On 13 July 2016 a draft bill for the Recovery and Resolution (Insurers) Act (Wet herstel en afwikkeling van verzekeraars, the "Draft Bill") and an accompanying explanatory memorandum ("MvT") were published for consultation; the consultation period closed on 28 August 2016. The proposed new rules are intended to strengthen the legislative framework for the recovery and resolution of insurers. In this newsletter we discuss a number of the most important changes to be introduced under the Draft Bill if passed in its current form.
According to the Explanatory Memorandum, there is a need for an effective and efficient framework for the orderly resolution of insurers. A disorderly resolution can lead to social unrest in view of the insurance sector's social function, the risk of contagion effect to other entities in the insurer's group and the effect on public confidence in the industry as a whole. The Explanatory Memorandum concludes that the current framework under the Financial Supervision Act (Wet op het financieel toezicht) is inadequate. The Draft Bill therefore creates a new recovery and resolution framework under which certain obligations are imposed on insurers and certain resolution powers are conferred on the Netherlands Central Bank (De Nederlandsche Bank, "DNB").
The Draft Bill is not the direct result of specific EU legislation. Its drafters were, however, influenced by the recommendations of the Financial Stability Board and EIOPA for the recovery and resolution of insurers and by the recovery and resolution tools introduced for banks pursuant to the EU Bank Recovery and Resolution Directive (BRRD) and Single Resolution Mechanism (SRM). The Explanatory Memorandum acknowledges the existence of differences between the banking and insurance industries and between the different types of insurers but says it is up to DNB to exercise the appropriate recovery and resolution powers, taking into account these differences.
The new recovery and resolution framework attaches great importance to the interests of policyholders, charging DNB with the duty to apply the tools in the way most advantageous to them. However, it cannot be ruled out that even policyholders may have to bear part of the losses when an insurer is resolved.
2. Changes to existing framework
The approach taken in the Draft Bill is to abolish the existing mandatory transfer arrangements (based on the Intervention Act), the emergency regulations (also with respect to banks) and the safety-net scheme for life insurers and replace all of these with a new recovery and resolution framework.
This means that many of the rules introduced by the Intervention Act will be repealed. Only the powers of the Minister of Finance under part 6 of the Financial Supervision Act will remain in effect. These include the power to expropriate assets owned by, or securities issued by or with the cooperation of, insurers or other financial undertakings (or their parent companies).
According to the Explanatory Memorandum, a number of the powers conferred on the administrator by the emergency regulations will be moved to the Bankruptcy Act. These include the power to modify the terms of the corresponding insurance agreement in the event of a transfer of rights and obligations under an insurance policy.
The new recovery and resolution framework will apply to the following entities:
all insurers subject to DNB's prudential supervision, e.g. all Netherlands-based life insurers, non-life insurers (including health care insurers), reinsurers, benefit-in-kind insurers and funeral expenses insurers;
Netherlands-based insurance holding companies, mixed financial holding companies and mixed insurance holding companies that are part of an insurance group ("group" as defined in Solvency II);
branches in the Netherlands of insurers based outside the EEA, other than insurers excluded from the scope of Solvency II because of their limited size (called "Solvency II Basic" insurers);
other Netherlands-based undertakings that are part of an insurance group if they perform services of crucial importance to the group's daily activities.
All of the above entities will be referred to below as insurers.
In the case of a group consisting of one or more insurers and one or more banks (a financial conglomerate), the recovery and resolution powers in the new framework may be exercised only against the insurer(s).
If an entity falls within the scope of both the resolution regime for banks and the corresponding regime for insurers (for example, because it is a mixed financial holding company), the regime for banks will have priority because of its basis in EU law.
Because the Draft Bill is limited to insurers that are subject to DNB's prudential supervision (and their affiliated undertakings), the resolution and recovery framework will not apply to the smallest Netherlands-based insurers.
4. Recovery and resolution tools: the preparation phase
The Draft Bill distinguishes two phases: the preparation phase and the resolution phase. During the preparation phase each insurer is required to draw up a preparatory crisis plan and DNB is required to draw up (and periodically evaluate) a resolution plan for each insurer. To enable measures to immediately be taken if an insurer gets into financial trouble, the insurer and DNB must have already drawn up these plans.
An insurer's preparatory crisis plan is to some extent comparable to the recovery plan drawn up by a bank. In such a plan, the insurer must provide insight into the possibility of recovery if it ceases to meet, or is in danger of ceasing to meet, the solvency requirements (SCR/MCR). A preparatory crisis plan precedes the recovery plan for insurers and short-term finance scheme provided for in the Financial Supervision Act, both of which are only required if the insurer in fact ceases to meet the solvency requirements.
The resolution plan to be drawn up by DNB for each insurer in the preparation phase must describe, among other things, the possibility of applying the resolution tools and powers. If DNB encounters substantial obstacles when implementing the resolution plan, it can require the insurer to take specific measures to remove them. For example, it can demand that the insurer sells specific assets or limit or cease existing activities. DNB may only refrain from drawing up a resolution plan if, in its view, there are sufficient guarantees of the insurer's resolvability.
For reasons of proportionality, Solvency II basic insurers are excepted from the obligation to draw up a preparatory crisis plan and DNB is not required to draw up a resolution plan for them. Branches of non-EEA insurers are excepted from the obligation to draw up a preparatory crisis plan.
5. Recovery and resolution tools: the resolution phase
A decision to resolve an insurer and thereby convert it from a going concern into a gone concern can only be taken after each of the steps in the Solvency II intervention ladder have been followed. These steps include the implementation of the recovery plan and short-term finance scheme. An exception applies if it is clear from the outset that the insurer's financial situation will not improve as a result of the above steps.
Conditions for resolution
DNB is required to resolve an insurer if all of the following three conditions are met:
the insurer is failing or likely to fail;
there is no reasonable prospect that alternative measures would prevent the insurer's failure within a reasonable time period;
resolution is necessary in the public interest.
In the case of insurance groups, certain holding companies and branches of non-EEA insurers additional conditions must also be met.
The Draft Bill elaborates on the above conditions. A noteworthy point is that according to the Explanatory Memorandum, the first two conditions will in any event be met if implementation of the short-term finance scheme (based on Solvency II) has not led to the desired result. If this is the case, DNB must then decide whether resolution is necessary in the public interest (condition 3). If the policyholders will be better off following resolution than following the alternative scenario of bankruptcy, DNB will probably answer this question in the affirmative and proceed with resolution. The protection of the interests of policyholders may be a decisive factor in this connection.
In the event of resolution DNB has at its disposal the following tools, which can be used individually or in combination:
the sale of business tool;
the bridge institution tool;
the asset separation tool.
Bail-in enables DNB to write down the insurer's liabilities to providers of debt capital and other creditors (including policyholders) or convert those liabilities into shares or other instruments of ownership of the insurer, its parent company or a bridge institution. Unlike for banks, the Draft Bill does not make a distinction between, on the one hand, the write down and conversion of the insurer's capital instruments (abbreviated in the legislative history as ''AFOMKI" based on the full name in Dutch) and, on the other hand, the bail-in of its other liabilities. The entire liability side of an insurer's balance sheet is in principle subject to bail-in.
Certain liabilities, such as those protected by a security interest (e.g. a pledge, mortgage or title transfer financial collateral arrangement), are excluded from bail-in. In addition, DNB can decide to refrain from applying bail-in to liabilities that would otherwise be eligible. An example given in the Explanatory Memorandum is that of derivatives used for risk-hedging. If such derivatives have a negative value, it can nevertheless be preferable to retain them as protection rather than apply bail-in. Moreover the Draft Bill provides that, in the case of derivatives, bail-in can only be applied after close-out and, where a derivative is subject to a netting agreement, only on a net basis (i.e. only after close-out netting).
Bail-in is applied in reverse order to the order in which claims against the insurer's bankruptcy estate would be eligible for payment. In other words, while shareholders are the last to be paid in bankruptcy, they are the first targets of bail-in. In contrast, policyholders are the first to be paid in bankruptcy and the last targets of bail-in, reflecting their privileged position.
The Explanatory Memorandum points out that, as a general rule, bail-in is aimed at preserving the continuity of the insurer's contract portfolio and not the continuity of the insurer itself. A policyholder will generally benefit more from the continued existence of the insurance agreement, even after bail-in, than from a bankruptcy distribution (although there are of course exceptions). In the event of an insurer's resolution, the continuity of its insurance contract portfolio can be achieved by using bail-in to re-launch the insurer as a going concern or by transferring all or part of that portfolio to a third party through one of the tools described below, whether or not in combination with bail-in (gone concern scenario).
Transfer tools: sale of business, bridge institution and asset separation
DNB can use (i) the sale of business tool or (ii) the bridge institution tool to sell shares or other instruments of ownership issued by or with the cooperation of the insurer, or the assets and/or liabilities of that insurer, to a private party or bridge institution on commercial terms. The asset separation tool is similar to the other transfer tools but can only be applied to an insurer's assets and/or liabilities. In addition, it can only be used in combination with other resolution tools and only, so as to avoid an unfair competitive advantage. A transfer tool can be applied to eligible liabilities either before or after the bail-in of those liabilities.
DNB's special powers
In addition to the abovementioned resolution tools and corresponding powers, the Draft Bill gives DNB special powers to take actions such as the following:
to take over the management of an insurer under resolution;
to appoint a special director to take over the insurer's management;
to convert the insurer into a different legal form if this is necessary to apply bail-in;
to terminate or modify the terms of an agreement to which the insurer is a party.
Exclusion, restriction and suspension of contractual rights
Under the Draft Bill, a counterparty is prohibited from exercising certain contractual rights (such as termination and close-out rights) and rights attached to security interests if those rights arose as a result of the application of a recovery or resolution measure or an event directly linked to the application of such a measure. However, this only applies if the insurer under resolution continues to perform its substantive obligations under the relevant contract, including payment and delivery obligations and the provision of collateral. Contractual rights arising as a result of an event other than the application of a recovery or resolution measure or a directly linked event are not covered by the prohibition.
In addition, DNB may temporarily suspend and/or restrict the payment or delivery obligations of an insurer under resolution or a counterparty's rights to terminate an agreement with the insurer under resolution or enforce a security interest. However, a counterparty's termination rights may only be suspended if the insurer continues to meet its substantive obligations to that counterparty.
In this connection, it should be noted that a suspension can sometimes apply to agreements with the insurer's subsidiaries. Furthermore, an (in principle) temporary suspension of termination rights can, under certain circumstances, become permanent. An example is the suspension of the counterparty's termination rights under an agreement that is subsequently transferred through the application of a transfer tool. Even after the suspension period ends, the termination rights can only be exercised upon the occurrence of an enforcement event in relation to the transferee.
The Draft Bill provides for certain safeguards for shareholders and creditors (including policyholders) of an insurer under resolution.
No creditor worse off
The principle "no creditor worse off"means that shareholders and creditors must not suffer greater losses as a result of the application of a resolution tool than they would have suffered if the insurer had been wound up in normal bankruptcy proceedings immediately before the resolution decision was taken. DNB must adhere to this principle when taking a resolution decision; however, this does mean that equally-ranked creditors must receive the same treatment. After resolution, an independent assessment will be made to determine whether any shareholders or creditors are worse off. If so, they will be entitled to compensation for the difference, to be paid from a fund financed by the insurance sector (see section 7).
The "no creditor worse off" principle makes it unlikely that certain resolution tools – in particular bail-in – will be applied in certain situations or in connection with certain types of insurance. For example, where the insured risk has not yet materialised it is difficult to imagine that bail-in would be more advantageous than bankruptcy. On the other hand, the application of bail-in to reduce death benefits received under a life insurance policy or distributions received under a non-life policy can leave the policyholder better off than would be the case in the event of the insurer's bankruptcy. In such cases, DNB can apply bail-in.
Partial transfer of assets and/or liabilities; modification of contractual terms
The Draft Bill contains rules for the protection of linked assets and liabilities of the insurer under resolution – such as assets and liabilities that are subject to a netting arrangement – in the event of a partial transfer of these assets and liabilities. Under the relevant rules, rights under certain agreements or arrangements may not be impaired (i.e. can still be exercised in full) by a decision to transfer some but not all of the assets and/or liabilities of an insurer under resolution, a decision to terminate or modify the terms of an agreement to which that insurer is a party, or a decision to replace that insurer with a transferee as a party to an agreement/arrangement. The rights that may not be impaired are rights under: (i) financial collateral agreements (e.g. GMRAs, GMSLAs or CSAs entered into in connection with an ISDA Master Agreement), (ii) covered bonds, (iii) structured financing arrangements, (iv) close-out netting agreements (as set out in an ISDA Master Agreement), (v) set-off agreements and (vi) security agreements.
In addition, the Draft Bill provides that if DNB takes one of the decisions described in the preceding paragraph, the following rules apply:
assets and liabilities falling under among others a financial collateral agreement, a set-off agreement or a netting agreement may only be transferred together;
rights and obligations protected under such agreements (e.g. a right of set-off) may not be terminated or modified;
the insurer under resolution may not be replaced with a transferee as a party to such an agreement;
security arrangements may not be impaired in certain ways, for example by transferring assets subject to the arrangement without also transferring the corresponding secured obligation and the benefit of the security or by terminating or modifying the terms of the arrangement as a result of which the obligations would no longer be secured.
If linked assets and liabilities are not transferred together or if DNB otherwise fails to comply with the above rules, this does not result in the transfer, termination or modification being void or voidable. However, rights under the types of agreements and arrangements listed above remain unimpaired. This means, for example, that rights under e.g. set-off agreements and financial collateral agreements can still be exercised despite a partial or split transfer.
Under the Draft Bill, if the application of a resolution tool results in the transfer of shares or other instruments of ownership issued by or with the cooperation of an insurer under resolution or of assets and/or liabilities of that insurer to another entity, such a transfer cannot be invalidated on the grounds of the fraudulent preference rules (actio pauliana).
The Draft Bill also provides for the protection of systems as defined in the Settlement Finality Directive. The protection entails that transfer orders that have already been entered into such a system cannot be revoked as a result of a resolution measure. In other words, such transfer orders must be executed despite the resolution measure. Nor can any exclusion or suspension of contractual rights (see above) affect the operation of systems and rules of systems covered by the above Directive.
6. Legal Protection
The legal protection of resolution measures applicable to insurers corresponds with the regular system of legal protection provided for in the Financial Supervision Act. However, an exception is made for the resolution decision, which can be appealed directly to the Trade and Industry Appeals Board (College van Beroep voor het bedrijfsleven). It is not possible to first file an objection with DNB. The period for lodging an appeal is only 10 days and a decision by the Board on the appeal is required within 14 days. The lodging of an appeal does not suspend the effect of the resolution decision, although the Board can be asked to order provisional measures while the appeal is pending.
7. Financing arrangements
In order to finance the resolution of insurers, the Draft Bill provides for the establishment of a fund. Unlike for banks, it is expressly stated that the fund may not be used to recapitalise or absorb the losses of insurers under resolution. The main purpose of the fund is to compensate creditors based on the "no creditor worse off"principle.
All Netherlands-based insurers and all branches in the Netherlands of insurers established in a non-EEA country (other than Solvency II Basic insurers) will have to contribute to the fund. DNB will set the amount of their contributions but the basis for calculating this amount has to our knowledge not yet been determined.
8. Amendments to Bankruptcy Act
Under the Draft Bill, new provisions will be added to the Bankruptcy Act. Among other things, these will require the bankruptcy trustee to make certain distributions to policyholders even before the creditors' meeting has taken place, provided that the policyholder is a natural person or small or micro-business. After the meeting, the distribution will be offset against the amount to which the policyholder is ultimately found to be entitled. In addition, the criteria for declaring an insurer bankrupt will be amended so as to be consistent with the first and second conditions for resolution discussed above in section 5.
Public consultation on the Draft Bill and the Explanatory Memorandum closed on 28 August 2016 and it is possible that the rules described above will be changed based on the reactions received. With that in mind, we would like to highlight a few key problems that could perhaps be addressed during the preparation of the final bill and accompanying memorandum.
In our opinion, the Explanatory Memorandum does not sufficiently address certain provisions in the Draft Bill, such as those on financing arrangements, legal protection, the resolution decision and the asset separation tool. In addition, for reasons that are unclear to us the Draft Bill contains a section with definitions applicable to the recovery and resolution framework for banks. Finally, although according to the Explanatory Memorandum a number of the powers conferred on the administrator by the emergency regulations will be moved to the Bankruptcy Act (see section 2), there are no such provisions in the Draft Bill.
The Draft Bill makes no distinction between DNB's actions in the capacity of resolution authority and its actions in the capacity of supervisor. To prevent conflicts of interest, this could be organised in the same way as DNB's dual capacities in relation to banks. This would mean separating the resolution duties from the supervisory duties both operationally and functionally.
In the case of financial conglomerates, it is conceivable that the recovery and resolution plans drawn up with regard to the banks in a conglomerate will overlap to some extent with those drawn up (under the legislation based on the Draft Bill) with regard to the insurers in the conglomerate. Neither the Draft Bill nor the Explanatory Memorandum considers this issue.
The Draft Bill does not provide for early intervention measures akin to those included in the recovery and resolution framework for banks, such as the appointment of a temporary administrator (as the next step after the appointment of an undisclosed administrator, which is also possible for insurers) or the convening of a general meeting. It is unclear whether the thought behind this is that such measures would be incompatible with Solvency II or that the existing measures are sufficient.
Under the recovery and resolution framework for banks, the European Commission can adopt delegated regulations (with direct effect in the Netherlands) for the interpretation of provisions in the BRRD or SRM. Although some of these regulations have been incorporated in the proposed recovery and resolution framework for insurers, it is unclear how the others will be dealt with in relation to that framework. Will they be included in secondary legislation issued in the Netherlands in respect of insurers?
Derivatives have a special position in the event of bail-in (see section 5). However, the Financial Supervision Act does not define the term "derivative" and the scope of the proposed rules is therefore unclear. We would at a minimum expect the recovery and resolution framework for insurers to refer to a definition of derivative in European legislation, the approach also taken in the parallel framework for banks.
It is noteworthy that when discussing DNB's powers to terminate or modify the terms of agreements entered into by the insurer under resolution the Explanatory Memorandum states that the terms modified can be those which result in the policy being qualified as usurious (woekerpolis). The Explanatory Memorandum does not explain the link between such modifications and the recovery and resolution framework. Although the Draft Bill contains very few provisions on DNB's powers to terminate or modify the terms of agreements entered into by the insurer under resolution, we would expect these powers to apply only in support of the recovery and resolution framework.
The scope of the financing arrangement is still unclear. The Draft Bill refers to "insurers having their seat in the Netherlands" whereas the recovery and resolution framework applies to such insurers only if they are subject to DNB's prudential supervision. This would mean that the very smallest insurers, even if established in the Netherlands, are excluded from the framework but covered by the financing arrangement. Furthermore, the Draft Bill seems to exclude from the financing arrangement Solvency II Basic insurers, but this could be a mistake. This exclusion may refer only to non-EEA insurers with branches in the Netherlands: if such an insurer is a Solvency II Basic insurer its Dutch branches are not required to contribute. Finally, as already mentioned, the basis for calculating the amount of the contributions to the fund is still unclear as are further details about the mechanics. Although these will probably be worked out in secondary legislation we would expect the core rules, including those regarding the charging of contributions, to be laid down in an Act or at least outlined in the Explanatory Memorandum.
Under the current framework (based on the Intervention Act) a counterparty cannot be restricted in exercising its contractual close-out rights where it concerns rights resulting from a financial collateral agreement with an insurer. In the Draft Bill there is no explicit protection for such rights. The question is whether this is actually intended.
In a general sense we wonder whether the Draft Bill serves any useful purpose, since it would create a framework for recovery and resolution for Netherlands-based insurers that deviates from and is more far-reaching than the frameworks in other EU member states. Whether foreign policyholders and other foreign creditors of a Netherlands-based insurer would have to accept the measures provided for in the Draft Bill remains to be seen.