that Mr. Sabbah founded Fortress Re 30 years ago and was soon joined by Mr. Kornfeld. "Despite the `Re' in its name, it wasn't an insurer," the newspaper said. "Instead, it managed a reinsurance business for the Japanese insurers - committing them to policies that Fortress sold, and taking a share of the profits. Aviation eventually became the main focus." (See Box on Page 19).

The Wall street Journal said Fortress wrote hundreds of millions of dollars worth of insurance policies on behalf of the Japanese companies but their deal with Fortress called for it to obtain reinsurance that cut the exposure to just $40,000 per policy.

"Fortress would collect premiums on the policies it sold, then attempt to buy reinsurance for a lower premium. The difference - minus fees and claims - was profit, to be shared between the Japanese insurers and Fortress."

In 1983, Fortress reported net profit for its Japanese clients, before deducting its slice, of $2 million after taking in $15.4 million of premiums. In 1991, premiums collected had soared to $584 million and profit was $145 million. Fortress earned almost $60 million in commissions and fees."

The Wall Street Journal reported that Fortress insured an estimated 40 to 60 percent of policies paying the portion of a crash loss between $50 million or $100 million and $400 million - the segment of the market that is almost sure to face claims in any major air disaster. "From 1998 through 2000, Fortress reported to the Japanese that the business had produced total profits, before its commission, of $275 million.

"However, a series of crashes caused executives at Nissan Fire to grow suspicious, including TWA 800's explosion off New York's Long Island, the Swissair crash off Nova Scotia, Egyptair and Alaska Airlines planes that dove into the sea, and the Concorde disaster on takeoff from Paris. The policies the insurers had written through Fortress had exposure to all of these, yet Fortress reported little impact on profits."

Nissan Fire began an investigation in 2000 and found that Fortress had been buying financial reinsurance to limit losses to $40,000 per policy rather than traditional reinsurance.

"Instead of transferring risk, (financial reinsurance) is like a line of credit from a bank. If there is a claim, financial reinsurance pays off - but by making what is essentially a loan, which has to be paid back in future years through higher premiums."

Nissan Fire said that as a result the three Japanese insurers ended up owing hundreds of millions of dollars to financial reinsurers, the newspaper said. Nissan Fire also says that in figuring profits, Fortress improperly treated the proceeds from financial reinsurance - which have to be paid back - like payouts from traditional reinsurance policies. Nissan Fire also said Fortress improperly used the bogus profit figures that resulted to calculate its own commission - which was one-third of the profits - and over the past 20 years Fortress paid itself $528 million as a share of the profits, when the business actually was "barely break-even".