C34 : Insolvency and closure Flashcards
(16 cards)
Explain why insurance companies rarely become insolvent
An insurance company is insolvent if
1. it is unable to meet its liabilities as they fall due
2. it does not have assets in excess of the value of the liabilities.
Insurance companies rarely go insolvent:
1. Required by regulators to hold a certain level of solvency capital as additional protections against solvency
2. Regular reporting requirements and checks on solvency position
3. Regulator monitors the financial position of
companies.
4. Insolvency may also be avoided through mergers or acquisitions
What actions might the regulator take If the required level of solvency capital is breached?
Regulator intervenes in the running of a company before it reaches the position of being unable to meet its liabilities e.g. regulator may require insurer to close to NB and/or make a recovery plan (e.g. change assets held or use reinsurance)
The recovery plan may include some or all of the following actions:
1. Changing the investment strategy to invest in less volatile asset classes
2. Increasing the amount of reinsurance the company has in place
3. Limiting the levels of new business sold.
Discuss potential implications of closing to new business
- unlikely that the insurance company will be able to re-open to NB
- regulator is unlikely to permit re-opening to new business until the company has substantially more than the minimum capital requirements built up.
- If a company maintains the infrastructure (staff, premises, systems) to enable it to re-open, these costs will be a further drain on capital while no business is being written.
- cost savings coupled with the release of capital
previously tied up in financing the new business strain of the business on the books, should enable the company to meet these liabilities in the short term - In the longer term, diseconomies of scale will bite and further actions will be needed
Describe long term issues for a mutual life insurance company that only sells with-profit, if regulator closes it to new business
In the longer term, the issues for the company will include:
1. Costs of closing down – eg moving to smaller premises, redundancies as fewer staff are required to administer the business
2. Restrictions on the investment policy – as the proportion of benefits that are guaranteed increases over time
3. Changes to the bonus philosophy – as the proportion of guaranteed benefits and investment policy change
4. Policyholders’ reasonable expectations – eg if the investment policy or bonus philosophy change radically from what they were at the time at which a policyholder took out the contract. Communication with policyholders will be important.
For an insurer facing insolvency, what is it necessary to model?
- insurer’s solvency position into the future on a range of deterministic scenarios, or with the aid of a stochastic model
- Estimate the actions that might be taken in various scenarios and include these in model
The issues that need to be addressed and modelled include:
1. Estimation of future post-tax profits available to equity shareholders
2. Current value of all surplus assets
3. Amount, and timing, of any loan or debt redemption
4. Problems relating to industrial relations (and redundancies). This means the insurer’s relationship with its employees and any trade union that represents them.
5.Issues relating to any staff benefit schemes – particularly if these schemes are in deficit
6. Outstanding financial obligations, minority interests and tax.
List four considerations for acquiring company prepared to take over the business,
- Location of the operation
- Integration of the computer systems
- Relocation of staff or whether there is an adequate labour force available
- The effect on unit costs.
Where an insurer cannot meet its liabilities and a buyer cannot be found, how might benefits be provided to beneficiaries?
-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.
Discuss the 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.
What does the type of closure of benefit scheme depends on?
The type of closure will depend on the circumstances of employer/sponsor
1. Employer / sponsor is insolvent
2. Needs to reduce costs,
3. 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.
What events might lead to the discontinuance of a benefit scheme?
- Insolvency of the sponsor
- Decision to stop financing the benefit provision.
What are the main factors affecting the level of benefits that will be paid to the members of the discontinued scheme?
The benefits that will be paid to the members of the discontinued scheme will be affected by the following factors:
1. Rights of the beneficiaries, which will depend on the terms under which the scheme operates and any overriding legislation
2. Expectations of the beneficiaries, which are likely to be the benefits that would have been available had the scheme not discontinued.
3. Funding level : If there are insufficient assets to meet the rights and expectations of beneficiaries, a lower benefit may be paid.
Discuss the factors to be considered if the scheme has insufficient assets to meet the benefits on discontinuance of the scheme
- Legislation may require debt to be placed on sponsor
- Sponsor might have to put in extra funds
- Might have insurance to ensure sufficiency of assets on insolvency of the sponsor
- Members benefits might have to be reduced. If members’ benefits are to be reduced, legislation may dictate the priority ordering of reduction in benefits
- State-sponsored fund to support benefits where the employer is insolvent. Such a fund may be paid for by a levy on solvent schemes.
- expenses involved in determining the benefit allocations, informing the beneficiaries and securing the appropriate form of provision will further reduce the assets.
Discuss the factors to be considered if the scheme has surplus assets to meet the benefits on discontinuance of the scheme
- Might be used to increase benefits
- Allocation of surplus will also depend on who the surplus is thought to belong to
- Allocation of surplus to beneficiaries might be done based on length of membership or based on extent to which members are thought to have contributed to the surplus
- Might be passed to sponsor
- Tax considerations if surplus is passed to sponsor
Consideration will need to be given to legislation and scheme rules
List the options that exist for the provision of the outstanding benefit payments on discontinuance of a scheme
The following options may exist for the provision
of the outstanding benefit payments:
1. Gradual removal of the liabilities by continuation of the scheme without any further accrual of benefits
2. Transfer of the liabilities to another scheme with the same sponsor
3. Transfer of the funds to the beneficiary to extinguish the liability. Regulation may require funds to be placed with an insurance company or in the scheme of any new employer
4. Transfer of the funds to an insurance company to invest and provide a group policy or an individual policy in the beneficiary’s name
5. Transfer of the liabilities to an insurance company to guarantee the benefits
6. Transfer of the liabilities to a central discontinuance fund, operated on a national or perhaps industry-wide basis. May be funded by a levy
Outline the risk to the if benefits remain in the scheme and the employer remains solvent
The employer may need to finance any initial deficit and any future deficits that may arise.
List the Factors to consider when comparing options when discontinuing
- Does the method give members a choice?
- Who takes the future risks of experience not being as expected?
- Do investments need to be realised, generating associated costs?
- What security and/or guarantees does the method offer?
- What expenses will be incurred?
- Will any scheme surplus or deficit be crystallised?
