Solvent schemes of arrangement are a viable exit and finality tool for insurance companies in run-off, writes David Chew.
Interest in exit and finality solutions for insurance companies in run-off (discontinued business liabilities) is emerging in Singapore, closely following the lead from the UK run-off market.
This interest is being driven by a number of factors, including the acknowledgement that run-off diverts human and capital resources from core business activities, shareholder pressure to solve past problems, as well as the risk that run-off administration costs will erode reserves.
Finality to the run-off owner is a complete exit of all run-off business, irrespective of whether this involves the finalisation of the underlying insurance liabilities.
The concept of solvent scheme of arrangement is a viable option as an exit and finality tool, but there are alternative options such as disposal of business and proactive run-off.
Solvent scheme of arrangement
A solvent scheme of arrangement in Singapore is an arrangement under Section 210 of the Companies Act, which enables a company to agree with its creditors on a mutually acceptable method of valuing a companys liabilities at a prescribed date, and settling the said liabilities.
The use of solvent schemes of arrangement in Singapore remains in the early stages, with two schemes of arrangement successfully sanctioned by the Singapore courts. In the UK, the use of solvent schemes of arrangement is much more developed, with more than 40 sanctioned by the UK courts.
Based on the success of companies that have proposed schemes of arrangement and received court sanction in the UK, and on the presumption that Singapore courts will take the lead on such matters (as it appears they have already done so), this would represent a viable exit and finality option.
Advantages and disadvantages
At a meeting of creditors, a scheme will be approved if there is a majority in number (more than 50 per cent) and 75 per cent in value of creditors voting in person and by proxy of the classes of creditors to whom the scheme applies. The scheme is then sanctioned by the court and is binding on all creditors.
There is no set time line to complete a scheme, and as a result, it is this flexibility that has made schemes so popular in the UK (and which is beginning to develop in Singapore). However, based on our experience and from precedents in the UK, the general time frame to complete is estimated at two to three years.
Disposal of business
Disposal of business could be achieved by a portfolio transfer of the book of business or an outright sale of the shares in the run-off company to a third party.
The main appeal to a disposal is the speed with which an exit can be achieved. This in turn frees up capital (human and financial) to the run-off owner, which can then be used on other more profitable business opportunities.
The buyer of the run-off, usually a professional service provider that has tool kits and experts in managing run-off, will then select and implement the appropriate strategy to achieve finality for the run-off.
One of the issues to be resolved before a disposal includes seeking the approval of the regulator and/or the court. There are also potential reputation implications because the seller of run-off loses control.
However, the key issue to be addressed by the run-off owner is the difficulty in identifying a buyer and finalising a transaction at a price that is agreeable to both the buyer and the seller. This may involve a significant discount to the net asset value of the run-off company, because the buyer is purchasing a company/portfolio that has no recurring cash flows from operations (only investment income), and liabilities that are possibly risky and unpredictable.
Continued run-off
The other alternative is to allow a company to continue in run-off.
To protect against the risk of the run-off company becoming insolvent, the main aim for owners of run-off is to minimise the risk that investment income earned will not be sufficient to cover the administration costs of the run-off and the risk of future claims inflation.
To achieve this aim, the strategy would involve a 'proactive' run-off program, where all contracts of insurance and reinsurance with known creditors are commuted.
Generally speaking, this would involve achieving commutation settlements at net present value, and would be achieved by commercial negotiations between the run-off company and the creditor.
A number of possible advantages to this strategy include a reduction in the risk of deterioration in a volatile book of assumed policies, a reduction in the risk of financial impairment of outward reinsurers, and lower run-off costs.
The key disadvantage, however, of allowing the run-off to continue is that while finality can be achieved, it is unlikely.
The future
Based on the success of schemes in the UK and now in Singapore, solvent schemes of arrangement represent a viable exit and finality tool due to their flexibility in dealing with the unique difficulties facing an insurance company in run-off.
Owners of run-off should consult with professional advisers on the implementation of a scheme as early as possible once the decision to enter run-off has been ascertained.
This will provide the greatest opportunity to maximise shareholder value in the shortest possible time frame.
David Chew (Hock-Lin.Chew@sg.ey.com) is an associate director of transaction advisory services, Ernst & Young Singapore.
Reference: November 2007, volume 77:10, p. 72-73 (Asia edition)
