Iowa and Georgia have joined Connecticut, Illinois, and Michigan in passing legislation which is intended to allow domiciled insurers to divide into two or more legal entities. (The insurance division statutes in Connecticut, Illinois, Iowa, and Michigan apply to stock insurers only, while Georgia’s statute applies to stock and mutual insurers.)
The division statutes’ mechanisms for the transfer of liabilities to a new entity would appear legally feasible, though, perhaps, subject to challenge. Moreover, there may be clearer and more assured options for insurers seeking a clean and final break from their liabilities.
How then can you capitalize on the potential opportunities opened up by these division statutes? What are the potential drawbacks?
In addition to the five states with specific insurance division statutes, Arizona and Pennsylvania have corporate division statutes that can be used by insurers domiciled in those states (see our analysis of the options here). CIGNA’s formation of Brandywine Holdings in the 1990s is an example.
The division statutes in the five states are the latest stage in the thawing of what had been the permafrost of US insurance legacy regulation. But these developments raise questions as well as attempting to provide 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?
Finality appears to be the intention of each insurance division statute. Although the language within the insurance division statutes differs slightly, it appears that the intent of each is that the Resulting Insurer is the successor to the Dividing Insurer for the policy liabilities allocated in the Plan of Division.
The Connecticut Division Statute indicates that the Resulting Insurer is the successor to the liabilities that have been transferred by the plan of division. See Public Act No. 17-2 (HB 7025) Sections 6 and 7. Section 6 (a) (6) provides:
“[T]he policies and other liabilities of the dividing insurer are allocated between or among the resulting insurers as provided in section 7 of this act and the resulting insurers to which policies or other liabilities are allocated are liable for those policies and other liabilities as successors to the dividing insurer, and not by transfer, whether directly or indirectly;”
Similar provisions are found in each other state’s division statutes though Iowa, Illinois, and Michigan include specific reference to the fact that the transfer is by “operation of law”. See Georgia SB 156 § 33-14-125 (a)(6); Iowa House File 264 § 11 (1)(f); Illinois 215 ILCS 4/35B-35 (a)(6); and Michigan Senate Bill 1029 § 5511 (1) (f).
Although all of the insurance division statutes require regulatory review and approval, only Georgia, Iowa, and Michigan require specific notice of the plan of division to policyholders and a public hearing. The division statutes in Connecticut and Illinois allow for notice and a public hearing if the commissioner determines that notice and a hearing are in the public interest – though Illinois will conduct a public hearing if one is requested by the Dividing Insurer.
Contrary to the provisions of the Oklahoma and Rhode Island Insurance Business Transfer Plan processes, none of the insurance division statutes requires judicial review.
Division of non-insurance business is common. Also common are insurance mergers and changes of control. The insurance division and business transfer processes are intended to allow the same result – to extinguish the Dividing or Transferring Insurer from the divided or transferred liabilities.
The insurance business transfer statutes in Oklahoma and Rhode Island specify that the policy obligations are novated to the Assuming Insurer subject to regulatory and judicial review. The standards for judicial review are set out in each business transfer statute.
The division statutes do not appear to specify that the policy obligations are novated (or that the Dividing Insurer is released from those obligations) but that the Resulting Insurer is the successor to the Dividing Insurer (and, as mentioned, in some statutes, by “operation of law”.)
Approximately 40 states have specific statutes or established case law prohibiting novation of contractual obligations without explicit consent. Although similar types of objections were made – and overruled – in the challenge to the GTE RE commutation plan, the novation aspect of insurance division and the absence of required judicial review of the division process may result in a prospective challenge.
Consequently, while separation of selected liabilities appears at the heart of the insurance division statutes, it would not be surprising if prospective division plans were subject to legal challenge. Indeed, until these processes are tested in court, the legacy limbo remains.
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 insurance business transfer are legacy assumed reinsurance exposures. They do not 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.
It may be that assumed reinsurance liabilities are more suited to insurance business transfer than division. Perhaps this is because the transferring company may consider that finality is more a more likely option. Perhaps it is because the regulator may be concerned about the quantum of assets left to support the remaining (perhaps guaranty fund covered) liabilities of the Dividing Insurer. Consequently, the assuming reinsurer may be more inclined to seek finality than a direct insurer.
More tried and certain options exist. 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?
Perhaps. If carriers domiciled in other states see division as a viable option.
In most, if not all, of the states that have passed insurance, rather than general corporate, division statutes, a carrier 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 economic development 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 appears 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 in run off. Transparent and accepted financial standards governing the regulatory and judicial approval of these processes will add to the clarity of, and confidence in, the Oklahoma insurance business transfer process – particularly those plans that involve direct coverages subject to guaranty fund protection.
Rhode Island’s insurance business transfer process, as recently amended, is more transparent – in part – 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) entire legal entities with (2) only commercial liabilities (where guaranty fund cover may be remote) and (3) where the 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, as noted above, 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.