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As part of such frameworks, most jurisdictions apply strict solvency regulations to insurance companies operating within their borders, thus protecting liabilities with technical provisions and additional assets. Where an insurer is experiencing difficulties, solvency regimes trigger intervention to differing degrees depending on the seriousness of the situation. Supervisory action aims to minimise the likelihood of an insurer becoming insolvent or going bankrupt. Some jurisdictions provide added protection for policyholders and ensure the priority of policyholder claims in the event of an insolvency through additional mechanisms within the supervisory framework such as the ring-fencing of assets (e.g. tied assets) that support insurance liabilities. This is consistent with ICP 12 (Winding-up and exit from the market) which stresses supervisory objectives of:
Compared with other areas of the financial services sector, the insurance industry has emerged from the crisis that started in 2007 comparatively unscathed. In jurisdictions with strong regulatory and supervisory frameworks, the collapse of an insurer writing traditional insurance business is unlikely. Nonetheless insurers have failed in the past, and some have got into difficulty due to non-insurance activities. The impact on policyholders can be severe, and there is a risk of wider disruption in the financial services sector, and consumer detriment. To mitigate the impact on policyholders and the general economy, jurisdictions are encouraged to be prepared for such an event.
Solvency regimes do not create a zero-failure environment and may not protect consumers from losses in the event of a failure. When failures do occur, governments can come under strong pressure to provide a safety net. In light of this, many jurisdictions have established one or more policyholder protection schemes (PPSs) to provide a minimum layer of protection to policyholders in the event that the safeguards within the supervisory regime are not sufficient.
PPSs are usually collective industry-funded schemes that are seen as last-resort mechanisms, providing a basic level of protection to policyholders (although some models are more comprehensive) when all other corrective and preventive measures have failed. PPSs are designed to protect policyholders and beneficiaries in the case of the insolvency of an insurer, serving as backstops against claims. Whilst PPSs’ objectives focus on providing a minimum level of protection to policyholders, where the design of the PPS includes such functions, they can also contribute to the objectives of resolution regimes by:
Whilst the paper discusses the above functions of PPSs, and acknowledges that these can contribute to insurer resolution, it is not the intention of this paper to discuss resolution regimes, including the roles and responsibilities of resolution authorities.
Where protection mechanisms - be they through a PPS or through other means such as tied assets or preferred claims - are in place, policyholders have increased protection in the event of a failure. As such, PPSs contribute to maintaining public confidence5 and stability in the insurance industry and the financial system; and this is enhanced where protection is provided in a transparent manner. A PPS also clarifies the obligations of the government and other safety-net participants and limits the scope for discretionary decisions that may result in arbitrary actions, and in so doing supports consumer confidence.
Where inadequate protection mechanisms are in place, governments may resort to discretionary ad hoc measures or put explicit but limited guarantees in place. This is unlikely to be an optimal solution and can be costly to all taxpayers, regardless of whether or not they are policyholders.
Insurance supervisors need to be aware of the PPSs that apply to insurers and policyholders within their jurisdiction. Where PPSs exist, their effectiveness is enhanced through close cooperation between the PPS and the insurance supervisor, which is sometimes formalised in a cooperation agreement. Whilst PPSs need to be operationally independent, involvement of the insurance supervisor in the governance of the PPS can help to ensure that the objectives of both are aligned. Cooperation and coordination between the two is particularly important where an insurance supervisor assesses an insurer as high risk, and in taking action in the case of a distressed insurer. These issues are discussed further in the paper.
This paper provides an overview of the features of PPSs and the functions they can perform. It is intended to serve as a source of information to insurance supervisors, including where the establishment of a policyholder protection scheme is being considered or where an existing scheme is being modified. This paper also discusses necessary conditions and challenges associated with such schemes to ensure that where they are established they are consistent with the objectives of the ICPs. Moreover, the paper discusses issues that arise in financial conglomerates and for insurers operating in more than one jurisdiction, where there is interaction between PPSs, and between PPSs and other protection plans (for example for deposit taking institutions and securities) and insurance supervisors. Annex I briefly describes mechanisms within the supervisory framework, such as tied assets, that can be used to provide effective protection to policyholders. Annex II includes case studies and examples of aspects of the operation of PPSs; Annex III summarise functions that PPSs in selected jurisdictions perform; and Annex IV provides selected reference material.