Andrew Rothseid and Lauren Benson from the Insurance Restructuring Group of PricewaterhouseCoopers LLP, provide an overview of the conclusions of the recently established Task Force to review laws regulating companies in run-off in Connecticut.

In Autumn 2005, Connecticut insurance commissioner Susan Cogswell established a Task Force to review the laws regulating companies in run-off, and, to the extent that regulations did not exist, to examine the feasibility and suggested content. The Task Force was comprised of representatives from insurance and reinsurance companies in run-off, policyholders, industry service providers and the regulator.

This article provides an overview of the Task Force conclusions. The complete text of the report is available at http://www.ct.gov/cid/cwp/view.asp?a=1273&q=255116.

Stakeholder concerns:

The Task Force identified the objectives and concerns of the principal "stakeholders" of a run-off company: the entity itself, policyholders, guaranty funds, reinsurers, other insurers and regulators. After identifying these concerns, insights were offered on appropriate legislation to address stakeholder concerns and bring transparency to the run- off process.

The run-off entity

Companies in run-off, whether marginally or substantially solvent, want to minimise operational expense and balance sheet uncertainty. Marginally solvent companies often look to attract capital in order to improve their balance sheet and minimise involvement from regulatory authorities. These companies seek to avoid litigation, retain key, knowledgeable personnel and pay their obligations full in order to release any excess funds to shareholders.

Policyholders want prompt full payment of their claims. If it is suspected that the company may not fulfill their obligations, policyholders want broad disclosure of the company’s financial status so that they can evaluate the company’s condition and plan accordingly.

Guaranty Funds are keen to keep their own expenses at a minimum. This can only be achieved if insolvency is avoided. Guaranty Funds serve to protect consumers and thus want to ensure that funds are equally distributed among claimants. They are concerned that if claims junior in priority to Guaranty Fund claims are paid out first, the subsequent liquidation can be more costly.

Reinsurers are generally opposed to any proposed legislation that forces the acceleration of their payment obligations, especially if those payments are uncertain estimates of their ultimate obligation.

Other financially healthy insurance companies want their Guaranty Fund assessments kept to a minimum, and therefore wish to avoid unsuccessful run-offs that lead to costly liquidation.

Regulators seek to avoid receiverships and to ensure that policyholders’ claims are paid. As elected or appointed officials, regulators also want to preserve constituent employment opportunities. The Task Force also considered the concerns of other parties, including brokers, employees, reinsurance intermediaries and third party claimants and found that their interests did not differ substantially from those mentioned above.

Benefits and outline of Prospective Legislation

After analysing the objectives of all entities, the Task Force concluded that many aspects of run-off are unregulated. The goal of any legislation should be to ensure fair and transparent treatment of all stakeholders, making the process more efficient and inexpensive. Because the regulatory obligations of companies differ based upon their level of solvency, the Task Force concluded that the laws should be tailored accordingly.

Substantially solvent companies should be required to notify the Connecticut Insurance Department (and other interested insurance departments) when they have stopped underwriting a line of business in all states. Acceptance of the notice by the Department would be contingent upon receipt of an accompanying closure plan. The Insurance Department would be responsible for overseeing the run-off and would require the entity to submit, at least, annual progress reports.

If a company chooses to run-off a book of business by commuting their liabilities on an accelerated basis, there should be greater regulatory scrutiny to ensure that a detailed run-off plan exists and all claimants are treated consistently. Another aspect of the regulatory intervention would be a requirement to file a disclosure document to be included with all commutation invitations. This Insurance Department approved disclosure would describe the company’s financial position and run-off strategy and serve as an explanation for the prospective claims handling. The Insurance Department would approve all commutation agreements that exceed a certain amount, with the threshold dependant upon the insurer's financial situation. The Department’s involvement would protect creditors against preference avoidance in the event of insolvency.

Creditors of marginally solvent companies should maintain the freedom to negotiate individually and in the manner most appropriate to their situation. It was noted, however, that the Insurance Department would be involved in setting guidelines for treatment of small creditors to ensure fair treatment.

An Accelerated Closure Plan

Solvent companies in run-off should have the opportunity to settle all of their liabilities with creditors through a court proceeding. This closure opportunity would not apply to troubled companies looking to continue to underwrite new business, nor would it be suitable for personal lines.

The court proceeding envisioned for marginally solvent companies would call for creditors to be divided into classes where each class would vote on a plan. The plan would be accepted by the court only if affirmed by the majority in number and super-majority in value.

Dissenting creditors within that class would be bound by the plan. Acceptance of any plan would be contingent upon creditors receiving at least as much as they would collect in a liquidation proceeding. Guaranty Fund covered claims would be protected. (This was considered not to be an issue as most participants would likely not be eligible to receive guaranty fund payments.) Dissenting creditors could reverse the application of the plan if they were able to prove that the plan would leave them with less than if the company were liquidated.

The Task Force proposed several alternatives that could be offered to policyholders whose payments are not at risk and who would not support the closure plan.

The first option proposed was to offer policyholders the right to file claims and collect payments normally, despite the fact that this choice would prevent the company from accelerating finality. Another alternative would be to allow the run-off entity to novate their policies to another firm of equal or greater financial strength. One additional substitute presented was to require the run-off company to make a cash payment equal to the amount required to replace the issued policy.

The fourth option put forth was to establish a liquidating trust that would pay claims as presented by policyholders over the course of the policy or allow for commutations as claims developed. Actuarial analysis would be required to determine adequate funding amounts and the arrangement would include an option for the company to withdraw any surplus after a reasonable period as determined by actuarial analysis. All applicable reinsurance would be transferred to the trust and commutations of reinsurance would be permitted as claims matured. An independent policyholder representative would be appointed. The representative would monitor the level of funding and negotiate any needed funding changes. This option would provide an advantage to policyholders who did not wish to have their claims estimated and would be equally advantageous to the run-off entity as it would allow for release of any further obligations with respect to such claims.

The Task Force also noted that it would not be realistic to recommend legislation that would oblige reinsurers to make payments based on estimated figures; however it was suggested that reinsurance could be transferred to a trust or for third party sale.

Extraterritorial enforcement of the proposed legislation would be handled in a manner dependent upon the level of solvency. The legislation applicable to marginally solvent companies looking to commute all of their business would be interconnected with the existing insolvency statutes. It would call for rehabilitation proceedings and the completion of a detailed runoff plan to ensure reciprocal treatment from other states. Enforcing a run-off law for substantially solvent companies for whom receivership is not an option is more difficult and would require that states acknowledge the judgment of the domiciliary state court.

With an estimated one hundred billion dollars in run-off reserves in the US, and no statutes to mandate consistent and fair business practices, the health of the entire industry could suffer if marginally solvent companies do not have a legal way to bring closure to their business. The consequence could be further entries into liquidation with the resulting burden on the guaranty fund system. Given the severity of the situation and the vast number of stakeholders affected, the Task Force has begun the deliberative process by proposing several solutions through which industry reputation can be maintained and stakeholders are treated equitably and consistently.

This Feature item appeared in issue 106 of JTW News - June 2006

Author: Andrew Rothseid | Lauren Benson - PricewaterhouseCoopers LLP