Insurance business transfer schemes have come of age as Paul Bugden reports
Achieving finality should be the ultimate objective of anyone managing a book of insurance business in run-off. One route to finality is to end liabilities to policyholders through an insurance business transfer scheme (IBTS). These have been considered and approved on several occasions by the courts and can be regarded as a tried and tested path to finality.
The IBTS was introduced in Part VII of the Financial Services and Markets Act 2000 (FSMA). Part VII Transfer has become the tag by which an IBTS is commonly known.
The great advantage of an IBTS is that it provides a more effective and adaptable procedure for transferring general insurance business than its predecessor. Most importantly, under an IBTS, the benefit of reinsurances protecting the business may be transferred, without the need for any approval from the reinsurers.
The terms of an IBTS are contained in a short scheme document. The scheme is subject to approval by the High Court, which has been given wide powers to make ancillary orders to ensure any IBTS is effective.
For example, the court may 'transfer property or liabilities'. It is this power that enables the court to transfer the benefit of reinsurance protections. This was established in the judgment1 approving the first IBTS, relating to WASA International (UK) Insurance Company Ltd.
Whilst an IBTS might be thought of as a means of restructuring business within an insurance group, it has become a method of achieving finality in its own right. Finality is achieved once the court approves the IBTS because the transferor has no further liability to policyholders under the transferred policies.
An IBTS may be used to achieve finality as follows:
- To transfer the whole or part of an insurance book in run-off, so the transferor can exit the market or the particular class of business concerned. If the transferor has no further business the court may also be asked to make a dissolution order (such as in the case of Stockholm Re UK Ltd2).
- In respect of a pool, to enable one member to take over the business of all other members, releasing them from liability and collapsing the pool with substantial savings in administrative costs. As an alternative, all pool members may transfer their business to a third party.
- To facilitate a scheme of arrangement, which would otherwise be impossible.
For example, by transferring a book of business from a European Economic Area state to a UK transferee with the intention of scheming the business in the UK following the transfer.
Using an IBTS to achieve finality is relatively straightforward and it has some advantages compared to schemes of arrangement. For example:
- Speed. If properly prepared, an IBTS can be achieved in less than six months. Schemes of arrangement usually take considerably longer.
- Under an IBTS, reinsurers are bound by the Order transferring the reinsurance but not by the terms of a scheme of arrangement.
- No consent by policyholders or reinsurers is required for an IBTS; whereas the required majority of creditors must vote in favour of a scheme of arrangement.
- Once approved, there is no further administration required to implement an IBTS; whereas a scheme of arrangement has complex procedures for submitting, agreeing and possibly adjudicating claims.
- Cost. Typically, an IBTS will be considerably cheaper to implement than a scheme of arrangement.
As with any finality solution, there are regulatory safeguards to take into account. The Financial Services Authority (FSA) plays an important role and should be consulted early and at various stages where its approval/action is required.
But the distinguishing feature in an IBTS is the need for a scheme report prepared by an FSA approved independent expert, who is often an actuary.
Having considered the IBTS, the expert must be sure the policyholders of the transferor and transferee will not be adversely affected by the transfer. The FSA must approve the form of the report issued by the expert.
A recent judgment3 makes it clear the expert is not expected to critically investigate the information provided and may accept, at face value, information which has been audited or is the subject of regulatory reports. Based on information obtained and taking into account the solvency margins of the transferee and transferor, before and after the proposed transfer, he will reach an opinion on whether the policyholders will be adversely affected by the transfer.
This is not simply a mechanical exercise in comparing solvency margins but an exercise in judgment. So, an expert may conclude policyholders will not be adversely affected even if the transferee has a worse solvency margin, provided it is still adequate to justify the opinion that policyholders are not in any real danger of having claims unpaid.
In a recent series of transfers4 the FSA approved of an expert taking into account the existence of group reinsurance protections, when assessing the solvency of the transferee. This was despite the absence of any direct contractual nexus between the policyholders and the parental company providing the reinsurance.
Whilst policyholders do not vote on an IBTS and their consent is not required, they must be given notice. An IBTS must also be advertised.
Should any policyholders object to an IBTS, they can object in writing which will be shown to the court. They may also appear either in person or by counsel and object at the court hearing.
The FSMA specifies5 that "the Court must be satisfied that, in all the circumstances of the case, it is appropriate to sanction the scheme." A balancing act has to be performed, which has been described6 as deciding "whether the scheme as a whole is fair as between the interests of the different classes of persons affected."
Even where one or even a few policyholders show they are adversely affected that will not necessarily prevent an IBTS being approved. It has been held7 that, "it does not follow that a scheme is unfair and hence to be rejected merely because one or more persons or classes of persons are adversely affected by it."
The expert's report is the cornerstone of the court judgment. Where proper procedures have been followed and it is supported by the scheme report and the FSA, there is a likelihood the IBTS will be approved, unless a very cogent case can be made that the scheme is unfair.
One question is whether the UK court order approving an IBTS would be recognised in the US, in particular, whether it would be possible to obtain permanent injunctive relief under Section 304 of the US Bankruptcy Code.
Such an injunction prevents proceedings being pursued against the transferor in the US by policyholders or reinsurers. This question has now been decided by the US courts on an application on behalf of the Aviva group of companies8.
The Aviva group wished to transfer the general insurance business of 12 of its subsidiaries to a single subsidiary: a typical use of an IBTS.
The UK court had approved the IBTS.
The application for Section 304 protection came before Judge Prudence Carter Beatty. She found the court did not have jurisdiction to grant a permanent injunction because an IBTS does not constitute a 'foreign proceeding' within the meaning of the US Bankruptcy Code as it does not concern a liquidation or the adjusting or discharge of debt, which she held was an essential charateristic.
That decision is subject to an appeal and, as it concerns the construction of a statute, there is room for an opposite view from an appellate court.
These developments should not, necessarily, prevent the use of an IBTS where there are US policyholders or reinsurers involved. The position regarding US policy holders can be effectively covered by contractual arrangements between the transferor and transferee.
Issues could arise where the benefits under reinsurances with US reinsurers are transferred to the transferee under the terms of the UK court order.
The US reinsurer may be tempted to take the position that the UK court order does not bind it and the transferor remains its contracting party.
This would enable the reinsurer to run the inequitable argument that it should escape liability completely because neither the transferor nor the transferee can recover from him. The former because it had divested itself of the underlying liability and the latter because it has no contractual right of claim despite the UK court order to the opposite effect.
Such difficulties could, of course, be obviated by obtaining the express consent of the US reinsurers. Another approach would be to assess the risk of US reinsurers taking adverse positions and to factor that into the consideration paid in respect of the IBTS.
In any event, arguments may be successful in the US court to obtain recognition of any IBTS approved by the UK court. Such issues will require careful consideration and proper advice, pending the outcome of the appeal.
In conclusion, the IBTS has come of age. The requirements for successfully promoting an IBTS are now well understood by regulators, legal advisers and the court, and have been growing in popularity in the market. The attraction is that an IBTS can be implemented in a flexible and effective manner, making this route to finality one of the most appealing.
1 WASA International (UK) Insurance Company Ltd, AGF Insurance Ltd and WASA International Insurance Company Ltd  EWHC 2698 (Ch), (2003) 1All ER (Comm) 696.
2 Stockholm Reinsurance Company (UK) Ltd (January 15, 2004 unreported).
3 A judgment by Mr Justice Lindsey in Norwich Union Linked Life Assurance Ltd and Others  EWHC 2802 (Ch), LTL 8/12/2004.
4 Chevanstell Ltd and Others and Riverstone Insurance (UK) Ltd (December 15, 2004, unreported).
5 Section 111(1) (3).
6 Hoffman J in London Life Association Ltd (February 21, 1989, unreported).
7 Norwich Union, Supra.
8 The decision of Judge Prudence Carter Beatty on December 29, 2004 in the matter of London and Scottish Assurance Corporation Ltd.
- Paul Bugden is head of the run-off group at Clyde & Co.