High Court rejects Part VII transfer in Prudential and Rothesay Life case which had been approved by the regulators and blessed by the independent expert.
The decision of Snowden J. in The Prudential Assurance Company Limited and Rothesay Life plc  EWHC 22455 Ch1, handed down on 16 August 2019, sets out a far more interventionist approach to the application of judicial discretion whether to approve a Part VII transfer. This is a very important case which needs to be considered by anybody carrying out a Part VII transfer, but will be of particular significance to acquirers of closed book / run-off insurance policies and insurers looking to sell portfolios to them (in both the life and non-life sectors).
In March 2018, Prudential plc announced plans to de-merge its UK and European business from its business in Asia, the US and Africa. In order to facilitate that demerger, the Prudential group needed to release regulatory capital from its UK and European business. The Prudential Assurance Company Limited (PAC) therefore reached an agreement with Rothesay Life (i) for Rothesay Life to reinsure c.400,000 of its policies, representing gross liabilities of c.£12.9 billion, and (ii) for those policies and liabilities to subsequently be transferred to Rothesay Life by way of Part VII transfer.
The independent expert opined that Rothesay Life would have a "somewhat stronger financial position than PAC, measured by SCR coverage ratio" and concluded that the proposed transfer would not have a material adverse effect on policyholders. Both the PRA and the FCA approved the proposed transfer in their formal reports to the court. Whilst notable for its size, there was nothing particularly unusual about the proposed transfer. Many such transfers have been approved in the past, and the court has generally rejected policyholder objections.
Notwithstanding the positive conclusion of the independent expert and the approval of PRA and the FCA, Snowden J. refused to approve the transfer, and agreed with a number of policyholder objectors. In the course of his 38 page judgment, Snowden J. set out the following reasons for his decision:
- PAC's capital management policy provided a slightly higher level of security than Rothesay Life's capital management policy;
- given that the annuities to be transferred represented policyholders' life savings and that the annuities are intended to last for the remainder of the lifetime of each policyholder, it is not correct to dismiss the possibility of financial failure of either PAC or Rothesay Life as "fanciful", notwithstanding the strong SCR ratios of both applicants;
- the discretion of the court whether to approve a Part VII transfer cannot be restricted to the actuarial analysis or regulatory criteria derived from Solvency II. Broader considerations are also relevant, such as the reputation of the applicants and the likelihood of parental support in the event of financial distress;
- therefore, it is relevant to consider that (i) in the event of financial distress of PAC, it is likely the wider Prudential group would provide parental support from its very large resources in order to protect its ongoing reputation, and (ii) there is uncertainty whether Rothesay Life would be able to access comparable resources from its three main shareholders (being two private equity investors and one US insurer), or that its three main shareholders would have the same reputational incentive to ensure the solvency of Rothesay Life in extreme circumstances;
- in exercising its discretion whether to sanction a Part VII transfer, the court needs to balance the commercial interests of the applicants against the interests of the policyholders. The fact that the reinsurance arrangement has already enabled PAC to release regulatory capital to achieve 90% of its objective is, therefore, a relevant factor.
Why this decision is important
This decision is important for a number of reasons.
1) The decision shows how far the judiciary is willing to go in exercising the discretion whether to approve a Part VII transfer. Whilst it has been accepted mantra for some time that the courts will not just "rubber stamp" the opinions of the independent expert and the regulators, this decision represents a significant shift in how far the courts are willing to go.
2) The decision shows just how broad the court's discretion is, being even wider than the scope of regulatory supervision pursuant to Solvency II and other legislation. The less clearly definable concept of reputation will be a relevant consideration.
3) A comparison of SCR ratios alone is not sufficient. It is important to also consider capital management policies and the likelihood of discretionary group capital support.
4) Transfers from large insurance groups to specialist run-off acquirers might be affected, as the court might conclude that the run-off acquirer will be (i) less able to draw on additional group capital, if it is part of a smaller overall group, and/or (ii) less likely to be able to draw on additional group capital as its investors will have less of a reputational imperative to ensure policyholder payments. Whilst this will be particularly relevant for life insurance, it should not be discounted for general insurance also.
5) Special consideration will need to be given to transfers of annuities (or other life-saving type policies) given the expected duration of those policies and the "catastrophic" consequences for policyholders if payments are not met.
6) Conclusions of an independent expert reached on the basis that an outcome is extremely unlikely to occur might not be accepted as valid by the court (particularly in the case of long term and/or life savings policies).
7) The decision casts doubt on previously accepted principles that (i) it does not matter if individual policyholders or groups of policyholders are adversely effected, so long as the proposed transfer is fair as a whole, (ii) it is not for the court to look for the best possible transfer, but to decide whether the transfer put forward by the applicants is fair. Snowden J. suggests that these principles are only relevant to transfer involving with-profits insurance policies.
Consequences for the closed book market
This decision will be carefully analysed by those in the market for the acquisition of closed book (or run-off) insurance portfolios. Whilst in many cases it will be possible to distinguish the key features which influenced the Snowden J. decision in Prudential and Rothesay Life, there will be many other cases where the characteristics of the Prudential/Rothesay Life transfer will be present.
Consequences for business transfer agreements
In the current case, it is difficult to see what the applicants can reasonably do amend the scheme in order to address the concerns of Snowden J.. A Part VII decision has never been appealed.
Therefore, this decision draws into sharp focus the need for the business transfer agreement (which precedes any commercially negotiated Part VII transfer) to set out what happens if the court rejects the proposed Part VII transfer. Should one party (or both parties) be obliged to provide more regulatory capital? Which party loses more if the Part VII transfer does not complete? Are both parties happy for the reinsurance arrangements to last in perpetuity? Should the parties provide that the reinsurance arrangements will be recaptured if the Part VII is not completed by a certain date, so as to avoid the court reasoning that the commercial objectives of the parties are already mostly met?
Consequences for policyholder documentation
It is worth noting that Snowden J. was influenced by PAC's policyholder documentation which emphasised that annuities with Prudential would be for the lifetime of annuitant. More than once, he noted that the policyholder documentation did not contemplate that the annuities might be transferred to another (re)insurer by way of Part VII transfer. Therefore, insurers might wish to start writing such permissive clauses into their policyholder documentation, so as to make it easier to transfer insurance portfolios in the future.