Ian Marshall, Managing Director in our Insurance team, discusses the first solvent scheme of arrangement sanctioned under the UK's dual PRA/FCA regime. A solvent scheme of arrangement for reinsurance business in run-o a solution thought dead by some was sanctioned by the English courts on 3 May 2016.

This scheme, for which FTI Consulting acted as principal business adviser, is for a UK subsidiary of one of the Japanese insurance groups and is the first to be approved in the UK for several years.

Why a solvent scheme of arrangement?

The primary purpose of a solvent scheme of arrangement as applied in the insurance world in the UK is to value and settle all remaining claims and to cut off future liability. The cut off is achieved by imposing a bar date after which claims can no longer be submitted. The counter balance to this significant change in ability to make claims is that approval by claimants, regulators and the court is required. These hurdles require significant effort to:

  • frame proposals which are likely to be supported;
  • manage the creditor population to be as certain as possible that creditors will vote for the scheme; 
  • value the votes; and
  • prepare evidence for regulators and the court that all necessary steps have been taken.

Prior to its cessation in April 2013, the FSA (the previous regulator of the insurance industry) appeared to have suspended schemes of arrangement for solvent companies so it could reconsider its approach. This led to the PRA issuing a consultation paper in September 2013, followed by its Supervisory Statement SS3/14 in April 2014, which said that it may not consider such schemes as compatible with its statutory objectives. It also introduced the concept of policyholders being provided with an `appropriate degree of continuity of cover'.

This scheme had to achieve the twin objectives of satisfying the PRA's approach to schemes of arrangement set out in the Supervisory Statement and the scheme company's objectives.

The PRA provides no written guidance as to what is meant by `appropriate' and on the face of it such cover is incompatible with the concept of a scheme imposing a bar date on the making of further claims.

Satisfying the Client and the Regulators

This scheme had to achieve the twin objectives of satisfying the PRA's approach to schemes of arrangement set out in the Supervisory Statement and the scheme company's objectives.

Our client sought ways to conclude as much of the remaining run off as possible and to then dissolve the company. By concluding the claims run off, the company benefits from greater certainty regarding future reserving and reduces the administrative cost of dealing with claims for years to come. The dissolution is primarily to release trapped capital, heightened by Solvency II requirements should the company continue as a standalone entity. The Solvency II benefits are twofold. Firstly, by eliminating reserves for all known claims on known policies the capital needed to support insurance liabilities is greatly reduced. Secondly by releasing all the company's capital to its parent, this can support other parts of the group's business.

On the other hand the PRA's requirement of providing policyholders with continuity of cover for the risks against which they are insured creates a potential conflict with the finality objectives.

A duo of firsts

The solution to these conflicting requirements was to develop a scheme of arrangement which provides continuity of cover and which is then implemented in conjunction with a Part VII insurance business transfer scheme. Both of these features are believed to be firsts in the UK.

So how could continuation of coverage work whilst still valuing and cutting off the claims tail? In this case the reinsurance run off had been in progress for 30 years, yet there were still open liabilities for LMX catastrophe losses and US source long tail claims. No new LMX catastrophe loss claims have been reported for many years, but the long tail claims are still developing, giving rise to the possibility of fresh claims. Despite the age of the run off, copies of slips for most of the business existed as rudimentary unindexed scanned images.

The Solution: (1)

To develop the continuation of coverage concept two concepts were examined. Firstly on the policy side we had to determine if the rudimentary images could be assembled back into individual slips to identify the reinsured and type of business. This meant we had to identify the reinsurance slips from the overall population which included several thousand direct policies.

We converted each image to an OCR file and then searched for key words relating to reinsurance in several languages. The end product was a schedule of several thousand policies by reinsured. However, there was no means of knowing that all policies ever issued were found. Therefore, the first solution in providing continuation of coverage was to limit the scheme to the known policies relating to those policyholders that could be located.

So, if a cedant reports a claim in the future on a policy not identified in the scheme, this claim will not have been cut off in the scheme and would be paid in the ordinary course of business.

The Solution (2)

The second concept required identifying the claims profile by type of claim, which we analysed to produce known types of claim subject to the scheme.

The analysis revealed that the claim types fall into two categories. Firstly there are LMX catastrophe claims. Since it is not possible for a new LMX property risk catastrophe from the 1980's to emerge today, all are subject to the scheme as known types of claim. Secondly there are long tail mostly US source liability claims. We defined the long tail claims by providing in the scheme documents the definitive list of the types of such claim subject to the scheme. The scheme deals with all the defined known types of claim. Any new claim type which might be reported in the future will not have been cut off in the scheme and these will therefore be subject to the continuation of coverage, even if the new claim type is reported on a known policy.

The knowns and unknowns

These twin solutions, whereby the scheme deals with known policies and known types of claim, provide a response to some of the past criticisms of schemes.

The scheme is definitive as to the policies to which it applies, and does not seek to force unknown policies and unknown types of claim to be cut off. The scheme does cut off all liabilities of which the company is aware. on a Solvency II basis, the only claims not dealt with will be the "events not in data" as these represent the unknown types of claim. The result should be a significant reduction in the solvency II capital requirements.

Implementing continuing coverage

To implement continuing coverage, the scheme documentation had to include information which had not been typically provided to scheme creditors. On the known policy side this meant providing all policyholders with their own unique lists of policies reinsured by the company. These were the known policies subject to the scheme and removed any uncertainty to policyholders identifying these policies.

On the claims side, we provided a list of all the claim types which were dealt with by the scheme. Again this removed any uncertainty as to the types of claim dealt with in the scheme, leaving any that might emerge in the future still covered.

Part VII transfer

The solvent scheme deals with part of the exit strategy. Because of the continuing coverage the scheme company would not be able to be dissolved. Therefore a Part VII transfer was implemented. This was sanctioned by the court immediately after the approval of the solvent scheme, and moves all the policies to the parent company, together with the now effective scheme of arrangement. The result is that the continuing coverage is being provided by the parent company and the scheme company will be dissolved. In turn all capital will be released and, for the group, reporting and regulatory requirements will be simplified with one less entity to deal with.

What does this mean for the insurance run-off market?

There is unlikely to be a return to the days of multiple solvent schemes. The mechanism described in this article will be less suited to a business recently put into run off or for direct insurance. But this transaction shows that in appropriate circumstances a solvent scheme of arrangement can deal with all known liabilities, but still provide a mechanism for unknown claims to be presented after the scheme has ended. This should achieve a better balance between the interests of insurer and policyholder.

What is the view of policyholders?

Clearly to have been sanctioned the scheme had to have been supported by the vast majority of claimants, including US based entities. However it does appear that some policyholders will continue to oppose schemes. Therefore it remains important to understand the claimant profile at an early stage of scheme implementation.

Solvent schemes have come a long way since the early ones in the 1990's. Historically schemes which developed from those early transactions had terms which were generous to policyholders, but dealt with all types of business to schemes either with terms such as to be, or which were implemented in ways somewhat unfriendly to policyholders.

This case shows we have returned to schemes with terms much more favourable to policyholders, and should help future schemes achieve the triple hurdle of policyholder, regulatory and court approval. This is particularly important in the current era of regulatory focus on conduct risk, which itself should rule out unfair schemes in the future.

It must be right that policyholders should expect not to be unfairly treated in the solvent scheme process, but reinsurers in run off should be able to manage their exit from the business through access to a variety of solutions.

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