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CHICAGO-States should only approve liability-based restructurings of insurers that protect policyholders' rights-including requiring prior consent and preserving guaranty fund protection-a panel of the National Assn. of Insurance Commissioners recommends.

Although the NAIC white paper discussing the issue does not specifically address the controversy surrounding recent restructurings by CIGNA Corp. and The Home Insurance Co., some observers say the deals would have run afoul of some of the paper's recommendations.

Protecting policyholders is one of several goals that regulators must weigh as they evaluate the pros and cons of liability-based restructurings, notes the final draft of a 29-page paper released last week at the NAIC's summer meeting in Chicago.

Regulators also must evaluate the goals and rights of insurers that support or oppose any liability-based restructuring. In addition, they must consider the impact on guaranty funds to properly assess the broad regulatory, legal and public policy issues that arise when a property/casualty insurer proposes such a restructuring, the final draft concludes.

Regulators have adequate authority to do this job, so no new model laws are needed at this time, the white paper says.

However, the NAIC should review existing model laws on guaranty funds, assumption reinsurance and holding companies to determine whether they need to be modified to respond to liability-based restructurings, or LBRs, as they are called in the white paper.

The final version of the white paper, authored by a panel of insurance commissioners or their staff representatives, was adopted unanimously last week by both its drafting group and the NAIC's Financial Condition Subcommittee. It is scheduled to be approved by the NAIC's Executive Committee in September and by the organization's entire membership in December.

"We feel very strongly that this is an important subject that needed attention and careful review, but it also needed a timely response," said Robert G. Lange of Nebraska. He succeeded former Utah Insurance Commissioner Bob Wilcox as chairman of the drafting group, which was established 15 months ago.

The most recent examples of LBRs involved CIGNA and The Home, which each split into ongoing and discontinued operations, primarily because of material exposures to asbestos, pollution and health hazard claims and other long-tail liabilities.

CIGNA currently is appealing a Pennsylvania appellate court ruling in March that vacated the Pennsylvania insurance commissioner's 1996 approval of the insurer's reorganization and called for CIGNA policyholders to have a greater voice in the proceedings (BI, March 10).

Meanwhile, worse-than-expected losses during runoff prompted New Hampshire regulators in March to put the runoff operations of The Home under formal state supervision after it fell far short of minimum capital requirements (BI, March 10).

Although the white paper summarizes but does not examine these deals, it does address some of the issues the restructurings have raised.

For example, the white paper states that: "From the viewpoint of the insurance consumer, absent express consent, guaranty fund coverage should not be reduced or eliminated by an LBR." However, "if it is concluded that an LBR places the availability of guaranty fund coverage in serious question, the structure of the proposed transaction or questionable component should be modified before approval."

The National Council of Insurance Guaranty Funds in December 1995 took the position that state guaranty funds likely would not respond to claims by CIGNA's runoff facility if it were to fail because the companies absorbing the liabilities either were not licensed or did not originally write the coverage (BI, Dec. 11, 1995).

CIGNA, though, has disputed the guaranty funds' position, arguing that its restructuring would be no different from policies shifted to a legal successor in a merger or division. The insurer also maintains that capitalization of the runoff entity makes it unlikely it will become insolvent.

The white paper also states: "If the effect of the LBR is intended to extinguish an insurer's obligation to its insureds, consent of the insureds should be required. Such transactions result in a novation or have the same effect on insureds as a novation and therefore should satisfy the procedural and legal requirements of a novation."

Several critics of the CIGNA deal have said the restructuring resembles a novation, a process whereby policyholders are moved to a new insurance company, which typically requires their prior consent.

However, CIGNA has consistently maintained that its restructuring involved a merger of CIGNA units, not a novation, and therefore did not require prior policyholder approval.

The white paper also addresses issues that were raised in The Home's restructuring. The paper says that "an LBR is not an acceptable alternative to appropriate regulatory action, such as the rehabilitation or liquidation of insurers in hazardous financial condition, unless the hazardous financial condition is corrected by the LBR."

Rating agencies in late 1995 downgraded The Home's ratings, citing worsening long-tail liability exposures. To preserve the company, New Hampshire regulators in 1995 approved a controversial deal in which the poorly performing business of The Home was placed in runoff, while Zurich Insurance Group took the insurer's better business, providing the runoff company with a $1.3 billion reinsurance contract (BI, June 5, 1995).

"Regulators in Pennsylvania and New Hampshire probably would not have allowed a restructuring to take place in either case," if they had followed the white paper's guidance, said Peter Lefkin, senior vp of government and industry affairs for Fireman's Fund Insurance Co. in Novato, Calif.

That is, there was a lack of policyholder comment and a lack of evaluation of guaranty fund coverage, especially in The Home's case, he said.

"I support the regulators' conclusion that any restructuring should have the consent of the insured and should also ascertain the potential exposure of guaranty funds," he said.

"CIGNA didn't follow the white paper's guidance for evaluating guaranty fund coverage, requiring a novation and holding a hearing that allowed for full participation by all affected parties, including policyholders," said James Schacht, who is national director of the insurance regulatory practice of Coopers & Lybrand L.L.P. in Chicago. Mr. Schacht formerly was chief deputy director of the Illinois Insurance Department.

"If CIGNA's restructuring had the effect of a novation, then it should have been treated as one and followed the procedures for a novation," said Nebraska's Mr. Lange, who chaired the NAIC drafting panel. However, he added, "that is still being disputed."

Mr. Lange also cautioned people from reading too much into the white paper.

The white paper is designed to deal with future LBRs and "defers to state regulators to make their own decision," Mr. Lange emphasized. "It's advice and recommendations. Whether it has authoritative value remains to be seen, but it doesn't have the authoritative value of a model law."

The final draft of the white paper, which includes checklists of essential pre-approval information and post-approval oversight issues, has received a favorable reception among regulators and the industry.

"You have covered an extraordinary amount of subject matter in a most open and deliberative way," said NAIC President Josephine Musser, who chairs the Financial Condition Subcommittee. "It's a great example of how we can do things here and do them well."

"The white paper is a road map for regulators which provides a balanced discussion of restructuring issues. CIGNA strongly supports an emphasis on financial solvency," said Carole Olson Gates, a regional vp-state government relations for CIGNA who is based in Kansas City, Mo.

"The American Insurance Assn. believes that the LBR white paper is a thoughtful, balanced document that stresses the need for regulatory discretion in evaluating each unique LBR transaction," said Phillip Schwartz, AIA vp-financial reporting and associate general counsel.

"The key to an LBR white paper, from an industry perspective, has always been the definition of an LBR transaction. It is critical that the scope of the paper excludes ordinary transactions such as changes in pooling percentages and standard runoffs of business," he added.

"I think members of the working group should be commended for avoiding a dogmatic, cookie-cutter response and in recognizing these restructurings need to be evaluated on a case-by-case basis," said Richard G. Liskov, at attorney with Chadbourne & Parke in New York. He serves as special counsel to the New Hampshire Insurance Department concerning Zurich Insurance Group's acquisition of The Home's business.

Messrs. Schwartz and Liskov said they look forward to the NAIC reviewing other model laws to determine if they need to be expanded to respond to LBRs.

"The NAIC's white paper embodies a reasonable approach," said a spokesman for CNA Insurance Cos. in Chicago. However, he added, CNA would support NAIC development of a formal model law on LBRs.