The PRA has recognised opposition to its proposed clampdown on solvent schemes in a Supervisory Statement (see SS3/14) published on 25 April 2014. The PRA's previous language, describing its dislike of solvent insurers' use of schemes of arrangement to achieve an early exit from the market, has been softened in response to criticism that its approach was "hard and inflexible". It remains to be seen whether a change of wording brings with it recognition that solvent schemes may come with the support of the vast majority of policyholder creditors and not simply be about giving shareholders early access to their capital. In practice, we expect that insurers wishing to promote solvent schemes will still face a sceptical regulator.
- Opinions on the use by solvent insurers and reinsurers of schemes of arrangement to exit insurance markets will undoubtedly remain polarised.
- Arguments will continue that solvent schemes unjustifiably favour shareholders in giving them early access to their capital while exposing policyholders to a loss of cover and/or under-valuation of their policies.
- For others, the Companies Act 2006 (CA 2006) establishes a mechanism that insurers may legitimately use to cut short the run-off process and which safeguards policyholder interests through voting requirements and the sanction of the court.
- It is assumed that the PRA's approach reflects an understanding that solvent schemes may vary in their approach and impact, and that continuity of cover may not be policyholders' preferred option, especially where the insurer may be of doubtful solvency.
The PRA's approach to solvent schemes
In an earlier briefing, we considered the PRA's proposed clampdown on the use of solvent schemes of arrangement by insurers outlined in its Consultation Paper CP6/13. We, along with many others, expressed concern about the PRA's assumption that solvent schemes were "unlikely" to be compatible with its policyholder protection objective on the basis that such a blanket rule seemed unjustified. In particular, we questioned the PRA's focus on securing continuity of cover for policyholders where an insurer is looking to exit the market. The procedure for schemes of arrangement provided in CA 2006 allows an insurer to make proposals to its creditors (in this case, policyholders) to vary or terminate contractual terms which creditors can consider and vote on collectively, as part of a scheme of arrangement, and which will bind all creditors if sufficient majorities and court sanction are obtained.
Against this background, it is helpful that the PRA has clarified that it will consider schemes on a case-by-case basis and that some solvent schemes could meet its policy objectives. It has acknowledged that solvent schemes vary in their type and impact on policyholders. The PRA also notes the need for firms to engage with both the PRA and the FCA on the terms of a proposed scheme. They should be ready to discuss the particular nature of the business and the extent to which policyholders would have appropriate continuity of cover. In practice, it seems likely that, despite the change of wording in SS3/14, insurers and those advising them on the scheme process may still have an uphill battle to persuade the PRA of the merits of a solvent scheme, at least absent a suitable opt-out feature.
Some other issues
SS3/14 clarifies that the PRA's views apply to both life and general insurance, answering a question raised in consultation.
Other questions asked of the PRA's proposed approach in CP6/13 included whether it should be interfering at all in a statutory process established by Parliament for varying creditors' contractual rights. That process depends on approval by the necessary majority of each affected class of creditors and the court's assessment of the merits of a proposal, and the PRA has no formal part to play (in contrast, for example, to a transfer of business under Part VII of the Financial Services and Markets Act 2000). The PRA has, however, offered a fairly robust view that it regards solvent schemes as firmly within its remit and representing a potential challenge to its objectives of safety and soundness and policyholder protection.
This seems to us to be a correct approach. Even though the scheme of arrangement process involves considerations of fairness by the court at the sanction stage, the court's analysis of what is fair can in practice (and in line with the relevant case law on schemes of arrangement) be limited, with the court unwilling or unable to consider the wider policy issues relevant to the PRA.
In practice, although the court has the final say on whether a scheme of arrangement goes ahead, those proposing a scheme are unlikely to incur the time and expense of preparing a scheme which is unlikely to have PRA support.
Finally, the PRA acknowledges that allowing insurers to exit the market has a potential competition benefit and that its new (secondary) competition objective will inform its consideration of each proposed scheme. This is helpful as, again, it should mean that the PRA considers each solvent scheme on its merits instead of assuming that they are incompatible with the protection of policyholders.
Likely practical impact of the PRA's approach
Where the PRA takes an unfavourable view of a particular scheme, it is unlikely that the scheme would get off the drawing board and actually proceed to a vote of creditors. We would expect the court to have a difficult task when being asked to sanction a scheme which lacked PRA support if, despite PRA objection, a scheme had been continued with and approved by the necessary majorities of creditors.
We anticipate that the PRA's preference for "alternative safeguards" for policyholders to meet its concern about dissenting policyholders who do want to achieve continuity of cover will prompt further work on what can be done for such policyholders. Finding a similarly rated insurer prepared to issue replacement cover is always a difficult task due to cost and scale, particularly for long tail business. Particularly where an insurer is planning to carry on conducting other lines of business, the "opt out" concept may provide a route forward, allowing policyholders to "opt out" of the application of the scheme and its effect on their policies, which would carry on in run off.
If the PRA turns out, in practice, to be deeply sceptical of all solvent schemes, we may see insurers who wish to exit the market turn increasingly to alternatives such as Part VII transfers. All will depend on the line the PRA actually takes when considering schemes on a case-by-case basis.