In the event of an insurance company becoming insolvent, the interplay of multiple stakeholders (with differing and often conflicting agendas) coupled with issues such as the estimation of long-tail claims, realisation of reinsurance assets, and unravelling of pool and other arrangements, makes for a challenging process which is not easily shoehorned into standard insolvency procedures.
The basic framework set out in the Insolvency Act 1986 (IA1986) is supplemented by the Financial Services and Markets Act 2000 (FSMA), together with an array of secondary legislation dealing with insurance-specific issues. This chapter provides a necessarily high-level introduction to a complex area – and one which may see significant change in the near future if a recent government consultation (see further below) leads to legislative action.
An insurance company may enter into liquidation, administration, or (unusually) a company voluntary arrangement under IA1986. In addition, section 377 of FSMA permits a court-sanctioned write-down of an insurer’s contracts as an alternative to liquidation. In general, an insolvency procedure will be combined with a scheme of arrangement pursuant to Part 26 of the Companies Act 2006 (CA2006), possibly in conjunction with a transfer of part of the business to another authorised firm under Part VII of FSMA.
The Prudential Regulatory Authority (PRA) and the Financial Conduct Authority (FCA) will be closely involved with any insurance insolvency. Part XXIV FSMA gives them extensive rights, both to initiate and be heard in any insolvency proceedings and to receive information and participate (but not vote in) meetings of creditors or decision procedures.
Policyholder protection
The Financial Services Compensation Scheme (FSCS) protects direct policyholders, where their insurer is in default, by paying 100% of all claims under compulsory insurance, and (for ‘eligible claimants’ as defined in the PRA Rulebook), 100% of claims under long-term, and 90% of claims under general insurance policies. Where it has made payments to policyholders, the FSCS will take an assignment of their rights against the insurer and be entitled to claim in the insolvency proceedings.
The Insurers (Reorganisation and Winding Up) Regulations 2004 give direct insurance creditors priority over all other unsecured creditors in relation to their insurance claims. Therefore, where an insurer writes both direct and reinsurance business, the claims of direct policyholders rank above those of reinsurance creditors in its insolvency. As it stands in the shoes of direct policyholders, the FSCS also benefits from this priority in relation to any recoveries it is entitled to make. The claims of secured and preferential creditors are not affected.
Special provisions govern the treatment of long-term business in an insolvency, with the objective of maintaining continuity of cover for policyholders. The FSCS must try to make arrangements to secure continuity of cover, and the liquidator or administrator of an insurer which writes long-term business must, unless the court issues a “stop order”, carry on such business with a view to it being transferred as a going concern to another authorised insurer.
Liquidation and administration
The Insurers (Winding Up) Rules 2001 provide a framework governing the conduct of an insurance liquidation, including separation of long-term and general assets of composite insurers, and rules governing the valuation of claims under long-term and general insurance policies.
The function of a liquidator is to estimate creditors’ claims and distribute the assets of the estate, in accordance with statutory priorities. However, an insurance liquidator cannot be sure of making a fair and equal distribution at an early stage due to the significant risk of underestimating future claims, particularly where the insurer has written long-tail business. The potential delay in distributions, coupled with the costs involved in a lengthy liquidation process, means liquidation generally offers a poor result for insurance creditors. As a result it became common practice for insolvent insurers to seek to implement a scheme of arrangement (see below) with their insureds.
One of the difficulties faced by an insolvent insurer wishing to implement such a scheme was the absence of a statutory stay upon hostile litigation against the insurer whilst it worked up its scheme proposal. Pre-2002, this meant that an insolvent insurer would have to resort to seeking the appointment of a provisional liquidator in order to obtain such a stay. However, since 2002 it has been possible for an administration order to be made in relation to an insurance company. Provisions relating to the conduct of an insurance administration are contained in The Financial Services and Markets Act 2000 (Administration Orders Relating to Insurers) Order 2010 (which replaced the 2002 instrument of the same name).
Schemes of arrangement
As noted above, the provisional liquidator or administrator of an insurer will typically seek to promote a scheme of arrangement. If approved by the statutory majorities at creditors’ meetings and subsequently sanctioned by the court, a scheme is binding upon all scheme creditors, whether or not they had actual notice. An insurance scheme will typically include an actuarial methodology for estimation of claims and an adjudication mechanism for disputes, as well as bespoke provisions covering matters such as the application of set-off and currency conversion.
Insolvent insurers may also propose a restructuring plan under the provisions in Part 26A of CA2006 (introduced by the Corporate Insolvency and Governance Act 2020) as an alternative to a Part 26 scheme. A Part 26A plan offers the same flexibility as a scheme, but with the potential benefit of the ability to bind a dissenting class of creditors, provided that one class of creditors votes in favour of the plan and the dissenting creditors are no worse off than in the relevant alternative. This ‘cross-class cram down’ feature may prove particularly useful in the case of insurers which wrote both direct and reinsurance business.
Insolvent schemes of arrangement fall into two broad categories. In a reserving or run-off scheme, the company will make dividend payments to creditors pro rata in relation to their agreed claims over time, based on the available assets of the company. This allows time for claims development and for the realisation of the company’s assets. A cut-off or closing scheme, on the other hand, provides a mechanism for estimating and crystallising all contingent liabilities, allowing a final distribution to be made to creditors much earlier than would be possible in a liquidation. Depending on the state of maturity of the business, the run-off of an insolvent company may be continued under a reserving scheme for some time, before ultimately being brought to a close through a cut-off scheme.
Amendments to the Insolvency Arrangements for Insurers: Consultation
The above government consultation on amendments to the insurance insolvency legislation closed in August 2021, and at time of writing the government is considering responses.
While there were several limbs to the consultation, the central proposal relates to the court’s existing power to order a reduction in value, or “write-down”, of an insurer’s contracts where the insurer is insolvent (s.377 FSMA). The proposals aim to clarify and enhance this (currently unused) procedure, making it available outside actual insolvency (but where an insurer is in financial difficulty) and creating a genuine alternative to administration or winding-up. Under the proposals a write-down would extend to all unsecured creditors (with limited exceptions, such as employees) and would give the insurer the benefit of a moratorium similar to that in administration. If the insurer’s position improved post write-down, it would be possible for liabilities to be subsequently “written-up”. It is envisaged that a write-down would be overseen in most instances by a court-appointed “write-down manager”.
In practice the enhanced write-down procedure mimics, in many respects, the terms of a reserving scheme – albeit without the element of creditor democracy at the outset. If introduced, together with other proposals in the consultation, this could have a significant impact on the insurance insolvency landscape.
This article was originally published in 2021 as a chapter of the (Re)Insurance Legacy Handbook, published by IRLA (the Insurance and Reinsurance Legacy Association).”
David Steinberg
Helen Martin