35 - Insolvency and Closure

Question 1

Under which circumstances is a firm insolvent?

Answer 1

When the firm cannot meet liabilities as they fall due and does not have assets in excess of liabilities.

Question 2

Why is it unlikely for an insurance company to become insolvent?

Answer 2

1. A regulator typically regularly monitors the financial position of insurance companies.
2. Insurance company regulation typically requires companies to hold a minimum level of solvency capital.

Question 3

Give strategies that the regulator may require an insolvent insurer to follow.

Answer 3

1. Close to new business

2. Establish a recovery plan that is closely monitored by the regulator.

Question 4

Give typical recovery plan objectives for an insolvent insurer.

Answer 4

1. Hold fewer volatile assets
2. Changing investment strategy (move to admissible assets)
3. Purchasing reinsurance
4. Limiting new business

Question 5

Describe why closing to new business may not be terribly helpful to an insurance company close to insolvency.

Answer 5

The company may already have low levels of new business due to reputation damage caused by the media or the regulator stepping in.

Question 6

Describe why an insurance company that closes to new business is unlikely to Reopen.

Answer 6

1. Creates dis-economies of scale
2. Maintaining staff and property to reopen puts strain on the financial situation since no new business is being sold.
3. Moving business location and other changes to the structure of business all have cost strains.
4. The capital required by regulators for an insolvent firm to reopen to business will be higher than usual and so it is unlikely that this can be built up without any new business.

Question 7

Describe circumstances that might allow an insolvent insurance company that has closed to new business to reopen.

Answer 7

1. The company has contracts that have high front-end fixed costs.
2. The closure to new business can free up a lot of capital invested used to cover development and marketing costs.

Question 8

Give the issues that should be addressed in a model for that projects the solvency position of the insurer.

Answer 8

1. Estimation of future post-tax profits available to equity shareholders.
2. The current value of all surplus assets.
3. The amount and timing of any loan or debt redemption.
4. Problems relating to industrial relations
5. Issues relating to any staff benefit schemes - particularly if in a deficit
6. Outstanding financial obligations, minority interest and tax

Question 9

What factors should be considered when there is an acquiring company willing to take over an insolvent insurer’s business?

Answer 9

1. Location of the operation
2. Any integration of the systems platform
3. Relocation of staff or whether there is an adequate labour force available.
4. The effect on unit costs

Question 10

What usually happens when an insolvent insurer cannot find a buyer for its business and can in no way meet its liabilities?

Answer 10

There is usually a statutory scheme from which all or some of the benefits will be paid that is funded by a levy on all other providers.

Question 11

Give the reasons a benefit scheme may cease.

Answer 11

1. The insolvency of the sponsor

2. A decision by the sponsor to stop financing benefits either to reduce costs or to follow market trends.

Question 12

What are the factors that affect the level of benefits paid out if a benefit scheme ceases?

Answer 12

1. Rights of the beneficiaries
2. Expectations of the beneficiaries
3. The level of assets in the scheme

Question 13

What should be taken into account if a benefit scheme ceases and it is underfunded?

Answer 13

1. Consideration should be given to the priority of the different groups of members.
   (This action is usually guided by legislation)
2. An allowance should be made for the expenses involved in determining the benefit allocations as these will have to be paid first and in full before any members receive their benefits.

Question 14

Describe appropriate actions if a benefit scheme ceases and is found to be overfunded.

Answer 14

1. The surplus should pass back to the employer or may be used to improve the benefits of the scheme members.
2. Consideration should be given to ensuring that all members’ basic rights are met before seeking to improve benefits.
3. Consideration should be given to the improvement of retired members’ benefits.
4. The duration of membership and which members contributed to the surplus should be considered when deciding to whom benefit improvements should be given.

Question 15

Give the options that exist for the provision of the outstanding benefits in a benefit scheme that is being discontinued.

Answer 15

1. Continuation of the scheme without any further accrual of benefits
2. Transfer of liabilities to another scheme with the same sponsor
3. Transfer of the funds to the beneficiary, in cash form if permitted by legislation or as a transfer to an insurance company or to the scheme of any new employer.
4. Transfer of funds to an insurance company to invest in a group or individual pension accrual policy without benefits.
5. Transfer of liabilities to an insurance company to guarantee benefits.
6. Transfer of the liabilities to a central discontinuance fund.

Question 16

Describe the circumstances in which a bank becomes insolvent.

Answer 16

1. Unable to meet its obligations to its depositors and creditors.
2. The value of assets falls below the value of its liabilities.

Question 17

Why are solvency issues in the banking system usually swiftly resolved?

Answer 17

Bank failures create systematic failure in an economy.

Question 18

What actions can a regulator take to resolve a Bank insolvency?

Answer 18

1. Curatorship (actions might include)
   > Transfer of assets and liabilities to other banks
   > Mergers with other banks
2. Liquidation (last resort)