Article by
Francine L. Semaya 
,
William K. Broudy 
and
Laurance D. Shapiro
Certain insurance programs, particularly workers' compensation programs with large deductibles, require the insured to deposit collateral with the insurer as security for performance by the insured of its payment obligations. The liquidation of Reliance Insurance Company in Pennsylvania brought collateral deposits into the spotlight and led Pennsylvania and Illinois to enact legislation addressing the right to such collateral in the event of the liquidation or insolvency of an insurer. New York does not have an equivalent statute, but an opinion letter issued by the Office of General Counsel of the New York Insurance Department (the "Opinion")1 on December 31, 2008 provides some guidance.
The Opinion, issued in response to an inquiry to the Department, addresses the issue of whether cash collateral placed with an insurer by a policyholder pursuant to the terms of a payment agreement governing an insurance program would be treated as general assets of the estate of an insurer in liquidation or rehabilitation ("receivership"). The Opinion concludes, with emphasis added, that:
The view that collateral should not be included in the general assets of an insurer undergoing liquidation or rehabilitation is generally consistent with the practice of the New York Liquidation Bureau, which has indicated to the Department that, in situations where there is a bona fide agreement between a policyholder and an insurer that specifically characterizes an asset as collateral and not part of the general assets of the insurer, such collateral will not be included in the general assets of the insurer's estate in liquidation or rehabilitation.
With respect to cash collateral held on an unsegregated basis, it is not possible to state categorically in advance how such collateral would be treated. A decision regarding such assets can be made only after an examination of the particular facts and circumstances of the case. Nevertheless, in cases where such cash collateral does not represent premiums earned by the insurer, and where a policyholder can demonstrate that it has posted an amount of collateral with an insurer for a specific purpose, that policyholder's contractual expectations as to the use, application, and return of its cash collateral will be respected even in the event of the rehabilitation or liquidation of the insurer."
The Opinion notes that existing law, Section 7408 of the New York Insurance Law, excludes from the definition of "general assets" of an insurance company in liquidation, property "...pledged, deposited or otherwise encumbered for the security or benefit of specified persons or a limited class of persons..."2 If a policyholder provides collateral to secure the payment of workers' compensation benefits to its employees, for example, that collateral would be excluded from the general assets of a company in receivership. If, however, collateral is provided to cover premium payments, that type of collateral deposit would be considered part of the general assets of the company, according to the Opinion.
By contrast, the first subsection of the Pennsylvania statute3 , enacted in 2004, provides, with emphasis added, that:
(a) Collateral shall not be considered an asset of the estate and shall be maintained and administered by the receiver as provided in this section, notwithstanding any other provision of law or contract to the contrary.
"Collateral" and "Deductible Agreement" are defined by the Pennsylvania statute as follows:
"Collateral" shall mean collateral held by, for the benefit of or assigned to the insurer or subsequently to the receiver in order to secure the obligations of a policyholder under a deductible agreement and also any collateral recovered or held by the receiver that secured the obligations of a policyholder under a deductible reimbursement policy.
"Deductible agreement" shall include any combination of one or more policies, endorsements, contracts or security agreements which provide for the policyholder to bear the risk of loss within a specified amount per each claim or occurrence covered under a policy of insurance and may be subject to aggregate limit of policyholder reimbursement obligations as set forth in an endorsement to a policy or in a program agreement.4
The Pennsylvania statute deals directly with the issues discussed in the Opinion, as does the Illinois statute, 215 ILCS § 5/205.1, entitled Policyholder collateral, deductible reimbursements, and other policyholder obligations. As is the case with the Pennsylvania statute, the Illinois law provides in its first subsection, with emphasis added, that:
(a) Any collateral held by, for the benefit of, or assigned to the insurer or the Director as rehabilitator or liquidator to secure the obligations of a policyholder under a deductible agreement shall not be considered an asset of the estate and shall be maintained and administered by the Director as rehabilitator or liquidator as provided in this Section and notwithstanding any other provision of law or contract to the contrary.
In other jurisdictions, including New York, there is far less statutory clarity concerning the treatment of collateral than is provided by the foregoing Pennsylvania and Illinois statutes. As recommended by the New York Opinion, policyholders would be well-advised to enter into "a bona fide agreement between a policyholder and an insurer that specifically characterizes an asset as collateral and not part of the general assets of the insurer." Otherwise, a New York receiver might take the position that such collateral becomes general assets of an estate in the event of liquidation.
Footnotes
1. OGC Op. No. 08-10-08.
2. New York Insurance Law Section 7408(b)(7).
3. Pennsylvania Insurance Law Section 40-11-405.1, entitled Deductible reimbursement agreements; collateral; obligations of policyholders and receivers.
4. Pennsylvania Insurance Law Section 40-11-405.1(n).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
