Graham Tomaszko asks whether the increasingly quick closure of schemes is a positive step or a worrying trend
As the song goes, "the times they are a-changing." This is just as true in the insurance world as it is elsewhere. Forty or even thirty years ago it was a major event if a company went into run-off. Whilst it was perfectly normal to cease underwriting unprofitable business and place a portfolio into run-off, to place the whole company into run-off was the exception rather than the rule. It caused major worries for the shareholders and potential loss of career prospects for many of the staff, who would often leave rather than face the threat of eventual redundancy.This in turn, caused even more concerns.The 1980s and 1990s saw the arrival of asbestos, pollution and health hazard claims (APH). Coupled with the major catastrophe losses of the late 1980s and early 1990s, the re/insurance market found itself in entirely new territory. It had suffered by the occasional major loss, which if occurring during a soft market would help sustain it, since the loss would result in rate rises and return the market to a buoyant state.Unfortunately, circumstances were now different. The market was heavily reliant on reinsurance; a large number of companies had huge LMX programmes in which they often participated themselves. It was a recipe for disaster.As claim upon claim was made, many reinsurers found it difficult to meet the financial demands made upon them. Soon this triggered a domino effect, with companies going into run-off and then into liquidation. Unable to meet their obligations, they brought others down with them. This resulted in creditors waiting for years for payment and eventually often only receiving a nominal sum.
Scheme arrivalIt could have been much worse. Fortunately, 1993 saw the birth of the scheme of arrangement, devised by PricewaterhouseCoopers (PwC) for Trinity Insurance Co. This gave relative security to the staff and enabled claims to be offset and dividends to be paid much sooner than was the case in a normal liquidation. It is probably not too far fetched to say the advent of the scheme was the likely saviour of a number of companies which would have been in serious financial difficulties if they had not been in receipt of the dividends the scheme brought them.To see how the concept of the scheme has progressed over the last decade, it is worth examining a number of companies that have taken this route to see how the run-offs have developed. All of the companies referred to are administered by PwC and underwrote in the London market.Three that can be grouped together are Trinity, Bryanston and Andrew Weir. They are all being run-off by Omni Whittington following its purchase of Bridgeway Management in 2000. Although all three went into provisional liquidation in 1992, which was within months of Trinity going into run-off and within a year of the other two, it was Trinity that was the first to enter a scheme in 1993, followed by the others in 1994. These are considered to be the pioneers of the insolvent scheme.Before this, when a company went into liquidation it would be years before the creditors received a dividend. Trinity was originally a run-off scheme, with the idea being to ensure that dividends could be paid in a timely manner, as there were no plans for closure; it was never built into the original scheme. To give some idea of how radical the whole idea was, at the first meeting in 1993 to discuss the scheme there were over 240attendees including the creditors and their lawyers. In 2003 when the new Trinity scheme was introduced to allow for closure, the panel numbers exceeded the creditor numbers.In 1994, when Bryanston and Andrew Weir entered schemes, the provision to close had been introduced and built into their schemes.
Anticipated closureIt is now estimated that all three should close by 2005, led by Andrew Weir in late 2004. At the time of writing under the management of PwC and Omni Whittington, creditors have received dividends of 65% on Trinity, 34% on Bryanston and 41% on Andrew Weir, with probably another 10% due on the first two and 5% on Andrew Weir.London and Overseas (L&O) together with OIC (formerly The Orion) is one of the largest run-offs to hit the market. They went into joint run-off in 1992 with combined liabilities of approximately $2.5bn. Within two years they were placed into provisional liquidation and into scheme within another three. It is estimated that it will take ten years from implementation of the scheme to eventual closure, and with dividends presently at 42%, they could exceed Trinity's eventual payout of 65%.When it is considered that L&O commenced underwriting in 1893 and OIC in 1931, and that they both were heavily involved in the LMX market with large APH exposures, the relatively short run-off and high dividends is a credit to Dan Schwarzmann and his team at PwC.More recently, Black Sea and Baltic (BS&B) entered run-off in 1998. By comparing BS&B with, for example, Andrew Weir we can see the progress made in schemes in recent years. Although BS&B went into liquidation within months of entering run-off, it did not go into scheme until December 2003, some five years later. The most noticeable point of this particular run-off is that despite having similar underwriting years and double the liabilities of Andrew Weir, it is estimated that the company will be closed in less than two years from the implementation of the scheme.We now come to what some may say is an even more radical run-off. Folksam International went into run-off in 1997 and administration in 2002, having written business since 1976, with estimated liabilities of £131m (twice BS&B's liabilities). Although not expected to enter scheme until mid-2004, it is quite possible that it may be closed by the end of 2005. This remarkable achievement is only possible by the use of what is known as the 'double dip' scheme developed by PwC.When asked to explain the 'double dip' scheme, Dan Schwarzmann said it was a hybrid scheme, and structured as follows:- following creditor (and court) approval of the scheme the first 'dip' is instigated. During a specified time, extensive discussions take place with the major reinsurers, which are effectively asked to indicate what sums they are willing to pay in settlement of their obligations on a fair basis; and- there would then be a proviso for a second meeting of creditors (the second 'dip') to consider whether the offers are acceptable (given the impact on the projected dividend) or whether they would prefer to reject the valuation option and choose to continue the run-off (if it is felt that this option may provide a better return, notwithstanding the time value of money). In the latter circumstances, a revised valuation scheme could be proposed and voted on at a later date.The implementation of the double dip scheme results in a distinct speeding up of payment to creditors, which was, after all, the main reason for the development of the scheme of arrangement in the first place. Consequently, it should result in dramatic savings in the cost of running a scheme by reducing the period from eleven years for Trinity (the first scheme) to potentially only eighteen months for Folksam. This alone could increase the eventual dividend.However, there are potential downsides. If the companies that are placed into a scheme are not allowed to run their normal course and are being forced into closure before time, there is a danger that creditors whose claims have not yet developed may lose out. It also can cause potential staffing concerns, with early closure once again bringing the threat of premature redundancy.
Questions of closureTony McQueen of Omni Whittington raised the question, "does closure occur when liability peaks or does planned closure cause the liability to peak?" One must consider what would have happened if Orion, or even the lowly Andrew Weir, had been closed within two years of being placed into scheme.Would the payout have been the same without allowing the losses to develop?Would even the creditors have been the same?If the double dip-type scheme does prove a success and the period between the date of scheme and proposed closure continues to reduce, creditors could be worse off. Surely the reason the scheme of arrangement was implemented in the first place was to ensure this did not happen.Graham Tomaszko is Managing Director of Turnstone Insurance and Reinsurance Services Ltd and Chairman of the Association of Insurance and Reinsurance Services Providers (ASP) and Run-Off Solutions Ltd.