The slow tightening of solvency requirements due to the 2008 market crisis may place regional insurers under financial strain. This update provides insight into the options available for struggling companies that might not be able to bear the financial strain.
A fortunate record
The most powerful spur to regulation is market failure. UK insurance companies had been relatively immune from distress until in 1971 an insurer called Vehicle & General collapsed leaving thousands of motorists without cover. It became apparent that the collapse of an insurer in an era of compulsory cover presented the Government with challenges that conventional insolvency legislation was ill equipped to contend with. The response (in addition to a predictable witch hunt within the ranks of the civil service) was the bolstering of the law of insurance supervision and the creation of a statutory safety net for policyholders, together with later the clarification of the rules for valuing claims in an insurance company winding up.
The market crisis of 2008 did not precipitate a round of insurance failure – in either western markets or in the UAE. However the slow tightening of solvency requirements, whether by Solvency II or its wider international ripple effects, may yet place insurers in this region under financial strain which some at least will not be able to bear. What are the options for struggling companies here?
Conventional liquidation and insurance companies do not mix well. How are claims to be valued, particularly under long term policies? How can a liquidator charged with duties to creditors keep cover in place? What is the position of the policyholder who needs immediate cover?
The UAE Federal Law 6 of 2007 concerning insurance (the Insurance Law) does contain a framework for liquidation of insurance companies. Liquidation can be initiated by shareholders or by the Court. Upon the commencement of the liquidation the board loses its authority to the liquidator. Proceedings or claims against the company are stayed for 6 months. As an alternative, merger, restructuring or cancellation of authorisation are possibilities.
Before one gets to liquidation or restructuring, Article 40 of the Insurance Law places a duty on an insurer’s auditor to report to the Insurance Authority (the IA) if the auditor in question finds that the financial position of the company is such that it will not be able to meet its obligations towards its insureds, or hinders its ability to meet statutory requirements or if he “observes a material deficiency in the company’s financial controls or procedures, including data entry in its accounting records”. Following such a report, or as a consequence of the IA’s own inspection, the Director General of the Insurance Authority (the DG) can require a range of actions, including shutting the offending company to new business, limiting premium receipts, requiring the deposit of assets to match specified liabilities, imposing restrictions on investments or removing the general manager, senior officers, directors or the Chairman. He can remove the entire board and replace it with ‘a neutral temporary administrative committee’ with a specified assignment for a period of six months, renewable for a further one year if required. Finally the DG may:
- take necessary steps towards merger with another company;
- suspend or cancel the company’s licence;
- restructure the company; or
- liquidate it.
Taking the most draconian route first, under Articles 81 to 98 of the Insurance Law, the liquidator’s function is blunt: simply to carry out the liquidation in accordance with the law. He can reach agreement with debtors on amounts owed by them; terminate employees’ contracts while paying sums owed to them in respect of the previous four months as a priority; gather in claims, and notify policyholders of ‘their rights and obligations’. Where claims have been made in the liquidation, then the liquidator must issue his decisions on them within six months of appointment, failing which they will be deemed to be dismissed.
Article 95 of the Insurance Law lays down an order of preference for creditors. First, employees in respect of their last four months entitlements; second, liquidator’s expenses; third, rights of insureds and beneficiaries from policies; fourth, other creditors; and fifth, shareholders.
In practice if a UAE insurer with a significant retail book (particularly motor or employers’ liability) found itself in financial difficulties, the impact on cover and claims of ordinary citizens would probably be such that the authorities would seek to take measures that would permit cover to continue on an interim basis while a temporary or permanent rescue package was put in place. Of course the UAE does not yet have, pending the eventual release of the long promised new Insolvency Law (now expected in the third quarter of 2013) a fully fledged administration procedure that permits the taking of action to ensure the survival of an enterprise as a going concern. Even when it does, the relationship of the new legislation to the insurance industry is as yet unknown. Even more to the point, insurers prefer to avoid the stigma of anything associated with insolvency, even administration: in the UK, HM Treasury statistics reveal only two administrations of insurance companies since this was first permitted in 2000, as compared to 43 schemes of arrangement.
The Insurance Law does provide for the merger or restructuring of UAE insurers in Articles 74 to 80. Either procedure could be utilised for a company in financial difficulties, but it is the restructuring provisions, in Article 77 (1) (b), that refer to one of the objectives of restructuring being to manage “the company and organising its difficult financial situation through negotiating with its creditors, for the purpose of determining the debts of the company and the terms of the settlement by approving the restructure plan”. The board of the restructuring company may be dissolved by the Board of the IA upon the DG’s recommendation, being replaced by a “neutral committee of sufficient experience and competence” to effect the restructure.
The neutral committee has a year to come up with a restructuring plan for the enterprise. After statutory advertising, creditors have thirty days to prove their debts supported by documentary evidence. No more than fifteen days after the debts are confirmed, the committee advertises the plan and invites creditors to approve it by a majority of creditors representing at least three quarters of non- preference and non-secured debts; a significant hurdle. Failure to approve the plan hands the initiative back to the DG to take action.
It is worth noting here that the UAE company law does provide for a ‘protective composition’ approach, but that this is not available to joint stock companies (all UAE insurers must be public joint stock companies). Both the insurance restructuring and the protective composition regimes are as yet untested.
One of the important boosts to schemes of arrangement in the UK was the 1985 Insurance Companies Winding up Rules, which put the valuation of claims on a sound modern footing. There is no equivalent legislation in the UAE which may make obtaining creditor consent for a restructuring scheme more difficult.
Standstill/suspension of authorisation
Articles 50 to 54 of the Insurance Law set out a procedure which provides for the ‘suspension’ of the licence of an insurer for up to a year where a company is in breach of the law, has ceased to carry on business for a year, failed to fulfil its financial obligations or refused to execute a court order in relation to an insurance contract. It has been suggested that this might permit a troubled company to cease writing new business and run off its obligations or at least struggle back onto its feet. The drafting suggests that run off does not amount to ‘transacting business’ within the terms of the law. However if the cause of the suspension lasts longer than one year, the company’s licence is cancelled and it is under an obligation to commence voluntary liquidation within a month of the one year time limit expiring. The company concerned is then under an obligation to commence proceedings for voluntary winding up.
What about run off?
In the UK the run off industry has achieved exponential growth over the last 15 years. In large part this is a symptom of a mature market. It is comparatively easy to enter the insurance industry if capital is available and difficult to achieve finality as a precursor to exit. In the UAE, achieving entry remains an overriding objective for many and little attention has been bestowed on exit. It took the FSA in the UK a considerable time to get to grips with run off regulation. In the UAE, in Articles 71 and 72 of the Insurance Law, one has the basic provisions permitting portfolio transfer which is one of the most useful tools for run off, although the provisions have been scarcely used at all to date. Moreover in the DIFC one has a formidable concentration of reinsurance capability. What a regulator would make of onshore administration of a run off allied to DIFC reinsurance remains to be seen.
Money, money, money
The UAE does have in place fairly sophisticated mechanisms to support financially challenged insurers. How well they may work will have to await the region’s first serious insurance failure: let us hope it never arrives.
Coming back to Vehicle & General in the UK all those years ago, it was the foundation of the Policy holders Protection Board (later the Financial Services Compensation Scheme) in 1975 which established the UK’s first effective insurance bail out fund, financed by an industry levy. This funding supplied the oil that has lubricated and facilitated insurance rescues over the years, unpopular as the levy may be with solvent insurers. One has no doubt that if the reputation of the UAE as a regional insurance hub was seriously threatened by insolvencies, the funds would probably and eventually be found for a bail out – but how quickly, and with what degree of industry debate and soul searching, is another matter.