What effect will government proposals have on insurers, policyholders and other stakeholders?
In May 2021, the government published a consultation on “Amendments to the Insolvency Arrangements for Insurers”, with proposals aimed at “enhancing and clarifying” certain aspects of the existing UK insolvency regime for insurers, notably the power for the court to order a “write-down” of an insurer’s contracts.
The five proposals consulted on are set out in the box below. In a response to the consultation published in April this year, the government addressed concerns which had been raised, particularly regarding the effect of the proposals on an insurer’s financial and other counterparties. In the remainder of this article, we consider key proposals 1 and 3 in more detail.
|Amendments to the Insolvency Arrangements for Insurers: proposals|
Proposal 1: "Write-down" of insurers' liabilities
Section 377 of FSMA contains a power for the court to reduce the value of one or more of an insurer’s contracts as an alternative to making a winding up order. To date this standalone provision has remained untested in the “toolbox” for distressed insurers, and the government proposes to create the necessary statutory framework to render it a useful alternative option for insurers in financial distress.
This includes setting out the parties who may apply for a write-down, and the conditions for sanction. To sanction a write-down, it is proposed that the court would need to be satisfied (i) that the insurer is, or is likely become unable to pay its debts, and (ii) that the write down would be reasonably likely to lead to a better outcome for the insurer’s creditors as a whole, including its policyholders, compared with the next most likely scenario. Any application would also require the prior consent of the PRA (Prudential Regulation Authority).
Other key aspects of the write-down proposals include a moratorium on legal process and enforcement of security, and the ability of liabilities to be “written-up” at a later date, either if the insurer’s financial position improved, or the insurer entered into formal insolvency proceedings. However, while the write-down is in force, the insurer’s balance sheet would only reflect the “written-down” amounts.
In the box below, we set out the effect of the proposed write-down procedure on certain key stakeholders:
Effect of write-down on key stakeholders
Fixed chargeholders will be excluded from the scope of the write-down. Floating chargeholders will remain within the scope of the write-down. The moratorium on legal process will suspend the right of secured creditors to exercise security. No mention is made of letter of credit holders, but they may be unable to drawdown on a letter of credit to top up the written-down amount, as there would be no “default” by the insurer.
Policyholders will be within the scope of any write-down. They will not have a right to be consulted on the proposals. Their rights are not extinguished – they may be “written-up” at a later date if the insurer’s financial position improves.
Excluded from the scope of the write-down. Employment tribunals will be exempt from the moratorium on legal process.
Financial contracts as defined in Schedule ZA2 to the Insolvency Act 1986 will be excluded from the scope of the write-down – this covers financial contracts including swaps, derivatives, repos and securities lending. However, bonds issued by the insurer will be included within the write-down.
Sums owed to suppliers in relation to the period before a write-down (arrears) will be within the scope. Ongoing payments for goods and services supplied during the write-down will payable in full.
Within the scope of write-down. The proposals do not specifically require the court to take account of the statutory priority given to direct insurance creditors, but the government states that any write-down plan which did not generally conform to the statutory creditor hierarchy would be unlikely to be sanctioned.
A statutory variation of the “pay-as-paid” doctrine is proposed, clarifying that any write-down of liabilities will not affect recoveries under any outwards reinsurance. This could only affect UK reinsurance contracts and would not be binding on overseas reinsurers.
Payment of dividends and other distributions to shareholders is proposed to be restricted, to prevent shareholders unfairly benefiting at the expense of creditors while an insurer is in a write-down procedure.
Proposal 3: Moratorium on ipso facto termination rights
Alongside the general moratorium referred to above in relation to the write-down process, a separate moratorium on certain contractual termination rights in service and financial contracts with insurers is proposed. This will take effect on application to the court for, and during, an administration or write-down procedure, or on the presentation of a winding-up petition.
The proposed moratorium would prevent the exercise of termination rights in financial and service contracts, where these rights arise solely as a result of the insurer’s entry into insolvency proceedings or write-down (so called “ipso facto” clauses). The insurer must continue to meet its substantive obligations under the relevant contract on an ongoing basis.
Counterparties will be able to apply to the court for an exemption from the moratorium where it will result in financial hardship. However, as the moratorium will be subject to the insurer continuing to meet payment and other substantive obligations under the affected contracts, it is thought that the hardship exemption will be rarely invoked.
Concerns were raised during the consultation process with regards to the impact of the “ipso facto” moratorium on the ability of counterparties to terminate or “close-out” derivative contracts with an insurer prior to its entry into insolvency proceedings.
It is likely that the proposed write-down power will be of use in fairly limited circumstances. It is envisaged that it is most likely to be used in the retail life insurance sector, where it could assist by offering continuity of cover for policyholders who may struggle to obtain similar cover elsewhere in the market. Due to uncertainty regarding overseas recognition, and the potential effect on creditor rights under non-UK law governed contracts - for instance in relation to letters of credit - it seems unlikely to be suitable for insurers or reinsurers with substantial non-domestic portfolios.
The government intends to legislate for these proposals when parliamentary time allows. Of potentially wider impact, the government is currently considering a proposal for a specific resolution regime for insurers aligned with internationally agreed standards and best practice. We await more detail on the proposal, and how it will interact with the current options available to insolvent insurers. For more information on the current regime, see our introductory article (originally published in the IRLA (Re)Insurance Legacy Handbook).