Rhode Island’s Voluntary Restructuring of Solvent Insurers Act (the Restructuring Act),1 modeled after similar acts long popular in the United Kingdom and Bermuda, allows financially solvent domestic insurers and resinsurers to commute run-off business by paying policyholders an estimated value of their claims in exchange for extinguishing their right to make future claims. The Rhode Island Superior Court, in In Re GTE Reinsurance Co. C.A. No. PB 10-377 (R.I. Super. Ct. April 25, 2011) (Silverstein, J.), recently ruled that the Restructuring Act violates neither the Contracts clause nor the Due Process Clause of the Rhode Island and United States Constitutions. Although this decision puts Rhode Island at the forefront in developing UK-style commutation schemes, it remains to be seen how the Rhode Island Supreme Court will resolve the constitutional challenges presented by the objectors on appeal.

Rhode Island’s Voluntary Restructuring of Solvent Insurers Act

The Restructuring Act was enacted in 2002 in response to the governor’s Insurance Development Task Force. The Task Force was created “to develop a legislative and regulatory agenda to establish Rhode Island as a highly competitive state in which to domicile companies in one or more segments of the insurance industry.”2 The Restructuring Act became effective in 2004 after the promulgation of Insurance Regulation 68 (Reg. 68) by the Insurance Division of the Rhode Island Department of Business Regulation (DBR).

The Restructuring Act allows a solvent commercial insurer or reinsurer that has ceased writing a category of business, but still remains liable under policies already issued, to commute those liabilities for the payment of a lump sum to its creditors. This is particularly enticing for insurance or reinsurance companies who have discontinued books consisting of a large number of occurrence based coverage, and for claims with long-tail liabilities such as asbestos and pollution. In these instances, a “run-off” can last years and tie up a considerable amount of capital.

Under the Restructuring Act, a commercial property and casualty company that is in run-off can commute payments of future liabilities. The applicant insurer or reinsurer must be domesticated in Rhode Island or else re-domesticate to the state prior to filing the application. An applicant must first submit a commutation plan to the DBR,3 which will review the plan and make recommendations and changes for the protection of creditors. If the applicant accepts DBR’s recommendations, then it must then apply to the Superior Court for a Meeting of Creditors. An implementation order from the court is contingent upon the applicant receiving approval from fifty percent of each class of creditors and seventy-five percent of the value of the liabilities owed to each class of creditors.4 After the necessary votes are obtained, the applicant has thirty days to petition the court for an implementation order. The order will be issued if the court determines that the plan would not materially adversely affect either the interests of the objecting creditors or policyholders.5 After the implementation order is issued, creditors are enjoined from pursuing claims against the commuting company and a date is set by which no new claims may be submitted.6

In Re: GTE Reinsurance Co.

In 2004 GTE Reinsurance re-domesticated to Rhode Island and became the first company to submit a proposed commutation plan to the DBR. The DBR reviewed the proposed commutation plan and recommended changes to GTE. GTE made the requested revisions and initiated an action in Rhode Island Superior Court seeking implementation of the commutation plan on June 28, 2010.7

On November 30, 2010, the Meeting of Creditors was held at which thirty-four of GTE’s thirty-nine creditors approved the plan, representing 87.18% of the single class of creditors and 97.37% of the value of liabilities.8 Five creditors objected on the grounds that GTE’s commutation plan formula undervalued their claims by almost $300,000.9

In the Superior Court proceedings that followed, the objecting creditors alleged that the Restructuring Act violated the Contracts Clause of the United States and Rhode Island Constitutions by altering or substantially impairing its right to indemnification by GTE for the actual value of all present and future claims. They argued that the central purpose of their treaties with GTE was to shift the risk from one party to the other, but the commutation plan abrogated this purpose by forcing them to accept a “potentially insufficient sum of money” in compensation for having that risk transferred back upon the objectors.10

The court turned these constitutional arguments aside, noting that the central purpose of the contract was “about the right to receive, and the obligation to make, a monetary payment when a claim arises.”11 The court then found that the claimed impairment of contract rights was not sufficient to establish a violation of the Contract Clause:

The mere fact that... the Commutation Plan may expose the [objecting creditors] to some risk that those payments will amount to less than their actual claims, does not constitute substantial impairment of the obligations under the [objecting creditors’] Treaties and is insufficient to violate the Contract Clause.12

The court further concluded that the objecting creditors’ contractual expectations should have been tempered by the prospect of future regulation in the insurance industry, citing previous U.S. Supreme Court precedent holding that where contractual rights are already subject to regulation, further regulation is foreseeable and may not constitute a substantial impairment of contractual rights.13 Expanding on this notion, the court noted that the objecting creditors should have anticipated the possibility of a solvent scheme arrangement because the treaties were originally entered into when GTE was domesticated in Bermuda, and Bermuda law had already recognized solvent schemes. The court likewise observed that any reliance on the lack of such procedures under Rhode Island law would have been unjustified because the insurance industry in Rhode Island is a highly regulated industry due to its recognized importance to the public interest.14

The court concluded that even if the objecting creditors experienced a substantial impairment, Rhode Island’s strong public interest in stimulating its economy by attracting new business is a legitimate public purpose that justifies any substantial impairment of contracts, and the Restructuring Act is reasonably necessary to advance that interest. Furthermore, the court noted that DBR has sufficient safeguards in place to protect the interest of creditors and cedents.15

Questions Moving Forward for U.S. Markets

Despite the Rhode Island Superior Court’s decision, it is far from clear whether U.S. markets will embrace solvent schemes. Strong arguments have been advanced on both sides of these of these arrangements. On the one hand, solvent schemes provide predictability to insurers and reinsurers seeking to commute liabilities by allowing these companies to liquidate liability and determine an endpoint for discontinued lines of business. Creditors likewise receive the benefit of quicker payment on claims where their existing exposure is known, or where the risk of future exposure is relatively low.

These perceived benefits, however, are not universally acknowledged, even in jurisdictions with well-established solvent scheme procedures. For example, in In Re British Aviation Ins. Co., [2005] EWHC 1621 (Ch) (Eng.), a company sought to impose a commutation plan on objecting creditors who faced substantial claims for asbestos exposure. The court denied approval for the proposed solvent scheme reasoning that there was a fundamental unfairness of requiring companies that had bought insurance policies to purposefully shift the risk of exposure to insurers, only to have that risk retransferred back upon them.16

In the U.S., moreover, creditors face the prospect of being summoned into a U.S. juris¬diction with which they may have had little or no previous contact, and whose law was only recently changed to provide a procedure unique in American jurisprudence. The Rhode Island Supreme Court has yet to weigh in on the constitutional challenges presented by objectors, and other courts will no doubt be called upon to determine whether a Rhode Island restraining order entered under its solvent scheme arrangement will be enforced in other jurisdictions. It is simply too early to tell, therefore, whether GTE Reinsurance truly signifies the arrival of solvent schemes of arrangement here, or whether constitutional issues will ultimately prevent these commutation plans from becoming a routine means of doing business in the United States.