18. Had the decision favoured MMI their liabilities would have been significantly reduced and a solvent run-off would have been more likely.

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1 EAST AYRSHIRE COUNCIL CABINET 29 JANUARY 2014 MUNICIPAL MUTUAL INSURANCE SCHEME OF ADMINISTRATION Report by the Executive Director of Finance and Corporate Support 1. PURPOSE OF REPORT 2. To advise the Cabinet of the financial impact to the Council arising from the triggering of the Scheme of Arrangement. 3. BACKGROUND 4. Municipal Mutual Insurance Ltd (MMI) is an insurance company limited by guarantee which was established by a group of local authorities on 13 March MMI suffered substantial losses between 1990 and 1992 which reduced their net assets to a level below the minimum regulatory solvency requirement. As of 30 September 1992 MMI ceased writing new business, or inviting renewal of policies. At that time MMI was the principal insurer of 90 to 95% of all local authorities in the UK. 6. In order to protect the interests of local authorities (and other public sector bodies) and allow MMI to continue to pay claims in full and achieve an orderly run-off of the company s liabilities, a Scheme of Arrangement (the Scheme) was proposed under Section 425 of the Companies Act The Scheme was subsequently agreed at a meeting of scheme creditors on 5 January 1994 and became binding on all creditors. 7. This Council, as the successor authority to Cumnock and Doon Valley District Council and Kilmarnock and Loudoun District Council, is a scheme creditor and is subject to the financial implications of the outcome of the run-off process. 8. During the initial scheme period (prior to any trigger event) all liabilities of MMI continued to be paid. All new insurance claims that were reported and which related to when MMI were on cover were also dealt with, and where appropriate paid in full. 9. The Scheme could only be triggered if the company s liabilities exceeded its assets and the company Directors concluded that there was no reasonable prospect that MMI would avoid entering insolvency. 10. If a trigger event occurred a levy could be imposed on all scheme creditors which since 30 September 1993 had been paid in excess of 50,000. No levy would be imposed on any scheme creditor in respect of the first 50,000 paid. The raising of a percentage levy was designed to enable MMI to claw back sufficient funds to maintain a solvent run-off. However, once a levy has been imposed future payments of claims will be made at a reduced rate.

2 11. The Board of Directors of MMI announced on 13 November 2012 that they had decided to trigger the Scheme. From that date control of MMI passed to the Scheme Administrator, Ernst & Young LLP, to conduct a financial review of the company and consider the level of any levy to be imposed on the scheme creditors. 12. ASSESSMENT OF REQUIRED LEVY 13. The original belief was that the run-off process for MMI would last for around twenty years. However, MMI is now in its 21 st run off year, and the company still receives large numbers of claims particularly in respect of abuse, asbestosis, deafness and mesothelioma. It is now anticipated that the Scheme may not close until around 2040 or indeed beyond. 14. Mesothelioma is the most serious of a number of diseases that can arise from exposure to asbestos dust. It is an aggressive form of cancer that affects the pleura, the thin membrane that surrounds the lungs and internal organs of the chest. Once diagnosed, the condition is essentially untreatable. It has a very long latency period, and generally can take up to 40 years to manifest. 15. MMI has been party to a series of test cases since 2006 designed to create certainty as to which insurer should respond to long tailed industrial disease claims where there is difficulty in determining when the injury arises. 16. The litigation process finally ended on 28 March 2012 with a ruling by the Supreme Court that MMI as insurer on risk at the time of the original exposure to asbestos dust should deal with current Mesothelioma claims. Mesothelioma claims account for approximately 76% of MMI s total liabilities with many new cases likely to be in the pipeline, and it is probable that it was this issue alone that necessitated the need to trigger the Scheme. 17. In reality the Supreme Court ruling merely endorsed the historical causation approach to policy interpretation that the insurance industry was responding to prior to the MMI legal action. 18. Had the decision favoured MMI their liabilities would have been significantly reduced and a solvent run-off would have been more likely. 19. The Scheme Administrator commissioned KPMG to carry out an updated actuarial review of the insurance liabilities of MMI as at 31 December As the projection of future claims is so uncertain KPMG presented a range of estimates of MMI s remaining liabilities from 189m to 379m. Using this information, together with other supporting evidence, the model indicated a levy of between 9.5% and 28.0% would be required to achieve a projected solvent run-off. 20. The Scheme Administrator has taken the mid-point of KPMG s assessments, and the initial levy rate has been determined at 15.0% of the claims paid (less the 50,000 deductible).

3 21. The levy rate is to be reviewed every 12 months to take account of liability trends evolving and the claims book. Due to the latent nature of the claims that MMI is still receiving and the fact that many of the trends in reporting continue to be adverse, the projections are subject to substantial uncertainty. It is therefore not possible to state with any certainty that this initial levy will be the only call on scheme creditors. 22. The setting of a levy now has an impact on the future payment of claims by MMI. Payment of future claims will be at the Payment Percentage, being 100% less the levy; consequently the Initial Payment Percentage will be 85.0% with the Council bearing the cost of the other 15.0%. 23. REVISED ARRANGEMENTS FOR NEW CLAIMS 24. Zurich Municipal will continue to administer and agree settlement of claims received but will no longer be able to make indemnity payments on behalf of policyholders. The restriction on payment is due to: The requirement that, post Levy, the payment percentage must be applied to all payments made in respect of claims; and The requirement that amounts paid to Scheme Creditors are adjusted where MMI has paid Elective Defence Costs, as defined in the Scheme. 25. As a consequence the Scheme Administrator is required to introduce a revised procedure for the payment of claims. New claims will continue to be presented in the normal course to MMI through Zurich Municipal. They will write to the Council to: i) Confirm receipt of the claim; ii) iii) iv) Advise they are dealing with it on behalf of MMI; Advise the claim is subject to the Scheme of Arrangement and that in the first instance all cost must now be paid by the Council; Confirm the cover applicable to the claim and refer to any shortfall identified; v) Ask the Council to confirm contact details and reference details are correct as these will be provided to claimants solicitors to use in the event of any issues arising in respect of payments requested under the Scheme of Arrangement. 26. Zurich will also write to the claimant s solicitors to: i) Confirm receipt of the claim; ii) iii) Advise they are dealing on behalf of MMI as their claims handlers; Confirm the extent of MMI s cover;

4 iv) Advise the claimant s solicitor that the claim is subject to the Scheme of Arrangement and what this will mean in respect of payments for damages and their costs. 27. FINANCIAL IMPLICATIONS 28. The amount of Established Scheme Liabilities and Elective Defence Costs paid on behalf of CDVDC and KLDC since September 1993 is 888, Allowing for the 50,000 exempt from claw back, the total payments subject to a maximum levy of 100% is 838, Based on the current levy rate of 15.0% the Council is required to make an immediate payment of 125,725 to MMI. 29. An initial analysis of the claims information provided by MMI is summarised in the following table. This shows the indicative allocation of the Levy between the HRA and General Fund. 30. MMI - SCHEME OF ARRANGEMENT CDVDC KLDC TOTAL % of Claims HRA 113, , ,645 38% General Fund 226, , ,523 62% Total 339, , , % Less Retention Exempt from Levy -50,000 Total Payment Subject to Levy 838,168 Notional Split of Levy HRA 47,371 General Fund 78, , No provision has been made within the financial statements due to the stated uncertainty in respect of the amount and timing of any levy. The 2013/14 budget for insurance includes an amount to cover the levy whilst provision has also been made in the estimates for 2014/15 and 2015/16 as a contingency against a further levy being necessary. 32. A decision is required to allocate the initial levy payment between the HRA and General Fund on the basis identified at paragraph 30 above. 33. LEGAL IMPLICATIONS 34. The legal consequences of the decision of the Supreme Court on 28 March 2012 effectively places the Council in a position that in order to minimise potential future unknown, and at this time unquantifiable liabilities, there is really no option than to make payment of the levy amount as detailed within this report. A failure to do so would result in the Council being required to resolve any future claims without any input from MMI.

5 35. RISK IMPLICATIONS 36. There is a possibility that the initial levy will not be sufficient to ensure a successful run-off of all liabilities. Should this arise a supplementary levy will then be imposed. The immediate financial risk can be offset by maintaining a contingency within the corporate insurance budget. 37. RECOMMENDATIONS 38. Cabinet is asked to: (i) Approve payment of the Levy of 125,725 as set out in paragraph 30; (ii) Otherwise note the contents of the report. Alex McPhee Executive Director of Finance and Corporate Support 22 January 2014 LIST OF BACKGROUND PAPERS NIL Members requiring any further information should contact Craig McArthur, Head of Finance (Telephone ). IMPLEMENTATION OFFICER Craig McArthur, Head of Finance