The New World of Run-off
Written by Luann Petrellis
Something new and important is coming to the $200 billion plus run-off market in the US! Proposed amendments to Insurance Regulation 68 are pending in the State of Rhode Island (RI) and are expected to be approved later this year. These amendments have the potential to invigorate and transform the market, similar to what has occurred in the UK run-off market over the last several decades resulting from the introduction of new run-off legislation. The RI regulations will provide expanded options for management of run-off liabilities and for the first time bring finality to legacy liabilities.
There are major challenges facing companies with P&C run-off business. These challenges include access to exit mechanisms, maintaining reputation, capital constraints, operational costs, adverse loss development, adverse impact to a company’s rating, and lack of skilled resource. The larger insurance groups are rethinking organizational structures with a view to maximizing the efficiency of capital deployed. Whether the entity is a small P&C company or an international insurance group, there has been a continual need for effective restructuring tools to optimize capital deployment as well as to manage run-off liabilities. Clearly the market is ready to consider new tools and approaches to address the challenges of run-off business.
Pursuant to Rhode Island Gen. Laws Section 27-14.5, the RI Department of Business Regulation has published Proposed Amendments to Insurance Regulation 68, providing for “Insurance Business Transfers” (“IBT”), which are defined as the “transfer of liabilities and assets in accordance with the procedures delineated in this Regulation.” The amendments provide a carefully monitored, transparent 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 through a department approved and court sanctioned novation process bringing finality to the legacy exposures of the transferring company. The IBT also provides an effective restructuring tool for insurers or reinsurers. IBTs can be used to 1) combine similar business from two or more subsidiaries, putting all into a single pot; 2) transfer business between third parties; or 3) separate out different books of business, putting them into separate companies.
As a public policy matter, the proposed amendments fill a huge void in the current regulatory environment for run-off business and are beneficial to all parties involved in the IBT transaction. The transferring and assuming companies receive value relative to their long-term interests and finality through the statutory novation effected by the Court Order. The policyholders and/or reinsureds in the transferring business benefit from the focused management of the Assuming Company and the oversight of the RI insurance department.
Currently the assumption and novation regulations in the U.S. are restrictive and significantly limit the options available to owners of run-off companies to pay their obligations to policyholders and terminate their exposure to future liability. As a consequence, capital is trapped and unable to be deployed for more beneficial purposes. The importance of the IBT transaction is the ability to provide a fair solution that balances the needs of all the company’s stakeholders. The RI Proposed Amendments allow companies with run-off business to distance
themselves transparently from these liabilities, while also providing security to policyholders through a closely monitored and judicially approved transfer process.
Consistent with the strong policyholder protection that currently exists in U.S. law, the proposed amendments include provisions that address policyholder concerns. To protect policyholders the statute has specific notice requirements that provide for notice to policyholders and various other specified parties. Also, the IBT approval process requires 1) extensive disclosure of financial information of the Assuming Company; 2) an expert report that will evaluate the impact to transferring policyholders and non-transferring policyholders; and 3) an independent evaluation by the Insurance Department. Most importantly, there is complete judicial review of the IBT Plan and, before the transaction will be approved, the Assuming Company must satisfy the Court that the transfer does not materially, adversely affect policyholders. Any party who feels adversely affected by the transfer can make a representation to the Court for consideration. Once approved, the Assuming Company is subject to the continuing authority of the RI Insurance Department.
A similar process has been available in the United Kingdom for many years and has resulted in hundreds of successful transfers of business. Building upon the UK process, the RI proposed amendments will permit more efficient management of transferred books of business, and allow dedicated capital and focused solutions to be applied to run-off liabilities. While providing a reasonable framework for transfers of insurance business, the proposed amendments also provide sufficient safeguards for policyholder protection resulting in a fair outcome for all parties involved.
The IBT process is initiated by the Assuming Company submitting an Insurance Business Transfer Plan (Plan) to the RI DOI for approval. The regulations set forth the requirements of the Plan, which include an expert report that opines on the potential impact to various groups of policyholders and an approval of the transfer by the domiciliary state of the Transferring Company. Once the DOI has approved the Plan, the Assuming Company may file a Petition with the Rhode Island Superior Court for approval of the transfer. The Assuming Company must comply with the broad notice requirements set forth in the statute, which include a requirement that notice be given to all policyholders at their last known address. Once approved by the court, the IBT results in a DOI approved and court sanctioned novation of the transferred policies, releasing the Transferring Company from liability under the transferred policies. While loss portfolio transfers and reinsurance provide some economic finality, the IBT will provide economic and legal finality to the Transferring Company.
Good planning and project management of an IBT are essential. There are certain challenges to be tackled in pursuing an IBT and early contemplation of potential obstacles makes all the difference. For companies promoting the transfer, their objective is to minimize risk of objection and to achieve regulatory and court approval of the transaction. Therefore, companies are well-advised to spend time up-front identifying where the risks of challenge may come from. Once the potential challenges have been identified, including identifying the parties which may bring them, a strategy is required to address potential objections such as:
• A communication strategy designed to define clearly the business being transferred, the purpose of the transfer and the impact on potential objectors. The communication process must also flesh out as early as possible the concerns of potential objectors, which can then be followed up, if necessary, on a one-to-one basis.
• A strategy for addressing concerns of potential objectors to secure their support, which may include amendments to operational plans or capitalization.
• A contingency plan for dealing with key objectors who will not support the transfer, which may include commutation, novation or exclusion from the transfer.
As the UK experience has proven, the IBT provides an effective restructuring tool for all insurers. In addition, for the first time in the US an insurer can achieve potential finality with respect to its run-off business through an IBT to a third party RI Commercial Run-off Insurer.
Published (date place)