Prudential-Rothesay Part VII transfer - sanction brings certainty for the insurance business transfer market

In a decision which marks the culmination of a hard-fought two year process, a transfer of insurance business from The Prudential Assurance Company Ltd (PAC) to Rothesay Life plc (Rothesay) pursuant to Part VII of FSMA (the Scheme) was sanctioned by the High Court on 24 November 2021[1]. The Scheme in question provides for the transfer of some 370,000 annuity policies written by PAC, and was vehemently opposed by a number of policyholders.

Sanction of the Scheme had been initially refused at first instance by Mr Justice Snowden[2]. In reaching his decision, Snowden J gave weight to the perceived difference in financial support and backing of the two companies, with PAC having the support (albeit non-contractual) of a large well-resourced group. He also concluded that it was reasonable for annuitants, having chosen PAC on the basis of its age and reputation, to assume that their policies would remain with PAC for their lifetime.

Over a year after the first instance decision, following an appeal by PAC and Rothesay, the Court of Appeal handed down a detailed judgment on 2 December 2020[3], allowing the appeal in relation to three central issues. In particular the Court of Appeal found that Snowden J erred in his finding of material disparity in parental financial support for each of PAC and Rothesay, and in any event this should not have been a material factor. He had also failed to accord adequate weight to the conclusions of the independent expert, and the non-objection of the regulators (PRA and FCA) to the Scheme. Furthermore, subjective factors, such as the policyholders’ reasons for choosing PAC, were not relevant to the court’s discretion.

Court of Appeal decision - key principles

As the first substantive appeal of a Part VII sanction decision, the Court of Appeal decision was significant in its exposition of the key principles to be followed by the court in such cases. While emphasising that the broad range of business types and commercial circumstances possible mean that no single list of factors can be applied to every scheme, Sir Geoffrey Vos in his judgment drew out certain principles of general application:

• The crucial question is whether the proposed scheme will have any material adverse effect on policyholders, employees or other stakeholders. An adverse effect will be “material” if it is:

1. A possibility that cannot sensibly be ignored having regard to the nature and gravity of the feared harm in the particular case
2. A consequence of the scheme
3. Material in the sense that there is the prospect of real or significant, as opposed to fanciful or insignificant, risk to the position of the stakeholder concerned

• The discretion of the court is unfettered and genuine – it is not there to act as a rubber stamp. However, in exercising its discretion it should take into account and give weight only to matters that are legally relevant, and ignore those which were not. It was noted that the correct identification of which matters fall on which side of the line has caused confusion in this, and perhaps other, cases.
• The court should (in the absence of defects) give full weight to the reports of the independent expert and regulators, not departing from them “without significant and appropriate reasons for doing so”.
• Key factors in determining whether a scheme has a material adverse effect will usually be the objective assessment of the security of policyholders’ benefits and their reasonable expectations, for instance in relation to service standards. The subjective opinions of policyholders are not relevant to the court’s decision.
• Even if the court does find that a scheme will have a material adverse effect on certain policyholders, it still has discretion to sanction the scheme. This may be appropriate, for instance, where the transfer is necessary in a business rescue context.

Sanction of the Scheme

The Court of Appeal remitted the matter back to the High Court for a sanction hearing, which finally took in November of this year. Due to the significant length of time which had passed since the original sanction hearing, new evidence was submitted, including two new reports from the independent expert. Notwithstanding the Court of Appeal decision, a number of policyholders renewed their opposition to the Scheme. It therefore fell to Mr Justice Trower to apply the principles set out by the Court of Appeal. We draw out several points of interest below.

Use of matching adjustment

A point of particular contention was the transferee’s proportionately larger reliance on the use of matching adjustment (MA) – a technique which allows insurers to value long-term insurance liabilities using an upward adjustment to the risk-free discount rate, where those liabilities are matched by long-term assets. The technique is permitted under Solvency II, and both PAC and Rothesay had the necessary PRA approval to utilise it, although Rothesay used MA for a much larger proportion of its business than PAC.

Although opposing policyholders sought to demonstrate that a larger reliance on MA significantly compromised the financial security offered by Rothesay, the independent expert did not give any weight to this. The judge accepted the opinion of the independent expert and noted that, given that the use of MA was a proper and lawful application of the existing regulatory regime, it was difficult to see how the court could conclude that a material adverse effect could be caused.

Persons entitled to be heard

S. 110(1) of FSMA states that “any person (including an employee of the transferor concerned or of the transferee) who alleges that he would be adversely affected by the carrying out of the scheme” is entitled to be heard at a Part VII sanction hearing. In this case, as part of what Trower J referred to as a “wider campaign against the use of matching adjustment”, evidence was filed by certain parties who had no legal relationship (whether as policyholders or otherwise) to PAC or Rothesay. Although they had an interest in the subject, their claim to be potentially adversely affected by this particular Scheme was tenuous at best.

Trower J found that s.110 FSMA is not intended to impose a “merits-based filter” on those who wish to appear, provided that they were capable of being adversely affected by a transfer scheme (however unlikely that may be). However, it was essential that there must be a genuine causative relationship between “the carrying out of the scheme” and the alleged adverse effect. In this instance, the alleged effects were too remote and the individuals in question were therefore not entitled to participate - although for other reasons Trower J did exercise his discretion in this respect and allow one such person to address the court.

Policyholder concerns

Having concluded that the financial security offered by Rothesay was equivalent (if not stronger) than that of PAC, the judge turned to the more subjective points aired by aggrieved policyholders. Trower J made it clear that, although the annuitants’ personal feelings about PAC or Rothesay were genuinely and strongly held, legally – as confirmed by the Court of Appeal – they were not relevant to the court’s decision. The only relevant consideration would be if the policyholders were to adduce objective evidence to back up their stated concern that Rothesay was unable to provide the level of cover required. As regards objective criteria, both the independent expert and regulators had reached the view that the transfer would not have a material effect on policyholders, and the court found no basis to reach a different conclusion.

David Steinberg, Partner in Stevens & Bolton’s insurance industry group, commented "it is rare for the Court of Appeal to be asked to adjudicate upon a Part VII FSMA transfer, so last December’s decision will have been welcomed by the industry and by professional advisers as providing invaluable guidance on this statutory procedure. Trower J’s judgment in sanctioning the transfer this November further emphasised the heaviness of the burden upon objecting policyholders who wish to oppose a transfer. In short, it does not suffice for a policyholder to resist such a transfer on the ground that he doesn’t like the ‘cut of the jib’ of the proposed transferee insurer. Rather, the objecting policyholder will need to substantiate a risk of material detriment, in circumstances where both the independent expert and the responsible regulators – who will inevitably have had access to far more information about both transferor and transferee than an objecting policyholder could hope to have -  will already have given their considered view that no such risk arises."