Q&A: The proposed new UK Insurer Resolution Regime

Last week HM Treasury published its much anticipated consultation paper on introducing a dedicated Insurer Resolution Regime (IRR) in the UK, which would implement key international standards.

We summarise below key questions and answers on HM Treasury’s proposals, on which it is seeking industry views. The deadline for responses is 20 April 2023 and there is much for the insurance industry (including its financial and legal advisers, and insolvency practitioners) to consider.

Why do we need a new regime in the UK? Is the UK’s insolvency regime insufficient? 

HM Treasury thinks existing insolvency processes for insurers may not always allow authorities in the UK to act sufficiently quickly to stabilise an insurer in distress and to minimise risks to the wider financial sector and public funds. There have been similar concerns in the EU, which have driven the mandate on the Insurance Recovery and Resolution Directive (IRRD). The IRRD aims to introduce a harmonised regime at European level for resolving insurers, to provide EU national authorities with the tools and procedures to address failures.

The new IRR is intended to address the UK concerns with a toolkit focused on stabilising insurers.  HM Treasury thinks the proposals should have a positive impact in five key ways:

• preserving UK financial stability, including provision of critical services;
• protecting policyholders, including by ensuring continuity of cover;
• reducing costs to industry compared to lengthy insolvency processes, avoiding the significant value destruction associated with insolvency;
• maintaining public confidence in the UK insurance sector by ensuring that even large, systemic insurer failures can be managed in an orderly manner; and 
• in the long-term, promoting effective competition, including by mitigating risks to economic growth and public funds.

What does the consultation paper cover? 

The paper covers the proposed framework for the IRR, stabilisation options and safeguards, pre-resolution planning, and some other issues.

Who is going to regulate the new IRR? 

The Bank of England is the proposed dedicated Resolution Authority under the IRR; this reflects the Bank’s experience as the current UK resolution authority for banks, building societies and CCPs, and its familiarity with the international standards the IRR would implement.

The proposals mention the Financial Stability Board’s ‘Key Attributes’. What are these? 

The Financial Stability Board (an international body that promotes international financial stability by monitoring and making recommendations about the global financial system), identifies twelve ‘Key Attributes’ of effective resolution regimes for financial institutions. These attributes are the ‘umbrella’ standard for resolution regimes covering financial institutions whose failure creates potentially systemic risk. They are designed to promote consistent assessments across jurisdictions and to provide guidance to jurisdictions when adopting or amending their resolution regimes. The proposed IRR would introduce resolution plans, to facilitate the effective use of resolution powers, which are intended to satisfy the Key Attributes.

Who will the new regime apply to? 

The Key Attributes state that ‘any financial institution that could be systemically significant or critical if it fails should be subject to a resolution regime’. As such, the proposed regime would be able to be applied to all UK-authorised insurers, defined as undertakings that have a Part 4A FSMA permission to effect and/or carry out contracts of insurance as principal, subject to certain exclusions and reinsurers.

But the proposed regime would not just apply to UK-incorporated insurance companies and reinsurers. It would also apply to: mixed financial holding companies; insurance holding companies; mixed activity insurance holding companies; regulated entities within the corporate group of an insurer; other non-regulated entities within the corporate group of an insurer; and UK branches of foreign insurers. Smaller insurers and friendly societies would be excluded. Lloyd's of London (including the various Lloyd’s market participants) would also be out of scope, primarily because it would be disproportionate to include Lloyd’s at this time.

Does this mean that the regime in its entirety could cover all insurers?

Yes, but likely no in practice. While the IRR’s proposed scope is broad, the government anticipates that the proposed statutory tests for resolution action would only be met in respect of a few major (re)insurers, with the majority instead being put into another existing legal or regulatory procedure at the point of failure.

What is resolution action intended to achieve (the ‘resolution objectives’)? 

The proposed regime includes ‘resolution objectives’ that the Resolution Authority and other relevant authorities must have regard to when taking or considering taking resolution action. These are:

• protect and enhance the UK financial system’s stability, particularly by preventing contagion and protecting policyholders’ ability to access critical functions, including the continuity of services on existing policies;
• protect and enhance public confidence in the stability of the UK financial system;
• protect public funds, including by minimising reliance on extraordinary public financial support;
• protect policyholders of the firm in resolution, including those covered by an insurance guarantee scheme; and
• avoid interfering with property rights in contravention of the European Convention on Human Rights.

In what circumstances could the Resolution Authority take resolution action?

Four conditions must be met before resolution action can be taken in respect of an insurer. These ‘Resolution Conditions’, which would be considered on a consecutive basis, are:

• the PRA (not the RA) assesses that an insurer is failing or likely to fail;
• the RA assesses that, having regard to timing and other relevant circumstances, it is not reasonably likely that (ignoring the stabilisation powers) action will be taken by or in respect of the insurer that will result in the insurer no longer being failing or likely to fail;
• the RA assesses that exercising stabilisation powers is necessary having regard to the public interest in advancing one or more of the resolution objectives (see above); and
• the RA assesses that one or more of the resolution objectives “would not be met to the same extent if stabilisation powers were not deployed”.

So, will the RA be able to act alone in taking resolution action? 

No. The proposals envisage significant inter-agency liaison over all this: the PRA would be required to consult with the RA before determining whether the first condition is met, and the RA would be obliged to consult with the PRA, FCA and HM Treasury before determining whether the other conditions are met.

Given that the PRA is part of the Bank of England, is there a conflict there? 

HM Treasury says there will be a code of practice setting out guidance as to how and in what circumstances the authorities will use the proposed resolution tools following the assessment of the Resolution Conditions. HM Treasury also expects the Bank of England (in its capacity as RA and PRA) to set out its approach to insurance resolution after the regime is introduced.

What happens once the Resolution Conditions have been satisfied? 

The stabilisation options which the RA could implement at this point include transfer to a private sector purchaser, a temporary bridge institution, bail-in and temporary public ownership. The IRR would also allow use of a balance sheet management vehicle and a new ‘insurer administration procedure’, equivalent to the provisions of Part 3 of the Banking Act 2009 in combination with the stabilisation options.

The government proposes that the Resolution Authority should be able to stabilise or bail-in a failing insurer by restructuring, modifying, limiting, or writing down its unsecured liabilities, including its policyholder liabilities.

HM Treasury considers that the proposed Resolution Conditions “would ensure that the proposed stabilisation options under the proposed IRR would only be exercised in a scenario, where all other options (including normal PRA and firm action to recover to place a firm in safe run-off) have been ruled out, and where it is in the public interest to do so”.

Where will policyholders sit in the hierarchy on a write-down? 

The write-down of liabilities would broadly follow the established creditor hierarchy. Insurance policyholders (not including reinsurance policyholders) will sit above other unsecured creditors, but below secured creditors and preferential creditors (including for example, employees with respect to their salary arrears). As in the established insolvency hierarchy, on a write-down, creditors ranking lower than insurance policyholders in an insolvency would generally have their claims fully written down or converted before policyholders are affected. So higher ranking creditors (e.g. insurance policyholders) will only be affected after all lower ranking creditor classes have been fully affected.

What happens if a firm is recapitalised after a bail-in stabilisation, can it write new business? 

The IRR does not aim to recapitalise a firm so that it can continue to write new business. Bail-in stabilisation is really aimed at allowing 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.

Who ultimately absorbs the losses on a bail-in? 

The Financial Stability Board’s Key Attributes say Resolution Authorities should be empowered to bail-in firms – i.e. reduce or convert it to equity all or part of unsecured creditor claims in a manner that respects the hierarchy of claims in liquidation. According to the Key Attributes, shareholders should absorb losses before creditors. The bail-in power proposed in the IRR would result in the creation of new shares, diluting existing shareholders’ ownership and allocating losses to shareholders relative to the extent creditors are affected. One potentially significant point which is not addressed directly is how this might affect mutual insurers.

What is the “no creditor worse off” safeguard?

According to the Key Attributes, “creditors should have a right to compensation where they do not receive at a minimum what they would have received in a liquidation of the firm under the applicable insolvency regime”. This is known as the “no creditor worse off” safeguard. The IRR contains a safeguard which is intended to meet that requirement: following the exercise of one or more of the stabilisation options, HM Treasury would make an order providing the mechanism by which the level of any compensation needed to ensure no creditor is worse off than in an applicable insolvency process could be calculated and paid.

So far, it looks like the proposals only cover a firm at the point where the PRA assesses that an insurer is failing or likely to fail. Does that mean there will be nothing for insurers to do unless/until they are at that stage? 

No. The PRA already works with insurers to develop recovery and resolution plans, and it has also been involved in resolvability assessments. The PRA’s Fundamental Rule 8 states that a firm must prepare for resolution so, if the need arises, it can be resolved in an orderly manner with a minimum disruption of critical services. The PRA also requires insurers to develop, implement and action an effective stress testing programme to assess their ability to meet capital and liquidity requirements in stressed conditions, as a key component of effective risk management.

The government proposes to “implement the full requirements of the Key Attributes on pre-resolution planning, while ensuring the regime recognises work the PRA and industry is already beginning to undertake following the conclusion of the Solvency II review”. In that case the resolution framework will seemingly need to provide for the Resolution Authority to carry out regular Resolvability Assessments, which would determine and address barriers to resolution and ongoing Recovery and Resolution Planning (RRP) for, at a minimum, systemically important insurers.

The government considers the recovery element of RRPs already exists under the UK framework through the PRA’s recovery and exit planning. As such, the proposed IRR will only need to introduce the Resolution Plan aspect of RRPs led by the Resolution Authority to fulfil the requirements of the Key Attributes.

The IRR’s scope means, in principle, most insurers could be placed in resolution if they meet the proposed RCs. But the government expects that only a small number of systemically important firms will be subject to Resolvability Assessment and Resolution Planning led by the Resolution Authority.

How are run-off insurers affected? 

Where a firm is closed to new business and is in run-off, this is not, on its own, a failure and HM Treasury notes that run-off does not necessarily lead to or entail insolvency. The consultation paper specifically addresses firms in run-off noting that each of Resolution Conditions 1 to 4 would be unlikely to be met on a safe run-off.

How does the Financial Services and Markets Bill 2022 (FSM Bill) affect these proposals? Doesn’t the FSM Bill also cover insurers in financial difficulty?

Yes, it does but the IRR provides for an overarching framework above and beyond the proposals set out in the FSM Bill. The insurer insolvency provisions in the FSM Bill were intended to enable the regulators to intervene earlier where an insurer was in financial difficulty, to better protect policyholders and maintain confidence in the insurance sector.

The powers within the FSM Bill amendments will extend and clarify the powers available to UK authorities and the courts on the insolvency of an insurer, but they may not assist in managing the failure of insurers in certain scenarios, including the failure of:

• one of the largest firms, especially a rapid failure;
• multiple insurers concurrently; and
• insurers offering ‘niche’ business lines where replacement or substitute cover cannot easily be obtained.

The IRR is broader than the proposals under the FSM Bill and would potentially expand the toolkit for managing insurers in financial distress.

Initial observations and next steps 

The proposals would give the UK authorities an immediate toolkit to address the problems caused by a failing insurer. For the insurers within scope of Resolution Authority-led resolvability assessments and resolution planning, they will also represent significant new regulatory engagement (though the regulators will probably say it is no more than the firms should be ready for). We are looking forward to discussing these proposals and their implications with clients and colleagues in the insurance and insolvency community in the coming weeks, ahead of the consultation deadline on 20 April. The government has clearly decided to act, and the consultation represents a meaningful opportunity to help ensure the proposals are as proportionate, practical and effective as possible.