In response to an imminent Order of Liquidation against the Kemper Insurance Companies, we have prepared the following “frequently asked questions” guide summarizing issues related to: (i) the financial regulation of insurance companies; (ii) the liquidation and proof of claim process in Illinois; (iii) potential recovery by policyholders of the amount of “covered” workers’ compensation claims from state guaranty associations; (iv) policyholder collateral; and (v) planning a response to the Kemper liquidation.1

I. FINANCIAL REGULATION OF INSURANCE COMPANIES

Who regulates the financial condition of insurers?

Each state has a regulatory agency, in the form of the State Department of Insurance, which is responsible for monitoring the financial health of insurance companies authorized to do business in the state. When the Director of the Illinois Department of Insurance (the “Director”) determines a company is in financial trouble, the Director is empowered by law to take appropriate steps to protect the policyholders and claimants of the company.

What action is the Director authorized to take?

Depending on the severity of the problem, the Director can take a variety of corrective actions. These may include one of three Orders: an Order of Suspension, an Order of Rehabilitation or an Order of Liquidation. Historically, a finding of insolvency by state regulators has triggered one of these Orders. However, in 2003, when the Illinois Department of Insurance determined that the surplus for the Kemper Group of Insurance Companies had reached the “mandatory control level” (as defined in 215 ILCS 5/35A-5) at the end of 2002, the Director did not seek such an Order. Rather, as of early 2003, Kemper began operating under a series of confidential corrective orders. Since March 19, 2004, Kemper has been operating under a voluntary, but confidential, plan of run-off (the “Kemper Run-Off Plan” or the “Plan”) and remains subject to the Director’s supervision. Although the details of the Kemper Run-Off Plan remain confidential, certain aspects of the three-year plan were made public. As discussed below, an Order of Liquidation will end the Kemper Run-off Plan.

Do federal bankruptcy laws apply to an insurer insolvency?

Because insurance is a state regulated industry, federal bankruptcy laws do not apply to insurers. Rather, when an Illinois insurance company such as one of the Kemper companies becomes insolvent and is ordered into liquidation, the company’s estate is administered by the Director as Liquidator, and overseen by the appropriate state court.

II. THE LIQUIDATION AND PROOF OF CLAIM PROCESS

What is a liquidation?

If the Director does not believe a company’s financial problems can be corrected and that continued operation of the company would be harmful to the company’s policyholders and creditors, the Director can seek an Order of Liquidation from the appropriate state court. Under an Order of Liquidation, the Director is appointed as the Receiver of the company to manage the liquidation process. The Director is assisted by the Office of the Special Deputy Receiver (“OSD”). After the court issues the Order of Liquidation, the OSD takes possession of the company’s offices, records, equipment and assets. A notice is sent to all policyholders and claimants informing them of the company’s liquidation and the steps they must take to file a claim against the company’s estate. The policyholders and claimants will also be informed that a guaranty association may handle the future processing of claims. The Receiver will work to marshal the assets of the company, including the collection of contractual balances (i.e., deductibles, deferred premium, retrospective premium and dividend recaptures) due from policyholders.

What is a proof of claim?

Policyholders will receive, and must complete, a proof of claim for all known claims against the insolvent insurer. A proof of claim consists of a notarized written statement setting forth the details of the claim and includes documentation in support of the asserted claim. To assert a claim against an insurance policy issued by Kemper, the claim must be based on a known loss or occurrence. The Receiver will establish a claim filing deadline for filing proofs of claim against Kemper. If a proper proof of claim is not received by this deadline, the policyholder will not have a timely filed claim and the policyholder’s chances of participating in any distribution of estate assets or benefiting from guaranty association recovery for such claim(s) will be greatly diminished.

How do policyholders get a proof of claim form?

The Receiver likely will mail proof of claim forms to all Kemper policyholders. The proof of claim form should also be available on the Web site of the OSD at http://www.osdchi.com/loss_accident_form.htm.

What is a claim filing deadline?

The claim filing deadline is the last day on which the Receiver may receive a proof of claim and accept it as timely filed for purposes of any distribution of estate assets. Typically, the claim filing deadline is one year from the day the Order of Liquidation is entered.

What is the process for filing a claim for a previously unreported claim?

The policyholder should contact both the OSD and the appropriate guaranty association. The OSD will likely mail the policyholder a proof of claim form (within six months) so that the policyholder may file the previously unreported claim against Kemper. Such a proof of claim, however, remains subject to the claim filing deadline set by the Receiver. If the initial proof of claim filed with the Receiver is properly drafted, it may be possible to argue that any unreported claim is covered by the contingent claim section of the initial proof of claim.

What happens if a proof of claim is not filed prior to the claim filing deadline?

If good cause exists, a proof of claim may be filed with the Receiver after the claim filing deadline and the claim will be treated as timely filed. If good cause does not exist to excuse the late filing, then the latefiled proof of claim may participate in distributions of company assets, if at all, only after all allowed timely filed claims of general creditors have been paid in full.

May I file a proof of claim for unknown or contingent claim?

Policyholders may also submit a policy-specific proof of claim for each policy issued by Kemper for contingent (i.e., “unknown” or “policyholder protection”) claims against the Receiver. A contingent claim is one where the occurrence or loss took place, but a determination of the policyholder’s liability for that loss or occurrence was not made at the time the Order of Liquidation was entered.

What is a contingent claim date?

To participate in a distribution of the estate at level (d) of the priority schedule, a policyholder having a contingent claim must first file a proof of claim prior to the claim filing deadline and then pay the claim asserted against it out of its own funds and provide evidence of such payment prior to the contingent claim date. This is also referred to as “liquidating a claim by actual payment.” As a result, it is important to establish a system to provide notice to the Receiver of any payments made with respect to contingent claims. The contingent claim date is set by order of the court supervising the receivership (the “Supervisory Court”) and is the last date that the Receiver may receive evidence demonstrating that such a payment was made. If a policyholder’s claim is not liquidated by actual payment on or before the contingent claim date, the claim may be still allowable at priority level (e).

Do any other entities require the filing of a separate proof of claim?

As mentioned above, some guaranty associations have separate proof of claim forms, and the proof of claim filing deadline may be different, and shorter, than the deadline established by the Receiver or the Supervisory Court.

When is a distribution made by the Receiver?

If there are sufficient assets in the liquidation estate, the Receiver will seek court approval to make a distribution of Kemper’s assets. A distribution of assets may occur only after all of the insurer’s liabilities have been determined with a high degree of certainty. Furthermore, a distribution to policyholders may occur only after distributions have been determined to satisfy the following obligations: (i) administration costs; (ii) secured claims; and (iii) debts due employees. In summary, distributions of the remaining assets of the estate are made by priority level and are made on a pro-rata basis, meaning that each allowed creditor at the same priority level receives payment at the same percentage of its claim. Given the complexity and overall size of the Kemper estate, policyholders should be prepared for lengthy liquidation proceedings. It is possible that the Receiver may seek approval to make “interim” distributions of remaining assets.

What special considerations exist for policyholders with captive reinsurance structures?

Policyholders whose Kemper programs are reinsured in captive facilities should consider the impact of a potential Kemper liquidation on such reinsurance. As an initial matter, insureds must determine whether their reinsurance structure includes a “cut-through” provision. A cut-through provision allows a party not in privity with the reinsurer (i.e., the insured-employer) to have direct rights against the reinsurer under a reinsurance agreement. These cut-through rights generally are limited and are triggered only by specific events enumerated in the cut-through provision. Cut-through provisions may take the form of a specific clause or an endorsement attached to the reinsurance agreement. A cut-through provision often makes the underlying insured a beneficiary under the contract. Thus, a reinsurer usually will draft the cutthrough provision so that when the reinsurer makes payments to a third party, the reinsurer will not be required to make payments to the reinsured or to a statutory receiver. Absent a cut-through provision, reinsurance proceeds will likely become a general asset of the Kemper estate, thereby exposing the insured/captive reinsurer to potential “double” liability for its losses. Even where a cut-through provision is present, the Receiver may not find the provision to be valid. If a cut-through provision is not present, or not enforced, the standard insolvency clause included in virtually every reinsurance contract (providing that the reinsurer must pay the reinsurance proceeds to the Liquidator based on the liability of the ceding company regardless of whether the Liquidator has paid or ever will pay the claim) also puts the captive at risk of having to pay the Receiver for reinsured claims. Furthermore, as discussed below, collateral held by Kemper to secure reinsurance obligations under a captive reinsurance program may also become a general asset of the Kemper estate.

III. STATE GUARANTY ASSOCIATIONS2

What are guaranty associations?

Guaranty associations are nonprofit organizations created by statute for the purpose of protecting policyholders from severe financial losses and preventing delays in claim payment because of an insurer’s insolvency. They do this by assuming responsibility for the payment of claims that would otherwise have been paid by the insurer had it not become insolvent. Each state has one or more guaranty association(s), with each association handling certain types of insurance. Insurance companies are required to be members of the state guaranty association as a condition of being licensed to do business in the state. How do guaranty associations obtain funds?

Guaranty associations obtain funds for their operations and payment of claims through assessments against the solvent insurance companies licensed to do business in the state and from the recovery of amounts paid on claims from the insolvent estate.

Do states have more than one guaranty association?

There are different types of guaranty associations. Some guaranty associations handle only claims related to life and health insurance. Some deal only with property and casualty insurance claims. Others address only workers’ compensation claims or other special lines of insurance. Although guaranty association laws are somewhat similar from state to state, significant differences do exist. For this reason, it is critical to determine which state guaranty association has responsibility for a policyholder’s particular claim, as this will affect not only where a claim must be filed but also whether that type of claim is “covered” and the maximum (if any) amount that the guaranty association will pay for a “covered” claim.

What happens to open claims?

During a Liquidation proceeding, the Receiver will transfer open claims to the appropriate state guaranty associations. Open workers’ compensation claims, for example, are transferred to the guaranty association in the state in which the employee was injured. Other (i.e., non-workers’ compensation) claims are transferred to the guaranty association in the insured’s state of domicile. The associations will evaluate the claims and determine which claims (if any) are “covered” claims that should be paid or settled with association funds. Claims are typically transferred to state guaranty associations in this manner regardless of whether the claims are potentially “covered” claims. For example, even claims within a policyholder’s deductible or Self-Insured Retention (SIR) are generally transferred to the appropriate state guaranty association. Attempts to maintain control over the administration of claims (including claims for which the policyholder has no protection) are often unsuccessful. Rather, state guaranty associations typically will contract with their own Third Party Administrator (TPA), or in some states use internal claims staff, to administer open claims against Kemper. The policyholder will be invoiced for amounts paid to claimants that are not “covered” by the state guaranty association.

Who pays the claims handling expenses?

Under the National Association of Insurance Commissioners (“NAIC”) Property and Liability Insurance Guaranty Association Model Act (the “NAIC Model Act”), the administrative expenses arising out of or related to the claims of the insolvent insurer and the overall liquidation process are generally charged against the estate of the insolvent insurer, thereby reducing the assets available for distribution to policyholders.

What requirements have to be met for a claim to be a “covered” claim?

In general, with some variation from state to state, to be “covered” by a guaranty association, at a minimum the claim must:

  • Be unpaid - The claim must not have been previously paid by Kemper or another party  
  • Exist before the insolvency or arise within 30 days after the Order of Liquidation  
  • Be on a policy written by a Kemper company that was licensed to do business in the state, and in a line of business covered by the guaranty association. Policies sold by Kemper companies that were not members of the guaranty association are not covered  
  • Be brought by a claimant or policyholder who is a resident of the state  
  • Be filed with the guaranty association before the claim filing deadline (which may or may not be the same claim filing deadline set by the Receiver)  
  • Not be covered by other insurance. If there is other insurance from which the policyholder’s claim can be paid, such insurance must first be exhausted before the guaranty association will pay any portion of the claim.  

Are all workers’ compensation claims “covered claims”?

Workers’ compensation claims are generally covered claims. With notable exception (such as California, where up to $500,000 of excess workers’ compensation claims submitted by qualified self-insured employers are covered), claims arising under excess workers’ compensation policies are generally not covered (as workers’ compensation) claims. Claim amounts within a policyholder’s deductible or SIR are likewise excluded. Furthermore, as discussed below, the majority of guaranty associations exclude from their protection (or may require reimbursement for amount paid on behalf of) certain policyholders whose “net worth” exceeds a specified amount. Even in states in which a net worth or other exception does not exist (or is not enacted), administrative efforts continue to scale back or otherwise limit recovery available to large commercial insureds.

What are “net worth” exceptions?

With notable exceptions such as California, Florida and New York, guaranty association laws in most states include provisions that exclude large commercial insureds and large third-party claimants from the class of “covered” claimants. More specifically, most states exclude from their protection certain insureds whose “net worth” exceeds a specified amount, usually $25 or $50 million. Note that the term “net worth” does not refer to the general financial status or profitability of the insured. Rather, an insured’s “net worth” generally is the remainder that is left after liabilities are deducted from assets. As a general rule, an insured’s net worth equals the aggregate of the net worth of the insured and all of the insured’s subsidiaries and affiliates. Of the guaranty association acts that contain a net worth provision, roughly half contain the NAIC Model Act provision, which gives the association the right to seek reimbursement from an insured for third-party claims paid on behalf of that insured if the insured’s net worth exceeded $50 million as of December 31 of the year preceding the date of the Order of Liquidation. It is noteworthy that both the National Conference of Insurance Guaranty Funds (“NCIGF”) and the NAIC (in the form of the NAIC Model Act) have recommended that all states enact a $25 million net worth exception for first-party claims (and a $50 million net worth “reimbursement” provision) precluding recovery by large commercial insureds.

What happens if a claim is not a “covered” claim?

The policyholder may file with the Receiver a claim for the unpaid portion of such claims. As described here, if sufficient assets remain following the liquidation proceeding, the Receiver will seek court approval to make a distribution of Kemper’s remaining assets to policyholders for such unpaid claims at priority level (d).

Do policyholders need to file claims with both the Receiver and the guaranty associations?

The claims filing process differs from state to state. In some states (and under the NAIC Model Act), the policyholder needs to file a claim only with the Receiver and it is automatically considered to be filed with the guaranty association. In other states, policyholders must file the claim separately (and satisfy a separate deadline) with the Receiver and the appropriate guaranty association. It is important that the policyholder carefully reads all information received and follows the instructions provided. Even where notice to the guaranty association is not required, it is recommended that a “courtesy” notice be provided to the appropriate guaranty association.

Can a policyholder file a claim with more than one guaranty association?

The state guaranty association system is intended to assign a given claim to only one guaranty association. In rare instances, one association may have primary responsibility for a claim and another association have secondary liability. In such cases it may be possible to file a claim with both associations. In any event, the total amount paid cannot exceed the amount of coverage provided under the policy.

How long will it take for the guaranty associations to pay claims?

The amount of time it takes for a guaranty association to pay a claim can vary widely depending on a number of factors, but claim payments usually begin as soon as possible following the Order of Liquidation. A period of 60–90 days is not uncommon. Because Kemper claims are currently administered by TPAs, the amount of time needed to get all claim information might be extended as files are gathered from such TPAs and transmitted to the guaranty associations. Note, however, that to the extent possible, the Liquidator will likely “pre-pay” workers’ compensation benefits for a period of 4–8 weeks to allow adequate time for the guaranty associations to process claims files.

In general, what should policyholders expect when dealing with state guaranty associations?

Significant procedural requirements and statutory limitations are imposed on recovery from state guaranty associations. Policyholders should expect that the entire claims process will become more complicated and more expensive. Certain policyholders should expect to receive significantly less for their claims than they would have otherwise from Kemper. Others should expect to “reimburse” guaranty associations for claims amounts paid on their behalf. Recovery is further complicated where the policyholder operates in multiple states. Accordingly, potential recovery from guaranty associations requires a critical state-specific analysis in all states in which the policyholder has open claims.

What happens to existing litigation?

If Kemper is already defending the case, the guaranty association will take control of the case and will continue to defend or negotiate a settlement on the policyholder’s behalf. The defense and amount of coverage provided will be on the same terms and conditions provided for in the insured’s policy. Generally, state law allows a stay of the litigation for some period of time to allow the guaranty association to assume control of the defense of the case.

IV. POLICYHOLDER COLLATERAL

What happens to policyholder collateral securing deductible obligations during a liquidation?

Under Illinois insurance law, collateral used to secure obligations under a deductible agreement with an insolvent insurer shall be used to fund or reimburse claims payments within the agreed-to deductible amount and shall not be considered an asset of the estate. In other words, such collateral held by Kemper cannot be used to pay claims of other policyholders or creditors, or to defray the Receiver’s general administrative expenses.

Can insureds continue to administer their own claims?

Under Illinois insurance law, policyholders with deductible reimbursement agreements who are entitled to use collateral funds to fund their own claims (either through self-administration or through a third party) within the deductible amount pursuant to a deductible reimbursement agreement may be permitted to do so as the Liquidator is “entitled” to enforce such obligations. If permitted, the funding of any of these claims by the policyholder within the deductible amount, including, but not limited to, any of these claims by the policyholder or the third-party claimant, will bar a claim for that amount in the liquidation proceeding and extinguish the obligation, if any, of any guaranty association to pay these claims.

What happens to policyholder collateral securing “other” obligations during a liquidation?

Collateral held by Kemper to secure “other” obligations, such as reinsurance obligations under a captive reinsurance program or adjustable premium obligations under a retrospectively rated insurance policy, may become a general asset of the Kemper estate. The Receiver will likely implement an “allocation plan” whereby policyholder collateral is equitably allocated among the policyholders’ deductible and these “other” obligations. This allocation plan must be filed with the Supervisory Court. Insureds should be aware of the accounting treatment Kemper may have been giving collateral funds and special program features that may convert collateral or loss payments into premium, thereby jeopardizing the protection of such funds during the Kemper liquidation proceeding.

Is the Receiver obligated to review and/or adjust policyholder collateral during a liquidation?

The Receiver must review and adjust the collateral annually, but is entitled to retain an amount sufficient to secure the “entire estimated ultimate obligation of the policyholder plus a reasonable safety factor” and may not return the collateral until all covered claims have been paid and the Receiver is satisfied that no new claims can be presented.

What administrative fees may be charged against policyholder collateral during a liquidation?

The Receiver is entitled to deduct up to 3 percent of the amount the Receiver actually collected from the amount of reimbursements owed to guaranty associations and/or policyholders or collateral to be returned to a policyholder for reasonable expenses incurred in fulfilling the Receiver’s responsibilities.

If a policyholder entered into a disengagement transaction with Kemper, can it be set aside as a “preference” during liquidation?

Illinois insurance law protects the types of disengagement transactions that insurers like Kemper execute with policyholders (during run-off) from later being set aside. Where the Director approves a prereceivership transfer (including a disengagement transaction such as a novation and/or a buyback) by the insurer in writing, such a transfer cannot later be found to constitute a prohibited or avoidable transfer based solely upon a deviation from the statutory receivership payment priorities. However, such a deal can still be challenged for other reasons, such as fraud.

IV. RESPONDING TO THE KEMPER LIQUIDATION

What steps should a policyholder take to respond to a Kemper liquidation?

  • Know your Exposure  
    • Prepare a chart identifying the coverages, limits, deductibles, SIRs, premium deferral plans, collateral obligations and other key financial terms of programs issued by Kemper.  
    • Ensure that you have proper documentation (i.e., insurance proposals, forms, endorsements, invoices and all related agreements) from Kemper for all years.  
    • Be aware of related merger and acquisition (M&A) activity and any Kemper exposures that you may have “inherited” through M&A activity.  
  • Understand your Collateral Position  
    • Prepare a summary of all outstanding collateral posted with Kemper to secure all policyholder obligations.  
    • Allocate “categories” of collateral by type of obligation secured (i.e., deductibles, dividend plans, retro and deferral premiums, reinsurance arrangements, etc.). Confirm these allocations under the terms of your insurance agreements and with Kemper.  
    • Be aware of the accounting treatment Kemper may be giving these funds and special program features that may convert loss payments into premium.  
  • Plan and Prepare Your Response to the Kemper Liquidation  
    • Engage experienced counsel at the onset.  
    • As soon as possible prepare a written plan detailing your response to a Kemper liquidation.  
    • Understand the liquidation process and related deadlines.  
    • Analyze potential recovery from applicable state guaranty associations and establish communication with these funds as soon as possible.  
    • Analyze potential recovery from second injury funds.  
    • Be prepared to file proofs of claims with the Illinois Receiver and applicable state guaranty associations.  
    • Understand the impact of a Kemper liquidation on any captive reinsurance structures involved in your Kemper Program.  
    • Understand the accounting implications of a potential Kemper liquidation and resulting liabilities.  
    • Identify internal personnel responsible for satisfying requirements and tracking the Kemper liquidation process.