SS3/14 - Schemes of arrangement by insurance firms
On 25 April 2014, the Prudential Regulation Authority (PRA) published a supervisory statement discussing its approach to schemes of arrangements. While there are no major changes discussed in the statement, it is an opportunity for the PRA to outline its expectations.
The full paper can be found on the Bank of England's website.
The statement covers the following:
- feedback on the responses to the consultation
- the PRA’s view of schemes of arrangement
- the PRA’s role in assessing schemes
Supplementary information on the interaction with the Financial Conduct Authority (FCA) and the complementary supervisory statement on capital extractions.
A scheme of arrangement (scheme) is defined by the PRA as 'a compromise or arrangement which may allow companies to reach a binding compromise with their creditors to discharge all remaining assets and liabilities.' The potential use of schemes by insurance companies is a concern to the PRA. This is due to the PRA’s statutory objectives and interest in protecting policyholders.
The PRA acknowledges that depending on the circumstances, the use of schemes by insurers may or may not be compatible with its statutory objectives. For example, the use of a scheme by an insolvent insurer may be in the interest of the policyholders to ensure maximisation of the pool of assets available to distribute. However, if a firm were to exit from a particular portfolio of business by using a scheme, e.g. for commercial reasons, this may not be compatible with the statutory objectives.
Under the Companies Act 2006, the PRA does not approve schemes (schemes of arrangement are court sanctioned). All schemes proposed by insurers will be reviewed by the PRA to ensure its statutory objectives are met. Following the assessment, the PRA will consider whether it wishes to inform the court of its view of a scheme.
Insurance companies who are proposing the use of a scheme should inform the PRA in advance. This must be in such a way which allows sufficient time for the PRA to assess the proposals. There are certain factors that the PRA expects to be explained by the insurer:
- the nature of the business
- the nature of the underlying policyholders
- how the use of the scheme is compatible with the PRA’s statutory objectives
- what steps have been taken to ensure that policyholders have an appropriate degree of continuity of cover for the risks against which they are insured
One of the FCA’s objectives involves consumer protection. As such, it will be interested in schemes of arrangement and firms should also discuss any proposals with it. The PRA expects to discuss any proposed scheme with the FCA directly.
SS4/14 - Capital extractions by run-off firms within the general insurance sector
On 25 April, the PRA also published a supervisory statement discussing capital extractions by run-off firms, which is inevitably linked as run-off firms are a key user of schemes.
- PRA expectations of run-off firms proposing capital extractions
- PRA review process
The full paper can be found on the Bank of England website.
General insurance companies in run-off may request to extract capital from the firm during the course of running off their liabilities. The PRA has outlined a set of guidelines for this process to ultimately ensure that the insurance policyholders are protected.
Statement SS4/14 highlights factors that the PRA expects the senior management of a general insurance run-off firm to take into account when considering making a request to the PRA to extract capital. The senior management is also responsible for ensuring that the firm maintains adequate financial resources at all times.
The PRA acknowledges that the request for capital may have legitimate reasoning; however capital extractions inevitably weaken the level of protection available for remaining policyholders. This concern is intensified for run-off firms due to their limited access to further capital and having less management actions available to restore capital levels, if the need were to arise.
The Board and senior management of run-off firms are expected to assess the level of capital required on an ongoing basis. The firm must be capable of running-off their business under adverse conditions and be satisfied that solvency levels after the proposed capital extraction will remain adequate.
The PRA has outlined the following steps that run-off firms should exercise if they wish to undertake a capital extraction:
- a thorough review of the capital position in order to assess the adequacy of the solvency position after the proposed extraction, including a review of the Minimum Capital Requirement (MCR)
- a consideration of the expected future progress of the run-off of the business, including as a minimum over the next 3-5 years
- approval from the Board regarding the capital extraction
The PRA has summarised its expectations for the review process:
- any concerns regarding the proposed capital extraction must be properly addressed before the proposal is implemented
- each firm should provide a copy of its latest Individual Capital Assessment (ICA) review and a copy of the analysis showing the projected evolution of the MCR and ICA
- the PRA may ask the firm to commission an independent review to provide assurance on the data or analysis surrounding the request
- once the PRA has reviewed the information, they may issue the firm with Individual Capital Guidance (ICG) specifying the details of the capital that they deem to be appropriate
- the PRA expects firms to hold capital above the level of ICA/ICG at all times