Joseph F. Scognamiglio takes a look at current developments in the insolvency industry, with particular emphasis on short-term creditors.
No one likes to wait for money that is due and owing to them, particularly when they have actually paid for the right to receive that money and there is no dispute as to the amount of their claim. Unfortunately however, insurance company insolvencies, although not commonplace, are a reality.
During the last few years there has been greater focus by liquidators, creditors committees and other advisors on shortening the waiting period and providing more timely and predictable distributions to creditors of insolvent insurance companies. Although the intentions have been good, still there have not been many significant dividends paid over a short period to creditors within the primary (as opposed to reinsurance) insurance company insolvency framework. There are several legitimate reasons for this delay in distributions, most of which result from the nature of insurance itself and the ability of creditors to file claims years after the insolvency has occurred. This makes it difficult for administrators of insolvent estates to accurately predict the extent of the liabilities that will need to be paid from the estate assets. Of course, not all creditors have to wait for collection on their claims. Depending on the US state or the country of domicile involved, creditors who are deemed "protected" will collect anywhere from $100,000 to $1,000,000 per claim or occurrence (subject to policy limits, of course) under most US Guarantee Fund systems, or up to 90% of claims for certain protected policyholders in the United Kingdom. As a factual matter, the bulk of the insolvent insurance company creditor balances probably fall within the "80/20" rule, ie, approximately 20% of the creditors are owed approximately 80% of these balances.
In all insolvent estates, liquidators must juggle the needs of short-term creditors whose liabilities have been settled, fixed or established and who seek to get paid as much as possible today, versus the needs of long-term creditors. Long-term creditors have no incentive to push for fast distributions since their claims have not been fully determined and potentially represent very high levels of ultimate allowed liabilities. If too much is paid out before the allowed amount of their claims has been determined, they may not receive equal distributions on their claims. As a result, most liquidators, if they make interim distributions at all pending the allowance of long-term claims, do so in a very careful and conservative manner, calculating all possible outcomes, and in an effort to fairly treat all parties, err on the side of withholding or delaying significant distributions.
In many of the large insurance insolvencies, and with respect to most older property and casualty insurance companies in general, a very large component of the ultimate liabilities (reserves and incurred but not reported losses - IBNR) are made up of long-term APH liabilities, consisting mainly of asbestos, pollution and health-related risk. Certainly this has occurred in the case of the Weavers Stamp companies in London, the insolvent portion of which consists of the KWELM Companies, Bermuda Fire & Marine, Bryanston, Anglo American, and Southern American to name a few. This is also the case for certain solvent run-off companies including Equitas, the Home Insurance Company, International Insurance Company and Brandywine Insurance Company (the famous bifurcated Cigna run-off operations). APH liabilities almost guarantee a large number of long-term creditors who could be hurt by quick liquidation and full pay-outs to creditors.
In an attempt to respond to the opposing views and needs of creditors and debtor insurance companies, a number of the large insolvent estates are contemplating new ideas, including the concept of creating an estimation scheme which would provide for the calculation of the present value of all insurance company obligations (including case reserves and IBNR), and the allocation of the liabilities through the reinsurance coverage specific to that insolvent estate, thereby maximising the assets of the estate and paying all creditors in cash in accordance with the specific priority of distribution schemes governing that estate. This, in theory, would require only a short period of time to make distributions and close estates, but in many cases would preserve a great degree of coverage for long-term creditors. In reality, this approach, although logical, would place a very large present-value obligation on the international reinsurance community which, for obvious reasons, would likely prefer to wait out the normal 15 or 20 years that is estimated to settle every possible case instead of being directly obligated to creditors on day 1 of the insolvency.
In addition, the reinsurers probably share our view that not all of the claims asserted at the commencement of an insolvency will actually materialise into allowed claims. The present-value process would compel the reinsurers to the equivalent of forced commutation negotiations with the insolvent insurance company, a situation that was not anticipated when the reinsurance was underwritten and priced. There are also other issues of policy-year allocation and coverage which reinsurers often need to litigate and which could slow down the anticipated "quick fix" of the estimation process. Moreover, if this estimation approach were to be implemented, in the bulk of the cases of insurance insolvency, and assuming that the level of loss reserves and IBNR reported in the marketplace is correct, it is the writer's opinion that this proposed system could render some of the reinsurers insolvent. If this occurred, creditors of many estates would wait even longer for their recoveries and would realise even fewer positive financial results than under the current system. Finally, there are numerous legal and practical business stumbling blocks standing in the way of estimation becoming the cure that some people are hoping for.
Other developments are taking place today in this industry, predominantly in the London market, which contemplate for the implementation of a "solvent scheme of arrangement" whereby all creditors would agree in advance to either a final dividend plan, present value methodology, an exit strategy, or a combination of the above. Solvent schemes of arrangement could be tailor-made to fit the needs or the book of business of a run-off operation and could be short-term or long-term in nature. However, obtaining the consensus of the necessary parties poses yet another set of problems and queries.
The true beneficiaries of the current system (which means 10-15 year liquidations on average) are long-term creditors and reinsurers. Short-term creditors, on the other hand, benefit only from the fast liquidation of their fixed and allowed claims. These short-term creditors have only a few options. They can wait for the liquidation to run its normal course, or they can sell their receivables/recoverables to willing buyers. Currently, there are only a handful of such buyers of insolvent debt, one of which is Quantum Consulting, Inc. of New York. As a general matter, these firms purchase claims by way of assignment at a discount on the face amount of the claims. The price paid for these claims is a function of the credit risk of the insolvent estate, the amount of dividends already distributed on claims by the insolvent estate, the priority of distribution of the claims being sold, the length of time that the estate has been in liquidation, and litigations and laws directly affecting the insolvent estate. These purchases/assignments can be structured as outright cash sales, or in certain circumstance, as joint venture partnerships between the buyer and the seller guaranteeing a certain cash recovery to the buyer. By assigning the receivables to a firm such as Quantum, short term creditors can obtain a lump sum value today and are free to focus their energies and expense allocations on more pressing matters.
Thus, taking into consideration the constraints described herein, it may make sense for a number of different types of short-term creditors to sell their solvent and insolvent receivables, whether such seller be a liquidator who is contemplating closing an estate, a short term creditor with relatively few established receivables, or a large sophisticated Fortune 500 company which would rather receive a certain consideration today without having to administer its claims through the remainder of the insolvency.
Regardless of the ultimate outcome of the new proposals being professed by liquidators, administrators and creditors, there remains a need in this market for a third party who can step in and assume credit and time risk by purchasing from creditors both solvent and insolvent reinsurance recoverables that would otherwise take months or years to collect from the insolvent estates and the various reinsurers. Corporate and individual creditors are not the only parties to benefit from these third-party buyers. Liquidators of estates holding claims and portfolios of claims against insolvent estates, and indirectly, the creditors of the estates, are additional beneficiaries.
In the case of the liquidations of estates whose asset-base includes insolvent debt against others, once these assets are transferred for value, the estate can be finalised and closed and distributions made to creditors. In many instances, it has become somewhat cumbersome and very time consuming for liquidators and run-off managers to chase individual small recoverable balances, especially those from the insolvent insurance market. Quantum can provide the estates with cash and end the administrative burden.
In light of the foregoing, and from my point of view as a consultant to insurers and reinsurers and as a buyer of insolvent debt, I would recommend the following, achievable changes to the current system which could help ease some of the burden suffered by creditors of insolvent insurance companies:
1. Adoption of the United Kingdom and the New York State (property and casualty) priority of distribution approach, whereby, with the exception of administrative fees, the bulk of all creditors are treated equally and at the same level of priority. I understand that the reinsurance community has the benefit of the set-off clause which gives them an inherent priority of distribution. However, these same reinsurers do finance the bulk of the estate after taking into consideration portfolio dividend income generated by the insolvent estate's liquid asset base.
2. Uniformly raise the Guarantee Fund limits for all US coverage, perhaps to $500,000 to $1,000,000 (as is already provided by the New York State Fund), at least for individuals and small businesses.
3. Give both the insurers and the insureds the option of leaving the Guarantee Fund system in those cases where a private system is in place to guarantee coverage when an insurance company's book of business is transferred to a special purpose vehicle (such as the Brandywine example).
4. Institute and encourage active creditors committee participation in US liquidations.
5. Institute a general policy of frequent dividend distributions (performed most regularly in Bermuda and the UK) to lessen the hardship on creditors and to enable them to make some predictions for receipts of funds. I do not believe in the fear of paying any one particular class of creditors too much as a valid excuse for not paying early dividends since, for the most part, liquidators can always earmark a special margin reserve at the outset of a liquidation.
Quantum is there at every step of the process and will assist creditors in many ways, from helping creditors to establish their debt to purchasing it and/or acting as their agent representative in the event that the creditor chooses not to sell and seeks help collecting on claims. These services are offered to both the solvent and insolvent international creditor community.
Joseph F. Scognamiglio is president of Quantum Consulting, Inc., an insurance and reinsurance consulting firm with expertise in finance, operations, audit procedures and realisation of asset values. Mr Scognamiglio has over 20 years' experience in the insolvent insurance industry and focuses Quantum's services on obtaining for clients significant recoveries on their claims and on purchasing claims from creditors at large. Tel: +1 718 802 9423. Fax: +1 718 802 9701.