What Happens When Your
Financial Guaranty Insurer
Goes “Bust”?
A Presentation on the Insurance Insolvency
of a Financial Guaranty Insurer
Richard G. Liskov
Donald J. Mros
How Regulators Identify
Troubled Insurers
Regulators use a variety of tools to measure the
solvency of insurers, not just outside ratings:
risk-based capital reports
independent actuarial and accounting audits
“IRIS” ratios
the insurer’s own plan for improving its finances.
2
How Regulators Deal with
Troubled Insurers
Regulators have used a variety of methods to
improve the situation informally:
encouraging the insurer to sell books of business
urging sales of subsidiaries
encouraging policy buy-outs
doing reinsurance deals that increase surplus
3
The Three Types of Proceedings
for Troubled Insurers
Supervision
Rehabilitation
(sometimes called Conservation)
Liquidation
4
Supervision
Supervision: regulator in insurer’s state of domicile
requires insurer to obtain numerous specific
approvals to operate, but:
management remains in place;
no court proceeding initiated;
and supervision is confidential.
5
Supervision (cont’d)
Typically, an insurer under supervision is placed into
runoff with no new policies written.
Insurer must obtain prior approval for:
all inter-company transactions;
all reinsurance transactions;
major investments;
levels of staffing and
changes in commission scales.
6
Rehabilitation
If supervision is not feasible or not effective, the
regulator will consider the next step:
seeking a state court order placing insurer into
rehabilitation or conservation.
Insurer must have notice and opportunity to
oppose the regulator’s petition, but very rarely
do insurers oppose.
7
Rehabilitation (cont’d)
Rehabilitation (sometimes called conservation):
state court in the home state appoints regulator to
manage insurer until the conditions causing the
rehabilitation are eliminated.
Insurers are not eligible to be debtors under federal
bankruptcy law, so only state courts deal with
insurer rehabilitations and liquidations.
8
Rehabilitation (cont’d)
Completely open-ended proceeding — no time limits
No such thing as 60-day rehabilitation
Insurer remains in existence but management
ousted with occasional exceptions, and regulator,
acting as rehabilitator, appoints managers
Insurer almost always stops writing new
business, but continues to pay claims,
except much, much more
slowly
9
Rehabilitation (cont’d)
Similar to an automatic stay in bankruptcy, a
rehabilitation order from state court will enjoin
policyholders and creditors from suing the insurer
or attaching insurer’s assets.
Policyholders living in other states are required to
file their claims with the Rehabilitator in the
insurer’s home state.
For most monolines that means New York.
10
Rehabilitation (cont’d)
State insurance codes give broad powers for
courts to order rehabilitation.
Not necessary for regulator to prove that insurer
is actually insolvent when applying for a
rehabilitation order.
11
Rehabilitation (cont’d)
It is sufficient in New York and other states
for regulators to allege that insurer is in
“hazardous financial condition” —
This is a very nebulous concept which does not
require detailed showing of insurer’s finances.
12
Rehabilitation (cont’d)
Like Chapter 11, with the objective of proposing and
implementing a plan of rehabilitation so that
insurer can operate normally again, but:
only regulator can initiate the proceeding;
only regulator can propose plan of rehabilitation;
policyholders and creditors can object to plan, but
courts typically defer to regulator’s plan.
13
Rehabilitation (cont’d)
Unlike federal bankruptcy, no “cram down”
procedure allowing creditors to control
insurer’s fate.
Rehabilitator either proposes plan for rehabilitating
the insurer, or regulator decides to seek
liquidation order.
State courts usually approve the plan, unless they
find it egregiously unfair or plainly inconsistent
with state insurance code.
14
Rehabilitation (cont’d)
In the plan of rehabilitation Rehabilitator
may propose:
having policies assumed by stronger insurer;
or
modifying policy terms so that insurer pays less
or
so that insurer pays over much longer time;
or
not paying reinsurers and general
creditors anything.
15
The Basic Rule of Rehabilitations
Policyholders and creditors cannot object to a
rehabilitation plan that gives them much less than
their policy or contract promised as long as:
the plan gives them at least what they would
receive if the insurer were liquidated.
Neblett v. Carpenter, 305 U. S. 297, 305 (1938)
16
Liquidation
Liquidation occurs when a regulator determines
there is no realistic possibility of rehabilitating
an insurer.
As with rehabilitations, the home state regulator
petitions that state’s court for a liquidation order.
17
Liquidation (cont’d)
Liquidation involves marshalling all of the assets of
the insurer, mainly reinsurance recoveries, and
distributing them according to priorities enacted in
the state insurance code.
In New York, the priorities for non-life insurers,
including New York-based financial guaranty
insurers, are set forth in section 7434 of the
Insurance Law.
18
Liquidation (cont’d)
After administrative expenses (including lawyers)
then, in order of priorities:
policyholders (but no interest for delayed
payment with certain exceptions)
↓
government claims
↓
general creditors, including ceding insurers
and reinsurers
↓
shareholders
19
Liquidation (cont’d)
All policyholders
must be paid in full
before any creditor gets anything.
20
Liquidation (cont’d)
Big unknown:
whether a credit default swap (“CDS”) that is not
specifically in the form of a financial guaranty
insurance policy will be treated as a policy for
purposes of priority.
New York Insurance Law appears to say a credit
default swap is not a policy, but the New York
Insurance Department has said some CDS are —
where CDS holder has an interest in the
referenced obligation.
21
Insurance Company Receiverships
Are Governed by State Law
Insurance company receiverships are conducted
under the state law of the domicile of the
insurance company.
Most states have enacted either a version of the
former NAIC Insurers Rehabilitation and
Liquidation Model Act (“Model Act”) or the Uniform
Insurers Liquidation Act (“Uniform Act”).
22
Insurance Company
Receiverships (cont’d)
In 2005, the NAIC revised its Model Act, which it adopted as
the Insurer Receivership Model Act (“Revised Model Act”),
but only Oklahoma, Texas and Utah have enacted all or part
of the revision to date.
New York has enacted a version of the Uniform Act (N.Y. Ins.
Law §§ 7401-36). The receivership of a New York domiciled
financial guaranty insurer would be governed by these
sections.
23
Map of Jurisdictions
Key
Red - NAIC Model Act/similar law
Blue - Uniform Act/similar law
White - NAIC Revised Model Act (IRMA)
24
Monolines Originally Insured Low
Risk Public Finance Business
Financial guaranty insurers originally provided
coverage for public finance business. This involved
providing coverage for defaults on bonds issued by
governmental bodies, such as municipal bonds.
This business historically did not pose a lot of risk.
Recently, however, due to the budget crisis in
California, monolines may be faced with larger than
expected exposures on their public
finance business.
25
The Economic Crisis Leads To
Financial Stress For The Monolines
Starting in the late 1980s and early 1990s, the
monolines expanded their business to cover
various structured finance risks, including credit
default swaps.
With the economic crisis, the insurers faced large
possible losses on these risks, leading to financial
stress and ratings downgrades for the monolines.
26
To Date, Monolines Have
Avoided Receivership
The monolines have avoided receivership through
restructurings or negotiated settlements
with creditors.
Recently, Syncora Guarantee reported a negative
policyholder surplus of $3.8 billion and was
ordered to stop paying claims by the NYID.
It has entered into a restructuring agreement with
credit default swap counterparties that is subject to
certain closing conditions.
27
ACA Financial Guaranty Corporation
and Kemper Insurance Companies
ACA Financial Guaranty was the first monoline to
restructure. Counterparty creditors received cash
payments on their claims and were issued
surplus notes.
The Kemper Insurance Companies have been operating
under a voluntary run-off plan since 2004 subject to the
supervision of the Illinois Insurance Department under
confidential plan.
Key component: reaching agreement with large
commercial insureds for “buy backs” of their policies.
28
Avoid A State Insurance
Company Receivership If Possible
Counterparties usually have an interest in avoiding a
monoline receivership due to the costs and delays that
such proceedings generally entail.
In states where contingent claims are not allowed, there
is likely to be considerable delay before distributions
are made to creditors since the maturity on public
finance obligations is often far in the future.
Even where contingent claims are allowed, it is likely that
there will be considerable delay as the receiver will
need to marshal assets and determine claims before
making distributions.
29
Bar Date
The bar date is the date by which a claim
has to be filed.
In general, if a claim is not filed by that date then it
is barred from receiving estate distributions or it
is placed in the lowest priority.
30
Bar Date In New York
In New York, creditors are to present their claims
within four months of the receivership order or such
longer period as allowed by the receivership court.
N.Y. Ins. Law § 7432(b)
Proofs of claims may be filed after the bar date but
they will not share in estate distributions unless all
timely filed claims are paid in full with interest.
N.Y. Ins. Law § 7432(c)
31
Bar Date In New York (cont’d)
In practice, the bar date in New York is not set within
four months of the receivership order.
American Fidelity Fire Insurance Company/American
Insurance Company was ordered into liquidation on
March 26, 1986 with a bar date of December 31, 2001
(more than 15 years later).
Ideal Mutual was ordered into liquidation on
February 7, 1985, with a bar date of December 31,
2003 (more than 18 years later).
32
Many State Insurance Laws Do Not Allow
For The Payment Of Contingent Claims
A contingent claim generally refers to a claim that
(1)
(2)
(3)
is uncertain as to whether there ever will be a claim;
uncertain as to the value of the claim; or
it is uncertain when the claim will become
payable.
Many state insurance laws, including New
York’s, do not allow for the payment of
contingent claims.
33
New York Law Does Not Allow
For Payment Of Contingent Claims
Under New York law, a contingent claim shall not
share in estate distribution unless:
(1)
(2)
it becomes absolute against the insurer on or
before the last day fixed for filing of proofs of claim,
or
there is a surplus and the liquidation is thereafter
conducted upon the basis that such insurer is
solvent.
N.Y. Ins. Law § 7433(c)
34
Definition of Absolute
A commercial general liability IBNR claim would not be
absolute based on case law in New Jersey, which has the
same contingent claim provision as New York.
In re Liquidation of Integrity Ins. Co., 193 N.J. 86, 935 A.2d 1184 (2007)
The New Jersey Supreme Court interpreted “absolute” to be
synonymous with “unconditional,” “non-contingent,” “free
from conditional limitation,” “free from doubt,” and “final
and not liable to modification or termination.” Under its
interpretation, an actuarial estimate, even by generally
accepted estimating techniques, is not absolute.
35
Financial Guaranty
Contingent Claim
There are no cases in New York on how the provision
on contingent claims might apply to a claim on a
financial guaranty policy for a credit default swap;
but
if there is a loss that is certain as to liability and
amount then it should not be considered a
contingent claim.
36
The NAIC Model Act Provision
On Contingent Claims
The 1977 Model Act provides that:
A contingent claim may receive estate distributions if it is
filed in accordance with Act’s claim filing requirements …
and does not prejudice the orderly administration of the
liquidation.
“Claims that are due except for the passage of time shall be
treated as absolute claims are treated, except that such
claims may be discounted at the legal rate of interest.”
NAIC Insurers Rehabilitation and Liquidation Model Act
§§ 37(B),(C) (1977)
37
Model Act (cont’d)
The Model Act’s contingent claim provision has not been
universally adopted in the Model Act states. Several
states have adopted a more restrictive contingent
claim provision, and do not permit contingent claims.
Me. Rev. Stan. Ann. tit. 24 § 4378
N.J. Stat. Ann. § 17:30C:28
Alaska Stat. § 21.78.280
Nev. Rev. Stat. Ann. § 696B.450
N.C. Gen Stat. Ann. § 58-30-195
Many of Uniform Act states also do not allow
contingent claims.
Ala. Code § 27-32-30
Ark. Code. Ann. § 23-68-128
N.Y Ins. Law § 7433
Ariz. Rev. Stat. Ann. § 20-63
Del. Code. Ann. tit. 18 § 5928
Wyo. Stat. Ann. § 26-28-127
38
NAIC Insurers Model
Receivership Act Provision
The 2005 Revised Model Act provides that:
An unliquidated contingent claim may be allowed if the
contingency is removed by the bar date.
A claim that is unliquidated by the bar date can be valued
using an accepted method of valuation and allowed if it
will not delay administration or the cost of valuing the
claim is not excessive relative to the amount available for
distribution for the claim.
NAIC Insurer Receivership Model Act, Art. VII, § 705(c)(2) (2005)
39
Illinois Allows Contingent Claims
In Illinois, contingent or unliquidated claims “that
have not been made absolute and liquidated” by
the bar date “may be determined and allowed by
estimation.”
Ill. Comp. Stat. 5/209(7)
Utah, Missouri and Connecticut also allow
contingent claims that can be valued with
reasonable actuarial certainty or another method of
valuing claims with reasonable certainty.
Utah Code Ann. § 31A-27a-605(2); Mo. Rev. Stat. § 375.1220(2);
Conn. Gen. Stat. § 38a-945
40
Transfers Within 12 Months May Be
Avoided As A Preference In New York
Whenever a creditor receives a payment from a
troubled insurer, the creditor has to be concerned
with a voidable preference claim. Preferences are
where a creditor receives better treatment than
similarly situated creditors.
Voidable preferences may be recovered by the
receiver of an insurance company, whether
the company is in a rehabilitation or
liquidation proceeding.
41
New York Preference Provision
A receiver may avoid “[a]ny transfer of, or lien
created upon, the property of an insurer within
twelve months prior to the granting of an order to
show cause under this article with the intent of
giving to any creditor or enabling [it] to obtain a
greater percentage of [its] debt than any other
creditor of the same class and which is
accepted by such creditor having reasonable
cause to believe that such a preference will
occur, shall be voidable.”
N.Y. Ins. Law § 7425(a)
42
Preference In New York
It is within a New York receiver’s discretion to decide
whether to seek to recover a payment on grounds of
voidable preference.
A payment in the preference period that is explicitly
approved in advance by regulators is not an
absolute defense, but reduces the risk that the
receiver would consider it a preference.
43
The New York Case Law
The little case law we found in New York focused
on the intent element. In Serio v. Rhulen, 806 N.Y.S.2d
283, 285 (N.Y. App. Div. 3d Dept. 2005) the court found
that the defendant insiders “[i]n disregard of Frontier’s
deteriorated financial condition, with knowledge and
intent . . . caused preferential payments to be made by
Frontier to [Frontier] Group and other Group-controlled
entities during the twelve-month period preceding the
entry of the Order of Rehabilitation for Frontier and a
finding of insolvency.”
44
Preference Under the Model Acts
Under the Model Act, a preference is any transfer (i)
within one year before a successful delinquency filing
(ii) that enables the creditor to obtain a greater
percentage of its debt than another creditor in the same
class would receive. NAIC Model Act § 28
Under the Revised Model Act, a preference is as any
transfer (i) within two (2) years before a successful
delinquency filing (ii) that enables the creditor to
receive more than the creditor would have received in a
liquidation of the insurer. NAIC Revised Model Act Art. VI § 604
45
Ordinary Course Of
Business Defense
In a recent case involving Reliance Insurance Company (in Liquidation),
the Pennsylvania Supreme Court ruled that an ordinary course of
business defense protected a payment on an insurance policy from a
preference claim, although there was no specific language in the
Pennsylvania statute.
Ario v. Ingram Micro, 965 A.2d 1194 (Pa. 2009)
The Pennsylvania court ruled that a payment on a policy was not on
account of an “antecedent debt” based on (i) public policy grounds, (ii)
legislative intent and (iii) on the bankruptcy code where payments in the
ordinary course of business are not considered preferential. Id.
There is no such case law in New York, and the Ario decision
may not have great persuasive value in New York since the
New York voidable transfer statute does not have an “antecedent debt”
requirement, although the public policy arguments may be persuasive to
a New York court.
46
Ordinary Course Of Business (cont’d)
The purpose of the ordinary course of business defense is to
leave undisturbed normal financing relations. Generally, to
prove a transfer is non-preferential under the ordinary course
of business defense, the creditor must prove:
(1) that the transfer was in payment of a debt incurred by the
debtor in the ordinary course of business or financial affairs of
the debtor and the transferee, (2) that the transfer was made in
the ordinary course of business or financial affairs of the
debtor and the transferee, and (3) that the transfer was made
according to ordinary business terms.
Ohio Rev. Code 3903.28; Covington v. HKM Direct Market Commc’n,
Inc., 03AP-52, 2003 WL 22784378 (Ohio Ct. App. Nov. 25, 2003)
47
Protection In Illinois
In Illinois, where the Director of the Illinois
Insurance Department approves a pre-receivership
transfer in writing it cannot be later set aside as
a preference.
215 Ill. Comp. Stat. 5/204(m)(C)
This does not protect against a fraudulent transfer.
48
Fraudulent Conveyance
A fraudulent conveyance may also be avoided by a
receiver under New York’s debtor creditor law but
this is more difficult to establish than a voidable
preference under New York Insurance Law.
49
Are There Any “Safe Harbors”
For Swap Claims?
The short answer in New York is no. Other states,
such as Maryland, have a provision protecting
against a payment on a swap being a
voidable preference.
50
Maryland Provision
Section 229.1(f) of the Maryland Insurance Code provides that:
“Notwithstanding any provision of this subtitle … a receiver may
not avoid a transfer of money or other property arising under or
in connection with a netting agreement or qualified financial
contract, or any pledge, security, collateral, or guarantee
agreement or any other similar security arrangement or credit
support document relating to a netting agreement or qualified
financial contract, that is made before the commencement of a
delinquency proceeding under this title.”
Md. Code Ann., Ins. § 9-229.1(f)
“This protection does not apply to a transfer made with the
actual intent to hinder, delay or defraud a receiver or other
creditors.”
Md. Code Ann., Ins. § 9-229.1(f)(2)
51
Arguably A Safe Harbor For
Swap Claims
This provision is arguably a safe harbor against a
voidable preference claim for a payment on a
financial guaranty policy covering a swap claim if the
policy relates to a “qualified financial contract.” A
qualified financial contract in Maryland is defined to
include a swap agreement.
52
Definition of A Swap Agreement
Swap agreement is defined as:
“an agreement, including the terms and conditions incorporated by
reference in the agreement, that is a rate swap agreement, basis
swap, commodity swap, forward rate agreement, interest rate future,
interest rate option, forward foreign exchange agreement, spot
foreign exchange agreement, rate cap agreement, rate floor
agreement, rate collar agreement, currency swap agreement, crosscurrency rate swap agreement, currency future, currency option, or
any other similar agreement, and includes any combination of
agreements and an option to enter into an agreement.”
Md. Code Ann., Ins. § 9-229.1(a)(9).
53
The Definition of Swap
Agreement (cont’d)
The definition of “swap agreement” does not
specifically include credit default swaps. Credit
default swaps should be considered a “similar
agreement,” but we found no case law on point.
54
Further Possible Statutory
Protection Under Maryland Law
Section 229.1(b)(2) of Maryland Insurance Code provides
that a person may not be stayed or otherwise prohibited
from exercising: “any right under a pledge, security,
collateral, or guarantee agreement, or any other similar
security arrangement or credit support document relating
to a netting agreement or qualified financial contract.”
Md. Code Ann., Ins. § 9-229.1(b)(2).
Again, the definition of qualified financial contract is key
since the protection is afforded if the guarantee
agreement is related to a “qualified financial contract.”
55
Protection Against The Stay
This provision should protect a counterparty from a
claim that it violated a stay by exercising its CDS
rights. This provision, though, is not included
in the New York insurance laws.
56
Other States With Similar
Provisions
Several other states, including Iowa, Michigan,
Texas, and Utah have similar provisions permitting
the exercise of rights under a qualified
financial contract.
Iowa Code Ann. § 507C.28A
Mich. Comp. Laws Ann. § 500.8115a
Tex. Ins. Code Ann. § 443.261
Utah Code Ann. § 31A-27a-611
57
Concluding Remarks
In a receivership of a financial guaranty insurer in
New York, counterparty creditors should anticipate:
long delays before any distributions;
possible advantages in a plan of rehabilitation to public
finance policyholders — issue sure to be litigated;
potential preference challenges to any payments
made within the 12 month look back period,
(but payments made with explicit prior
regulatory approval may be OK); and
potential litigation over whether a stay
would apply to CDS remedies.
58
Conclusion
Thanks for attending what we hope was a
useful and informative program.
The views we expressed are ours but not
necessarily those of Chadbourne clients.
We’d be pleased to assist you on particular
issues involving your company.
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