US legacy options
One size does not fit all
Andrew Rothseid, of RunOff Re.Solve LLC, explores the diverse and evolving options for legal and financial finality of US legacy risks
A combination of new legislation, implementing regulations and innovative application are coming together to broaden the opportunities for accelerated closure of US-domiciled legacy liabilities and the invaluable capital this would release. What has changed and what are the key issues to consider when weighing up the evolving options? The available options are diverse. No one jurisdiction provides a single answer for all types of exposures. As a result, carriers seeking to implement these solutions must weigh up the attributes of all, rather than focusing solely on one.
At a time when US insurers and reinsurers are grappling with soft market rates, subdued asset returns and pressure to invest in new technological capabilities, legacy liabilities can no longer be tucked away in a corner and allowed to edge gradually towards final closure. Discontinued business ties up a huge amount of capital and administrative expenses that could be profitably used elsewhere. And as liabilities can take several decades to expire, there is a continuing risk of adverse loss development.
Sale or reinsurance would transfer the liabilities and costs. Yet, a lot of value is left on the table as acquisition prices and reinsurance rates need to take account of the risk of reserve deterioration and the buyer’s need to generate profit. That’s why clean break alternatives, such as commutation plans, are attracting increasing board interest. And many of the uncertainties and restrictions that have discouraged firms from pursuing these options are being lifted. There are growing opportunities to separate active from inactive business and transfer portfolios to a state where legislation allows for accelerated closure. Innovative application is opening up further opportunities.
Yet, there is no silver bullet. Each of the main exit mechanisms has distinctive pros, cons and focuses of application. Effective run-off management requires a clear, balanced and well-informed weighing up of the advantages, risks, and costs of each option.
So what are the key changes coming through and what are the key issues to consider when evaluating, selecting and enacting these processes?
1/ Rhode Island Commutation
The Rhode Island Commutation Plan Statute allows insurers and reinsurers to accelerate the final closure of eligible business in run-off.
Implementing regulations only used to allow whole companies to be transferred to Rhode Island for commutation, but a 2015 amendment (Regulation 68) permits insurers and reinsurers to separate and package up an eligible block of business for transfer and eventual commutation. The Rhode Island insurance business transfer process was authorised by a 2007 amendment to the Rhode Island commutation plan statute, which only allowed for transfers of portfolios in furtherance of a commutation plan.
Claims that Regulation 68 compromises policyholder rights and raises public policy concerns are unfounded as it only applies to commercial business rather than personal lines or workers’ compensation business. Further, the amendment provides full transparency, regulatory review and due process protections in both Rhode Island and transferring state. Indeed, the solvency and financial condition safeguards mean that policyholders will be as protected, if not more protected, by the security of the ‘assuming company’ than they were by the ‘transferring company’.
Issues to consider
The process suits some portfolios more than others, which means that we are likely to see a judicious flow of insurance business transfer plans and subsequent commutation plans, rather than the flood that some anticipate. To win approval for transfer to Rhode Island and achieve subsequent commutation, insurers and reinsurers need to develop a clear justification, focused closely on the protection of policyholder interests. They will also need to develop effective structures for the plan, which reflect the demands of the legislation and the particular characteristics of each block of business.
2/ Pennsylvania Association Transactions Act
Separation of active business from inactive portfolios ready for run-off. Separation would allow the active business to bolster its rating and focus resources on new business development.
2015 amendments to the Act expand the scope by permitting the direct conversion of a business organisation from a foreign to a domestic entity (or vice versa), which was previously only allowed by merger or some similar action.
While upholding the fundamentals of the separation process, the amendments include a number of new definitions and a major update of forms and filing requirements. The law on corporations and unincorporated associations has also been modernised through the creation of a comprehensive statutory framework for a business entity to use when engaging in a transaction with another form of entity.
Issues to consider
The process requires board and shareholder approval, fairness and solvency opinions, and actuarial reviews of various financial and accounting measures. Policyholders should be consulted, but the process does not require their approval.
The new definitions require applicants to learn a new ‘vocabulary’. New forms must be filed for mergers, divisions and domestication of foreign entities, among other activities, and several foreign forms have been amended. It’s important to review the amendments to identify any necessary filings, which would be related to the particular structure of the transaction.
3/ Vermont Legacy Insurance Management Act
Facilitate and streamline the process for transfers of commercial insurance policies and reinsurance agreements between solvent insurance companies.
Issues to consider
The Vermont Statute has been compared to the Part VII process in the UK. However, distinctions exist. Differences also exist between the Vermont and Rhode Island processes. The Vermont Statute applies only to excess and surplus lines carriers and not to admitted companies. By contrast, the Rhode Island Statute applies to admitted and non-admitted carriers.
The Vermont Insurance Commissioner decides whether or not to sanction the transfer. The transferring party’s home-state regulator must only submit a letter of 'no objection'. The Rhode Island Statute allows for broader scrutiny by requiring review and approval by the home-state regulator, Rhode Island regulator and the Rhode Island court. That scrutiny is key to fair consideration of all interests, and therefore finality.
Under the Vermont Statute, certain policyholders can choose to opt-out of the transfer process. This has the disadvantage of splitting the assets and making it more difficult to ensure that liabilities are covered by sufficient backing assets. Rhode Island has no opt-out provision.
The Vermont Statute does not provide a process for the liabilities to be crystallised and closed. This leaves the policyholders subject to the potential erosion of capital in the newly created Vermont entity.
4/ New York Regulation 141
Allows a troubled New York-domiciled reinsurer to offer to pay a percentage of cedants’ losses in return for an agreement on commutation of liabilities.
Issues to consider
Comparable, if not, identical, offers must be made to each and every cedant. Commutation terms must also be consistent. The New York Superintendent of Insurance judges the fairness of the offers as part of its power of review, approval, and possible modification. Individual cedants can say no, rather than having to follow a majority decision, so it is important to take soundings in advance to see how many will accept, and hence whether the plan is viable.
Making this work
The pressure to deploy capital and management resources more efficiently is increasing. There need to be smarter solutions and a careful analysis of the advantages and issues of all available solutions.
Beyond the legal technicalities, it is important for the carrier to put itself in the policyholders’ and regulators’ shoes. What concerns might they have? What are the mutual benefits, and how will they be better off through accelerated closure? This underlines the importance of transparency and thinking about the reputational implications.
Indeed, some of the key openings for innovation and creative development of these processes lie in communication and stakeholder engagement, which can in turn inform and enhance the structuring and chances of successful outcomes.
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