REINSURANCE ASSOCIATION OF AMERICA
Telephone: (202) 638-3690 Facsimile: (202) 638-0936 http://www.reinsurance.org
Via E-Mail March 24, 2008
Mr. David Vacca, CPA Senior Financial Analysis and Receivership Manager Financial Regulatory Services Division National Association of Insurance Commissioners 2301 McGee Street, Suite 800 Kansas City, MO 64108 Subject: Call for Comment – Restructuring Mechanisms for Troubled Companies Dear David: The RAA is a national trade association representing property and casualty organizations that specialize in reinsurance. The RAA membership is diverse, including large and small, broker and direct, U.S. companies and subsidiaries of foreign companies. Together, RAA members write more than two-thirds of the gross reinsurance coverage provided by U.S. professional reinsurance companies. We appreciate the opportunity to submit the following comments on the Call for Comment issued by the Restructuring Mechanisms for Troubled Companies (E) Subgroup of the Financial Condition (E) Committee. We believe the Subgroup should first identify the relevant issues and concerns that need to be addressed in evaluating any restructuring mechanism, or restructuring mechanism proposal, and agree with the approach outlined in the seven questions presented for comment. It is also important that the Subgroup make a distinction between solvent and insolvent companies. The RAA believes certain principles should be reflected in any study of alternative restructuring mechanisms. In both the insolvent and solvent company contexts, due regard should be paid to honoring the terms and conditions of commercial contracts. In the insolvency context, there are important public policy reasons to allow certain modifications of contractual obligations to ensure that creditors and debtors are treated fairly and equally. In the solvent company context, the same public policy considerations are not present and the need to honor contractual terms and conditions is even greater. With respect to solvent companies, the competitive implications must also be considered. The design of any restructuring process cannot allow a company that has competed and taken business as an ongoing concern company to then evade its contractual responsibilities on that business and then reenter the market. In the past several years, there has been much discussion in the insurance and reinsurance industry regarding whether U.S. insurers or reinsurers who voluntarily opt to exit the market ought to be afforded some type of special statutory treatment similar to the United Kingdom’s
schemes of arrangement or Part VII transfers. For the reasons set forth below, the RAA has consistently opposed the need for such legislation in the U.S. Reinsurance is a global business and plays a critical role in maintaining the financial health of the insurance marketplace and ensuring the availability of property and casualty insurance for U.S. citizens. Today, U.S. insurers cede reinsurance risks to more than 4,200 reinsurers in 95 jurisdictions outside the United States.1 Non-U.S. reinsurers account for approximately 53% of the reinsurance written in the United States.2 Any study of restructuring mechanisms must take into account the global character of the reinsurance industry. A troubled company in the U.S. is likely to have numerous international stakeholders. Such stakeholders necessitate a mechanism that addresses cross-border enforcement as well as provides meaningful opportunities to participate. Solvent Schemes Foreign insurers and reinsurers with asbestos, environmental and other long-tail risks in the United States have increasingly used solvent schemes of arrangement as an alternative to liquidation or protracted run-off in the U.K. These schemes, implemented under §425 of the United Kingdom’s Companies Act 1985, have been an alternative means of finalizing all or part of a company’s portfolio of business and returning capital to shareholders. If the necessary majority creditor approval is obtained and the U.K. court sanctions the scheme, it becomes binding on all creditors. Claims submitted by a date certain, including estimates of currently unknown future liabilities (“IBNR”), if allowed, are paid at present value. All other claims are forever extinguished. A U.K. scheme does not provide for the acceleration of reinsurance recoverables except by consensual commutation. In the UK and its legislatively related territories reinsurers are not bound to respond to contracts, except on the basis of actual settled (or agreed) claims. Some solvent schemes seek to fairly adjust debts and distribute the assets of a company that is in questionable financial condition. Other solvent schemes, however, are proposed by companies whose financial strength is not in doubt. There may be good cause to question the reasonableness of such schemes where the scheme company is fully able to pay its obligations as they mature, but does not wish to do so. While the benefits of a solvent scheme to the scheme company and its shareholders are clear, serious questions may be raised in many cases as to whether a solvent scheme is beneficial and fair to creditors. Solvent schemes are of particular concern to U.S. policyholders and reinsureds who lose the bargained-for protection of coverage for future claims in exchange for payment based on an estimate of what those claims may be, assuming that they have the loss history and resources to submit a sufficiently documented claim based on IBNR to be allowed any payment at all. Further, reinsurers have repeatedly expressed opposition to any system that could result in the accelerated and involuntary payment of their obligations based on any estimation of policyholder claims. Reinsurers oppose compelled payment of reinsurance recoverables based on IBNR on the
1 Reinsurance Association of America, Alien Reinsurance in the U.S. Market 2 (2007). 2 Id. at 13.
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basis that they are theoretical losses with theoretical values allocated in a theoretical fashion. Because reinsurance is a contract of indemnity, reinsurers cannot be required to pay losses, such as incurred by not reported losses, which are unidentified or unknown. Part VII Transfers The UK’s Part VII legislation came into force under the Financial Services and Markets Act 2000 (FSMA) and enables direct insurers and reinsurers to transfer all or part of their books of business to another approved insurer. The liabilities and assets are transferred by way of a court sanctioned novation. Generally, a reinsurance contract should not be viewed as a fungible financial instrument that conveniently can be transferred from one bearer to another. It is an agreement that entails the reinsurer's reliance upon a cedent's effective performance of a number of essential services and functions including underwriting, pricing, production management, auditing, accounting, records management and claims adjustment. To some extent, a reinsurer may protect its interest in the quality of a cedent's systems by negotiating "special termination" or "non-assignment" provisions that allow the reinsurer to avoid the transfer of its contractual obligations and entitlements to another party under certain specified circumstances. Such provisions often are the subject of extensive negotiation and are supported by the consideration provided by each party. Allowing a transferor to evade these commitments by virtue of a statutory override of contract terms would violate fundamental contract principles that are basic to efficient commercial activity. Requiring a reinsurer to expose its operations to a transferee's systems that do not meet the reinsurer's standards is both dangerous and unfair. Disruption of the original contractual relationship can have serious financial consequences for the reinsurer. A nonconsensual substitution of a new party to the reinsurance agreement may materially increase the contractrelated risks to which the non-consenting reinsurer would be subject. Additionally, "forced" transfers of reinsurance agreements may have unintended adverse implications with respect to the reinsurer's ability to collect under its retrocession agreements. Any restructuring mechanism should not require the transfer of reinsurance obligations in a manner that is inconsistent with contractual terms agreed upon by sophisticated commercial parties. Instead, prior to entering into a transfer arrangement, the transferor should be required to negotiate a mutually satisfactory resolution with the reinsurers that will be affected by the transfer. Runoff Proposals in the U.S. The RAA has consistently joined the rest of the industry in opposing the need for any special statutory provisions addressing solvent runoff companies. The RAA has specifically objected to any proposal which advocates estimation and acceleration of reinsurance recoveries based on IBNR or the unilateral transfer of rights to payments under ceding reinsurance agreements to third parties. Moreover, the proponents of change in the area of restructuring mechanisms have not demonstrated any need for special solvent runoff legislation. Ongoing concern companies are
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currently free to commute their existing liabilities and insolvent companies are governed by state receivership laws. The intent of the legislative proposals in this area seems to be, in part, is to allow an insurer to restructure and continue to write business. To the extent this allows a competitor to shed itself of certain liabilities and then continue to compete in the marketplace it enables an insurer to take advantage of a “good bank/bad bank” type of arrangement. By compromising claims of reinsurers, commercial creditors and claims of policyholders not covered by guaranty associations, an insurer under these runoff proposals could satisfy such claims with less than full payment and be considered to have satisfied then in full – all the while continuing to directly compete in the marketplace. All segments of the insurance marketplace should have concerns about a statutory mechanism that provides special advantages to a solvent insurer in order to strengthen that insurers bargaining position with customers and others in which it has engaged in commerce. In view of the statutory authorization for the troubled insurer to return to the competitive market after it has cleaned out certain liabilities, the proposals create unfair competitive advantages over other authorized insurers. In addition, changing the rules for one subset of ongoing companies regarding claims determinations and payments could reduce public confidence in the overall insurance market. The owners of solvent insurers already have adequate avenues available to exit the business. Runoffs are successfully managed today, making the need for such legislation questionable. These existing runoff mechanisms do not receive any statutory special treatment in executing the same commercial responsibilities as other insurers and reinsurers. The proposed legislation the RAA has seen to date contemplates that solvent insurers would avoid or rework their contractual obligations and imposes on other parties, like policyholders and reinsurers, compulsory compromises not otherwise required by statute or contract. In addition, the proposals often permit the compromise and impairment of claims which essentially amounts to a “cram down” of a definitive compromise where the insurer has not been adjudged financially impaired and unable to pay its obligations. These components of the proposals raise concerns over the unlawful acceleration of reinsurance recoveries. Many state receivership laws (as well as NAIC’s IRMA) currently contain some type of prohibition on the nonconsensual estimation and acceleration of reinsurance recoveries based on IBNR. Without such a prohibition, these proposals could compel reinsurers to pay for losses that may never develop. Finally, the proposals, as a whole, often do not provide meaningful opportunities for participation by policyholders or reinsurers. All stakeholders must be allowed the ability to object to actions that are adverse to their interests. Because runoff operations are a significant element of the insurance and reinsurance industry, the RAA applauds the formation of this Subgroup and wishes to participate in the Subgroup’s study of the issues related to restructuring mechanisms for troubled companies. The RAA remains
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willing to discuss the subject matter and assist in improving the efficiency and effectiveness of receiverships and runoffs by addressing these issues. Thank you for the opportunity to comment. We encourage members of the Subgroup to consider the issues raised in these comment in any discussion of restructuring mechanisms and are available to answer any questions. Best regards,
Tracey W. Laws Senior Vice President and General Counsel
Matthew T. Wulf Vice President and Assistant General Counsel
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