Insurers in financial difficulties Policyholder Surrender Rights
Certain life insurance policies include an investment element and accrue cash value over time. These policies typically include ‘surrender’ clauses allowing policyholders to terminate their contract early in return for a proportion of its cash value. Examples include unit-linked policies and with-profits policies, which are economically similar to managed funds. Unit linked insurance policies offer both insurance coverage and investment exposure (usually to equities, bonds or an index), allowing policyholders to make regular premium payments which build up additional units. In effect, these products act as a savings/investment vehicle for policyholders. With-profit policies serve a similar purpose, but rather than policyholders buying units representing specific underlying assets (or asset classes/indexes), policyholders share in the overall profits and losses of a firm’s with-profits fund. This allows the insurer to ‘smooth’ investment returns to with-profits policyholders.
	In both cases (unit-linked and with-profits), the policies have a surrender value which policyholders are generally able to convert to cash at will, or switch between different funds in order to reduce investment exposure. When a life insurer is known to be in financial distress, policyholders may choose to surrender their contracts over concern that they will lose value, creating a situation similar in motivation and effect to a ‘run’ on a bank. Widespread policy surrenders could make it more difficult to estimate an insurer’s liabilities or force an insurer to rapidly sell assets in order to meet demands for payment. This could exacerbate an insurer’s financial difficulties, potentially leading to worse outcomes for its policyholders and other creditors.
	The Act introduces a temporary moratorium on life insurance policyholder surrender and switching rights, which will apply in the same circumstance as the moratorium on contractual termination rights described above. The stay will last for an initial 6-month period, with the possibility of extension if granted by the court (or the period the insurer is in administration or a winding up petition has been presented but not withdrawn or determined). The stay will prevent life insurance policyholders from surrendering their policies, although small withdrawals (or ‘partial surrenders’), of up to 5% of the value of the policy in any 12-month period, will still be allowed. The Act also provides HM Treasury with a power to amend this percentage limit through statutory instrument under the draft affirmative procedure (Paragraph 12 of new Schedule 19C to FSMA 2000). As with the moratorium described above, the Act makes available hardship exemptions where the stay would otherwise be likely to cause hardship to policyholders. Such hardship exemptions can be granted by certain parties, including the write-down manager (as well as by the court), making the process less expensive and more rapid, whilst protecting the firm from widespread surrenders.