On 9 September 2013, the PRA published a draft Supervisory Statement for consultation in “Consultation Paper CP6/13 Schemes of arrangement by general insurance firms” (CP). The draft Supervisory Statement explains the stance the PRA will take when reviewing schemes of arrangement promoted by solvent general insurers pursuant to the Companies Act 2006. The PRA intends to adopt the Supervisory Statement contained in the CP when the consultation period closes on 26 October 2013, subject to any responses received.
The draft supervisory statement
The PRA has designed the draft Supervisory Statement to help ensure it meets its statutory objectives, namely: (1) to promote the safety and soundness of all PRA authorised firms; and (2) to contribute to the securing of an appropriate degree of protection for policyholders. Specifically, the PRA seeks to ensure that insurers are able to meet policyholder claims as they fall due; and that firms wishing to exit the market do so in a way that takes proper account of the need to provide an acceptable degree of continuity of cover for the risks they have provided insurance against.
A scheme of arrangement may, with the support of a majority of voting policyholders, allow an insurer to reach a binding compromise with all of its policyholders to: (1) terminate cover; and/or (2) settle claims or potential claims at less than their full value. The PRA is concerned in particular that a termination of cover could be detrimental to the dissenting minority of policyholders.
The PRA accepts that the use of a scheme by an insolvent insurer may be in the interests of policyholders generally, if it maximises the pool of assets available to distribute to creditors, or it allows for a quicker distribution. However, it is concerned that the use of a scheme in other circumstances may be incompatible with the PRA’s statutory objectives. For example, if the firm is meeting its regulatory capital requirements, and it expects to be able to meet policyholder claims as they fall due, a scheme may remove cover from policyholders who wish to retain it. It may also allow shareholders to extract capital from the firm at the same time as policyholders are subject to a binding compromise of all current and future claims.
The CP states that the PRA will expect firms to explain the reasons why a scheme is compatible with the PRA’s statutory objectives, particularly with respect to continuity of cover. The PRA’s starting point will be that schemes for solvent insurers do not have this compatibility unless a firm can persuade it otherwise and/or provides continuity of cover for the dissenting minority.
This consultation is both surprising, and entirely unsurprising.
It is surprising because the FSA generally took a pragmatic approach to solvent schemes of arrangement. Like the PRA, the FSA’s statutory objectives included securing “an appropriate degree of protection” for policyholders. However, the FSA generally took the view that the Companies Act scheme of arrangement process automatically delivered an “appropriate degree of protection” if:
- The classes of scheme creditor were properly constituted (the Court would check);
- Each class of scheme creditor voted in favour of the scheme by the requisite majorities (again, the Court would check); and
- The Court was prepared to exercise its discretion to sanction that scheme, even after hearing policyholder objections (if any).
In those circumstances, there was no need for the FSA to intervene, and it would not do so.
The FSA also generally accepted that, if it did intervene, it would force some firms to bear a disproportionate burden if it required them to carry on their insurance business despite the relatively high cost of doing so, when their run-off was so advanced that there was only the remotest chance that a valid and material claim would be made at some time in the future.
For these and other reasons, the FSA was even prepared – occasionally – to accept a solvent scheme when the effect would be to cancel what would otherwise have been compulsory insurance in circumstances where policyholders might technically commit an offence because the scheme left them uninsured for a period (however slight).
It is entirely unsurprising because the Courts have long accepted, and the FSA occasionally accepted, that solvent schemes of arrangement can be unfair if the effect is to terminate cover at a time when policyholders cannot obtain replacement cover for a sensible cost on equivalent terms, if they can obtain it at all. After all, the argument goes: why should the Courts and the regulator release an insurer from a contract of insurance freely entered into, simply because the insurer’s circumstances have changed, if its policyholders are still relying on its cover?
It is also entirely unsurprising because the PRA hinted, in its “Approach to Insurance Supervision” published on 1 April 2013 that it would focus on continuity of cover when seeking to meet its policyholder protection objective.
But does this mark the end of the solvent scheme as some commentators have suggested?
We think not. Solvent schemes have long faced objections from dissenting minority policyholders and promoters have had to continuously evolve the terms of their schemes to address such concerns and to ensure that they treat all policyholders fairly. Such evolution is already at the point where an “opt-out” scheme that offers replacement cover for dissenting policyholders is the next logical step. Edwards Wildman is currently advising on such a scheme which is expected to launch shortly.
However, we acknowledge that, although a firm with both live and legacy business can more easily promote an opt-out scheme by offering replacement cover by its live business, a pure legacy insurer may struggle and the need to buy replacement cover will be a new cost which may make a scheme commercially unviable.
Finally, it is worth noting that the CP relates only to the PRA’s approach to solvent schemes; we have yet to see what its twin (the FCA) has to say.