The insolvency of UK insurance companies is, fortunately, a fairly rare event. Even in the current difficult times - and despite speculation about the solvency of some insurers - we have yet to see a UK insurance company actually go into liquidation. This is due at least in part to the prudential regulatory regime applicable to insurers, particularly large life insurers, which imposes substantial margins for changes in the market value of assets and tries to deal with the issues identified as a result of the collapse of Equitable Life, for example the failure to value and charge appropriately for embedded contractual options and benefits.
If, however, an insurer were to fail, a slightly different regime from that applicable to insolvent companies of other types would apply in order to protect policyholders - and in particular, long term business policyholders. Long term business is defined by the Financial Services and Markets Act 2000 (see Schedule 1 of the Regulated Activities Order SI2001/544) as broadly including life, annuity, long term health and annuity business. The insurance liquidation regime includes:
Rules to ascertain (with actuarial assistance) what the insurance liabilities are
Once appointed, a liquidator would seek to value an insurer’s liabilities and continue its insurance business, often - in the case of long term business policyholders - with the aim of transferring the assets and liabilities to another insurer. The liquidator is specifically required to keep records with a view to the long term business being transferred to another insurer.
Rules on priority of winding up
The rules which apply to winding up of an insurer (the Insurers (Reorganisation and Winding Up) Regulations SI2004/353) provide that direct insurance debts (e.g. monies owed to an insurer's own policyholders) are to be paid in priority to all other unsecured debts, except staff remuneration and pensions contributions. This rule does not however apply to policyholders of other insurance companies which the insurer has reinsured. In practice, unit-linked policyholders are often protected because the reinsured company will have taken security in the form of a floating charge which effectively puts its unit-linked policyholders into the same position as the direct policyholders of the reinsurer.
Use of long term business assets
The rules on the availability of particular assets as part of the insolvency are contained in the Insurers (Winding Up) Rules (SI2001/3635). The distinction between long term and other business assets of the company is important. The purpose of the rules is to maintain the principle, applicable whilst solvent, that an insurer should only use the assets of its long term business fund for the purposes of its long term business. By contrast the rules requiring ring-fencing of unit linked liabilities (linked to property rather than an index) do not continue to apply in insolvency. Hence on insolvency, unit-linked policyholders rank pari passu with other life policyholders. Any surplus of the long term business cannot necessarily be applied by the liquidator for the purposes of the company’s other business (even if it has already been transferred out of the long term fund by the company). The liquidator has to make an application to court to authorise such use.
The availability of compensation
If a UK insurer becomes insolvent, its direct policyholders are eligible to make a claim under the Financial Services Compensation Scheme (FSCS) for at least 90 per cent of their policy value. Once the FSCS has paid out to policyholders it effectively steps into their shoes to become a creditor (with the same priority enjoyed by the policyholders) in the liquidation. In relation to a long term insurer, it is more likely that the FSCS will pay an amount to enable benefits to be secured with another insurer.