A recent letter issued by the New York State Insurance Department has clarified an important point of insurance law for those issuers who may be looking to get out of their current bond insurance policy.
The letter, dated May 9 and posted May 13, says that in the event a contract has a "non-cancellation" provision, the policy can be canceled only if all parties to the insurance policy - the bond insurer, issuer, and bondholders - agree. If the parties do not agree, and the policy contains a "non-cancellation" clause, then the policy should remain, the department advised. The regulators also suggested that in the case that all parties do agree, the policy should be canceled in a considered manner that evaluates the merits of the termination.
The impetus for the letter was to clarify state insurance law for a number of issuers that had contacted the department looking for guidance.
"A couple of municipalities had come to us wanting to get out of the policies. They wanted to make sure they could do it and we wouldn't be opposed to it if there were a non-cancellation clause," a spokesperson for the department said. "It's a contract issue and if everybody agrees, we don't have a problem with that."
The issue has arisen because of rating downgrades, or threatened downgrades, for many of the bond insurers. As a result, variable-rate bonds and auction-rate securities with insurance policies have suffered falling values and failed auctions. In response, many issuers have looked for ways to isolate the insurance policy through creative solutions and in some cases, looked to rid themselves of it entirely.
However, some issuers said they were told by the bond insurers that if there was a non-cancellation clause, the policy could not be terminated, leaving a refunding transaction as the only option for issuers still looking to end the policy completely. Refundings, however, can mean more costs to the issuer and less favorable financial results.
"Since the crisis first hit and people started calling their bond insurers, they have taken the position that you can't cancel these policies because of these clauses," said John Craford, executive vice president for finance and administration at the Connecticut Housing Finance Authority. "What this ruling does at the very least is make it clear that if everybody agrees, it can be canceled."
The bond insurers have not been eager to allow issuers to cancel their policies. Some are concerned that allowing one issuer to arrange a deal would open the floodgates to other issuers doing the same, while others may be concerned about giving up unearned premium that would be paid on an annual or periodic basis. In some cases, Craford said, insurers are requiring a payment to cancel a policy that still has unearned premium associated with it.
"This still requires the insurer's consent to cancel the insurance," Craford said. "It still leaves a situation where they could be looking for a make-whole provision for the premiums."
Ambac Assurance Corp. has a relatively small exposure to policies with unearned premiums and an MBIA Insurance Corp. spokesperson said they do not have any such arrangements. The insurance companies point out that the non-cancelable clause in these documents is meant to protect the policyholders in times when the insurance policy might be drawn upon.
"Our policy is unconditional and irrevocable, I don't want the marketplace in general to lose sight of the value proposition," the MBIA spokesperson said. "The New York State Insurance Department letter clarifies and confirms that policy cancellation is permitted upon request of the insured and recommends that insurers work with issuers to provide alternatives to prematurely terminating the policy."
Bond insurers have helped issuer clients find solutions that have preserved the insurance policy or deferred it until a time in the future when the current turmoil has presumably passed. Both MBIA and Ambac have released detailed explanations of these solutions in recent weeks.
