Written by Luann Petrellis
Luann is an insurance professional who specializes in developing runoff and restructuring strategies for discontinued (re)insurance businesses. Luann drafted the Insurance Business Transfer regulations for the state of Rhode Island, the first restructuring tool of its kind that enables companies to achieve finality for commercial P&C legacy liabilities. Luann also worked closely with the Oklahoma Department of Insurance to draft the Oklahoma Business Transfer Law.
According to PwC’s latest Global Insurance Run-off Survey, the size of the US runoff market is estimated at $335 billion. Respondents to PwC’s survey noted that interest in transactions, capital efficiency and potential finality solutions for run-off management in the US continue to grow. The significant levels of US run-off liability are drawing increasing attention from owners and acquirers of legacy liabilities.
This interest is borne out by the level of deal activity in the US last year. During 2018, $5bn of legacy liabilities were transacted, more than the rest of the world put together (see figure).
It is rare that run-off business is fully contained within a single subsidiary legal entity. More frequently, the business is intermingled with other core business that the company does not wish to dispose of. If only there was a way of carving out a specific subset of liabilities for disposal!
Fortunately, the regulatory tools that enable such carve-outs have arrived. As a result, more and more (re)insurers are now considering how restructuring tools could benefit their businesses, from a carve-out transaction in which a seller divests part of its business, to consolidating related business written across the group into a single entity. Business subsets targeted might include a particular customer group, product line or geographic area.
There are other companies looking to build market share by acquiring and consolidating active and legacy businesses within their existing operations. The seller typically benefits from exiting non-strategic or unprofitable lines, while the acquirer can increase scale, diversification or geographic reach.
There are two recent US regulatory developments in particular that have moved the landscape forward:
- The enabling of Insurance Business Transfers (“IBT”s) in Oklahoma, and
- Division legislation in Connecticut, Illinois, Iowa, Georgia and Michigan.
These restructuring mechanisms build on the pioneering developments in Rhode Island and Vermont and have the potential to simplify and expedite the separation of core from non-core business lines, thereby encouraging restructuring transactions.
The Insurance Business Transfer (IBT)
The Oklahoma IBT closely follows the format and processes of the UK’s much-used ‘Part VII’ transfer. Governed by state legislation and regulatory approval and supervised by the courts, it enables insurance policies of all classes, retail or wholesale, to be novated to an Oklahoma domiciled insurer from an insurer in any other jurisdiction without the individual consent of policyholders.
Sellers can establish an insurer in Oklahoma and transfer non-core business lines to the entity in preparation for a sale, or the buyer can establish an insurer in Oklahoma and receive the non-core business at closing.
The IBT approval process requires regulatory and judicial review and approval and results in a court-sanctioned novation (without the need for policyholder consent) of the transferred policies including the attaching reinsurance. The process also requires review by an independent expert who evaluates the impact of the transfer on affected policyholders, both transferred and assumed, to ensure that all policyholders are protected.
The IBT brings the transferring company complete finality for the transferred policies and is more cost effective than traditional novation that requires consent from each policyholder individually.
Transfers must be planned carefully with due consideration for implementation actions and the position of the companies after the transfer in order to avoid potential pitfalls. The key elements of an IBT are shown in the diagram. It is important to consider all key areas in the planning process and follow an overall transition approach and structure that enhances potential benefits and meets corporate objectives. With many interrelated work streams, careful project management becomes central to the success of the transfer, not only in terms of meeting important deadlines but also in ensuring that all work streams operate to deliver the required result.
Key Elements of the IBT Process
The CT, IL, IA, GA and MI Division Legislation
In 2017 Connecticut passed division legislation that allows a domestic insurer to divide into two or more “resulting insurers” and allocate assets and obligations, including insurance policies, to the new companies. Since then Illinois, Iowa, Georgia and Michigan have passed similar legislation.
Essentially, division legislation is a de-merger, requiring only regulatory approval of the plan of division. It is expected that any new entity created by a division will need to be merged with an entity holding the necessary state licenses or merged into a shell company. The receiving company could be another group company, in the case of an intra-group restructuring, a shell company to be sold or an existing company owned by a buyer.
The legislation may enable a company to restructure its business and operations into separate insurers, either to promote operational efficiencies or to position for sale to a third party. The legislation applies to any type of business and is not limited to closed blocks. Each resulting insurer is responsible individually for policies and other liabilities allocated to it under the division plan. The plan of division cannot become effective unless it is approved by the chief insurance regulator after reasonable notice and a hearing, if the regulator determines notice and hearing are in the public interest (a hearing is required in some states). Although the division legislation allows a company to segregate its business, it must be combined with a subsequent sale or an IBT to achieve legal finality.
Planning and Organization
Transparency, optionality, and speed of execution are critical to maximizing deal value. The flexibility to execute deals via alternative structures, such as the IBT and division legislation, helps maintain optionality.
Transactions must be structured to ensure policyholders are protected – regulators will be focused on the successor company being adequately capitalized, with appropriate management, governance and oversight.
In the initial stages, regulators can rely on existing statutory and regulatory guidelines to review capital and solvency requirements with the discretion to require additional capital or reinsurance protections to receive regulatory approval. But, as experience with these tools grow, a modus operandi for US transactions will develop and US regulators may develop additional guidelines for capital and solvency requirements as more transactions are affected and experience is gained. For any transfer of business, state licensing requirements and guarantee fund issues must be considered to ensure regulatory compliance in all states where policies have been issued.
To facilitate speed of execution, executives need to focus simultaneously on multiple priorities, including deal execution, separation planning, and negotiation of transitional service agreements. Leading practices include having a transaction committee that can rapidly make decisions, a project office that guides the planning effort, and the use of external advis0rs with deep expertise in insurance transactions to support and guide the in-house transaction team.
Following a recent succession of P&C and reinsurance megadeals, it is predicted that insurance industry transactional activity will continue. Multi-line insurers have divested themselves of numerous franchises over the last 3 to 4 years and this trend seems likely to continue. The new legislation that is emerging in several states can provide more efficient restructuring tools for companies to achieve operational and capital efficiencies as well as legal finality and will catalyze further activity in this area. However, transactions using these new regulatory tools are complex and depend on many internal and external factors. Working with an experienced adviser to help your organization through the process will pay dividends and ensure success.
Case Study: Lloyd’s of London and Equitas – Finality for Names
A UK Insurance Business Transfer was a crucial, final component of the reconstruction and renewal plan that saved the Lloyd’s of London insurance market in the 1990s that was in financial peril due to asbestos exposures. In the first stage, all 1992 and prior liabilities, including extensive US asbestos and environmental losses, were reinsured to the newly created vehicle, Equitas. It was not until Berkshire Hathaway became involved and a UK Insurance Business Transfer legally removed the liabilities away from the original names, that they at last achieved finality.
Case Study: A group reorganization
One of the largest insurers in the UK wanted to rationalize its general insurance business. Over time, it had accumulated 12 insurance entities with each requiring separate governance, report and accounts, and capital. The group used a UK insurance business transfer to consolidate into a much simpler structure with three entities, including one primary entity for general insurance underwriting, an entity for legacy liabilities and a white-label carrier.
Case Study: A sale of legacy liabilities (1)
A large US insurer wished to dispose of legacy operations in the UK but these operations were split across 4 different entities, one of which was not even part of the group. Using a UK business transfer, it was able to package all of the liabilities for sale into a single entity creating a simpler proposition for a share sale and thereby maximizing value.
Case Study: An accelerated transaction
A large UK insurer sought to transfer a portfolio of legacy liabilities and timing was a primary consideration. The company was able to arrange a reinsurance protection from a legacy consolidator providing the economic transfer in the required timeframes. It then followed up with a UK business transfer to ensure legal finality, completing the deal and giving the buyer full control.
Case Study: A sale of legacy liabilities (2)
A large UK insurer wanted to improve its capital position by disposing of a subset of liabilities written prior to 2005. It found a suitable purchaser and used a UK Insurance Business Transfer to transfer the liabilities directly. The counterparties were able to coordinate their activities so that the transfer of the sale portfolio coincided with a consolidation of the purchaser’s own entities, maximizing the efficient use of capital.
This article was first printed inThe Demotech Difference, Summer 2019.