Hype, as the studio moguls have learned, is no longer a guarantee of box office success. Even the most star-studded of Hollywood blockbusters can flop. Kevin Costner's budget-busting Waterworld and Barbara Streisand's The Mirror Has Two Faces are just two better-known films that have struggled to make a return on their mega-bucks investment.
Hollywood movie tycoons are increasingly nervous about ploughing tens of millions of pounds into films that have a poor prospect at the box office.
Studios thought they had found an answer to their escalating film costs when they stumbled on the idea of insurance-backed film finance in the mid-1990s. Intended to insure studios and their backers against film failure, insurance-finance products have always been a hugely risky business.
One type of policy is the time variable contingency (TVC), otherwise known as bums-on-seats cover. This indemnifies a studio if a film fails to become a hit at the box office. They are used to guarantee box office revenue, usually for three years after release. If a film flops, the studio's bank can claim the shortfall. Insurers would generally charge a premium of between 10% and 14%, but this could reach 25% for more risky projects.
The first major insurance-finance deal was arranged in 1996 by Hollywood lawyer Peter Hoffman through his independent film company Phoenix Pictures with Chase Manhattan bank.
Chase became one of the leaders in the insurance-finance market and has lent more than £428m worth of TVC loans.
Hoffman arranged £35m worth of insurance-backed loans from Chase to finance one-third of four Paramount films: The Phantom, In and Out, The Truman Show and The Beautician and the Beast. Other Hollywood films covered by TVC policies are The People v Larry Flint and Barbara Streisand vehicle The Mirror Has Two Faces, both of which flopped at the box office.
Paramount would subsequently finance a total of 25 films using insurance-backed loans, including such films as Double Jeopardy and Runaway Bride.
Insurers calculated that the failure of one or two feature films would easily be compounded by the success of the other ones.
Roger Sampson at Aon says: “There have always been, and will always will be, insurers that are attracted to high risk deals.”
Insurance-backed gap film financing, as bums-on-seats cover is also known, is extremely risky, however, as insurers have practically no influence on the production and promotion costs of a film.
Often, badly reviewed films tend to stretch their promotion budget even further – as it was the case with The Mirror has two Faces which spent £18m on advertising – and the risk for insurers gets potentially higher.
Roger Bassett, at broker Heath Lambert, by far the largest broker dealing in this market, does not agree: “If the insurers pay the claims, they take over the banks' rights to future revenues, and still can make money out of a failed film.”
But mounting losses at the box office have brought about a rethink among those insurers with a large Hollywood exposure.
Things came to a head last November, when a group of 10 insurers, among them Axa, Generali, Royal & SunAlliance, Copenhagen Re and Assitalia, began legal proceedings against Chase and brokers Heath, alleging fraudulent misrepresentation and non-disclosure.
Chase has since lodged a counter-claim for non-payment of claims arising from The Phantom and The Beautician and The Beast. Both Heath and Chase deny they have committed any wrongdoing.
Axa has the most exposure of the ten insurers – up to £1bn – and is believed to have already spent £12m on legal fees. Insurers have had to put up with an overall worldwide loss of up to £1.43bn since the beginning of the trade.
The problem facing Chase could not be more fraught. If insurers can prove they should not pay Chase's claims, the bank could be forced to write off £429m worth of loans it has made to finance films over the past four years.
The £1.43bn figure is dismissed by Bassett, however. He said: “This seems much too high.” He said his firm had “quality clients with quality films”, and the insurers could be sure of getting their money back via the film revenues.
Heath Lambert started dealing with insurance-backed gap film financing in 1992, but from 1995 on, it started working on a much larger scale and it is still the biggest player in the business.
While several Lloyd's syndicates – whose underwriters cannot put up that kind of financial guarantee – say they “would be surprised if there was still a market”, Bassett insists that “there is still a future”.
He concedes that the scale of the market has been greatly reduced: “It's about 20% of what it was in its heyday.” At its best, Bassett estimates that its worth was roughly £71.4m. And he is positive that it might soar again: “It could increase to 40% to 50% of what it was before.” Heath Lambert is still placing policies at the moment.
No wonder, as the brokers are thought to have hugely benefited from the market. Sampson thinks that “the only people who made money out of it are the brokers who placed those policies”. This is vehemently contradicted by Bassett. “The ones who are making money are the independent film producers who do a good film. They keep all their rights, have the ownership and the profits.”
Bassett considers that film producers profit from expensive debt and cheap equity. “An equity investor would ask for 50% of his upside, much more than the premium the producer has to pay us.”
Sampson is more circumspect: “It is a big business, but most don't understand the risk – gap finance has never worked.”
The Lloyd's syndicates also agree that “it's just not an insurable risk – it is like betting on the success of a film, which is not insurance”.
Everybody agrees on the fact that even if the market improves, it will not be what it was. Sampson reflects: “Anyway, it may say something about your film in the first place if you are not able to get any financing for it.”