Written by Rick Newton
& Luann Petrellis
The recent world financial crisis has changed the way business looks at itself as well as the way the public and regulators think about businesses. The outlook of most business leaders has changed from the pre 2007 expected future of unlimited growth to a more somber and practical current outlook that deals with loss of wealth, asset protection, increased scrutiny and higher levels of financial risk. The near-death experience of AIG during the financial crisis and the restructuring that was forced upon AIG is the best example of how companies must look to avoid complicated and constrictive financial structures in order to effectively manage their operating businesses in the post crisis financial environment.
This change in the world‘s business outlook affects the priorities of many financial managers. Consider the views of the CFO’s attending the recent CFO Network conference organized by the Wall Street Journal  in mid-June 2013. According to the opinion of these CFO’s, US companies should pursue concrete objectives such as energy cost reduction, management of restructuring processes and the better understanding of global risks including cyber security. Today’s business environment mandates concrete objectives while in the past CFOs were interested in more general global objectives to grow and achieve vertical integrations.
Today, business managers are focused on the restructuring process that means introducing changes to a company to make it viable and more profitable. The objective of any restructuring is to implement changes in the corporation so that it will generate enough cash flow to pay its liabilities, cover the cost of debt and remunerate its shareholders satisfactorily. The ability of the US commercial P&C (P&C) Industry to accomplish these restructuring objectives is more challenging today than at any time in the past.
Restructurings are more complicated for those companies that operate in regulated industries. For example, increased regulatory scrutiny of the banking industry since the financial crisis has led several large non-bank companies to be designated as SIFIs, or systemically important financial institutions, and undergo restructurings. SIFIs are banks, insurance companies or other financial institutions whose failure might trigger a financial crisis. GE, after being designated a SIFI, now intends to reduce its financial assets towards its goal of $100 billion in asset sales before year-end 2015, with a final goal of $200 billion by year-end 2016 by selling off most of GE Capital. This is a most profound change to the financial services industry as GE Capital was ranked as the 6th largest banking group in the US prior to embarking on this restructuring.
What does this portend for the financial services industry? The insurance industry is well aware that increased oversight, continuing expansion of state regulations, and limited restructuring options have created operating issues, increased compliance costs, and raised additional concerns that consume management time and attention.
How does the US P&C Industry participate in a restructuring process? The answer is with difficulty, especially when one major component includes run-off liabilities from expired polices with long term claim exposures that total hundreds of billions of dollars. To advance the restructuring of the US P&C Industry or a specific insurance company, there must be an effective run-off strategy that focuses on capping or eliminating open-ended legacy liabilities.
A.M. Best A&E Study
To gain an appreciation of the risks being confronted by the P&C Industry, one simply has to consider recent A&E loss development experience. In a recent study, A.M. Best estimates the industry’s ultimate net liabilities have increased to $85 billion for asbestos and $42 billion for environmental. Compared to current industry reserves, this represents unfunded liability of $7 billion for asbestos and $4 billion for environmental. Total A&E incurred losses (paid claims plus reserves) have increased in five of the last seven years, including a 16% increase in 2013.
The overall conclusion by Best is that asbestos claim counts, losses, and loss estimates are unlikely to decline given latency periods, the size of the affected population, the increase in lung cancer claims, and recent court decisions. Many companies struggle with retaining these risks on their balance sheet.
Current State of US Run-off Market
Whether the entity is a small P&C company or an international insurance group, there is a continual need for effective restructuring tools to optimize capital deployment as well as to manage run-off liabilities. Three of the larger insurer groups that represented 50% of 2013 incurred losses from A&E, have engaged in large loss portfolio transfers with Berkshire Hathaway’s National Indemnity. These larger insurance groups can afford to enter into these sophisticated reinsurance transactions, but what about the remainder of the insurance industry? There are limited options for many small and mid-sized insurance companies.
In addition, many companies have portfolios of business that are either inconsistent with their core competency or provide excessive exposure to a particular risk or segment of the market, such as product, asbestos, environmental, and director and officer liability exposures. These non-core and/or discontinued polices and portfolios are often associated with potentially large exposures and lengthy time periods before resolution of the last remaining insured claims, resulting in significant uncertainty to the insurer or reinsurer covering those risks. These factors can distract management, require additional capital and surplus and negatively impact the insurer’s or reinsurer’s credit rating, which makes the disposal of the unwanted company or portfolio an attractive option.
Management View of Run-Off
Management at many US carriers is frustrated by the lack of exit options available to a company in the highly regulated insurance industry. Large amounts of insurance capital are deployed to support run-off portfolios that are generally viewed negatively by rating agencies and investors. Sale, commutations, reinsurance and loss portfolio transfer have been the most frequently utilized alternatives but each of these has limited application and in many cases are not practical solutions, particularly in the low interest rate environment of recent years.
Most companies have considered these alternatives and are looking for other effective ways to deal with the “rump” of the run-off legacy liabilities that remain on the balance sheet. Many senior managers in the US run-off industry believe that the US run-off market has become staid and complacent. Senior management is frustrated by the lack of progress and available options to address their legacy liabilities.
Rhode Island Insurance Regulation 68— the Insurance Business Transfer
Now for the answer!
The Rhode Island Department of Business Regulation has approved Amendments to Insurance Regulation 68 providing for “Insurance Business Transfers” (“IBT”), which are effective as of August 18, 2015. The IBT is a carefully monitored, transparent and court sanctioned novation process for the transfer of some or all of a company’s commercial run-off liabilities to a newly formed or re-domesticated RI company. The transferred polices move from one company, (does not have to be a RI company) to another company (must be a RI insurer), and includes the attaching reinsurance. The terms, conditions, exclusions and limitations of the transferring policies remain unaltered and only the obligor changes as a result of the court-sanctioned novation.
The IBT applies to all lines of reinsurance, other than life, and all lines of insurance, other than life, worker’s compensation and personal lines insurance. The transferring policies must have a natural expiration date more than sixty months prior to the date of filing for an IBT and be in a closed book of business or a reasonably specified group of policies. The bottom line is that the IBT provides an effective restructuring tool for commercial P&C insurers or reinsurers with run-off business.
The IBT approval process requires a rigorous financial review, including the report of an independent expert and regulatory and judicial review and approval. The requirements involved in the approval process include an analysis of the economic feasibility of the transfer plan to ensure that the viability of both the transferring and assuming companies are sustainable over time.
The importance of the IBT transaction is the ability to provide a fair solution that balances the needs of all company stakeholders. Companies with run-off business can transparently exit from these liabilities, while the interests of policyholders are protected by a closely monitored and judicially approved transfer process.
Impact of RI Run-off Regulations on US P&C Market
The IBT allows for a more level playing field for all insurance carriers, whether large international insurance groups or small companies, to have access to expanded options to address their run-off exposures. Because of its versatility, the IBT provides expanded options for management of run-off liabilities and for the first time brings finality to legacy liabilities.
The IBT permits more efficient management of transferred books of business, and allows dedicated capital and focused solutions to be applied to run-off liabilities. It also provides a reasonable framework for transfers of insurance business while also safeguarding the interests of policyholders, resulting in a fair outcome for all parties involved. It is expected that over time the IBT will become a widely accepted restructuring tool for insurers.
The Insurance Business Transfer is modeled on the UK Part VII Transfer that has been in place since 2001 and has resulted in hundreds of successful transfers of business. To date, there has been no Part VII transfer that has encountered financial difficulties. Investors have come to view the UK market more favorably because a large amount of captured surplus has been freed up to be re-deployed.
Benefits of the RI IBT
Like the UK Part VII transfer, the IBT is very versatile and can be applied to discrete portfolios or to change a company’s whole business. Because of the IBT’s flexibility, there are significant benefits to both the transferring and assuming companies. Some of these benefits include:
- Capital efficiency
- Group restructuring
- Regulatory and operational efficiency
- Corporate simplification/Consolidation of legacy business
- Removal of non-core lines
- Economic and legal finality (if external transfer)
- Removal of risk of adverse loss development
- Regulatory and operational efficiency
- Potential opportunity for tax savings
- Market presence/increased share
- Creation of center of excellence
- Profit from efficient management/exit
- Consolidation of legacy business
- Rational process to enter run-off market
For a restructuring to be accepted by regulators, policyholders and other constituents, it must be fair to all parties. The IBT process requires that both transferring and non-transferring policyholders be treated fairly within the regulatory legal framework. At the same time, through its rigorous review process that requires extensive financial disclosure, the IBT ensures stability to both the transferring and assuming companies. The future success of the company, after recognizing its obligations to all policyholders, ensures the integrity of the regulatory process.
 The Executive Guide to Corporate Restructuring, by Francisco J. Lopez Lubian, 2014
 Wikipedia definition
 A.M. Best Releases Annual A&E Study – February 5, 2015 by KCIC