Australia: Solvent Run-Off Scheme A First For Australia

NRG's solvent run-off scheme, approved by the Federal Court last month, is an Australian first.

Under the scheme, which applies to reinsurance written by NRG's Australian wing, cedants will be able to achieve immediate settlement of both existing and future claims. Paying out the policies will allow NRG to close its Australian reinsurance run-off book.

This is the first time that Australian reinsurance liabilities have been subject to a solvent run-off scheme. This development clears the way for schemes by other solvent reinsurers whose Australian business is in run-off.

It is important to note that the NRG scheme related to reinsurance policies. There is probably still some work to be done before (if ever) a run-off scheme would be allowed for direct insurance policies.

Clayton Utz acted for NRG. We also acted for MMIA, in putting together Australia's first solvent run-off scheme (involving overseas liabilities) in 2002.

The Corporations Act 2001 allows a company to enter into a scheme of arrangement with its creditors. If the scheme is approved by 75 percent in value of the creditors and by a court, it will bind both the company and all creditors.

In the case of a run-off scheme, the cedants are the creditors of the reinsurer.

A scheme usually involves a compromise between the company and the creditors. In the case of an insurance company run-off scheme, that compromise takes the form of a process under which all existing and future claims are settled by an estimation and adjudication process. The benefit for the insurer is that the scheme effectively terminates its future liabilities under the policies that are subject to the scheme. For their part, the policyholders get the benefit of an immediate payout of future claims under their policies.

There have been a considerable number of solvent run-off schemes (ie. where the insurer is solvent) in the UK in recent years. To date, this has not been reflected in Australia, in part because we do not have a run-off industry remotely comparable to that in the UK (where the size of non-life run-off liabilities is over £35 billion). Another issue is the attitude of APRA, which has concerns about the effect of a run-off scheme on direct insurance holders.

For that reason, the NRG scheme is a real breakthrough for the Australian insurance industry.

NRG wrote reinsurance in Australia and overseas. That reinsurance business had been in run-off since 1993.

It proposed a scheme of arrangement under which cedants would be paid a sum in final settlement of current and future claims under their reinsurance policies. If the scheme were approved, cedants would be invited to submit their claims to NRG within 120 days of the scheme's becoming effective. The scheme documentation set out a detailed procedure governing how claims would be evaluated by NRG; it included provision for adjudication if NRG and a cedant could not agree on the valuation of a claim.

The scheme would be governed by section 411 of the Corporations Act. As mentioned above, this allows a company to enter into a binding compromise with its creditors. If the scheme achieves the required majority vote from the creditors and the approval of the Court, it binds all creditors whether or not they voted in favour of it.

The formal timetable for a run-off scheme is:

1. submission of the scheme to APRA and ASIC, to allow them to determine whether to oppose the scheme;
2. an application to the Court for an order for a meeting of the cedants;
3. the cedants meet and vote on the scheme - the required majority is 50.1 percent by number of the cedants who vote, representing 75 percent in value of the claims against the reinsurer;
4. an application to the Court for an order approving the scheme;
5. lodgement of the court order with ASIC.

The NRG cedants met on 15 August and approved the scheme by the necessary majority. The Federal Court approved the scheme the following day. That court approval was immediately filed with ASIC, bringing the scheme to life and initiating the 15 day window for NRG to contact cedants and to invite them to lodge claims.

A solvent run-off scheme can be advantageous for both cedants and their reinsurer.

For cedants, the benefits are both short- and long-term.

The short-term benefit is the immediate receipt of cash in respect of claims that may lie many years into the future (if at all). In the case of the NRG scheme, that benefit was compounded by the fact that there will be no discount for early payment in respect of claims that are projected to settle within the next five years. Longer term, cedants would be relieved of a solvency risk attaching to the reinsurer.

The benefit for the reinsurer is that the anticipated closure date of its run-off reinsurance book can be reduced from decades to months. This provides two benefits for the reinsurer (and its owners):

• administration costs can be dramatically reduced;
• after settling all claims under the scheme, the reinsurer can return surplus capital to its investors, rather than having it tied up in a prudential reserve.

Although there are benefits all around, it must be remembered that a run-off scheme is still a compromise for both cedants and reinsurers. The industry regulator, APRA, will oversee schemes, and expects to be consulted at all stages of the process. Based on our experience in talking with APRA about the NRG scheme, we would believe that the regulator would require that any run-off business proposed for a scheme should be quite mature (ie. the business should have been in run-off for at least 10 years). That sort of track record would provide a high degree of certainty about the expected liabilities of the business, thus improving the reliability of the settlement process proposed under the scheme.

Another factor which APRA will look at is the type of insurance covered by the scheme. Cedants can generally be expected to be experienced insurance industry players, who are capable of evaluating the pros and cons of a run-off scheme. However, at this stage, it is unlikely that general insurance policyholders would be considered suitable candidates for a scheme.

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