R.I. Case Could Have Impact on Insurer, Reinsurer Run-Off Portfolios

By Jeff Jeffrey
A.M. Best Co.
April 29, 2011

A state judge in Rhode Island has upheld the constitutionality of a state law that authorizes an insurance company to extinguish its liabilities for past and future claims without going into an insolvency proceeding. Now that it has been upheld in court, some say that law -- the first of its kind in the United States -- could have a significant impact on Rhode Island's ability to attract insurers and reinsurers to the state.

The case stems from an effort by GTE Reinsurance Co. Ltd., a solvent Providence, R.I.-based reinsurer, to have the court approve GTE Re's commutation plan that allows the company to pay its policyholders the value of the policies now and extinguish any future claims.

Although a super-majority of policyholders voted to approve the plan, several subsidiaries of Stamford, Conn.-based Odyssey Reinsurance Group, which court records refer to as "the Odyssey insureds," opted to challenge as creditors of GTE Re the constitutionality of the Voluntary Restructuring of Solvent Insurers Act, the state law that authorizes the accelerated closure of a solvent U.S. insurance company's claims.

Gary Lee, a partner in the New York office of Morrison & Foerster who represented GTE Re, said because many insurers and reinsurers have long-tail run-offs in place that can run into the tens of billions of dollars, having a system whereby they can extinguish some of their liability without going through insolvency proceedings can "offer them attractive balance sheet and capital incentives."

The case could prove to be an incentive for insurers and reinsurers with U.S. run-off portfolios, he said.

"Mechanisms similar to the one in Rhode Island have worked quite well in places like the U.K. for the past 10 years. Over time, more and more insurers and reinsurers have come to regard this as an appropriate way to discharge their liability," Lee said. Rhode Island has the advantage of having a Department of Business Regulation having experience with the process, knowing how to screen these plans and now having its law upheld in court, he said, noting "that puts every other state behind in this area."

Between 1980 and 1986, GTE Re entered into several reinsurance contracts with Odyssey insureds, making GTE Re liable for its share of all losses that occurred during the period of its participation as a reinsurer, according to court records.

GTE Re proposed a commutation plan, allowing the company to make lump-sum payments to each of its creditor-policyholders — rather than wait for claims to arise in the future. In exchange, GTE RE would be released of all liabilities remaining under its contracts.

GTE Re submitted its commutation plan to the Rhode Island Department of Business Regulation for review. DBR reviewed the plan to ensure it complied with the Restructuring Act, both procedurally and substantively, according to court records. As part of its review, DBR reviewed over half a dozen drafts of the plan, focusing on its effect on creditors, GTE Re's financial proposal, and the dispute resolution procedure.

On Dec. 14, 2010, Odyssey insureds filed objections to the plan and the constitutionality of the law allowing GTE Re to come up with it. At the time, Odyssey Insured estimated the value of their claims to be in excess of $1.3 million.

Justice Michael Silverstein of the Providence County Superior Court determined that Odyssey had failed to prove that the law didn't comply with the Contract and Due Process clauses of either the U.S. Constitution or the Rhode Island Constitution.

"The court believes that the Restructuring Act and Commutation Plan do not substantially impair the Odyssey insureds' contract rights," Silverstein wrote. "Nevertheless, even if the court were to have found a substantial impairment, GTE Re and the state have sufficiently established that any impairment is justified by a legitimate public purpose achieved through reasonable and necessary means."

In addition to allowing the GTE Re commutation plan to go forward, Silverstein's opinion also creates a precedent under which other, similarly situated insurers and reinsurers in "run off" could set up their own accelerated closures as a means to extinguish long-tail exposures that often sit on their books for decades.

Lee said in order for other states to consider enacting laws similar to Rhode Island's, they would have to ensure that regulators play an active role in screening and analyzing proposed commutation plans. "DBR played a very important role in pre-screening this and negotiating the terms of the scheme," Lee said.

He added he did not know whether the Odyssey insureds planned to appeal the decision. They were represented by Howard Merten, a partner at Providence, R.I.-based Partridge, Snow and Hahn. Efforts to reach Merten for comment were unsuccessful.

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