Bermuda: Bermuda Protection Of Policyholders: Legal Reform On The Horizon

Last Updated: 3 July 2017
Article by Nick Miles

The Bermuda Monetary Authority ("BMA") has published its second Consultation Paper on the subject of "Policyholder Protection" (dated June 2017). The Consultation Paper restores to the agenda the questions whether legislation should be introduced protecting policyholders in the event of failure of an insurer registered under the Insurance Act 1978 (the "Insurance Act"), and if so what form it should take. The proposal has laudable objec­tives but may need technical refinement to be workable. Interested persons have until 14 July 2017 to provide feedback. The proposal applies to all insurers registered under the Insurance Act (that is, commercial insurers, captive insurers and special purpose insurers), whether the insurer carries on long-term business or general business. It applies to the insurer's obligations to reinsurance policyholders as well as its obligations to direct insurance policyholders.

Many jurisdictions make specific provision for the protection of policyholders on insurer failure, whether by statutory priority of debts or a policyholder protection scheme, or both. As yet, Bermuda has no such regime applicable to insurers generally. The International Association of Insurance Supervisors regards the existence of a legal framework that affords priority to the claims of policyholders in a liquidation of an insurer as among the criteria of a sound regulatory and supervisory regime. In keeping with its position as a leading supervisor of insurance, the BMA has proposed amendments to the statutory priority of creditors' claims in a winding up of an insurer.

As things stand, in the winding up of a company under the Companies Act 1981 ("Companies Act"), whether or not the company is registered as an insurer under the Insurance Act, the claims of creditors of the company are ranked, subject to the earmarking of any long-term business fund of the insurer for the payment of long-term business liabilities, in the following order:

1 secured creditors with fixed charges enforce their security outside the liquidation, but essentially in priority to all other creditors;

2 the costs and expenses of the liquidation;

3 debts due to employees located in Bermuda under section 33(3) of the Employ­ment Act 2000;

4 "preferential payments" to preferential creditors pursuant to section 236(1) of the Companies Act 1981, including unpaid taxes under the Taxes Management Act 1976, unpaid social insurance/Government pension contributions under the Contributory Pensions Act 1970, liability for compensation under the Workmen's Compensation Act 1965, and payments of up to $2,500 due to employees resident outside of Bermuda;

5 debts secured by a floating charge (although higher priority debts must be paid out of any property secured by a floating charge if the assets of the company are not otherwise sufficient to meet them pursuant to section 236(5) of the Companies Act 1981);

6 unsecured creditors' debts;

7 post-liquidation interest on unsecured creditors' debt claims; and

8 debts due to shareholders in their capacity as such.

Each category of debts must be paid in full before payment of creditors in the subsequent category. Creditors in the same category rank equally among themselves.

In its Consultation Paper, the BMA proposes changes to the Insurance Act that dis-apply section 236 of the Companies Act (referred to in paragraph 4, above) in a winding up of an insurer, and that introduce a new waterfall of preferential payments. In particular, instead of:

(a) confining the range of "preferential payments" to the categories identified in paragraph 4 above; and

(b) giving parity to all such debts, so that preferential creditors rank equally among themselves in respect of preferential payments;

the BMA proposes to add certain insurance debts to the range of preferential payments and to introduce an internal "waterfall" within the category of preferential payments, as follows:

(i) pension contributions under the Contributory Pensions Act 1970;

(ii) wages or salary due to employees due to employees resident outside of Bermuda;

(iii) accrued holiday remuneration due to employees due to employees resident outside of Bermuda;

(iv) all amounts due to policyholders of any contract of insurance (excluding prepaid premium amounts);

(v) prepaid premium amounts made by a policyholder prior to inception of a contract of insurance;

(vi) unpaid taxes including under the Taxes Management Act 1976; and

(vii) compensation under the Workmen's Compensation Act 1965.

The changes would not affect the priority given to debts in categories 1 to 3, above (fixed charge-holders, employees located in Bermuda, liquidation costs), which will continue to rank ahead of preferential payments.

As the BMA notes in its Consultation Paper, given the infrequent incidence of insurer failures in the jurisdiction, the exacting nature of the prudential standards applicable under Bermuda's supervisory regime, and the predominantly wholesale character of the business written by Bermuda insurers, the establishment of a statutory priority in a winding up of an insurer should give sufficient protection to policyholders and is not unduly burdensome on the industry.

The BMA has prudently proposed that the priority of insurance debts should apply to both direct insurance and reinsurance claims (in other words, that there should be no priority of insurance debts over reinsurance debts). Given the large volume of reinsurance business written in Bermuda and the predominance of large, commercial clients, this is obviously appropriate.

While the balance that the proposal strikes between the need for policyholder protection and the interests of the industry is laudable, the BMA's proposal may need to be adjusted in order to address the following issues:

  • The BMA has not explained how if at all the balance of section 236 of the Companies Act will apply to insurers being wound up under the Companies Act. Thus, the remainder of section 236 covers various matters, such as a sub-limit on preferential payments of wages or salary, restriction of preferential Workmen's Compensation Act payments taking a form of periodic payments, the respective ranking of preferential debts between themselves (under the Companies Act, they have parity with each other, but the BMA's proposal is to apply a waterfall within the class of preferential debts), and the ranking of preferential debts over the claims of floating charge-holders. The BMA's proposal will need to explain the interplay with these matters.
  • The proposal does not explain the relative priority of the claims of holders of debentures secured by, or holders of, any floating charge created by the insurer. Under section 236(5) of the Companies Act, preferential payments have priority, so far as the assets of the company available for payment of unsecured credi­tors are insufficient to meet them, over the claims of floating charge-holders. Assuming the same structure applies the BMA's restructured category of prefer­ential payments, the BMA's proposal would have the quite bold result that the claims of floating charge-holders are postponed until all policyholder creditors of the insurer have been paid in full. This would rob a cedant with a floating charge over an insolvent reinsurer's assets of the security for its debts in the winding up of the reinsurer, the secured assets being made available for the payment of insurance debts generally (not just those of the cedant). To be fair, as noted above, it is not clear that section 236(5) of the Companies Act will apply to the BMA's proposal, but if it does not, then the BMA needs to confirm what replaces that section.
  • It does not explain how the preferential payments waterfall is to be applied where the insurer is a composite insurer. For a composite insurer, one would expect there to be two classes of preferential payments, those attributable to the long-term business of the insurer and those attributable to the general business of the insurer, with any surplus assets attributable to either business to be available to pay any preferential payments not satisfied out of assets attributable to the other business.
  • It confines the insurance debts with preferential status to the claims of "policy­holders". This term is liable to create confusion. For example, it is not wholly clear that it includes persons who are not designated "policyholders" under a contract of insurance but who nevertheless have the legal right to claim or benefit under the policy. Additionally, it may not encompass persons with independent direct rights against the insurer under foreign statute.
  • It is not clear why preferential refunds of premium should be confined to advances paid prior to inception. Why should refunds of "time off risk" premium under cancelled policies not enjoy a similar priority?
  • The subordination of claims for refunds of premium to claims for policy proceeds may cause unfairness in some contexts. For example, some contracts of long-term insurance business have a surrender value on termination of the policy, essentially involving return of premium. It may be unfair that the rights of creditors proving in respect of surrender value should be postponed until those proving in respect of policy proceeds have been paid in full.

A simpler solution (the equivalent of which as has been adopted in other jurisdictions, such as the United Kingdom) may be to leave the category of preferential payments under section 236(1) of the Companies Act unchanged and interpose insurance debts as a category that is subordinate to preferential payments and senior to the claims of general unsecured creditors. This would have the advantage of retaining the sub-limits on prefer­ential payments imposed by subsequent provisions of section 236 of the Companies Act, including the clarification that the claims of floating charge-holders are subordinate to pref­erential payments but senior to insurance debts. Of course, this would stymie the BMA's objective of an internal priority of preferential payments, with overall priority to pension contributions. However, it would make the overall proposal of policyholder protection considerably clearer and easier to implement.

The BMA has signalled that restructuring the liquidation waterfall is just the initial stage of its consultation on insurer resolution, and that other issues will be examined in future consultations. Whether this will include consultation on formal insolvency procedures alternative to winding up, such as administration, is not yet clear.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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