UK's Solvent Schemes Dealt Another Blow: Hopefully, the Coup de Grâce

The travesty that is the Solvent Scheme of Arrangement has been dealt another blow; one hopes a fatal one. A month after issuing a blistering attack on the practice, Lord Glennie entered final judgment this week refusing to sanction the Scottish Lion scheme. It is worth taking a long look at Lord Glennie’s lengthy opinion.

The issue, succinctly stated by the court, was: “Can it ever be fair to sanction a ‘solvent’ scheme of arrangement in the face of continuing creditor opposition to having their occurrence cover compulsorily terminated?” The court’s answer was, Probably Not.

Under UK law, an insurance company can wind up its operations under either an Insolvent Scheme of Arrangement or a Solvent Scheme of Arrangement. An Insolvent Scheme has US equivalents in our state-run insurance liquidation processes. However, Solvent Schemes are unique to the UK. They allow an otherwise solvent insurance company, including companies that sold occurrence policies for which the company has largely unquantifiable continuing obligations to its policyholders, to wind up operations by forcing policyholders to accept policy commutations. 

Solvent Schemes are governed by Section 899 of the Companies Act 2006 (although they have been around longer). The act requires 75% of the value of each class of creditors to approve the Scheme. The attacks on the British Aviation Insurance Scheme led to the current requirement that creditors with IBNR (Incurred But Not Reported) claims be treated separately from those with existing claims, with separate meetings and votes. 

The valuation of IBNR claims by Scheme administrators have led to numerous attacks. Those valuations are critical to the voting, since they determine the weight of each creditor’s vote. Objectors usually are US policyholders with IBNR long-tail claims under occurrence policies, usually environmental, product liability and toxic tort claims. That was the case in Scottish Lion as well. Whatever the merits of “actuarial science” in the context of liability coverage may be, it is certain that the projected value of the IBNR claims will be wrong, whether too high or too low. These valuations also determine the amount paid in the eventual commutation, once the Scheme is sanctioned.

The objections to Solvent Schemes can be summarized as follows:

  • Policyholders paid substantial premiums for occurrence-trigger policies, which are valuable and now irreplaceable assets
  • No amount of money paid in commutation will allow a policyholder to replace this coverage.
  • Unless the policyholder is in need of short-term cash, there is no benefit to these commutations for policyholders; all of the benefit goes to the insurance company and its owners and managers.
  • Nothing prevents a policyholder which wants a commutation from seeking one; there is no reason to force unwilling policyholders to do so. 

In the end, the court agreed, following the reasoning of the court which refused to approve the British Aviation scheme in 2006:

"If individual policyholders wish to compound the company's contingent liabilities to them, and to accept payment in full of an estimate of their claims, there is nothing to stop them doing so. But to compel dissentients to do so would ... require them to do that which it is unreasonable to require them to do."

That unreasonableness seems to me to stem from the fact that where the company is solvent it is unnecessary for the body of creditors or class of creditors to as a whole that there should be any scheme, still less a scheme forced upon unwilling participants. I respectfully agree with that reasoning.

The Court of Session is Scotland’s supreme civil court. The case may eventually end up before the new Supreme Court of the United Kingdom which opened on October first


UPDATE [November 3, 2009]: PricewaterhouseCoopers, Scheme Advisors to Scottish Lion and many other effective and proposed solvent schemes has announced their intent to appeal Lord Glennie's decision.

The Equitas-Speyford Deal: The Train (Destination Solvent Scheme) is Leaving the Station

This post was written by Ann Kramer and Paul Walker-Bright.

By now most of us have received notices of the Equitas-Speyford Part VII transfer. A court hearing to approve the transaction will take place in London on June 24th and the transaction is to take effect on the 30th of June. The letter asks policyholders to set forth any objections by June 9th: “If you intend to make written representations and/or appear at the Court hearing, either in person or by Counsel, you are requested to provide the written representations or written notice of your intention to appear at Court and details of your concerns as soon as possible, and preferably by no later than 9 June 2009.”

The Names seemingly are the big winners from this deal, although policyholders will get the benefit of an additional $1.3 billion in reinsurance limits from Berkshire Hathaway’s National Indemnity Company. 

Hugh Stevenson, Equitas chairman, said: “This transfer and reinsurance will … mean that the Names will finally be able to walk away under English law.

“We would like to say to the Names that as best we can judge you no longer have to worry.”

According to Equitas’ letter to the Names advocating the transaction:

In the very unlikely event that Equitas subsequently becomes insolvent, no policyholder with an unsatisfied claim will be able to recover it from any Name anywhere in the European Economic Area – that is all of the European Union, together with Iceland,Norway and Liechtenstein.

We are still considering the extent to which it is practicable to seek recognition of the Part VII transfer in other major overseas jurisdictions, in particular the United States of America.

The independent actuary’s report ― of course, with none of the underlying data available for review ― says that policyholders will be better off with the additional reinsurance than with access to the Names. However, policyholders have (a) no way to verify that the reserve level for pending and future claims is adequate and (b) no valuation of the assets of the Names that they are being asked to give up their rights to. 

So if we assume, as the independent actuary asks us to, that the impact of this on policyholders is more theoretical than real [Which policyholders have the appetite to go after the Names individually?], what is the harm? 

Think about the next step for Speyford. Under UK law, the Names, and hence Equitas, could not implement a Solvent Scheme of Arrangement (a unique process to shut down solvent insurance companies permitted only by the UK). Speyford, on the other hand, can. The pull to do a Solvent Scheme will likely become irresistible, and indeed there appears to be no reason for the proposed transfer other than to clear the way for an eventual Solvent Scheme. Equitas claims that it has no present plans to do a Scheme but will not promise not to do one.

The advent of a solvent scheme for Speyford is when policyholders with large IBNR {incurred but not reported) claims will be really devastated. The valuations of IBNR under both solvent and insolvent schemes of arrangements ― with no realistic appeal rights ― often pitifully undervalue the risks that policyholders assume when these schemes wipe out policyholder rights under policies purchased decades earlier. Coverage that cannot be replaced. This process was bad enough when it happened with individual London Market companies, but think about it writ large, across the millions of Lloyd’s policies sold prior to 1993.