On 25 March 2010, HM Treasury published a consultation paper which proposes improvements to the protection and payment of benefits for policyholders of insurers in financial difficulty. In particular, the proposals address certain gaps in the regime for insurers in administration in contrast to the regime applied in liquidation. According to the Treasury, this gap in the rules has the potential to result in certain policyholders (especially those with long-term contracts) not receiving equivalent protection under insolvency law when an insurer is in administration, as opposed to liquidation.
The financial crisis has prompted the UK Government to revise aspects of the insolvency regimes applicable to the financial services sector. Perhaps due to the historically low number of insurer insolvencies, the procedures and rules applied to insurers in default are not as developed as those for other sectors.
The current regime for insurers
Initially the Insolvency Act 1986 did not permit insurers to be put into administration. It was common practice for insurers in financial difficulty to petition the courts to appoint a provisional liquidator who could continue to receive premiums and pay claims with a view to transferring the business to another insurer.
The Financial Services and Markets Act 2000 (FSMA) allowed insurance companies to be placed into administration. This power was applied through the Financial Services and Markets Act (Administration Orders Relating to Insurers) Order 2002 which aligned certain aspects of the administration regime with that for liquidation. However, there remain certain areas where the regime for administration and liquidation are not the same.
The Financial Services Compensation Scheme (FSCS) is the UK compensation scheme of last resort for the customers of UK financial services firms. The fund will pay out 90 per cent of insurance claims with no upper limit and 100 per cent of all compulsory insurance claims.
The problems identified by the Treasury
HM Treasury have identified the followed problems with the regime applicable to insurance companies in administration:
- At present, there are no rules for the valuation of general or long-term insurance contracts which causes a lack of clarity as to how to deal with such contracts when an insurance company defaults.
- Under the present regime an administrator is able but not obliged to:
(i) provide assistance to enable the FSCS to administer the scheme and secure continuity of contracts of insurance; and
(ii) continue the business of the insurance company and make payments under the policies.
The current regime requires the administrator of an insurance company to perform his functions in the interests of the company’s creditors as a whole with the aim of either: rescuing the insurer as a going concern; achieving a more preferable result for the company’s creditors than would be the case if it were wound up; or, realising property in order to make a distribution to one or more preferential creditors.
At present, there is no duty to assist the FSCS which can mean that policyholders dependant upon regular payments of benefits under long-term policies could suffer financial hardship due to delays.
The proposed reforms
The Treasury consultation paper makes a number of proposals to amend the administration regime for insurance companies. The proposals are to:
- Apply the existing rules for valuing contracts of insurance in liquidation (as set out in the Insurers (Winding Up) Rules 2001) to those in administration;
- Revise the objectives of the administrators of insurance companies by:
(i) changing the law to require administrators to provide assistance to the FSCS which will enable it to administer the compensation scheme for policyholders and secure the continuity of the insurance contracts; and
(ii) apply the existing powers relating to continuity of long-term insurance on the liquidation of an insurer to administration.
Under the proposals, the administrator will assist the FSCS, thereby providing benefits to policyholders. The administrator will be able to assist with claims, paying benefits falling due on long-term policies, maintaining existing cover and facilitating transfers to other insurers. The Treasury believe that this continuity will reduce the risk of hardship for long-term policyholders.
Furthermore, in contrast to the winding-up regime, at present the appointed administrator of an insurance company has no obligation to carry on contracts of long-term insurance with a view to transferring them to an alternative company. At present, under the compensation scheme, recovery is limited to 90 per cent of any claim. The proposals would impose a requirement on the administrator to carry out the insurers’ long-term contracts with a view to a transfer - thereby securing full recovery under the policy. This duty will be an exception to the administrator’s duty to act in the best interests of the insurers’ creditors as a whole.
In addition, the proposals would allow an administrator to do the following:
- enter into new contracts of long-term insurance where beneficial to existing policyholders;
- vary contracts whose original terms are unreasonably burdensome for the insurance company;
- apply to the court to appoint a Special Manager who can provide particular commercial or managerial expertise
Furthermore, the court should have the right to reduce the value of one or more contracts of insurance and to appoint an independent actuary when the insurer goes into administration. These provisions replicate existing provisions under section 376 FSMA for insurers in liquidation.
The Government has asked for stakeholders to contribute ideas for any other improvements to the insolvency regime for insurers. Responses should be received by 25 June 2010.
To view the consultation: HM Treasury consultation on strengthening the administration regime for insurers