The UK Government is consulting on the introduction on a new insurer resolution regime (the “UK IRR” or the “regime”) for insurers which are failing or likely to fail. The regime has parallels with the existing resolution regime applicable to UK banks.
It is proposed that the UK IRR will be an alternative to a corporate insolvency for: UK-authorised insurers1, together with certain of their holding companies and group companies; UK branches of foreign insurers; and reinsurers2. However, the Government has indicated that the focus of the regime is insurer failures which pose a systemic risk3. The Bank of England will be the supervisory authority that leads the resolution of a failing insurer.
If introduced, the regime would have material implications for insurers and reinsurers, their shareholders, policyholders, bondholders and other counterparties (including lenders and suppliers).
The UK IRR demonstrates further regulatory divergence with Europe; which issued its own proposal for the resolution of European insurers in 2021. The Insurance Recovery and Resolution (“EU IRR”) provides that the European supervision authority for the resolution of failing EU insurers and re-insurers will be the European Insurance and Occupational Pensions Authority (“EIOPA”). This means that where cross border insurance and reinsurance groups are failing they will have to navigate two different regulatory frameworks where the group has a presence in the UK and Europe.
What is the existing insolvency and regulatory framework for failing insurers?
Large, systemic insurers in the UK are already subject to recovery and resolution planning.
At present, insurer failure is managed through a modified version of the standard English corporate insolvency and restructuring procedures, such as administration.
Section 377 of the Financial Services and Markets Act 2000 (“FSMA”) includes provisions to address the failure of a (re)insurer. This includes express powers of the court to order a write down of liabilities in contracts of insurance. In the recently announced Financial Services and Markets Bill 2022 which is currently under review by the UK Parliament there are proposals to amend FSMA to expand the court’s write down powers. The insolvency related provisions in the Financial Services and Markets Bill have been proposed to permit the UK regulatory authorities to exercise early intervention powers where an insurer is failing. These proposals are intended to operate alongside the IRR by providing further regulatory tools to resolve insurers at an earlier stage.
What conditions need to be satisfied for an insurer to be placed in the UK IRR?
There are several conditions (resolution triggers) which need to be satisfied on a consecutive basis, the first being the most material. These are as follows: (i) an insurer is failing or likely to fail; (ii) it is not reasonably likely that (ignoring any regulatory intervention) action will be taken that will result in condition (i) falling away; (iii) regulatory intervention is necessary having regard to the public interest; (iv) one or more of the statutory resolution objectives would not be met.
What measures under the proposed UK IRR may regulators take to stabilise a failing insurer?
The proposed UK IRR comprises a number of “stabilisation options” which are similar to bank resolution and may be exercised by the relevant UK authorities4, including:
- the full or partial transfer of an insurer’s shares or business (assets and liabilities) to:
— a willing third party purchaser or
— a temporary bridge insurer (for instance, housing a “good book” of commercially viable business pending due diligence and valuation)
- the bail-in of an insurer (in order to return it to a level of capital coverage sufficiently in excess of liabilities to permit a safe run-off of its business)
- as a last resort, temporary public ownership.
The exercise of the stabilisation options would be underpinned by an independent valuation of the insurer's assets and liabilities.
Similar to bank resolution, the expectation is that the use of the proposed stabilisation options may interfere with the contractual rights and legal interests of creditors and shareholders. Creditors would be protected by a similar "no creditor worse off" safeguard, triggering a right to compensation if, following the exercise of a stabilisation option, they do not received at a minimum what they would have received on the liquidation of the firm under the applicable insolvency regime. This will be a challenging principle to navigate for cross border groups where insolvency proceedings and creditor hierarchies in different jurisdictions may result in different legal and commercial outcomes for creditors.
In conjunction with the stabilisation options, a failing insurer’s non-performing or difficult to value assets and liabilities (a so called "bad book" of business) could be transferred to a "balance sheet management vehicle" with a view to maximising their value through eventual sale or wind down.
The regime also includes an insurer administration procedure (equivalent to the existing bank administration procedure5).
What are the implications for creditors, policyholders and shareholders?
Veto rights overridden: Any transfer of an insurer’s shares or business6 would override veto rights of third parties, including shareholders, policyholders and other creditors and would take effect without the involvement of the Court. For example, the shareholder of the insurer (or holding or group company) would be compelled to transfer its shares by way of a transfer instrument.
Bail-in of unsecured claims: Unsecured creditor claims (including policyholder claims) would be susceptible to bail-in and, as such, could be reduced or converted into equity or other ownership instruments of the insurer (or its holding company) in a manner which respects the hierarchy of such claims in a liquidation.
Reinsurance: Pay-as-paid clauses7 in the insurer’s reinsurance contracts would be overridden such that reinsurers will remain liable for the pre-written down amount due, even if a bail-in has reduced the value of the liability owed by the insurer to the underlying policyholder.
Protection of set-off, netting and title transfer arrangements: These are of particular importance for insurers. The exercise of the bail-in stabilisation option8 and any partial property transfers9 will each be subject to protections for these types of arrangements.
Ban on ipso facto clauses: There will be a prohibition on the exercise of contractual default or early termination rights if triggered by the exercise of the stabilisation options10. However, other termination rights (such as for non-payment) could still be exercised.
Policyholder surrender: If a stabilisation option is exercised, there will be a time-limited restriction on policyholder surrender rights.
Ancillary powers: The UK authorities may exercise a number of ancillary powers, alongside stabilisation options, subject to appropriate safeguards. These include powers to:
- prohibit the transfer or pledging of an insurer's assets without the approval of the UK authorities
- impose a temporary (up to two day) suspension of: payments to unsecured creditors; creditor action to attach to assets or otherwise collect money or property; and termination of contracts11
- apply to the court for stay of legal proceedings
- terminate, modify, assign (etc) contracts, including derivatives, securities, financing transactions and insurance contracts, subject to appropriate safeguards, including to protect set-off, netting and title transfer arrangements. For instance, in the event that derivatives were transferred, this would only take place alongside the backing collateral or security.
Following any write-down and re-capitalisation will insurers be able to continue to write new business?
This is where the current proposals differ substantially from bank resolution and it is likely to be a material point of contention.
Under the UK’s bank resolution regime, certain large firms are required to hold loss absorbing capital (“MREL”) to ensure that there are sufficient resources to write down or convert into equity if the bank fails. MREL is not proposed as part of the UK IRR and accordingly other unsecured creditors (including policyholders) may be bailed-in instead. The IRR (as currently drafted) does not aim to recapitalise an insurer so that it can continue to write new business.
Instead, the bail-in stabilisation option is the most likely to be in the IRR which would allow the failed insurer to return to a level of capital coverage sufficiently in excess of liabilities to enable it to continue a safe run-off of all the business or in combination with the other stabilisation tools.
1 Undertakings that have a Part 4A FSMA permission to effect and/or carry out contracts of insurance as principal, subject to certain exclusions.
2 Smaller insurers and reinsurers which are not subject to recently announced Solvency II reforms (ie gross premium income below £50m and gross technical provisions of less than £50 million), friendly societies and Lloyd’s of London are outside of scope.
3 For instance, failures of large insurers or those insurers who provide products for which there are no readily available substitutes or where there are multiple concurrent insurer failures.
4 It is proposed that the Bank of England will be the dedicated Resolution Authority under the regime, but that it will work on an inter-agency basis with the Prudential Regulation Authority. Under the proposals, the two supervisory agencies will consult with each other to determine the conditions for resolution have been met.
5 This administration procedure could be used in conjunction with a partial transfer in order to enable the residual insurer to continue to provide any essential services and facilities which cannot be immediately transferred.
6 This could include the transfer of relevant reinsurance.
7 Clauses which stipulate that a reinsurer must only pay out the amount the original insurer (cedant) actually pays to underlying policyholders.
8 In line with s48P of the Banking Act 2009.
9 This power would parallel the provisions of s47 and 48 of the Banking Act 2009, and the Banking Act 2009 (Restriction of Partial Property Transfers) Order 2009 made under those provisions.
10 In line with s48Z Banking Act 2009.
11 In line with s70A – 70D Banking Act 2009.