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Insurers in the Unites States have long faced structural challenges in changing business mix or shedding lines of business or legacy books. When insurers try to streamline their corporate structures, they often grapple with diverse books of business written across diverse corporate entities, or runoff legacy books trapped within active companies.
Insurers often must divest lines of business through complex reinsurance transactions. The United Kingdom and other common law jurisdictions have embraced a system of corporate transactions and business transfers to help, but it is generally unknown if these structures would be honored by U.S. courts. Rhode Island has enacted a series of statutes and regulations to attract new insurers to the state by allowing them to enter into U.K.-style transactions.
The problem is simple: How does an insurer exit a line of business and know, for sure, that it won’t be sued if the transferee company goes bust? Connecticut has recently enacted a new approach.
Effective Oct. 1, Connecticut is allowing domestic insurers to divide into two or more insurers. Public Act 17-2, An Act Authorizing Domestic Insurers to Divide, was signed by the governor on May 16. The law establishes an entirely new procedure, effectively a demerger, which creates multiple distinct legal successors to the originating insurer.
To divide, an insurer must first create a plan of division and submit that plan for approval to the Connecticut insurance commissioner. The plan must designate, among other information, how liabilities — including insurance policies — will be divided between the resulting insurers; how the dividing insurer’s assets, including real property, will be distributed; and how each of the new insurers will be governed.
The plan must also provide for the manner of distributing ownership interests in the dividing insurer and the resulting insurers. Holders of ownership interests in the original insurer may lose their interest following the division, subject to appraisal rights, if applicable. The sponsor may amend or abandon the plan until it is effective. All documents submitted to the commissioner, apart from the plan of division and incorporating documents, must be kept confidential.
The dividing insurer must approve the plan of division in accordance with its governance documents. If the insurer has specified a certain procedure for mergers, that process must also be followed for a division. Creditors that have lent money to the dividing insurer prior to Oct. 1, 2017, and have the right to approve a merger, must approve the division.
The commissioner must approve a plan unless the commissioner finds the division will not protect policyholders and interest holders or if it constitutes a fraudulent transfer. Once the plan is approved by the commissioner, a certificate of division describing the effect of the transaction is filed with the Connecticut Secretary of State.
Following the division, each of the resulting insurers is individually liable only for the policies and liabilities that are allocated to that insurer, but the resulting insurers are jointly and severally liable for every policy and liability not allocated by the plan of division. This provision encourages well-planned divisions.
The act is modeled after similar statutes in Pennsylvania and Arizona. However, statutes in the other states apply to general corporate matters, whereas the new Connecticut law is dedicated to insurance.
There are somewhat similar laws in the U.S. and overseas that allow insurers to restructure. For example, Part VII of the United Kingdom’s Financial Services and Markets Act 2000 enables a U.K. insurer, after regulator and court approval, to isolate a portion of its policies and transfer them to another insurer. There is very little precedent to indicate if the release of the transferring insurer would be honored by U.S. courts.
Rhode Island Insurance Regulation 68 permits “insurance business transfers,” which are very similar to Part VII transfers. Regulation 68 specifically applies to insurance companies and requires an elaborate plan to transfer assets and liabilities plus calls for both regulator and court approval. No transfers have been completed to date in Rhode Island, but at least two companies competing to purchase runoff insurance liabilities have set up vehicles in Rhode Island to receive liabilities through insurance business transfers.
So what is different about Connecticut’s new mechanism? There are three primary differences:
• First, under the Connecticut system, one insurer either (i) divides into two insurers or (ii) forms two completely new insurers, all within the same corporate family. After a division, one of the new entities could be sold, but that is not part of the new statute. Part VII and Rhode Island both allow transfers to unrelated entities.
• Second, Part VII and Regulation 68 both require regulatory and court approval, while the Connecticut division structure is solely a regulatory process. Until a plan is challenged in another state, we will not know if courts in other states would give less deference to a regulator than to another court.
• Third, Connecticut’s division process is a change in the corporate form, not, on its face, a transfer. The U.S. Supreme Court has long told us that “(c)orporations are creatures of state law,” for example in Cort v. Ash in 1975. If a state can dictate how an insurer may merge, why can’t the state tell the insurer how to demerge?
Still, by definition, divisions must leave each resulting insurer with a smaller pool of surplus than the combined entity had, without the insured’s consent. Policyholders may object on the grounds that they are afforded less security than they had before and have lost their ability to sue the other corporate sibling if the entity that assumes the policyholder’s policy becomes insolvent. Is that a taking or an impairment of a private contract, both of which are barred by the U.S. Constitution?
If it is an impairment of contract, is there a compelling legitimate public purpose that would allow it to pass constitutional muster? All of those concerns seem to fade if a Connecticut division is simply a change in corporate form of a Connecticut corporation, over which the state reigns supreme. When a transaction is proposed, if there are objectors, the courts will need to decide, but for now, a powerful new tool for corporate efficiency may be added to the insurance tool kit.
William D. Goddard is a partner at Day Pitney L.L.P. in Hartford and New York, where he concentrates on insurance, reinsurance and insurance insolvency matters. He can be reached at 860-275-0117 and firstname.lastname@example.org.