Chapter 35 - Insolvency & Closure Flashcards
Insurance Company Insolvency
Due to strict solvency and reporting requirements, insurers rarely become insolvent
If the required level of solvency capital is breached, the regulator intervenes to protect the interests of existing or prospective policyholders. If the insurers financial position is in a serious state then the regulator may require the insurer to close to new business, so that new policyholders are not entering a fund whose solvency may be in doubt. This is a last resort however.
A recovery plan will be established, and this will be monitored closely by the regulator
Projecting Solvency of an Insurance Company
In any of these recovery scenarios it will be important to project the insurer’s solvency position into the future on a range of deterministic scenarios, or with the aid of a stochastic model.
It will be important to estimate the actions that might be taken in various scenarios, and to include these in the model. The issues that need to be addressed and modelled include:
- estimation of future post-tax profits available to equity shareholders
- the current value of all surplus assets
the amount, and timing, of any loan or debt redemption - problems relating to industrial relations (and redundancies) This means the insurer’s relationship with its employees and any trade union that represents them
- issues relating to any staff benefit schemes – particularly if these schemes are in deficit
- outstanding financial obligations, minority interests
and tax
If there is an acquiring company prepared to take over the business, it will be necessary to consider:
- location of the operation any integration of the
- systems platform
- relocation of staff or whether there is an adequate labour force available
- effect on unit costs
Compensation Schemes
Where an insurer cannot meet its liabilities (as opposed to not having adequate solvency capital), and a buyer cannot be found to take them on, there may be a statutory scheme set up from which some or all of the benefit payments are paid.
Such a scheme is usually funded by a levy on all other providers. The FSA ( Financial services authority ) governs this in South Africa
Closure of a Sponsored Benefit Scheme
There are two types of closure of a benefit scheme: ·
- the scheme is closed to new members but existing members’ benefits continue to accrue
- the scheme is closed to new members and no further benefits accrue to existing members
The type of closure will depend on the circumstances:
- whether the employer / sponsor is insolvent or needs to reduce costs
- whether the employer wishes to follow market trends in benefit provision, or any other reason
For a defined benefit scheme, the scheme rules will need to set out the benefits that will be provided on discontinuance.
Closure types in more details
Closed to new members only
- In defined benefit schemes, benefits continue to accrue with additional service and salary increases
- There are no human resource issues as a scheme is not offered on joining employment and the new employee accepts the salary and benefits package offered
- The sponsor expects to continue to pay contributions for the declining number of active members. The contribution rate as a percentage of salary is likely to both increase and also become more volatile as the membership reduces
Closed to new members and no accrual of any future benefits
- Existing members are given reduced benefits on the date of closure
- There are human resource issues, as previously promised benefits are reduced.
- If the scheme is sufficiently funded at the point of closure, it would not be necessary to reduce existing benefits. However, poor funding levels may well have been the reason for closure.
- The sponsor expects to pay a one-off settlement (perhaps over a period if the scheme is in deficit), but essentially to make no further contributions.
Level of benefits paid in the event of a closure
The benefits that will be paid to the members of the discontinued scheme will be affected by the following factors:
- the rights of the beneficiaries, which will depend on the terms under which the scheme operates and any overriding legislation
- the expectations of the beneficiaries, which are likely to be the benefits that would have been available had the scheme not discontinued
If there are insufficient assets to meet the rights and expectations of beneficiaries, a lower benefit may be paid
Provision of Benefits on Discontinuance
The following options may exist for the provision of the outstanding benefit payments:
- gradual removal of the liabilities by continuation of the scheme without any further accrual of benefits
- transfer of the liabilities to another scheme with the same sponsor
- transfer of the funds to the beneficiary to extinguish the liability
Legislation may not allow an individual to receive the capital value of their benefits. However, an alternative may exist that allows the individual to place the funds with an appropriate insurance company or in the scheme of any new employer.
- transfer of the funds to an insurance company to invest and provide a group policy or an individual policy in the beneficiary’s name
- transfer of the liabilities to an insurance company to guarantee the benefits
- transfer of the liabilities to a central discontinuance fund, operated on a national or perhaps industry-wide basis.
Insolvency of a Bank
Banks are also normally subject to some form of State regulation and they are usually required to maintain a certain level of solvency capital
Banks are also often required to have plans in place with regards to what will happen if they get into difficulties. For example, banks in the European Union have recovery and resolution plans, hopefully enabling them to recover but, if not, enabling them to fail in an orderly manner to limit or avoid a knock-on effect on other banks (i.e. systemic risk)
Under resolution, the regulatory authorities ensure continuity of the bank’s critical functions and seek to recover parts of the bank that are viable. Parts of the bank that are not viable are allowed to go into liquidation.
