The PRA's Stance on Solvent Schemes of Arrangement & Omnibus II
The Omnibus II directive, which amends the text of the Level 1 Solvency II directive, was finally agreed in March 2014.
Amongst the numerous administrative and other amendments there are a large number of transitional arrangements. These effectively operate as a grace period in certain areas that delay the full force of the new regime taking effect from the implementation date of 1 January 2016.
Amongst these are transitional periods that are available to insurers that are by 1 January 2016 in run-off and in the process of seeking finality. The detail can be found at article 308b on pages 164 to 167 of the directive. These provide for a grace period of (i) three years where the insurer has satisfied its regulator that that it will have "terminated its activity" by 1 January 2019; or (ii) five years if the insurer is subject to a formal re-organisation process and an "administrator" has been appointed. The first period would seem to apply to a run-off insurer that is able to satisfy its regulator that its outstanding insurance liabilities will by then have naturally expired. The second period would seem to apply to a run-off insurer that has initiated a formal process – such as a portfolio transfer or scheme of arrangement – to accelerate legal finality. These provisions do not disturb article 12 of the original Solvency II text which remains available to a reinsurer that has gone into run-off by 10 December 2007.
Whilst these new transitional provisions are of course helpful, there are some important caveats. The first is that the insurer in question must not form part of a group that contains live carriers. The rationale for this appears to that the live operations can support the run-off operations. However, this will in practice severely limit the benefit of this provision, since pure run-off insurers/ groups are relatively few in number.
A further caveat is that the regulator must remain "satisfied with the progress that has been made towards terminating the undertaking's activity". This may be a grey area. How quickly must an insurer move? What active steps are required? And what happens if it encounters bona fide obstacles along the way? What happens if these obstacles take the form of resistance from the regulator to the finality proposals themselves? The following example, concerning schemes of arrangement, illustrates the point.
The UK's Prudential Regulation Authority (PRA) has made clear in a recent supervisory statement that it will take some considerable persuasion to support a scheme of arrangement for a run-off book that is solvent. It has however left the door open in that it has said that it will consider proposals on a case by case basis. This means that there will need to be careful analysis of what a company is seeking to achieve in the scheme and a convincing case must be made that a scheme is right in the circumstances. There is then the possibility of the PRA effectively blocking a proposal for a scheme, which may derail an insurer's plans for finality. You can see where this might lead.
If this in turn lifts that insurer out of the criteria for the transitional period, it will find itself subject to the full force of Solvency II. If the effect of this were to force a run-off insurer into an insolvent situation, could this open the PRA to charges of unwarranted damage to shareholder value? Would this be enough to persuade the PRA not to object to the scheme in the first place? Also, could the PRA's implementation of this recent supervisory statement lead itself unwittingly into a conflict with Solvency II by depriving a run-off insurer of the benefit of the transitional period in a manner not envisaged by the Solvency II law-makers? In particular, Solvency II is designed to be largely "maximum harmonisation" in nature, and so create an even playing field. In other words, each EU member state must not over-implement (or "gold-plate") with its own additional requirements. The transitional provisions at article 308b are no exception to this. Might the PRA's stance on solvent schemes in practice constitute an additional hurdle or criteria to the availability of this transitional period, and could it find itself subject to challenge?
These questions will require careful consideration on the facts, and are likely to colour an insurer's discussions with the PRA as to the availability of a solvent scheme.