Vol 13 (2016) - Issue 6

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Cutting the Gordian Knot on Run Off Insurance

The Rhode Island Commutation Plan Statute allows insurers and reinsurers to crystallise their liabilities and then accelerate closure of the eligible business in run off. But the Commutation Plan process has been successfully applied only once (GTE Reinsurance in 2012). Since then, no company has tested the process and recent amendments to the implementing regulations remain controversial in some quarters. Are the misgivings justified? What does case law say about the possibilities and potential objections? How does the recently updated Statute process square with the National Association of Insurance Commissioners’ (NAIC) guidance on alternative mechanisms for troubled insurance companies?

A Gordian Knot
The billions of dollars held in portfolios closed to new business have become a Gordian Knot for insurers and reinsurers. As they grapple with geopolitical instability, soft market rates, subdued asset returns, and pressure to invest in new technological capabilities, they cannot afford to tie-up capital needlessly. But to release the capital from discontinued business, they need to address a multiplicity of client obligations, regulatory stipulations and reputational sensitivities. Insurers and reinsurers are clearly keen to release capital in run off. But after some investigation, most conclude that the knot is too tangled to allow for any more than letting the business run off through to closure or the slightly more active alternatives of sale or reinsurance transfer. All these options leave a huge amount of value on the table. Run off to closure is a slow process, tying up capital and management time for decades. Sale may be quicker, but the acquisition price is unlikely to reflect anything like the value of the assets as it needs to take account of the risk of future adverse loss development and continued administrative expense and distraction. Similarly, the reinsurance transfer price (i.e. the reinsurance premium) needs to reflect the potential adverse loss development.
Is there another route? Commutation allows insurers and reinsurers to accelerate the closure of eligible business in run off. Unlike the solvent schemes of arrangement and Part VII transfers available in the UK, the openings for US commutation plans are limited to those brought under the Rhode Island Commutation Plan. Originally enacted in 2002, the Statute allows eligible insurers domiciled in the state to terminate liabilities and close down the business for good.

Tight criteria
To provide full protection for policyholders, the Rhode Island Commutation Plan process is subject to rigorous eligibility criteria and close scrutiny by both courts and regulators. Unlike the UK’s solvent scheme of arrangement, which applies to a whole company or individual portfolio, the Commutation Plan process only applies to a whole company. Moreover, the Statute only applies to commercial business and hence knowledgeable parties, rather than personal lines or workers’ compensation business. Crucially, the company and the book of business in run off need to be entirely solvent (this has been reinforced by subsequent amendments on the transfer of business we discuss further on). The process does not apply to troubled companies, putting it beyond the situations in which the NAIC will permit some form of alternative closure mechanism to stave off the risk of insolvency. Commutation must be approved by (1) 50% or more of the creditors by number, and (2) 75% or more of the creditors by value, who vote in person or by proxy. The process also requires review by the Rhode Island Department of Business Regulation’s (DBR) and approval by the court overseeing the process, in order to ensure that the plan does not adversely affect the rights of the policyholders in a material way.