8 二月 2023 Tim Brown Financial Regulation - Insurance

PRA consults on dealing with insurers in financial difficulties

The Prudential Regulation Authority (the “PRA”) is consulting on changes to its rules and policy which would implement a new regime for insurers in financial difficulties. 

Background

Section 377 of the Financial Services and Markets Act 2000 (“FSMA”) currently provides a power for the court to reduce the value of one or more of the contracts of an insurer which has been ‘proved to be unable to pay its debts’ as an alternative to making a winding-up order. This reduction is referred to as a ‘write-down’ of liabilities. The power in FSMA has never been used, and is only described at a high level in legislation. As such, significant uncertainties around its application exist.

In May 2021, HM Treasury proposed a series of targeted amendments to the existing insurer insolvency arrangements, including changes to clarify and enhance the court’s existing power under section 377 of FSMA. The Financial Services and Markets Bill 2022-23 (the “FSM Bill”), which is currently progressing through Parliament, contains provisions which would enact the Treasury’s proposals. 

The changes set out in the FSM Bill would, amongst other things:

  • clarify the liabilities in scope of the write-down, the parties eligible to apply to the court for use of the write-down power and the test the court must apply when considering such applications;
  • make the write-down power available (as an alternative to the making of a winding-up order) when an insurer is, or is likely to become, unable to pay its debts, rather than solely in the event that it is proved unable to pay its debts;
  • introduce a new position of ‘write-down manager’, an officer of the court tasked with helping to design, advise the court on, and monitor a court-ordered write down. The write-down manager will be empowered to make recommendations to the insurer’s directors, and there is provision for the write-down manager to apply to the court for orders and directions;
  • make provision for the rules relating to the Financial Services Compensation Scheme (the “FSCS”) to require the FSCS to make top-up payments in relation to protected policyholders whose payments are reduced under a write-down; and
  • impose a six-month (extendible) suspension of certain termination rights under supply and financial contracts, and a stay on the surrender of with-profits and unit-linked policies (subject to appropriate exemptions). These restrictions would apply while an insurer is undergoing certain insolvency or write-down procedures (subject to any disapplication or modification by the court).

These proposals are intended to support the long-held objective of the regulators’ powers in relation to insurers in financial difficulties – being to promote continuity of cover for policyholders – by allowing earlier intervention by the regulatory authorities when an insurer is suffering financial distress, reducing costs to industry and helping maintain public confidence in the UK’s insurance sector. They are separate from (though complementary to) recent proposals from the Treasury for a new Insurer Resolution Regime – see our client alert for more on the IRR. 

Changes to the PRA’s rules and policy 

The draft clauses in the FSM Bill require the PRA to take steps to implement the new regime for insurers in financial difficulties. The PRA’s consultation paper sets out how it proposes to do this. Its proposals are intended to manage the risks posed by insurers in financial difficulties by allowing a firm to exit the market safely or return to viability. They are also designed to ensure policyholder protection and set robust expectations for how firms should engage in relation to the new regime.

Key changes proposed by the PRA include: 

Policyholder Protection Rules and FSCS Statement of Policy

While the FSM Bill sets out the general framework for the compensation scheme’s role in a write-down, the detail concerning how the FSCS operates is left to the PRA to provide for in its rules. The PRA rules setting out FSCS protection for insurance business are in the Policyholder Protection Part of the PRA Rulebook (the “PPP Rules”). The PRA proposes to amend the PPP Rules to reflect the changes introduced to FSMA by the FSM Bill and provide clarity to the FSCS by amending the Policyholder Protection Statement of Policy (the “FSCS SoP”) (which is addressed to the FSCS in respect of its role as scheme manager of the policyholder protection scheme).

The PRA’s proposed amendments to the PPP Rules cover matters including:

  • payment triggers – the PRA proposes that the PPP Rules would oblige the FSCS to make top-up payments to protected policyholders only when the court has issued a write-down order (“WDO”) and the insurer, acting through the write-down manager, has provided the FSCS with written notification of the WDO;
  • payment mechanics – the PRA proposes that payments would be made by the FSCS directly to the insurer for onward transmission to the policyholders;
  • recovery rights – the PRA proposes that the FSCS would have a right of recovery against the insurer in respect of the top-up payments. The PRA considers that an additional recovery right is needed because, under the current regime, the FSCS only has a recovery right in respect of compensation payments (whereas top-up payments are akin to financial assistance); and
  • declaring an insurer in default and final compensation – this would occur when the insurer has been through the write-down process but is not returning to viability, thus triggering an insolvency event. The PRA proposes that the FSCS would only be able to declare an insurer to be in default and provide final compensation to policyholders if the WDO has been terminated or completely lifted by the court.

PRA rules regarding notification of affected persons

The proposed new section 377F of FSMA will set out the basis on which affected persons are required to be notified of the making and effect of a WDO by the court. It will also state that an ‘affected person’ will be described in PRA rules. The proposed PRA rules would specify who an ‘affected person’ is, what information they should be given and how such notification should be made (i.e. its form and manner).

New PRA Statement of Policy 

An application for a WDO may be made by the Treasury, the PRA, the insurer, a shareholder of the insurer or a policyholder or other creditor of the insurer. It is ultimately for the court to determine whether to sanction a WDO under the proposed new section 377A of FSMA. However, the PRA must first consent before an application can go to court. The PRA proposes to introduce a new PRA Statement of Policy that would set out the PRA’s consent process for an application to court for a WDO and the appointment of a write-down manager. The consent process would include the PRA consulting with the FCA and the provision to the PRA by those applying for a WDO of certain documentary information on the write-down application. 

Next steps

Responses to the PRA’s consultation are requested by Friday 31 March 2023. The PRA proposes that the implementation date for the changes would be in or around July 2023.