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Retrocession payment a key to keeping Scottish Re restructuring on track

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Retrocession payment a key to keeping Scottish Re restructuring on track

Subsidiaries of Scottish Re Group Ltd. have taken steps to ensure the company's U.S.-domiciled life reinsurance business, which assumed billions of dollars in life insurance and annuity reserves from unaffiliated domestic third parties as of year-end 2016, remains in good standing with its primary regulator.

Scottish Holdings Inc., the immediate parent of Scottish Re (U.S.) Inc., is one of two Scottish Re companies that sought Chapter 11 bankruptcy protection in January. Though Scottish Re (U.S.) is not a party to those cases, the debtors' CFO warned in a Feb. 2 court filing that a motion to modify the automatic stay imposed under the bankruptcy code is necessary to facilitate the insurer's sale as proposed to an affiliate of Hudson Structured Capital Management Ltd. and to potentially stave off a "value-destroying chain of events" that could include the insurer's seizure by the Delaware Department of Insurance.

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In addition to its assumptions of life and annuity reinsurance from domestic cedants, Scottish Re (U.S.) also retrocedes business to offshore affiliates. One of them, Scottish Annuity & Life Insurance Co. (Cayman) Ltd., filed for Chapter 11 protection and, as such, requires relief from the U.S. Bankruptcy Court for the District of Delaware to pay to Scottish Re (U.S.) a regular periodic settlement amount under the retrocession agreements of $4.3 million for the fourth quarter of 2017.

CFO T.J. Keller said Scottish Re (U.S.) would suffer an immediate reduction to its surplus in the event that amount is not paid. And to the extent Scottish Annuity & Life continued to fail to honor its retrocession-related obligations, the U.S. company might no longer be able to obtain credit on its financial statements for those agreements.

The impact of a default by Scottish Annuity & Life on its obligations to pay Scottish Re (U.S.) would, at the very least, lead to a sharply lower risk-based capital level and could lead to seizure by the regulator, Keller said. Such a default would also prompt the buyer to walk away from the deal, thereby forcing Scottish Annuity & Life into liquidation, he added.

In that case, Scottish Re (U.S.) would be forced to recapture all of the business it ceded to the affiliate. Once that occurred, it would then be required to maintain higher reserves to support the influx of liabilities, Keller explained.

"As a result of the loss of financial statement credit coupled with the increase in required reserves and capital, [Scottish Re (U.S.)'s] RBC level would plummet to a level mandating an immediate and irreversible seizure," he said.

Scottish Re (U.S.) reported $472.6 million in reserve credits taken as of Dec. 31, 2016, for business ceded to affiliates. Of that amount, $320.5 million pertained to a coinsurance with funds withheld agreement with Orkney Re II Plc, $149.8 million resulted from various agreements with Scottish Annuity & Life, and the balance was linked to Ireland-based Scottish Re (Dublin) dac.

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Nearly all of the life and annuity reserve assumptions reported by Scottish Re (U.S.) in its 2016 annual statement pertained to business ceded by U.S.-based third parties through yearly renewable term and coinsurance agreements. It assumed reserves in excess of $100 million as of Dec. 31, 2016, under various agreements with affiliates of seven groups: Protective Life Corp., John Hancock Life Insurance Co. (USA) and its affiliates, Lincoln National Corp., Pacific Mutual Holding Co., Nationwide Financial Services, Fidelity & Guaranty Life, Transamerica Life Insurance Co. and its affiliates, and Ohio National Mutual Holdings Inc.

U.S. life insurers reported Scottish Re (U.S.) reserve credits of $2.86 billion in the aggregate as of Dec. 31, 2016. Scottish Re (U.S.) reported the assumption of $2.80 billion in reserves from unaffiliated entities as of that date, including modified coinsurance reserves.

As things stand, the Delaware Department of Insurance might have the authority to seize Scottish Re (U.S.), the Scottish Re entities stated in bankruptcy court filings, by advancing the position that the insurer's continued transaction of business is "presently or prospectively hazardous to its policyholders." Not only does Scottish Annuity & Life reinsure a significant portion of Scottish Re (U.S.)'s liabilities, it is also party to an agreement to maintain minimum capital and surplus at the insurance company.

But that hypothetical scenario is unlikely to play out to the extent the debtors' obtain the relief they have requested from the bankruptcy court. Scottish Holdings CEO Gregg Klingenberg said in a filing that company representatives had been in communication with various regulators, including the Delaware Department of Insurance, and they believed that their proposed court-supervised restructuring "is likely to satisfy" them.