The usually predictable world of portfolio transfers received a jolt on 16 August when Mr Justice Snowden declined to exercise his discretion to sanction the proposed insurance business transfer of a £12.9 billion book of in-payment annuities from The Prudential Assurance Company Limited (Prudential) to Rothesay Life Limited (Rothesay). This is believed to be the first time ever that the court has refused to sanction a Part VII scheme that has been passed by both the independent expert and the insurance regulators, the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA).
Whilst certain commentators believe that this may signal the death knell for other large life insurance transfers, we believe that the scope of Mr Justice Snowden’s judgement is of relatively limited effect. The judgement centres on:
- The particular nature of in-payment annuities whereby (unlike general insurance and other types of life insurance) the policyholder is unable to surrender his policy or otherwise switch to a new provider if he doesn’t like the transferee imposed on him under a scheme. In such a case, the choice by a policyholder of the original insurer arguably bears significantly more importance than such choice for other types of insurance; and the age, history and reputation of the selected insurer may be relevant factors in determining whether the court should sanction the transfer.
- The contrast between an insurer that is part of a large financial services group where the parent company which might be called upon to inject capital in the event of financial deterioration, is linked by reputation to the insurer in question, has substantial resources and a history of providing capital as required; and a relatively new entrant with a parent (or significant investor), such as an investment fund, which might not be able to raise further monies if further capital is required by the new insurer.
In the current case, Prudential agreed to sell the book of annuities to Rothesay in March 2018. The transactions (both the initial reinsurance and the anticipated subsequent Part VII transfer) were motivated by Prudential’s need to reduce the solvency capital requirement of its shareholder-backed business in order to facilitate its announced demerger (namely the demerger of M&G Prudential from the Prudential group so that Prudential plc and M&G Prudential will become independent listed companies, the former focusing on business in Asia, the US and Africa and the latter on the UK and Europe). Prudential will become part of the M&G Prudential group.
As is common in transactions of this nature, Rothesay reinsured the policies proposed to be transferred, and hence assumed the economic liability for the book at the time the deal was struck (i.e. in March 2018) pending the Part VII transfer, which would typically take between 12 and 18 months to complete. Insurance business transfers follow a process prescribed by statute (under Part VII of the Financial Services and Markets Act 2000) and although transferring policyholders have the right to object, they have no right to veto the transfer. Instead, the statutory process has built-in protections for the policyholders. These include the report of an independent expert (invariably an actuary) who is required to opine on whether the scheme will have a materially adverse effect on the policyholders; and reports from both the PRA and FCA that (if positive), effectively give their blessing to the proposed transfer. In the current case, the independent expert and the regulators were satisfied that the scheme would not materially adversely affect the policyholders and were therefore supportive of the scheme.
Mr Justice Snowden thought otherwise. His judgement emphasized the following points:
- The role of the court is distinct from that of the independent expert and the regulators and the court’s discretion to sanction the transfer is of real importance: “not to be exercised in any sense by way of rubber stamp…” Snowden J. also considered that the court’s discretion was broad and not constrained by actuarial analysis or regulatory criteria as was the case for the independent expert or the regulators – “If that were the case there would be little purpose to the role of the court in a Part VII scheme”.
- There were about 1000 policyholder objections to the scheme. Their main objection was summarized as being that policyholders who had specifically selected Prudential as their annuity provider for life were being transferred against their will to a smaller insurer with a very different history and reputation, and without a larger group to support it, in order to further the commercial purposes of Prudential.
- Various items of Prudential’s marketing and policy literature emphasized the financial stability, history and reputation of Prudential; and the lifetime nature of the commitment once an annuity was bought from Prudential. It was noted that the lifetime nature of the commitment was one way, e.g. once a policyholder had chosen a Prudential annuity, he was not free to change insurance company; however, although nothing in the literature committed Prudential to itself pay the annuity for life, Snowden J. took the view that it was entirely reasonable for policyholders to assume that if they gave their pension pot to Prudential and could not change that choice, it would be Prudential and no other company that would be providing them with the resultant annuity for the rest of their life.
- Snowden J. considered that the particular nature of an annuity policy represents an important factor in the exercise of the court’s discretion – he noted that the purchase of an annuity was for many people one of the most important decisions that they would ever make, the annuity providing the only, or main, source of regular income for their retirement. Critically, once an annuity has been purchased, the policyholder cannot switch providers. The consequence, in his view, was that policyholders will be particularly concerned to select a company with a good reputation and financial standing that they trust. He contrasted this with a general insurance policy, where a policyholder can usually cancel or not renew their policy each year and seek an alternative insurer in the market place. Snowden J. was of the view that the age and established reputations of the transferor and transferee were not irrelevant where consumers have chosen an annuity provider based on such factors. In such a case, they are factors the court can take into account in exercising its discretion.
- Snowden J. noted that the fact that Rothesay is smaller than Prudential does not necessarily mean that policyholders would have less security of benefits at Rothesay; indeed he noted the view of the independent expert that, measured by coverage ratios for capital purposes (Solvency II Solvency Capital Requirement (SCR) ratios), Rothesay could be considered to be slightly stronger than Prudential. However Snowden J. considered that this does not provide a complete answer to the question of security of benefits and it was necessary to consider the respective capital management policies of the two companies and to understand how they each might react to an unexpected deterioration of their financial position.
- In this regard, Snowden J. agreed with the independent expert’s view that in the event of a deterioration in Prudential’s financial position, it is likely “for obvious reputational reasons” that Prudential plc would provide the necessary financial support to Prudential and that, notwithstanding the demerger, there will remain very considerable financial resources available.
- In contrast, Rothesay – which was originally set up by Goldman Sachs and is now owned by Blackstone (private equity), Mass Mutual (a US mutual insurer) and GIC (a global investor) – could not necessarily look to a parent company with similar substantial resources. Although it was noted that Rothesay had raised funds from shareholders of its parent on previous occasions for its business acquisitions, Snowden J. considered that this “was not the same as the provision of restorative capital to make good an unexpected deterioration in the financial position of the company or to avoid insolvency”. He further considered that the business operations, names and reputations of Blackstone, GIC and Mass Mutual (or any investors that might replace them) were not inherently tied to the business of Rothesay in the same way as the business operations, name and reputation of other parts of the Prudential group are tied to the business of Prudential.
- Snowden J. considered this disparity between the external support potentially available to be a material factor affecting policyholder interests, which had to be taken into account in the exercise of his discretion. Moreover, dismissing the counter argument that since both companies had healthy SCRs and were unlikely to become insolvent, he should address only real threats to policyholders as opposed to fanciful ones, Snowden J. emphasised the long term nature of the annuities and that some would require payment for decades. Whilst he acknowledged that the SCR constitutes sufficient capital to absorb the impact of a 1 in 200 year event in the next year, he said there simply could not be the same level of confidence that a material deterioration of the balance sheets of either company might not occur at some time over the extended period of the annuities. Further, he said that the dicta relating to fanciful threats to policyholders was made in the context of a short term general property and motor liability insurance. The contrast with the current case was, he said, “obvious” – the duration of the annuity policies are many times greater, the impact of a default on annuitants catastrophic in comparison with likely loss under a general policy, and the annuitants do not at any time have the opportunity to renew with any other insurer than Rothesay.
- A final factor that Snowden J. considered was that Prudential had already achieved its substantial business purpose via the reinsurance. Noting the argument that Prudential would have to continue to hold £100m in respect of its credit risk exposure to Rothesay as its reinsurer, he noted that £100m was but a small proportion of the benefits Prudential obtained from the reinsurance; and that in any event, it reflected the credit risk of Rothesay, which the scheme sought to pass on to the transferring policyholders. For Rothesay, the downside was more stark, the disadvantages of remaining the reinsurer include its inability to use the collateral backing the transferring policies and the inability to reduce administration costs. To this Snowden J. gave short shrift - Rothesay knew the scheme required the sanction of the court and should not have assumed it would inevitably be sanctioned.
At the time of writing, we understand that Prudential and Rothesay will be pursuing an appeal. Unless this is expedited, this can be expected to take up to a year and, in the meantime, all part VII transfers will have to take heed of, and seek to differentiate themselves from, the Prudential/Rothesay scheme.