Insolvency Tom Crossland

The road to ruin

Definitions Financial Services & Markets Act - IPRU(INS) Companies Act Insolvency Act –Balance sheet –Cash flow

Definitions A company is deemed unable to pay its debts if: it is proved to the satisfaction of the court that it is unable to pay its debts as they fall due [or] the value of the company’s assets is less than the amount of its liabilities taking into account its contingent and prospective liabilities. [Section 123 Insolvency Act 1986]

Cash flow Consistently profitable non-life insurer Highly experienced management team Quoted company, doubled in size in five years Charismatic Chief Executive Analysts recommend a ‘buy’

Causes of failure Underwriting risk: –premiums –catastrophe –growing too fast –run-off Asset risks: –overvalued; –reinsurance failure Fraud

Warning signs

Quality/attitude of management Rapid growth Significant change in business Unidentifiable competitive advantage Low ratings

Underlying data and not views of management Key long term trends Comparison with similar companies Generally the market does not “lie” Warning signs

Administration The new route

The current route Provisional liquidation - why? Scheme of arrangement –Companies Act procedure –binds all policyholders and cedants if approved by each class 50% by number 75% by value court sanction required

The current route Two types of scheme: –Run off: a payment percentage is set and claims paid as agreed –Cut-off: all claims (agreed and IBNR) valued and residual funds distributed

The current route Important issues: –Attitude of reinsurers –Up front costs vs saving of run-off costs –IT systems/records –Legal disputes –Trust funds –Letters of credit and security –Set off –Staff

Administration Introduced for companies other than banks and insurance companies in 1985 Rescue culture - carry on the business Possible outcomes: –Company can survive –Liquidation –Scheme of arrangement

Administration No requirement to pay funds into the ISA Antecedant transactions can be challenged Survival of the company Perception Payment of creditors

Administration No need for a run-off scheme No enforcement of security (collateral for letters of credit) Set off from date of administration

Administration Watch out for: –Enterprise Bill –European Directives

The end of the road

Distributions Basic rule is equal distribution But compensation for personal policyholders Preference for employees Ring-fencing of long-term funds Schemes can apply to any part of a business with sufficient connection to the UK to be wound up

Distributions Insurers Winding up Rules 2001 –No initial actuarial valuation required –More explicit recognition of IBNR, but non-life rules largely unchanged –Basis of valuation changed from a modified net premium basis to a gross premium basis –Unitised with profits valuation rules –Policyholders’ reasonable expectations and interaction with compensation scheme rules

EU Directive Home state rule Information in home language Who gets priority? How is priority given?

Who gets priority now? Insolvent insurer InsurersPolicyholders Employees Compensation

Who will get priority? Insolvent insurer Insurers Policyholders Employees Compensation

How will priority be given? Two possible methods –administrative costs and consultation Ring fencing –long term business –composites –with profits funds

Practical effects Credit ratings Restructuring Transitional issues Lloyd’s UK branches of EU companies

Drive carefully