On 26 January HM Treasury published a consultation paper on a proposed “resolution regime” for insurers (IRR). The IRR will supplement, rather than replace, the existing insolvency regime applying in the case of an insolvent insurer, as proposed to be amended by the Financial Services and Markets Bill 2022-23 (see box below).
The consultation proposals are significantly influenced by the UK’s existing resolution regimes for banks, building societies and central counterparties, and aim to implement relevant international standards into UK law – notably the Financial Stability Board’s “Key Attributes of Effective Resolution Regimes for Financial Institutions”.
Financial Services and Markets Bill 2022-23 (FSM Bill)
The FSM Bill (currently at committee stage in the House of Lords) contains certain provisions relating to insurers in financial difficulties which, in particular, aim to clarify and enhance the existing power for the court to order a reduction in value, or “write-down”, of an insurer’s contracts where the insurer is insolvent.
Key aspects of the proposed IRR
The Bank of England will be designated as the Resolution Authority (RA) responsible for exercising resolution powers over firms under the proposed IRR. The RA will be required to coordinate closely with other authorities, notably the PRA and HM Treasury, in exercising its powers.
The proposed regime is intended to apply to all UK-authorised insurers (i.e. firms which have Part 4A FSMA permission to effect and/or carry out contracts of insurance as principal), as well as certain other relevant entities including insurance holding companies, other entities within the corporate group of an insurer, and UK branches of foreign insurers.
Lloyd’s entities would be excluded from scope, as would friendly societies and smaller firms which do not meet the Solvency II threshold. In practice, the government expects that the statutory tests for resolution action are likely only to be met by a small number of systemically important insurers, with existing approaches being sufficient in most instances.
When taking or considering resolution action, the RA and other relevant authorities are to be guided by five “resolution objectives”:
- Objective 1: protecting and enhancing the stability of the UK’s financial system (including by preventing contagion and protecting access to critical functions)
- Objective 2: protecting and enhancing public confidence in the stability of the UK financial system
- Objective 3: protection of public funds (minimising reliance on public support)
- Objective 4: protecting policyholders of the relevant insurer
- Objective 5: avoiding interference with property rights
Conditions for resolution
The statutory test for resolution action is proposed to consist of four “resolution conditions” (RCs), all of which would need to be satisfied for an insurer to be placed in resolution:
- RC1: The PRA assesses that an insurer is “failing or likely to fail” (which broadly means failing to satisfy the Threshold Conditions, insolvent or likely to become so, and/or requiring extraordinary public financial support)
- RC2: RA considers that it is not reasonably likely that action will be taken by or in respect of the insurer that will result in RC1 ceasing to be met
- RC3: RA considers that public interest in the advancement of the Resolution Objectives requires exercise of stabilisation powers
- RC4: RA considers that one or more of the Resolution Objectives would not be met to the same extent if stabilisation powers not exercised
When taken together, the proposed RCs are intended to ensure that the new resolution options are only invoked in an extreme scenario where all other options have been ruled out, and it is in the public interest to invoke the new resolution regime.
Where the Resolution Conditions are met, the IRR proposals give the RA a menu of powerful “stabilisation options” to select from, including compulsory business transfer and a bail-in procedure (see box below). These may be supplemented by the use of additional tools, notably a new insurer administration procedure (only available where an insurer is in resolution). A pre-resolution valuation of the insurers assets and liabilities would be carried out to inform the RA’s decisions.
IRR stabilisation options
Transfer to a private sector purchaser
A compulsory transfer of the business or shares of the failing insurer to a (willing) purchaser, effected by the RA under its own authority without requiring consent of policyholders or court approval.
Transfer of business to a bridge institution (wholly or partially owned and controlled by the RA) on a temporary basis, to facilitate a more permanent resolution. The lifespan of the bridge insurer would be restricted.
Power for RA to “bail-in” a failing insurer by restructuring, modifying, limiting or writing down its liabilities, including policyholder liabilities (but respecting the statutory priority of direct insurance creditors). Losses will be allocated to shareholders and subordinated debt holders.
Temporary public ownership
Power for HM Treasury to place a failing insurer into temporary public ownership – a tool of last resort in the extreme event that other stabilisation options insufficient, and where there is a serious threat to financial stability or public interest reasons.
Additional tools – may be used in conjunction with the stabilisation options
Balance sheet management vehicle
RA may establish a balance sheet management vehicle to hold assets and liabilities of failed insurer with a view to maximising value through sale or orderly wind down (may be used to separate a “bad” portfolio, enabling a sale of the remaining business).
Insurer administration procedure
Special administration procedure introducing the objective for an appointed administrator to provide support to a bridge insurer or private sector purchaser (where one of these stabilisation options is used) by the supply of services/facilities to enable it to operate effectively. Only to be exercised in relation to a firm in resolution.
No Creditor Worse Off (NCWO) safeguard
Resolution is unlikely to result in a worse outcome for creditors than an insolvency procedure. However, the government proposes that, following the exercise of the resolution powers, HM Treasury would be required to make an order providing the mechanism by which NCWO compensation (if any) could be calculated and paid.
Pre-resolution planning requirements
The proposals will involve some firms in additional pre-resolution planning work, although the impact of this will be limited to the systemically important insurers who are most likely to satisfy the “public interest” test in RC 3. The new requirements consist of:
- Resolvability assessments: to be carried out by the RA on a regular basis, with the aim of understanding features of the relevant insurers which might constitute barriers to use of the proposed stabilisation options. Information sharing between the PRA and RA is intended to prevent duplication of existing PRA work and limit additional information requests. However, if the RA considered that there were barriers to resolvability, it would be empowered to direct the firm to take action to remedy these (with potential enforcement action for failure to comply).
- Resolution plans: will set out the proposed resolution strategy for a firm and an operational plan for its implementation. Plans will be updated by the RA annually, or where material changes take place within a firm or in macro-economic conditions. These are likely to involve additional work for firms, as they relate to new powers and legislation and are not therefore currently factored into planning.
David Steinberg, Partner comments:
"As the consultation paper observes, it is unlikely that the new resolution powers would be invoked for anything other than a systemically important risk carrier. Given the public interest ‘qualifier’, and given also the existing range of alternative restructuring/insolvency procedures already available to distressed risk carriers, the resolution procedure is most likely to be invoked in the case of a large life insurer or of a P&C insurer underwriting ‘compulsory’ risks such as Employers’ Liability, where continuity of cover is critical for policyholders and where readily available alternative providers may be thin on the ground."
The consultation closes on 20 April 2023.