Policyholders protest Highlands runoff plan

AUSTIN, Texas--Policyholders and other creditors of Highlands Insurance Co. are wrangling over the defunct insurer's fate following the rejection of a runoff plan proposed by state insurance regulators.

A court-appointed special master recommended against the plan last month, finding that it relied on overly optimistic projections of Highlands' long-tail liabilities and of its ability to settle claims at deep discounts. The special master also concluded that the plan would not treat all policyholders equally, favoring workers compensation claimants and potentially disadvantaging future claimants.

The Texas Insurance Department's special deputy receiver for Highlands has asked a state judge to overturn or modify the special master's recommendation and approve the runoff plan. The receiver is being joined by a unit of ACE Ltd., which both reinsured Highlands and ceded business to it, and which supports the runoff.

Opponents of the plan, meanwhile, are asking the judge to confirm the special master's findings and reject the plan, a move that could end in Highlands' liquidation. Opponents include Highlands Insurance Co. (U.K.) Ltd., a Gloucester, England-based Highlands affiliate, and several asbestos defendant policyholders.

The Texas court has not yet scheduled a hearing on the motions, lawyers familiar with the case say.

Texas-domiciled Highlands, a large writer of excess and umbrella casualty and workers comp risks, was ordered into rehabilitation in 2003 after a failed effort to reorganize the company and wind down its business.

Highlands faces roughly $640 million in liabilities, with asbestos and pollution claims accounting for about half of its exposure, according to court filings.

Last July, Highlands' receiver sought court approval for a rehabilitation plan that would run off the insurer's liabilities over many years. Actuarial projections backing the plan suggested that Highlands would be able to pay all allowed policyholder claims in full through at least the first 10 years of the runoff, court documents show.

A number of policyholders and others objected to the runoff idea on various grounds, though, and the dispute was referred to Tom Collins, the court-appointed special master for the receivership. Along with Highlands (U.K.), those objecting included the Celotex Asbestos Settlement Trust, Dana Corp., Dow Corning Corp., Federal-Mogul Products Inc., Harley-Davidson Inc. and Allstate Insurance Co.

After a series of hearings over several months, Mr. Collins recommended against the runoff in an April 18 memorandum.

The Highlands plan is the first to be ruled on since Texas' 2005 enactment of the Texas Insurer Receivership Act, he noted. The act includes provisions for rehabilitations and liquidations but does not deal specifically with runoffs.

The receiver has framed the runoff as a rehabilitation, and though the plan is not a "true 'rehabilitation'...in the ordinary meaning of the word," Mr. Collins said he would defer to the receiver's judgment that a runoff is allowable under the law.

Numerous flaws

The special master cited a number of flaws in the plan, though, that he concluded make it unworkable.

The long-tail nature of Highlands' environmental mass tort exposures makes it very difficult to predict its ultimate losses and require conservative projections if the plan is promising to pay allowed claims in full, Mr. Collins wrote.

The plan, however, uses mid-range loss projections provided by actuarial consultant Tillinghast; if Tillinghast's more conservative, high-end estimates are used, Highlands would be "underwater" by $9 million after 10 years, Mr. Collins found.

The Tillinghast study also assumed that Highlands would be able to settle with future asbestos and pollution claimants for 50 cents on the dollar, a discount he found "overly optimistic and aggressive."

The Highlands plan also runs afoul of the Texas receivership law's requirement that it be "fair and equitable" to all parties, he wrote. This means, among other things, that all policyholders must be paid substantially the same percentage of the amount of their claims, and that no subclasses of claimants can exist within policyholder or other claimant classes.

Under the plan's terms, a current claimant might receive 100% of its allowed claim; if the estate runs short of funds after 10 years and converts to liquidation, though, a future claimant may receive only half of its allowed claim, he said.

"The estate cannot as a practical (and, in some instances, as a legal) matter recoup monies from claimants paid 100% of their claims years earlier. Therefore, to the extent to which the assets of Highlands' estate ultimately prove insufficient...the 'later' (policyholder) claims will not be able to receive, as they are entitled to receive by law, the equalized pro-rata payment," Mr. Collins found.

Highlands' workers comp liabilities also present the receiver with a "Catch-22," the special master said. These claims must be paid in full, and in a liquidation would be paid by state guaranty funds, which would then recoup as much as they could from the Highlands estate. The guaranty funds would not be triggered in a runoff, though, meaning that Highlands would have to pay the claims itself. If a future cash shortage forced it to defer or pro-rate payments to other policyholders, it would still have to pay the workers comp claims in full, potentially creating an illegal subclass of workers comp claimants, Mr. Collins concluded.

The special master's decision has thrown the Highlands rehabilitation into a "state of uncertainty," said David F. McGonigle, a Pittsburgh-based lawyer with Kirkpatrick & Lockhart Preston Gates Ellis L.L.P., who is not involved in the case.

It is unclear what may happen if the Texas court accepts Mr. Collins' recommendation and throws out the runoff plan, but the recommendation may be moving Highlands closer to liquidation, Mr. McGonigle wrote in an analysis of the case.

The runoff plan itself states that if it is not approved by the court, the estate will convert to a liquidation, he noted. The special master's decision, meanwhile, leaves "room for skepticism" that any rehabilitation plan could meet the standard of treating all class members substantially the same while also paying workers comp claims timely and in full, Mr. McGonigle wrote.