13 September 2004
One of the most significant issues for the London insurance market is how to deal with the myriad legal and regulatory issues which arise from the ‘run-off’ market.
Run-off, in this context, means either a book or books of discontinued business or a discontinued insurance or reinsurance company. In both cases, no new business is being written and the business that has been written carries with it not only actual, but also potential, future liabilities.
With recent estimates of the UK non-life run-off market comprising total liabilities of £30bn-plus, it is unsurprising that those responsible for run-off must consider all available options. In short, these entities will be looking for one thing – finality. This means:
- Finality for policyholders with actual or potential claims.
- Finality for the company in run-off in maximising the main asset that it holds, namely its reinsurance recoveries.
- Finality for the shareholders of the company in run-off in terms of releasing any available capital to the shareholders once all inwards claims have been paid and outwards reinsurance collected.
At one end of the spectrum of attaining finality is the option of running off the book of business or the company’s liabilities to the natural expiry of all policies written. Depending on the type of business underwritten, this can be a lengthy and costly process. At the other end of the spectrum is the possibility of closing down the run-off at a much earlier stage, thereby accelerating the release of reserves to shareholders. For obvious reasons, the latter approach is generally preferred.
An early exit from run-off is achievable if the necessary legal and regulatory requirements are met. In summary, this will require: the agreement of the policyholders to buy into the early closure; the agreement of the Financial Services Authority (FSA) and the High Court that the policyholders are not being prejudiced by the early closure; and the tacit agreement of reinsurers that an early closure is in their best interests.
Schemes of arrangement – solvent and insolvent
The attraction of a valuation (or ‘cut-off’) scheme for a solvent or insolvent company in run-off is finality. A scheme of arrangement under Sections 425 and 426 of the Companies Act 1985 is a compromise or arrangement between the company in
run-off and its creditors or any class of them. A scheme is legally binding on all the creditors if the necessary majority vote in favour and the High Court approves it.
Schemes of arrangement for insolvent insurance/reinsurance companies found popularity in the late 1980s to early 1990s. Solvent schemes of arrangement, which became a popular exit method during the mid to late 1990s, are presently attracting renewed interest from insurers/reinsurers in run-off.
The key steps in the preparation and the implementation of a valuation scheme (whether on a solvent or insolvent basis) are:
- The drafting of the scheme rules with input from significant creditors, the FSA and, increasingly, reinsurers.
- The filing of an application for directions with the court to convene a creditors’ meeting (or as many separate creditors’ meetings as classes of creditor).
- The holding of a creditors’ meeting(s) to vote on the scheme.
- Applying for the court’s sanction of the scheme.
- The claims submission period during which liability for, and the quantum of, claims submitted by creditors are agreed, or in the event of dispute adjudicated.
- The payment of the substantive distribution.
- The payment of any final distributions.
One of the most common issues that can arise relates to the number of separate class meetings of creditors. One such example arises from the potential for tension between established and short tail creditors on the one hand (for whom the valuation mechanism has little or no impact) and those creditors with IBNR (incurred but not reported) claims on the other (on whom the valuation mechanism clearly impacts).
The flexibility of schemes means that they are becoming increasingly popular in the London insurance market to bring finality to solvent run-offs. They can also be used for underwriting ‘pools’ (a situation where an underwriting agent writes business for a number of insurance companies) and in relation to the UK branches of overseas companies and companies deemed to have a ‘sufficient connection’ to the UK.
The attractiveness of schemes is further demonstrated by the fact that certain Commonwealth jurisdictions, such as Bermuda and Singapore, possess legislation similar to Sections 425 and 426 of the Companies Act 1985. Moreover, the US state of Rhode Island has recently passed legislation which mirrors in many ways the key features of a solvent valuation scheme under Sections 425 and 426 to enable US companies in run-off to redomesticate to Rhode Island to achieve early closure of their run-offs.
Business transfer schemes
Part VII of the Financial Services and Markets Act 2000 (FSMA) has greatly improved the procedure for transferring general insurance business to another company. Part VII is a court-approved novation. There are two key features: the transfer must be supported by the report of an FSA-approved actuary confirming that policyholders will be no worse off; the transfer must be approved by the High Court.
Other key features of a Part VII transfer are that it also allows the outwards reinsurance recoveries to be transferred to the transferee, as well as other benefits such as trust funds and other guarantees. The legislation also allows the transferring company to be dissolved at the same time and by virtue of the same court order.
Part VII schemes are particularly relevant in the context of underwriting pools in run-off where the liabilities of each individual pool member can be transferred to one single remaining pool member. This in turn facilitates and reduces the cost of the run-off of the pool business.
While not strictly a mechanism for implementing an exit strategy, administration combined with a scheme of arrangement can achieve finality for an insolvent insurer/reinsurer.
Until May 2002, insurers were unable to take advantage of the administration procedure and were instead forced to use provisional liquidation to obtain the statutory moratorium on creditor enforcement which administration now affords. More recently, the administration procedure applicable to insurers/reinsurers has been amended to take into account the Enterprise Act 2002 (which made significant changes to insolvency laws more generally). One purpose for which the administration procedure has been utilised is the implementation of an insolvent valuation scheme of arrangement. In light of recent secondary legislation altering the order of priority as between insurance and other creditors (including reinsurance creditors), this is an area in which further legal developments can be expected.
The growth in the use of solvent schemes of arrangement and Part VII transfers as exit strategies for the London run-off market has been significant in recent years, and such growth is expected to continue for the foreseeable future as the London market (and, indeed, the worldwide insurance market) tries to get to grips with the run-off of old books of business. It is also clear that the legal and regulatory framework under English law means that London is very much at the forefront of the global run-off market.
Ian McKenna and Richard Gregorian are partners in Mayer Brown Rowe & Maw’s insurance insolvency group