Momentum has been building around recovery and resolution in the insurance sector for quite some time. The government’s latest consultation on implementing a new insurer resolution regime complements existing tools to manage insurance failure:
- The Prudential Regulation Authority (PRA) already works with insurers to develop recovery and resolution plans, and in 2023 expects to consult further on the preparation of exit plans for insurers (as set out in its Dear CEO letter).
- There are amendments to the arrangements for insurers in financial difficulties contained in the Financial Services and Markets Bill 2022-23 (FSMB) – currently going through Parliament.
- The PRA has powers to oversee the execution of a recovery plan and place a firm into run-off, consistent with the ‘ladder of intervention’ under Solvency II.
However, regulators believe that these tools may be less effective in managing the failure of insurers in certain scenarios, however, including the failure of:
- one of the largest firms, especially a rapid failure
- multiple insurers concurrently
- insurers offering niche business lines where replacement or substitute cover can't easily be obtained.
The new proposals in the IRR go beyond those included in the FSMB. The intention is to ‘provide additional tools for cases where recovery or wind-down might not be appropriate to secure the UK’s financial stability, the protection of policyholders and of public funds’ (the resolution objectives). The IRR will also satisfy the 12 key attributes set out by the Financial Stability Board, the international body promoting financial stability and making recommendations about the global financial system.
Who does the Insurer Resolution Regime apply to?
Theoretically, all UK-authorised insurers would fall under the IRR, including their holding companies, group companies, UK branches of foreign insurers and reinsurers.
But in practice, only a few insurers – those considered systemically important – are likely to meet the proposed statutory tests for resolution action. This could include, for example, large insurers, or insurers who provide products with no available substitutes. Most other firms would be subject to another procedure at the point of failure, such as a wind-down or other insolvency process. Smaller insurers and Lloyd's of London aren't included in the scope of the IRR.
The Bank of England will be the resolution authority under the IRR. Note that the IRR diverges with EU regulation, where the European Insurance and Occupational Pensions Authority (EIOPA) is the supervision authority. This means that cross-border insurers may potentially be subject to conflicting requirements or resolution actions.
When could an insurer be placed into the IRR??
Insurers would have to meet four resolution conditions on a consecutive basis in order to be placed into resolution:
1 The insurer is failing or likely to fail
2 It's not reasonably likely that action will be taken by, or in respect of, the insurer that will result in resolution condition 1 ceasing to be met (ignoring regulatory intervention)
3 Use of the stabilisation powers (see below) would be in the public interest
4 One or more of the IRR's resolution objectives wouldn't be met if stabilisation powers weren't deployed
The Bank of England, in its capacity as resolution authority, and the PRA will set out the approach to insurance resolution following the introduction of the proposed regime.
Stabilisation powers for the resolution authority
The IRR outlines four proposed stabilisation powers that the resolution authority can consider:
1 Transfer to a private sector purchaser
This could be a full or partial transfer – it wouldn't need the consent of shareholders, policyholders or creditors, or court approval.
2 Transfer to a bridge institution
A bridge institution would be used as a temporary measure, to allow time for due diligence and valuation, while still allowing critical functions to take place.
Unsecured creditor claims (including policyholder claims) could be reduced, written off, or converted into equity. This process would respect the creditor hierarchy for insurers, as set out in the Insurers (Reorganisation and Winding Up) Regulations 2004 (SI2004/353). The hierarchy provides for direct policyholders to rank ahead of other unsecured creditors (including indirect policyholders).
Bail-in would only be intended to restore a level of capital coverage to allow for solvent run-off, not to an extent that would allow new business.
Policyholders protected by the Financial Services Compensation Scheme (FSCS) would be eligible for top-up payments to the same limits that would apply under insolvency.
4 Temporary public ownership
This would only be considered as a last resort.
In addition to the four stabilisation options, the resolution authority could also use the following tools:
- balance sheet management vehicle – to allow the resolution authority to transfer relevant assets, liabilities, property or rights from the failed insurer in order to maximise value through sale or orderly wind down
- insurer administration procedure – to allow the resolution authority flexibility to use the stabilisation tools while ensuring critical functions can continue to operate
The IRR contains a ‘no creditor worse off’ safeguard to provide compensation to ensure no creditor is worse off than in an applicable insolvency process.
What can insurers do now?
The PRA already requires insurers to undertake recovery and exit planning. The resolution authority is also expected to carry out recovery and resolution planning, and regular resolvability assessments, to determine and address barriers to resolution.
There's potential for considerable new regulatory engagement, especially for those insurers viewed as systemically important or who provide products that can't easily be substituted.
Insurers can get ahead by ensuring their recovery and exit planning is thorough and relevant and ready for any application of stabilisation powers should such an event arise.
Existing regulatory requirements around operational and financial resilience also feed into recovery plan content, but this must now include extra analysis to identify any barriers to resolvability. Key elements should include the following:
- Governance – consideration of how any recovery plan integrates into firm-wide processes and who would take ownership of any engagement with the resolution authority. Board involvement is essential
- Critical products and services – what are the functions that underpin them and an assessment of how these would continue in a distressed scenario
- Scenario testing – these should test different and sufficiently severe stresses to understand how elements of the plan would interact under such circumstances, and any barriers that arise
- Recovery options – the PRA expects firms to ensure they have sufficient credible options to restore capital and liquidity in, or following a stress
- Valuation – the resolution authority must value assets and liabilities before exercising stabilisation options; consider the challenges that might occur when valuing balance sheets in distress, and how these can be minimised
- Interdependencies – the extent to which the regulated entity is reliant upon resources, such as people and systems held in other group entities that could impact or create risks to recovery options
Resolution in action
The proposed IRR is substantially similar to resolution tools available for banks. The collapse of Silicon Valley Bank in March 2023 and the subsequent rescue of Silicon Valley Bank UK (SVB UK) has recently shown us resolution in action.
The Bank of England, as resolution authority, was able to swiftly and efficiently apply the resolution tools, in this case transferring SVB UK to a private purchaser (HSBC) for £1. This avoided the existential risk that would otherwise have faced SVBUK’s 3,300 UK clients and clearly illustrates how important resolution is to customers and the wider markets.
For more insight and guidance, contact Bradley Chadwick.
Financial services restructuring and insolvency
The financial services sector is a diverse, dynamic and competitive marketplace.