The Court of Appeal disagreed with the following aspects of the judge's decision not to sanction the transfer:
- He ought not to have concluded that there was a material difference between the non-contractual external support potentially available for each of Prudential and Rothesay. Any such difference was not considered by the Court of Appeal to be a material factor.
- He did not accord adequate weight to the Independent Expert’s conclusion that the risk of Prudential or Rothesay needing external support in the future was remote and to the Regulators’ lack of objection to the scheme.
- Finally, he ought to have disregarded the fact that policyholders originally chose Prudential on the basis of its age, venerability and established reputation, and their assumption that Prudential would always provide their annuities.
The transfer has now been remitted to the High Court for a renewed application for sanction.
Background
The scheme proposed the transfer from Prudential to Rothesay of around 370,000 annuity policies written by Prudential. Prudential had sought to transfer the policies because it wished to reduce its regulatory capital requirements in connection with a planned demerger of businesses of the Prudential Group. The economic risk and reward relating to the annuity business had already transferred by means of reinsurance arrangements between Prudential and Rothesay.
The Independent Expert had concluded that the financial security provided by Prudential and Rothesay was comparable and that the scheme would not have a material adverse effect on Prudential and Rothesay policyholders.
Around 1,000 policyholders opposed the scheme on the grounds that they had chosen Prudential as their annuity provider based on its long history as a leading UK insurance company, its reputation for prudence, its size and the fact it was a member of the wider Prudential Group (which could be relied upon to support Prudential if necessary).
The judge refused to sanction the application, whereupon the applicants appealed against his decision.
The Court of Appeal's decision
Giving the judgment of the Court of Appeal, Sir Geoffrey Vos (Chancellor of the High Court) noted that under section 111(3) of the Financial Services and Markets Act 2000, the Court must consider that "in all the circumstances of the case, it is appropriate to sanction the scheme". Given the wide range of businesses that may be transferred under Part VII and the even wider range of circumstances in which such transfers may be proposed, the application of the deliberately broad terms of section 111(3) will require consideration of different factors, depending on the particular business and circumstances of the transfer. There could be no single test nor a single list of factors to be applied in all cases. The relevant legal authorities have to be viewed in their specific context.
Sir Geoffrey then summarised the approach which a judge hearing an application for the sanction of an insurance business transfer under Part VII should take, and made the following comments:
- The discretion of the Court has frequently been said to be unfettered and genuine and not to be exercised by way of a rubber stamp. That is true but, as in the exercise of all discretions, the Court must take into account and give proper weight to matters that ought to be considered, and ignore matters that ought not properly to be taken into account.
- There was a tendency to treat the judgments of Hoffmann J in London Life and Evans-Lombe J in AXA as if they were a comprehensive statement of the factors that should be applied by the Court in all insurance business transfers. The London Life and AXA cases were addressed to the particular circumstances of those cases and to the types of business being transferred.
- The Court should consider whether there are any errors or inadequate or defective reasoning in the Independent Expert's or Regulators' reports. In the absence of any errors, the Court should always, in exercising its discretion, accord full weight to the opinions of the Independent Expert and the Regulators. That does not mean that the Court can never depart from the recommendations of the Independent Expert or the non-objections of the Regulators, but it does mean that full weight should be accorded to them, so that a Court would not depart from such recommendations and non-objections without significant and appropriate reasons for doing so. Whilst the judges hearing Part VII applications have considerable experience of the actuarial and specialist issues reported on by both an Independent Expert and the Regulators, the Court should rely on the expert opinions submitted to it (in the absence of errors or omissions).
- The crucial question for consideration by the Court is whether a proposed scheme will have any material adverse effect on policyholders, employees or other stakeholders. An adverse effect will only be material to the Court's consideration if it is: (i) a possibility that cannot sensibly be ignored having regard to the nature and gravity of the feared harm in the particular case, (ii) a consequence of the scheme, and (iii) 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. Even if the Court finds that the proposed scheme will have a material adverse effect on some group or groups of policyholders, it may still sanction the scheme in the exercise of its discretion.
Issues raised in the Prudential/Rothesay transfer
The judge's rejection of the Independent Expert's opinion
The Court considered that the judge was not justified in rejecting the Independent Expert's view that there was no disparity between the financial resilience of Prudential and Rothesay either now or in the future.
Although the judge had accepted that the relative financial strengths of Prudential and Rothesay were comparable, and the fact that Prudential was larger than Rothesay did not, of itself, mean that Rothesay policyholders would have less security of benefits, the Court of Appeal considered that the judge should have taken greater account of the ongoing future regulation of Rothesay and the financial assessment of insurance companies under Solvency II. The Independent Expert and the Prudential Regulation Authority (the "PRA") were judging the solvency metrics of the companies as at a specified date on the basis of their analysis of the companies' likely resilience to a 1-in-200 year stress event within the coming year under Solvency II requirements. However, the fact that Rothesay would continue to be regulated under the same rules from year to year into the foreseeable future meant that the conclusion of the Independent Expert and the PRA were based on valid parameters for an assessment of Rothesay’s future security.
The Court of Appeal also disagreed with the judge's view that the possibility that less external financial support was potentially available for Rothesay than for Prudential was a material factor to be taken into account in the exercise of the Court’s discretion. The Court did not think that the likelihood of non-contractual parent support being available was a relevant factor to take into account. No one can assume that non-contractual parental support will be available in the future. Parent companies cannot be required to support their subsidiaries whether for reputational or other reasons and can always sell their subsidiaries to others with lesser resources (indeed, the subsequent demerger had resulted in Prudential ceasing to be a subsidiary of Prudential plc and becoming part of a smaller group). Insurers themselves are also entitled to dispose of their excess own funds above their technical provisions and solvency capital requirement at any time. This was why the evaluation of an insurer’s solvency metrics, taken together with the prospect of its continuing regulation, was both necessary and normally sufficient to measure its resilience to future events.
Prudential's age, venerability and established reputation
The appellants submitted that the judge wrongly attached weight to the fact that consumers had chosen Prudential for its age and reputation. The consumers may have been justified in doing so, but the Court could not take that into account in the Part VII context. The Court had access to the insurers’ detailed financial information and Solvency II metrics, and the opinions of experts and Regulators, which provided a far more reliable guide to the security of policyholders’ benefits than any subjective factors which a policyholder may have considered. The appellants also submitted that the judge had been wrong to accord weight to the policyholders’ assumption that there would be no transfer. They had no contractual right to remain with PAC, and the only correct question was whether the transfer would have a material adverse effect on the security of their benefits. Finally, the appellants submitted that the judge had been wrong to place so much weight on the nature of the annuity business. The policyholders’ legitimate central concern was not one of fairness, but of ensuring that the transferee was in a financial position to meet its obligations.
The Court of Appeal agreed. As already explained, the Court should not depart from the view of the expert or the non-objections of the Regulators without good reason. In relation to security of policyholders’ benefits, the question is whether the scheme would have a material adverse effect on the policyholders. If the policyholders’ prospects of being paid are essentially the same with and without the scheme, it is hard to see how there can be any material adverse effect on the security of benefits caused by the scheme.
The commercial judgment of Prudential's Board
The appellants also contended that the judge did not give adequate weight to the commercial judgment of Prudential's Board. The Court of Appeal disagreed with this. The judge had understood that, in exercising his discretion, he must give due recognition to the commercial judgment entrusted by the company’s constitution to its board. He had considered whether there was a material adverse effect on policyholders’ benefit security, and this was the correct approach to take.
Prejudice caused to Prudential and Rothesay
The appellants also submitted that the judge was wrong to conclude that the detriment to PAC and Rothesay caused by refusal to sanction the Part VII transfer and the continuation of the reinsurance agreement did not constitute significant prejudice when set against the fundamental change in status and material disadvantage to transferring policyholders. The Court of Appeal considered that the judge had been quite correctly considering whether there was a material adverse effect on policyholders. Had he been right that there was a material adverse effect on policyholders, the Court of Appeal did not consider that any prejudice to the commercial interests of Prudential or Rothesay would have been in point. Those commercial interests were unrelated to the interests of the transferring policyholders and, if the scheme had involved a material adverse effect to policyholders, the Court of Appeal did not see why their interests should give way to the commercial interests of the companies and their shareholders.
Authored by Charles Rix
