Neil Golding explains changes afoot in insolvency law which will have major implications for the run-off sector.
The law relating to the insolvency of insurance companies in the UK is about to undergo a number of fundamental changes. This will have a big impact on all those who have any dealings with companies which are in, or which might at some stage end up in an insolvency or reorganisation process. The changes include a radical alteration to the rules regarding the priority of the payment of claims; in a fundamental change to the current system, insurance claims will have priority over the claims of other unsecured creditors.
The aim of this article is to explain briefly how the present regime for insolvent insurance companies operates and then to consider the nature of the changes which are about to be introduced.
Over the past 15 years or so, the insolvency of UK insurance companies has developed well-established procedures:
So far as distributions are concerned, the terms of the scheme will broadly reflect the position which would have applied if the company in question had gone into liquidation. In other words, all unsecured creditors (whether the policyholders, reinsurers or otherwise) are treated similarly. In general terms, no group of unsecured creditors would have any form of priority. Finally, the provisional liquidators ultimately become scheme administrators.
The system has worked perfectly well in practice. Critics have said that the system is too slow and that estates could be wound up more quickly, but everybody was familiar with the rules of the game.
But that position has changed recently. Firstly, the prohibition on insurance companies going into the insolvency procedure known as administration has been removed so that administration became available to insurance companies from 31 May 2002. Even though there has only been one case to date where administrators have been appointed - Folksam International Insurance Co (UK) Ltd - the likelihood is that, going forward, any new insurance insolvencies will involve administrators rather than provisional liquidators being appointed. While the change is of great interest to those who specialise in the area of insurance insolvency, it will be of less significance to the industry more generally. In practice, it is likely to consist of broadly the same people doing broadly the same job, but merely wearing a different hat.
The same cannot be said of a much more significant change which is to be introduced following the adoption on 15 February 2001 by the European Union of the Insurers (Reorganisation and Winding-up) Directive. The directive has no direct effect under English law, but has to be brought into force in the UK by means of secondary legislation by 20 April 2003. Recently, there has been a consultation process taking place in which the UK government was considering the best means of implementing the directive. The government issued a consultation document in November 2002 and requested responses by the end of January 2003. A range of interested parties (including the Association of British Insurers) have submitted responses.
Although the government has issued a draft of the statutory instrument which would give effect to the directive, this may well be amended in light of the consultation process. As a result, the precise method by which the directive will be brought into force remains unclear.
What is beyond doubt, however, is that the directive will have a big impact on insurance insolvency in the UK. Several key points should be noted:
Major change afoot
The new regime is going to have a big impact on the industry. For insolvency professionals, the approach currently adopted towards preparing schemes of arrangement will have to change to reflect the fact that `insurance claims' and other unsecured claims will now need to be dealt with separately, and will therefore amount to different classes. It remains to be seen how the professionals will deal with the existing schemes which have already been approved though for commercial reasons need to be amended, but for which the amendment cannot take place until after the directive is introduced. The directive may also call into question the abilities of English officeholders (whether provisional liquidators or administrators) to obtain relief under section 304 of the US Bankruptcy Code. This has become a staple part of existing best practice, and obtaining an injunction restraining the piecemeal break-up of an insurance estate in the US has almost become a matter of course. It may not be so easy to obtain (or maintain) such injunctions following the introduction of the directive.
For a reinsurer, the directive raises a difficult question when dealing with a party which is in some difficulty (or which might at some stage find itself in that position). For example, would it now make sense for a reinsured to commute as soon as possible rather than risk being in a much worse position if its insurer were to end up in an insolvency or reorganisation process which was governed by the directive? In addition, so far as future business is concerned, reinsurers will need to give even greater thought than before to the possibility of obtaining security to ensure that their position is protected.
However, it will not be possible to deal with all the ramifications of the directive until the final form of the statutory instrument is available, and to see how the industry deals as a matter of practice with the issues which seem certain to arise.
In a discussion document released after this article was prepared and at the time of going to press, the UK government now appears to be taking the view that schemes of arrangement do not fall within the scope of the directive.
By Neil Golding
Neil Golding is a partner in Freshfields Bruckhaus Deringer's restructuring and insolvency group.