Part VIIs after Prudential/Rothesay: new judgment suggests limited appetite for interventionism

10 February 2020

The recent High Court ruling approving a Part VII transfer between Equitable Life Assurance Society (Equitable) and Utmost Life and Pensions Limited (Utmost), suggests that the interventionist approach in the Prudential/Rothesay Life case will not become the new norm.

Part VIIs before Prudential/Rothesay

Part VII of the Financial Services & Markets Act 2000 (FSMA) provides a court-sanctioned procedure for the legal transfer of insurance policies from one insurer to another, provided the necessary requirements are deemed by the court to be met. The procedure requires a report on the viability of the transfer to be submitted by an independent expert, which will be considered by the court in addition to submissions from the FCA and PRA and any objections made by policyholders.

While it is strictly speaking acknowledged, following Re TGC plc, that the court’s approval “does not act as a rubber stamp simply to pass without question the view of the majority”, it is also widely accepted (and was acknowledged in that case) that a court would be slow to refuse a transfer which had the approval of the regulators and independent expert. The decision in Prudential/Rothesay Life, handed down by Snowden J. on 16 August 2019 was therefore met with some surprise by the industry.

The judgement in Prudential/Rothesay

In his decision, Snowden J. rejected the proposed transfer of c.£12.9bn in annuity liabilities from The Prudential Assurance Company Limited (PAC) to Rothesay Life (Rothesay), despite regulatory approval and the independent expert being satisfied that the proposed transfer would not materially adversely affect policyholders (and indeed, that Rothesay’s financial position would be stronger than that of PAC). Snowden J. did so on the basis, that:

  • in the event of financial distress, PAC was more likely to receive support from its parent company than Rothesay was from its equity backers;
  • policyholders had a reasonable expectation (based in part on the language of their policies and PAC’s brand marketing), that they would receive their annuity from PAC, which was a “household name”, whereas Rothesay, as a relatively new entrant, did not have a comparably longstanding reputation;
  • the court should balance the commercial interests of the applicants with policyholder’s interests and, in this case the existing reinsurance arrangement between the parties meant the commercial aim of releasing regulatory capital had largely been achieved without the transfer; and
  • the court should have regard to these broader considerations, not only to the actuarial or regulatory criteria considered by the regulators and expert reports.

This unexpected judgement caused some concern amongst insurers that judges may now take a more interventionist approach to Part VII applications - having more regard to the objections and expectations of policyholders and less to the commercial interests of applicant insurers, even where the view of regulators and experts is that there is no cause for concern. But the subsequent judgment approving the Part VII transfer between Equitable Life Assurance Society (Equitable) and Utmost Life and Pensions Limited (Utmost), handed down by Zacaroli J. in December 2019, may suggest otherwise.

Part VIIs after Prudential/Rothesay – the judgement in Equitable/Utmost

The case involved the Part VII transfer of a book of (a) “with-profits” and (b) “unit-linked” life assurance and pensions contracts from Equitable to Utmost, and an associated scheme of arrangement to restructure the “with-profits” policies as “unit-linked” policies, as part of Equitable’s business plan for solvent run-off. In approving the transfer, Zacaroli J. considered Prudential/Rothesay, but distinguished it on the basis that, in contrast to Prudential/Rothesay:

  • policyholders would in most cases be free to transfer their policies to another provider post-transfer (as they would be unit-linked policies, rather than annuities);
  • the transfer from Equitable to Utmost was commercially necessary to achieve Equitable’s aim of distributing assets fairly to policyholders while in solvent run-off;
  • the transfer and associated scheme of arrangement were intended to benefit the policyholders as a whole by avoiding unfairness between them and cost-inefficiencies in run-off; and
  • as a company with potential capital support from its parent, Utmost had a greater likelihood of receiving financial support in distress than Equitable Life (which is a stand-alone mutual company in solvent run-off).

Notably, apart from noting the support of the majority of policyholders’ for the transfer, Zacaroli J. gave much less consideration to the policyholders “reasonable expectations” as to whom their policy was with and whether it was capable of transfer.

Zacaroli J.’s apparent willingness to distinguish Prudential/Rothesay may suggest there is limited judicial appetite for the more interventionist approach adopted by Snowden J in that case. This is perhaps unsurprising, given the challenge it would pose to the insurance industry if such transfers could not be effected with certainty. Indeed, the Prudential/Rothesay ruling has yet to be used as authority to refuse a Part VII transfer (and the ruling is also currently the subject of an appeal).

Nevertheless, Zacaroli J.’s reasoning suggests that the decision in Prudential/Rothesay will direct the courts’ attention more to certain policyholder-focused features of a transfer – such as the ability of policyholders to transfer their policy, the reputation of the transferee and expectations of policyholders where they cannot freely transfer their policy, and the applicants’ relative likelihood of support in financial distress. As such, efforts to distinguish Prudential/Rothesay from comparable Part VII transfers may see the development of new principles regarding the appropriateness of transferee insurers.

Questioning the prudence of Matching Adjustment

The case is also interesting for Zacaroli J.’s discussion of Matching Adjustment in response to an objection raised by a policyholder with former experience in capital management at the Bank of England. Matching Adjustment allows insurers to seek regulatory approval to value certain long-term liabilities at a higher than risk-free discount rate where those liabilities are matched with eligible buy-to-hold assets, on the basis that insurers are not exposed to the risk of having to sell such assets before maturity. As this lowers the balance-sheet value of those liabilities, insurers are required to hold fewer assets to cover such liabilities, allowing them to price more competitively to insure them. Due to the long-term nature of the liabilities they insure, Matching Adjustment is a significant aspect of the balance sheet of many life insurers.

The policyholder objected that Matching Adjustment should not apply, on the basis that “if a liability is issued on the expectation or promise that it is risk-free, then it must be discounted at the risk free rate”, and doing otherwise artificially inflates the insurer’s capital position (since, in the absence of Matching Adjustment, more of its assets would be applied to cover the liabilities it insures). The policyholder argued that Utmost’s capital position, when judged without Matching Adjustment, should be considered to pose a solvency risk. Predictably, the judge dismissed the objection on the basis that the transfer should be assessed on the basis of the current applicable law, and the case was the inappropriate forum to challenge the introduction of the matching adjustment concept into legislation. Nevertheless, the discussion provides an interesting insight into competing views of this key element prudential regulation.

The judgment can be found here.