Chapter 35: Insolvency and Closure Flashcards
Why do insurers rarely become insolvent?
Insurance companies are normally subject to some form of state regulation and they are usually required to maintain a certain level of solvency capital.
There are also regular reporting requirements that enable the regulator to monitor the financial position companies, which enables the regulator to intervene in the running of an insurance company before it reaches the position of being unable to meet its liabilities
For example, the regulator might require the insurer to close to new business so that new policyholders are not entering a fund whose solvency is in doubt, and/or make a recovery plan (e.g. change the assets held so better matched or increasing the amount of reinsurance used or limiting the levels of new business sold)
Insolvency may also be avoided through the sale to, or merger with, another provider.
The insurance company can also be liquidated
- the assets are sold-off
- the in-force policies are transferred to an industry insurance fund
What are the pros and cons of closing to new business
Pros
- new policyholders not exposed to risk of (potentially) insolvent company
- limit the new business strain … reduce working capital requirement
- commission
- new business capturing
- limited marketing
- Reduce some expenses (less marketing, distribution costs etc)
- (possibly?) more freedom (capital need to fund new business strain, now available as “free reserves” … likely to be small)
Cons
- reduction in new business => increase in per policy expense
- adverse effect on image in market … leads to withdrawal of existing business => further reduction in existing business
- incurring additional costs,
- retrenchment packages for sales staff, new business capturing
- having to explain to market, and try to preserve existing business
NEED CRITICAL MASS OF BUSINESS
=> merger / sell business
Limitations the regulator can place on insurance companies facing insolvency
- The types of business can accept
- Investment policy
- Product price
- SA example: Stop advertising
- Minimum reinsurance requirements
If an insurance company is facing insolvency, it is necessary to project the insurer’s financial position into the future with a model under a range of deterministic scenarios(or with the aid of a stochastic model) to help determine the actions that should be taken in each of the scenarios.
List 6 issues that need to be addressed and monitored.
- 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) - insurer’s relationship with its employees and any trade union that represents them
- Issues relating to any staff benefit schemes - particularly if these benefit schemes are in deficit.
- Outstanding financial obligations, minority interests and tax.
If an insurance company facing insolvency is to be acquired by another provider, list 4 things that it is necessary to consider.
- The location of the operation
- The integration of computer systems
- Relocation of staff or whether there is an adequate labour force available.
- The effect on unit costs.
What can be done if insurers experience solvency problems
- Turn-around strategy
- Sell the business
- Industry compensation scheme
Turn-around strategies for insurers facing insolvency
- Changing business strategy (different products, geographical regions, distribution strategy, etc)
- Cost cutting
- More conservative investment
- Increase reinsurance
- Limit the levels of new business sold
Why would someone buy a company in distress?
- Cost savings - Additional business may reduce unit costs
- Geographical Diversification
- New distribution force
- Products - Intellectual property
Industry compensation scheme
There may be an industry compensation scheme, such as the Financial Services Compensation Scheme (FSCS) in the UK, which will fund some or all of the benefits payable to policyholders.
The compensation scheme is usually funded by a levy on all other providers.
Pros
- protection to policyholders
- Helps to create stable industry (if not such scheme, a company failure may lead to a “run” on other insurance companies …)
- decrease reliance on state (dont need state pension)
Con
- company management may take more risks, knowing that there is a safety net
- why should well-managed companies be “taxed” (via the mandatory contributions to the compensation scheme)? Remember this cost passed onto policyholders
- cannot deal with an industry-wide problem
State:
- The two main types of benefits scheme closure
- The implications of each type for sponsor contributions.
- What the type of closure implemented will depend on
- Closed to new members only
- existing members’ benefits continue to accrue are unchanged (In DB schemes benefits continue to accrue with additional service and salary increases)
- 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 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, which can lead to human resource issues as the promised benefits are reduces
- The sponsor expects to pay a one-off settlement (possibly spread over a period) if the scheme is in a deficit, then no further contributions.
The type of closure chosen will depend on:
- whether the sponsor is insolvent or needs to reduce costs
- whether the employer wishes to follow market trends in benefit provision
- any other reason
A DB scheme will need to set out the benefits that will be provided on discontinuance
What are the three most important factors for the sponsor to consider when determining the benefits that will be paid to the members of a discontinuance benefit scheme?
- The rights of the members, which depend on legislation and scheme rules (different interpretations - for example only a right to the benefits that have been, or should have been received, or the right to receive what they would have received if they remained in the scheme until retirement)
- The expectations of the members, which are likely to be based on the benefits that they would have been paid had the scheme not discontinued: Need to decide whether to include the future accrual of benefits, the future growth and any discretionary benefits
- The funding level of the scheme (see q 12 and 13)
The ultimate benefits received may be different value placed on the benefit
- the actual future experience may differ from the assumptions used
- where the benefit is purchased, the provider’s profit margin may reduce the benefits received by the members
What might happen if a scheme is in deficit on the discontinuance date?
Benefits paid to members may be reduced.
- There will be hierarchy of who has priority on scheme assets.E.g.
- pension in payment
- accrued benefits
- increases on pensions
- other PRE benefits …
- If the members’ benefits are to be reduced, legislation or scheme rules may dictate which benefits will be reduced or what types of beneficiaries will have their benefits reduced.
- The administration expenses of determining the allocations, informing beneficiaries and securing provisions will further reduce the benefits.
There may be a requirement on the sponsor (if solvent) to put in extra funds to make up the deficit
- May be a legal requirement - debt of the sponsor
What might happen if a scheme is in surplus on the discontinuance date?
The surplus might be used to increase the benefits and/or be passed to the sponsor.
Considerations will need to be given to the legislation and scheme rules, which may require funds to be used to increase benefits.
Need a method to increase benefits which may depend on
- Length of service
- Proportion of the value of their benefits
- How much different membership categories have contributed to the surplus eg if pension increases were less than reserved for then the pensioners may need to receive a greater increase
List 6 options for providing outstanding benefits if a scheme is discontinued
- Gradual removal of the liabilities by the 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, as cash (if permitted by legislation) or to place with an 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 the liabilities to an insurance company to guarantee the benefits.
- Transfer of the liabilities to a central discontinuance fund, operated on a national / industry-wide basis
What factors should be considered when comparing the options for providing outstanding benefits for a discontinuance scheme? (Maak seker oor hierdie)
- Who takes on the future risks of experience not being as expected?
- What expenses/costs will be incurred?
- Does the method give members a choice?
- Do the members need expertise to execute the option?
- Do investments need to be realized, generating associated costs?
- What security and/or guarantees does the method offer?
- Will any surplus or deficit be crystallised?
