If the BAIC decision taught us anything, it's not to be complacent, warns John Winter
The run-off community may be breathing a sigh of relief following the decision to sanction the Mercantile & General solvent scheme of arrangement, but it is vital the industry does not forget this summer's BAIC sanction refusal. This proved that, while solvent schemes are a very valuable tool to deal with legacy issues, they are only effective if supported by an immense amount of pre-scheme expert analysis and policyholder consultation.
As the concept of schemes has become more familiar there appears also to have been a growing assumption that schemes are easy to execute, perhaps because the focus has tended to be on the legal framework surrounding such initiatives rather than the practical, hands-on detailed work required to make them successful. This is simply not the case.
The benefit to policyholders
Solvent schemes are consensual agreements and as such need to be tailored to create sufficient benefit for policyholders and risk carriers alike. Despite the perception given by some recently proposed schemes, there are undoubtedly significant potential advantages to policyholders inherent in a properly structured scheme. Perhaps the most obvious advantage is that of replacing uncertainty of payment - ie that an insurer will be around to meet claims in the longer term - with certainty while achieving the savings in management time, and often legal expenses, of achieving finality sooner rather than later.
However, there are also potential financial benefits that are all too often forgotten. For a start, in order to expedite a rapid resolution a well-managed scheme will usually aim to pay claims at a higher estimate of future liabilities than a policyholder is likely to receive under a normal run-off. Second, while a discount for time value of money is applied to claims payments, this will tend to be based on the average return of government bonds for a period equivalent to that over which claims payments would have been made if the scheme had not existed. By receiving all payments immediately and investing those funds to achieve higher returns than apply for government bonds, creditors can significantly increase the total funds received over the same period.
Given these real potential benefits, the key difference between a successful and unsuccessful scheme lies in the design, planning and implementation of such initiatives, rather than legal and technical issues, such as the number of creditor classes that need to be created, as these should be automatically accommodated in a well-researched and planned proposal.
Learning from BAIC
The key impact of the BAIC ruling on those developing schemes, therefore, should be a greatly increased appreciation of the level of focus and detail that needs to be brought to the pre-scheme consultation process. For instance, much was made in the BAIC judgement both about the apparent unfairness of compulsorily re-transferring risk exposures back to direct policyholders that had originally paid to transfer such risks out of their businesses, and also the way in which votes were apportioned to policyholders. Yet in all likelihood these problems would never have arisen at the sanction hearing stage if a clear process of assessment and consultation had taken place prior to the scheme being drafted and proposed.
Accordingly, even though Justice Lewison indicated he was satisfied with the communication process supporting the BAIC scheme, the depth and detail of the pre-scheme consultation process is the primary area the industry should be seeking to tackle going forward.
Standard due diligence pre acquisition should include analysing portfolios down to the individual policyholder and policy level, assessing actuarial best estimates for portfolios against market estimates and verifying whether outstanding claims have been updated regularly in light of market developments. In addition, one should assess the adequacy of policy records to ensure that such factors as policies that have not yet been triggered, but are likely to do so, are caught early.
Post acquisition, the main body of work involves adapting existing systems, or creating new systems, to support the solvent scheme, as opposed to run-off, process. The critical factor in this transition is developing a creditor, rather than individual claims, view that enables a comprehensive picture to be developed of each policyholder's total position, including IBNR.
Supporting the solvent scheme
To do this, a wide number of issues need to be addressed. These range from housekeeping activities such as updating contact details and consolidating all creditor policy and claims information into one file (as opposed to various files under different names) through to incorporating wider claims assessment factors into the overview - including relevant attorney reserve information, actuarial estimates and market policy and claims information.
In-depth communication with policyholders enables additional data to be collected - for instance "lost" policies and impending claims - and the real position on IBNR to be comprehensively assessed. When combined with the wider policyholder consultation process - including face-to-face meetings so that the scheme manger can establish and address any specific concerns and assist creditors through the voting and claims procedures - this reduces the likelihood of surprises for the vast majority of those affected by the time the scheme is proposed.
Indeed, experience has shown that all the common issues raised by policyholders: late notice of the proposed scheme; insufficient time to prepare the analysis required to substantiate a vote or a claim under the terms of a scheme; or concerns over the working of specific clauses can be addressed by effective, detailed communication with as many creditors as possible well in advance of a scheme being formally proposed. Consequently, once approved, a scheme can be completed swiftly as some 90% of the work in relation to the assessment and agreement of claims has already been completed. What is left is largely a processing job, with any disagreements over final settlements being handled by a scheme's independent adjudicator.
It can therefore be argued that in many ways the future of schemes is still very much business as normal - provided that the "norm" for those involved is one of highly expert analysis and extensive communication and consultation with policyholders both before and during a scheme's life.
John Winter is CEO of Ruxley Ventures.
The way ahead
The industry should be giving further consideration to introducing new forms of independent checks-and-balances for policyholders such as the concept of scheme monitors which has been a subject of discussion since early this year.
In his judgement Justice Lewison listed one of the objections by the opposing policyholders as being that the scheme as proposed was unfair because the process of administration was shrouded in secrecy and could not be effectively policed. While the judge did not comment specifically on this point, it is clear that the appointment of scheme monitors could be helpful in countering such concerns.
Unlike advisers, scheme monitors would be totally separate from the day-to-day management of the scheme and remunerated on a time-incurred basis completely unrelated to the scheme's success or otherwise, so ensuring the impartiality of the role. Appropriate candidates would be highly respected run-off experts from such organisations as top flight law or accountancy firms.
Appointed to provide policyholders with independent external oversight of the voting process and of the general responsiveness of the scheme architecture to issues highlighted during policyholder consultation, such monitors would be involved until a proposed scheme receives court sanction.
Such a role would have particular worth in relation to the valuation of voting rights as this is an area where the application of solvent schemes, as provided for by section 425 of the Companies Act 1985, is far more complex for run-off portfolios than it is for other applications such as mainstream corporate mergers and acquisitions.
This is because apportioning voting rights on, say, a merger is relatively easy because the calculations are based on the number of shares held by each affected party. However, with solvent schemes for run-off portfolios the calculations are based on the total liability to each affected party including claims that have been incurred but not reported (IBNR).
In order for a proposed scheme to go to a creditor vote, the scheme monitor would have to be satisfied that an appropriately fair approach had been taken to the estimation of all claims, including IBNR, and in the resulting apportionment of voting rights.
Overall, therefore, the use of scheme monitors would enhance the reputation of schemes, increase the level of policyholder awareness and pre-empt potential problems by providing policyholders with an independent umpire.