Tom Riddell:?There are two ways to look at it though. I do not believe schemes are the solution for companies with a really high credit rating and a direct book. I think schemes are fine for reinsurance books, and for companies with a low credit rating. Schemes are something which the creditor base can actively think about and decide whether they would prefer this solution or rather see it all crumble. I think that works. In my view, particularly with the American market, I have great sympathy with direct insurers who are a bit bitter and twisted about having their cover taken away from a high credit rating insurance company. In those situations, I think the solution ought to be a Part VII or transfer to someone like TAWA, that would actively manage the book until it is small enough to be schemed.
Ian McKenna: I think you are right Tom, and it is part of the evolution process. The harbingers of doom, post-BAIC, said there would never be another solvent scheme in the market. I tend to look at these things as a “glass half full” man. English law in any area of commerce evolves and develops. Mr Justice Warren in the WFUM convening hearing, although he did not give us the definitive answer, recognised what Mr Justice Lewison said about BAIC was based on the facts of that particular case. He said he would not be bound by that because the facts might be different in other schemes going forward. Pragmatically, he made the point that Tom made: look at your creditor base, and if it is effectively US direct policyholders you may well have a problem and it may not be fair or transparent, but for a pure reinsurance company it might be right and appropriate to be in one class of creditors and move forward on that basis. It is very much a part of the evolutionary process and the English judges are at the forefront of recognising that London is a centre of excellence and expertise.
Sean McDermott: The scheme is provisioned under the Companies Act and it says you just enter into a compromise with your creditors. All of the schemes have had the same compromise offer. They do not necessarily need to have that compromise position. It could be a completely different sort of compromise that you could put forward, so they could be evolved in different ways. They could be used to tidying up an old book with thousands of policies. You could say if you still have an ongoing policy you will elect to continue with it, and then you could reduce the book down from 50,000 policies to maybe 1,000 or so. So those that want to keep their policies and have continuing exposure can do so.
Rhydian Williams: Surely the concern of the American policyholders is the “cram down” element. The fact is that enough people turning up on the day with the right level of vote can force a dissenting minority to be bound by the scheme. That is their major concern, is it not? Is that not a concern we should be sensitive to?
Ian McKenna: I think we are and increasingly so. BAIC has put the issue in the market. I think people are much more aware of that and the issues that US policyholders are addressing. One also should not lose sight of the fact that ultimately it is the judge who sanctions the scheme; he or she has to be convinced by the evidence at the sanction hearing that this has been a totally fair and transparent process at all stages. That is the ultimate stop gap, if you like.
Rhydian Williams: Would you say that BAIC and WFUM are an endorsement of the whole process, or an indictment of it?
Tom Riddell: I think they are an endorsement of it. I do not think WFUM or BAIC were surprised by it. So what if the court says that in its view the IBNR creditors have a different interest, therefore they have to be a different class of creditor? What is the problem with that?
Ian McKenna: Having looked at it recently, there is a bit of Lewison’s judgement which is often overlooked in this context. He says something to the effect that ultimately there is nothing wrong with a scheme company effectively buying votes. I should be very careful, though, because he does not quite put it in those terms! Of course, in terms of BAIC, we all know how creditors of IBNR were treated, and I will say no more than that.
Nick Stimpson: I do not see a challenge to those schemes as a failure of a scheme if that challenge is successful. It is part of the process. To my way of thinking, it should not be deemed a failure of the scheme per se.
Lee Brandon: It comes back to Beth’s point about treating customers fairly. On direct business in particular, you should only be promoting a scheme if you have gone out and really spent time consulting with people. In our experience, policyholders, including American ones, will do a deal because the accelerated payment has greater value to them. In many cases, these policyholders’ balance sheets are far stronger than the insurers’. It is particularly relevant with pools, and I agree that they are too fragmented and costly. You may get one or two dissenting policyholders but you should not be promoting a scheme unless you are reasonably confident that the majority will support it. If you have that situation, you come back to the point at the end of the day of whether the view as to one or two minorities who fundamentally do not want to give the coverage supersedes the will of the majority. That is an issue for the courts to decide.
Ian McKenna: There are different levels of direct policyholders and different levels of sophistication amongst them. Direct policyholders may have different thoughts about why they have purchased that insurance in the first place. Clearly, some of the more sophisticated ones can probably absorb more within a policy commutation-type deal within a balance sheet than those who do not have a balance sheet-type solution to absorb the loss of that policy effectively. We need to be aware of that.
Tom Riddell: It will be quite interesting if the market did develop retrospective cover because you answer the point about loss of cover completely if you can buy replacement cover. It is commonly regarded that you cannot do that, but I do not think that it’s true.
David Vaughan: The issue I am hearing here is whether schemes are okay and whether they will carry forward. I agree with Tom that there are specific instances where you can say that is well set for a scheme or a pool. It might be the most efficient way if you have a very mature portfolio that you cannot do anything more with so you want to end it, and those tend to be small values and high volumes. However, I am intrigued by the timescale issues. The early schemes had first mover advantage. I think policyholders were not set up. It is like going back to the old days of 1992 when there were all those insolvencies and you had the International Policyholders Association because it is the same old lawyers who have come up to represent the schemes. Basically, they got that 25% block on the schemes, and when you spoke to most of them they would say, “It is great. I got this really good deal as a result of proposing a scheme”. Equally, with Part VIIs, I heard the other day on a Part VII someone say,“I got a commutation at really good terms which I never would have got had it not been for the fact that the company is trying a Part VII and needed to get rid of me”. I am interested in how this affects the decision timetables and the outcome. Can anyone now, with a great amount of accuracy, work out how much it will cost to exit a scheme, how long it will take, and what other legal decisions will come along in the meantime, given that a lot of people are spending a lot of money?
Rhydian Williams: Are you saying that opposition to schemes is an issue of price rather than principle?
David Vaughan: It is a little of both. We do not propose schemes. We just hear the vibes. Certainly, in 2001 if someone on PXRE came and said “Do a scheme”, you would be thinking he has three multi-year policies, huge uncertainty on reserving, and you just would not do it. In ten years’ time, when it is probably small value and lots of policies, you would do it.
Ian McKenna: In colloquial terms, David, it is not a much bigger ask to push those schemes in terms of getting over the various hurdles and legal procedures. There is no question that the landscape has changed there. I do not think that makes schemes a useless tool from an exit strategy perspective.
Peter Hartley: I keep coming back to the consultation bit. We have done two company schemes where we spent a lot of time consulting before we even brought it to the market. We only had one vote against us. We also wrote to every individual policyholder on the Lloyd’s syndicate. It was all direct stuff, not reinsurance. It was clearly beneficial that we had done the consultation and worked with the regulators.
Rhydian Williams: Part VIIs are wonderful tools for confusing the hell out of the market by transferring different portfolios, excluding certain things and including others. Is that a recipe for disaster in your opinion?
Beth Rees: Can we ask you that question, Rhydian?
Rhydian Williams: With Equitas we could be looking at the mother of all Part VII transfers. It is an enormously exciting prospect. At least in that sense the whole package will be moving over. What I am getting at is the fact that Part VII allows you to pick off portfolios, to start dissecting and transferring them to different people. Maybe one objective of scheming is splitting out the business again. Is that something we should be concerned about? It goes back to the issue of lack of transparency.
Tom Riddell: I think it has a lot in common with schemes in that it is the duty of the companies, both the one wanting to do a transfer and the scheme company, to help policyholders understand. There ought to be an automatic assumption and requirement that any company that wants to do a Part VII or a scheme has to offer policy reconciliation to any policyholder who wants it. If that genuine offer is there then the scheme company or the transferring company can do the work to help them know what is in it. One of the problems with some of the earlier schemes and with some of the Part VIIs is that the word description the courts seemed to find satisfactory did not work in practice and the market did not recognise it. In those circumstances, the scheme company or the Part VII company should offer policy reconciliation. I think that would deal with quite a few creditor issues.
Ian McKenna: We have seen that in the context of Part VIIs with consultation with treasury departments. Subject to certain exceptions, the benefit of the reinsurance should be automatically notifiable. I think what you are saying is if you have that requirement on the outward side, why not have that on the inward side as well and offer that policy reconciliation to everybody to assist in that process.
Tom Riddell: But if you refuse to give it, I think your creditors should be entitled to go to the court and say it is unfair because they are not being told.
Maik Wandres: It goes back to data consistency on old books of business. The worry we would have as a scheme manager for some of the older portfolios is whether, if you provide information, it will be complete and contain all the data. It is a good thing in itself that both the Part VII and solvent schemes we have worked on in the past have led to data mining and a fully comprehensive overview of the books. When it comes to the intention of the schemes or Part VII transfers, obviously there are plenty of safeguards. First of all the regulator looks at it, also the courts, and in the Part VII transfer there is the independent expert. I would think that the intention in the Part VII transfer would be that there is disclosure and it would also fall within the remit of the independent expert to see whether or not that is in the best interests of the creditors.
Ian McKenna: It is an essential part. Under the FSA rules they will need evidence of that independent actuarial advice.
Beth Rees: Yes, but to pick up on Maik’s point, it is not necessarily in the best interests of the policyholders. I think there is quite a defined purpose in the relevant bit of the handbook on FiSMA [Financial Services and Markets Act] which discusses whether the interests of policyholders will be adversely affected. In a way, it comes back to managing their expectations. The standard is not necessarily a positive standard that has to be achieved on a Part VII. There should not necessarily be an enhancement.
Maik Wandres: The process does ensure that the creditors are no worse off afterwards, as well as ensuring an efficient industry.
Beth Rees: The process is intended to be transparent. When the Reinsurance Directive is fully implemented in the EU then I personally have no doubt that we will see more Part VII transfers of business in the UK.
Rhydian Williams: Part VII transfers simply pass the parcel and do not actually address anything. Will it just be a means to package it up and put it into a particular defined unit to be addressed in a particular way? Is that what it will be?
David Vaughan: It probably enables portfolios to go to someone who is interested in run-off as opposed to someone who probably does not want run-off.
Rhydian Williams: Is that necessarily good for the policyholder where they might go to an organisation that has an aggressive as opposed to a more sympathetic attitude towards claims settlement?
Tom Riddell: It is an interesting question because there seems to be no credence given to that by the courts. We all know that if we had to choose which reinsurer we would like to be reinsured by, and we had a particular policy wording, there are some reinsurers we would like to have and some we would not, regardless of their credit rating. Therefore, if the court is going to allow transfers regardless of that factor, which appears to be the case, then, in the experts’ opinion, today we are really looking at solvency issues. However, there is nothing to say they could not be rated.
Sean McDermott: But should it be any different to the banking sector and moving a portfolio of mortgages? Why should it be any different to suddenly get a piece of paper through the post simply saying that your mortgage is now with somebody else? It comes back to the whole capital efficiency of the market. There was also a point made earlier about having good people in the run-off area. If people in an organisation recognise a run-off portfolio and the capital attaching to it, and the return that is giving back to the investors, then that is the right way forward if people are going to keep it internally or sell it off externally.
Lee Brandon: I think there is a fundamental difference between insurance and mortgages. If someone transferred my mortgage and I did not like them, they have to get me to pay the money back. Reinsurance is the other way around: you are buying future security. I am being very simplistic, but you are buying it on a certain reputation, credibility, ability to pay or whatever, in case you need it in the future.
Ian McKenna: If your insurance is transferred to a new entity and your risk carried is backed by a reinsurance protection that is five times the existing one, why would you object to that? Why would you not be happy?
Lee Brandon: No, I am not saying you would not. I think most Part VIIs are not done at this stage with a run-off in mind, but instead to simplify the balance sheet and administration for Solvency II. You have people with a myriad of legal entities, capital trapped all over the place, and their primary aim at that moment is to simplify the group structure. They do not want to continue to have branches all over the world and subsidiaries stuck everywhere as they used to do in the old days. Their aim is to get rid of the subsidiaries and move it back to one balance sheet. As mentioned earlier, you may have one balance sheet for live and one for run-off.
Beth Rees: It will also be interesting to see how the market responds in terms of the new Companies Act, because that will allow a slightly different basis on which you can extract capital. I will be interested to see how we respond to those requests. You can see the potential for Part VII under the new Companies Act that you can simply make your application to the court without having to notify creditors that that is what you want to do and take it out of the balance sheet.
Rhydian Williams: Of course, the whole Part VII process is under review. There is a consultation out at the moment to clarify certain aspects of the Part VII facility. I believe it has been used effectively once within Lloyd’s. Will it be used more effectively in future?
Lee Brandon: It is an interesting question because Lloyd’s does have this thing at the moment that Lloyd’s security is paramount. The Part VII facility has been there since 2001, specifically aimed at regulation to allow Part VIIs. Apart from some exceptional circumstances that is not traditional Lloyd’s business, it has not happened. I think it will be quite interesting now bearing in mind, as you said earlier, that Lloyd’s are facilitating potentially the largest Part VII transfer ever. If anyone goes along now and really pushes for Part VIIs it will be interesting to see whether Lloyd’s, having done it themselves, will be supportive.
Tom Riddell: I think a great deal of this will be Lloyd’s changing their attitude to the existing run-off within Lloyd’s because it will be accepted by the market that that is a satisfactory solution for Equitas. There will be pressure in the future because it is the large writers who will pay for the new Central Fund. If a large writer within Lloyd’s has to fund the legacy business of someone else, or they can go and set up on their own and not fund legacy business with someone else, in the end there will be pressure within Lloyd’s to stop the fund.
Lee Brandon: Now that Lloyd’s is actively working on an exit solution, if you like, for the Names, how can it deprive other people of the exit solutions, which frankly it has done up until now? I agree that it is a watershed.
Tom Riddell: This might go back to David’s point about maturity. If the company market is perceived as having mature solutions to run-off, then there is no reason why they should not apply. If they are generally accepted there is no reason they should not apply to Lloyd’s, because Lloyd’s is just the same as the company market, just branded under a different franchise really.
Rhydian Williams: The London market has many different providers. We have touched upon consolidation. With consolidation comes the potential for confusion and disruption. Do you think we will see more consolidation in the market and therefore more disruption and confusion, either from service providers, brokers, or even Lloyd’s?
Lee Brandon: I can only speak for service providers. I have a slightly different view on this to most other people. There is a myriad of providers of different sizes but just a handful of larger ones. There has been a fair amount of activity in that space recently, as Nick will know. My personal view is that I cannot see the benefit of merging two organisations of a similar size without creating additional value. I have always been into acquisitions where you add value to the organisation. Those who are professional and have ability will prosper, and those who do not have the ability will struggle and fail, then they may get taken over or not. The number of major service providers is shrinking, which perhaps reflects the success of some of the alternative solutions. Frankly, I think consolidation is overstated.