NCOIL Model Act Could Facilitate “Good Bank/Bad Bank” Insurance Structures | Kramer Levin Naftalis & Frankel LLP

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Insurers whose mix of assets and liabilities might make it attractive to split into a “good bank” and “bad bank” should monitor a recent model law passed by an influential body of state legislators. On May 3, the National Conference of Insurance Legislators (NCOIL) announced the adoption of the Insurer Division Model Act, which would permit an insurer to divide into multiple legal entities. Theoretically, the act would permit flexibility for an insurer seeking to disaggregate into multiple entities according to blocks of business or operations based on perceived profitability, attractiveness or other factors. Any such split would have to satisfy the various procedural and substantive requirements for fairness set forth in the model act. The model act expressly states that upon approval by the state insurance commissioner (the Commissioner) of a plan of division, the conditions for “freeing” resulting insurers from the liabilities of the dividing insurer and for “allocating some or all of the liabilities of the dividing insurer” are deemed satisfied.

Plan of Division. Under the model act, a stock insurance company domiciled in a state adopting the act may divide into two or more resulting insurers pursuant to a plan of division, which must include:

(1) The name of the domestic stock insurer seeking to divide;

(2) The name of each resulting insurer created by the proposed division and, for each resulting insurer, a copy of the resulting insurer’s charter and bylaws;

(3) The manner of allocating assets and liabilities, including policy liabilities, among all resulting insurers;

(4) The manner of distributing shares in the resulting insurers to the dividing insurer or the dividing insurer’s shareholders;

(5) A reasonable description of all liabilities and assets that the dividing insurer proposes to allocate to each resulting insurer, including the manner by which the dividing insurer proposes to allocate all reinsurance contracts;

(6) All terms and conditions required by the laws of the state and the charter and bylaws of the dividing insurer; and

(7) All other terms and conditions required by the division.

If a dividing insurer is to survive a division, the plan of division must also include (i) all proposed amendments to the dividing insurer’s articles of incorporation and bylaws; (ii) if the dividing insurer intends to cancel some but not all shares in the dividing insurer, the manner in which the dividing insurer intends to cancel the shares; and (iii) if the dividing insurer intends to convert some but not all shares in the dividing insurer into shares, obligations or other property, a statement disclosing the manner in which the dividing insurer intends to convert the shares.

If a dividing insurer is not to survive, the plan must include the manner in which the dividing insurer will cancel its shares or convert them into shares, obligations or other property.

“To facilitate the merger or consolidation of any resulting insurer with and into another company simultaneously with the effectiveness of a division,” a dividing insurer may adopt a plan of merger or consolidation as part of the same process as the division. If so provided in a plan of merger or consolidation, such merger or consolidation would become effective simultaneously with the effectiveness of a division. The insurer may request that the Commissioner approve such merger or consolidation as part of the Commissioner’s approval of the plan of division.

Appraisal Rights. If a dividing insurer is not to survive a division, a shareholder of the dividing insurer is entitled to appraisal rights (also known as dissenters’ rights) to the extent provided for a corporation under the state’s corporation laws.

Effect on Existing Instruments; Third-Party Consents. Except as provided in the dividing insurer’s charter or bylaws, a division does not give rise to any rights that a shareholder, director or third party would have upon a dissolution, liquidation or winding up of the dividing insurer. Furthermore, a division does not constitute an assignment of any insurance policy, annuity, reinsurance agreement or other type of contract.

However, if a debt instrument, whether secured or unsecured, or a provision of any contract (other than an insurance policy, annuity or reinsurance agreement) that was issued or incurred by the dividing insurer before the effective date of the act requires the consent of the obligee to a merger of the dividing insurer, or treats such a merger as a default, the provision applies to a division as if the division were a merger. If a division breaches a contractual obligation of the dividing insurer, all resulting insurers are jointly and severally liable for the breach. The act specifies that the validity and effectiveness of the division are not affected by the breach.

Submission of Plan to Commissioner. A dividing insurer may not file a plan of division with the Commissioner until the plan has been approved in accordance with all provisions of the dividing insurer’s charter and bylaws. (If the charter and bylaws do not specifically provide for a division, the provisions in those documents concerning approval of a statutory merger apply.)

After such approval, the dividing insurer must file the plan of division with the Commissioner. Within 10 business days after such filing, the dividing insurer must provide notice of the filing to each reinsurer that is a party to a reinsurance contract allocated in the plan.

A division does not become effective until it is approved by the Commissioner.

Notice of Hearing. Before approving a plan of division, the Commissioner must, in “large or complex” divisions, hold a public hearing. The model act includes a “Drafting Note” explaining that “some state insurer division statutes provide the Commissioner discretion to hold such a hearing regardless of the size or complexity of the division. When considering whether or not to require a public hearing, legislatures should take note that state insurance departments are situated and staffed differently with varying degrees of expertise across the country, and, as such, the size, public interests affected and level of complexity of a division necessary to warrant public hearings may vary from state to state.”

The Commissioner must provide notice of the public hearing to state insurance regulators and appropriate state guaranty associations in states in which the dividing insurer is authorized to do business. The Commissioner must also “be satisfied” that the dividing insurer has made “reasonable efforts” to provide all policyholders, annuity holders and reinsurers with at least 30 days’ notice of the hearing. (“Policyholders” and “annuity holders,” for purposes of the act, exclude certificate holders or other covered persons under a group policy or group annuity.) The Commissioner may determine that there are other interested persons to whom it would be “unreasonable or unfair” not to give notice. Thirty days’ notice must also be given to these classes of persons as well.

In “large or complex” divisions, the Commissioner must engage “an independent expert” to review the plan and issue a report to the Commissioner, which report addresses the following:

  • The business purposes of the proposed division
  • Capital adequacy and risk-based capital, including consideration of the effects of asset quality, nonadmitted assets and actuarial stresses to reserve assumptions
  • Cash flow and reserve adequacy testing, including consideration of the effects of diversification on policy liabilities
  • Business plans
  • The impact, if any, of concentration of lines of business following the proposed division
  • Management’s competence, experience and integrity

The insurer must bear all expenses incurred by the Commissioner in connection with a division, including expenses for outside attorneys, actuaries, accountants and other experts.

Criteria for Approval. The Commissioner is required to consider, as part of his or her consideration of the plan of division, any merger or acquisition of a resulting insurer that is contemplated to occur in connection with the division. In making a determination over a proposed division, the Commissioner must consider, “among other things,

  • all assets, liabilities and cash flows;
  • the nature and composition of the assets proposed to be transferred in support” of the division; and
  • “all proposed assets of the resulting insurer [sic], which consideration must include an assessment of the risks and quality, including the liquidity and marketability, of the proposed portfolio of the resulting insurer; consideration of asset and liability matching; and the treatment of the material element of the portfolio based on statutory accounting practices.”

The Commissioner “shall approve” a plan of division if he or she finds that the following requirements are met:

  • The financial condition of a dividing insurer, a resulting insurer or an acquiring party of a resulting insurer, if any, will not jeopardize the financial stability of the dividing insurer or prejudice the interests of its policyholders, contract holders or reinsurers in a manner that is unfair to them.
  • The terms of the plan of division are “fair and reasonable” to the dividing insurer’s, and any resulting insurer’s, policyholders, annuity holders or reinsurers.
  • The dividing insurer, any resulting insurer and any acquiring party have no plans or proposals to liquidate the dividing insurer or any resulting insurer, sell assets of the dividing insurer or of any resulting insurer, consolidate or merge the dividing insurer or any resulting insurer with a person, or “make any other material change in the dividing insurer’s or any resulting insurer’s business or corporation structure or management that is unfair or unreasonable to” policyholders, annuity holders or reinsurers or “not in the public interest.”
  • The competence, experience and integrity of the persons who would control the operation of a dividing insurer (if it is to survive the division), and any resulting insurer, are such that they would be consistent with the interest of the dividing insurer’s and any resulting insurer’s policyholders, annuity holders or reinsurers and the general public.
  • The division is not likely to be hazardous or prejudicial to the insurance-buying public.
  • The interests of the policyholders of the dividing insurer that may become policyholders of a resulting insurer will be adequately protected by the resulting insurer or the acquiring party of a resulting insurer, if any.
  • The dividing insurer, if it is to survive the division, and the resulting insurer will be solvent upon the consummation of the division.
  • The assets allocated to the dividing insurer, if it is to survive the division, and to the resulting insurer will not, upon the consummation of the division, be unreasonably small in relation to the business and transactions in which the insurers were engaged or are about to engage.
  • The proposed division is not being made for the purpose of hindering, delaying or defrauding any policyholders, annuity holders or reinsurers.
  • In the case of life insurance, each resulting insurer that will be allocated life insurance policies or annuity contracts will be licensed in each line of business in each state where the dividing insurer was licensed or had ever been licensed. The resulting insurer need not be licensed with respect to any line of business in any state where, at the time of division:
    • The dividing insurer is not licensed and had never been licensed with respect to the line of business or
    • The state does not provide guaranty association coverage or similar coverage with respect to the allocated policies or contracts
  • For each resulting insurer that will be allocated property-casualty insurance policies, the dividing insurer has demonstrated that the laws of each state where any such policies are allocated to any resulting insurer extend eligibility for guaranty fund coverage to persons who hold such policies, but only to the extent such policies were eligible to be covered by the guaranty fund in the state prior to the division.
  • If the plan of division allocates policies of long-term care insurance, “the liabilities associated with the allocated policies do not constitute more than a de minimis amount of the insurance liabilities allocated to the dividing insurer, if it survives the division, or to any resulting insurer.”

Confidentiality of Materials; Limitations. Under the model act, all materials submitted to the Commissioner in connection with a plan of division are confidential and subject to the same protection afforded by the state’s insurance holding company act (the state statute that governs insurance companies controlled by other entities), until the time, if any, that a notice of the hearing is issued. After the issuance of a notice of the hearing, information lodged with the Commissioner may be treated confidentially to the extent that the insurer requests (other than the plan of division and any materials incorporated by reference therein “that must not be eligible for confidential treatment”). Such materials are treated equivalently to materials disclosed to or obtained by the Commissioner in the course of an examination or investigation made under the holding company law. However, if the Commissioner determines that the public’s interest in making the information available for public inspection outweighs the interest of the dividing insurer in keeping the information confidential, the Commissioner may, after notice and an opportunity to be heard, make the information available to public inspection in accordance with the state’s open records or freedom of information law.

Approval of Plan. If the Commissioner approves a plan of division, the Commissioner must issue an approval order including findings of facts and conclusions of law, as well as certificates of authority for the new insurers surviving the division and any merger. An officer or a duly authorized representative of the dividing insurer must sign a “certificate of division” that sets forth all of the following:

(1) The name of the dividing insurer;

(2) A statement disclosing whether the dividing insurer survived the division. If the dividing insurer survived the division, the certificate of division must include any amendments to the dividing insurer’s charter or bylaws as approved as part of the plan of division;

(3) The name of each resulting insurer that is created by the division;

(4) The date on which the division is effective;

(5) A statement that the division was approved by the Commissioner;

(6) A statement that the dividing insurer provided reasonable notice to each reinsurer that is a party to a reinsurance contract allocated in the plan of division;

(7) Charter and bylaws for each resulting insurer created by the division; and

(8) A “reasonable description of the capital, surplus, or other assets and liabilities, including policy liabilities, of the dividing insurer that are to be allocated to each resulting insurer.”

Effectiveness of Plan. The certificate of division is effective on the date that the dividing insurer files the certificate with the secretary of state and provides a concurrent copy to the Commissioner, or on another date as specified in the plan of division, whichever is later. However, the certificate of division becomes effective no later than 90 calendar days after it is filed with the secretary of state. A division is effective when the relevant certificate of division is effective.

On the effective date of a division, if the dividing insurer survives, the dividing insurer continues to exist and must amend its charter and bylaws if the amendments are provided for in the plan of division. If, on the other hand, the dividing insurer does not survive, the dividing insurer ceases to exist and any resulting insurer created by the plan of division comes into existence, with its charter and bylaws becoming effective at that time. Each resulting insurer holds any “capital, surplus and other assets” allocated to the resulting insurer by the plan of division “as a successor to the dividing insurer by operation of law, and not by transfer, whether directly or indirectly.”

Effect on Assets. All capital, surplus and other assets of the dividing insurer:

(a) That are allocated by the plan of division vest in the applicable resulting insurer as provided in the plan of division or remain vested in the dividing insurer as provided in the plan of division;

(b) That are not allocated by the plan of division remain vested in the dividing insurer if the dividing insurer survives the division and are allocated to, and vest pro rata in, the resulting insurer individually if the dividing insurer does not survive the division; and

(c) Otherwise vest as provided in this section without transfer, reversion or impairment.”

If capital, surplus or other assets are allocated to a resulting insurer, where the assets constitute collateral covered by an effective financing statement, the allocation is not effective until a new effective financing statement naming the resulting insurer as a debtor is effective under the state’s Uniform Commercial Code. Similarly, the act states that “liens, security interests, and other charges on the capital, surplus or other assets of the dividing insurer are not impaired by the division.” If the dividing insurer is bound by a security agreement governed by any jurisdiction’s Uniform Commercial Code or substantially equivalent law, and the security agreement provides that the security interest attaches to after-acquired collateral, a resulting insurer is bound by the security agreement.

Effect on Liabilities. A resulting insurer is liable only for the liabilities allocated to the resulting insurer in accordance with the plan and is not liable for any other liabilities as a successor or under any other theory of liability applicable to transferees or assignees of assets.

A resulting insurer to which a cause of action is allocated may be substituted or added in any pending action or proceeding to which the dividing insurer is a party when the division becomes effective.

All liabilities, including policy liabilities, of a dividing insurer are allocated among any resulting insurers, and each resulting insurer to which liabilities are allocated is liable only for those liabilities, including policy liabilities, allocated as a successor to the dividing insurer by operation of law and not by transfer or assumption, whether directly or indirectly.

A resulting insurer is individually liable for the liabilities, including policy liabilities:

(1) That the resulting insurer issues, undertakes or incurs in its own name after the division; and

(2) Of the dividing insurer that are allocated to or remain the liability of the resulting insurer to the extent specified in the plan of division.

The dividing insurer remains responsible for the liabilities, including policy liabilities, of the dividing insurer that are not allocated by the plan of division if the dividing insurer survives the division. Similarly, a resulting insurer is liable pro rata individually for the liabilities, including policy liabilities, of the dividing insurer that are not allocated by the plan if the dividing insurer does not survive.

Except as otherwise expressly provided in this section, when a division becomes effective, a resulting insurer does not have liability for:

(1) Any liabilities, including policy liabilities, that another resulting insurer issues, undertakes or incurs in the resulting insurer’s own name after the division; or

(2) Any liabilities, including policy liabilities, of the dividing insurer that are allocated to or remain the liability of another resulting insurer under the plan of division.

Unless otherwise provided in the plan of division and specifically approved by the Commissioner, an allocation of a policy or other liability may not:

(1) Affect the rights that a policyholder or creditor has under any other law with respect to the policy or other liability, “except that the rights are available only against a resulting insurer responsible for the policy or liability” under the act; or

(2) Release or reduce the obligation of a reinsurer, surety or guarantor of the policy or liability.

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