Part VII transfers of insurance business are now a well-established process in the UK. The insurance market recognises their value and effectiveness, which has translated into an increasing number of applications across all business lines. In this newsletter, we focus on the importance of Part VII transfers; the alternatives to a transfer under Part VII; the evolving role of the regulators; and the role and impact that the introduction of Solvency II is having on the Part VII process.
What is a Part VII transfer?
English law insurance policies are a contract and accordingly, the liabilities under an insurance policy cannot be transferred without the agreement of both the original parties (the insurer and the policyholder) and the new third party (the transferee) to a novation of that contract. Due to the vast number of policyholders an insurer may have, the need for policyholder consent to effect a novation raises a number of obvious practical issues when considering the transfer of whole, or part, of an insurance business. Insurance business transfers under Part VII of the Financial Services and Markets Act 2000 (as amended from time to time) (FSMA) enable insurance and reinsurance business, potentially comprised of millions of insurance and/or reinsurance policies, to be transferred from one insurer to another by operation of law, bypassing the need for individual policyholder consents (although the policyholder must be notified about the proposed transfer and their interests and objections taken into account).
Part VII transfers can be used to transfer general, life and pure reinsurance business. Part VII also contains wide powers to allow an insurer to transfer assets, liabilities and other non-insurance contracts related to the business, so as to give proper effect to the transfer of the insurance business. Part VII transfers are effected by way of court order, the effect of which is to allow the transfer of insurance contracts within the EEA. The rights of the transferring insurer are transferred to a new insurer and the transferee is released from its ongoing obligations and liabilities in accordance with the terms of the order.
The legislative authority for Part VII transfers under FSMA derives from various European insurance directives which require member states to provide a mechanism for sanctioning transfers of business by insurers. The objective of these directives is to increase the free flow of insurance services and to consolidate and harmonise the process by which insurance business transfers are facilitated across the EEA.
Alternatives to a Part VII transfer?
The requirements to make applications to the court, to carry out an extensive policyholder communication exercise and the duration and costs of a Part VII transfer process may lead insurers to consider alternative methods for the transfer of insurance businesses, the alternatives are few in practice:
- Novating individual policies. Where an insurer is seeking to transfer only a small number of policies, it may be possible to individually novate them if policyholder consent can be obtained. However, it is important to note that the Part VII regime is mandatory for transfers of direct insurance business. This means that the novation of even a small number of policies with the consent of policyholders may still amount to a “transfer of insurance business” requiring the sanction of the court under Part VII. The FCA has issued guidance on this point in its Supervision Manual (SUP) at SUP 18.1.5 and the PRA has set out its view in its April 2015 Statement of Policy “The Prudential Regulation Authority’s approach to insurance business transfers” (the PRA Statement of Policy). Both the PRA and FCA are likely to consider a novation, or a number of novations, as amounting to an insurance business transfer only if their number or value were such that the novation was to be regarded as a transfer of part of the business. There is no further guidance on the number of novations that may constitute an insurance business transfer. In practice, this means that, in the event of the transfer of even a small number of policies, the regulators should be consulted in order to confirm that the novation does not trigger the Part VII regime. If an insurer agrees to meet the liabilities (this may include undertaking the administration of the policies) of another insurer by means of a reinsurance contract, including Lloyd’s reinsurance to close, this would not constitute an insurance business transfer because the contractual liability remains with the original insurer; nor would an arrangement whereby an insurer offers to renew the policies of another insurer on their expiry date.
- Reinsurance. Entering into a reinsurance agreement presents a viable option for avoiding a full transfer of legal title under Part VII of FSMA while still transferring economic risk in a portfolio. However, the insurer will remain liable to its policyholders if the reinsurer becomes insolvent or otherwise fails to pay.
- Transferred renewals. Where small portfolios of general insurance are renewed from year to year, the transferor and the transferee can agree that, as and when the insurance needs to be renewed, the transferee will renew the policy so that the transferor will avoid liabilities under the renewed policies. However, this will not necessarily prevent policyholders making a claim against the transferor if the transferee becomes insolvent, notably on a "claims arising" basis.
- Sale of shares in an insurance company. Where the whole of an insurance business is being transferred, it may be more appropriate to effect a sale of the entire issued share capital of the company. By doing so, there is no need to novate the insurance policies themselves although other regulatory consents will be needed (e.g. consent for a change in control of the insurer itself).
Role of the Regulators
Transfers of insurance business under Part VII fall under the remit of both the PRA and the FCA. Although, the PRA Statement of Policy no longer includes references to the "appropriate regulator" and makes it clear that under the Memorandum of Understanding between the PRA and the FCA (the MoU), it is the PRA that leads the process for insurance business transfers and will be responsible for specific regulatory functions connected with Part VII applications, including the provision of certain certificates under section 111 of FSMA.
That said, in practice both regulators play an active role in any Part VII transfer and both independently express their requirements, views and opinions according to their specific statutory objectives. The FCA sets out its approach to, and expectations in respect of, insurance business transfers in SUP 18 of the FCA Handbook. For the FCA, Part VII proposals will be considered in light of the following statutory objectives: (i) to secure an appropriate degree of protection for consumers; (ii) to protect and enhance the integrity of the UK financial system; and (iii) to promote effective competition in the interests of consumers. An insurance business transfer by way of a Part VII offers several layers of protection for policyholders: policyholders have the opportunity to object to the proposed transfer; the scheme is reviewed by an independent expert whose role includes determining whether the scheme should be permitted; the transfer must be reviewed by both the FCA and the PRA; and the scheme is subject to approval by the court.
The PRA states that one of its key concerns is to satisfy itself that each policyholder has adequate information and reasonable time within which to determine whether or not he is adversely affected, and, if adversely affected, whether to make representations to the court. In practical terms, the FCA team will focus on issues such as policyholder protection, whilst the PRA will take the lead on the independent expert’s report.
PRA Statement of Policy
The PRA Statement of Policy sets out the PRA’s approach to and expectations in respect of transfers of business under FSMA, some insurance business transfers outside of the UK and friendly society transfers of engagements and amalgamations and it should be read together with the FCA guidance set out in SUP 18 of the FCA Handbook. Whilst the changes made by the Statement of Policy were not significant, its publication marked a departure from the standards in SUP 18 and has created some regulatory overlap but has provided clarification in a number of areas.
The Statement of Policy suggests that firms can discuss their insurance business transfer proposals with either the FCA or the PRA first as it no longer includes references to approaching the PRA first as was the position under SUP 18. In practice, firms tend to approach both regulators at the outset on a joint basis to ensure consistency of presentation and messaging and that both regulators are treated equally.
To the extent that the transferee is authorised in the UK, the PRA will need to certify that the transferee will meet its solvency margin requirements after the transfer. If a transferee does not meet its solvency margin, the position under SUP was that the PRA would not issue a certificate of solvency in any circumstances. Under the Statement of Policy, this position has shifted slightly and the PRA now appears to be able to “reply favourably” unless the PRA has “serious concerns” about the firm.
One of the key differences between the PRA Statement of Policy and FCA SUP 18 is the removal of the references to fairness. The PRA clearly notes that its statutory objectives differ to those of the FCA and does not include any references to objecting to a Part VII if it is “unfair” to policyholders in the way that the FCA guidance does. In terms of notifying policyholders, the PRA no longer expects any “further notification” if it is not satisfied that policyholders have received adequate information in the PRA Statement of Policy.
The starting point for communications with policyholders is that unless the court directs otherwise, notice of the application for a Part VII transfer must be sent to all policyholders of the parties and any reinsurers whose contracts of reinsurance are proposed to be transferred as part of the transfer. In practice, the parties invariably seek a waiver from the court from having to comply with such an onerous requirement, on the basis of an overall communications strategy which is agreed with the PRA and FCA in writing in advance of the first hearing (the directions hearing). A notice of the application must also be published in the London, Edinburgh and Belfast Gazettes and at least two newspapers, in accordance with requirements in the Financial Services and Markets Act 2000 (Control of Business Transfers) (Requirements on Applicants) Regulations 2001 (Business Transfer Regulations).
Two significant issues that are often encountered in preparing a communications strategy are a lack of up to date policyholder records and the cost of communicating with policyholders. Whilst the Business Transfer Regulations only require that the PRA approve, in advance, the form of the notice sent to policyholders and published in the press, in reality both regulators seek to comment in detail on the overall communications plan and the specific communications documents at an early stage of the process . They will also want to ensure that there is an adequate period of time between receipt of the communications documents by policyholders and the date of the final court hearing. Current PRA and FCA guidance is that this period should be no less than six weeks, depending on the nature of the book of policies subject to the transfer. Obtaining PRA approval is one of the two hurdles in the communication strategy as the approval of the court must also be obtained at the first court hearing.
Impact of Solvency II
In January 2015, Andrew Bulley and Chris Moulder of the PRA wrote to firms to explain how the PRA would deal with Part VII transfers during 2015 in light of the implementation of Solvency II. The emphasis of the letter was upon the limited resources the PRA had to meet the requirements of the significant number of firms who were seeking to complete transfers before the implementation of the Directive.
In practice, this meant that no new applications for Part VII transfers by the end of this year were accepted by the PRA and FCA, meaning there is now a backlog of transfers as we move into 2016. Therefore, going forward, whilst resource constraints may ease next year, early engagement with both regulators in order to agree a timeline is key. Once the timeline is set, it is imperative that the parties stick to the milestones in that timeline in order to ensure a successful Part VII transfer.
Whilst there has been an increase in Part VII transfers recently, on average such transfers are taking longer to be approved and sanctioned. The "twin peaks" regulatory framework has added to the complexity and length of the process and both regulators are taking a more forensic approach to their review of Part VII transfers. Recent transfers have highlighted the need to communicate early and frequently with both regulators, and certainly, both the FCA and PRA emphasise the importance of early engagement as it allows them to establish a realistic timetable for all involved in the transfer. Further, it allows any issues to be raised at an early stage so that they can be addressed as quickly as possible rather than being addressed at the point in time of the court hearing.
While the final decision of whether a scheme should be sanctioned is one for the court, the court will rely on both regulators for their technical knowledge and comfort that it is appropriate to sanction the scheme.