Part VII business transfers - adding flexibility to the run-off equation

The news in May this year that the UK High Court had sanctioned the first Part VII business transfer of liabilities out of a Lloyd’s syndicate in run-off, so creating an alternative to reinsurance to close (RITC) as the route for closing orphan syndicates. This fresh idea, introduced by Clyde &Co, once again underlined the way in which this relatively new mechanism is increasingly being used to tackle legacy issues.

Under that particular initiative Lloyd’s managing agency, Spectrum Syndicate Management, received Court approval to transfer the liabilities from Syndicate 982 to Sterling Life. At the time the move triggered considerable speculation that similar moves would follow as the Lloyd’s market continues to seek ways of managing its post Equitas run-off issues.

However, given that the fact that the identity and addresses of every creditor of syndicate 982 was known and that none were located in the US was a significant factor in the Council of Lloyd’s approval of the transaction, it would be unwise to regard this transfer as setting a precedent for future transfers from Lloyd’s in different circumstances. Accordingly, as yet little in the way of real clarity has emerged on the nature and scope of portfolios that the Council of Lloyd’s would generally be prepared to see taking this approach.

But whatever the eventual outcome for the Lloyd’s market, there is no doubt Part VII business transfers are increasingly proving themselves a very flexible tool for facilitating insurer restructuring both in respect of live and old years’ business.

So what are Part VII business transfers? The mechanism, which came into being under the UK’s Financial Services and Markets Act 2000, effectively allows a 'statutory novation' to take place under which many contracts of insurance can be changed without the individual consent of each policyholder.

Accordingly, the process, which involves the close involvement of, and supervised by, the UK’s Financial Services Authority (FSA), enables Court sanction to be granted for some or all of the insurance contracts of a risk carrier to be transferred to another insurer along with all rights and duties under those policies. The UK legislation also allows the transfer of the outwards reinsurance of the portfolio to be transferred without the explicit agreement of the reinsurer. As such they are a very different proposition from either reinsurance to close (RITC) or schemes of arrangement.

In comparison to RITC contracts, where legally the original liability remains with the original insurer, Part VII business transfers enable a portfolio to be transferred once and for all to the transferee.

When looked at in comparison to schemes of arrangement, Part VII transfers are far less complex to administer as individual creditor - or policyholder - approval from a majority of those who vote does not have to by sought. That said, however, unlike schemes of arrangement Part VII business transfers do not offer a mechanism that actually closes off those liabilities.

In essence, therefore, Part VII business transfers are simply a mechanism that facilitates the process of moving groups of insurance contracts from one risk carrier entity to another. But even the most simple application can offer benefits in terms of the management of run-off books of business - for instance, by using them internally within an insurance or reinsurance group to 'tidy up' books of discontinued business into one vehicle in order to achieve reduced administration costs and free up management resource.

In the same vein, Part VII business transfers can be used to bring together a portfolio of risks as a precursor to the sale of that business to a third party run-off expert - an approach which also carries with it the attractions of removing discontinued portfolios from a business, so strengthening the balance sheet. In such cases, the recipient of the portfolio typically will then use a scheme of arrangement to close off the run-off book of business.

Similarly run-off experts are increasingly examining ways in which Part VII business transfers can be used to overcome situations where a portfolio contains business, such as personal lines policies or compulsory insurances, which is not suitable for scheming. By first using Part VII transfers to separate the business which cannot be schemed from that which can, conventional reinsurance arrangements can the be used in respect of the former while a solvent scheme of arrangement is used to close the remainder of the portfolio.