Euphemism of the day – «Certain changes to the rules on public administration of insurance undertakings»

It has long been well known that Silver Pensjonsforsikring AS (Silver) has been facing major challenges in trying to meet the capital requirements of the Solvency II Directive, and that the company is most likely to go into liquidation if it fails to find a strategic solution to the capital requirements. The Ministry of Finance has so far shown little mercy towards Silver and the company’s owners. Per now Silver meets the capital requirements that apply to pension funds, i.e. the Solvency I rules, but must increase its capital by between NOK three and four billion (source: Dagens Næringsliv, 13.8.2015) in order to meet the Solvency II requirements. Needless to say, it is not a viable option to ask the current owners or new shareholders to inject between NOK three and four billion in new equity in order to manage paid-up policy funds worth approximately NOK eight billion.
Tuesday, August 23, 2016

In November 2015 the Ministry of Finance refused Silver’s application for a temporary exemption from the Solvency II requirements on the grounds that the Ministry was concerned with the safeguarding of customers’ rights. At the same time the Ministry of Finance gave Silver an extended deadline until 1 January 2017 to comply with the Solvency II requirements. Since then Silver’s situation has been most uncertain. The company’s management and owners are working hard to ensure the company’s survival, while about 20 000 customers (mostly holders of paid-up policies) with about NOK 8 billion under management are purportedly trapped in the company (source: Dagens Næringsliv, 13.8.2015).

On Friday 19 August this year the Ministry of Finance issued a hearing note entitled “Certain changes to the rules on public administration of insurance undertakings.” The title, which refers to a proposal to amend the Financial Institutions Act, bears resemblance to a euphemism and conceals some of the dramatics associated with the proposal. Seen from the outside, it is in fact nothing which indicates that the Ministry will deflect and assist Silver or its owners in the battle for the company’s continued existence.

Silver’s insurance portfolio consists primarily of paid-up policies. The company’s business idea was to offer customers “respectable returns” on assets attached to paid-up policies, and the company name Silver were meant to signify that paid-up policies were the pension market’s dusty silver heirloom - thus the company name Silver originated from the Old Norse name “Silfra”. Customers were encouraged to brush the dust of paid-up policies, which according to the company had been lying on the bottom of the chest at the other life insurance companies, without adequate Returns.

Paid-up policies are accumulated (fully funded) defined benefit pension rights which are either earned in previous employment (issued at termination), or issued when an existing occupational defined benefit pension scheme is converted to a defined contribution scheme. The paid-up policies are characterized by the policyholders being entitled to a specific annual pension benefit, usually referred to as contractual or guaranteed benefits. However, a paid-up policy must annually see at least a certain rate of return - often referred to as the interest rate guarantee – in order for the policy to disburse the stipulated annual benefit the policyholder is entitled to receive. It is this interest guarantee which causes Silver’s “challenges” (another euphemism), as capital requirements under Solvency II is considerably more burdensome than those which apply under Solvency I. As far as we know, Silver’s customer base also has a high average interest rate guarantee - probably just below 4% p.a. – which intensifies the problem in today’s low interest regime.

In the case that Silver must be placed under public administration, it follows from section 21-20 (1) of the Financial Institutions Act that the administration board is obliged to attempt to transfer the company’s insurance portfolio to one or more life insurance companies. The appetite of other life insurance companies for acquiring guaranteed benefits is, to put it mildly, modest, and if Silver is forced to be placed under public administration, it is anticipated that a large depreciation of the guaranteed benefits may be required in order to transfer the insurance portfolio to another insurance company - market players have speculated that a depreciation of 30-40% may be required, perhaps more. Such a writing-off will presumably affect policyholders (the owners of the paid-up policies) differently, but for the insurance collective at Silver as a whole, this may result in large overall losses.

In the hearing document published on Friday 19 August the Ministry of Finance proposes a possible solution to this problem - not for Silver, but for its customers. More specifically, the Ministry proposes that the administration board of an “insurance undertaking” (guess which one...) instead of proposing that the paid-up policy benefits may be reduced to enable the transfer to another life insurance company, might propose that all paid-up policies are converted to paid-up policies with investment options for the policyholders. In such a scenario policyholders will no longer be eligible for certain (guaranteed) annual payments, but will then bear the risk of changes to the value of the investment portfolio assigned to the individual paid-up policy. For holders of paid-up policies this implies a possible reduction in value, but also an opportunity for capital appreciation, since policyholders will be able to assign a higher percentage of equities to the paid-up policy than what the life insurance companies per now would consider appropriate. On the expiry of the interest rate guarantee each policyholder will thus be better off if they at least achieve an annual return equal to the interest rate guarantee (excluding administrative and management costs), which can certainly  be an alternative to a greater depreciation of the guaranteed benefits if the portfolio must be transferred to another insurer.

Silver’s customer base must continue to live in uncertainty regarding the company’s fate, also after the Ministry of Finance’ proposed reform, but many will presumably draw a sigh of relief that one can, provided the Financial Institutions Act is amended as suggested, avoid a greater depreciation of the guaranteed benefits if Silver is placed under public administration, and an administration board then proposes a forced conversion to paid-up policies with investment options.

For Silver’s management and owners the Ministry’s proposal, however, must be a gloomy read. Seen from the outside there is nothing to suggest that the Ministry of Finance has any intentions of saving Silver.

The deadline for giving comments to the hearing note is 30.9.2016. We expect the Ministry of Finance will shortly thereafter issue a formal proposal to change Financial Institution Act, with an aim to have the changes passed by the Norwegian Parliament before 1 January 2017.