Insolvency and closure

An insurance company is insolvent if it is unable to meet its liabilities as they fall due, or does not have assets in excess of the (statutory) value of the liabilities (plus any Statutory Minimum Solvency Margin).
Regular statutory reporting allows the regulator to monitor the financial position of individual companies and, if necessary, to intervene in the running of a company before insolvency occurs.
If the SMSM is breached, the company will be required to produce a recovery plan, which will then be monitored by the regulator.
A recovery plan: cutting down unnecessary expenditure. Make some structural changes to the company to improve solvency position.

• The regulator will have regular reporting requirements to track the capital position of company.
• The regulator may increase the frequency of monitoring of the capital position
• The regulator may become more closely involved in the management of the company
  • adopting a more matched investment strategy.
  • requiring additional reinsurance cover to be purchased.
  • limiting the amount of new business sold
  • restrict the asset classes the company can invest in, insist on a certain ALM approach. The company itself could take this action voluntarily to improve capital coverage
  • managing the expense position or claims philosophy. Again, the company itself could take this action voluntarily to improve capital coverage
  • The severity of any actions taken by the regulator will depend on the degree to which the company is below required capital threshold

However, in extreme cases, the regulator may close the company to new business to protect the interests of existing and prospective policyholders.

• Preventing the company from writing new business should result in a significant cost saving in the short term (e.g. costs associated with sales and marketing).
• In addition, there will be a release of capital previously tied up to finance new business.
• Thus, even in extreme cases, the company should be able to meet any immediate outstanding liabilities.

However, in the longer term,

• dis-economies of scale (i.e. spreading the fixed costs over fewer in-force policies) can lead to further problems.
• Thus, it may be that the regulator will require that the insurer is sold or merged with another provider who takes on responsibility for the liabilities.

However, in practice, this may prove difficult. if company is making losses (or has a book of poor-quality business), it may be difficult to find a buyer.
Where the company cannot meet the outstanding liabilities and a buyer cannot be found, there may be a statutory fund (statutory bailout fund) from which some of the outstanding liabilities can be met.
Such a scheme is usually funded by a regular levy on all authorised providers in the market.
What are the main advantages of such a scheme?

• it provides security for policyholders in the event of an insurance company becoming insolvent, ensuring that the policyholders receive most (if not all) of the promised benefits
• this, in turn, is likely to increase consumer confidence in the insurance market, which might lead to higher business volumes (and, hence, profits)

What are the main disadvantages of such a scheme?

• Moral hazard – i.e. may encourage insurers to take on more risks (as they can benefit if things go well and statutory fund will bail them out if things go wrong).
• System failure can hardly be recovered using it. If a number of companies fail at the same time, which is totally possible due to some global financial crisis, then fund may be unable to cover all losses.
• the annual levy is likely to lead to higher insurance premiums (or lower profits for insurance companies)

An occupational pension scheme may be closed as a result of

• insolvency of the sponsoring employer
• or, simply, because the sponsoring employer elects to stop financing the benefit provision.

In this case, consideration needs to be given to the benefits payable to the members of the scheme at the closure date.
It is important to distinguish between:

• the rights of the beneficiaries under the terms and conditions of the scheme (and any over-riding legislation), and
• the expectations of the beneficiaries, which are likely to be based on the benefits that would have been paid on retirement had the scheme not been discontinued

In practice, legislation is likely to be in place to define the benefit rights of the different classes of members, in particular:

• active members will usually be entitled only to the benefits that would have been received if the member had left the scheme voluntarily on the discontinuance date
  • i.e. a deferred pension payable from NRA based on current salary and past pensionable service only. The link to the final salary is broken.
  • this will usually be revalued in the period prior to retirement (to reduce erosion as a result of inflation)
• current pensioners, however, would usually be entitled to a full continuation of any pensions in payment (including any guaranteed pension increases and spouses’ pensions)

Defining the benefit expectations of members is more difficult and will usually be a matter of judgement.
What factors are likely to influence members’ benefit expectations?

• benefits outlined in trust deed and rules of scheme,
• any discretionary benefits currently (or previously) paid to other members
• benefits provided in other schemes
• Priority of members – payments of existing pensioners may be honouredx
• Whether the scheme is solvent
• Whether there is a debt on the employer and whether the employer can meet it if so
• Potential for recourse to a nationwide protection fund

For example, active members may have an expectation for:

• accrued benefits to date to be based on final salary (rather than current salary), and
• accrual of future service benefits in period prior to retirement

In some cases, they may even have an expectation for enhanced early and/or ill-health retirement benefits.
Current pensioners may have an expectation for any discretionary increases to pensions in payment to continue in future.
In practice, in the event of a scheme discontinuance, it is highly unlikely that the assets of the scheme will be sufficient to meet the expectations of the beneficiaries.
because, in practice, scheme is likely to be wound up only if it does not have sufficient assets to meet the current accrued liabilities.
What circumstances are likely to lead to a scheme discontinuance? employer has decided that cost of providing the promised benefits has become unsustainable. bankruptcy of employer. takeover/merger.
Indeed, it will often be the case that there are insufficient assets even to meet the minimum benefits promised as of right.
In this case, the scheme trustees will have to ensure that the available funds are shared between the different groups of beneficiaries as fairly as possible.
In practice, scheme rules and over-riding legislation will also have to be considered here.
Suppose that, on discontinuance, the assets of the scheme are equal to 80% of the total minimum benefits promised as of right to the all of the scheme’s beneficiaries.
Why is it usually considered unfair to simply give each member benefits equal to 80% of those promised?

• Because current pensioners have no opportunity to make good the shortfall in the benefits provided. Current active members could save more towards retirement and/or retire later to increase their pension in retirement.

In the event of discontinuance, legislation may require that any pension scheme debt is placed on the insolvent employer
This debt may rank above, alongside or even below other debtors (so, in practice, any recovery will be far from guaranteed).
In addition, any expenses associated with the discontinuance of the scheme (e.g. legal, administration and actuarial costs, costs of realising investments) will usually have first call on the assets.