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Sometimes the biggest news comes from the smallest places. And certainly that’s the case with the recently approved amendments to Rhode Island’s Insurance Regulation 68, which are poised to transform the huge commercial insurance runoff market in the US. Similar legislation has had a profound effect on the U.K. market in recent decades.
The capital, unpredictable exposure and management time involved in running discontinued businesses and the effects of the discontinued business on the company’s ratings are serious concerns to companies with runoff business. Currently, senior managers in the runoff industry are frustrated by the lack of available options to address legacy liabilities. The new Rhode Island runoff regulations fill a huge void in the current regulatory environment for runoff business and provide insurers and reinsurers with a means to deliver strategic reorganization plans.
The backdrop of increasing oversight in the industry and ongoing expansion of state regulation is also worth mentioning. There is growing concern that banking-style regulation (including the definition of systemically important financial institutions) will come to insurance. Thus, executives are trying to avoid complicated and constrictive financial structures for their companies. But, to date, insurers have had limited restructuring options, which often led to operating issues and higher compliance costs.
This is especially true for small and mid-sized insurance companies, which lack the ability to engage in large-loss portfolio transfers or complex reinsurance transactions to reduce their exposure to long-term liabilities. Enacted in August 2015, the Rhode Island regulations present new options for insurers and reinsurers to restructure and manage runoff liabilities and legacy liabilities. In effect, they level the playing field for all sizes of insurance carriers in managing the risk exposures presented by runoff business and bring finality to legacy liabilities.
Insurance Business Transfers
At the heart of the new regulations are insurance business transfers, or IBTs, which allow the transfer of some or all of the US domiciled commercial runoff liabilities of one company (does not have to be a Rhode Island insurer) to another company (must be a Rhode Island domiciled insurer), including attaching reinsurance. This transfer can be to either a third-party insurer or retained internally to restructure and consolidate the books of business. The IBT applies to all lines of reinsurance, other than life, and all lines of insurance, other than life, workers’ compensation or personal lines insurance. Essentially, IBTs are a restructuring tool allowing a company to combine similar business from two or more subsidiaries into a single entity, transfer business between third parties or assign different books of business into separate companies. They provide a more efficient way to manage runoff liabilities and a more effective way to deploy capital.
The IBT process is designed to be fully transparent and will be monitored by the Rhode Island Department of Insurance. Consistent with the strong policyholder protections in US law, the regulations include many provisions to safeguard the interests of policyholders. The transfer must be approved not only by the regulator in Rhode Island but also by the regulator in the transferring company’s state of domicile. In addition, there is a complete judicial review of the transfer and the proponents of the transfer must present evidence to the court that the transfer will not materially adversely affect policyholders.
There are multiple beneficiaries to these new transactions. Both transferring and assuming companies receive value relative to their long-term interests. Policyholders and/or reinsureds benefit both from the focused management of assuming companies and the oversight by the Rhode Island Department of Insurance.
In this sense, IBTs provide a fair solution that balances the needs of multiple stakeholders. Companies with runoff business can reduce their exposure to future liabilities through a transparent and court-sanctioned process. Policyholders are protected by the rigorous review process of the insurance department as well as the court. These independent evaluations of IBT plans by Rhode Island’s and the transferring company’s regulators, as well as the court, are likely to boost everyone’s confidence in the process.
The UK market proves the effectiveness of this approach. Hundreds of successful transfers of business have occurred there, providing an effective exit mechanism relative to runoff liabilities while also protecting policyholders.
Constraints on Capital
More broadly, insurers now have another way to address non-core or discontinued portfolios of business or those that expose companies to excessive risk in terms of particular risk market segments. The loss development experiences regarding asbestos and environmental are examples. These portfolios typically have lengthy time periods before resolution of the last remaining insured claims, resulting in significant uncertainty to the insurer or reinsurer covering those risks. Again, these factors constrain capital and reduce return on equity and may negatively impact the credit ratings and brand reputations of both insurers and reinsurers. That’s why there is so much interest in disposing of such risks. It’s also why the regulatory news from Rhode Island is generally viewed favorably by the industry.
Insurers interested in conducting an IBT should consider the need for good planning and project management, as well as strategies to avoid certain risks. Anticipating potential objections is likely to be one key to securing regulatory and court approval of IBTs. Communication plans should clearly define the business being transferred, explain why it’s being transferred and address likely objections. Securing the support of potential objectors through appropriate amendments to operational and/or capitalization plans may also be necessary.
Given the significant upside for the industry—from more efficient management of transferred books of business and freed capital to increased protections for policyholders and a transparent regulatory process—it’s no wonder that many insurers are moving quickly. Their first steps involve analyzing the costs and modeling the value of such transactions given their unique portfolios and risk exposures. When it comes to Rhode Island Regulation 68, there is ample reason to believe that this regulatory change is very much for the better.
Disclaimer: The views expressed herein are those of the authors and do not necessarily reflect the views of Ernst & Young LLP or the global EY organization.