A bespoke UK resolution regime for insolvent insurance companies

Outcome of the UK government's market consultation and the likely shape and impact of the proposed regime

The United Kingdom government has announced plans to introduce a resolution regime for insurers¹ which will provide the Bank of England with new stabilisation powers and tools to enable it to manage the failure of systemically important insurers. The proposals aim to align the UK resolution regime with international standards as set out by the Financial Stability Board in Key Attributes of Effective Resolution Regimes for Financial Institutions (Key Attributes).²

His Majesty’s Treasury published a consultation paper setting out its proposals for a resolution regime for insurers (IRR) in January 2023.³ Having considered responses to the consultation received from interested parties, the government published its response to the consultation in August 2023.⁴

The proposed IRR bears many similarities to the existing UK bank special resolution regime as set out in the Banking Act 2009 (in respect of which the Bank of England is also Resolution Authority). However, the IRR is tailored to the insurance sector and designed to take into account the particular capital structure and risk profile of insurers. These proposals should also be viewed in the wider context of the move towards a harmonised European Union-wide insurance recovery and resolution framework, by way of the European Commission’s legislative proposal for an Insurance Recovery and Resolution Directive.⁵

This article presents a brief summary of the UK government’s proposals and draws out some of the aspects clarified by the government in its recent consultation response, in particular those that may be of interest in the context of international insurance groups.

The framework of the proposed resolution regime

The IRR is intended to supplement, rather than replace, the existing insolvency regime that applies in the case of an insolvent UK insurer. The Bank of England will be designated as the sole Resolution Authority, while day-to-day supervisory responsibilities will remain with the Prudential Regulation Authority. The Resolution Authority will be required to liaise with the Prudential Regulation Authority and, where appropriate, the Financial Conduct Authority in exercising its functions as the Resolution Authority. Of course, in practice, both the Prudential Regulation Authority and Resolution Authority are separate limbs of the Bank of England, but the Bank will be required to ensure operational independence between its resolution and supervisory functions.

The Resolution Authority and other relevant authorities are to be guided, when taking or considering resolution action, by five resolution objectives. These objectives will not be ranked, but rather balanced as appropriate in each case. The objectives are to:

• Protect and enhance the stability of the UK’s financial system (including by preventing contagion and protecting access to critical functions, such as 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 public support
• Protect policyholders of the firm in resolution, and
• Avoid interference with property rights in contravention of the European Convention on Human Rights.

Against the backdrop of these overall objectives, the decision to place a firm into resolution will be based on the assessment by the Prudential Regulation Authority and the Resolution Authority of four resolution conditions. The proposed conditions, all of which must be met for a firm to be placed into resolution, are:

• The Prudential Regulation Authority assesses that an insurer is "failing or likely to fail"
• The Resolution Authority considers that, having regard to timing and other circumstances, it is not reasonably likely that action will be taken by or in respect of the insurer that will result in the first condition ceasing to be met
• The Resolution Authority considers that public interest in the advancement of one or more of the resolution objectives requires exercise of stabilisation powers, and
• The Resolution Authority considers that one or more of the resolution objectives would not be met to the same extent if stabilisation powers were not exercised.

The trigger for assessment of the other conditions will be the Prudential Regulation Authority’s initial assessment (made in consultation with the Resolution Authority) that an insurer is "failing or likely to fail". The Prudential Regulation Authority is given considerable discretion in relation to this decision. It will not be based upon any specific intervention point, such as breach by a firm of its solvency capital requirement or minimum capital requirement under Solvency II.

The cumulative effect of the conditions is intended to ensure that the new resolution tools are only deployed in an extreme scenario where all other options have been ruled out, and it is in the public interest to invoke the new resolution regime.

Stabilisation tools and procedures

Where the conditions are met, the IRR will give the Resolution Authority a menu of potential stabilisation options to select from. These stabilisation options consist of:

• Transfer to a private sector purchaser: A compulsory transfer of the business or shares of the failing insurer to a (willing) purchaser, effected by the Resolution Authority under its own authority without requiring consent of policyholders or court approval.
• Transfer to a bridge institution: Transfer of a failing insurer’s business or shares to a bridge institution (wholly or partially owned and controlled by the Resolution Authority) on a temporary basis, to facilitate a more permanent resolution at a later stage. The lifespan of the bridge insurer would be restricted.
• Bail-in: Power for the Resolution Authority to "bail-in" a failing insurer by restructuring, modifying, limiting or writing down its liabilities, including policyholder liabilities. Losses would be allocated to shareholders and subordinated debt holders first.
• Temporary public ownership: Power for HM Treasury to place a failing insurer into temporary public ownership – a tool of last resort in the extreme event that other stabilisation options are insufficient, and where there is a serious threat to financial stability or for public interest reasons.

The Resolution Authority would be required to commission an independent valuation of the relevant firm’s assets and liabilities to inform its decisions, including how to assign losses, before any stabilisation options were exercised.

The IRR resolution toolkit is to be complemented by two additional tools, which could only be used in combination with one of the stabilisation options:

• Balance sheet management vehicle: The Resolution Authority may establish a balance sheet management vehicle to hold assets and liabilities of a failed insurer with a view to maximising value through sale or orderly wind down (may be used to separate a "bad" portfolio, enabling the sale of the remaining business).
• Insurer administration procedure: A special administration procedure introducing the objective for an appointed administrator to provide support to a bridge insurer or private sector purchaser (where one of these stabilisation options is used) by the supply of services/facilities to enable it to operate effectively. This is only to be exercised in relation to a firm in resolution.

Bail-in

The allocation of losses in a bail-in exercise is intended to respect the hierarchy of claims in a liquidation. Losses will be allocated to shareholders before creditors are written down, and secured creditors holding a fixed charge or financial collateral arrangement will be excluded from bail-in. Direct insurance policyholders will retain their priority over other unsecured creditors (including reinsurance creditors), meaning that any lower-ranking creditors would have their claims fully written down before direct policyholders were affected by the bail-in.

Under the special resolution regime, banking institutions are required to maintain a minimum amount of their own funds and eligible liabilities (MREL) to ensure they have sufficient loss-absorbing capacity to enable the effective exercise of the bail-in stabilisation option. The IRR will not introduce an equivalent MREL requirement for insurers. The IRR bail-in procedure is intended to restore a firm’s ratio of capital to liabilities to a sufficient extent to enable a safe and orderly run off. It is not intended to enable an insurer to recapitalise to the extent necessary to enable it to continue in business, and the government considers that it would be disproportionate to introduce an MREL-type requirement.

With respect to the likely impact of a "bail-in" of a firm’s insurance liabilities upon the firm’s outwards reinsurance protections, the government intends to legislate to ensure that reinsurers will remain obliged to indemnify the reinsured firm on the basis of its pre-bail-in insurance liabilities.

Creditor protection

Where a write-down applies to policyholders that benefit from Financial Services Compensation Scheme (FSCS) protection, it is intended that the FSCS will provide "top-up" payments to such policyholders, as would be the case in an insurer’s insolvency.

The Key Attributes state that creditors should be compensated where a resolution results in them receiving less than they would in a liquidation (the "no creditor worse off" or NCWO safeguard). The government proposes that following the exercise of the resolution powers, HM Treasury would be required to make an order providing the mechanism by which NCWO compensation (if any) could be calculated and paid.

The NCWO valuation will be carried out by an independent valuer appointed by HM Treasury to determine the level of NCWO compensation (if any) to be paid to the resolved firm’s creditors and/or shareholders. This would be separate to the pre-resolution valuation carried out before the Resolution Authority exercised its stabilisation powers. 

Other tools available to enhance the integrity of the business transfer option include the mandatory transfer of outward reinsurance contracts to the purchaser, and the "switching off" of counterparties’ contractual rights to terminate their contracts with the transferring firm consequent upon the transfer.

Scope of the IRR

The proposed regime is intended to apply to all UK-authorised insurers (ie, firms that have Part 4A FSMA permission to effect and/or carry out contracts of insurance as principal), including non-friendly society mutual insurers. Lloyd’s will be excluded from scope, as will friendly societies.

The scope of the regime will also exclude smaller firms not subject to regulation under the UK Solvency II regime. In its recent consultation on adapting the Solvency II framework for the UK market,⁶ the Prudential Regulation Authority proposed to increase the thresholds for regulation under UK Solvency II to exclude firms with gross premium income not exceeding £15m (the current threshold being €5m) and gross technical provisions not exceeding £50m (currently EUR25m) and that meet certain other conditions.

In practice, even without the exclusion of non-Solvency II firms, the conditions are likely to be met predominantly by large, systemically important insurers. However, it is possible that some "niche" insurers of smaller size may also qualify. The government notes that the failure of an insurer that provides specialised insurance products to certain parts of the market (potentially where alternative providers of those products are not readily available) could generate significant financial or economic cost and therefore meet the conditions.

A number of other entities will be within the scope of the regime – it will also apply to insurance holding companies, other (regulated and non-regulated) entities within the corporate group of an insurer, and UK branches of foreign insurers.

UK branches of foreign insurers

The government has confirmed that UK branches of foreign insurers will fall within the scope of the regime – on the face of it potentially giving rise to conflict with home jurisdiction resolution procedures. However, the government has clarified that the primary intent of inclusion of UK branches within the regime is to facilitate cross-border resolution, led by the home authority. 

The IRR will grant the Resolution Authority a power to give UK "recognition" to resolution action taken by a home resolution authority, and to support the home resolution authority’s action by exercising its stabilisation powers in relation to the UK branch. However, the Resolution Authority will retain backstop powers to independently resolve the UK branch of a foreign insurer in certain circumstances, for instance where the home authority has not commenced resolution proceedings or where cooperation with the home authority proves ineffective.

Group companies

Both holding companies and other (regulated and non-regulated) entities within the same corporate group as an insurer will fall within the scope of the IRR. Intervention may therefore take place at holding company level or at the level of other group entities.

This is subject to proportionality considerations. The regime will include principles that require the Resolution Authority to have regard to minimising the effect of any resolution action on other entities in the group. For example, it is anticipated that the Resolution Authority would be unlikely to exercise stabilisation powers and tools at holding company level if the failing insurer only represented a small part of the wider group business.

Gibraltar-based insurers

Gibraltar-based insurers are currently able to access the UK market through transitional passporting arrangements.⁷ A permanent replacement to the passporting regime, the Gibraltar Authorisation Regime is in the process of being established.⁸ The Regime will enable Gibraltar-authorised insurers to access the UK market as authorised persons on either a services or branch basis by means of a "Schedule 2A" permission, without having to apply for full authorisation.

The government proposes that Gibraltar-based insurers with a Schedule 2A permission and a UK branch are to be included within the scope of the IRR. The government is, however, open to further representations on this point from stakeholders.

What implementation work will be required for insurers?

Pre-resolution planning requirements

The Key Attributes state that resolution frameworks must provide for national resolution authorities to develop resolution and recovery plans and conduct resolvability assessments for firms. The government recognises that the Prudential Regulation Authority’s current supervisory framework covers recovery and resolution planning and therefore goes some way towards satisfying the Key Attributes in this regard. However, to fully align with the standards in the Key Attributes, the government proposes to introduce Resolution Authority-led Resolvability Assessments and Resolution Plans.

The purpose of Resolvability Assessments, which the Resolution Authority must carry out on a regular basis, is to understand features of relevant insurers that might constitute barriers to use of the proposed stabilisation options. If the Resolution Authority considered that there were barriers to resolvability, it would be empowered to direct the firm to take action to remedy these (with potential enforcement action for failure to comply).

Meanwhile, Resolution Plans will set out the preferred resolution strategy for a firm and an operational plan for its implementation. The development and assessment of Resolution Plans will be the responsibility of the Resolution Authority, but clearly it will need to engage with firms in order to do so. As well as providing information to the Resolution Authority, firms may be required to carry out an assessment of relevant operational processes, carry out simulation exercises to test the Resolution Plan, and establish clear crisis-management roles and responsibilities. Resolution Plans will be updated by the Resolution Authority annually, where material changes take place within a firm or in macro-economic conditions.

Importantly, UK branches of foreign insurers will be excluded from any statutory requirements as to pre-resolution planning. With regard to UK domiciled insurers, the government proposes to limit the scope of Resolvability Assessments and Resolution Plans to a small number of systemically important firms.

Non-law governed contracts

The government intends to require relevant non-UK law governed contracts to incorporate certain contractual recognition clauses to give effect to the IRR:

• Bail-in recognition clauses, in order to ensure that non-UK law governed liabilities can be converted or written down by the Resolution Authority, and
• Recognition of restrictions on termination rights and policyholder surrender rights (referred to as the "stays" recognition clause requirement). 

The Bank of England and Prudential Regulation Authority are to issue guidance on the scope of the recognition clause requirements in due course. 

The government has stated that it does not expect the bail-in recognition clause requirement to include all third-country law governed liabilities of UK insurers.

Existing contracts will be exempt from the new requirements unless and until they come to be materially amended, so insurers will be able to implement the required changes incrementally over time.

Implementation

The government intends to legislate for the IRR when parliamentary time allows. The industry will need sufficient time and notice to implement any changes required in relation to the new regime, and the government has stated its intention to work with the industry as its legislative plans and timings develop.

On the European front, publication of the IRRD in the Official Journal, and its consequent entry into force, is currently expected to take place around late 2023 or 2024, with national implementation to follow within 18 months. It seems likely that the entry into force of the UK’s IRR will precede the implementation of the IRRD by Member States in most cases. However, we note that some Member States – such as the Netherlands⁹ – have already implemented, or taken steps towards implementing, their own insurance resolution regimes.

In due course it will be interesting to see how the IRR and IRRD regimes interact. With many major insurance groups having both EU and UK operations, effective co-operation in relation to the resolution of such cross-border groups and "recognition" of third-country resolution procedures may be of key importance.

Notes

1    Throughout this article, references to "insurers" and "insurance" should be taken to include "reinsurers" and "reinsurance".

2    Financial Stability Board, Key Attributes of Effective Resolution Regimes for Financial Institutions (15 October 2012).

3    HM Treasury, Introducing an Insurer Resolution Regime (Consultation, January 2023).

4    HM Treasury, Introducing an Insurer Resolution Regime: Government Response to Consultation (August 2023).

5    European Commission, Proposal for a directive of the European Parliament and of the Council establishing a framework for the recovery and resolution of insurance and reinsurance undertakings and amending Directives 2002/47/EC, 2004/25/EC, 2009/138/ EC, (EU) 2017/1132 and Regulations (EU) No 1094/2010 and (EU) No 648/2012, COM/2021/582 (22 September 2021).

6    Bank of England Prudential Regulation Authority, Review of Solvency II: adapting to the UK insurance market (Consultation, CP12/23).

7    By way of the Financial Services (Gibraltar) (Amendment) (EU Exit) Regulations 2019, SI 2019/589.

 8    The Financial Services Act 2021 (FS21) inserts a new Schedule 2A into the Financial Services and Markets Act 2000 relating to Gibraltar-based persons carrying on regulated activities in the UK. The Financial Services Act 2021 (Commencement No 5) Regulations 2023, SI 2023/934 brought certain provisions of FS21 relating to the Gibraltar-based persons into force on 1 September 2023, but a date for commencement of the remaining provisions has not yet been announced. 

9    Act on the Recovery and Settlement of Insurers (Wet herstel en afwikkeling van verzekeraars) 2019. 

This article first appeared in the November 2023 issue of Insolvency and Restructuring International (Vol 17, No 2), and is reproduced by kind permission of the International Bar Association, London, UK. © International Bar Association.