The financial crisis demonstrated the need for adequate recovery and resolution measures to ensure that financial institutions can continue to operate on a near business as usual basis in times of crisis. This was addressed at the global level by the G20 and the Financial Stability Board whose agenda was to stabilise the financial system and the broader economy. At the EU level, the adoption of the BRRD aimed to establish a harmonised framework for the recovery and resolution of troubled credit institutions and investment firms.
In recent years, the focus has widened to consider harmonisation of other financial institutions. Two years after issuing an opinion calling for a harmonised recovery and resolution framework for (re)insurers across the European Union (EU), EIOPA published a consultation paper on 15 October 2019 on changes to Solvency II, which reiterates the necessity of harmonisation. EIOPA is of the view that the current fragmentation of insurance resolution and insolvency legislation across the EU presents significant risks for policyholders and market stability as a whole. EIOPA’s work builds on two reports published by the European Systemic Risk Board in which it argued that harmonised recovery and resolution frameworks are also essential in insurance given the importance of the industry.
EIOPA proposes that in order to protect policyholders and maintain financial stability in the EU, there should be minimum harmonised rules for recovery and resolution of re(insurers), with “recovery” meaning deteriorating circumstances but remaining a ‘going concern’ and “resolution” meaning a ’gone concern’. The proposed regime includes the following key aspects:
- A requirement for each (re)insurer to develop and maintain pre-emptive recovery planning describing, in a proportionate way to its business, the possible measures it would adopt to recover financially following a significant deterioration. EIOPA is of the view that non-compliance with the Solvency Capital Requirement (SCR) should remain the trigger for entry into recovery, as is the case under Solvency II.
- The grant of a wide range of early intervention powers for national supervisory authorities, to be exercised where solvency is likely to continue to deteriorate and fall below the SCR if no remedial action is taken. These powers may include requirements of additional or more frequent reporting, implementation within a specific timeframe of measures within the pre-emptive recovery plan, or examination of the undertaking’s situation, amongst others.
- The appointment of an officially designated administration resolution authority in each member state.
- A requirement for the development of resolution plans and resolvability assessments detailing the way in which a failing (re)insurer would be resolved and identify any impediments to resolution.
- The grant of a minimum of 13 harmonised resolution powers for resolution authorities, including the right of sale or transfer of business to a third party, the temporary restriction or suspension of policyholders’ rights to surrender their insurance contracts, the right to impose a moratorium suspending payments to unsecured creditors and a stay on creditor actions and the right to appoint an administrator.
- The introduction of judgment-based resolution triggers that should be set to trigger before a (re)insurer becomes insolvent. EIOPA suggests that three triggers for resolutions should include at least: <br/>the undertaking is no longer viable or likely to be no longer viable and has no reasonable prospect of becoming so; <br/>possible recovery measures have been exhausted, either tried and failed or ruled out as implausible to return the undertaking to viability, or cannot be implemented in a timely manner; and<br/>a resolution action is necessary in the public interest.
- The establishment of cross-border cooperation and coordination arrangements between resolution authorities for crisis situations, including the exchange of information between countries.
It is a long-held industry view that imposing a full recovery and resolution regime for (re)insurers would be unnecessary as well as unpopular. Insurance Europe, a trade body consisting of insurance associations representing approximately 95 per cent of European premium income, previously argued that the proposed recovery and resolution regime was unnecessary, viewing the current safeguards under Solvency II as sufficient. Their 2014 study, “Why insurers differ from banks”, highlights why existing frameworks should be considered for (re)insurers instead of mapping rules from the banking sector.
Risk pooling and risk transformation is a fundamentally different business model to the deposit-taking, financing and trading activities of banks. Banking is inherently interlinked. Whilst the role of insurers is critical, the interconnections in the insurance industry are materially different in providing protection against negative events or providing long-term investment. And given the very different liability profile of insurers, deterioration beyond the point of return is therefore much more likely to become apparent over time, giving the insurer the opportunity to take corrective action in line with the current Solvency II regime. What’s more, there is higher substitutability with insurance products than in banking.
EIOPA cited three member states (France, Romania and the Netherlands) that granted resolution powers to national authorities, to demonstrate that parts of the EU are sufficiently concerned about the possibility that an insurer will become insolvent and so resolution powers should be made available just in case they are needed. No doubt such powers could be useful in some scenarios. However, the question is whether it is worth subjecting the entire EU insurance industry to a harmonised recovery and resolution framework.
Finally, from a UK insolvency perspective, it is also unclear from EIOPA’s proposals relating to resolution measures exactly how the appointment of an administrative resolution authority interplays with the role of the existing directors of any (re)insurer. Is the role of the existing directors entirely usurped? Do their duties fall away, in arguably what is the ‘twilight zone’, a period where ordinarily the directors of a UK entity would need to have an increased awareness of their duties to creditors. Equally, the triggers for entry into resolution (as set out above), which include the undertaking “no longer being viable”, seem to almost mirror the test for ‘insolvency’ as a matter of English law. Yet the proposals expressly state that these triggers provide for a “timely and early entry into resolution before an undertaking is balance sheet or cash sheet insolvent”. How is this distinction to be drawn? While there may be significant learning from the equivalent bank regime, directors of (re)insurers will wish to seek clarity on in due course.
EIOPA will provide its final advice in June 2020. It will be interesting to get clarity on if, and how, it might be applied in the UK in light of Brexit.