On 5 December 2012, the European Insurance and Occupational Pensions Authority (EIOPA) published its response to the EU Commission Consultation on a possible recovery and resolution framework for financial institutions other than banks.
RRP for Insurers
EIOPA supports the principle of RRP for insurers, but emphasises that (re)insurers are believed to have a more stable business model, are less interconnected and, in some cases, are more substitutable than banks. As such, it claims that the financial stability argument for resolving insurers is not as persuasive as for banks. It recognises that some insurers are rightly regarded as systemically important but warns that this should not be the sole motivating factor for developing RRP for insurance companies. Rather, the importance of policyholder protection must be recognised alongside the more general goal of ensuring financial stability and further work is required in order to determine the hierarchy of these objectives.
EIOPA believes that a clear delineation between the mandates of supervisory authorities and resolution authorities is required in order to smooth the transition from recovery to resolution and so avoid “inaction bias” and the “cliff effect”. Supervisory authorities should have discretion to provide “breathing space” to failing firms as this can lead to better outcomes and avoid pro-cyclical actions that might arise as a result of immediate enforcement. However, excessive forbearance is to be avoided. As such, a balance must be struck between the need to act early in the interests of maintaining critical functions and preserving financial stability and the need to protect private property rights. This balance should be based on a graduated approach to trigger conditions referencing factors such as authorisation requirements. The graduation would reflect the severity of a breach. For example, a trigger allowing the appointment of a Special Manager or Administrator would be less onerous and further from the point of balance sheet insolvency than a trigger authorising asset separation or forced sales/transfers.
EIOPA considers that the following resolution tools are applicable to traditional insurance:
- Portfolio transfer;
- For non-life mutual and mutual-type associations with variable contributions, the ability to call for supplementary member contributions;
- Recourse to Insurance Guarantee Schemes to secure continuity of insurance policies by transfer to solvent insurers or compensation of beneficiaries/policyholders;
- Restructuring of liabilities to ensure that losses are fairly distributed among policyholders/creditors;
- Appointment of an Administrator/Conservator or Special Manager; and
- Compulsory winding-up.
However, there is a recognition that the effectiveness of these tools in the resolution of a large, complex insurance group with extensive cross border operations (or the failure of several smaller insurers within a single jurisdiction) is as yet untested and may prove to be inadequate. In addition, EIOPA believes that some resolution tools, such as the imposition of a moratorium on payments, are primarily designed to protect creditors and so may not provide optimal outcomes for policyholders. As such, it welcomes the initiative to consider expansion and development of the resolution toolkit to address broader objectives.
With specific reference to the Asset Separation tool, EIOPA sees the merits of being able to separate non-insurance related assets/activities in order to affect resolution of an insurance group but questions the practical relevance of such a power given that non-insurance activity conducted by a solo insurance undertaking is likely to be limited. Moreover, to the extent that insurance liabilities are matched by assets, it is not clear to EIOPA how such a power would be used.
EIOPA would support measures to broaden the availability of the Bridge Institution tool, especially in the context of dealing with multiple failures. Similarly, it views the ability to appoint an Administrator or Special Manager options as being useful if capable of being triggered at a suitably early stage.
EIOPA considers that the Bail-In tool is relevant to the insurance industry, but suggests that policyholders should not be subject to its terms. In addition, development of a Bail-In tool for insurance would need to take account of the fact that the insurance sector is primarily equity funded with unrestricted Tier 1 funds accounting for in excess of 80% of own funds. In these circumstances, Bail-In may be less effective as a tool than is the case for the banking industry.