The Iskaboo Guide to Part VII Transfers

By Barbara Hadley

The Iskaboo Guide to Part VII Transfers is a unique practitioners’ guide to Europe’s most popular legal mechanism for exiting or restructuring business portfolios. Since 2002, the number of transfers has risen dramatically with more than 250 approved applications involving thousands of companies. Following the implementation of the European Solvency II regulations in 2016, the increasing popularity of Part VIIs is also set to receive yet another significant boost. Written by practitioners, for practitioners, Part VII transfers: the Guide offers a step-by-step guide on how to implement this complicated but crucial mechanism along with in-depth analysis of the potential risks and pitfalls all updated for 2016. It includes details of new regulations and processes following the establishment of PRA and FCA; the impact of Europe’s Solvency II regulations; an analysis of policy holder objections being considered in EEA courts; and a breakdown and analysis of all transfers from 2002 to January 2016.

• Language: English
• Publisher: BookBaby
• Release date: Mar 7, 2016
• ISBN: 9780957559547

Book preview

Published by

Iskaboo Publishing

22c Lady Margaret Road

London NW5 2XS, UK

www.iskaboo.co.uk

ISBN 978-0-9575595-4-7

Published 2016

Editors

Barbara Hadley

[e-mail]

Dewi James

[e-mail]

Contributors

Derek Austin and Tom Rennell

Design

Victoria Wren

[e-mail]

The original Part VII transfers – a practical guide was written by Nick Miles, Dewi James and Steve Goodlud and published in 2008. This new electronic version has been revised and updated by Dewi James and Barbara Hadley. Acknowledgments also to Mark Chudleigh, Robert S Gebhard and David Powell who contributed to the original publication.

Copyright ©Iskaboo Publishing Ltd 2016. All rights reserved. No part of this publication may be reproduced, stored in any retrieval system or transmitted in any form - electronic, mechanical, photocopying or otherwise - without the prior permission of the publisher. Every care has been taken to ensure that the information in this publication is accurate, but the publisher cannot accept and hereby disclaims any liability to party for loss or damage caused by any errors and omissions.

Contents

Executive summary 4

Introduction 8

Chapter 1

What is an Insurance Business Transfer Scheme 10

Chapter 2

Uses of insurance business transfers 13

Chapter 3

Background legislation – what business may be transferred? 22

Chapter 4

Recognition 36

Chapter 5

What does the court order cover? 52

Chapter 6

The Independent Expert 59

Chapter 7

The FCA, PRA and other EEA regulators 74

Chapter 8

Notification 79

Chapter 9

Practical considerations and implementation issues 84

Chapter 10

Decision of the court 95

Appendix 1

List of Part VII transfers to end 2015 103

Appendix II

Case study – Provident Insurance plc to MMA Insurance plc 144

Appendix III

Case study – Hartford/Excess 147

Appendix IV

Case study – Faraday 148

Appendix V

Case study – Royal London (CIS) 149

Appendix VI

FCA Guidance for Part VII transfers 150

Executive summary

Since it came into effect in 2001 the UK’s insurance business transfer mechanism, commonly known as a Part VII transfer, has grown in popularity, receiving a further boost from the implementation of the European Solvency II regulations at the beginning of 2016. This has acted as a key driver for companies looking to restructure their operations and utilise capital more effectively.

Among their many uses, Part VII transfers are now the most popular legal mechanism when it comes to exiting from loss making or non-core business portfolios within Europe, or effecting a Europe-wide internal restructure. This is because, given the correct level of preparation, Part VII transfers can generally be straightforward and cost effective to implement.

Since 2004 there has been an average of 18 Part VII sanctions a year, with over 250 transfers of life and non-life portfolios effected by the end of December 2015 (see Figures 1 and 2). Perhaps in line with this increase in popularity, the time between application for a Part VII transfer and court sanction has increased moderately over the past decade, with decisions taking an average of 14.6 weeks (see Figure 3). Interestingly, December has been overwhelmingly the most popular month for Part VIIs to be sanctioned (see Figure 4).

Many of these transfers have been in order to reorganise business within large insurance groups – for example AIG, Aviva and Zurich have made extensive use of Part VIIs to reorganise their European organisational structure. Some companies have also used Part VIIs to consolidate their legacy business as well – for example RSA legacy business into British Engine in 2006, Travelers’ consolidation of Unionamerica and St Paul legacy business in 2007 and Hartford Group’s UK legacy business consolidation into Hartford Financial Products in 2015. Those three consolidations through Part VIIs together amounted to around £2.4 billion.

But the process is equally applicable to transfers between third parties, often in order to dispose of legacy business – for example Zurich Specialities to Swiss Re in 2012 and Eagle Star to Riverstone in 2013, transfers which together represented $1.2 billion worth of insurance liabilities.

Due to increased regulator scrutiny, especially where overseas regulators are involved, the time it takes to obtain approval is becoming longer. This, together with increasingly complex compliance issues, a greater emphasis on notification and a growing range of policyholder objections, can make today’s Part VIIs more challenging to implement smoothly. Understandably, specialist legal knowledge is crucial – which may be why over 50 per cent of Part VIIs to date have been led by just six law firms¹ (see Figure 5). Similarly, the Independent Expert plays a vital role in the process, and those appointed to date have mostly been actuaries with extensive expertise in this area.

Looking forward, it is clear that Part VIIs will continue to be popular given their many advantages and benefits, but that greater time and effort on behalf of the transferors, transferees and their advisors will be needed for a successful outcome.

Footnotes:

1 Five if those by Hogan Lovells International LLP and its predecessor firm Lovells LLP are combined.

Introduction

The Part VII transfer takes its name from Part VII of the Financial Services and Markets Act 2000 (FSMA), which replaced the previous business transfer regime set out in Schedule 2c of the Insurance Companies Act 1982.

Part VII of FSMA implemented Article 12 of the EU Third Non-Life Directive and Article 14 Consolidated Life Directives requiring all member states in the European Economic Area (EEA) to allow insurance business transfers. Following amendments in 2007, it also implements Article 18 of the Reinsurance Directive providing for transfers of business of pure reinsurers.

A distinctive feature of the Part VII mechanism, over both its predecessor UK legislation and comparable legislation in other European countries, is that it expressly allows for the transfer of the associated reinsurance asset along with the liabilities.

A further difference between the UK Part VII process and business transfer schemes in other EEA countries is that in the UK the process is controlled by the courts, while in other countries approval is usually granted by the regulator. An amendment in 2009 removed the anomaly regarding Lloyd’s, so that the Part VII provisions now extend to the business of all former as well as current members of Lloyd’s, thereby enabling the Part VII transfer between Equitas and Berkshire Hathaway in June of that year.

A Part VII transfer scheme amounts to a novation of the transferred business. The court order sanctioning the scheme changes the identity of the insurer, so it is as if the policyholder’s contract had always been with the transferee. Therefore this process brings complete finality for the transferor in respect of further exposure to liabilities, to the same extent as a sale, and if appropriate a winding up order can be obtained at the same time as the transfer to close down the transferor if there is no business left in that entity.

Where the portfolio to be transferred is in run-off, the transfer may be the first step in extinguishing its liabilities, perhaps by transfer to the UK where a solvent scheme of arrangement is possible. However it is important to remember that a solvent scheme is a separate process for which approval will have to be sought separately and certain classes of business are excluded from the scope of a solvent scheme (compulsory lines of business notably Employer’s Liability).

The implementation of a Part VII transfer is relatively straightforward and a non-life transfer can be achieved within nine months. Complications may arise which lead to an extended time-frame, for example

• contracts concluded in other EEA states may cause delays

• a Transfer to an EEA insurer not in the UK may similarly lead to extended scrutiny by the UK regulator

In order to sanction the scheme the court must be satisfied that policyholders are not adversely affected. The policyholders affected fall into three groups:

• The transferring policyholders.

• The existing policyholders of the receiving portfolio.

• The remaining policyholders (if any) of the transferor portfolio.

To assess the effect on policyholders, an Independent Expert (IE) must be nominated, and he/she must be approved by the UK regulators - the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) . The IE compiles a report (the form of which must be approved by the regulators), which is then submitted to the court. The regulators may also submit their own reports to the court at both the directions hearing and the sanction hearing stages. In its decision, the court will be influenced by the findings of the IE’s report, the attitude of the regulators and the strength of arguments made by any objectors to the transfer.

The number of objections raised to Part VII insurance business transfers has grown over the years, both informally prior to the court hearing and formally at the transfer sanction hearing. It is likely that many transfers never get to court, either because of objections raised informally or because it appears that the IE’s report will not be favourable. A thorough knowledge of the Part VII procedure and the grounds for approval should help to minimise the chances of a successful objection.

This publication is intended as a practitioner’s guide to the implementation issues of a Part VII transfer, setting out the legal basis for the transfer and the sequence of steps which need to be undertaken to carry out the process. It sets out the uses of business transfers and what business may be transferred, and looks at the issues surrounding international recognition of transfers. In addition to setting out the roles played by the court, the IE and the regulators, it provides a list of practical considerations to be taken into account and a timeline to help plan a successful transfer from start to finish.

Chapter 1

What is an Insurance Business Transfer Scheme

An insurance business transfer scheme (transfer scheme) relocates legal liability in respect of a contract or group of contracts of insurance without the consent of policyholders. With the transfer of legal liability, naturally, go economic, operational and credit risks inherent in the contracts. In its simplest form, it could be assimilated to a wholesale, court-ordered, compulsory novation of all inwards policy obligations from one insurer (the transferor) to another (the transferee). However, the analogy with novation does not take too much probing: novation involves the discharge of obligations under one contract, and the creation of a fresh contract; a transfer, on the other hand, merely involves the substitution of one counterparty for another within the same contract. As discussed below, a transfer scheme may also encompass associated contracts, rights and liabilities; but its greatest value derives from its potential to relieve conclusively the transferor of its policy obligations, and vest these in the transferee.

As a device, it is extremely advantageous to a sophisticated, flourishing insurance industry in allowing firms to adapt themselves to changing regulatory environments, for example through group reorganisation; to avert overall financial distress where the capital requirements of one business line prevent successful lines from generating their full potential of return on equity; to bring finality to the business; and to release capital tied up in insurance portfolios.

The legal regime for transfer schemes in the UK is part of a broader European legislative landscape providing for a harmonised and co-operative approach to authorisation and supervision of insurance business and transfer of insurance business between members of the EEA. (The EEA comprises all European Union Member States¹ plus Liechtenstein, Norway and Iceland.) In the UK, the statutory framework providing for transfer schemes appears in Part VII of the Financial Services and Markets Act 2000 (FSMA) – The Control of Business Transfers, sections 104 to 117.

Because of the non-consensual nature of the process, certain checks and balances exist designed to protect the position of the policyholder. The applicants must take extensive steps towards exhaustive notification of all affected parties. Under the Part VII FSMA procedure an IE, approved by the regulators, must opine that the transfer scheme does not materially adversely affect the position of policyholders. The regulators must confirm that they do not object to the transfer scheme, and that the transferee has provided evidence that it meets requisite solvency and capital adequacy requirements. Where other EEA jurisdictions are involved, local regulatory supervisors must be consulted on the transfer scheme. Finally, the court, whose sanction of the transfer scheme is a pre-condition of its taking effect, will only give its sanction if it is satisfied that in all circumstances it is appropriate to do so.

Each of these stages is subject to a detailed legal framework which promoters of a transfer scheme need to observe.

Transfer schemes are versatile enough to allow the reorganisation via one unitary procedure of books of business in the UK and overseas, regardless of location of risks and policyholders. European legislation provides for the automatic mutual recognition of certain transfers made by courts or regulators within the EEA. This legislation dovetails into the European framework of the authorisation of insurers. It allows an insurer to use its own local courts to sweep up the business of its branch offices throughout the EEA and redomesticate it into one place – whether under its own roof, that of a subsidiary or an altogether unrelated firm. One, and only one, EEA court or regulatory supervisor will have the power to subject EEA wide businesses of one firm to a transfer scheme. Which court or supervisor will depend upon where the firm is headquartered and/or incorporated. This book will identify overseas business that can be reorganised by virtue of a UK transfer scheme and explain the principles that determine which authority in which jurisdiction will be empowered to sanction the transfer of business with an international dimension.

Various items of derivative secondary legislation develop the framework, including the requirements on transfer scheme promoters regarding the notification of policyholders, consultation with overseas regulators, and so on. This book will comment on applicable provisions of Part VII and relevant secondary legislation in the course of discussing specific themes relating to transfer schemes, or stages in the transfer scheme process. Key ‘Guidance’ for promoters of transfer schemes is also provided by the FCA in Chapter 18 of the Supervision section of the FCA Handbook (amended 2013 see Appendix VI), the PRA Statement of Policy (Policy Statement 7 - PS7/15) on its approach to insurance business transfers and the Memorandum of Understanding between the FCA and the PRA.

This book provides a simple, practical account of the process of transferring insurance business, from start to finish, its breadth, uses, and limitations. For brevity, except where context requires greater clarification, this book refers to insurance business transfer schemes as ‘transfer schemes’.

What does ‘business’ amount to?

Transfer schemes may transfer not just the policies themselves but the accompanying infrastructure, essential to the carrying out of the policies or effecting of fresh ones, as well. This includes premises, claims/policyholder records and databases, IT licences, assets capitalising reserves, reinsurances etc. But what is the minimum necessary to constitute a transfer scheme? If only one policy is transferred, is that a transfer? Looking at the same question from a different perspective, will the proposed novation of one or a small number of policies trigger Part VII, requiring transferor and transferee to submit to the entire Part VII procedure before the novations can be regarded as effective?

Carrying on insurance business is defined as effecting and carrying out contracts of insurance. So in theory a transfer of the ‘business’ need not necessarily involve the transfer of contracts of insurance at all, provided the transfer scheme will transfer the functions associated with carrying them out (eg. human resources, the books and records necessary to conduct the business, etc).² This is achieved by transferring the benefit and burden of non-insurance contracts, such as equipment hire arrangements, contracts of employment, etc.

There is nothing in FSMA or relevant statutory instruments that casts much light on this. Rather elliptically, the SUP 18 Guidance states at 18.1.5 that ‘The regulators 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.’

‘Carrying on’ insurance business encompasses effecting contracts and administering them. At several points this book emphasises the importance of where these activities take place. The court will not have jurisdiction to sanction transfer schemes which do not fulfil the criteria set out in section 105 of the FSMA. The criteria are discussed extensively in Chapter 3. In some cases, objecting parties have raised lack of jurisdiction as a ground for opposing the transfer scheme. More about jurisdiction as a ground for objection can be found in Chapter 4.

Notably, business effected outside the UK can still be brought within the jurisdiction of the UK court provided other activities amounting to ‘carrying on’ a business occur within the UK. Adjusting and settling claims are examples of activities amounting to carrying on an insurance business. Thus steps can be taken to bring contracts which are originally beyond the jurisdiction of the English court