In May 2021, the UK Government published a Consultation which set out its proposals for targeted (but significant) amendments to certain aspects of the existing UK insolvency arrangements for insurers. The UK Government has now responded to comments on the Consultation received from market participants. In its response, the Government has clarified the scope of its proposed amendments and indicated that it intends to legislate when parliamentary time allows.
Overview of the proposed amendments
The UK Government has proposed (among other things):
- significant enhancements to the Court's existing powers under s377 Financial Services and Markets Act 2000 ("FSMA") to write down the value of an insurer's contracts; and
- the introduction of a moratorium on the exercise of contractual termination rights in certain service contracts and financial contracts which would apply in conjunction with the enhanced write-down procedure or the administration of an insurer,
The Government has also stated that it is actively engaging with the Bank of England to develop a separate proposal for the introduction of a specific resolution regime for insurers, which would complement (and not replace) the Proposals2.
The write-down procedure
The current version of s377 FSMA enables the Court to reduce the value which an insolvent insurer owes under its contracts as an alternative to making a winding-up order in respect of the insurer. However, this existing power is only set out in broad terms such that there is uncertainty concerning certain aspects of its operation (such as: which parties may apply to the Court for a write-down; and which debts can be written down by the Court). In the Proposals, the Government is therefore seeking to clarify and enhance the Court's current write-down power.
There are a number of important aspects to the write-down power:
- Treatment of secured creditors: in the original May 2021 Consultation, the Government proposed that secured creditors would fall outside the scope of the write-down power.However, it has now clarified that this will only be the case where a secured creditor holds a fixed charge.Where the charge, as created, was a floating charge, it will remain in scope.
- Treatment of unsecured creditors: a wide range of unsecured creditors could be subject to a write-down. However, a number of key exceptions are proposed, which include: liabilities with an original maturity of less than seven days; certain employee liabilities; liabilities arising from financial contracts (see below); liabilities arising from commercial and trade creditors for critical services; and payments due to suppliers for goods and services which are to be provided following the write down order being made.
- Financial contracts and bonds: the Government has now clarified that the financial contracts excluded from the scope of the write-down power will be those in Schedule ZA2 Insolvency Act 1986, excluding arrangements involving the issue of capital markets investments (paragraph 6 of the Schedule). The Government states that this definition will capture the financial contracts an insurer is likely to hold (including swaps, derivatives, repos and securities lending), but not debt issued by the insurer.This exclusion has been tailored to mitigate potential concerns that the pricing or terms on which insurers are able to enter financial contracts could change if all financial contracts were within the scope of the write-down power.However, the Government also seeks to balance this with the fair treatment of creditors by allowing bonds issued by the insurer to be written down.The Government states that it has recognised the importance of the cost of debt issuance. However, its view is that, from the perspective of the lender, the additional risk of default as a result of the Proposals is zero. The Government believes that it is unlikely that the losses incurred by lenders as a result of the exercise of the write-down power would be greater than the losses they would incur if the insurer were to enter into an alternative insolvency procedure (given that a write-down will only be sanctioned where it is deemed preferable to creditors (as a whole) than the alternative and can only be ordered where the insurer is (or is likely to become) insolvent.
- Moratorium on legal process and enforcement of security3: the Government has now confirmed that this moratorium will not only protect an insurer from legal action but will also suspend the right of a secured creditor to exercise security.It is proposed that the moratorium will apply on an interim and then permanent basis following an application being presented to the Court/the Court sanctioning a write-down, subject to an automatic termination point six months after the write down comes into force.This six month period may be extended by the Court and, conversely, creditors may be able to apply to the Court for its early termination.
- Writing-up and interest: written-down liabilities would be deferred (off balance sheet) and not extinguished and could be reactivated (for example: written up if the insurer's financial position is later found to be better than assumed in the initial write-down; the insurer enters into administration or liquidation; or the availability of a surplus following completion of a solvent run off).In the event that a written-down liability is subsequently "written-up", statutory interest will be payable on both any written-down portion of a liability which would have been due and payable (rather than merely contingent) prior to the write up; and any unpaid liability (whether or not written down) which would have become due and payable except for the effect of the proposed moratorium on legal process, and in respect of which the creditor was prevented from taking enforcement action.
The moratorium on the exercise of contractual termination rights
The Government's position is that the termination of an insurer's financial contracts (see below) and service contracts could significantly impact on an insurer's financial position and operational continuity and could slow or destabilise the recovery/insolvency process.
The Proposals therefore contain an automatic statutory moratorium on certain termination/suspension rights (including the exercise of such rights and the ability to take legal action to enforce such rights) for financial and service contracts where the termination/suspension rights arise solely as a result of the insurer's entry into insolvency proceedings or a write-down under s377 FSMA (including petitions or applications to the Court for these)4.
It is also proposed that the statutory moratorium would also affect termination/suspension rights if triggered by one of the following events and the counterparty has not exercised the resulting termination/suspension right prior to the moratorium subsequently taking effect:
- the insurer coming under financial stress/hardship (no matter how defined in the contract); or
- the insurer failing to make a payment, or to make a payment on time (in this case the operation of the moratorium would be conditional on all payment terms being met during the operation of the moratorium, but would not require payment of previous arrears).
Termination/suspension rights arising from events unrelated to the insurer's financial position or arising from a failure to make payments (and meet any other contractual obligations) on an ongoing basis should not be affected by the moratorium.
The moratorium would be subject to a "financial hardship" exemption (granted by the Court).
The Government has taken on board concerns expressed by market participants regarding the potential impact on netting opinions, and therefore on the cost and availability for insurers generally of entering into derivatives (regardless of whether they go on to use the write-down procedure). It has stated that it will introduce a targeted exemption for set-off and netting arrangements (and associated security and title transfer arrangements). The proposed exemption will use the concept of "protected arrangements" provided for in s48P of the Banking Act 20095. However, it should be noted that the Government is proposing to take a delegated power to amend the scope of this moratorium.
If enacted in the form of the Proposals, this legislation will represent a significant development for certain of an insurer's contractual counterparties.
1 With the exception of one specific aspect (not dealt with in this bulletin), the Proposals apply to all insurers with a Part 4A permission to effect or carry out contracts of insurance as principal. However, the Proposals do not apply to Lloyd's of London business, which is the subject of specific restructuring and winding-up procedures. The Government has indicated that the Proposals, particularly the amendments to s377 FSMA, are most likely to be used in relation to retail life insurers.
2 The existing insolvency arrangements for insurers comprise a modified version of standard corporate insolvency procedures, with certain additional provisions, with the key options in the event of insurer financial difficulty/failure being a run-off or transfer of insurance business, a scheme of arrangement or the administration or winding up of the insurer.
3 This is distinct from the moratorium on the exercise of contractual termination rights, as discussed below. The Proposals suggest that it will have similarities to the administration moratorium set out in paras 40 to 44, Schedule B1, Insolvency Act 1986.
4 The moratorium would comprise: an "interim moratorium" (which could come into force when an application for administration or write-down is made to the Court or a winding up petition is presented and would remain in place until the application/petition is heard or withdrawn); and a "permanent moratorium" would apply during an administration or write-down, lasting an initial 6 months subject to extensions. The "permanent" moratorium would not apply during the course of a winding-up.