AIRROCWebinarSeries:IntroductiontoRun-Off

LeveragingLegacyLiabilities

Originally Broadcast on February 6, 2019

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Presenters

•  JonathanBank,OfCounsel,LockeLordLLP•  KatherineBarker,KBConsultingLLC•  AlBottalico,InsuranceSpecialist,LockeLordLLP•  AndrewManeval,CheshamConsultingLLC•  CarolynFahey,ExecutiveDirector,AIRROC

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Bank Barker Bottalico Fahey Maneval

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TableofContents•  Presenters•  AboutAIRROC•  IntroductiontoRUNOFF•  WhatisRUNOFF•  FormsofRUNOFF•  Recentdevelopments•  PWCSurvey•  Questions

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AIRROC’sMissionandVision•  AIRROCisanon-profitorganizationofinsuranceandreinsurancecompaniesthathavelegacybusinessintheirportfolio.Wehavebeensupportingtheindustryfor13years.

•  AIRROC’sVisionistobethemostvalued(re)insuranceindustryeducatorandnetworkproviderforissueresolutionandcreationofoptimalexitstrategies.

•  AIRROC’sMissionistopromoteandrepresenttheinterestsofentitieswithlegacybusinessbyimprovingindustrystandardsandenhancingknowledgeandcommunicationswithinandoutsideofthe(re)insuranceindustry.

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AIRROC’sMembersAIG, Allianz, Allstate, Argo Group, Armour Risk,Arrowpoint Capital, AXA Liabilities Managers,Brandywine/Chubb, Catalina, CNA, Compre,Crawford, DARAG, Dominion, Enstar, EWI Re,Federated Re, Fleming Re, Munich Re, NYLiquidationBureau,OKInsuranceDept,Orion/PwC,Premia Re, PRO, QBE, R&Q, Requiem, Resolute,RiverStone,ROMRe,SafetyNational,Sentry,Sirius,SunPoint, Swiss Re, The Hartford, The Home,TigerRisk,Travelers,WillisTowersWatson 5

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INTRODUCTIONTO

“RUNOFF”

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TheJobWithNoIdentity

Intheearly1970’s,IwasaverynewLosAngeleslawyerwithnoinsuranceexperience,andnodesiretogainany.Butmyemployer,Teledyne,purchasedanumberofcompanies,includingsomeinsurancecompanies.AmongthosewasArgonautinMenloPark,CA.ArgonauthadintherecentpastenteredintoagreementswithwhatwerethenreferredtoasMGAs.InJanuary1974,Iwasinstructedtoterminateallagreements,whichIdid.Allofthebusinessthathadbeenwrittenwassuddenlyin‘limbo’…nowreferredtoasRun-Off.Run-Offwasn’treferredtoasRun-Off,asitdidn’tyethaveaname.Itwasjustanembarrassingrealityofunderwritinggoneastray.Companiesnotonlydidn’thighlightit,butinmanycasestriedtoignoreit.Sincetheonlyrealsurvivingfunctionwasclaimshandling,thatwouldfalltoeitherthenewestoroldestclaimsassociateswithinthecompany.Itwasperceivedasadeadendopportunity.Duringthisandpartofthenextdecade,underwritingamongmanyp/cinsurers/reinsurerswasreckless,insomecasesleadingtothecompany’sdemise,butalsoincreasingthevolumeof‘limbo’business.

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RecognitionBytheearly1980’s,recognizingtheriskofthe‘tailwaggingthedog’,companiesbegantocometogripswiththe‘problem’,andindividualsemergedwhospecializedinhandlingthisdiscontinuedbusiness,eventuallyadoptingthename,“Run-Off”.Fastforwarding,bythe1990’s,companiesbegantoemergethateitheragreedtomanageRun-Offbusiness,orto‘purchase/reinsure’thebusiness(orcompany)outright.Itbecameathriving,respectablebusiness,andwasevenreferredtoinmorepristinecirclesas‘legacybusiness’.In2004afledgingassociationwasstarted,notwithoutsomeskepticism,namedTheAssociationofInsurance&ReinsuranceRun-OffCompanies(AIRROC).TheAssociationhasalmost50members,includingmajorUSandinternationalinsuranceandreinsurancecompanies,rehabilitations,receivershipsandliquidations.TodayAIRROCcontinuestothriveandhasdevelopedmuchexpertise.Therehasbeenmuchinnovationandopportunitiescreatedintheinterveningyearsandthisisexpectedtocontinuewithrecentlegislativedevelopments. 8

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IndustryHistory:The“PerfectStorm”

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RegulatoryPerspectiveofRunoff“SolventRunofforTroubledInsurer”

Stateinsuranceregulatorshavewell-developedreceivershipstatutes,practices,andprocedurestohandleimpairedandinsolventinsurers.Thesestatutes,practices,andproceduresserve,firstandforemost,thegoalofconsumerprotection.TheyareacriticalandessentialpartoftheRegulatorySolvencyFramework.However,givenimprovementsinregardtotheearlydetectionoffinanciallytroubledinsurersandinsureds’requirementsforA-ratedcoverage,anewlandscapehasemergedwithagrowingnumberoftroubledinsurersseekingtoengageinmechanismsofrun-offorrestructuringasanalternativetobeingplacedintraditionalreceivershipproceedings.

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WHATIS“RUNOFF”

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Howdoesyourorganizationdefinerunoffbusiness?Runoffbusinessismostwidelydefinedaslinesofbusinessthatarenolongerwritten.Sampleresponsesinclude:• “Alllinesofbusinesswherepremiumsarenolongerbeingwritten.”• “Anydiscontinuedlineofbusiness.”• “Businessthatisbeingwounddownandnolongerunderwritten.”• “Closedbookofbusinesswithnomoreunderwriting.”• “2001andprior.”• “Discontinuedcompanies,affiliatesorsegments.”• “Non-coretothegroup.”• “Nonewwrittenbusiness.”

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AllReinsuranceandInsuranceCompaniesareInvolvedinRunoffWhatis'Runoff'?RunoffisthetermusedtobroadlydescribetheprocessanInsurance/Reinsurancecompanyfollowswhenithasablockofbusiness,forwhichitmakesfutureplansforhandlingtheliability(expectedfutureclaimsthatitexpectstopayandforwhichareservehasbeenestablished)andisnotsupportedsimilarlyto“ongoingbusiness.”

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WhyDoesRunoffExist

Insolvencies

•  Companiesforcedintotheliquidationprocess(Reliance,Kemper,Legion,etc)

StrategicPortfolioManagement

•  FocusonCoreBusiness

•  Exitbusinesswithpoorreturns(ROE,Growth,Profitability,etc.)

•  Capitaldeployment(directtomostpromisingsegments,pressureofratingagencies,SolvencyIIetc)

M&AActivity

•  Assumerunoffliabilitiesthroughbroaderacquisition

•  Discontinuationofsegmentofbusinessacquiredthroughacquisition

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ElementsofActiveRunoffManagementManagementSupportandCommitment

•  DedicatedTeam•  TimeCommitment•  Resources•  Howwillunitbemeasured?

PortfolioStrategy •  DefinePortfolio•  HighlevelShortandMidTermStrategy

(Roadmaptofinality)•  BusinessKPI’s•  ProcessbuiltaroundRunoff

RunoffSpecialists •  DedicatedsolelytoRunoff•  Experiencewithvarioustasksrelatedtorunoff

(Commutations,LitigationManagement,APH,Accounting,Data,Audits,etc

Mindset •  ActiveratherthanPassivemindsettoreduceliabilities

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RunoffBasic(Outdated)Model

ContinuedAdjudicationofclaims

PaymentofClaims

ClaimAdministration MaintainStaffto

AdministerFuturestaffretentionorpotentialstaffreduction

Reportingfunctions,HR,Accounting,etc.maintained

OtherAdminstration

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RunoffToday–It’saBusiness

BASICRUNOFF

+MaintainandManagewith

Internalresources

SaletoorManagementby3rdParty

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MarketConsiderationsU.S.companiesareseekingeffectiveexitsolutionsforrun-offportfolios•  TheU.S.P&Crun-offmarketisestimatedtobehundredsofbillionsofdollars.

•  Companieswithrun-offlegacyliabilitiesstruggletofindwaystoexitthisbusiness.

•  Commutations,sale,reinsuranceandlossportfoliotransferhavebeenthemostfrequentlyusedrun-offexitmechanisms,buttheseoptionsarelimitedintheirscopeandeffect.

•  Mostcompanieshaveconsideredthesealternativesandarelookingforothereffectivewaystodealwiththe“rump”ofrun-offlegacyliabilitiesthatremainontheirbalancesheets.

•  CompanieswillusetheRIIBTregulationstorestructureorexitbusinessandachievelegalandeconomicfinalityforthetransferredpolicies.

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StatusoftheU.S.CommercialRun-offMarketTherearemajorchallengesfacingcompanieswithP&Crun-offbusiness

•  Accesstoexitmechanisms•  Maintainingreputation•  Capitalconstraints•  Operationalcosts•  Adverselossdevelopment•  Adverseimpacttoacompany’srating•  Lackofskilledresources•  Reinsurancecreditrisks

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FORMSOFRUNOFF

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CompanyManagement–VoluntaryRunoffofatroubledcompany•  Atroubledcompanyrunoffisusuallyavoluntarycourseofactionwheretheinsurerceaseswritingnewbusinessonalllinesofbusiness,butcontinuescollectingpremiumsandpayingclaimsastheycomedueonexistingbusiness.Duetostatecancellationlaws,theinsurermayberequiredtorenewbusiness,whichcanbeparticularlychallengingforinsurersrunning-offpersonallinesrisks.Theinsurermayseektorunoffbusinessinthetraditionalsense—payingclaimsinfullintheordinarycourseofbusiness—ormanagementoftheinsurermightseektoendorlimittheirexposureoninsurancebusinessbeforepolicytermsexpirebyutilizingreinsurance,assumptiontransfers,negotiatedsettlements,and/orvoluntarypolicycommutations.Thesetransactionsshouldnothaveanegativeimpactonpolicyholders,ascloseregulatorymonitoringisnormallymaintainedthroughouttheprocess.Thegoalistocompletelycloseoperationswhileremainingsolvent.

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VoluntaryRunoff(continued)•  Inordertosucceedinrun-off,assetsandincomemustbemaintainedatsufficient

levelstocovertheremainingclaimsandadministrativecostsofhandlingthoseclaims.However,solventrun-offsmayhavelittlerevenueotherthaninvestmentincome,andrun-offsmaydevelopintoinsolvenciesthatcouldrequirereceivershipproceedings—forexample,iftheinsurerisunabletocollectreinsurance,makeserrorsinestimatingrecoverableassets,experiencesadeclineinassetvaluesandinvestmentincome,and/orencountersothercashflowissuesatanypointintheprocess.

•  Run-offofatroubledcompanymaybesubjecttoregulatorysupervisionunderapplicablestatelaw.(See,e.g.,NAICRisk-BasedCapital(RBC)ForInsurersModelAct,Section6.B(2).)Regulatorysupervisionofatroubledcompanyrun-offmaybetriggeredinordertoenhancetheregulatoryoversightandmonitoringofthefinancialperformance,consumerprotections,andmarketconductrelatedtoimplementationoftherun-offplan.Enhancedregulatoryoversightmayincludeincreasedfinancialandregulatoryreportingrequirements,regulatoryapprovaloftransactionsandclaimsettlementpractices,andon-siteregulatorysupervision.Supervisionoftherun-offplanisconductedinordertoensurethatpolicyholders,consumers,andothercreditorsfarenoworseundertherun-offplanthaninreceivership. 22

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VoluntaryRunoff-Advantages

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VoluntaryRunoff-Disadvantages

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Liquidations•  Delinquencyproceedings(receiverships)areinstitutedagainstaninsurancecompanybyaninsurancedepartmentforthepurposeofconserving,rehabilitating,orliquidatinganinsurancecompany.Allrequireacourtorder,andthedomiciliarystatecourtwilltakejurisdictionovermattersinvolvingtheresultingreceivershipestate.Thecourt’sroleistoensuretransparencyanddueprocessandtobeanindependentarbiterofanydisputesthatmayarise.Thenature,timing,andextentofregulatoryactioninanygiventroubledinsurersituationdependonthecircumstancesoftheparticularsituation.

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“Outsourcing”ofRunoffSolutions

•  EngagingOutsideRun-OffManagementFirm;•  Sale/Disposition•  AggregateStopLossReinsuranceContract•  LossPortfolioTransfer•  ComprehensiveNovation(s)

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“SchemesofArrangement”(UK)

•  1.DESCRIPTION•  Aschemeofarrangementisessentiallyastatutorycompromiseorarrangementbetweenacompanyanditscreditors.TheprocessisallowedunderPart26oftheUnitedKingdomCompaniesAct2006thatrequiresmajoritycreditorapprovalrepresentingatleast75%invalueofobligations;confirmationbytheUKFinancialServiceAuthority(FSA)ofnoobjections;andcourtsanction.Ifapproved,theprocesswillbindallcreditors,butdoesnotnecessarilybindreinsurers.

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CurrentusageofSchemes•  Followingchallengestosomesolventschemesbypolicyholderssurroundingfairnessandtheremovalofinsurancecoveragewherefutureclaimsweredifficulttoestimate,thePRApublishedasupervisorystatementthatessentiallysaidthatschemespromotedbyhighlysolvententitiesneededtoincludeoptoutprovisionstoprovidepolicyholderswithcontinuityofcover.

•  Practicallythisdefeatedtheobjectiveofschemeswherecompaniesconsideringanexitwantedfullfinality,notasituationwherethemajorityofpolicyholdersoptout.ThePRAguidanceconsideredschemessuitableforinsolvententitiesandperhapswheremarginalsolvencyexists.

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PartVII–PortfolioTransfers(UK)DESCRIPTION• PartVIIoftheFinancialServicesandMarketsAct2000(FSMA)allowsforatransferofinsurancebusinessunderastatutoryandcourtprocess.Thetransferallowsaninsurerorreinsurertomoveallorcertainofitsinsuranceorreinsurancebusiness(assetsandliabilities)toanotherinsurerorreinsurerwithouttheconsentofeachandeverypolicyholderbutwiththesanctionoftheUKHighCourt.Themainstatutoryrequirementsare:1)policyholdernotification;2)areportbyanindependentexpert;3)UKHighCourtapproval;and4)noobjectionbytheFSAorotherregulatorsandinterestedparties,includingpolicyholders.• Thecourtisinvolvedthroughouttheprocessandifsatisfiedthatalltheconditionshavebeenmetwillconveneahearingtosanction/approvethetransfer.• ThetransfereemustbeaninsurancecompanyestablishedinaEuropeanEconomicArea(EEA)state.However,thetransferorcanbeauthorizedintheUK,anEEAbranchofaUKfirm,aUKbranchofanEEAfirm,anEEAfirmwithnoUKbranch,oranon-EEAthatispermittedtocarryonbusinessintheUK.

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WhyaPartVIITransfer?•  Rationalization-Combinesimilarbusinessfromtwoormoresubsidiaries,puttingall

intoasingleregulatedentity;•  Efficiency-Transferbusinessbetweenthirdparties,separatingoldliabilitiesinrun-

offfromnewbusiness,puttingeachintoseparatefirms;•  Capitalreduction–Transferbusinesstoanewfirmandextractanysurplus

shareholders’funds;•  Exit–Transferbusinesssuchasemployers’liabilitythatcannotbeschemed.

ThelegaleffectofaPartVIItransferisastatutoryunilateralnovationoftheaffectedcontractsofinsuranceorreinsurance,includinganyrightsattachingtothosecontracts.

Thetwoprimaryaspectsfortheprotectionofaffectedpartiesareasfollows:1)the

independentexpert’sreport,whichneedsonlytoconsidertheeffectonpolicyholders;and2)thecourtisrequiredtobesatisfiedthatthetransferasawholeisfairasbetweentheinterestsofdifferentclassesofpersonsaffectedbythetransfer.

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ComparisonofSchemesandPartVIITransferswithApplicableUSLaws

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RecentdevelopmentsRhodeIslandwasamongthefirststatestointroducecomprehensiveIBTlegislation,withCT,PA,&VThavingvariationsofthattheme.OKpassedalaweffectiveinlate2018.GAandILareamongthestatesconsideringoptions.

Interestisgrowinginthisarea,transactionswouldrequireregulatoryapprovals.Thisisarapidlychangingarea.PleasecontactAIRROCtofindoutlatestdevelopments

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U.S.BasedCommutationPlanStatutes/Procedures•  RecentlyRhodeIslandreviseditsVoluntaryRestructuringofSolventInsurersActasimplementedbyDBRRegulation68.Thiswas,inmanyrespects,modeledaftertheUK’sPartVIITransaction,which,subjecttocourtapproval,enablesaninsurancecompanytotransfer/novateabookofbusiness(anddivestitselfofallresidualliability),toanotherunrelatedinsurerwhichassumesallliabilitiesassociatedwiththatbusiness.Reg68isnotasbroadasthePartVIIlegislation,butneverthelesscreatesanoptionintheUnitedStatesthathadnotheretoforebeenavailable.

•  OklahomarecentlypassedtheInsuranceBusinessTransferActeffective11/1/18.

•  ConnecticutandPennsylvaniahave“division”statutesthatallowcompaniesdomiciledinthosestatestodividebooksofbusinesswithinacompanywithregulatoryapproval. 33

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OverviewoftheIBTprocessWhatisit?

•  Insurancedepartmentapprovedandcourt-sanctionedlegaltransfer(novation)ofsomeorallofthecommercialinsuranceorreinsurancerun-offbusinessofonecompanytoanothercompanyincludingattachingreinsurance.

•  TheRIIBTappliestoreinsuranceofanylineofbusinessotherthanlifeandinsuranceofanylineofbusinessotherthanlife,worker’scompensationandpersonallinesinsurance.

•  Alltransferringpoliciesmusthaveanexpirationdatemorethan60monthsfromthedateoffilingforapprovalofanIBTplanandbeinaclosedbookofbusinessorreasonablyspecifiedgroupofpolicies.

•  TheIBTisaneffectiverestructuringtoolforrun-offliabilities,providingcompleteeconomicandlegalfinalitytothetransferringcompany.

•  OklahomaIBTlaw(effective11/1/18)willapplytoalllinesofbusinessandincludein-forcepolicies.

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GeneralProceduralRequirementsforanIBTTheapprovalprocessisamulti-layered,transparentprocessthatbalancestheneedsofallstakeholders.

ThemainrequirementsforanIBTapprovalprocessinclude1) anindependentexpertreportevaluatingtheimpactofthetransferonaffectedpolicyholders;2) notificationtoallaffectedpolicyholders;3) reviewandapprovalfromtheTransferringCompany’sstateofdomicile;4) reviewandapprovalfromRIorOKregulators;5) ahearingandanopportunitytobeheard;6) reviewandapprovalbytheCourt;7) other 35

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Notfortroubledcompanies

Everycarrierhasrunoff!(It’syesterday’sunderwriting)

Bringsoperational,management,administrativeefficiencies

Restructureandconsolidateinternally

Releasescapitalforcoreornew

business

Exitfromordisposeofnon-

profitablebusiness

Reduceriskandcomplexitywithinthecompany

Deliverslegal,operationalandeconomicfinality

Welltriedprocessmodeledafter

Europe

WhyIBT?

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PotentialpitfallsforanIBT•  Somestatesmaybehostileand/orexpressconcernsregardingavoluntaryrestructuringandtransfersunderanIBT.Earlycommunicationwithotherregulatorsisquiteimportant.

•  Someinsurers,insureds,reinsurersandindustrygroupsmayopposethem.•  Whetherthetransferandcommutationplanarerespectedbyotherstateshasnotbeentestedincourt.Thereisagoodargumenttobemadethatstatesshouldgiveproperdeferencetothelegislation.

•  TheinsurerassumingbusinessunderanIBTmayberequiredtoprovidecollateralsuchasReg114trusts,lettersofcredit,etc.sothattransferringinsurermayclaimfullreservecreditforanytransferbecause:

•  Theassumingcompany(particularlyifanewdomestic)cannotbewidelylicensedduetoseasoningrequirements,andmaynothaveratingorsignificantassetsorsurplus.

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MajorCarriers

Interested

TransactionsLikely

MultipleState

Involvement

TransfersRequireHighSolvencyRatio

HighLevelofDue

DiligenceRequired

What’sNext?

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Source:PwCGlobalInsuranceRunoffSurvey,2018.www.airroc.org/pwc-global-insurance-runoff-survey

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Source:PwCGlobalInsuranceRunoffSurvey,2018.www.airroc.org/pwc-global-insurance-runoff-survey

PwC March 2018

Global Insurance Run-off Survey Slide 10

Key restructuring or exit tools to be used in the next three years

41%

Solvent scheme of arrangement

Re-domestication of business

Sale Reinsurance Insurance business transfer

All territories US

41%

Source: PwC Global Insurance Run-off Survey 2018

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CarolynFaheyExecutiveDirector703.730.2808

carolyn@airroc.orgwww.airroc.org

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