Insurance Coverage Alert
April 2007
Authors:
David F. McGonigle
+1.412.355.6233
david.mcgonigle@klgates.com
John M. Hagan
+1.412.355.6770
john.hagan@klgates.com
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Special Master Recommends Rejection
of Highlands Rehabilitation Plan
The Texas rehabilitation proceedings regarding Highlands Insurance Company
(“Highlands”)1 remain subject to significant uncertainty in view of the April 18, 2007
issuance of the Special Master’s Memorandum Recommendation and Findings of Fact and
Conclusions of Law (“Recommendation”) recommending denial of the Special Deputy
Receiver’s (“SDR”) Application for Approval of Rehabilitation Plan (“the Plan”).2 The
Special Master issued its Recommendation that the receivership court reject the Plan after
hearing evidence presented at a trial on the Plan and receiving arguments on the Plan from
the SDR and several claimants.3 Policyholders with claims against Highlands may wish
to monitor the proceedings going forward, in view of the risk that the proceedings may
eventually be converted into a liquidation.
Summary of the Proposed Plan
In a prediction that seemed questionable at the time to some observers,4 the Plan states that
the Highlands estate would pay Class 2 claims (policyholder and workers comp claims) as
they come due in the next ten years, and that the estate will thereafter have $179 million
in cash and investment assets remaining to pay claims in 2015.5 The SDR based these
projections on the estate’s economic cash flow model (“ECFM”). The ECFM forecast
estimated inflows and outflows on an annual basis through December 31, 2032, based on
known asset account balances as of December 31, 2005 and estimating an annual yield on
investments of 5.00%, and based upon estimates of future liabilities and future assets such
as reinsurance recoveries.6 The SDR acknowledged that the Plan contained uncertainties,
most significantly the ultimate value of long-tail environmental and mass tort claims to
be faced by Highlands during the rehabilitation.7 The Plan states that if future claims far
exceed the ECFM’s projections, then the Plan will not succeed and the Highlands estate
would enter liquidation.8
The Special Master’s Recommendation
The Recommendation concludes that the SDR did not offer sufficient evidence that
the estate’s financial condition will allow the Plan to meet the rehabilitation statute’s
requirements. The Special Master found that the SDR bears the burden to prove that the
Plan complies with Texas law.9 The Special Master focused its legal analysis on three
requirements for rehabilitation plans: 1) that all claims within a class must be paid
substantially the same percentage of the amount of claim; 2) that there are no subclasses
1
See generally McGonigle, David F. and John M. Hagan, Highlands Proposes Rehabilitation Plan, K&LNG
Alert (August 2006) (discussing the SDR’s Plan), available at http://www.klgates.com/newsstand.
2
See Memorandum Recommendation and Findings of Fact and Conclusions of Law (Proposed Plan of
Rehabilitation), filed on April 18, 2007 in State of Texas v. Highlands Insurance Company, No. GV3-04537
(Travis County, Texas).
3
Recommendation, at 3-5.
4
See McGonigle and Hagan, at 1.
5
Application for Approval of Rehabilitation Plan at 18, filed on July 24, 2006 in State of Texas v. Highlands
Insurance Company, No. GV3-04537 (Travis County, Texas).
6
Plan, at 16-18.
7
Plan, at 20.
8
Plan, at 20.
9
Recommendation, at 16.
Insurance Coverage Alert
within a class; and 3) that a claim must not receive less
favorable treatment than would occur in liquidation.10
According to the Special Master, the essential problem
with the Plan is that Class 2 Claimant “A” could receive
100% payment next year, but if in ten years the estate
has limited assets, then Class 2 Claimant “B” could
receive 50% payment.11 The Special Master stated
that this situation fails to treat the claims substantially
the same and effectually creates subclasses within
Class 2.12 Also, because the Special Master stated
that a liquidation would essentially result in a pro rata
payment among Class 2 claimants, the “later” Class 2
claimants would not receive under the Plan as much
as they would in a liquidation.13
analyses of Highlands’ finances using different
levels of aggressiveness in its projections of future
liabilities. The SDR used Tillinghast’s “best estimate,
mid-point” analysis, which projected the $140 million
reserve in 2015 after paying 100% of Class 2 claims.22
Yet Tillinghast’s most conservative analysis projected
that the SDR’s Plan would result in a $9 million
deficit present valued as of 2015.23 In addition,
Tillinghast—based on the SDR’s prior settlements
with eight unnamed policyholders—assumed that the
SDR would be able to settle with future policyholders
at a 50% discount.24 Tillinghast did not consider what
effect the Plan’s stated intent to pay 100% of claims
would have on this 50% discount assumption.25
The Recommendation’s conclusion that the SDR
failed to establish that the estate will have sufficient
resources to fund the Plan is based on the Special
Master’s analysis of the ECFM. The SDR developed
the ECFM using studies prepared by Tillinghast, an
actuarial firm.14 The Special Master viewed Tillinghast
as a leading actuarial firm with extensive experience
in mass tort evaluations generally, and in particular
with respect to Highlands’ portfolio.15 Tillinghast’s
actuarial studies are often used by insurers to help
determine reserves.16 For Highlands, Tillinghast
worked for over a year to prepare a comprehensive,
policyholder-by-policyholder analysis of the gross
policy reserves and the net reserves liabilities for
environmental and mass tort liabilities.17 Yet the SDR
did not use Tillinghast’s analysis to set reserves, but to
prepare the ECFM.18
The Special Master found that the SDR’s use of
Tillinghast’s analysis did not prove that the estate
would have resources sufficient to support the Plan.
Given the Plan’s intention to pay Class 2 claims in
full, the Special Master concluded that the SDR
could only establish that the Plan will treat all Class
2 claims substantially the same if the SDR proved
by a preponderance of the evidence 1) that all Class
2 claims will be paid in full, or 2) that the Plan has
a mechanism that will insure that all Class 2 claims
receive a substantially similar percentage payment
if ultimately all claims cannot be paid in full.26 Yet
the SDR’s decision not to use Tillinghast’s most
conservative projections and to use the 50% discount
assumption, given the inherent uncertainty of future
environmental and mass tort claims, led the Special
Master to conclude that the SDR did not meet its
evidentiary burden.27 Consequently, the Special
Master recommended that the receivership court not
approve the Plan.28
In creating the ECFM, however, the SDR did not use
Tillinghast’s most conservative numbers.19 Relying
on Tillinghast’s analysis, the ECFM projects that the
estate can pay Class 2 claims in full and still have
“$140 million in excess collectible inflows present
valued to 2015.”20 Yet both the SDR’s Plan and
the Special Master agree that projecting ultimate
liabilities for environmental and mass tort claims is
inherently difficult.21 Tillinghast produced different
10
11
12
13
14
15
16
17
18
19
20
21
Recommendation, at 20-21.
Recommendation, at 27.
Recommendation, at 27-28.
Recommendation, at 28.
Recommendation, at 6.
Recommendation, at 6.
Recommendation, at 6.
Recommendation, at 6.
Recommendation, at 6.
Recommendation, at 30.
Recommendation, at 7.
Recommendation, at 8.
The Special Master also found problems with the
Plan’s treatment of workers comp claims, although the
Recommendation acknowledges that the rehabilitation
statute forces these difficulties.29 According to the
Special Master, the statute requires that workers comp
claims and policyholder claims both be in Class 2.30
Yet the Special Master said that it will not recommend
approval of a plan that does not make timely and
22
23
24
25
26
27
28
29
30
Recommendation, at 9.
Recommendation, at 9.
Recommendation, at 10.
Recommendation, at 11.
Recommendation, at 23.
Recommendation, at 30.
Recommendation, at 37.
Recommendation, at 34.
Recommendation, at 31.
April 2007 | 2
Insurance Coverage Alert
full payment of workers comp claims.31 Given that
the statute does not permit subclasses within a class
and that the estate likely cannot pay all policyholder
claims timely and in full, the Recommendation admits
that the workers comp situation requires the Plan “to
force a square peg into a round hole.”32
The Special Master also objected to the Plan’s
provisions for deferring payment of claims, which
would permit the SDR to delay payment of a claim
by six months.33 Also, the Special Master sounded
sympathetic to a modification to the Plan proposed
by policyholder Celotex that would pay 65% of all
allowed Class 2 claims and then pay all claimants
an equal additional percentage later if the estate
permitted.34 Yet the Special Master found that this
proposal may not be legal and deferred to the SDR’s
opinion that the proposal would create substantial
practical problems.35
Finally, the Recommendation notes that the SDR’s
Plan poses a case of first impression in Texas.36
Texas’s current insurer insolvency statute was enacted
as Highlands moved into receivership. Highlands is
the first insurer in receivership to proceed under this
statute.
What Happens Next to the
Rehabilitation?
The Special Master’s Recommendation leaves the
Highlands rehabilitation in a state of uncertainty.
The receivership court’s original Order of Reference
to Master (“the Order”) provides some procedural
guidance now that the Special Master has made
its Recommendation. The Order provides that the
Special Master must report its Recommendation to
the court, and that “If any party objects to the master’s
recommendation, the party shall file its objection
31
32
33
34
35
36
Recommendation, at 34.
Recommendation, at 34.
Recommendation, at 34-35.
Recommendation at 35-36.
Recommendation, at 36-37.
Recommendation, at 1.
within ten (10) days and set a hearing before the judge
on the central docket. A copy of any objection with
notice of hearing shall be served on the master and
all interested parties.”37 Thus, any objections to the
Recommendation must be filed by April 30.38 Neither
the Texas rehabilitation statute nor any orders of court
provide other procedures, and as discussed above, no
other rehabilitations have occurred under this statute.
It is unclear how long the receivership court will have
to reach a decision on the Plan. Also unknown is
what will happen should the court accept the Special
Master’s Recommendation and reject the Plan.
The Recommendation may, however, have brought
the Highlands estate closer to liquidation. The SDR
stated in the Plan itself that if a rehabilitation plan
is not approved for Highlands, “the case ultimately
will be converted to a liquidation proceeding.”39 The
SDR stated in an April 23 status conference that it is
still evaluating its course of action in response to the
Recommendation. Moreover, the Recommendation’s
findings regarding the Plan leave room for skepticism
that any rehabilitation plan would meet the Special
Master’s standards that a plan treat all class members
substantially the same and yet also pay all workers
comp claims timely and in full.
Conclusion
The Recommendation may create uncertainty
for policyholders currently seeking to negotiate
settlements with the SDR, and certainly creates
uncertainty as to the ultimate outcome of the Highlands
proceedings. Interested policyholders may wish to
monitor the proceedings, and may do so at the SDR’s
website: http://www.highlandsrehabplan.com.
37
Order of Reference to Master at 4, filed on November 6, 2003
in State of Texas v. Highlands Insurance Company, No. GV3-04537
(Travis County, Texas).
38
The Order gives parties ten days to file objections to the
Recommendation, but this ten day period expires on Saturday,
April 28. Texas law extends the deadline to the next Monday in
such situations, which in this case means that the deadline for filing
objections is Monday, April 30. See Tex. R. Civ. P. 4 (2007).
39
Plan, at 42.
April 2007 | 3
Insurance Coverage Alert
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