FOCUS: New York's Liquidation Bureau and its Processes A Critical Analysis Part I of II By Peter Bickford

Since the Mid-1980s I have actively represented managements, shareholders, policyholders, claimants, and reinsurers (both as creditors and as debtors) of insurance operations in liquidation or rehabilitation in New York. During that time I have observed the handling (or mishandling) of the receivership process spanning the administrations of five Governors and eight superintendents. Each new administration has vowed to "do something" about the system, and in particular address the "mess" at the Liquidation Bureau. What has been clear from these efforts over the years is that the "mess" has been largely misunderstood and the entrenchment and resilience of the Bureau grossly underestimated.

When the current administration came on the scene in 2007, it was under the banner of openness, transparency and reform. When there appeared to be a significant disconnect between the promise and reality, and in response to numerous expressions of exasperation by colleagues, I began a series of eight articles on the receivership process in New York, which I posted at http://insuranceioi.blogspot.com/ from August 2008 through March 2009. After completing the series, I received a number of requests for the entire series. I am therefore presenting this series of postings as one combined article.

Part I: What exactly is the Liquidation Bureau anyway?
It is easier to state what the liquidation bureau is not. According to the New York Court of Appeals, it is not a state agency (and therefore not subject to audit by the state comptroller). According to the records of the Secretary of State, it is not a corporation. And according to the Insurance Law . . . : well, let's just say its status is undefined.

Before 1993 there were no statutory references to a liquidation bureau in the Insurance Law, including the receivership article, Article 74. In 1993, subsection (g) was added to Section 7405 ("Order of liquidation; rights and liabilities") requiring the superintendent as receiver to prepare an annual report on the status of each company in liquidation or rehabilitation. The last sentence of this new section states: "This report shall be separate and apart from other reports issued by the liquidation bureau of the department in the normal course of its business." This is the only reference in the Insurance Law (actually the only reference in the entire New York Consolidated Laws) to a liquidation bureau.

The Bureau's existence may be assumed, but its status and mandate are not defined anywhere in the law. The home page of the Liquidation Bureau's web site states:
"The New York Liquidation Bureau (NYLB) is a unique entity. [No debate there!] Receiving no funding from taxpayers, it carries out the responsibilities of the Superintendent of Insurance as Receiver, and acts on his behalf in the discharging of his statutorily defined duties to protect the interests of the policyholders and creditors of insurance companies that have been declared impaired or insolvent."

The bureau's web site also states that it has "performed this function since 1909, when the New York State Legislature passed the law mandating that the Superintendent assume the separate responsibility of Receiver." However, the law does not establish a bureau to carry out this function. The law requires that the superintendent be designated as rehabilitator or liquidator to take control of the assets of an insolvent company and liquidate or manage the estate. It also permits the appointment of deputies and assistants to support the superintendent in this role as receiver. It was clearly anticipated that these appointments would come from the key employees of the insolvent company itself -those with the greatest knowledge of the business and operations of the company being liquidated - and would be engaged only for the duration of the receivership process.

The hiring of employees of the insolvent company, and the temporary nature of these appointments, was succinctly summarized in a 1915 report to the New York State Constitutional Convention Commission on the Organization and Functions of the Government of the State of New York (at page 118) - just a few years after the statute referred to in the Bureau's web site:
"The practice is to retain such of the employees of each company which comes into liquidation as may be necessary to attend to the details of its affairs, and to dispense with them as rapidly as consistent with the proper conduct of its business."

The current statute is consistent with this historical record of the temporary nature of the receivership of insurance companies. Rather than authorizing the establishment of a permanent bureau, current Section 7422 authorizes the superintendent to appoint deputies and others to assist in the performance of the receivership function, "and all expenses of conducting any proceeding under this article shall be fixed by the superintendent, subject to the approval of the court, and shall be paid out of the funds or assets of such insurer." Article 74 clearly views each insolvency as a separate proceeding with the superintendent acting as receiver under the supervision and control of a Supreme Court judge for that estate. Nowhere in the law is there any provision for the establishment of a permanent agency or bureau to carry out this function, and there is no central judicial oversight designated to coordinate the handling of all pending receivership proceedings collectively.

The limited role and temporary nature of the agents assisting the receiver for a particular estate has evolved into a permanent liquidation bureau, particularly over the past thirty years. This evolution occurred without a statutory, judicial or regulatory mandate to do so. As the number and size of insolvencies increased dramatically in the late 1970s and into the 1980s, the liquidation bureau grew into its own self-operating permanent bureaucracy, flying under the radar and accountable to no one - not the legislature, not the courts, and not the regulators.

The Bureau today has half as many employees (over 450 employees) as the entire New York Insurance Department, and most of them are protected by union contracts. The Bureau also purports to have a budget of over $100 million, but this "budget" is not subject to any independent oversight. Although Section 7422 requires court approval of expenses for an estate, there is no requirement in the law - including the much-touted new legislation that would require annual audits - that the supervising court be provided with any regular, interim financial or status report. More significantly, no one court would be looking at the bureau or its budget as a whole.

The current administration has made a lot of noise about reforming the bureau and making it more "transparent." It is doing this, however, by making the bureau even more permanent, contrary to the mandate of Article 74 and the statutory receivership scheme.

Is there an existing example of how the system could and should work under the existing statutory authority? The answer is yes!

Part II: The Right Stuff
On July 7, 1994, a consensual order of rehabilitation was entered against United Community Insurance Company (UCIC) in Upstate New York. Less than a month later, on August 3, 1994, the then superintendent of insurance, Sal Curiale, filed a petition with the New York Supreme Court in Schenectady to liquidate UCIC. The management of UCIC, having just consented to rehabilitation, vehemently opposed the petition and the issue of the actual financial condition of the company became the subject of an evidentiary hearing and the hiring by the court of an independent actuary. In the meantime, the New York Liquidation Bureau was effectively dismantling the company under the rehabilitation order. When the new superintendent, Ed Muhl, reviewed the stalemate in early 1995, he made an extraordinary decision: he appointed a special agent from outside the Liquidation Bureau to assess the financial status of UCIC and to handle the rehabilitation or liquidation of UCIC, whichever was warranted. The special agent put together a small team of experts and a plan of action and advised the court of those plans. The special agent determined to the satisfaction of the court that the company was insolvent and an order of liquidation was entered on November 9, 1995 - more than 14 months after the petition had been filed - and this time with the consent of UCIC's owner and board of directors.

The management of the UCIC estate by the special agent and his team since 1995 has been an example of how efficiently and transparently an estate can be managed for the benefit of policyholders and creditors in New York under the existing statutory scheme. This was accomplished by the special agent working closely with the various state guaranty funds, creditors and reinsurers, by staffing commensurate with the actual needs and activity of the estate, and by being accountable to the liquidation court through regular conferences and reports. UCIC is the only company in liquidation in New York that has consistently filed with the liquidation court annual statements prepared on a statutory accounting basis. While dividend declarations by estates in liquidation in New York are rare, UCIC has paid dividends over the years totaling 35% of recorded liabilities. Information on the estate is regularly provided by the special agent to the liquidation court and all interested parties, including representatives of the principal creditors, reinsurers and guaranty funds.

The Liquidation Bureau, however, has done its best over the years to downplay the record of UCIC and bring the estate into the fold of the Bureau. For instance, searching for UCIC on the Bureau's website will produce no reference to the special agent (the contact person listed is an employee of the Bureau and not the special agent), no indication that any dividends have been paid, and no reference to any filed documents other than the order of liquidation. If it were not for the level of involvement by the liquidation court, creditors, and guaranty funds fostered by the special agent over the years, this estate would have years ago become just one more mishandled estate in the Bureau's quiver. What was extraordinary about Superintendent Muhl's decision to use a special agent outside of the Liquidation Bureau was not that it was outside the statutory scheme, but rather quite the opposite. The UCIC case is extraordinary because it is squarely within the statutory scheme, and it is the only estate that actually follows the original concept of the statute. It is the only estate that works closely with the court, files regular reports, prepares its annual statements on a statutory basis, and gets all its expenses and actions approved with full disclosure to all interested parties. This feat could not have been accomplished without the foresight of Superintendent Muhl, his understanding of the scope of his authority as receiver, and the pro-active participation of the court.

The original statutory scheme recognizes that each estate is different and allows the superintendent to bring the appropriate expertise to bear on each individual circumstance. Unfortunately, the Liquidation Bureau, by its very nature (a fixed staff of 500 people, most of whom are protected by a union contract), is a one-size-fits-all operation, with a voracious appetite but little flexibility. The result is a statutory process that has been highjacked by a non-statutory entity accountable to no one.

It will take more than adding layers of reports and audits to this already cumbersome operation to provide efficient and transparent management of insolvent estates. It will take a return to the actual intent and structure of the statutory scheme!

Note: The legislation sought by the Liquidation Bureau as a "reform" action, requiring the annual audit of the Bureau and the estates under its management, was signed into law as Chapter 540 on September 4, 2008. Part V of this series addresses this law and why it will move the Bureau even further from proper oversight, and make the administration of insolvent estates even more costly and inefficient.

Part III: [In]Security Funds
This seems like a particularly good time to discuss insurance security funds as part of the review of the insurance insolvency process in New York. While every state has some form of security or guaranty fund coverage for both property/casualty and life insurance products, New York does it differently - not necessarily better, but definitely differently.

Guaranty Fund Overview
The various state insurance guaranty funds generally provide coverage to resident policyholders against the failure of any carrier admitted to do business in the state. There are limitations and caps on coverage that vary from state to state. For information on any particular states coverage, go to the web sites of the National Conference of Insurance Guaranty Funds (www.ncigf.org) for information on property/casualty funds, and the National Organization of Life and Health Insurance Guaranty Associations (www.nolhga.com) for information on life and health funds. Both of these organizations make available detailed information on the coverages, caps and limitations on a state-bystate basis. The NCIGF site also has some excellent publicly available summary charts comparing coverages and limitations by state.

Even though these associations make information publicly available about the funds, the insurance guaranty funds are little known to or understood by the insurance consumer. There are many factors contributing to this lack of understanding including:

• Insurance claims are not as readily determined, for instance, as the balance in a bank account covered by Federal Deposit Insurance;
• The caps, coverages and exclusions are not uniform but vary greatly from state to state; and
• Most insidiously in this age of instant communication and "openness," the laws of most states specifically prohibit the advertising of the existence or coverage of the insurance security and guaranty funds, particularly the life insurance funds (see my June 18, 2008 post, "Outing Life Guaranty/Security Funds").

This series, however, is about the insolvency process in New York and, of course, the insurance security funds in New York have their own quirks and distinctions from the rest of the universe.

New York has five, count 'em, five insurance security funds - three property/casualty funds and two life funds. The three New York p/c funds are the Property/Casualty Insurance Security Fund, the Workers' Compensation Security Fund and the Public Motor Vehicle Liability Security Fund. The two life funds are the Life Insurance Guaranty Corporation, which was replaced (but not eliminated) by the Life Insurance Company Guaranty Corporation of New York in 1985.

The New York P/C Funds
There are two main differences between New York's three p/c funds and the p/c funds in all other states:

1. The New York funds are pre-assessed rather than post-assessed; and
2. The New York funds are controlled directly by the superintendent of insurance as receiver rather than by separate guaranty associations.

By statute, the New York p/c funds are funded by annual assessments of all licensed carriers writing the kinds of business covered by each fund. For the largest of these funds, the Property Casualty Insurance Security Fund, all licensed p/c insurers are assessed 0.5% of "net direct written premiums" in any year where the balance in the fund falls below $150 million. According to the 2007 Annual Report of the Superintendent to the Legislature, the balance in this fund at March 31, 2007 (the latest published report) was $180,903,187. Although this balance is in excess of $150 million, it is likely that the annual calls will continue without break for the foreseeable future because of the extensive demands against the fund in recent history, including the solvency concerns with the other two p/c funds.

The other two funds are not only smaller, but they are financially stressed to the point of having required legislative intervention to support them - particularly the Public Motor Vehicle Liability Security Fund, which at March 31, 2007 had a balance of $92,760. The Workers' Compensation Security Fund had a March 31, 2007 balance of $52,748,854, but this balance was supported by loans in excess of $17 million from assets of estates in liquidation. These loans were authorized by legislation adopted in 2005 as part of emergency measures taken by the New York Legislature to shore up the stressed funds -measures that raise a number of unanswered questions about the long term viability of the funds and the proper or improper use of estate funds.

The 2005 legislation required the superintendent of insurance to evaluate the funds and make recommendations to the Legislature for "long term" solutions to the fund issues. This resulted in a May 2006 report by then Superintendent Howard Mills, supported by an extensive evaluation by the consulting firm of RSM McGladrey, recommending a number of statutory and administrative reforms. Among the more significant recommendations were proposals to eliminate the cap on assessments; reduce the $1 million cap on claims to either $500,000 or $300,000 consistent with other state funds (NY is the only state with a cap in excess of $500,000, and most states cap claims at $300,000); exclude claims of large commercial insureds (again, consistent with the restrictions in many other states); and merge the Public Motor Vehicle Liability Security Fund with the more broadly funded Property/Casualty Insurance Security Fund. To date, however, I am not aware that the current administration has actively pursued these or other proposed reforms with the Legislature.

The pre-assessment/post assessment dichotomy between New York and other states is probably not terribly significant today. While it might have been argued in the past that pre-assessments allow greater flexibility in addressing insolvencies on a timely basis, the sheer volume of insolvencies, the resulting claims, and the resulting financial stress on the funds, has de facto made even the New York funds close to being post-assessment funds.

The second significant difference between the p/c funds in New York and those of other states is that in the rest of the country, each state's fund is managed by a separate entity - generally a guaranty association that is independent of the receiver and that include industry representation (the funds are, after all, the funds of the contributing insurers!). In New York, however, there is no separate entity managing or overseeing the funds. The New York p/c funds are nothing more than general accounts, subject to the sole control of the superintendent of insurance. There is no industry representation, no separate claim handling function and no separate oversight.

The existence of guaranty associations provides an excellent check and balance in the insurance insolvency system. Receivers benefit from the expertise of the associations and their members in the management and payment of claims, and the associations provide an opportunity for the industry to have a better understanding of potential fund requirements and the unique issues facing particular insolvent estates.

In New York, however, the industry has limited, if any, involvement in the management or review of claims of an estate, and very little input to estate-specific issues that may arise, except in the context of costly and time consuming adversarial proceedings.

Finally, and of most significance, the absence of separate p/c guaranty associations in New York results in even more authority over the control and management of insolvent estates residing with the Liquidation Bureau as the superintendent's agent - a Bureau that, as I have pointed out in earlier installments in this series, is not a state agency (it just acts like one), has no clear statutory foundation, is subject to no central regulatory or judicial oversight, and despite its claims of transparency, is not obligated to provide any significant information about its operations to any regulatory, judicial, consumer or industry body. In effect, the New York p/c funds are pools of money collected from the industry, with unfettered check-writing authority granted to the superintendent's agents - the Liquidation Bureau - who are accountable to no one!

The New York Life Funds
The principal life insurance guaranty fund in New York is the Life Insurance Company Guaranty Corporation of New York, which was created by special legislation in 1985. The creation of the Life Insurance Company Guaranty Corporation of New York in 1985, however, did not terminate the Life Insurance Company Guaranty Corporation, which continues to cover claims on policies issued before August 1985 that are not covered by the "new" fund.

The life fund in New York bears a much closer resemblance to the funds in other states. Assessments from the industry are made only on an "as needed" basis so there is no pre-funding involved. Also, unlike the New York p/c funds, the New York life fund is actually managed by a separate not-for-profit corporation whose members are all New York licensed life insurers. The members in turn select the directors of the corporation who are charged with its management. The pre-1985 fund remains relevant because the "new" fund has limitations and coverage distinctions quite different from the pre-1985 fund. Most significantly, the "new" fund has a $500,000 cap on claims, and covers only New York resident policyholders of licensed companies, while the pre-1985 fund covers claims under any policy issued by a domestic life insurer. These distinctions are likely to play a significant role in addressing the Liquidation Bureau's work-out plan for Executive Life Insurance Company of New York in Rehabilitation, whose remaining book of business consists primarily of single premium deferred annuities issued before and after August 1985. Although the New York life funds are closer to the traditional separate entities found in most other states, they seem to fly under the radar to a greater extent than the New York p/c funds. For example, information on the p/c funds is included each year in the superintendent's annual report to the Legislature, but there is no information included regarding the life funds. This is the case even though Article 77 of the insurance law covering the new fund requires an annual report be filed with the superintendent.

The New York insolvency process is fraught with inconsistent and ineffective reporting requirements. Parts IV-A and IV-B of this series explain these requirements and how they affect the effectiveness of the process.

Part IV-A: Information Highway or By-way?
The current administration has repeatedly stated its intent to be more transparent in its operation of the liquidation process in New York. The Liquidation Bureau has demonstrated this intent by issuing numerous press releases on its activity and has posted significant information and documents on its web site (www.nylb.org). Most recently, it has posted the long-awaited audit of the Bureau and the estates under its management for calendar year 2006, and has sought and received significant press coverage of this event ("NY Liquidation Bureau Issues First Complete Independent Financial Audit In Its 99Year History - Bureau Receives Unqualified 'Clean' Opinion from Auditor on its 2006 Financial Data" - Press release of October 29, 2008). The administration has also touted the passage of the legislation it proposed requiring the audit of the Bureau and the estates it manages in the future ("Bureau Sought Change to State Insurance Law to Provide Greater Transparency" - Press release of August 7, 2008).

But does this seeming plethora of information constitute true transparency - in the open and helpful sense? Does it provide meaningful information to interested parties in insolvent estates, including policyholders, creditors, other claimants, reinsurers, guaranty funds, regulators, courts and legislators? What does the law require, and are the receiver and his agents complying with those requirements? What information is required to be made available by the security funds in New York? Is the information available from the security funds consistent with the statutory requirements? How helpful is the Freedom of Information Law (FOIL) to anyone seeking additional information about an insolvent estate or a security fund?

In order to present this material in manageable bites, I have divided the subject into two parts: in this Part IV-A, I will cover the reporting requirements and practices of the rehabilitator and liquidator, including the Liquidation Bureau. The next Part (Part IV-B) will cover the reporting requirements and practices of the security funds.

Licensed New York insurers are required by statute to file financial statements on a statutory accounting basis with the Insurance Department on or before March 1 of each year (Insurance Law §307(a)(1)). Within five months of the end of a calendar year, each licensed insurer (other than companies with minimal premium volume) are required to file audited financial statements, which statements, together with the auditor's opinion, are to be made publicly available by the Department ((§307(b)(1)). In addition to the reporting requirements, the superintendent of insurance has the power to examine the affairs of an insurer "as often as he deems it expedient," but at least every 3 to 5 years, depending on the business of the insurer (§309). But what happens to these reporting and examination requirements when an insurer is placed into liquidation or rehabilitation in New York? Interestingly, the liquidation and rehabilitation article of the insurance law (Article 74) is silent on the subject. Under a plain reading of the law, so long as the insolvent insurer remains licensed, it should continue to be subject to the same statutory reporting requirements as solvent insurers. The statute does not provide for automatic withdrawal or stay of the license or licenses of insolvent insurers. Liquidators try to justify not filing reports and not subjecting the entity in liquidation to examination by arguing that after an order of liquidation is entered, the entity in liquidation ceases to be a licensed entity. However, that argument is not supported by the law as written and is further belied by the common practice of liquidators treating licenses as tangible assets that can be sold. Moreover, even if that argument could be accepted for companies in liquidation, it cannot be said to be applicable to companies in rehabilitation, where the specific charge of the rehabilitator is "to conduct the business thereof, and to take such steps toward the removal of the causes and conditions which have made such proceeding necessary as the court shall direct." (§7403).

The other argument made to try to justify not filing reports and not allowing examination is that under Article 74, the courts assume responsibility for the conduct of the liquidators and rehabilitators of an estate, thus taking the place of the regulators. However, while the law requires court approval of the material actions or plans of the liquidator or rehabilitator, it does not remove the applicability of §§307 and 309, and it does not provide the court with the necessary authority or tools to perform regulatory oversight of an estate. For example, none of the statutorily required reports discussed in this article are required to be filed with the rehabilitation or liquidation court. In fact, there is no statutory requirement for the liquidator or rehabilitator of an estate to file any report on the status of an estate with the court, except for a final report to close the estate. (Note: I referred in the prior Part of this series to the requirement in §7422 that the expenses of an estate are subject to the court's approval. A review of the docket of any of the significant estates under the Liquidation Bureau's management shows that this requirement is followed more in the breach than in the practice). Only one of the current estates in liquidation files regular annual statements on a statutory basis (and that estate is the one estate not managed by the Liquidation Bureau). The two estates in rehabilitation have started filing statutory statements, but no estate - liquidation or rehabilitation - prepares and files with the superintendent annual audited statements within five months of the end of the calendar year (Note: the recently enacted statutory requirement for annual audited statements of the Bureau and each estate under its management has less strenuous requirements in terms of time and content and does not specifically eliminate the requirements of §307. That legislation, which is not effective until December 31, 2009, and which directly conflicts with existing law, will be addressed in a later installment of this series). Furthermore, once an insurer is placed in rehabilitation or liquidation in New York, the insurance department ceases to continue the regular periodic §309 examinations of those entities, even though the insurance law does not exempt those entities from such examination. While I have been informed that there have been instances of insurance department examination of companies in receivership in the distant past, the practice has evolved that once a company is ordered into liquidation or rehabilitation, the insurance department ceases to be the regulator of that entity - perhaps to avoid the inherent conflict of the superintendent regulating himself.

Assuming for the moment that insolvent estates are no longer subject to §§ 307 and 309 (as seems to be the unstated position of the Liquidation Bureau and the bureaus of the insurance department responsible for the regulation of licensed companies), what reports are they subject to? There are only two other reporting requirements in the Insurance Law regarding estates in liquidation or rehabilitation: §206 and §7405(g). Section 206 requires the superintendent to include in his annual report to the Legislature: "Lists of...insurers organized, admitted, merged, withdrawn, or placed in liquidation, conservation, or rehabilitation" (§206(a)(5); and "Tables relative to liquidation, conservation or rehabilitation proceedings by the department for prior years including the preceding calendar year" (§206(b)(3). The 247 page annual report for 2007 (obtainable in pdf format from the Department's web site at www.ins.state.ny.us/nyins.htm) has 10 pages devoted to the receivership process: 4 pages of narrative about the Liquidation Bureau, 2· pages listing all the estates under its management, and an income and disbursements sheet for each of the three p/c security funds. There are no statements or other financial data for any of the estates.

The other applicable section, §7405(g), requires the rehabilitator or liquidator to submit to the insurance department an annual report for each estate in rehabilitation or liquidation within 120 days of the end of the calendar or fiscal year for that estate, which report is to be prepared "upon whichever standard the corporation conducts its financial affairs" and "shall include a financial review of the assets and liabilities of the corporation, the claims accrued or paid in that period, and a summary of all other corporate activity and a narrative of the actions of the rehabilitator or liquidator respecting such corporation." The report, therefore, need not be on a statutory basis, and need not be a full and complete financial report. Also, even though §307(a)(1) requires licensed insurers to file on a calendar year basis, the §7405(g) reports do not have to be on a calendar year basis. The last sentence of §7405(g) is also interesting. It states that the report under this section "shall be separate and apart from other reports issued by the liquidation bureau of the department in the normal course of its business." This statement seems to provide further support for the conclusion that the law does not excuse the liquidator or rehabilitator from the filing requirements of §307 or from examination under §309.

Even if the rehabilitator or liquidator does not file §307 statutory statements by March 1 each year, an interested person can at least obtain a copy of the §7405(g) report on an estate after April 30, right? Well, yes, but not from the Liquidation Bureau. As noted above, the Liquidation Bureau is not a state agency...