While division is a useful option, splitting off liabilities into a new entity doesn’t extinguish them.

Iowa and Georgia recently joined Connecticut, Illinois, and Michigan in passing legislation that allows domiciled insurers to divide into two or more legal entities. The potential benefits include being able to separate live and legacy business. Yet out of sight isn’t out of mind. The dividing and new entities remain jointly responsible for the transferred obligations, which leaves the liabilities in something of a ‘legacy limbo’. What these new division statutes do not offer is a measure of finality as some commentary has suggested. So, how can you capitalize on the division option? What are the drawbacks? What are the options for true finality?

Iowa’s House Bill 264 and Georgia’s Senate Bill 156 have been enacted and become effective at the beginning of July 2019.

In addition to the five states with specific insurance division legislation, Arizona and Pennsylvania have general corporate division statutes that can be used by insurers domiciled in those states (see our analysis of the options here). An example is CIGNA’s formation of Brandywine Holdings in the 1990s.

The division legislation in the five states is the latest stage in the thawing of what had been the permafrost of US insurance legacy regulation. But these developments raise as many questions as answers:

Key Question One – Finality

If companies follow their state’s legislative path to division, will they achieve finality in respect of the divided liabilities?

Not likely – at least with respect to entities created through one of the five insurance division statutes, which contain the following or strikingly similar language:

“If a division breaches an obligation of the dividing insurer all of the resulting insurers shall be liable, jointly and severally, for the breach, but the validity and effectiveness of the division shall not be effected by the breach.”  GA S.B. 156 § 33-14-126 (b).
See also IA HF 264 § 521I.12 (4); CT Public Act No. 17-2 § 7(b); IL Public Act 100-1118 § 35B-40(d); MI §500.5513 (4)

Accordingly, the dividing company is unlikely to be able to claim that it has extinguished its liability from the exposures that are the subject of the division. (It is unclear whether the dividing company’s liability for a division’s breach of a contractual obligation would survive a subsequent sale of the division to an unrelated third party.)

Key Question Two – Clean Break

Where do these developments leave insurers that want to distance themselves – if not extinguish – the appropriate legacy liabilities from legal entities that continue to write  active and profitable business? 

The underlying question here is whether to divide or transfer. The liabilities most readily available for business transfer are legacy assumed reinsurance exposures. They rarely – if ever – involve guaranty fund participation. They are often mature exposures. The counterparties or ceding companies are most often sophisticated insurers that can readily evaluate their ceded exposures.

These liabilities are more suited to insurance business transfer than division – if only because the transferring company in the insurance business transfer process more often than not seeks finality. The language quoted above makes it clear that finality is not assured with a division under one of the five division statutes in effect while corporate division (Arizona and Pennsylvania) can result in a clean separation, as was seen in the CIGNA/Brandywine transaction.

The path to finality for assumed reinsurance business in Rhode Island has been demonstrated through the success of GTE RE. It presents a model for a carrier that seeks to honor and extinguish its legacy assumed reinsurance exposures.

Key Question Three – Setting a Trend

Now that seven US states have legislation (corporate and pure insurance) allowing for the division of domestic insurers, will other states follow? 

Will companies domiciled in these seven states be sufficiently engaged by the possibility of division that they will separate specified lines of business into new legal entities?

In most, if not all, of the states that have passed insurance, rather than general corporate, division statutes, a carrier or carriers has been the proponent of the legislation. This suggests that division of insurers is a market-driven initiative. This stands in contrast to insurance business transfer legislation, like the measures in place in Rhode Island and Oklahoma, which may be viewed as opportunities to attract insurance business to the relevant states.

Key Question Four – Comparing US and UK

If the UK’s Part VII transfer process is so popular that it has been used over 276 times since 2002, why have only three US states  Rhode Island, Oklahoma, and Vermont – enacted statutes that allow for insurance business transfers  the US equivalent of the Part VII transfer?

If Part VII worked so well in enabling UK insurers to transfer unwanted lines of business to an acquirer, it would seem reasonable for the US to follow suit.

Perhaps not. Aside from the fact that the US has a more diverse and segmented state regulatory environment, a more litigious judicial system (where the loser is not as frequently liable for the victor’s costs), the US also has a robust guaranty fund system.

Those guaranty funds are – with good reason – loathe to see assets that could be used to cover guaranty fund covered liabilities go to support non-guaranty fund covered exposures.

As mentioned, only two states, Oklahoma and Rhode Island, have adopted insurance business transfer procedures. (Vermont’s Legacy Insurance Management Act is, in essence, modeled on the Part VII process but it applies only to carriers that are not admitted in Vermont and provides cedents or policyholders with the ability to opt out of the process.)

Oklahoma’s statute applies to virtually all lines of business  – property and casualty and life and health – active and inactive (in run off). Until there are transparent and accepted financial standards in place governing the regulatory and judicial approval of these processes, there is the potential for guaranty fund impact of an insurance business transfer process involving an assuming company in Oklahoma.

Rhode Island’s insurance business transfer process, as recently amended, is more transparent as it is limited in scope and application. The insurance business transfer aspects of the statute, Voluntary Restructuring of Solvent Insurers, applies only to (1) commercial liabilities (where guaranty fund cover may be remote) and (2) liabilities that have been in run off for at least five years. While guaranty fund coverage may not apply to the business that is transferred to the assuming company in Rhode Island, the original domiciliary regulator may be concerned with the resulting financial condition of the transferring company – which may retain guaranty fund covered liabilities.

Key Question Five – Worth Pursuing

Do the issues surrounding division mean that the process shouldn’t be pursued? 

Absolutely not.  All carriers – property and casualty – life and health – should explore the full range of regulatory options to divest or restructure unwanted exposures. Where divestiture or restructuring is not possible, skilled, experienced resources should be employed to design and implement proactive strategies through which the retained liabilities can be managed to profitability.

Who are RunOff Re.Solve?

Traditional solutions to legacy issues – such as sale or reinsurance – can leave huge amounts of value on the table. Today’s more innovative solutions can secure finality from the expense and distraction associated with legacy liabilities and release more funds to all affected stakeholders. However, they require specialized knowledge and experience in execution that is generally not available within brokers or reinsurers.

This is where RunOff Re.Solve comes in. We solve problems. We identify, assess, and resolve exposure, organizational, regulatory, underwriting management, and capital issues facing the insurance industry.

From the first, and to date, only successful Rhode Island commutation plan to the more recent settlements of liabilities of insolvent insurance exposures at Westmoreland Casualty and Rockwood Insurance, we have pioneered innovative approaches to accelerated closure. Alongside the specialist knowledge, we have the tenacity, legal, and relationship skills to deliver these capital releasing solutions for our clients. The more complex and seemingly intractable the problem, the more you should talk to us.

Feel free to talk to us
We would be pleased to speak or meet with you to discuss the issues raised here or other aspects of capital, enterprise, underwriting, or risk management.

Andrew Rothseid

RunOff Re.Solve LLC
Two Bala Plaza, Suite 300
Bala Cynwyd, Pennsylvania 19004
610 660 7738 (Direct)
267 253 3529 (Mobile)