Locke Lord QuickStudy: NAIC Restructuring Mechanisms Working Group Continues its Study of IBTs and Corporate Division Statutes

At the NAIC Summer Meeting in New York on August 4, 2019, the NAIC’s Restructuring Mechanisms Working Group (“Restructuring Working Group”) held its meeting on insurance business transfers (“IBTs”) and corporate division statutes.  The Restructuring Working Group (and its Subgroup which is working on accounting and related subjects) continue to gather information on this important industry development.

As noted in a previous Locke Lord client alert on this issue, U.S. reinsurers and insurers are looking for new solutions to provide economic and legal finality to transfers of legacy insurance risks as a means to improve the efficient allocation of capital and management resources to both legacy and on-going insurance operations. As of this date, Rhode Island, Oklahoma, Arizona, Connecticut, Illinois, Iowa, Michigan, Pennsylvania and Vermont have adopted IBT or corporate division statutes with varying requirements and procedures to segregate insurers’ books of business.

At this meeting, the Restructuring Working Group adopted minutes of the Spring National Meeting and subsequent interim meetings, which included the July 1 updated and proposed changes to the Restructuring Working Group’s and Subgroup’s charges for 2020. When the two groups were formed in early 2019, it was hoped that they would complete work on their charges by the end of this year.  One of those charges for the Restructuring Working Group, whose co-chairs are Elizabeth Dwyer from Rhode Island and Buddy Combs from Oklahoma, is the evaluation and preparation of a White Paper to address (a) the perceived need for restructuring statutes, the issues those statutes are designed to remedy and alternatives that insurers are currently employing to achieve similar results; (b) the existing state insurance company restructuring statutes; and (c) legal issues posed by an IBT court order (or a corporate division) effected in one state that affects the policyholders or cedents in other states.  The White Paper is also expected to address the impact that a restructuring of an insurer might have on state insurance guaranty funds’ coverage of transferred policyholders and the legal and accounting issues associated with restructurings that use protected cells. The target date for completion of the White Paper is now the Summer of 2020.

The Restructuring Working Group also adopted a revised charge to request that the Executive (EX) Committee approve the development of changes to NAIC model laws and regulations to accommodate the findings that might come from the White Paper.  It is expected that those findings would be ready for action by appropriate NAIC Committees by the 2020 Fall National Meeting.

The Subgroup, whose co-chairs are Dave Smith and Doug Stolte from Virginia, and Jack Broccoli, from Rhode Island, has its own charges for 2020, which include developing best practices for: (a) reviewing proposed restructuring transactions including, the expected level of reserves and capital expected after the transfer, and (b) monitoring insurers after restructuring.  The target date for completion of this charge is also the 2020 Summer National Meeting.

The Subgroup is also charged with (a) considering the need to make changes to the RBC formula to better assess the minimum surplus requirements for companies in runoff, and (b) reviewing the various restructuring mechanisms and developing, if needed, protected cell accounting and reporting requirements.  Those charges are to be completed by the 2020 Fall National Meeting. Any recommended changes to the RBC formula or protected cell accounting would be referred to the NAIC Working Groups responsible for those subjects.

A number of issues and conceptual uncertainties continued to dog the discussions of IBTs and restructuring proposals, not only at the Restructuring Working Group but also among proponents and opponents of the proposals.

• Because of the differences in guaranty fund laws among the various states, it is unclear how many states will need to amend their laws to protect policyholders eligible for guaranty fund coverage whose policies or claims are transferred by IBTs or allocated to successor insurers by a corporate division. Questions have arisen regarding whether inuring reinsurance will follow underlying risks in an IBT or division.  This issue is of lesser importance given the fact that a court ordered IBT or a division becomes effective by operation of law.  The terms of the court order or division will determine the rights and obligations of not just the insureds (or cedents), but of all parties to contracts with the insurer, including reinsurers (or retrocessionaires).
• The term “novation” sometimes confuses the discussion.  As shorthand, speaking of IBTs as a court-ordered “novation” may help describe some aspects of the transaction.  The term “novation” is used even in some statutes as a description of the process.  However, an IBT or division does not meet the legal definition of novation, as there is no agreement by both the existing and the new parties, nor execution of new documents among them.  Instead, the transfer is effective without contract execution but by operation of law by court order or the result of a corporate division.  As in the case of a merger - where a surviving corporation succeeds to the rights, obligations and contracts of the old merged corporation - those rights, obligations and contracts are not novated, but are transferred by operation of law.
• Questions have also arisen regarding whether an insurer accepting an IBT or resulting from a corporate division would need a license in the states of residency of existing policyholders.  It is likely that such licenses would be needed, at least for guaranty fund coverage.  The solution could be a merger of the new insurer with an insurer already licensed in the needed states or obtaining those licenses by new application.  Applications for new licenses, however, may be difficult due to seasoning or other licensing requirements and mergers may sometimes face regulatory obstacles in some states.

Locke Lord will continue to monitor and report on the progress of the Restructuring Working Group and Subgroup and any new developments with respect to the use of IBTs in the U.S.