This episode of The Standard Formula podcast discusses three emergent insurance resolution regimes that deal with the failure, or potential failure, of insurers. 

Lamya Al-Yazdi, a member of Skadden’s London insurance team, joins Skadden partner Rob Chaplin to discuss the U.K. HM Treasury consultation on the insurer-specific recovery and resolution regime (IRR), the EU Insurance Resolution and Recovery Directive (IRRD) and the proposals outlined in the consultation paper by the Bermuda Monetary Authority.

Starting with the U.K., Rob and Lamya review the four resolution objectives for the IRR. They also discuss the EU’s proposed set of rules for handling insurance company failures. The rules will apply to EU insurance and reinsurance companies covered by Solvency II, EU insurance holding companies and EU mixed financial holding companies.

Finally, they review proposals from the Bermuda Monetary Authority (BMA). The first proposal involves the implementation of recovery planning regulations to aid insurers in proactively addressing adverse scenarios, enabling them to make informed decisions and develop credible survival strategies for severe stress situations. The second proposal suggests that the Bermuda Monetary Authority could mandate insurers to undertake recovery planning measures.

💡 Meet Your Host 💡

Name: Robert Chaplin

Title: Partner, Insurance at Skadden

Specialty: Rob primarily focuses on transactional and advisory work in the insurance sector. He advises on mergers and acquisitions, disposals, joint ventures and strategic reinsurances. He also counsels on regulatory issues, with an emphasis on Solvency II. 

Connect: LinkedIn  

💡 Featured Guest 💡

Name: Lamya Al-Yazdi

What she does: Lamya is a trainee solicitor focused on financial institutions and insurance.

Organization: Skadden

Words of wisdom: “The BMA will use specific criteria as a guide for determining which insurers will require a recovery plan, subject to appropriate proportionality, and risk analysis.” 

Connect: LinkedIn 

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The Standard Formula is a podcast by Skadden, Arps, Slate, Meagher & Flom LLP, and Affiliates. This podcast is provided for educational and informational purposes only and is not intended and should not be construed as legal advice. This podcast is considered advertising under applicable state laws.

From Skadden, The Standard Formula is a Solvency II podcast for UK and European insurance professionals. Join us as Skadden partner, Robert Chaplin, leads conversations with industry practitioners and explores Solvency II developments that matter to you.

Welcome to The Standard Formula Podcast. In our last episode, we covered who the International Association of Insurance Supervisors, or IAIS, is, and the impact the IAIS has on the insurance industry. Today, we'll be making the natural progression from that subject to looking at three emergent insurance resolution regimes that deal with the failure or potential failure of insurers. We'll focus on the UK HM Treasury consultation, on the Insurer Specific Recovery and Resolution Regime, the EU Insurance Resolution and Recovery Directive, and the proposals set out in the consultation paper published by the Bermuda Monetary Authority. The UK, EU, and Bermuda regimes build on the core principles and common framework of the IAIS and the Financial Stability Board's key attributes of effective resolution regimes for financial institutions. The UK and EU regimes also build on the existing regimes for bank resolution.

I'm Rob Chaplin, one of the insurance partners at Skadden, based in London, and I'm delighted to be joined by Lamya Al-ion authority wee, who's also a member of our London insurance team. Over to you, Lamya.

Thanks, Rob. So let's start with the UK position. We'll take a look at the Insurer Specific Recovery and Resolution Regime, or IRR, from the recent HM Treasury consultation. It's similar to the EU proposals for an Insurance Resolution and Recovery Directive, and broadly mirrors the existing UK bank resolution framework, which was recently tested in relation to the UK arm of Silicon Valley Bank.

The four resolution objectives for IRR are protecting and enhancing financial stability by preserving access to critical functions and preventing contagion, protecting and enhancing public confidence in the stability of the UK financial system, minimizing the use of public funds, and protecting policy holders and minimizing the limitation of property rights. The IRR will enable the Bank of England as resolution authority to step in where the failure of an insurer or multiple insurers threaten UK financial stability.

Currently, insurers exit the market through a solvent or insolvent runoff, using the longstanding runoff regime of the Prudential Regulation Authority, or PRA. This starts on either a voluntary or involuntary basis, and the firm must submit a runoff plan to the PRA. Following this, the firm is supervised by the PRA to ensure it has sufficient capital to continue to meet its policy holder obligations. The IRR will apply on a group basis and capture mixed financial holding companies, insurance holding companies, mixed activity insurance holding companies, regulated and non-regulated entities within the corporate group of an insurer, and UK branches of foreign insurers. Lloyd's firms, smaller insurers and friendly societies will not fall within the scope of the IRR. Even though the IRR is widely scoped, the HM Treasury believes it would only apply to insurers deemed systemically important.

Rob, could you take us through the four cumulative conditions that an insurer needs to meet to be placed in resolution?

Thank you, Lamya. The resolution authority will be granted new powers, which can be applied once all resolution conditions are triggered. These conditions are the insurer is failing or likely to fail, there is no reasonable prospect of an alternative plan, resolution is necessary in the public interest, and it's assessed that resolution objectives would not be met to the same extent if resolution action wasn't taken.

And Rob, what are the stabilization options and safeguards once these conditions are met?

The resolution authority has four options. First, to transfer a failing insurer's shares or business to a private sector purchaser. This differs to the current existing arrangements under the Financial Services and Markets Act 2000, or FSMA, in terms of control and speed, as the resolution authority would not require court approval. Second, the resolution authority may transfer a failing insurer's business or shares to a bridge institution temporarily, buying time for due diligence and valuation before finding a long-term resolution. Third, a bail-in which involves reducing or converting unsecured creditor claims into equity or other ownership instruments to follow the hierarchy of claims in the insurer's liquidation. Also, it would override pay-as-paid clauses in reinsurance contracts. HM Treasury proposes that since insurers have different risk profiles and funding structures compared to other financial institutions, the IRR should not include a minimum requirement owned funds and eligible liabilities, or MREL requirements. So shareholders in a failing insurer will be the first to absorb losses before unsecured creditors, to fund the bail-in of an insurer, keeping taxpayers in the clear. And finally, is temporary public ownership, which would be considered as an option of last resort.

Additional tools include a new insurer administration procedure, and the transfer of assets, liabilities, property or rights to a balance sheet management vehicle. The IRR also provides a mechanism to compensate any creditors that end up worse off as a result of the use of the IRR tools than if the normal insolvency process had been followed. The UK government intends to legislate to implement the proposals as soon as parliamentary time allows.

So Lamya, what's the EU position?

Thanks, Rob. The EU is in the process of approving its own set of rules for handling insurance company failures. The EU Insurance Resolution and Recovery Directive, or IRRD, is intended to create a minimum harmonized credible set of resolution tools to intervene sufficiently early and quickly, if an insurance company is failing or likely to fail, to ensure a better outcome for policy holders, while minimizing the economic impact. It will apply to EU insurance and reinsurance companies covered by Solvency II, EU insurance holding companies, and EU mixed financial holding companies as well. However, unlike the Bank Resolution and Recovery Directive, or BRRD, the IRRD will not apply to other EU holding companies, such as mixed activity insurance holding companies. Member state supervisors will require in-scope insurance companies that are not part of an insurance group to prepare preemptive recovery plans, based on their size, business model, risk profile, interconnectedness, substitutability, and cross-border activity.

The resolution authority will be able to take resolution action where, one, the insurance company or holding company is failing or likely to fail. Two, when it breaches, or is likely to breach, its minimum capital requirement under Solvency II. Three, the company no longer meets the conditions for authorization, or is in serious breach of its obligation. Four, the company is unable to pay its liabilities when due. Or five, the company requires extraordinary public financial support. Once conditions for resolution are satisfied, the resolution authority has various tools at its disposal. These include solvent runoff, sale of the business, use of a bridge undertaking, assets and liability separation, write-down and conversion, in other words, bail-in. These are similar to the UK IRR resolution tools.

Resolution authorities will have a range of other powers to support resolution actions, including powers to, one, restructure insurance claims, cancel or reduce insurance claims, and otherwise cancel or modify contracts. Two, control the entity in resolution. Three, exercise the rights of shareholders and directors, replace management, and appoint a special manager. And four, require group entities to provide operational services or facilities to support the entity in resolution.

Rob, what are the safeguards for shareholders and creditors?

Well, under the IRRD, compensation is paid to shareholders or creditors whose claims are not transferred to a purchaser or bridge institution, or whose claims are written down or converted, if a valuation shows that they are worse off than if the entity had been wound up in normal insolvency proceedings, additional safeguards would apply, where the resolution tools are used to transfer part of the business of an entity in resolution to a purchaser or bridge institution, to provide protection where there is a transfer of some rights and liabilities under a title transfer, collateral, set off, or netting arrangement, or a reinsurance agreement, against a transfer of a secured liability without the assets over which the security applies, against a transfer of some of the assets, rights and liabilities, constituting a structured finance arrangement, or unit-linked insurance, or other ring-fenced portfolio, and for clearing, settlement and other systems designated under the settlement finality directive. The proposal for the IRRD has entered the ordinary legislative procedure. The Council of the EU and the European Parliament are now considering the legislative proposal. The IRRD is expected to be finalized and published later in 2023 or in 2024.

Lamya, over to you.

Thanks, Rob. Finally, let's take a look at the proposals from the Bermuda Monetary Authority, or BMA. In June 2022, the BMA set out proposals for the introduction of rules to regulate recovery planning for the Bermuda commercial insurance sector, and most recently, in May 2023, the BMA has published further details of the proposed rules. Having a formal and structured recovery planning process aligns with the BMA's overall regulatory mandate to promote the safety and soundness of the Bermuda financial system and the regulation of insurers. The intention of the BMA's proposals are twofold. To support insurers in understanding their own risks from severe stress scenarios, and to help strengthen Bermuda's insurance regulatory and prudential framework, by making sure there is planning in place for insurers to act in an orderly and timely manner when dealing with situations where they're under severe stress.

The BMA says that it will implement and apply the proposed framework in line with the IAIS proportionality principle. The framework will address two issues. First, if and when a recovery plan is required. Second, where a plan is required, the plan's form, content and level of detail, which would be in line with the nature, scale and complexity of institutions within the Bermuda insurance market. Let's explore this further.

Rob, what's the BMA's first proposal?

Well, the first proposal relates to the introduction of recovery planning regulations. The BMA identifies that recovery planning is a tool that helps insurers prepare for potential adverse situations. It allows insurers to take effective and thoughtful measures, before it's too late, in a time of crisis, and without unnecessary pressure. An insurer should develop and own a recovery plan, which identifies the insurer's own credible options for surviving various severe yet plausible stress scenarios. Additionally, there should be integration between the recovery plan and the insurer's overall Enterprise Risk Management, or ERM, framework. And by its nature, the recovery plan should be preemptive. The BMA intends for recovery planning to go hand-in-hand with ERM tools already available to insurers, such as the Commercial Insurer's Solvency Self-Assessment, or CISSA. The BMA recognizes that there may be an overlap between the objectives of some of the insurer's existing ERM tools and their recovery planning objectives. Where this is the case, the insurer may utilize existing tools within its ERM framework as a starting point.

The BMA also outlines that the recovery plan is a critical supervisory tool which can allow the BMA both to identify and assess the options available to an insurer in order to recover financial strength and viability under severe stress. The BMA proposes that it should have powers to allow it to evaluate and challenge a recovery plan's robustness and soundness, for example, looking at elements such as credibility, depth, strength, and governance. The BMA suggests that it should be able to require insurers to take action for recovery if they come under severe stress.

Lamya, what does the second BMA proposal cover?

Thanks, Rob. The second proposal covers scope and proportionality. The BMA proposes that it may, at its discretion, require insurers to take necessary recovery planning measures without drafting a formal plan, for instance, evaluating specific risks and options and possible recovery scenarios. However, insurers of economic importance who are systemically significant may be required by the BM A to prepare a formal recovery plan. In the BMA's assessment of economic importance, and whether it could be systemically significant or critical to Bermuda if the insurer fails, the BMA will, alongside other factors, consider the class of registration, size or market share, external and internal interconnectedness, complexity, business model, risk profile, substitutability, and cross-border activities of the insurer. The BMA will use specific criteria as a guide for determining which insurers will require a recovery plan, subject to appropriate proportionality, and risk analysis. The criteria looks at things like definitions from the Insurance Act 1978 for insurance group and domestic insurer. Following the BMA's review of public consultation feedback, the rules will be finalized and come into effect 12 months after being published.

Thank you, Lamya. And that concludes this episode of The Standard Formula Podcast. We do hope you found it useful. Please join us next time.

Thank you for joining us on The Standard Formula. If you enjoyed this conversation, be sure to subscribe in your favorite podcast app so you don't miss any future episodes. Additional information about Skadden can be found at skadden.com. The Standard Formula is a podcast by Skadden, Arps, Slate, Meagher, Flom LLP and affiliates. Skadden is recognized for its deep experience in representing insurance and reinsurance companies and their advisors on a wide variety of transactional and regulatory matters. This podcast is provided for educational and informational purposes only, and is not intended and should not be construed as legal advice. This podcast is considered advertising under applicable state laws.