Schemes are becoming increasingly popular. They can free up capital and provide flexibility and finality for solvent insurance companies seeking an exit solution. Dan Schwarzmann explains
Solvent schemes of arrangement have come of age for insurance and reinsurance companies with discontinued businesses. In the first five months of this year alone over ten schemes have been proposed. This brings the number of schemes issued over the last few years to just under 40. Schemes have been introduced for UK pools, UK branches of overseas companies and non-UK entities. This is a good time to consider the increasing popularity of schemes and the implications for the run-off market.
What is a scheme?A solvent scheme is a wholesale commutation (under section 425 of the Companies Act) between the company and its policyholders. Under schemes, policyholders are paid in full for their estimated future liabilities. Insurers, faced with the prospect of years of run-off costs eroding value, bring finality to solvent discontinued insurance business, free up capital to invest in new businesses and return funds to shareholders.Although the idea of using schemes as an effective exit solution for solvent insurance companies was conceived several years ago, it is only in the past two years that they have gained recognition. This partly reflects prevailing market conditions: insurers facing capital pressures can release equity as part of a scheme. However it is the flexibility of schemes that is making them increasingly attractive to shareholders and policyholders looking for finality and certainty. For example, it is possible for a scheme to include "safety mechanisms" so the company can always revert to normal run-off at any time during the scheme should it wish to do so. Schemes have evolved over time to address a wide range of issues for a diverse range of stakeholders. Rather than a "one size fits all" solution, the scheme is designed to address the specific characteristics of the book or books of business and the needs of the interested parties. This was a factor in a scheme recently effected. The company had been in run-off for many years and it was thinly capitalised with continued uncertainty as to the ultimate value of policyholders, claims owing to potential exposure to US asbestos, environmental pollution and health hazard related losses. Speed of closure was important so that long tail expense savings could be passed on to policyholders and investors. There were also a large number of low value claims, including IBNR claims. By incorporating measures such as requiring the creditor to provide certain information, a view on the extent of future losses, and the use of adjudicators to protect the interest of stakeholders, a fair and flexible approach was delivered to satisfy all parties.
Moving into new areasThe flexibility of schemes has allowed them to be adapted to new markets.For example, schemes have recently been introduced to a number of UK branches of overseas companies with "sufficient connection" to the UK (as a result, for example, of their policyholder makeup). There have been schemes for companies domiciled in countries (typically Commonwealth jurisdictions such as Bermuda and Singapore) where section 425 Companies Act-type provisions are available.The first solvent schemes for UK pools have also recently been approved. In this case the surviving members of the underwriting pool each effected a scheme for their participation in that pool. From a legal perspective policyholders needed to approve each company's scheme. However, from a practical perspective only one scheme document was required and once the scheme became effective only one 'pool-level' claim was required to be submitted by creditors.For either legal, technical or commercial reasons schemes may not be suitable for all types of business. Solvent schemes are, however, growing in popularity for the very real benefits they deliver to shareholders and policyholders alike. I anticipate that such schemes will become an increasingly familiar part of the run-off landscape.