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US: The New "Best Interests" Standards developed by US Courts for Insurance Rehabilitation Plans in 2013

21 February 2014
The October 24, 2013 decision of the Wisconsin Court of Appeals to affirm approval of a rehabilitation plan for the Segregated Account of Ambac Assurance Corp. (the “Ambac Segregated Account”) concluded a year of dramatic shift in the standards for approval of rehabilitation plans, at least in regards to financial guaranty insurers. See Nickel v. Wells Fargo Bank (In the Matter of the Rehabilitation of Segregated Account of Ambac Assurance Corporation, 351 Wis.2d 539, 841 N.W.2d 482 (2013)). The Nickel court found that the plan of rehabilitation for the Ambac Segregated Account (the “Ambac Segregated Account Plan”) favored the public policies served by insurance and the best interests of the insurer’s policyholders “as a whole.” Therefore, the Ambac Segregated Account Plan was approved notwithstanding that the plan may not have met the “best interests” of individual policyholders, which traditionally has required that each policyholder receive at least the liquidation value of its claim. This decision appears to be part of a trend by state courts in insurance insolvency proceedings to move away from the “best interests” test, which in federal chapter 11 cases sanctions rehabilitation distributions that equal or exceed liquidation value of claims, and the “fair and equitable” standard that is well known to chapter 11 practitioners and has guided insurance rehabilitations since the Great Depression.

The Ambac Segregated Account Decision

To reach its holding, the Nickel court deftly rejected arguments that the United States Supreme Court’s decision in Neblett v. Carpenter, 305 U.S. 297, 59 S.Ct. 170, 83 L.Ed. 182 (1938) (affirming Carpenter v. Pac. Mut. Life Ins. Co. of Cal., 74 P.2d 761, 778 (Cal. 1938)), established a liquidation value baseline for rehabilitation plans. See Nickel, 841 N.W. 2d at 503-504, citing Consedine v. Penn Treaty Network America Ins. Co., 63 A.3d 368, 453 (Pa. Commw. 2012) (rejecting rehabilitator’s petition to convert the case to a liquidation proceeding, and reasoning that “[t]he Court must consider the greater good, including the consequences to the larger class of policyholders and the taxpaying public”) (citations omitted). The Wisconsin court explained that the Neblett decision merely addressed arguments by holders of non-cancellable health and accident policies that the provisions of the plan at issue allowing them to opt-out and receive liquidation value based on breach of their policies was an unconstitutional taking, Nickel, 841 N.W. 2d at 528-529, and therefore did not set a standard for all rehabilitation plans. (The decision was also premised on the requirements of Wisconsin law, and in that way the court may have decreased the impact of its departure from the Carpenter v. Neblett standard.)

The Nickel court also held that although the Second Amendment prohibits states from retroactively impairing private contract rights, the plan of rehabilitation of the Ambac Segregated Account fell within the public interest exception that allows limited impairment. See Nickel, 841 N.W.2d at 509 (“[I]t is axiomatic that the commissioner, in the reasonable exercise of the state’s police power, may structure a rehabilitation plan that has the potential to adversely affect the interests of individual policyholders when the plan advances the broader interests of the policyholders, the creditors, and the public as a whole.”), citing American Eagle Ins. Co. v. Wisconsin Ins. Sec. Fund, 286 Wis. 2d 689, 714, 704 N.W.2d 44, 56 (the State may exercise the powers vested in it for the general good of the public even when doing so has the potential to impair contracts); Caminetti v. Pacific Mut. Life Ins. Co., 22 Cal. 2d 344, 361, 139 P.2d 908 (1943) (“[T]he power of the commissioner with respect to statutory proceedings against insolvent or delinquent insurers is of general public concern.”).

The Ambac Segregated Account Decision Seems to be Part of a Trend

This trend in insurance restructuring cases to move away from the “best interests” test may have begun as early as a year before, when the New York court in ABN AMRO Bank N.V. v. Dinallo, 962 N.Y.S.2d 854, 856 (N.Y. Sup. 2013), rejected challenges to the New York regulator’s administrative approval of the restructuring of MBIA. In Dinallo, policyholders objected to a restructuring transaction that left their claims with a thinly capitalized insurer, while MBIA’s public finance business was transferred to a financially robust company. The Dinallo court held the agency’s approval of the transactions splitting MBIA’s business into two companies to be “fair and equitable” because it would allow continued municipal bond coverage to the U.S. public finance market, which in 2009 was struggling. At the same time, the Pennsylvania court in Consedine reasoned that the rehabilitator could not convert the case to liquidation on the grounds that rehabilitation would not pay liquidation value of claims. See Consedine, 63 A.3d at 44. Then, the Opinion issued on August 16, 2013 by Hon. Doris Ling-Cohan In the Matter of the Rehabilitation of Financial Guaranty Insurance Company, Index No. 401265/12 (N.Y. Sup. 2012), also fired a warning shot across the bow of the liquidation value/best interests test and the traditional “fair and equitable” standards. The FGIC court considered and rejected arguments by holders of Residential Capital (“ResCap”) securities insured by FGIC that they treated unfairly by the settlement between the FGIC rehabilitator and the ResCap chapter 11 estate, because the proposed distribution of settlement proceeds to them could result in a lesser distribution than was to be paid under the FGIC plan to similarly situated policyholders. The FGIC court approved the settlement notwithstanding failure to comply with traditional “fair and equitable” and “best interests” standards as regarded the objecting policyholders, because “it is in the interest of all FGIC policyholders as a whole that the Settlement Agreement be approved.”

From the fall of 2012 to fall of 2013, each of these courts rejected the generally accepted standard for rehabilitation, that policyholders are entitled to payment of at least the value that they would have received under the state priority statute if the insurer were liquidated. This standard was originally used to support seminal decisions in Carpenter v. Pac. Mut. Life Ins. Co. of Cal., 74 P.2d 761, 778 (Cal. 1938), aff'd sub nom., Neblett v. Carpenter, 305 U.S. 297, 59 S.Ct. 170, 83 L.Ed. 182 (1938); Matter of People of the State of N.Y., by Van Schaick (In re Nat'l Sur. Co.), 268 N.Y.S. 88, 91 (N.Y.A.D. 1 Dept. 1933), aff'd, 191 N.E. 521 (N.Y. 1934). In Nat’l Surety, the rehabilitation plan contemplated three companies: one for “selected lines of preferred risks,” a second for “obligations under mortgage guaranties,” and a third to liquidate the remaining assets. Nat'l Surety, 268 N.Y.S. at 91. In Carpenter, life policyholders were transferred to a new company and paid as before, but non-cancellable disability policyholders were to receive a percent of their claims based on the year of their policy’s issuance. Carpenter, 74 P.2d at 768. Carpenter and Nat’l Surety have been relied upon by modern courts to hold that insurance company rehabilitation plans must provide policyholders with the liquidation value of their claims or the right to opt out and receive what they would have in liquidation. See, e.g., Koken v. Fidelity Mutual Life Insurance Co., 803 A.2d 807, 826 (Pa. Cmwlth. 2002) (citing Neblett for the proposition that “[c]reditors and policyholders must fare at least as well under a rehabilitation plan as they would under a liquidation”).


Together with the New York court’s decisions to approve the ResCap settlement and the New York court’s rejection of challenges to the administrative approval of MBIA’s restructuring, the Nickel court’s decision regarding the Ambac Segregated Account Plan reveals an obvious trend. Though the FGIC and Dinallo cases preceded the Nickel court’s decision, because of the procedural context of the Nickel case, the decision is more recognizable as a shift from prior law. The FGIC plan of rehabilitation was approved after many compromises and settlements, whereas the decision on the Ambac Segregated Account Plan came after years of litigation and appeals, and the court supported its holding logically by relying on statements from the Pennsylvania court in Consedine and by clearly distinguishing Neblett. Thus, the Wisconsin court’s decision shifts in favor of analyses of insurance rehabilitation plans that consider fairness of a plan and best interests of constituents – present, as well as future policyholders – as a whole and in the context of the public need for insurance. Such analysis abandons the “best interests” and “fair and equitable” standards for plan approval that are used in chapter 11 reorganizations under the Bankruptcy Code as standards for creditor treatment, and that have long-guided insurance rehabilitation cases.

Because each of the Dinallo, FGIC and Nickel cases involved financial guaranty companies, the harms prevented by these decisions – e.g., massive mark to market losses on financial contracts and loss of “control rights” to mortgage-backed securities (a form of salvage that generates on-going returns) – are not readily duplicated by any other line of business. Thus, it remains to be seen whether the results garnered in these monoline rehabilitation cases will translate to restructuring efforts by insurance companies engaged in other lines of business.


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