With the compromise proposal for an Insurance Recovery and Resolution Directive (IRRD) published by the EU Council in January 2024, EU legislative initiatives to establish a recovery and resolution framework for insurance undertakings are taking shape. The following article has summarised selected aspects concerning Austrian (and potentially other EU) insurers, which - from experience with early stages of the Bank Recovery and Resolution Directive (BRRD) - are of particular interest for group-wide asset liability management and capital planning, collateral management, the product landscape and investor-related considerations.
The draft proposed by the Council is still subject to review and change under the EU legislative procedure.
PONV write down or conversion
Under Recital 51 of the draft IRRD, the EU legislator seems to recognise a BRRD-style write down/conversion of capital instruments at the point of non-viability (PONV) and before any resolution action is taken (usually referred to as PONV write down/conversion in banking practice).
PONV definition: PONV is described as (i) "the point at which the resolution authority … determines that the insurance … undertaking meets the conditions for resolution" (i.e. where the undertaking is found to be failing or likely to fail), or (ii) "the point at which the resolution authority concerned decides that the insurance … undertaking would cease to be viable if those capital instruments were not written down or converted."
BRRD/BaSAG background: Both the circumstances under which resolution authorities may write down/convert capital instruments at PONV and the PONV definition as such corresponds to the BRRD framework (i.e. Art 59 (3)(a) and (b) as well as Art 59 (4) BRRD; §§ 70 (2), 71 (2) Austrian BaSAG).
Different from BRRD II, the IRRD does not provide for a group resolution regime based on internal minimum requirements for own funds eligible liabilities (internal MREL) (where certain non-capital instruments can also be written down/converted at PONV, i.e. outside resolution). In this regard, the IRRD is similar to the original 2014 BRRD.
Potential To Do: PONV write down/conversion as it stands under the draft IRRD is expected to require insurance undertakings as issuers of Tier 1, Tier 2 and/or Tier 3 capital instruments to provide for PONV write down/conversion in the terms and conditions governing the instrument and in any prospectus published or provided in connection with the instruments (i.e. no statutory/risk factor approach, but a contractual approach).
Write down or conversion tool
In Chapter IV (resolution tools) Section 4 of the draft IRRD, write down/conversion is provided as a resolution tool available to the resolution authority, clearly modelled after the BRRD bail-in tool.
As with the BRRD, resolution is intended to kick in when the insurance undertaking is failing or likely to fail (taking into account private sector measures and public interest). The failing or likely to fail criterion is then tied to a breach of the MCR, non-fulfilment of licensing conditions and certain (pre-)-insolvency type situations (Art 19 (3) draft IRRD).
Instruments subject to write down and conversion (Art 34 (4) draft IRRD)
All capital instruments and all liabilities of an insurance undertaking may potentially be written down/converted unless they are exempt. The following observations may be made:
§ Insurance claims: are subject to write down/conversion (Recital 47: "last resort measure"; insurance claims, which are covered by technical reserve assets - this will most likely be relevant for life insurance - are proposed to be exempt (Art 34 (5)(d) last subpara draft IRRD).
§ Exempt liabilities (Art 34 (5) draft IRRD): The list is similar to the list of excluded liabilities under Art 44 (2) BRRD / § 86 (2) Austrian BaSAG and includes, inter alia, secured liabilities, employee salary payments, tax payments and social security contributions. Under the IRRD, the exclusion of liabilities arising from compulsory insurance against civil liability in respect of the use of motor vehicles and liabilities arising under private health insurance contracts is noteworthy.
§ Eligible liabilities: Since there is no MREL-style buffer requirement to build up (and similar to the original 2014 BRRD), the definition of eligible liabilities corresponds to BRRD II "bail-inable liabilities" rather than BRRD II "eligible liabilities". The latter refers to MREL eligibility, which is more restrictive.
§ NCWO: The No-creditor-worse-off-Principle applies. Since the IRRD does not provide for MREL or a similar buffer requirement (which fosters subordination and issuance to non-retail creditors), this could be more relevant than in a BRRD context.
Sequence of write down and conversion (Art 37 draft IRRD)
§ Tier 1 items
§ Tier 2 instruments
§ Tier 3 instruments
§ Other eligible liabilities, in accordance with the hierarchy of claims in normal insolvency proceedings, including the ranking of insurance claims provided for in Article 275 (1) of Directive 2009/138/EC. Insurance claims towards Austrian insurance undertakings currently have a higher ranking than other insolvency claims and claims for insurance benefits to be paid have a higher ranking than other claims under insurance contracts.
Potential To Do: Calculate the volume of bail-inable liabilities (taking into account NCWO impediments to bail-in), calculate the recapitalisation capacity of non-senior liabilities to determine the point at which senior creditors (including policyholders/insured persons) could be affected, identify relevant secured assets, set-up management and calculation tools for monitoring and reporting the loss-bearing capacity of capital exceeding SCR/MCR (and the corresponding recovery capacity, see also Recital 18 of the draft IRRD).
Resolution in a group context
IRRD group resolution planning is reminiscent of the original 2014 BRRD (i.e. before the more precise determination of resolution groups, resolutions entities and internal MREL available for the "up-stream" of losses between those entities).
Therefore, the details of group resolution do not seem to be easily predictable at this point in time (Recital 25 draft IRRD: "Resolution authorities should assess the resolvability of insurance … undertakings at the level of those undertakings where it is expected that, in accordance with the group resolution plan, resolution actions would be taken").
Potential To Do: As banks have done under the BRRD, insurance undertakings may wish to contribute to resolution planning (done by authorities) by being prepared, i.e. by identifying whether certain subgroups or subsidiaries could be separately resolved (somehow reflecting an MPE approach), or whether resolution capacity would primarily be dependent on the parent (e.g. since relevant volumes of liabilities to be written down are only available at that level and critical functions are highly centralised).
For more information on the IRRD proposal, related EU legislative initiatives and how these could affect your EU-based business, contact your CMS client partner or CMS experts: Walter Gapp