Council approves new rules on Insurance Recovery and Resolution (IRRD): Key impacts for (re)insurance undertakings

The European Commission proposed the Insurance Recovery and Resolution Directive (IRRD) in September 2021 as part of the ongoing review of the directive on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II¹). Following trilogue negotiations, the EU Parliament approved the IRRD on 23 April 2024. The EU Council gave its final approval on 5 November 2024, which is the last step before the text is published in the Official Journal. 

The IRRD establishes a new minimum harmonisation framework for the recovery and resolution of (re)insurance undertakings. It provides tools to prevent and mitigate the impact of failures of such undertakings. 

This newsflash offers a high-level overview of the main impacts of the IRRD on (re)insurance undertakings. If you have any specific questions, we encourage you to reach out to our experts.

What is the current state of play in Luxembourg?

Limited regulatory requirements for failing (re)insurance undertakings are currently provided by the Law of 7 December 2015 on the insurance sector (the “2015 Law”), which transposed Solvency II in Luxembourg. Under this framework, (re)insurance undertakings are required to:

• establish contingency plans as part of their general governance system to ensure continuity and regularity in the performance of their activities (Article 71 of the 2015 Law);
• establish procedures to identify deteriorating financial conditions and notify the Commissariat aux Assurances (CAA) once these conditions are detected (Article 122 of the 2015 Law);
• immediately inform the CAA if the solvency or minimum capital requirement is no longer met, or if there is a short-term risk of non-compliance, and submit a recovery plan for approval (Articles 124 and 125 of the 2015 Law).

What are the new requirements and key impacts for (re)insurance undertakings?

Under IRRD certain undertakings will be required to draft pre-emptive recovery plans, which must be submitted to the supervisory authority (CAA in Luxembourg) for review and assessment. Furthermore, newly established resolution authorities will draw up resolution plans for certain undertakings after consulting with the supervisory authority.

In this context, Luxembourg must establish a new (re)insurance resolution authority. It is likely that a similar approach to the banking sector will be adopted, where the CSSF acts as both the supervisory authority and the resolution authority, (i.e. by delegating resolution responsibilities to the CAA).

Establishment of pre-emptive recovery plans (Article 5 of IRRD)

Supervisory authorities must ensure that at least 60% of the life and non-life insurance and reinsurance market in their Member State are subject to pre-emptive recovery planning requirements. These requirements consider factors such as size, business model, risk profile, interconnectedness, substitutability and cross-border activities. To ensure consistency and proportionality, (re)insurance undertakings with a resolution plan must comply with pre-emptive recovery planning, but small and non-complex undertakings are generally exempt from these requirements.

Accordingly, (re)insurance undertakings that are not part of a group subject to group recovery planning (Article 7 of the IRRD) will be required to establish and maintain updated pre-emptive recovery plans as part of their governance system. These plans should include measures to restore their financial position if it deteriorates significantly. The IRRD specifies necessary elements for recovery plans, such as indicators for assessing the need for remedial actions, a range of remedial actions and a communication strategy. Recovery plans must be updated at least every two years or whenever there are significant changes in the company’s structure or financial situation.

Pre-emptive recovery plans will be stress tested and EIOPA will issue guidelines detailing the stress testing scenarios that must be considered.

Supervisory review of individual pre-emptive recovery plans by (re)insurance undertakings (Article 6 of the IRRD)

The supervisory authority must review pre-emptive recovery plans within nine months of submission. This review assesses the plan’s ability to restore the (re)insurer’s financial health and its viability during financial stress. If material deficiencies in that plan or material impediments to its implementation are identified, the supervisory authority will notify the undertaking, requesting a revised plan within two months, extendable by one month.

Should the revised plan be deemed inadequate, the authority may require specific changes. If the (re)insurer fails to submit a satisfactory revised plan, the supervisory authority can issue a reasoned decision, instructing necessary and proportionate measures to address the deficiencies.

Establishment of group recovery plans by the ultimate parent undertaking (Article 7 of the IRRD)

The IRRD requires that the group supervisor, as defined by Solvency II, have the authority to require the ultimate parent undertakings to prepare group pre-emptive recovery plans. These requirements are based on the same proportionality criteria as those applicable to individual pre-emptive recovery plans. The group pre-emptive recovery plan shall outline remedial actions to be taken at both the ultimate parent undertaking and its subsidiary undertakings to restore their financial positions if they significantly deteriorate to ensure coordinated and consistent measures across the group.

Supervisory authorities will have the power to require individual subsidiaries to submit their own pre-emptive recovery plans if a group plan does not exist or if previously required changes to the group pre-emptive recovery do not adequately address their concerns.

Establishment of resolution plans by resolution authorities (Article 9 of the IRRD) and obligation to cooperate for (re)insurance undertakings (Article 12 of the IRRD)

The resolution authorities must ensure that at least 40% of the Member State’s life insurance and reinsurance market and 40% of its non-life insurance and reinsurance market are included in resolution planning. These plans will apply to undertakings that are more likely to require resolution action in the public interest if they fail, or those that perform a critical function (are activities, services or operations that cannot be easily substituted, and where their unavailability would be likely to have a significant impact on the financial system or the real economy in one or more Member States) and based on the proportionality assessment by the resolution authority. Similarly to the pre-emptive recovery planning, small and non-complex undertakings are generally exempt from resolution planning requirements. Thus, after consulting the supervisory authority, the resolution authorities will draw up individual resolution plans² for selected entities. 

Resolution authorities are tasked with developing and reviewing plans at least every two years, utilising the insights from undertakings who have in-depth knowledge of their operations. In this respect, the IRRD empowers resolution authorities to demand undertakings to cooperate in drafting these plans and to provide all necessary information (Article 12 of the IRRD). Moreover, the IRRD mandates undertakings to promptly communicate to the resolution authorities any events requiring updates or changes to the resolution plans (Article 9(5) of the IRRD). 

Obligation to notify failure (Article 63 of the IRRD) and resolution tools available to resolution authorities under the IRRD (Articles 26 to 41 of the IRRD) 

The IRRD requires resolution authorities to take resolution action when all resolution conditions as provided by Article 19(1) of the IRRD are met i.e. (a) supervisory and resolution authorities determine that undertaking is failing or likely to fail, (b) there is no reasonable prospect that any private or supervisory action can prevent the failure within a reasonable timeframe and (c) resolution action is in the public interest.

Article 19(4) of the IRRD states that an undertaking is failing or likely to fail in any of the following circumstances: 

(a) It breaches or is likely to breach the Minimum Capital Requirement under Solvency II with no reasonable prospect of compliance being restored; 

(b) It no longer fulfils authorisation conditions or seriously fails its obligations under relevant laws and regulations, or is likely to do so soon, justifying authorisation withdrawal; 

(c) Its assets are, or are likely to soon be, less than its liabilities; 

(d) It is unable to pay its debts or liabilities, including payments to policyholders or beneficiaries, as they fall due, or is likely to soon be in such a situation; 

(e) Extraordinary public financial support is required.

Pursuant to Article 63, the management of the concerned undertakings is required to notify the supervisory authority where they consider that their entity is failing or likely to fail. The supervisory authority informs thereafter the resolution authority about such notification. 

Five resolution tools are provided to resolution authorities by the IRRD in case of failure of a (re)insurance undertaking, namely:

1. The solvent run-off tool (Article 27 of the IRRD) prohibits new contracts and limits activity to managing the existing portfolio until termination and winding-up.
2. The asset and liability separation tool (Article 30 of the IRRD) allows transfer of all or part of assets and liabilities to specific asset management vehicles.
3. The sale of business tool (Article 31 of the IRRD) involves transferring shares or all or part of assets and liabilities to a purchaser on commercial terms.
4. The bridge undertaking tool (Articles 32-33 of the IRRD) enables transfer of shares or all or part of assets and liabilities to a specific bridge undertaking.
5. The write-down or conversion tool (Article 35 of the IRRD) grants the power to recapitalise the entity to apply the solvent run-off tool, or convert equity or other instruments that are transferred to a bridge undertaking or used in the sale of business or asset and liability separation tool.

Sanctions for infringements to recovery and resolution planning obligations (Article 83 of the IRRD)

The IRRD sets out administrative penalties and measures for infringements to:

(i)    the obligations to draw up, maintain and update (group) pre-emptive recovery plans, 
(ii)   the obligations to provide all the information necessary for the development of resolution plans; 
(iii)  the failure of the management of an entity to notify the supervisory authority when that entity is failing or likely to fail.

Bail-in recognition clauses (Article 48 of the IRRD) and recognition of resolution stay power clauses (Article 52 of the IRRD)

The IRRD addresses situations where resolution actions involve assets, rights, liabilities, shares and other instruments of ownership governed by the law of a third country. To ensure the effectiveness of these actions, the IRRD requires the inclusion of bail-in recognition clauses in related agreements. Parties to such agreements shall acknowledge that liabilities may be subject to write-down or conversion powers and agree to any resulting reductions, conversions, or cancellations by a resolution authority. Resolution authorities may also require entities to provide a reasoned legal opinion from an independent legal expert confirming the legal enforceability and effectiveness of such clauses.

Entities will be also required to include contractual recognition of resolution stay powers in any financial contract governed by third-country law. These clauses ensure parties acknowledge that the contract may be subject to actions by the resolution authority to suspend or restrict rights and obligations.

These requirements apply only to contracts that: (a) create a new obligation or materially amend an existing one after the national transposition of this provision; or (b) include termination rights or rights to enforce security interests that would be subject to stay powers if the contract were governed by the laws of a Member State.

EIOPA will draft regulatory technical standards specifying the content of these clauses.

Next steps

The IRRD shall be transposed into national laws and applied within 24 months from when it comes into force. We will provide regular updates on the transposition process of the IRRD into Luxembourg law. In the meantime, (re)insurance undertakings should prioritise comprehending the new recovery planning obligations, which exceed current requirements. Additionally, they should conduct a gap analysis of their contracts to identify where new clauses may need to be included, and start preparing for their implementation¹.