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Caution urged as exit routes sought

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PricewaterhouseCoopers L.L.P. recently published the second edition of its survey of discontinued insurance business in Europe, entitled "Unlocking Value in Run-off—A Survey of Discontinued Insurance in Europe." The survey is presented as a barometer of the current attitudes of European insurers and reinsurers to runoff and the use of portfolio transfers and schemes of arrangement.

It is also a vehicle aimed at encouraging Continental European insurers in particular to consider either portfolio transfers to the United Kingdom that are followed by U.K. schemes of arrangement, or "sufficient connection" schemes of arrangement that do not need prior transfers.

Policyholders—especially those with long-tail claims—must be vigilant to ensure that their rights are not eroded if and when portfolios of discontinued insurance business are transferred to the United Kingdom from Continental European countries and made subject to solvent schemes of arrangement.

The survey reports an increased level of activity among Continental European insurers and reinsurers in the area of runoff and a greater appreciation of the "exit routes" available to deal with discontinued business.

This is to be expected, given the future implementation of the E.U. Solvency II directive, planned for 2012, and the recent or imminent implementation in EEA member states of the Reinsurance Directive (2005/68/EC), which facilitates the transfer of reinsurance business throughout the European Economic Area.

Policyholders must, therefore, brace themselves for the numerous proposals to change the ways in which their claims are handled, as Continental European insurers embrace the new concepts to them of separate runoff, with the associated, more aggressive, claims handling.

Policyholders must also expect to see proposals to transfer their business from one insurer to another and from one country to another, as insurers seek to take advantage of perceived organizational and financial benefits. Lastly, policyholders might possibly be faced with the "exit route" of a U.K. scheme of arrangement that would not have been directly possible for the original insurer, but has now become applicable through a portfolio transfer.

All this means that policyholders must review at the earliest possible moment all steps that may lead to U.K. schemes of arrangement for Continental European portfolios. They must scrutinize proposals for any portfolio transfers between EEA states, and particularly to the United Kingdom.

Portfolio transfers do not require the consent of policyholders. It is, therefore, important that regulators are made aware of policyholders' interests and concerns with regard to any proposed transfers. They should consider, in particular, the likely prejudice of the transfer to all classes of policyholder, including large commercial policyholders, whose interests often do not seem to be regarded as top priority by regulators-see, for instance, the "Financial Services Authority Process Guide to Decision Making on Schemes of Arrangement for Insurance Firms of July 2007."

Policyholders may also need to consider what legal action may be available to ensure their interests are taken into account.

Policyholders also need to question in particular whether the aim of a transfer is to make the business ultimately subject to a U.K. scheme of arrangement. The potential prejudice to policyholders of solvent schemes has been highlighted in litigation in the English Courts in recent years concerning British Aviation Insurance Co. Ltd. and WFUM Pools Cos. schemes.

Although policyholders were successful in the reported decisions, the WFUM case, ironically, confirmed the availability of U.K. schemes for foreign insurers where there is sufficient connection with the United Kingdom, a decision that was pounced upon enthusiastically by promoters of schemes and their advisers.

The most fundamental prejudice to policyholders of a solvent scheme is that it brings about the unilateral extinction of potentially valuable insurance coverage in return for inadequate or no consideration.

Although the statutory regime contemplates that a scheme must be approved by votes at a creditors' meeting from over half of the policyholders who must also hold 75% or more of the value of the claims, this safeguard has not in practice prevented scheme proponents from extinguishing valuable insurance coverage for a minority of creditors with very significant long-tail claims, particularly where there are disputes about the value of the policyholders' claim.

Apart from this basic issue, policyholders have also had concerns with regard to a number of other matters. This includes inadequate consultation facilities with other creditors, the valuation of claims by the scheme managers and the voting adjudicator, a lack of information about the voting and valuation of votes at creditors' meetings, and a lack of time to enable creditors to develop information in relation to claims.

The PWC survey does not indicate how insurers will guarantee that policyholders' rights are protected while they rush for a U.K. exit. Policyholders must, therefore, keep alert for transfer proposals that might represent the first step towards that exit.

Richard Mattick, Of Counsel in the European policyholder litigation practice of Covington & Burling L.L.P., in London.