In May 2021, the UK government issued a Consultation which presented its proposals for targeted (but significant) changes to certain aspects of the existing UK insolvency arrangements for insurers. The British government has now responded comments on the consultation received from market participants. In its response, the government clarified the scope of the amendments it is proposing and indicated that it intends to legislate when parliamentary time permits.
Overview of Proposed Changes
The UK government has proposed (among other things):
- significant improvements to the Court’s existing powers under section 377 of the Financial Services and Markets Act 2000 (“FSMA”) to depreciate the value of the contracts of an insurer; and
- the establishment of a moratorium on the exercise of contractual rights to terminate certain service contracts and financial contracts that would apply in the context of the enhanced amortization procedure or the administration of an insurer,
The government has also said it is actively working with the Bank of England to develop a separate proposal for the introduction of a specific resolution regime for insurers, which would complement (and not replace) the proposals2.
The depreciation procedure
The current version of Section 377 FSMA allows the court to reduce the value an insolvent insurer owes under its contracts instead of making a winding up order against the insurer. However, this existing power is defined only in general terms, so that there is uncertainty regarding certain aspects of its operation (such as: which parties can seek impairment from the court; and which debts can be canceled by the court). court ). In the proposals, therefore, the government seeks to clarify and strengthen the Court’s current power to depreciate.
Depreciation power has a number of important aspects:
- Treatment of secured creditors: During the initial consultation in May 2021, the government proposed that secured creditors would not fall within the scope of the impairment power. However, he has now clarified that this will only be the case where a secured creditor holds a fixed charge. charge, as created, was a floating charge, it will remain in scope.
- Treatment of unsecured creditors: a wide range of unsecured creditors could be subject to impairment. However, a number of key exceptions are offered, including: liabilities with an original maturity of less than seven days; certain employee responsibilities; liabilities arising from financial contracts (see below); liabilities arising from trade and commercial creditors for essential services; and payments due to vendors for goods and services to be provided as a result of placing the depreciation order.
- Financial contracts and obligations: the government has now clarified that the financial contracts excluded from the scope of the write-down power will be those in Schedule ZA2 of the Insolvency Act 1986, excluding agreements involving the issue of investments on capital markets (paragraph 6 of the appendix). The government says this definition will capture financial contracts an insurer may hold (including swaps, derivatives, repos and securities lending), but not debt issued by the insurer. This exclusion has been adapted to alleviate potential concerns that pricing or the terms under which insurers can enter into financial contracts could change if all financial contracts were covered by the write-down power. However, the government also seeks to balance this with the fair treatment of creditors by allowing bonds issued by the insurer to be written down. The government says it has recognized the importance of the cost of issuing debt. However, its view is that, from the lender’s perspective, the incremental risk of default resulting from the Proposals is nil. The Government considers that it is unlikely that the losses suffered by lenders as a result of the exercise of the power to write down would exceed the losses they would suffer if the insurer entered into alternative insolvency proceedings (given that a -down will only be sanctioned if it is deemed preferable to creditors (as a whole) than the alternative and can only be ordered if the insurer is (or is likely to become) insolvent.
- Moratorium on legal proceedings and the application of security measures3: the government has now confirmed that this moratorium will not only protect an insurer from legal action, but will also suspend the right of a secured creditor to exercise a security right. It is proposed that the moratorium will apply provisionally and then permanently following a request before the Court/Tribunal sanctioning an impairment, with an automatic termination point six months after the entry into force of the impairment . This six-month period may be extended by the court and, conversely, creditors may be able to apply to the court for its early termination.
- Writing and interest: impaired liabilities would be deferred (off-balance sheet) and not extinguished and could be reactivated (for example: reassessed if the insurer’s financial situation later proves to be better than expected at the time of the initial impairment; the insurer enters into recovery or liquidation; or the availability of a surplus after the completion of a solvent run-off). In the event that an impaired liability is subsequently ‘revalued’, statutory interest will be payable on both any impaired portion of a liability that would have been due and payable (rather than merely conditional) prior to the writing; and any unpaid debt (whether written or not) which would have become due but for the effect of the proposed moratorium on legal proceedings, and in respect of which the creditor has been prevented from taking enforcement action.
The moratorium on the exercise of contractual termination rights
The government’s position is that the termination of an insurer’s financial contracts (see below) and service contracts could have a significant impact on an insurer’s financial condition and operational continuity and could slow down or destabilize the process. recovery/insolvency.
The Proposals therefore contain an automatic statutory moratorium on certain termination/suspension rights (including the exercise of those rights and the ability to bring legal action to enforce those rights) for financial and services contracts where the rights of termination/suspension result solely from the insurer’s commencement of insolvency proceedings or write-down under Article 377 FSMA (including petitions or demands in court to that effect)4.
It is also proposed that the statutory moratorium will also affect termination/suspension rights if it is triggered by any of the following events and the counterparty has not exercised the resulting termination/suspension right before the moratorium does not subsequently take effect:
- the insurer experiencing financial stress/difficulty (regardless of the definition of the contract); or
- the insurer fails to make a payment, or fails to make a payment on time (in this case, the application of the moratorium would be conditional on the fulfillment of all payment conditions during the application of the moratorium, but would not require payment of previous arrears).
Termination/suspension rights resulting from events unrelated to the financial condition of the insurer or resulting from default in payment (and compliance with any other contractual obligation) on an ongoing basis should not be affected by the moratorium.
The moratorium would be subject to a “financial hardship” exemption (granted by the Court).
The government has taken into account the concerns expressed by market participants about the potential impact on clearing notices, and therefore on the cost and availability for insurers in general to enter into derivatives (whether or not they use the depreciation procedure). It said it would introduce a targeted exemption for netting and netting agreements (and associated security and title transfer agreements). The proposed exemption will use the concept of “protected devices” provided for in Article 48P of the Banking Act 20095. However, it should be noted that the Government proposes to take a delegation of power to modify the scope of this moratorium.
If enacted in the form of the proposals, this legislation will represent a significant development for some of an insurer’s contractual counterparties.
1 Except for one specific aspect (not covered in this bulletin), the proposals apply to all insurers authorized under Part 4A to underwrite or perform insurance contracts as principal. However, the Proposals do not apply to the business of Lloyd’s of London, which is subject to specific restructuring and liquidation procedures. The government has indicated that the proposals, in particular the changes to section 377 of the FSMA, are most likely to be used in relation to retail life insurers.
2 Existing insolvency agreements for insurers include a modified version of the standard corporate insolvency procedures, with certain additional provisions, the main options in the event of financial difficulty/failure of the insurer being liquidation or transfer of business of insurance, a plan of arrangement or the administration or liquidation of the insurer.
3 This is separate from the moratorium on the exercise of contractual termination rights, as discussed below. The proposals suggest that it will bear similarities to the administrative moratorium set out in paragraphs 40 to 44, Schedule B1, Insolvency Act 1986.
4 The moratorium would include: a “provisional moratorium” (which could come into effect when an application for administration or expungement is presented to the Court or a motion for liquidation is presented and would remain in place until the application /motion be heard or withdrawn); and a “permanent moratorium” would apply upon administration or write-down, lasting initially 6 months subject to extensions. The “permanent” moratorium would not apply during a liquidation.