Financial Services and Markets Act 2000: Administration Orders Relating to Insurers
REGULATORY IMPACT ASSESSMENT
1. This regulatory impact assessment accompanies the Financial Services and Markets Act 2000 (Administration Orders Relating to Insurers) Order 2002 (?the Order?).
Purpose and Intended Effect
2. Section 360 of the Financial Services and Markets Act 2000 (?the Act?) gives the Treasury power to modify Part II (Administration Orders) of the 1986 Insolvency Act to allow insurers to be placed into administration. The Order applies the existing administration regime to insurers, modifying it to meet their specific needs. It makes one substantial modification to Part 4 of the Insolvency Rules (Companies Winding Up) addressing the issue of the 'setting off? of debts against insurers that, having been in administration, subsequently enter into liquidation. In the Schedule, the Order modifies the powers of an administrator to include the power to make payments due to creditors, or to make payments on an on account basis to creditors.
3. This assessment provides estimates of the costs and benefits of allowing insurers to be placed into administration. Much of the impact of the change does not, however, lend itself to numerical quantification. This is because the costs/benefits of the change will depend largely upon the size and numbers of insurers entering administration. It will also depend upon whether an administrator takes advantage of the power in the schedule of the Order to make payments to creditors, and, if payments are made, at what level.
Costs and Benefits
4. Although the modification of the current administration regime to limit the operation of statutory set-off when an insurer that goes into administration subsequently goes into liquidation will limit the ability of individual debtors and creditors of the insurer to make savings through the assignment of their debts/claims, overall the cost impact of this change in the liquidation proceedings is neutral. The benefits otherwise available to individual debtors and creditors by way of assignment of debts/claims could result in losses to the asset pool of the insurer in liquidation available to meet the claims of other creditors of the insurer.
Administration vs. Provisional Liquidation
5. The tax consequences are virtually identical as between administration and provisional liquidation. The cost of administering the case of an insurer in administration would be very similar to that of an insurer in provisional liquidation. However legal costs will be less under administration than under the existing practice of the appointment of a provisional liquidator immediately after the presentation of a winding up petition because the costs of applying every 6 months for the hearing of the winding-up petition to be further adjourned is estimated at between £10,000 and £30,000. Assuming that it takes an average of three years to agree a scheme of arrangement, an insurer in administration will save between £60,000 and £180,000 on average. These savings will, however, need to be offset against any costs that may arise from complying with Part 2 of the Insolvency Rules.
6. Employee rights to compensation from the National Insurance fund on the insolvency of an insurer would be triggered under administration but are not triggered by provisional liquidation. An insurer that made 100 redundancies at an average of £200 x 2 weeks pay in lieu of notice per employee for each would cost the Treasury £40, 000.
The impact of the prohibition on the exercise of security over an insurer's assets on the Insurance Letters of Credit (ILOC) business
7. The Government does not believe that either an administrator, or the court will limit the ability of banks that issue ILOCs to draw down on their collateral as the letters of credit are honoured. In the short run, the risk that neither the administrator, nor the court, will allow the security to be drawn down, and consequently the bank faces a delay in being able to draw against the collateral, are likely to lead to a change in the pricing of the services provided under letter of credit schemes and/or an increase in the amount of cash collateral required to reflect this risk. By way of example, a reinsurer using a US Treasury Bond with slightly less than five years to maturity as collateral would receive about 4.4% pa compared with about 1.5% for cash collateral. In the long run, we believe that banks will downgrade the risk (as it becomes apparent that neither administrators nor the court will limit their ability to draw down on the collateral they hold under the ILOC scheme) and that pricing and collateral rules will reflect this downgrade. There is also a possibility that this may serve as an incentive for others to enter into the ILOC market.
Impact on Small Businesses
8. Insurers are generally large organisations, so the Order should not affect small businesses in a substantial way. However, it is possible that a change in the pricing of the ILOC scheme will impact the profitability and financial flexibility of smaller, less credit secure insurers with heavy exposure to the US market.
9. The Treasury's proposals for introducing administration for insurers were put out to public consultation. Responses were overwhelmingly favourable and were received from all key stakeholders: insolvency practitioners, insurers and lawyers. Very few comments were received on the initial Regulatory Impact Assessment included in the consultation document, although a few respondents drew attention to the possible impact on the ILOC market. A majority of respondents urged the inclusion of a specific power for an administrator to make payments to creditors which has been added to the Order.
I have read the Regulatory Impact Assessment and I am satisfied that the benefits justify the costs.
Signed by the responsible Minister:
Economic Secretary to the Treasury
2 May 2002
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