Creditors of the liquidated Citizen Insurance Company have high expectations now that the time frame set by the Reserve Bank of Malawi (RBM) to accept creditors’ proof of claims has elapsed. As a recap of the ordeal, Citizen Insurance Company (hereinafter referred to as “Citizen”) was placed under Statutory Management on November 26 2011, following RBM’s invocation of Section 68 (2) (a) (ii) of the Financial Services Act 2010, alleging that Citizen was “in gross breach of the Financial Services laws.” To be more precise, it was “in an unsound financial position” as stipulated in the above provision.
By petitioning the High Court for a winding-up order as a consequence of fruitless 120 days of statutory management, implies that RBM, as a regulator, was convinced beyond reasonable doubt that Citizen was impaired, insolvent and in unsound condition.
The High Court granted the winding up order but it was subsequently challenged by the Citizen’s former directors, giving the impression and realigning public opinion that Citizen was not ‘absolutely’ impaired, insolvent and in unsound condition.
After months of a protracted legal battle on the matter, the Supreme Court of Appeal recently, upheld the High Court’s ruling. As a court-appointed liquidator, RBM has been inviting Citizen’s creditors (both preferential and non-preferential) to file their proof of claims and November 30 2014 was the bar date.
Just as RBM’s statutory intervention in the affairs of Citizen sought to protect the interests of the policyholders and the general public, it is envisaged that the distribution of Citizen’s asset in course of the winding up process would seek to promote and achieve the same cause.
It is not surprising to note that Citizen’s fair value of its assets is currently far much less than its liabilities right from the statutory management to liquidation process as it accurately defines the legitimate status quo of a company wobbling in insolvency. But what is even more surprising is RBM’s procrastination to intervene and provide technical support in an attempt to resuscitate Citizen’s capital and economic viability.
Solvency margin is a regulatory benchmark that ensures a prudentially regulated financial institution, such as Citizen, is financially sound and secure.
Liquidation of Citizen is a litmus test for RBM. At stake is the trust and confidence of the insuring public, which is currently at ground zero in the wake of prolonged claims settlement delays, a tendency practised by most insurers with some having worst case scenario.
Fair distribution of Citizen’s assets is the starting point to restore the lost trust and confidence of the policyholders and the general public that have a hierarchy of needs aside from insurance.
In the event that Citizen would be wound up as an ordinary company (non-financial institution), its assets would have been distributed under Section 287 (1) of the Companies Act 1984, which essentially outlines preferential debts.
Preferential debts are liabilities of a company in liquidation which must be paid in priority to all other unsecured debts. In some legal systems, preferential creditors have priority over all other creditors, including secured creditors.
In the United Kingdom, for example, there is a hybrid system according to which preferential creditors do have priority over secured creditors but only if the security of the secured lenders is in the nature of a short-term and unfixed or in short, floating charge.
In Malawi, preferential debts as provided for under the Companies Act include winding up costs, liquidator’s costs, employees’ salaries and worker’s compensation, just to mention a few.
Conversely, distribution of Citizen’s assets would be governed by the Financial Services Act 2010 under which Citizen was specifically authorised to carry on insurance business in the country. Section 115 of this Act provides that “wherever the provisions of this Act are inconsistent with the provisions of the Companies Act, the provisions of this Act shall prevail over to the extent of the inconsistency”.
On ranking of creditors’ claims, the Financial Services Act 2010 [Section 72 (8)] confers liquidation costs top priority. As mentioned above, the Supreme Court has appointed RBM as a liquidator of Citizen but its execution might be outsourced for the sake of competency.
Liquidation costs, therefore, encompass the liquidator’s costs (either internal or external, or both), support staff and services costs and costs of any audit carried out for the purpose of Citizen’s liquidation.
Policyholders’ claims are ranked second. By strict market practice, these claims are two-fold: First party claims and third party claims. First party claims are short-tail, direct and easy to ascertain quantum. Examples include theft, fire damage, accidental damage and loss of insured property (both domestic and commercial).
Third party liability claims are long tail, indirect, complex and oftentimes, costly especially made against bodily injuries and fatalities. Legal costs escalate quantum.
Secured creditors are given third priority. According to Curzon’s Dictionary of Law (4th Edition), a secured creditor “is one who holds a mortgage or charge on debtor’s property.”
Unlike the Companies Act, the Financial Services Act ranks fourth all accumulated but net earnings of Citizen’s former employees. A number of these people have been recruited within and outside the insurance industry and yet, some remain unemployed, banking their hopes on RBM.
Government would be the fifth beneficiary of the Citizen’s winding up process through taxable income and with the economic development prevailing in the country, every penny counts.
Last but not least; the Act considers “other creditors in pari passu.” In other words, these are non-preferential but eligible creditors. ‘Pari passu’ is a Latin phrase literally which means “with an equal step.” In the context of liquidation proceedings, these are creditors ranking equally. Examples include Citizen’s outward reinsurance costs, brokers’ commission, loss adjusters’ fees, and other unspecified outsourcing service providers.
Citizen is presumed to possess net assets worth one percent of its current liabilities. In numerical terms, if the net assets have a fair value of K10 million then, by inference, its liabilities are valued at K1 billion.
To resolve this issue under the authority of the law, the liquidator has three options. First and foremost, elimination method would scale down volumes of claims deluging the liquidator’s desk.
For example, RBM, as a regulator, levies on all regulated financial institutions and the levy it generates can suffice to offset all liquidation costs, whether execution was performed internally or externally – taking into account that RBM’s balance sheet is quite viable and incomparable.
Under common law, all third liability claims are subjected to limitation of three years for personal injury and six years for property damage. Hence, all third party claims which occurred but were not made against Citizen, at least, prior to the deadline of 26 November 2014 would be barred and therefore rendered illegitimate.
The liquidator needs to be vigilant to detect fraudulent claimants and render their claims void once detected.
On the fourth ranking of creditors, all unemployed staff members should be given preferences over employed ones. Business as usual, Government should waive tax liability against Citizen’s assets as it does with foreign investors through tax holiday. And all non-preferential creditors are automatically striped of their right to claim by virtue of inadequate resources.
Secondly, the small cake can be equally shared among the preferential creditors, taking into account elimination principle as it applies in this article.
In the worst case scenario, the liquidator can rely on Section 283 (1) of the Companies Act 1984 which reads: “A liquidator shall not be liable to incur any expense in relation to the winding up of a company unless there are sufficient available assets.”
It is imperative to note that liquidation of insurance companies is not only a local but also global issue. For example, United Kingdom’s insurers namely Chester Street and Independent were liquidated in 1989 and 2001 respectively and their liquidation sparked heated debate in the House of Commons which led to the evolving regulatory reforms.
In the United States of America, precisely, Pennsylvania State, its Insurance Department’s website suggests that at least 52 workers’ compensation insurers have had gone into liquidation between 31 May 1979 and 21 August 2014.
But this should not serve as a scapegoat rather; it is a wake-up call for RBM to find a lasting solution. One remedy is for the regulator to set up a compensation scheme that will take care of all eligible claimants as defined within the relevant statute or regulation yet to be drafted and promulgated.
In the UK, the Financial Services Compensation Scheme (FSCS) was established under the country’s primary legislation after the liquidation of Chester Street but, it coincided with Independent’s insolvency. And each State in the US has a Guaranty Association which, like FSCS, remedies insolvent insurers in terms of unpaid insurance claims and unearned premium.
Since its inception, FSCS has helped over 4.5 million people in the UK, paying out K26 billion in compensations. Processing of insurance claims of eligible claimants of the insolvent Millburn Insurance Company is underway and FSCS keeps the claimants well updated on its website.
Liquidation is a culmination of a risk which an entity has onerously failed to manage within its risk management framework but ably handled by Government through statutes and regulations.
In its report entitled “2014 US Industry Report: Financial Institutions”, Aon Risk Solutions asserts that within the insurance and finance sector, top ten risks include regulatory/legislative changes, increasing competition, economic slowdown/slow recovery, damage to reputation and failure to innovate/meet customer needs.
Perhaps, some or all of these risks had substantially contributed to the financial impairment and insolvency of Citizen. Recently, RBM has issued risk management and claims payment directives. It is hoped that all financial institutions will fully comply with each piece of delegated legislation to avert falling into Citizen’s trap.
Whichever option (as outlined above) or any method or formula that the liquidator would employ and apply in distributing the estate of Citizen Insurance Company, let justice takes its course and allow equity to prevail where plausible.
—The author is a chartered insurance practitioner and programme director of GISC Insurance Career Centre.