Article written by Linklaters as part of the sponsorship of ACA Insurance Days 2023, whose content is the sole responsibility of its author.
On 24 January 2024, the final compromise text of the Insurance Recovery and Resolution Directive (IRRD) was published following completion of the EU’s trilogue procedure[1]. The IRRD aims to establish a legal framework for the recovery and resolution of distressed insurance and reinsurance undertakings, largely modelled on the rules for the banking sector adopted in 2014 in the form of the Bank Recovery and Resolution Directive (BRRD) in response to the global financial crisis.
The EU Council has already endorsed the final compromise text, and it has now moved on for endorsement of the European Parliament’s Economic and Monetary Affairs Committee. After legal linguistic review and translation of the final text, the IRRD is expected to be formally adopted and published in the EU Official Journal before the European Parliament elections in June.
In most cases the final compromise text of a directive is amended only linguistically, but material changes in certain areas cannot completely be ruled out. The current text nevertheless offers a realistic picture of the final wording of the directive as it will come into force, so it’s worth looking at the core rules and begin preparation for their implementation.
The IRRD creates a completely new framework and a comprehensive set of rules to ensure the effective recovery and resolution of distressed or failing (re)insurance undertakings. It will apply to all insurance and reinsurance undertakings covered by article 2 of the Solvency II Directive (2009/138/EC), insurance holding companies and mixed financial holding companies as well as certain EU branches established by third-country groups. However, there is an exemption for small and non-complex undertakings, and a provision for simplified obligations (see section 2.3 below).
Member States will have to create early intervention mechanisms to identify and address undertakings in financial distress, involving the establishment of national insurance resolution authorities. In addition, similar to the system for banks under the BRRD, most insurance and reinsurance undertakings will need to draw up pre-emptive recovery and resolution plans. Resolution authorities will be equipped with a range of tools, some of them familiar from BRRD.
Member States will designate a resolution authority empowered to apply resolution tools and ensure undertakings take on the necessary planning. While there has been discussion about an independence obligation on resolution authorities, it has been clarified that a supervisory authority may also act as the resolution authority, as long as structural arrangements such as separate staff and reporting lines exist to ensure effective operational independence. Most Member States are expected to designate their current insurance regulator as the resolution authority, which in Luxembourg would be the Commissariat aux Assurances.
The final text of the IRRD requires at least 60% of a Member State’s life and non-life insurance market to be subject to pre-emptive recovery planning, compared with 80% in the original proposal. Market share is calculated according to gross technical provisions for life insurance and gross written premiums for non-life business. Following negotiations on whether pre-emptive recovery planning should apply at individual and/or group level, the final text opts for the latter; individual undertakings are not subject to separate planning requirement if they are adequately covered by group recovery plans.
The aim of pre-emptive recovery plans is to identify measures to be taken by either the ultimate parent undertaking or the individual undertaking to restore a potential deterioration in its financial situation. They must identify and monitor quantitative and qualitative indicators that can trigger remedial action set out in the pre-emptive recovery plans, in the best interest of policyholders and aligned with their risk management systems. The indicators may cover areas including capital, liquidity, asset quality, profitability, market conditions, the macroeconomic environment and operational events. For example, capital-related indicators should at a minimum cover breaches of the Solvency Capital Requirement set out in the Solvency II Directive.
The European Insurance and Occupational Pensions Authority (EIOPA) has been mandated to draw up draft regulatory technical standards providing further detail on the content of pre-emptive recovery plans within 18 months of the IRRD’s entry into force. IRRD stipulates that the compilation, updating and application of pre-emptive recovery plans should be covered by the governance system stipulated under Solvency II’s article 41. Insurance undertakings and groups will have to update their recovery plans every two years, rather than annually as originally proposed.
Resolution authorities must also draw up a resolution plan for insurance undertakings and groups for which they regard resolution action as especially in the public interest, by comparison with other undertakings in the sector. These should represent at least 40% of a Member State’s life and non-life insurance market – reduced from 70% in the original proposal after criticism from the industry. As with pre-emptive recovery planning, non-life market share will be calculated by gross written premiums and life market share by gross technical provisions.
Resolution planning should generally apply at group level, except for undertakings not covered by group resolution planning, and shall be updated every two years.
Resolution plans will be required to include a demonstration of how critical functions and core business lines could be legally and economically separated, identification of assets that would be expected to qualify as collateral, resolution options that could be financed without any exceptional public financial support apart from insurance guarantee schemes or financing arrangements, and critical dependencies. A summary of the plan’s key elements should be disclosed to the undertakings in question.
The original IRRD proposal did not envisage a separate outline of the minimum elements to be considered by resolution authorities when assessing the undertakings’ resolvability. However, the final compromise text takes a similar approach to the BRRD and sets out a minimum scope of resolvability aspects such as operational continuity, separability, loss absorption capacity and funding in a separate Annex.
If a resolution authority concludes that substantive impediments exist to the resolvability of an insurance undertaking or group, it will notify them. If the authority believes measures proposed by the undertaking or its group fail to address or rectify such impediments adequately, it will be empowered to undertake alternative measures to improve its resolvability. For example, the authority may require the undertaking or group to limit its maximum exposures, divest assets or restructure liabilities, restrict or halt the development of new or existing business lines or products, or impose changes to its legal or operational structures.
Small and non-complex undertakings will not be obliged to draw up separate pre-emptive recovery plans and are not subject to resolution planning, unless a resolution authority considers that a particular undertaking represents a risk at national or regional level.
Resolution authorities may also decide to apply simplified obligations for certain undertakings in areas including the contents, details and frequency of updating pre-emptive recovery plans, as well as the level of detail of information they must provide. The criteria to determine whether simplified obligations can be applied include an undertaking’s risk profile, size, interconnectedness with other undertakings or with the financial market, and the complexity of its activities, with details to be added in guidelines by EIOPA.
The compromise final text adopts various resolution tools familiar from the BRRD, amended to incorporate insurance-specific features, including the:
The IRRD introduces the so-called solvent run-off tool, which gives resolution authorities the power to prohibit an undertaking under resolution from entering into new insurance or reinsurance contracts, with a view ultimately to termination of its activities and its winding-up under normal insolvency procedures, maximising the coverage of insurance claims by existing assets.
The asset and liability tool gives the resolution authority the power to transfer assets, rights or liabilities of an undertaking under resolution, or a bridge undertaking, to one or more asset and liability management vehicles. The main aim of this tool is to facilitate a portfolio transfer during a resolution.
The sale of business tool is intended to enable resolution authorities to conduct a sale of the insurance undertaking or part of its operations to one or more purchasers (other than a bridge undertaking) without the consent of shareholders. When applying the sale of business tool, authorities should provide for arrangements for the marketing of the undertaking or part of it in an open, transparent and non-discriminatory process, and seek to maximise the sale price as far as possible.
This tool will allow resolution authorities to transfer shares or other ownership instruments as well as all or any assets, rights or liabilities of one or more undertakings under resolution to a bridge undertaking – an entity wholly or partly owned by public authorities or an insurance guarantee scheme, and created to achieve the resolution objectives set out in the IRRD: protecting the collective interest of policyholders, beneficiaries and claimants, and maintaining financial stability. A resolution authority may also assign insurance guarantee schemes (see section 5 below) with the duties and powers of a bridge undertaking.
This tool will enable the resolution authority to write down or convert capital instruments, debt instruments and other eligible liabilities to provide an internal loss absorption mechanism.
The final compromise text allows Member States to exclude certain insurance claims linked to assets in a special register and private health insurance or long-term care insurance contracts that replace the mandatory component of the statutory social security system (exemptions that were disputed during the EU’s trilogue negotiations).
The IRRD does not introduce a concept such as the Minimum Requirement for Own Funds and Eligible Liabilities under the BRRD. However, its review clause (see section 8 below) stipulates that the review should assess the need to introduce “minimum harmonised definitions on the level of covered policies and eligible claimants and policies” in the future.
Before resolution authorities may initiate resolution actions regarding an insurance undertaking and/or group, various conditions must be met. These include assessment by the resolution authority that no reasonable prospect exists of any alternative private sector measures or supervisory action (including preventive and corrective measures) to avert the failure of the undertaking or group within a reasonable timeframe. In addition, resolution must be necessary in the public interest.
The IRRD stipulates that an undertaking shall be considered as failing or likely to fail if, broadly speaking, it (i) is in breach of the minimum capital requirements under Solvency II, (ii) no longer fulfils authorisation requirements or is seriously deficient in its legal obligations, (iii) is unable to pay debts or other liabilities, (iv) requires extraordinary public financial support, or (v) has liabilities greater than its assets. Unlike the BRRD, the IRRD does not provide an exemption for precautionary recapitalisation, i.e. public measures that may be carried out without triggering a determination that the undertaking is failing or likely to fail.
The IRRD will not adversely affect or prevent the co-existence of national insurance guarantee schemes officially recognised in a Member State with the recovery and resolution framework introduced by the IRRD. This would in any case not affect Luxembourg, which does not have a national insurance guarantee scheme.
There is no harmonised system of insurance guarantee schemes across the EU, but a review clause, mandating the Commission in consultation with EIOPA to submit a comprehensive report on existing insurance guarantee schemes as well as policy options 24 months after the entry into force of the IRRD, could pave the way for harmonisation in this area.
Unlike the resolution regime applicable to banks, the final compromise IRRD text – as was already apparent during the trilogue – does not envisage an EU-wide single resolution fund. Instead, it provides for financing arrangements to be implemented by Member States. These should ensure that the resolution authority has adequate funds at its own disposal through ex ante or ex post contributions, or a mix thereof, on the country’s insurance undertakings.
The aim of the financing arrangements is to compensate policyholders, beneficiaries and claimants of insurance undertakings, as well as to satisfy any no-creditor-worse-off claims[2] of other creditors and shareholders if this is necessary to avoid reliance on public funds. This may entail a decision by Member States that the financing arrangements can be used to absorb losses of policyholders, beneficiaries and claimants. In such cases, the failing undertaking would exit the market and all or part of its portfolios of insurance contracts transferred using the sale of business tool or to a bridge undertaking, or maintained in the undertaking under resolution if it is placed in solvent run-off.
Under the IRRD, EIOPA will have responsibilities including drawing up guidelines, regulatory technical standards and implementing technical standards. In the absence of an insurance union comparable to the EU banking union and supervision by a central authority such as the European Central Bank, the IRRD does not envisage a central resolution authority, such as the Single Resolution Board. Instead EIOPA should play a mediation role to ensure effective co-operation across borders if national resolution authorities disagree on decisions relating to insurance undertakings or groups. For this purpose, EIOPA will establish a Resolution Committee on which all heads of national resolution authorities are represented.
The IRRD will enter into force 20 days after its publication in the EU Official Journal. Member states shall transpose the IRRD into national law within 24 months of its entry into force.
The IRRD incorporates a review clause requiring the Commission, in consultation with EIOPA, to submit a comprehensive report about the effectiveness of the directive within 60 months of its entry into force.
For any assistance regarding the IRRD, please contact us:
Linklaters Luxembourg
Eliane Dejardin Botelho – Partner, Luxembourg, Capital Markets and Banking eliane.dejardin_botelho@linklaters.com
Gonçalo Sampaio – Associate, Luxembourg, Capital Markets and Banking
goncalo.sampaio@linklaters.com
Linklaters Germany
Frederik Winter – Partner, Frankfurt, Financial Regulation
frederik.winter@linklaters.com
Linklaters Belgium
Etienne Dessy – Partner, Brussels, Financial Regulation
etienne.dessy@linklaters.com
Linklaters France
Ngoc-Hong Ma – Partner, Paris, Financial Regulation
ngoc-hong.ma@linklaters.com
Linklaters Netherlands
Bas Jennen – Partner, Amsterdam, Financial Regulation
bas.jennen@linklaters.com
Linklaters Spain
Paloma Fierro – Partner, Madrid, Financial Regulation
paloma.fierro@linklaters.com
Linklaters Italy
Anna Ferraresso – Counsel, Milan, Banking and Capital Markets
anna.ferraresso@linklaters.com
Linklaters Portugal
Vera Ferreira de Lima – Counsel, Lisbon, Capital Markets
vera.lima@linklaters.com
[1] The final compromise text is available here
[2] No creditor worse off claims are calculated according to the creditor hierarchy in normal insolvency proceedings, preventing shareholders and other creditors from receiving compensation before policyholders, beneficiaries or claimants have been fully compensated.
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