The London market has a real opportunity to win worldwide run-off business thanks to its reputation as a centre of excellence, believes Nigel Montgomery and Antony Newman
As major insurers grapple with their worldwide discontinued business issues, a common question is emerging: is it practical to consolidate the run-off in order to reduce cost, increase bargaining leverage and leave business units free to concentrate on the live market?
This presents the London market with a real opportunity to play to its strength as a centre of excellence in the run-off market.
London has a respected regulatory regime which well understands the issues facing run-off, a significant number of run-off specialists with many year' experience of discontinued business and legal technology which facilitates the process.
To illustrate this, consider the problems likely to beset international insurance companies. Very few insurers make contractual provisions at a group level which allow them to set off amounts they owe as a reinsurer against sums that may be owed as a reinsured.
Instead they have discontinued business in a number of jurisdictions, including continental Europe, the US and Asia. This will be administered by different teams under different profit or cost centres, each jealous of its independence. As a result, friction costs arise and opportunities for global offset and commutation are missed. A centralised run-off operation, however, can take account of such factors when carrying out commutations.
Consolidating the run-off in a single operation, either a branch or subsidiary in the UK with appropriate Financial Services Authority (FSA) authorisation, enables these issues to be addressed in a regulatory environment which is internationally respected, whilst also giving access to the UK legal regime which allows Part VII transfers and schemes of arrangement.
This avoids the reputational risk of moving run-off to a jurisdiction which is not so well thought of, so causing damage to the image and standing of the insurer in the continuing market.
It also gives access to the considerable range of UK-based run-off specialists.
Run-off requires different skills from live business and the use of skilled third party administrators enables management to concentrate on the (hopefully) profitable live business which they understand best, leaving the management of discontinued business to those who specialise just in that field.
How does the legal and regulatory regime help this?
Part VII transfers
Under the Part VII process - a statutory portfolio transfer mechanism contained within the Financial Services and Markets Act 2000 (FSMA) - the sanction by the court of an insurance business transfer scheme (IBTS) will result in some or all of the insurance contracts of one insurance company (or Lloyd's syndicate) being transferred to another insurer along with all rights and duties under those policies.
The effect of an IBTS is to alter the insurer under many contracts of insurance without the individual consent of each policyholder. In this respect, the process is entirely different from reinsurance to close where the original liability remains with the original insurer.
The finality for the transferor provided by an IBTS means that an insurer can be wound up or left free to carry out new business once all old business is transferred.
There are a number of prescribed steps which must be taken by a party seeking to utilise Part VII.
In particular, the FSA must be consulted at an early stage and notices must be sent to policyholders of both the transferor and the transferee, although the court does have power to grant an exemption from these notice requirements so that notice is only given to those policyholders holding the policies which will be transferred. Notices must also be published in national gazettes and two national newspapers in the UK.
If the holder of any policy to be transferred is located in a European Economic Area (EEA) state, the FSA will conduct a liaison process with that appropriate EEA state regulator.
This can be a potentially time-consuming process, as FSMA permits the EEA state regulators up to three months to voice any concerns that they may have in relation to the proposed transfer. After this time has expired the consent of the EEA state regulator is deemed to have been received in the absence of any contrary indication.
An initial directions hearing must be sought from the court. This hearing will determine the parameters of the notice, giving obligations on the transferor and transferee. A final court hearing must also take place to sanction the proposed IBTS.
The Part VII process is a very effective run-off tool, enabling parts of an insurance business to be separated and transferred. The act of separating the business is very neat as a sanctioned IBTS will result in all the rights and liabilities of the transferring policies (including outwards reinsurance in respect of those policies) transferring to the transferee.
The Part VII process also means that a group can move discontinued business into the UK, and within group companies, to separate live business from run-off.
The technique also facilitates the acquisition of discontinued lines by the growing range of specialist buyers of run-off business.
The FSA oversees this process with a view to ensuring that the acquirer is adequately capitalised and this can greatly assist dealings with overseas regulators who might be uneasy about allowing run-off business to be transferred to another less well regulated jurisdiction.
Part VII transfers can equally be used to split out parts of the business which cannot be closed by a scheme of arrangement, such as live contracts and compulsory insurance policies (including employers' liability and Road Traffic Act policies).
Schemes of arrangement
Schemes of arrangement are another UK speciality, although one which is being adopted in other jurisdictions as the only practical way of providing closure to run-off.
A scheme of arrangement is a procedure available under section 425 of the Companies Act 1985 which enables a company and its creditors to agree a method of dealing with its liabilities.
A solvent scheme facilitates the valuation of all liabilities on a fair and consistent basis, enabling them to be discharged in full in a prescribed payment pattern and is a highly adaptable tool for closing a run-off.
The legislation leaves the scheme's draftsman free to design and tailor the scheme specifically to meet a company's particular needs and circumstances.
Schemes can also be used where a company is currently, but may not remain, solvent.
As with Part VII transfers, the FSA is to be consulted and the court's leave is required to convene the meeting of creditors. Appropriate notices must be despatched to creditors and a meeting held at which creditors will vote on whether the scheme is to be implemented. Provided creditors approve the scheme, the court's sanction is required. It will then bind even those who voted against it or who failed to receive notice of it.
London market run-off companies are, of course, increasingly active in overseas markets such as Singapore where techniques similar to portfolio transfers and solvent schemes can be used, often backed by London market expertise.
It is interesting to note that the first Irish solvent scheme of arrangement has just been announced and that solvent schemes have been used successfully in Bermuda, while also available in most Commonwealth jurisdictions. They are also being promoted in Rhode Island in the US.
General regulatory environment for run-off
On 14 January 2005 the requirements of the EU Insurance Mediation Directive (IMD) were implemented in the UK by way of modification to the Regulated Activities Order (the Order implementing much of the FSMA authorisation requirements).
The IMD imposes requirements upon EEA states regarding the regulation of insurance and reinsurance mediation.
The IMD defines 'insurance mediation' and 'reinsurance mediation' as including the activities of introducing, proposing or carrying out other work preparatory to the conclusion of contracts of insurance or reinsurance, or of concluding such contracts. It also includes assisting in the administration and performance of such contracts, in particular in the event of a claim.
The IMD applies to insurance intermediaries such as brokers, but, in the published view of the FSA, not to pure run-off managers if they only assist the insurer in carrying out the contract (assisting in the administration and performance of the contract, to use the language of the IMD).
The FSA's view has been welcomed by service providers in the run-off market and has eliminated much of the uncertainty which might otherwise have arisen.
Obviously companies and branches in run-off in the UK are still subject to supervision and regulation, and run-off service providers must remain cognisant of this. The regulation of the underlying business in run-off assists in providing the London run-off market with its regulatory credibility.
- Nigel Montgomery is head of the insurance and risk solutions (IRS) team at DLA Piper Rudnick Gray Cary and Antony Newman is IRS specialist in Part VII transfers and regulatory law.