The United Kingdom is home to a few signal legal travesties afflicting policyholders: the solvent scheme of arrangement, an insurance policy rescission standard so low as to practically bestow upon insurance companies rescission as of right, and painfully drawn-out and expensive London arbitrations. We address the first here. More on the others another time.
Under U.K. law, an insurance company can wind up its operations under either an insolvent scheme of arrangement or a solvent scheme of arrangement. Insolvent schemes are perfectly normal, with U.S. equivalents in state-run insurance liquidation processes.
Solvent schemes, however, are unique to the U.K. They allow an otherwise solvent insurance company to shut down and leave their policyholders holding the bag. Policyholders have been fighting this for years with momentary successes and, then, disappointment.
Unsurprisingly, to date, the constituencies who benefit from these schemes are U.K. insurers and investors, while often the policyholders who get the short shrift are not from Britain. They are U.S. policyholders facing long-tail claims such as asbestos, environmental and toxic torts. Long-tail claims can be made decades after the end of the policy period, after long latency periods, when the injury or damage manifests itself and leads to the filing of a claim against the policyholder. It is at that point that these solvent schemes exact their price on policyholders.
Policyholders paid substantial premiums for occurrence-trigger policies, which become valuable and irreplaceable assets. With the solvent scheme arrangement, though, the policies being commuted cannot be replaced at all in the current insurance market, and certainly not with the typically paltry proceeds of the commutation settlements. Unless the policyholder is in need of short-term cash, there is no benefit to a commutation. Again, all of the benefit goes to the insurance company and its owners and managers.
HOW IT WORKS
The process is overseen by administrators and U.K. courts, but as the track record of U.S. policyholders' shows, they afford little protection.
Solvent schemes are governed by Section 899 of the Companies Act 2006 (although they have been around longer). The act requires 75 percent of the value of each class of creditors to approve the scheme.
Attacks on an earlier solvent scheme (British Aviation in 2006) led to the current requirement that creditors with long-tail IBNR (Incurred But Not Reported) claims be treated as a separate class from those with existing claims, with separate meetings and votes.
The solvent scheme law allows a solvent insurance company to shut down and extinguish liabilities by setting bar dates for claims to be made and forcing policyholders into a patently unfair estimation process that ends in a commutation of the policies.
The estimation process leaves a lot to be desired in the context of liability coverage. Because of restrictions and documentation requirements of the schemes, the deck is stacked against policyholders. The only certainty is that the estimation will be wrong. The overwhelming likelihood is that the valuation will be low. On top of that, policyholders are forced to waive privilege as to any documents submitted in the vote valuation process.
After the scheme is approved, there is another valuation to determine the amount paid in the eventual commutation. Contesting the scheme's commutation value means arbitration before a person picked by the scheme.
THE SCHEME QUESTIONED
The most recent scheme to be addressed by the U.K. courts was Scottish Lion. Policyholders were delighted when, in September 2009, Lord Glennie (of Scotland's Outer House Court of Session) refused to approve the Scottish Lion Scheme and, in so doing, called into question the entire solvent scheme process as it applies to insurance companies that issued policies to cover potential future latent injury claims.
The issue, succinctly stated by Lord Glennie, 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.
"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," the court found.
I respectfully agree with that reasoning. That unreasonableness seems to me to stem from the fact that, where the company is solvent, it is unnecessary that there should be any scheme, still less a scheme forced upon unwilling participants.
Sadly, however, just four months later, that decision was reversed by the presiding judge of the Inner House, Court of Session.
Happily, the reversal sent the case back for further proceedings and does not foreclose the possibility that the scheme eventually will be prohibited. Still, the opinion does send some signals that do not bode well for U.S. policyholders with future exposure to long-tail claims.
DOUGLAS CAMERON is a partner and practice group leader of the firmwide Insurance Recovery Group at Reed Smith.
January 24, 2011
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