The state of Rhode Island is the first to enact a 'solvent run-off' scheme Lewis Fickett considers the pros and cons of this unique system.
In a move with significant implications for the US insurance industry, the state of Rhode Island has enacted a unique 'solvent run-off' scheme.Since court-approved run-off has only been an option for insolvent insurers in the US, large amounts of capital have been needlessly tied up in insurers which are no longer of use to their parent companies, and the capital of such insurers has been subject to an onerous 'tax' in the form of administrative costs.Now that court-approved solvent run-off is available in one state in the US, such a scheme may prove attractive to a variety of segments of the insurance industry. While there may be benefits to be reaped from a solvent run-off scheme, the industry must understand the hoops to be jumped through in its implementation.The Rhode Island solvent run-off statute permits Rhode Island-domiciled property and casualty commercial insurers that have ceased writing new business to run-off their business while still solvent by entering into a court-approved 'commutation plan' with their creditors. The term 'commercial insurers' encompasses insurers whose business consists of the reinsuring of any line of insurance other than life and/or the insuring of any lines of insurance other than life, workers' compensation and personal lines insurance. An insurer whose business includes any of these prohibited lines may still enter into a commutation plan if it has novated its risks in the prohibited lines through an assumption reinsurance agreement.
Structured run-off processThe primary benefit of the scheme is the creation of a structured statutory run-off process as an option for solvent insurers, increasing management flexibility and options. The second key benefit is that the likely shortening of the run-off period should reduce the administrative costs incurred in traditional run-offs, and the delays in the extraction of capital and the payment of policyholders and other creditors.Approval of a commutation plan requires the consent of 50% of each 'class' of the insurer's creditors and the consent of the holders of 75% of the aggregate value of the liabilities owed to each class of creditor. After creditor approval, the court will enter an implementation order which will require that all creditors submit information relating to their claims and that the insurer obtain court approval before making any payments to creditors other than as permitted under the commutation plan or those made in the ordinary course of its business. The implementation order will also enjoin certain litigation, release the insurer from all obligations to its creditors upon payment of the amounts specified in the commutation plan and be binding upon the insurer and its creditors and owners, whether or not a particular creditor or owner is affected by the commutation plan or has accepted it. The binding nature of the commutation plan, is particularly important because it may incentivise creditors to participate in the commutation process. After the plan has been completed, the court enters another order that transfers liabilities subject to assumption reinsurance agreements to the assumption reinsurers, assigns each assumption reinsurer the benefit of any applicable reinsurance (if such assignment is permitted) and dissolves the insurer or discharges it from the proceedings without liabilities.Court-approved solvent run-off may appeal to multiple segments of the insurance industry. Insurance holding companies seeking to sell a subsidiary may find such a sale easier once they have potential access to a court-approved solvent run-off mechanism. When a holding company decides to divest a subsidiary, it must 'clean' that company of liabilities in order to make it a true 'shell' and thereby more attractive to would-be purchasers.This process is usually long and difficult and, where effected by reinsurance, not completely successful because the shell will remain primarily liable on its ceded policies.One option has been for the insurer to block (non-renew) its existing business until it is free of liabilities. A series of block non-renewals is, however, time-consuming. State statutes and regulations impose strict requirements with which an insurer must comply in order to effect a block non-renewal. These regulatory roadblocks may become virtually impassable where the insurer is attempting to non-renew a heavily regulated line such as personal automobile coverage or a line of insurance coverage which is in short supply in the state. Furthermore, the state-by-state nature of insurance regulation may cause an insurer licensed in multiple states to face varying non-renewal requirements, causing complications and potentially divergent degrees of success in block non-renewing policies.
Block renewalsEven where an insurer has been able to navigate the labyrinth of state block non-renewal approval requirements, regulators may require that the non-renewed insureds be offered similar coverage in one of the insurer's affiliates. Since the presence of unprofitable business may have been a primary reason for the holding company jettisoning the non-renewing insurer, regulator-mandated assumption of this business into an affiliate may be unappealing. Finally, block non-renewals are time-consuming because they require the insurer to wait out the renewal terms of the policies.Since block non-renewals may be problematic, a holding company may choose instead to prepare the insurer for sale by ceding 100% of its liabilities to reinsurers. While this approach should take less time than a series of block non-renewals, the result is that the insurer will remain primarily liable for the ceded business. Consequently, the insurer will not be a true shell and will be less appealing to potential purchasers.The solvent run-off scheme offers a more attractive option. Following the conclusion of a commutation plan, the court can discharge the insurer from the run-off free of all its liabilities. Consequently, through the mechanism of court-approved solvent run-off, a holding company can relieve a subsidiary of liabilities while avoiding the regulatory roadblocks and needless delays traditionally faced in this process. Once the insurer has been discharged of its liabilities, it can be sold as a true shell and substantial sums realised for the existing licenses.
Predicting durationSince court-approved solvent run-off is a new concept in the US, it is difficult to predict the duration of a solvent run-off. To some degree, this time frame will hinge on the nature of the insurer and its liabilities.The structure provided by the statute and the incentive for creditors to participate in the plan, since it will bind them upon its approval, should expedite the run-off process.Easing the difficulties involved in selling unwanted subsidiaries may become more important if Congress enacts legislation allowing for the federal chartering of insurers. In such a circumstance, holding companies may charter one of their companies nationally and move books of business from other insurers into that federally chartered company. Those holding companies will be left with insurers that are no longer writing or renewing business and are licensed in some but not all states.Captive insurers could also be candidates for court-approved solvent run-off. Insureds typically form captives during hard markets because premiums have risen sufficiently to make the captive alternative a desirable solution to a business's insurance needs. When the hard market softens, or the insured's needs change, the captive insurer may become superfluous.A captive may have significant capital that its insured would like to be able to extract while also eliminating a source of unnecessary corporate bookkeeping.One of the biggest roadblocks to the expansion of solvent run-off in the US is the relatively small number of insurers currently domiciled in the state of Rhode Island. Since Rhode Island domicile is a prerequisite for executing a commutation plan, any potential candidate for solvent run-off not currently domiciled in Rhode Island must first redomesticate to the state.Rhode Island redomestication law largely mirrors the NAIC model redomestication law. A foreign insurer licensed in Rhode Island seeking redomestication to Rhode Island must comply with the state's requirements for the licensing of a domestic insurer and file its organisational documents, amended to comply with Rhode Island law, with the Rhode Island Insurance Superintendent, whose approval is required. No merger, consolidation or corporate reorganisation is necessary to effect a redomestication to Rhode Island. Obviously, if the insurer is not currently licensed in the state, it must first obtain a Rhode Island license.The solvent run-off statute requires additional staffing of the Rhode Island Insurance Division before companies are permitted to redomesticate in order to enter into a commutation plan. This provision should help prevent excessive strain on Rhode Island regulators from a flood of redomestications seeking to enter into commutation plans.In order to avoid the need for future redomestication, the presence of both the court-approved solvent run-off option and a captive statute in Rhode Island may encourage businesses to form captives in Rhode Island rather than in a traditional captive domicile like Vermont or emerging captive choices like South Carolina. By forming a captive in Rhode Island, an insured will be able to smooth its transition to running off that captive should it become unnecessary.Another roadblock to the expansion of court-approved solvent run-off in the US is that it is a new concept. There will be an adjustment phase for both companies and regulators. Furthermore, the Rhode Island court system could become overburdened if presented with a rush of commutation plans. Both of these problems should resolve themselves relatively easily with the passage of time.
Potentially problematicA potentially more serious problem in this solvent run-off scheme is that the insurer in run-off cannot compel payment from its reinsurers for IBNR (incurred but not reported) or incurred but unpaid losses and loss expenses. This prohibition will limit the funds the insurer in run-off can recover from its reinsurers, thereby reducing the funds available for commutation negotiations and the appeal of such commutations to the policyholders.It is important for insurers considering court-approved solvent run-off to obtain services from professionals familiar with the insurance business and Rhode Island law.