Case Studies of Insurer Insolvencies – New Appleman on Insurance Law Library Edition, Chapter 104

By Patrick H. Cantilo, Mark F. Bennett, and Arati Bhattacharya

Abstract

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In this chapter, five insurance insolvencies are discussed in detail to illustrate a number of the issues that are presented in the management of troubled insurers.  The companies discussed are the Legion Insurance Group (see Section 104.01), Shenandoah Life Insurance Company (see Section 104.02), Lumbermens Mutual Casualty Company (sometimes referred to as the “Kemper Companies”) (see Section 104.03), Reciprocal of America (see Section 104.04), and Ambac Assurance Corporation (see Section 104.05).  No suggestion is made that these represent the largest, most important, most unusual, or even the latest significant insolvencies.  Indeed many others from among the thousands of U.S. insurers subjected to rehabilitation or liquidation proceedings might have been included on this list.  Instead, the authors have selected these cases because they illustrate both the typical issues that arise in insurance failures and also certain unusual challenges or results.

The Legion case represents many of the challenges that arise with long-tail business (as do in fact the Lumbermens and Reciprocal cases) but also gave rise to unusual reinsurance issues, especially concerning “cut-through” provisions.  The discussion of this Pennsylvania case at Section 104.01[2][a] demonstrates how reinsurance problems are often the catalyst for the collapse of troubled companies and how late-stage capital contributions frequently do little more than postpone the inevitable for a short interval.  Section 104.01[2][b] shows how short-lived rehabilitation efforts may be, especially in the face of difficulty obtaining state deposits and reinsurance recoveries.  Section 104.01[3] examines the unusual success of policyholders in their efforts to gain direct access to reinsurance recoveries.  Section 104.01[6] provides an informative discussion of the role of guaranty associations in insolvency situations.

Shenandoah, a Virginia insurer, is the only life insurer in this group and thus exemplifies issues that arise with that line of business.  More importantly, however, its true rehabilitation represents a very rare outcome and the discussion of this accomplishment provides a useful roadmap for similar cases.  The discussion at Section 104.02[1] and Section 104.02[2] illustrates the impact of difficulties in the broader economy on what would otherwise have remained a healthy and thriving insurer. The discussion in Section 104.02[3] addresses the unusual role of the Federal Home Loan Bank as a secured lender to the insurers. Section 104.02[4] explains how the plan for the company’s extraordinary rehabilitation was developed and implemented, resulting ultimately in preservation of the insurer with its sale out of receivership.

The Lumbermens case, involving an Illinois insurer, showcases many of the complexities in dealing with very large casualty company failures but also presents an innovative run-off effort that adopted the unusual technique of policy buy-backs. It also highlights the difficulties with voluntary rehabilitations occurring outside of court proceedings.  Sections 104.03[2] and 104.03[3] discuss the attempts to resolve the company’s problems through a run-off outside receivership, including the use of policy buy-backs and novations.  Section 104.03[4] addresses the eventual involvement of regulators in the efforts to rehabilitate the company.  Section 104.03[5] considers the role of guaranty associations as the voluntary run-off gave way to formal proceedings.

Reciprocal of America (“ROA”), a Virginia insurer, is in many respects a more typical property and casualty receivership but its case demonstrates the complexity of affiliate reinsurance, the contrast between risk retention groups and conventional insurers, the difficulty of managing workers’ compensation insurance (especially when a significant portion is not covered by guaranty associations), and an unusual wind-down technique. Section 104.04[1] reviews the company’s rapid growth particularly in the workers’ compensation market, and the creation of risk retention groups in another state (Tennessee) to fuel that growth by avoiding regulatory requirements.  Sections 104.04[2] – 104.04[4] provide a detailed and helpful guide of some of the mechanics of such a receivership, including the use of Deputy Receiver Directives and a Receivership Appeal Procedure.  Section 104.04[5] examines the difficult relationship this receivership has had with guaranty associations, including the unprecedented effect of net worth exclusion provisions.  Sections 104.04[6] and 104.04[7] consider issues that arose between ROA and its quasi-affiliate offshore reinsurer and also those involving the risk retention groups it reinsured.  Section104.04[8] describes some of the asset recovery efforts that ultimately proved critically important in the ability to pay policyholder claims in full, as discussed in greater detail in Section 104.04[10].  Section 104.04[9] describes the rescission efforts of the company’s directors’ and officers’ liability insurer due to management’s alleged fraud, illustrating an issue of which receivers should always be mindful.

The Ambac case is unusual in that it deals with a monoline insurer and also illustrates an innovative and controversial rehabilitation plan.  Section 104.05[1] reviews this Wisconsin company’s history as it grew to become one of the nation’s leading insurers of municipal bond issues.  It also catalogues the events that led to its decline and eventual receivership beginning in the 1990s and culminating in formal proceedings commenced in 2010.  Section 104.05[2] analyzes the Ambac restructuring plan, including the controversial creation of a segregated account for the riskiest policies with the intent of salvaging the rest of the company.  Sections 104.05[3] through 104.05[7] describe the initial rehabilitation order, key claims payment and mitigation issues, request for approval of the rehabilitation plan, its financial condition, and the proposed structural change.  Section 104.05[8] considers in some detail the objections levied against the rehabilitation plan and Section 104.05[11] discusses key responses of the rehabilitator.  Sections 104.05[9] and 104.05[10] describe the court’s approval and resulting appeal.  Section 104.05[12] describes the company’s financial projections.

These case studies may certainly not be viewed as a comprehensive survey of all the material issues that arise in insurance receiverships or rehabilitations. However, they provide a useful collection of problems and approaches illustrative of what receivers and creditors must address in the case of troubled insurers.  These cases are likely to serve as precedent for some time in key areas of insurance insolvency law and practice.

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Patrick Cantilo, Mark Bennett, and Arati Bhattacharya are partners in Austin, Texas based Cantilo & Bennett, L.L.P. (“C&B”), which focuses its practice on representation of state regulators throughout the country in insurance insolvency and complex transactions.  Founder of the firm, Patrick Cantilo, has spent more than 30 years in this field, has written and lectured extensively on this topic in the U.S. and abroad, and is also a founding member, past president, and director of the International Association of Insurance Receivers.  Co-managing partner Mark Bennett has also devoted approximately 28 years to this practice area and is recognized for his transactional, rehabilitation, and investment expertise.  Arati Bhattacharya has been at C&B approximately six years and has developed particular expertise in rehabilitation techniques.

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Table of Contents

§ 104.01 Legion Insurance Group

[1] Company Background

[a] Company History and Characteristics

[b] Company’s Insurance Products

[2] Commencement of Proceedings

[a] Financial Condition and Triggering Events

[b] Nature of Proceedings

[i] A Short-lived Rehabilitation Attempt

[ii] Impaired Cash Flow and the Push for Liquidation

[A] Insufficient Available Liquid Assets to Pay Insurance Claims

[B] Delayed Reinsurance Recoverables

[C] Inability to Access Statutory Deposits

[D] Lack of Additional Income and Capital

[E] Inability to Meet Claims Payments

[3] Significant Issues in Proceedings

[a] The Policyholder Intervenors

[i] Overview: Policyholders Given Direct Access to Reinsurance Proceeds

[ii] Pulte Homes, Inc.

[iii] Psychiatrists’ Purchasing Group, Inc.

[iv] Rural/Metro Corporation

[v] American Airlines

[b] The Court’s Findings in Favor of the Policyholder Intervenors

[c] The Rehabilitator’s Motion for Reconsideration

[d] Outcome of Post-trial Motion and Motion for Reconsideration

[4] Court Decisions

[a] Recoverables from John Hancock

[b] Additional Reinsurance Recoveries

[5] Adopted Plan in Proceedings

[a] Procedure for Policyholder Intervention

[b] Procedure for the Proof of Claim Process

[6] Outcome of Proceedings

[a] The Company’s Financial Condition

[b] Early-Access Advances and Guaranty Association Involvement

[c] The Collection of Reinsurance Recoverables

[d] The Proof of Claim Process

§ 104.02 Shenandoah Life Insurance Company

[1] Company Background

[a] Company History and Characteristics

[b] Company's Insurance Products

[2] Commencement of Proceedings

[a] Financial Condition and Triggering Events

[b] Nature of Proceedings

[i] Appointment of Receiver

[ii] The Development of the Plan of Rehabilitation

[iii] Preparations for Shenandoah's Purchase

[iv] Selection of a Purchaser for the Rehabilitation of Shenandoah

[3] Significant Issues in Proceedings

[a] Troubled Assets
 
[i] Shenandoah's Investment Portfolio

[ii] Federal Home Loan Bank

[b] Insurance Products
 
[c] Court Decisions
 
[i] Surplus Note
 
[ii] Sale of Shenandoah Life's Group Business
 
[4] Plan Adopted in Proceedings
 
[5] Outcome of Proceedings
 
[6] Significant and Unique Aspects of Proceedings
 
[a] The Benefit of Receivership Exemptions
 
[b] The Company's Solvency

§ 104.03 Lumbermens Mutual Casualty Company

[1] Company Background

[a] Company History and Characteristics

[b] Company’s Insurance Products

[2] Commencement of Proceedings

[a] Financial Condition and Triggering Events

[b] History of Operations Before Being Placed Into Receivership

[i] Year 2000

[ii] Year 2001

[iii] Year 2002

[iv] Berkshire Hathaway Transactions

[v] Year 2003

[vi] Reinsurance Intercompany Pooling Agreement

[c] Summary of Key  Developments Leading to Run-off

[3] The Run-off

[a] Nature of the Run-off

[b] Significant Issues in Run-off

[i] Troubled Liabilities and Troubled Insurance Companies

[ii] Management of the Kemper Companies

[iii] Paring Down of Kemper Companies’ Business

[c] 2004 to 2011 Operations—The Run-off Plan in Action

[i] 2004 Operations

[ii] 2005 Operations

[iii] 2006 Operations

[iv] 2007 Operations

[v] 2008 Operations

[vi] 2009 Operations

[vii] 2010 Operations

[viii] 2011 Operations

[d] 2012 Operations Bring the Death Knell for the Kemper Companies

[i] Summary of Financials Shortly Before Receivership Instituted

[ii] March 31, 2012 Quarterly

[iii] June 30, 2012 Quarterly

[iv] September 30, 2012 Quarterly

[e] Insurance Policy Buybacks and Novations Reexamined

[i] Summary LMCC Policy Buybacks &Novations/Reinsurance Commutations During Run-off

[ii] Distinguishing Between Policy Buyback and Policy Novation

[4 Nature of Rehabilitation Proceedings

[a] Rehabilitation Proceeding and Illinois Department of Insurance Work on Run-off

[b] Effect of Receivership Order for Rehabilitation

[c] Significant Issues in Receivership Proceedings

[5] Role of Guaranty Associations in the Kemper Companies’ Receivership Proceedings

[6] Outcome of Kemper Companies’ Run-off and Receivership Proceedings

§ 104.04 Reciprocal of America

[1] Company Background

[a] Company History and Characteristics

[b] Company’s Initial Insurance Products and Reinsurance Programs

[c] Company’s Expanded Product Line, Creation of Tennessee Risk Retention Groups, and Changes to Reinsurance Programs

[2] Commencement of Receivership Proceedings

[a] Financial Condition and Triggering Events

[b] The Receivership Orders

[c] Initial Directives of the Deputy Receiver

[d] Application for Approval of Liquidation

[e] First Hearing, and Order of Liquidation With Finding of Insolvency

[f] Second Hearing, and Order Approving Plan of Liquidation and Granting Related Relief

[3] Financial Condition Over Time

[4] The Receivership Appeal Procedure and Incremental Increases in the Percentage Paid on Approved Policyholder Claims

[5] Issues Involving Insurance Guaranty Associations and Guaranty Coverage

[6] Disputes and Litigation With the Special Deputy Receivers of the Risk Retention Groups

[7] Litigation Between First Virginia Re and the Deputy Receiver

[8] Asset Recovery Efforts

[9] Rescission Action by ROA’s Directors and Officers Liability Insurer

[10] Increased Payments on Approved Policy Claims, Likely Full Payment of Claims of Every Priority, Likely Distribution of Residual Assets, and Planned Wind-down of Receivership

§ 104.05 Ambac Assurance Corporation

[1] Background

[2] Ambac Restructuring

[a] The Commissioner’s Restructuring Plan Involved Three Main Aspects

[b] The Segregated Account

[c] Proposed Settlement of Credit Default Swaps

[d] The Rehabilitation

[3] First Day Rehabilitation Orders

[4] Key Aspects of Claim Payments and Loss Mitigation

[5] Wisconsin Commissioner Requests Approval of Rehabilitation Plan

[6] Ambac’s Financial Condition

[7] Structural Change for Ambac

[8] Objections to the Rehabilitation Plan

[9] Receivership Court Approval

[10] Appeal of Receivership Court Approval

[11] Key Response Points of the Rehabilitator

[12] Financial Projection in Disclosure Statement

[13] Conclusion

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