Insurers in financial difficulties Section 377 of the Financial Services and Markets Act 2000
Section 377 of FSMA 2000 currently provides a power for the court to reduce the value of one or more of the contracts of an insurer which has been ‘proved to be unable to pay its debts,’ as an alternative to making a winding-up order (which would place the insurer into liquidation). This reduction is referred to as a ‘write-down’ of liabilities. The power in FSMA 2000 has never been used, and is only described at a high level in legislation. 13 As such, significant uncertainties around its application exist, and may limit its usability, even where it could provide a better outcome for the creditors and policyholders of an insurer in financial distress; for example, by ensuring continuity of cover. The Act clarifies aspects of this power, including:
The liabilities in scope. Broadly, all unsecured liabilities will be in scope, including liabilities to policyholders. The Act creates a number of exemptions, including debts to employees and pension schemes, and sums owed in respect of financial contracts.
The parties eligible to apply to the court for use of the power; and
The test the court must apply when considering such applications.
	The Act also makes the power available when an insurer is, or is likely to become, unable to pay its debts, rather than solely in the event that it is proved unable to pay its debts. 14
	The Act introduces a new position of ‘write-down manager’, an officer of the court tasked with monitoring a court-ordered write down. In practice, we expect the write-down manager will help design the write-down order. Unlike an insolvency practitioner, a write-down manager would not be ‘in possession’ of an insurer, as managers will retain control of the firm. The write-down manager will be empowered to make recommendations to the insurer’s directors, and there is provision for the write-down manager to apply to the court for orders and directions. The role of write-down manager continues until a write-down is terminated or the insurer is wound-up.
	The Act also makes provision for the rules relating to the Financial Services Compensation Scheme (FSCS) to require the FSCS to make payments in relation to protected policyholders whose payments are reduced under a write-down. 15 Currently, while protected policyholders would be eligible for FSCS compensation in the event that their insurer became insolvent, they would not be eligible for FSCS compensation in the event of a write-down under section 377 of FSMA 2000. This mismatch in available protection creates a situation in which protected policyholders may be better off if their insurer fails (given that FSCS protection would apply) than if the court orders a write-down under section 377 of FSMA 2000 to avoid that failure (whereby FSCS protection would not currently apply). The government’s intent is to align the protection available following a write-down with the protection available in insolvency, to better protect policyholders. As the FSCS operates within rules set by the Prudential Regulation Authority (PRA), in its Rulebook , the Act establishes a legislative framework to ensure the PRA is able to make rules facilitating the protection described above.
	The Act also empowers the court to (partially or fully) reverse a write-down if an insurer’s financial position improves, and it is deemed able to pay a greater proportion of its debts. This would result in the value of the insurer’s liabilities being increased.
	The Act additionally sets out that written-down liabilities (and the potential for a future reversal of the write-down) will be disregarded for the purposes of section 123 of the Insolvency Act 1986 (to ensure that an insurer cannot be deemed ‘unable to pay its debts’ on the basis of liabilities which have been written-down), and for the of purposes of Art. 11 of the Solvency 2 Regulation (Recognition of contingent liabilities) and purposes of the PRA’s prudential rules governing insurers. This is to ensure that written-down liabilities are treated as extinguished for these purposes, for so long as the write-down is in force. Without this, an insurer could still meet the statutory test for insolvency following its liabilities being written-down or have the potential for a future reversal of the write-down reflected on its balance sheet as a contingent liability, contrary to the intended effect of the write-down which is to restore an insurer’s balance sheet. The Act gives HM Treasury a power to amend the provisions for which purposes written-down liabilities are disregarded (through statutory instrument under the draft affirmative procedure) (Paragraph 9(3) of new Schedule 19B to FSMA 2000). This power allows HM Treasury to keep the list of provisions in paragraph 9(2) of that Schedule up-to-date, ensuring HM Treasury can address potential future changes in prudential rules and insolvency legislation.
	In addition, the Act introduces a statutory moratorium on certain types of legal action taken against an insurer which is undergoing a write-down. While the moratorium is in place, creditors will not be able to take legal action to recover their debts or to enforce security. 16 In this way, the new moratorium has similarities to the moratorium which currently applies while a firm is in administration. The Act sets out that certain processes, including any actions taken by the PRA or Financial Conduct Authority (FCA), actions to enforce financial awards made by the Financial Ombudsman Service (FOS), and employment tribunals, will be exempt from the effect of the moratorium. Certain arrangements in financial contracts are also excluded from the moratorium to protect parties’ risk management practices. The Act gives HM Treasury a power to alter these exclusions by regulation made by statutory instrument under the draft affirmative procedure (Paragraph 3(4) of Schedule 19B to FSMA 2000). Other types of legal action against the firm or its assets will still be available with the permission of the court. The Act also introduces certain restrictions on an insurer subject to a write-down disposing of its assets without consent from the PRA.