Insolvency

Tom Crossland

The road to ruin

Definitions

• Financial Services & Markets Act - IPRU(INS)

• Companies Act

• Insolvency Act

– Balance sheet

– Cash flow

Definitions

A company is deemed unable to pay its debts if:

it is proved to the satisfaction of the court that

it is unable to pay its debts as they fall due [or]

the value of the company’s assets is less than the

amount of its liabilities taking into account its

contingent and prospective liabilities.

[Section 123 Insolvency Act 1986]

Cash flow

• Consistently profitable non-life insurer

• Highly experienced management team

• Quoted company, doubled in size in five years

• Charismatic Chief Executive

• Analysts recommend a ‘buy’

Causes of failure

• Underwriting risk:

– premiums

– catastrophe

– growing too fast

– run-off

• Asset risks:

– overvalued;

– reinsurance failure

• Fraud

Warning signs

Warning signs

• Quality/attitude of management

• Rapid growth

• Significant change in business

• Unidentifiable competitive advantage

• Low ratings

• Underlying data and not views of management

• Key long term trends

• Comparison with similar companies

• Generally the market does not “lie”

Warning signs

Administration

The new route

The current route

• Provisional liquidation - why?

• Scheme of arrangement

– Companies Act procedure

– binds all policyholders and cedants if approved• by each class• 50% by number• 75% by value• court sanction required

The current route

• Two types of scheme:

– Run off: a payment percentage is set and claims paid as agreed

– Cut-off: all claims (agreed and IBNR) valued and residual funds distributed

The current route

• Important issues:

– Attitude of reinsurers

– Up front costs vs saving of run-off costs

– IT systems/records

– Legal disputes

– Trust funds

– Letters of credit and security

– Set off

– Staff

AdministrationAdministration

• Introduced for companies other than banks and insurance companies in 1985

• Rescue culture - carry on the business

• Possible outcomes:

– Company can survive

– Liquidation

– Scheme of arrangement

AdministrationAdministration

• No requirement to pay funds into the ISA

• Antecedant transactions can be challenged

• Survival of the company

• Perception

• Payment of creditors

AdministrationAdministration

• No need for a run-off scheme

• No enforcement of security (collateral for letters of credit)

• Set off from date of administration

AdministrationAdministration

• Watch out for:

– Enterprise Bill

– European Directives

The end of the road

Distributions

• Basic rule is equal distribution

• But compensation for personal policyholders

• Preference for employees

• Ring-fencing of long-term funds

• Schemes can apply to any part of a business with sufficient connection to the UK to be wound up

Distributions

• Insurers Winding up Rules 2001

– No initial actuarial valuation required

– More explicit recognition of IBNR, but non-life rules largely unchanged

– Basis of valuation changed from a modified net premium basis to a gross premium basis

– Unitised with profits valuation rules

– Policyholders’ reasonable expectations and interaction with compensation scheme rules

EU Directive

• Home state rule

• Information in home language

• Who gets priority?

• How is priority given?

Who gets priority now?

Insolvent insurer

InsurersPolicyholders

Employees

Compensation

Who will get priority?

Insolvent insurer

Insurers

Policyholders

Employees

Compensation

How will priority be given?

• Two possible methods

– administrative costs and consultation

• Ring fencing

– long term business

– composites

– with profits funds

Practical effects

• Credit ratings

• Restructuring

• Transitional issues

• Lloyd’s

• UK branches of EU companies

Drive carefully