Paul Evans and Julian Turner examine the arrival of the e-scheme for North Atlantic Insurance Co and look at its potential impact on insolvent run-offs.

Many people in the international insurance market will be familiar with the thump of a several hundred page document landing on their desk as yet another scheme of arrangement is presented to policyholders and brokers. In the case of North Atlantic Insurance Co (formerly British National Insurance Co), no such document has been circulated and yet the scheme has been supported by the policyholders and the Court, and is now effective. As a result, an estimated two million pages went unprinted, and yet the scheme is operating.

A scheme of arrangement is now acknowledged as the most likely vehicle for dealing with the resolution of an insurance company's insolvent run-off (and increasingly as a means of bringing solvent run-offs to finality), and scheme contents have continued to develop over the ten years or so since they were first introduced to the insurance market. This scheme for North Atlantic takes a step into the cyberage and also introduces other innovations.

The North Atlantic scheme has, for the first time:

  • distributed a scheme document electronically;

  • proposed a large estimation and cut-off of a direct insurance book;

  • used a web-based approach for the submission of claims; and

  • obtained the support of the Financial Services Compensation Scheme (FSCS) for a cut-off scheme.

    Up until now, it has been normal practice in all types of schemes to circulate the proposed details and the Notice of the relevant meetings using a mass mailing to all known policyholders, as well as advertising the Notice of meetings in appropriate journals and newspapers. Generally, this results in each policyholder receiving a large package of documents and voting papers. In North Atlantic's case, if this approach had been taken, more than 9,000 separately identified individuals would have received such a circular. At the same time, recent security concerns in the US, where the majority of North Atlantic's policyholders are based, have led to delays and difficulties in sending large packages through the mail service. So a different route was taken.

    An initial application was made to the UK Court to seek approval for the proposal that North Atlantic place the scheme document on public areas of a dedicated website. This proposal was based on the widespread availability of internet access, particularly among commercial business policyholders. The proposal also set out the intention of mailing each policyholder a one-page summary of the Explanatory Statement, together with voting forms and details of how to access the website, ensuring strict compliance with the requirements of the Companies Act.

    The application was approved and the Court made positive comments about the approach, in particular about the substantial savings in printing and postage costs. Access to the scheme documents is immediate for policyholders, as is access to any other notices or market circulars. The documents are placed on the website in a format that cannot be amended by any third party but, of course, anyone who wants a hard copy can simply download the document and print it out in the usual way. The scheme administrators can also add notes about the scheme and its operation, further reports to the market and, in due course, announcements about anticipated dividends without incurring additional distribution costs. At the same time, copies of the documents can also be transmitted electronically within large policyholder groups. In practice, the ease of posting news items on the website means that communication with creditors is likely to be more frequent than is realistically possible using conventional paper-based distribution.

    Estimation and cut-off
    The insolvencies of most London market carriers that wrote a mixture of insurance and reinsurance have been handled through a scheme of arrangement which permits a period in which claims have been agreed in the ordinary course and a `payment percentage' applied to those agreed claims. Well-known examples include Trinity, KWELM, English & American and Orion. A number of other reinsurers went straight into an estimation or cut-off scheme, which place a present value on all future claims, crystallise a company's liabilities, declare a final dividend and close the estate. Examples of this technique include ICS Re, RMCA Re, Charter Re and Hawk.

    Earlier run-off schemes are now being converted into estimation schemes, either using a special resolution of policyholders already provided for in the original scheme, for example the Andrew Weir run-off, or after an amending (ie a second) scheme to bring about the same result. Whereas the necessary actuarial techniques for estimating and allocating the liabilities of a reinsurer have been in use for many years, the new challenge is to extend the techniques to direct insurance, in particular where there is substantial reserving for asbestos, pollution and health hazard risks (APH).

    The Andrew Weir scheme has been converted to a final cut-off with total liabilities around $500m, substantially with APH exposures. North Atlantic's liabilities are estimated in excess of $800m, with more than half in respect of direct business and over 80% of the whole in respect of APH. With over 9,000 potential principals which might submit claims, the need was to provide an estimation methodology that was seen to be fair in allocating a limited pot of assets. North Atlantic also believed that it was important to produce a methodology that would assist those policyholders which do not have access to market data or to appropriate expertise to value their own claims, especially for APH.

    As a result, policyholders are invited to submit data and information, preferably electronically, to support their claims for additional paid claims, outstandings or claims incurred but not reported (IBNR). This information supplements data held by North Atlantic. Policyholders can accept the information on the website detailing paid losses and outstanding loss reserves, discounted to a net present value, as a commercial offer, without taking any further action. It is anticipated that this offer will be attractive to various types of policyholders including those who have settled claims with solvent London market insurers, those with de minimis claims where it is not worth the effort to substantiate a case for a modest IBNR, and those whose claims are substantially mature and where North Atlantic's records reasonably accurately reflect the outstanding loss position. Alternatively, policyholders can make a fuller submission where North Atlantic's records do not accurately reflect the paid loss or outstanding loss reserve position, or where they wish to substantiate a claim for IBNR. In the latter case, a scheme feature is that policyholders do not advise a figure for IBNR. Instead, they provide data, for example statistics on asbestos claims filings, so that the scheme actuary can estimate the policyholder's ultimate claims. Only if data or information submitted by policyholders is disputed by North Atlantic will there be reference to an independent scheme adjudicator whose decision is binding on all parties. The estimation of ultimate liabilities and the allocation of those amounts cannot be the subject of dispute.

    This approach avoids the possibility of negotiations with every policyholder, which could be time-consuming and costly given the number of policyholders, and also provides a uniform estimation methodology which applies to all. The North Atlantic scheme has received overwhelming support from policyholders, and, in particular, US policyholders have accepted estimation as a means of bringing older run-offs to a close.

    Web-based submissions
    The North Atlantic website ( ) contains both public areas and a series of secure areas, each one accessible only to a specified policyholder with appropriate user identity and password. These latter areas contain a series of screens allowing policyholders to add to North Atlantic's data and to submit claims in sufficient detail to assist the scheme actuary's estimation.

    The exercise of circulating policy and some claim information to policyholders is key to an estimation scheme. In previous cases this exercise has been undertaken manually on paper forms, resulting in highly labour intensive new data inputting and results analysis. In contrast, the North Atlantic web-based system is demonstrably more efficient and less costly than any paper equivalent.

    The advantages for policyholders include a user-friendly environment that enables multiple submissions for business placed through different agents.

    For North Atlantic and its scheme administrators there is a unified format for responses which, with a direct link to core systems, avoids inputting new information with the inevitable risk of transcription errors. It also avoids having to interpret handwritten comments or amendments on paper forms. Control of claims verification is improved, as is the flow of management information as the responses of policyholders are received.

    As ever, the proof of the pudding is in the eating. North Atlantic is awaiting 30 April 2003, the final date for policyholders to submit information and claims.

    Within North Atlantic's agreed claims and reserves are amounts in respect of policies that may be protected under the Policyholders Protection Act 1975 (PPA), in particular arising from professional indemnity and employers' liability business. Operation of the PPA and its interaction with schemes of arrangement was in the hands of the Policyholders Protection Board (PPB) until

    1 December 2001, when these responsibilities passed to the newly formed Financial Services Compensation Scheme Manager.

    Whereas an established method involving the PPB in reserving schemes has been developed over the years, prior to the North Atlantic scheme there had not been a cut-off scheme for an insolvent run-off involving FSCS-protected policyholders. For some time a clash of objectives has been identified - the scheme administrators are looking to crystallise all the company's liabilities, collect the remaining assets and pay a final dividend so that the run-off can be completed and the company dissolved. This process necessarily must include putting a present value on future claims from protected policyholders. For professional indemnity policyholders, that may not be too difficult as, with older run-offs such as that for North Atlantic, policies have not only expired but are often well beyond the normal period of extended discovery for new claims to be notified. Given that the original policies are usually written on a claims-made basis, there cannot therefore be any new claims in the future and reserves are for determining any deterioration in known claims (`Incurred But Not Enough'). However, for employers' liability business written on an occurrence basis, there will inevitably be a genuine reserve for IBNR, although this is likely to be calculated on a class basis as it is impossible to determine in advance which policyholder will actually incur the loss in the future.

    A further difficulty is that the Financial Services Authority has indicated strongly its concern about the legality of any employer agreeing to commute an employers' liability policy, inter alia because of the potential impact on third parties which might benefit from claims under the policy. This issue above all had created a block on the ability to crystallise a direct book of business including protected policies.

    The solution developed for North Atlantic, and likely to be the precedent for all subsequent relevant cut-off schemes, is to separate the cut-off of the estate from the run-off of the policies. As part of the actuarial valuation of all liabilities, North Atlantic's scheme actuary will place a present value on all outstandings and IBNR in respect of protected policies as a class, using information from North Atlantic's records and from policyholders as submitted as part of the scheme process. Dividends in the scheme will be paid on this class valuation to the FSCS and protected policyholders whose claims are finally agreed at a later date within the scheme period will be paid directly by the FSCS at the appropriate protected percentage (100% or 90%). Protected policyholders' claims that are finally agreed after the scheme period in a subsequent liquidation will be paid directly by the FSCS whose obligations will be triggered by the liquidation in accordance with the PPA. Claims under protected policies that have been agreed before the start of the scheme will be paid by the FSCS in the scheme as soon as practical.

    This process ensures that:

  • protected policyholders receive the protected percentage whenever their actual claims are agreed without having to be subject to an actuarial valuation;

  • the FSCS continues to make payment in accordance with the PPA on claims under a policy (policies will continue to exist until the company is dissolved);

  • the FSA is content with the solution; and

  • North Atlantic can, in due course, complete its run-off.

    The development of these new features for a scheme of arrangement dealing with a run-off demonstrates yet again the general flexibility of such schemes, allowing solutions to be tailored to the specific circumstances of any case. In this way a commercial deal that attracts sufficient support from those affected can be contained within an appropriate legal envelope which, once approved, will lead to that ultimate goal of finality.

    By Paul Evans & Julian Turner
    Paul Evans is a partner in PricewaterhouseCoopers' discontinued insurance practice and Julian Turner is a solicitor with international law firm Richards Butler.