Capital Obligations of Insurance Companies and Circumstances of Financial Weakening

1. INTRODUCTION

Recently, many insurance companies have been faced with capital inadequacy and weakening of the financial structure. This situation is not only a sectoral problem, but has gained a dimension that directly affects the rights and claims of the insured. This bulletin summarizes the capital adequacy regulations for insurance companies, the classification of capital insufficiency situations and the administrative sanctions that may be imposed by the SEDDK, as well as a general roadmap on the steps to be followed for the policyholders of companies with weakened financial structure.

Insurance companies operating in Türkiye are subject to certain capital requirements in order to protect the rights and interests of policyholders, ensure the financial stability and sustainability of the sector. In this framework, the minimum capital requirements of insurance companies are regulated by legislation. Weaknesses in the financial structure are monitored by the Insurance and Private Pension Regulatory and Supervisory Authority (“SEDDK“) and intervened with various administrative measures when deemed necessary.

In this article, we provide general information on the administrative measures to be taken by SEDDK for companies deemed to have a weakened financial structure and the rights of policyholders in this case.

2. CAPITAL INADEQUACY

Turkish Commercial Code No. 6102 (“TCC“) and insurance-specific regulations regulates the minimum capital requirements for insurance companies in order to continue their operations.

Accordingly, the shareholder’s equity of insurance companies should not be lower than their required shareholder’s equity.

In accordance with the Insurance Regulation on Measurement and Assessment of Capital Adequacy of Insurance, Reinsurance and Individual Pension Companies[1] (“Insurance Capital Adequacy Regulation“), shareholders’ equity is calculated using the formula below:

2.1. Shareholders’ Equity = According to the Insurance Capital Adequacy Regulation, Shareholders’ Equity of insurance companies shall be calculated according to the formula below:

[(paid-up capital + capital reserves + profit reserves + losses and gains recognized in shareholder’ equity in accordance with Turkish Accounting Standards + net profit for the period + retained earnings)[2] + (balancing reserve + subordinated loans up to 30% of the required shareholders’ equity for companies established as cooperatives and up to 30% of the required shareholders’ equity for other companies)[3] +  50% of the committed capital, provided that it is deemed appropriate by SEDDK, at least 25% of the nominal capital is paid up and limited to 30% of the required shareholders’ equity]

–

[period loss + accumulated losses + company’s own shares + the companies insurer subsidiaries’ paid-up capital + any other points that can be deemed required to be included by the SEDDK]

2.2. Required Shareholder’s Equity

“Required shareholders’ equity” is the minimum capital level that a company must hold in order to continue its operations. This amount is calculated in two different ways in accordance with Articles 7 and 8 of the Insurance Capital Adequacy Regulation and varies according to the risks carried by the company.

If shareholder’s equity is lower than the required equity, the consequences vary depending on how low the equity is.

2.3. Stages of Capital Inadequacy

The stages when the equity is less than the required equity and the actions to be taken in these cases are explained in the table below:

2.4. SEDDK Procedure for Capital Adequacy Determination

In accordance with the Regulation on Financial Reporting of Insurance, Reinsurance and Private Pension Companies[4] (“Insurance Financial Reporting Regulation“) Article 5, financial statements consist of balance sheet, income statement, statement of changes in equity, cash flow statement and profit distribution statement. Notes and explanations to the financial statements and explanatory reports and tables related to the information contained in the financial statements are integral parts of the financial statements. The balance sheet and income statement and related notes and explanations and appendices constitute the basic financial statements.

Pursuant to Article 11 of the Insurance Financial Reporting Regulation, the financial statements, explanations, footnotes and independent audit report issued in the form and content above constitute the financial report.

In addition, pursuant to Article 12 of the Insurance Financial Reporting Regulation, the board of directors is responsible for the submission of financial reports to the competent authorities, including SEDDK

Reporting and auditing in this context proceed as follows:

- SEDDK Periodical Reporting: According to Article 14 of the Insurance Financial Reporting Regulation the insurance company shall issue the unconsolidated year-end financial reports as of the end of December within two months and the consolidated ones within three months to the SEDDK and the Association of the Insurance and Reinsurance Companies of Türkiye. In case the said financial reports are audited, two weeks shall be added to these periods.

- Capital Inadequacy Reporting: From the date of submission of the financial reports to the SEDDK, reports containing the relevant action plans are made to the SEDDK based on the time periods in the tables in Article 2.3.

- SEDDK Audit: Pursuant to Article 28 of the Turkish Insurance Code 5684^[5] (“Insurance Code“) and Articles 4 and 10/5 of the Presidential Decree on SEDDK^[6] , SEDDK is authorized to conduct audits on Insurance Companies through on-site inspections. In this context, SEDDK has a very detailed checklist and is able to determine the stage of equity capital adequacy in accordance with the Regulation on Insurance Capital Adequacy.

3. WEAKENING OF THE FINANCIAL STRUCTURE AND SEDDK MEASURES

Insurance companies are required to hold sufficient capital to ensure financial stability and fulfill their obligations to policyholders.

As explained above, failure to meet minimum capital requirements has serious legal and financial consequences.

If the shareholder’s equity of insurance companies falls below the required shareholder’s equity, various regulatory measures may be applied.

These measures may range from board changes to operational restrictions and may even lead to license revocation and company liquidation in the later stages. To avoid such consequences, insurance companies should fulfill their capital adequacy obligations and take proactive measures in line with insurance regulations.

Pursuant to Article 11 of the Regulation on the Financial Structure of Insurance, Reinsurance and Pension Companies[7] (“Insurance Financial Structure Regulation”) a company’s financial structure is considered to be weakened if the minimum equity amount required by capital adequacy is not met. In this case, SEDDK is authorized to apply the following measures:

3.1. Primary Measures

Pursuant to Article 20 of the Insurance Code, if it is determined that the financial structure of insurance companies has weakened in such a way as to jeopardize the rights and interests of the insured, the SEDDK may request the following measures to be taken (by giving an appropriate period of time to the insurance company to strengthen the financial structure), regardless of whether it has received a prior notice or not:

- Present and implement an encompassing recovery plan that includes how it shall correct the weakness of its financial structure and protect the rights and benefits of the insured,

- Increase capital, to pay the outstanding portion, to make payments to the company as compensation for the capital, to stop dividend payments or to allocate additional guarantee,

- Dispose the assets in part or in full, or to stop such disposition, to stop acquiring new affiliates and fixed assets,

- Take measures to strengthen its financial structure and liquidity, and to reduce the risks,

- Convene an extraordinary general meeting with an agenda to be determined, or to postpone the general meeting,

- Perform other similar duties.

The Board of Directors is obliged to take the measures requested in this regard and to report its decisions and measures to the SEDDK in monthly reports.

3.2. Secondary Measures

Regardless of whether a warning has been given to the company or a Primary  Measures has been requested, SEDDK is authorized to apply the following second stage measures in the event that (i) the company does not take the Primary Measures or the financial weakening continues despite taking the first stage measures, (ii) it is determined that the weakening of the company’s financial structure cannot be corrected by any means, (iii) the company suspends its payments, or (iv) the company’s shareholder’s equity, excluding unpaid capital, falls below one third of the required shareholder’s equity for the company:

- Transfer the insurance portfolio belonging to one or all of the insurance branches in which its companies operate to another company or companies together with its collaterals and reserves, and if there is no company to take over, to leave the management of the portfolio to the Assurance Account (Güvence Hesabı) or to take all kinds of measures for the liquidation of the portfolio to be transferred.

- Limit the insurance portfolio

- Replace part or all of the members of the board of directors or auditory board, or to appoint new members to these boards by increasing the number of existing members, or to request that the management of the insurance company or reinsurance company is assigned to a trustee,

- Revoke the insurance or reinsurance company’s right to conclude further insurance contracts in all branches or the relevant branches and its authority to renew policies,

- Withdraw the company’s license,

- Block the company’s assets, its assets,

- Request the liquidation of the company.

Recently, many insurance companies in Türkiye have been facing various measures taken by the SEDDK. In its public announcements, SEDDK has stated that it continues its monitoring, surveillance and audit activities with a proactive approach in order to protect the rights and interests of policyholders and to ensure the reliable, stable and efficient functioning of the sector. In this context, policyholders of insurance companies that have been subjected to such measures have been experiencing various concerns due to uncertainty and lack of information about the status of their policies and open claim files.

4. ASSESSMENT OF THE SITUATION FROM THE POLICYHOLDERS’ PERSPECTIVE

Insurance companies operating in Türkiye are required to recognize a provision for outstanding claims in accordance with Article 17 of the Insurance Code. These provisions are in the nature of collateral reserved for the receivables of the insured. In accordance with the legislation in force, the outstanding claims reserves of insurance companies facing administrative measures due to financial weakness should be allocated to the payment of the rights and receivables of the insured.

In the press releases issued by SEDDK for the policyholders of insurance companies that were subjected to second stage financial measures due to financial weakness, it was stated that necessary financial and organizational measures were taken to ensure the prompt payment of indemnities related to existing claim files.

Although the statement made by the SEDDK and the provisions of the legislation regarding the coverage aim to protect the rights and interests of the insured under all circumstances, it should be recognized that the claims of the insured who have receivables from financially weakened insurance companies are risky. In this context, it should be emphasized that policyholders the right to cancel their existing policies on a daily basis. In such a case, possible damage payments should be paid on a day-by-day basis.

Another regulation aiming to protect the rights of the insured is Article 14 of the Insurance Code. Pursuant to the relevant article, in the event that the insurance company’s license is permanently revoked in all branches due to its financial weakness or in the event of its bankruptcy, it may apply to the Assurance Account established within the Association of Insurance, Reinsurance and Pension Companies of Türkiye for the material and bodily damages it is obliged to pay.

5. CONCLUSION

Insurance companies’ compliance with capital requirements and maintaining a strong financial structure is not only a regulatory obligation, but also of vital importance for the protection of the rights and interests of policyholders. SEDDK regulations, which come into effect in the event of insufficient capital or weakening of the financial structure, not only ensure the safety of the sector, but also have direct consequences for the existing policies and claims of the insured.

When an insurance company’s equity falls below the required level, companies are progressively monitored by the SEDDK, and preventive or intervention measures are implemented if deemed necessary. In this process, the company is expected to submit and implement an action plan to close the capital gap. Otherwise, second stage measures may be taken, including license revocation, portfolio transfer or liquidation.

For the insured, the effects are twofold:

- While existing policies remain in force for the duration of the effective period, the claims-paying capacity of financially weakened companies may be uncertain.

- The right to cancel on a daily basis allows the insured to conclude a new insurance contract in line with their risk perception. This right is particularly important for non-compulsory insurance products.

On the other hand, in the event of the cancellation of the insurance company’s license in all branches or its bankruptcy, the indemnity claims of the insured must be covered by the Assurance Account in accordance with Article 14 of the Insurance Law. However, this is only possible in the event of revocation of authorization in all branches or bankruptcy by court decision.

For these reasons, in order to protect their rights and receivables, it is important for policyholders who hold policies with insurance companies that are experiencing financial weakness to closely follow the process and especially the SEDDK announcements, and to seek legal assistance if necessary.

[1] Regulation on Measurement and Assessment of Capital Adequacy of Insurance, Reinsurance and Pension Companies, which was published in the Official Gazette dated 23 August 2015 and numbered 29454.

[2] The sum of these five elements has been defined as “Core Capital” under the Insurance Regulation on Capital Adequacy

[3] The sum of these five elements has been defined as “Supplementary Capital” under the Insurance Regulation on Capital Adequacy

[4] The Regulation on Financial Reporting of Insurance, Reinsurance and Private Pension Companies whicah was published in the Official Gazette dated July 14, 2007 and numbered 26582

[5] Turkish Insurance Law No. 5684 which was published in the Official Gazette dated June 14, 2007 and numbered 26552.

[6] The Presidential Decree on SEDDK which was published in the Official Gazette dated October 18, 2019 and numbered 30922.

[7] The Regulation on the Financial Structure of Insurance, Reinsurance and Pension Companies which was published in the Official Gazette dated August 7, 2007 and numbered 26606.