Stephanie Mocatta examines the processes, pitfalls and successes involved in putting together a solvent scheme.
Have you been at the conferences where they say of solvent schemes: a panacea for run-off/get rid of all your liabilities with no comeback/easy to do - just get a lawyer/maintain your solvency margin.
Or have you been in the wine bars where the conversation is along the lines of: they will never work/what about the reinsurance programme?/they have not thought of the reputational issues/the costs are ridiculously high/if I ever get the chance I'll vote one down.Actually the reality is somewhere between these two schools of thought. Having almost completed a solvent scheme for Crombie Insurance Co (UK) Ltd, I have written a personal view of the processes, pitfalls and successes involved in putting together a solvent scheme. It will not necessarily persuade you that a solvent scheme is for you, but it might just persuade you to think about it.
No one admits that their records are bad, however once a company has been in run-off for some time it is extremely likely that there will have been deterioration in the state of the records. This can be for a variety of reasons: change of management; systems conversions; in-house transfer of records; indifference of the brokers. In order to undertake a scheme it will be necessary to have as complete a record as possible and in particular the ability to have principal to principal accounting.
The systems platform
That brings us on to the systems platform. Some run-offs simply arrive in cardboard boxes, which at least means you do not require a systems conversion - just a system. The nature of the platform required for a solvent scheme is different from that required for a long term run-off. Cash flow is not of vital importance in a scheme, however the ability to identify all the principals involved, both inwards and outwards, is of utmost importance.
For Crombie we decided the most appropriate route was simply to build an Access database and ensure that every individual record, both inwards and outwards, had the correct reinsurer code. To give you some example of the size, we were dealing with around 3,500 policies on the inwards side and their associated transactions. Many systems houses now supply a scheme package as part of, or an add-on to, their main system. In Crombie's case we decided on the Access route because it was the cheapest option and also gave us complete control over the design of the system. After some considerable heartache in terms of identification of policyholders and reinsurers we now had a principal to principal accounting system. Now all we needed was a scheme.
Drafting the scheme document
It is said, again if you frequent a particular sort of wine bar, that scheme documents should just come straight from the word processor and that the lawyer's function is purely secretarial. My experience, however, suggests that there are an enormous number of variables to consider when drafting your scheme documentation and you do need the help of a good lawyer with a full understanding of the range of possibilities.
For a starting point you must be clear in the strategy and objectives which you are trying to achieve. This is not simply the closure of the book but can include:• Are there significant large creditors who will be part of the scheme? If so they are likely to want a say in the drafting of the document, which in turn may not suit your ultimate goals. It may be worth considering a global commutation with them before the scheme.
• Is there Lloyd's syndicate involvement? If so this must be dealt with separately in the scheme to cover the issues arising with individual Names.
• Is there US involvement? Do you want to include a section 304 binding US creditors, or is it cheaper or easy to commute with these first?
• Do you want a provision for offset? One of the major stumbling blocks of schemes is the outwards reinsurance position, if you can include an offset position and you have a “traditional” London market book where your inwards and outwards match you may go a long way to solving the outwards problem with a well-drafted offset clause.
• Do you want an insolvency provision? The Financial Services Authority (FSA) may well have a view on whether or not one should be included, but if you do have insolvency provisions in the scheme it is well advised to keep them completely separate from the solvent scheme provisions and avoid confusion.
The next best place for confusion to arise is the explanatory statement. Drafting this can take as much time as the scheme documentation itself. With the explanatory statement you are trying to achieve the unlikely balance of telling the whole truth, not introducing irrelevant information and making it interesting and coherent enough for people to read.
It is a reflection on the competent drafting of the scheme document and the explanatory statement in the Crombie scheme document that the creditors voted unanimously in favour of the scheme.
It is worth noting that the FSA will have a particular interest in the drafting of the explanatory statement and the scheme documentation and it is worth including them in the drafting process from the early stages. Support of the FSA is vital for any scheme to succeed.
OK, so what can go wrong?
With the Crombie scheme we were working to a particularly tight timetable (see timetable), specifically we were working towards an initial court hearing of 22 June 1999 - for this we needed an actuarial report and the report and accounts completed.
The actuary's report
Part of any solvent scheme is going to be an actuarial review of the book and Crombie was no exception. Because we had effectively reconstructed Crombie's records and also introduced a principal to principal accounting system the actuaries review of the records for the scheme highlighted a number of differences from previous reviews. These issues all had to be individually investigated and an explanation found to the satisfaction of the actuary, it would be easy to underestimate how much time this can take.
The report and accounts
Crombie has a 31 December year end, thus under normal circumstances you would not expect the report and accounts to be completed much before mid to late June, particularly in view of the delay in the actuary's report. Getting the report and accounts signed by 21 June in time for the court hearing was a major achievement and required some particularly intense negotiations.
The additional costs
A scheme is a little bit like inviting builders into your home to build an extension. Not only do some completely unexpected things go wrong, not only do you find yourself being asked questions you never even knew existed let alone can answer, but also the costs only go up not down.
An easy example of this is the posting of legal notices. Once the scheme was sanctioned at the court hearing you are obliged to place advertisements in the press detailing the scheme and the date of the creditors meeting. Our experience is if you phone the trade press asking for an advertisement of a particular size they will offer you all sorts of discounts, deals, three for one offers, etc. However, once they know it is a legal notice, which you are obliged by law to post, the price suddenly trebles.
Apathy of creditors
One of the issues with a solvent scheme can be the apathy of the creditors. This can be particularly true of non-UK based companies for whom the scheme may not be in their native language. While there is no legal minimum requirement of the numbers voting, both the FSA and the court prefer to see a significant turn-out of voters.
With Crombie we addressed this by contacting all creditors individually, made sure they understood the scheme and answered all their queries. This task was made easier because we have a good library of contacts within the industry, which we keep up to date with the mergers, acquisitions and name changes that are rife. It also helped having staff who are native French and German speakers.
We are justifiably proud of the speed with which we have undertaken the solvent scheme for Crombie. The timetable below shows the timings to date and the expected finish date.
Task Dates Time takenScheme drafting Mar-June 99 3 monthsActuarial review May-June 99 6 weeksInitial Court hearing 22 June 99Creditors meeting 27 July 99Court sanction date 1 Sept 99Bar date for claims 30 Nov 99Expected payment Total:date Mid-Dec 99 10 monthsWas it worth it?
A solvent scheme is certainly hard work and has nothing in common with simply running-off an old book of business. I would agree with some of the greybeards in the market, solvent schemes are not suitable for every company.
However, on Crombie, we will have achieved the shareholders' objectives: we will have completely closed down Crombie and extinguished all liabilities in under one year for considerably less money that the long term run-off provision. In doing so we have also maximised the potential reinsurance recovery and maintained the solvency throughout the process. We have also acted in a professional and efficient manner protecting the reputation both of the company and those involved in the process.
I would suggest therefore that a solvent scheme is potentially suitable for any London market company, writing LMX, that wishes to shut down in a professional and efficient manner.
Treat a solvent scheme like a building project, expect the worst and be delighted when it is finally over. Before you start make sure you have everyone's co-operation, from shareholders through to auditors and including the staff, and make sure that everyone is on side.
Stephanie Mocatta is a director of Crombie Insurance Company (UK) Ltd and of Whittington Insurance Services Limited, which provides services and solutions to the insurance industry. Ms Mocatta began her career with CT Bowring Reinsurance. She moved to the English & American in 1989 as a reinsurance underwriter and joined Whittington in 1995.
The lawyer's tale
Stephanie Mocatta has described very well the trials and tribulations, together with the rewards, of promoting a solvent scheme of arrangement. I was delighted that all the hard work in relation to Crombie paid off and the creditors voted unanimously for the proposed solvent scheme.
Finality for an insurance operation in run-off must be a goal worth fighting for. Run-off can be such a long, costly and uncertain procedure that alternatives need to be found.
Solvent schemes are not a universal panacea. Where a company has very material uncertainty as to its assets or liabilities it may well be that specific issues may need to be resolved before a solvent scheme will work. However, once an actuarial valuation of IBNR becomes possible, and there is a reasonably clear view on assets, including reinsurance recoveries, then a solvent scheme should be seriously looked at. It may be that someone will buy the business or that you really do want to continue to handle the run-off in-house through to the end of time. If neither of those possibilities are attractive then the scheme of arrangement may well be for you.
How do they work?
Schemes of arrangement are essentially a compromise between a company and its creditors. They are based on provisions of the UK Companies Act but similar legislation exists in Bermuda and Singapore. We are working on ideas for developing similar structures to solvent schemes in other parts of Europe and even companies with numbers of subsidiary companies may be able to effect a scheme by portfolio transfers and other devices.
Once the parent company or the shareholders have decided to embark on a scheme they need to put together a detailed proposal which will be put to creditors.Provided the proposals are supported by a majority in number and 75% in value at a creditors' meeting they become binding on all creditors. You do not need the support of 75% in value of all creditors but only those who attend the meeting of creditors or vote by proxy.
Schemes of arrangement have been applied to insurance companies, both solvent and insolvent, because UK insolvency law provided no remedy other than liquidation for the winding-up of the business of an insurance company. Schemes have now been so successful that they are recognised as the best method under English law for bringing an insurance company's operations to conclusion. Liquidation is simply far too lengthy and expensive a process to be contemplated in anything other than extreme circumstances.
As Ms Mocatta has indicated in her article, there can be problems with schemes. There are a number of questions which need to be resolved. If you are doing a scheme which estimates future liabilities you must bring your reinsurers with you. Generally speaking, insurers cannot be bound to pay claims based on estimated future liabilities which have not yet crystallised.
Generally, the UK regulators are very supportive. They have encouraged solvent schemes of arrangement as a way of achieving finality and avoiding the insolvency which can result from lengthy and costly run-offs.
What does the future hold?
The liabilities of worldwide companies in run-off were estimated at $230 billion in 1996 and are projected to be $350 billion in 2001 and $505 billion in 2006. There are 180 authorised insurance companies plus 50 subsidiaries of composites and 50 to 60 branches of EU companies in run-off in London. The liabilities of London companies in run-off are estimated at between $17 billion and $25 billion, excluding Equitas!
These figures show how important it is to achieve finality and to reduce the crushing burden of these liabilities. The advantages to policyholders are obvious; they get cash in the short term and certainty of payment, together, hopefully, with a fair estimation of claims. For shareholders they crystallise value and achieve an earlier return on capital. For reinsurers there is accelerated payment of claims but at a discount.
Crombie contains within its scheme an insolvency provision. This is to cover the fact that everyone's predictions may turn out to be wrong, as in any proposed scheme, and the insolvency alternative needs to be considered. However, even if insolvency does result, a scheme does have many, many attractions. It will still lead to far earlier payment than the alternative of liquidation.
Are schemes very expensive?
They have certainly been so in the past but the costs are coming down as the scheme has become simpler. It all depends on the company's records and what needs to be done to get a handle on the overall level of claims and assets.
Ms Mocatta's enthusiasm for the Crombie Scheme has been infectious. Everyone working on it has enjoyed the process. The challenge now is to develop both schemes and other ways of achieving finality for insurers in the London market. We need to bring European companies more into the fold and develop cross-border solutions to finality. I hope that this will be a theme, certainly for some of those attending Monte Carlo this year.
Charles Gordon, Manches.