Title: IAIS Insurance Core Curriculum ICP 16: Winding up and exit from the Market
1IAIS Insurance Core CurriculumICP 16 Winding up
and exit from the Market
- Craig Thorburn
- Senior Insurance Specialist, The World Bank
- Policy Advisory Consultant, CGAP
- cthorburn_at_worldbank.org
- 1 202 473 4932 or 1 202 470 6012
- Skype craig_thorburn
2Agenda
- Pre-test
- Introduction
- Identifying Weak Companies
- A Sound Supervisory Process
- Using Supervisory Powers
- Putting Principles into Practice
- Policyholder Protection Schemes
3Pre-Test
- A quick pass to see what we will concentrate on
today
4Winding-up a company refers to
5Winding-up an insurance company could be
initiated by ...
6In winding-up a company voluntarily, it is
important that the following parties be actively
involved in the process
7When an insurer is forced to be wound-up,
preferential treatment is given to
8The goal of winding-up a company is to
9It is important that the winding-up process be
set out in the law so that the
10If the board of directors appeals a decision by
the supervisor to wind-up the company, it is a
sign that the
11Introduction
12Market Exit
- May be voluntary
- Sell the company to another owner
- Transfer the insurance obligations and operations
to another insurer and close the company - Cease new business and run-off the outstanding
obligations - Hire a liquidator / appoint an administrator to
run-off the business - Or involuntary
- External party initiates action that relieves
owners (and possibly senior management) of
control of the company - Insurance supervisor
- Other creditors
- Sometimes through court processes
13ICP 16
- The legal and regulatory framework defines a
range of options for the orderly exit of insurers
from the marketplace. It defines insolvency and
establishes the criteria and procedures for
dealing with insolvency. In the event of
winding-up proceedings, the legal framework gives
priority to the protection of policyholders.
14Three essential criteria
- (A) Legal framework determines point where it is
no longer permissible to continue in business. - Explanatory note discusses point where insurer is
no longer financially viable or insolvent so
not just Assets lt Liabilities - (B) Procedures for insolvency and winding up are
clearly set forth in the law. - (C) High legal priority is given to the
protection of policyholders and other
beneficiaries. This priority ensures that, as far
as practical, disruption to the provision of
benefits to policyholders is limited. - Explanatory note recognises priorities to
employee entitlements, taxation authorities, and
relevance of policyholder protection schemes as
an option.
15Identifying Weak Companies
16Why do companies fail?
- Asset problems
- Poor investments
- Non performing assets
- Mismatched assets and liabilities
- Inadequate liquidity
- Special asset problems
- Related parties (performance and or valuation)
- Goodwill and intangibles and Future Income Tax
Benefits go from a maybe to a definitely not - Creditors not making payments in a timely manner
- Reinsurance that does not perform as expected
- ANY OTHER ASSET PROBLEMS?
17- Liability problems
- Poor underwriting selection and mispricing of
insurance risks - Aggressive market underpricing
- Unrealistic provisioning
- Adverse claims experience
- Other financial issues
- Adverse expense levels
- Uncontrolled or excessive growth
- All leading to inadequate capital levels
18- Non financial issues
- Non compliance with legislative requirements
- Market conduct scandals
- Loss of reputation
- Inadequate business planning
- Inadequate management controls and practices
- Lack of understanding of market conditions
- Delays in claim settlement
- Fraud
19It all comes back to governance
- Inadequate or breakdown in governance
- Ineffective (or worse) boards
- Dominant (or worse) controllers
- Dominant (or worse) CEO
- Ineffective systems or internal controls
- Incompetent (or worse) management
- Incompetent, inconsistent, or absent strategy and
business plan - Especially for life insurance, ships that have no
direction can drift onto shoals
20When a company fails
- Assets may exceed liabilities but the company
could still not be viable - But when normal operations stop
- Some assets loose value
- Reinsurers may be more likely to dispute
obligations - Future Tax Benefits may be loose value
- Goodwill may disappear
- Assets expected to be sold at discounts due to
known financial distress - Asset mix may have to be realigned given reduced
cash flow to ensure liquidity, reducing expected
returns. - Some liabilities increase in value
- Claims come in faster
- Valuation assumptions may have to be made more
conservative
21Rocks not turned over
- Claim payment delays
- Cash flow underwriting
- Preferential payments to related parties
- Lenders having imposed heavy obligations /
collateral - Claim provisions understated through poor or
deliberate file management - Margins in asset values realised to support
profits - Improper use of reinsurance to dress up accounts
- What appeared to be legitimate business
transactions uncovered as inappropriate
22Delay creates its own problems
- So orderly exit should start before company
position reaches real peril - Unwarranted optimism, delay, and supervisory
forbearance generally do not work in the best
interests of policyholders - Supervisory inaction can destabilize the whole
market through market reputation and efforts of
well managed companies to compete with those with
poor practices. - Risk or systemic crisis
- Orderly markets require participants to know what
is expected of them. Expectations are reinforced
through transparent and effective implementation
of supervisory processes
23Less tangible tests
- The cufflinks are worth more than the company
- Board room art or foyer fountains are inversely
proportional to policyholder interests - The bigger the office the further to fall
- Long standing companies eventually run out of
luck - Not invented here is no good
- The captain of the ship is good at hosting
cocktail parties. - Brown envelopes are not letter bombs
24Voluntary Market Exit
- Companies may wish to exit for many valid
reasons, for example - Business is not meeting expectations for growth
and profit - Company is having difficulties in other markets
and needs to realise the asset - Management strategy to focus on other markets or
business lines - Supervisory control of exit is important as
remaining policy obligations still have to be
protected - Clear processes and roadmap will ensure that
those wishing to exit do not linger and neglect
the insurer. - Change of ownership approvals
- Demutualisation (where relevant)
- Transfer of obligations
- Taxation and similar issues may also need
attention
25Exercise / Discussion 1
26What improvements do we need?
- The CAIR Executive is meeting later this week to
discuss various matters including future work. We
also will want to consider what we cover in the
next workshop and training events. - When we reflect on what happened with CLICO, and
where we are now, did we all have the capacity
and knowledge to identify the weaknesses and form
a view of the concerns? What do we need to put in
place for the future? - What was the fundamental cause of the failure?
- What scorpions emerged under the rocks when they
were turned over?
27A Sound Supervisory Process
28Objectives
- Robust process
- Aimed to detect problems as far as possible
- At the earliest practical point of time
- Increasingly Risk Based approaches adopted not
solely focused on compliance - Uniformly applied, (generally) transparent,
objective, credible - Improves chances that management will support and
accept outcomes and commit to taking improvement
measures - Supporting defence of decisions if disputed
- So process that is structured and documented
- Defining and managing the process of dealing with
weak or troubled companies is an important aspect
of supervision
29Process overlays powers
Review and Analyse
Assess and determine action
Implement intervention
Financial Reports
Taking control
On Site Inspection
Imposing Directions
Limiting Business
Sanctioning Individuals
Replacing Officers
Changing owners
Requiring capital
Winding-up
Note Illustrative list of powers
30Assessment process
- Analysis of financial and non financial
information - Company and market wide
- Qualitative and quantitative information
- Adequate capital
- Current and prospective view
- Ultimate concern equals view of the supervisory
authority that the company is not viable to be
sufficiently able to operate the practical
business affairs and is unlikely to retain,
regain or maintain financial strength, thus
potentially placing its policyholders at
unreasonably higher risk of loss. (text p9) - Action should be consistent with the severity of
the problem and the manner in which similar
problems have been handled with other companies.
(text p5)
31- Identifying a potentially weak company is always
a challenge for the supervisory authority because
this task most frequently involves investigating
and drawing conclusions that are at odds with the
conclusions that management and the board reached
when looking at the same evidence. (text p5) - Determining if a company is or is not viable
involves judgment (text p6)
32Focus on adequate capital
- Minimum capital requirements
- Defined liability and assets
- Formulaic determined minimum capital
- Companies should have a buffer consistent with
risk and to avoid falling below regulatory
minimum - Higher risk implies need for higher buffer
- Having capital is based on a reason
- What is the company policy for buffer capital?
- How is this determined?
- How is this monitored?
- When is it breached?
- Short order restoration when breached
- Orderly markets prefer capital to be restored as
the first option
33But
- Failure of companies is not restricted to failure
to meet capital tests. Forced market exit is the
last possible action against a company no matter
how it got into that position (text p11)
34Early Warning Systems
- Range of risk and indicators
- Detect declining trends before minimum capital
levels breached - Detect other concerns before company is no longer
viable - Combination of outcomes toward graded position
- Normal Routine supervision process
- Concern Company to resolve issues
- More concern Time bound urgency
- Immediate restoration required Short time urgency
- Forced exit External control of resolution
- Publication of process enhances supervisory
standing
35Using Supervisory Powers
36Range of options for intervention
- On site inspection
- Normal processes apply
- Also do targeted inspections
- As a normal process
- to validate and confirm specific concerns
- to gather evidence / documents etc.
37Request / require / mandate (1)
- Specific to address issues (examples)
- Remove and replace an officer that is not fit and
proper - Make particular improvements to processes and
systems - Deal with particular assets in a particular way
- Adopt a different assumption for valuation
purposes - Reinsure
- Change ownership
- Restructure / demutualise
38Request / require / mandate (2)
- Specific to enable issues to be addressed
(examples) - Align capital to risk / Increase capital / reduce
risk - Increase provisions
- General
- Develop sound business strategy
- Address concerns
- Re-establish viable performance
- Improve customer relations
- Make more frequent reports to the supervisor
39- Sanction the company
- Sanction individuals
- Fines
- Removal from position
- Removal from industry
- Criminal actions (usually referred to other
authorities)
40Broad Powers that can be useful
- Direct the company at any time and on any issue
- Hire a consultant to investigate at the cost of
the company - Instruct the external auditor to prepare a
special purpose or expanded audit - Force the sale of the company, or a line of
business - Instruct the company to cease writing one or more
lines of business - Change the company pricing
- Change the company liability or asset valuations
- Increase capital
- Sell
41Moral Suasion versus Legal Powers
- Moral Suasion Does it work? Can it be relied on?
- Example of when it works
- AMP and GIO Capital Issue
- HIH CEO
- Macquarie Life Reporting Issue
- Jawboning on DII profitability
- Strengthening the case
- Industry best practice research
- Risk of name and shame / requirements to report
against practices / targeted inspections /
questionnaires signed by senior officers or
boards - Y2K and suppliers - reinsurers
- Fit and proper management and boards do what they
are told - Escalation to chairman, independent directors,
board level - Power to turn request into requirements at short
notice
42Most severe is to force market exit
- Legally may be one or more of winding-up, refusal
to renew a license, withdrawal of a license,
apply to court for wind-up - Powers required to
- Take control of company
- Replace management
- Convince another company to take over the ailing
insurer - Place company into run-off
- Commence wind-up
- Recapitalise and sell
- Full tool kit implies that triggers can be
problematic. - For example, only take supervisory control of
insurer if insolvent.
43Exercise / Discussion 2
44What improvements do we need?
- The CAIR Executive is meeting later this week to
discuss various matters including future work. We
also will want to consider what we cover in the
next workshop and training events. - When you consider your supervisory system
- Do you think that you have all the processes
fully working to identify weak insurers? - Do you think you have all the regulatory support
to these processes to make them credible to the
market? - Do you have the resources required to make and
manage assessments, review and intervention? - Do you know if each of your insurers has a
capital policy? - Do you feel you have the full armory of
intervention powers? - Can you use moral suasion effectively? If not,
what are the limitations?
45Putting Principles into Practice
46Underlying Principles
- Clearly state the problem to be fixed
- Ask the company to develop a strategy to resolve
the problem - Set criteria for success (to identify that the
problem has been resolved) - Set clear and realistic timeframes for plans,
action and resolution - Monitor progress (set intermediate checkpoints)
- Give credit to management when it works
- Be sure that management owns the problem and not
the supervisor - If actions are not successful, have an escalation
option - Use the escalation option
- (text p26)
47Contingency Planning
- Hope for it to work
- But plan for it not to work
- The company is under stress, and your actions
increase this stress - Be prepared that they will not meet the goals
- What will you do if they fail?
- Monitor carefully along the way even if it
seems to be overkill - HR needs to be mobilised at the supervisor
- Legal issues need to be addressed
- Communication wit key stakeholders (Who might
they be?) - Get the steps planned clearly
48Document
- Document
- Document
- Document
- Document
- Document
- Document
- Document
- document
- Good practice anyway
49Policyholder Protection Schemes
50IAIS Statements
- Policyholder protection schemes can be one way
that a jurisdiction achieves priority and orderly
exit protection for policyholders - Priority
- Essential Criterion (c) This priority ensures
that, as far as practical, disruption to the
provision of benefits to policyholders is
limited. - Wind up processes can disrupt provision of
benefits - Normal liquidation processes freeze all actions
until assets and liabilities are determined then
payout claims based on - priorities and
- proportion of funds available.
- Can involve considerable delay as insurance
liabilities are difficult to determine
51Need to keep funds flowing
- Transfer to an existing insurer in short time to
restore normal functioning - May need to top up or guarantee any shortfall
- State engagement
- Protection Scheme
52My view on Protection Schemes
- Two types of scheme exist
- The one you have
- The one you do not know you have
- Economists argue about
- Moral Hazard
- Risk based premiums
53Principles
- Establish the scheme in calm water if possible as
it is less costly and better structured. - Recognise that
- Insurance cannot be diversified as bank products
can so the obligation on customers is not so
feasible an excuse not to have a scheme - Compulsory classes tend to need something anyway
for the uninsured or unidentified victims - Not all claimants benefit from buying insurance
cheaply akin to bank deposits paying higher rates
of return - If commercial bankruptcy laws apply, it takes
ages to determine the insurance company
liabilities - Have a special system for insurers or
- You have to have a scheme to protect
policyholders from the conventional bankruptcy
implications - A scheme will help observe the ICP
54- When the scheme is well designed, it may support
having resolution options available - For example, transfer of obligations when there
is a small shortfall - When you have third party products, then this may
mean you include the compulsory class issues and
have some prefunding - Make sure that the scheme defines who is
protected - Normally not all policyholders, but locals
individuals and small business, sometimes not
large commercial clients or inward reinsurance. - Old case where US policyholders were the main
beneficiaries of a European failure brought this
to a head.
55- To limit moral hazard, compensation should be
partial and capped - Advance funding might be attractive to the sector
in some ways, but adds practical complexity and
might be more trouble than it is worth - When post funded through a levy, special
consideration of long term life insurance, single
premium investment products, and life annuities
should be thought through - Post funded, at least in part, will need a banker
identify this in advance - Risk based premiums work in theory and in the
USA. Small markets present practical challenges.
56Exercise / Discussion 3
57What improvements do we need?
- The CAIR Executive is meeting later this week to
discuss various matters including future work. We
also will want to consider what we cover in the
next workshop and training events. - When you consider your supervisory system
- Do you have arrangements in place now that would
be relevant to ensure that policyholders are
protected without disruption? - Do you think that future problems, wherever they
come from, can be handled? If not, what are you
concerned about? - What do you need to do now for most benefit to
give you the comfort you need to protect
policyholders?
58End