Last night (Monday 12 August) the Financial Stability Board (FSB) released its consultative document on the "Application of the Key Attributes of Effective Resolution Regimes to Non-Bank Financial Institutions". For the first time this sets out specific international guidance on resolution requirements for insurers, as well as guidance on client asset protection and Financial Market Infrastructure. This blog post addresses the key areas of impact for insurers within the Insurance annex from the broader consultative document.

This consultation reflects the desire of regulators to reduce, and where possible remove, systemic risk from the international financial system.

In the case of insurers this follows on from the announcement of nine Global Systemically Important Insurers (G-SIIs) in July 2013. 

The consultation recognises that in the majority of circumstances tried and tested "run-off" tools and portfolio transfers will be sufficient to deal with a failing insurer. However, it consults on whether, and in what form, additional tools are required.

Insurer specific objectives

Although the objectives remain in-line with the general objectives for Key Attributes, as detailed in the  broader FSB document released in October 2011, it is clear that the FSB have the additional objective of securing adequate protection for insurance policyholders.

Resolution authority and resolution powers

The explicit level of focus given to policyholder protection suggests a shift in emphasis when dealing with insurance failure. The paper also suggests potential additional powers for resolution authorities.

As with banks, non-viability triggers for an institution will be set by the resolution authority, these would be targeted to take effect before an insurer's balance sheet shows that it is insolvent.

The consultation suggests a significant range of powers for the resolution authority and / or the bridging institution to have available when undertaking to control, manage and operate an insurer's business.  These extend to continuing to write new business. 

The annex also sets out prospective powers to restructure liabilities, including insurance liabilities. These powers are potentially significant and do allow losses to be allocated to some classes of policyholders – potentially extending the concept of "bail in" to insurers.

The cross border effectiveness section also considers mechanisms to focus on the effective operation of liability restructuring when contracts are written within a different jurisdiction from that where the insurer is located.

In addition, the supervisory authority will have powers to transfer insurance liabilities and accompanying reinsurance assets, and while doing so to vary or reduce the value of contracts being transferred. Whilst similar transfer mechanisms exist across Europe, and elsewhere, they tend to be lengthy, don't necessarily have the power to vary liabilities and often fail to deal with reinsurance assets so this could provide a significant development in the resolution tools available to regulators.

The paper also introduces the power to temporarily restrict or suspend the rights of insurance policyholders to withdraw from or change their insurance contracts. This is accompanied with powers to stay rights of reinsurers of the firm to terminate their contracts.

Although the additional powers given to resolution authorities may be beneficial for policyholders and the overall stability of the industry, the effect on creditors requires careful analysis and will differ depending upon the situation in which they are employed.  For this reason the tools are only expected to be employed depending upon need and after consideration of the existing, traditional, run-off and insolvency mechanisms.

Safeguards

The annex reinforces the desire to respect the liquidation hierarchy of claims. However, it emphasises that the hierarchy of claims should give a high priority to policyholders, with shareholders and unsecured creditors, such as debt holders, absorbing losses before they do. This is broadly aligned to the established principle across the EU, where insurance liabilities get priority to other unsecured claims (including those of reinsurers). 

The proposals do, though, allow the resolution authority to depart from the pari passu principle (that all creditors be treated the same) when considering policyholders. This could therefore allow these to be grouped by sub-class (e.g. in same product line) and for those different sub-classes to be treated differently in resolution. 

Funding from compensation schemes

There is a call for privately funded insurance compensation schemes – to bring insurance globally in line with banking. This broadly aligns with the position in the UK where many insurance policyholders are covered by the Financial Services Compensation Scheme but will require more significant changes elsewhere, many jurisdictions do not have established insurance compensation schemes.

Resolvability assessments

As expected the resolvability assessments will focus on the continuity of critical functions and the ability of an insurer financially and operationally to transfer insurance policies to another party.

However there is an apparent extension of focus beyond pure systemic impact into "broader economic" impact.  The implication of this being recognition of the potential "real economic" impact of a major insurer failing.

In order to prepare their resolvability assessments insurers will need to deal with the significant MI and Data issues that may be required to support their analysis. This will particularly be the case for those with complex legal entity structures that do not align to corporate structures upon which current MI and reporting is based.

Recovery and Resolution Plans

The paper also implies that the requirements to agree "living wills" with regulators may be applied to a wider set of insurers, i.e. to all those that could be considered important or critical upon failure, with functions of this type separately identified within firms.

It highlights that recovery plans should be based off severe stress tests, which reflect the specifics of the insurance policies written, for example longer payout durations that reflect the insurers risk profile.

Key questions to consider

  • Which insurers over and above G-SIIs may be required by their regulators to draw up RRPs?
  • How will these proposals extend to insurers not engaged in Non-Traditional Non-Insurance Activities?
  • What additional complexities, if any, will these guidelines introduce for internationally active insurance groups?
  • If agreed, how long would it take to put in place the required legal arrangements to support these proposals?
  • What new capabilities will these proposals introduce for insurers and to what extent does this introduce contingency planning for more severe stresses than are captured within Solvency II?

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.