Chapter 35: Insolvency and closure

Question 1

Why do insurers rarely become insolvent?

Answer 1

The regulator requires that insurers hold a certain amount of solvency capital, as an additional protection against insolvency.

There are regular reporting requirements and checks on the solvency position and the regulator is likely to intervene before the situation reaches crisis point.

For example, the regulator might require the insurer to close to new business, and/or make a recovery plan (e.g. change the assets held so better matched or use reinsurance)

Insolvency may also be avoided through the sale to, or merger with, another provider.

Question 2

How are an insurance company’s expenses likely to change if it closes to new business?

Answer 2

• Initially it should be possible to make cost
  savings (e.g. reduced sales force, less new
  business administration and
  underwriting).
• However, the company may incur some
  additional costs relating to the closure,
  e.g. redundancy payments
• It may decide to maintain the
  infrastructure to enable it to re-open in
  the future, and these costs will continue to
  be incurred.
• In the longer term (if it remains closed),
  diseconomies of scale will bite (fixed
  expenses will have to be spread over a
  small volume of in-force business).
• There will be additional costs relating to a
  merger / sale if this occurs.

Question 3

If an insurance company is facing insolvency, it is necessary to project the insurer’s financial position into the future with a model under various scenarios (possibly stochastically) to help determine the actions that should be taken.

List 6 issues that need to be addressed and monitored

Answer 3

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
   (and redundancies)
5. Issues relating to any staff benefit
   schemes - particularly if these benefit
   schemes are in deficit.
6. Outstanding financial obligations,
   minority interests and tax.

Question 4

If an insurance company facing insolvency is to be acquired by another provider, list things that it is necessary to consider.

Answer 4

• Location
• Integration of computer systems
• Relocation of staff or whether there is an
  adequate labor force available.
• Effect on unit costs.

Question 5

How might policyholders still get their benefits if an insurance company does become insolvent?

Answer 5

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.

Question 6

State:
- The two main types of benefit scheme
closure
- The implications of each type for sponsor
contributions.
- What the type of closure implemented
will depend on

Answer 6

• Closure to new members only, existing
  members’ benefits continue to accrue -
  contributions continue, rate as % salary
  likely to increase and become more
  volatile.
• Closed to new members and no further
  benefits accrue to existing members - one
  off settlement (possibly spread) may be
  needed 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
- market trends (and whether the sponsor
wishes to follow them)
- any other reason

Question 7

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.

Answer 7

1. The rights of the members, which
   depend on legislation and scheme rules.
2. 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.
3. The funding level of the scheme.

Question 8

What might happen if a scheme is in deficit on the discontinuance date?

Answer 8

Benefits paid to members may be reduced.

There may be a requirement on the sponsor (if solvent) to put in extra funds.

Alternatively, legislation may require a debt to be placed on an insolvent sponsor, which may rank alongside, above or below other creditors.

The scheme may have to take out insurance to ensure the sufficiency of assets on insolvency of the sponsor.

There may be a State-sponsored fund to support benefits where the sponsor is insolvent (may be funded by a levy on solvent schemes).

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.

Question 8

List 6 options for providing outstanding benefits if a scheme is discontinued

Answer 8

1. Transfer of the liabilities to another
   scheme with the same sponsor.
2. Transfer of the funds to the beneficiary,
   as cash (if permitted by legislation) or to
   place with an insurance company or in
   the scheme of any new employer.
3. Transfer of the funds to an insurance
   company to invest and provide a group
   policy or an individual policy in the
   beneficiary’s name.
4. Transfer the liabilities to an insurance
   company to guarantee the benefits.
5. Transfer of the liabilities to a central
   discontinuance fund, operated on a
   national / industry-wide basis.
6. Gradual removal of the liabilities by
   construction of the scheme without any
   further accrual of benefits.

Question 9

What might happen if a scheme is in surplus on the discontinuance date?

Answer 9

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.

The allocation of surplus to beneficiaries might be done based on length of membership or based on the extent to which members are thought to have contributed to the surplus.

Question 9

What factors should be considered when comparing the options for providing outstanding benefits for a discontinuance scheme?

Answer 9

• 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?