Introduction
6.1 In this section I consider the effect of the implementation of the Scheme on the transferring policies of ELAS.
6.2 As described in Section 3, the transferring business comprises exclusively non-profit in payment annuities with Pillar I liabilities of approximately £975 million (as at 31 December 2014). This business, excluding any unit-linked annuities and new annuities since March 2015, is currently reinsured to the CLL NPF under the Reassurance Arrangement.
6.3 None of the policies to be transferred under this Scheme carries membership rights of ELAS, although policyholders may be members through ownership of other policies.
6.4 As a result of the implementation of the Scheme, the transferring ELAS policies will transfer into and become direct policies of the CLL NPF. Therefore, the key points to consider are:
The financial resources available to provide security for the benefits of the transferring ELAS policies after the implementation of the Scheme compared to those currently available;
Any change to the profile of risks to which the transferring ELAS policies will be exposed as a result of the implementation of the Scheme; and
The effect of the implementation of the Scheme on the reasonable expectations of the transferring ELAS policyholders, including benefit expectations, service standards, management and governance that these policyholders should expect after the implementation of the Scheme.
These are considered in turn below.
The financial resources available to provide security of benefits
Introduction
6.5 The transferring ELAS policies, other than the unit-linked annuities and any new annuities written since March 2015, are currently reinsured to the CLL NPF. However, ELAS remains responsible for paying the benefits due to policyholders, and can claim an appropriate amount from CLL under the Reassurance Arrangement. Should CLL be unable to fulfil its obligations under the Reassurance Arrangement, ELAS will need to continue to pay the benefits. Therefore the transferring policies currently rely primarily on the resources of ELAS for the security of their guaranteed benefits. That is:
Assets backing the liabilities and capital requirements of the ELAS OLTF; and
Excess capital resources in the ELAS OLTF (which are intended to be distributed to policyholders in line with company strategy).
6.6 The ability of CLL to fulfil its obligations under the Reassurance Arrangement will affect the strength of ELAS and therefore security for the transferring policies will also be provided by the assets held in CLL. In particular, the assets deposited back under the Reassurance Arrangement have restricted risk exposures and are ring-fenced for the benefit of ELAS, thereby contributing to the financial strength of ELAS and therefore the security of the benefits of the transferring policies.
6.7 I understand that CLL is proposing to reinsure (or “retrocede”) 90% of the sterling-denominated transferring annuities (not including the unit-linked annuities) to Canada Life Assurance Company (“CLAC”) (Barbados branch) prior to the Effective Date. This would operate in a similar way to the two existing reinsurance agreements with that company (see paragraph 4.73). Once the Scheme has been implemented, the primary responsibility to pay the transferring annuities will be with CLL, regardless of this onwards reinsurance. I have been informed that this retrocession is expected to be completed in October 2015 with an effective date of 1 January 2015.
6.8 In addition, and principally for ease of administration, it is currently proposed that the Irish and German euro denominated annuities be 100% reinsured to Irish Life Assurance and Canada Life Assurance Europe respectively.
However, it is possible that the German euro denominated annuities will instead be administered via an outsourcing
arrangement with Canada Life Assurance Europe rather than via a reinsurance arrangement. The final decision will be confirmed prior to implementation of the Scheme.
The ELAS and CLL capital policies
6.9 The capital policy of an insurer sets out the capital that a company has committed to hold and is typically
expressed in terms of regulatory capital requirements. The regulatory capital requirements may target a specified probability of remaining solvent over a certain time horizon: for example for both the current Pillar II regime and Solvency II, it is a 99.5% probability of remaining solvent over a one year time horizon. By requiring additional capital to be held on top of the regulatory requirements, the capital policy increases the probability of remaining solvent over a particular timeframe and therefore increases the security of the benefits provided under the relevant policies subject to the capital policy.
6.10 When considering the financial resources available to provide the security of the benefits of a particular group of policies, greater reliance can be placed upon assets held in adherence to the capital policy than on assets in excess of this level, since assets in the latter category are potentially available for distribution (subject to the PRA rules).
6.11 Capital policies provide a trigger for actions by management with the aim of reducing the likelihood of a breach of required regulatory capital levels and subsequent regulator intervention.
6.12 Currently the security of the benefits under the transferring ELAS policies depends upon the assets of ELAS held in accordance with the ELAS capital policy as set out in Section 4. Following implementation of the Scheme, the transferring business and any residual assets attributed to it will be transferred into the CLL NPF and security for the benefits of the transferring ELAS policies will subsequently be provided by the assets of CLL held in
accordance with the CLL capital policy, also set out in Section 4.
6.13 The proposed transfer will not lead to any change in the risk appetite or capital policies for either ELAS or CLL and therefore a comparison of the relative strengths of the capital policies of ELAS and CLL will be key to the consideration of the effect of the Scheme on the benefit security of the transferring policies. This should be a comparison of both the relative levels of capital required under the two policies, and the qualitative aspects of the capital policies such as the governance of each capital policy and the required response of management to a breach of the capital policy.
6.14 The current ELAS and CLL capital policies are partially set out in terms of the capital requirements under the current Pillar I and Pillar II regimes. As described in Section 3, from 1 January 2016 the Solvency II regime will be in force so I should consider the relative strengths of the capital policies under Solvency II.
6.15 However, neither ELAS nor CLL has finalised its capital policy under Solvency II and such a comparison has not been possible. The companies have both stated that, when rewritten to take account of Solvency II, their capital policies will reflect a similar likelihood of remaining able to pay policyholder benefits and will therefore afford the respective policyholders of ELAS and CLL at least the same level of protection as currently. I therefore set out below an analysis of the relative strengths of the current capital policies as a proxy for an analysis of the capital policies under Solvency II.
6.16 I shall comment in my Supplementary Report on the ELAS and CLL capital policies to apply under Solvency II.
The relative strengths of the capital policies
6.17 ELAS’s capital policy aims to meet two potentially conflicting objectives:
To meet its economic capital and regulatory solvency capital requirements; and
To distribute all of its assets amongst the with-profits policies as fairly as possible over the lifetime of those policies.
6.18 In order to meet both of these objectives the ELAS Board has made Risk Appetite statements within its capital policy which are set in terms of a target ICA cover range. On a Pillar II basis ELAS’s capital policy currently provides for a target cover in excess of 120% of its ICA capital requirement (including any ICG). This minimum level of cover aims to ensure that the company’s economic and regulatory capital requirements are met.
6.19 Furthermore, should the cover fall below 150%, ELAS would consider reducing Policy Values and Capital Distribution Amounts to restore the solvency position. If the ratio fell below 120%, such action would almost certainly be taken.
6.20 CLL’s capital policy is targeted such that CLL maintains total aggregate capital resources sufficient to satisfy the most stringent of the following requirements:
Maintaining a target cover 140% of the CRR subject to a range of 126%-154% under Pillar I;
Maintaining a target cover of 120%-130% of its ICA capital requirement (including any ICG) under Pillar II; and
Maintaining a target cover of 175%-200% of its Canadian MCCSR.
6.21 ELAS’s capital policy is not readily comparable to CLL’s on a Pillar I or Canadian MCCSR basis, but the Pillar II policies can be compared.
6.22 Assuming that the underlying reserves and capital requirements (ICA) are calculated consistently between the two companies, it appears that the CLL and ELAS capital policies are similar in terms of strength on a Pillar II basis as they both target a minimum cover ratio of 120%.
6.23 The ELAS and CLL capital policies currently provide for a buffer over the PRA’s capital requirements, and therefore the policyholders of ELAS and CLL will be afforded a greater level of security than that strictly required under the PRA’s rules. Holding such a buffer is in line with normal practice within the UK life insurance industry.
The required response of management to a breach of the capital policies
6.24 In addition to considering the actual level of capital intended to be held under the relevant capital policies, I also consider what the required management response would be to any breach.
6.25 As a mutual insurer, ELAS does not have easy access to external sources of capital, and therefore should its available capital fall below its target level, the most likely actions would be to reduce the level of risk within its asset portfolio, and to adjust the Capital Distribution Amount or Policy Values for its with-profits policies.
6.26 CLL has a wider range of possible actions available to it in response to any breach of capital policies including, but not limited to:
Reduction or suspension of any dividend payments;
Requesting capital injections from its parent company;
Issuing debt or subordinated debt;
Reduction in the level of new business; and
Reduction in its risk exposure (e.g. by increasing the level of reinsurance cover).
The governance of the capital policies
6.27 The ELAS capital policy is reviewed at least annually by the ELAS Board, and can be amended at any time.
6.28 The CLL capital policy is reviewed annually by the CLL Board, or more frequently if deemed necessary by the CFO.
The security provided by the deposit back arrangement
6.29 As described above, there is currently a deposit back arrangement in place, which reduces the counterparty risk exposure to CLL. This provides extra security to all of the ELAS policyholders (including but not limited to the transferring policyholders). In the event that CLL failed to honour its obligations under the Reassurance Arrangement, ELAS could take control of the assets held under the deposit back arrangement. The transferring policyholders would not have any preferential claim on any of these assets, as they would be available to support all of ELAS's business. Accordingly, although the deposit back arrangement plays an important part in reducing the counterparty exposure to CLL, it does not provide any specific additional security to transferring
policyholders.
6.30 Following the implementation of the Scheme, the deposit back arrangement will cease and the transferring policies, as direct policies of CLL, will have security provided by the assets in CLL, including those currently covered by the deposit back arrangement. The investment guidelines (covering quality, type and restrictions) that govern the management of the assets which are deposited back to ELAS under the Reassurance
6.31 I am satisfied that the cessation of the deposit back arrangement and associated investment guidelines will not have a material effect on the security of benefits under the transferring business.
The financial resources available to provide security for benefits
6.32 Table 6.1 below shows the pre-Scheme financial strength of ELAS and the pro-forma post-Scheme (including the proposed onward retrocessions to CLAC, Irish Life and Canada Life Assurance Europe as discussed in section 6.7 to 6.8 (collectively, the “Retrocessions”)) financial strength of CLL as at 31 December 2014 on the Pillar I Regulatory Basis:
Table 6.1: Post Reassurance Arrangement ELAS and post-Scheme CLL regulatory solvency
Regulatory Balance Sheet (£m)
Excess of assets over liabilities (A) 546 2,287
Capital Resources Requirement (B) 209 1,408
CRR Cover (A/B) 261% 162%
Notes to Table 6.1:
*Includes adjustment to the published figures at 31 December 2014 for the recapture of unit-linked business from Halifax Life Limited and the Reassurance Arrangement during 2015, and hence presents a more favourable regulatory solvency position than shown in Table 4.5. A more detailed analysis of the change is included in Table 7.1.
**CLL post-Scheme solvency position as at 31 December 2014 after the proposed retrocession to CLAC (Barbados branch) and the proposed 100% retrocession of the Irish and German euro-denominated annuities to Irish Life and Canada Life Assurance Europe respectively. In June 2015, CLL reassured an additional amount of its existing annuities to CLAC, but this has not been reflected in above CLL position. I have been informed that the impact of the Scheme allowing for this additional reassurance is expected to be similar.
6.33 Table 6.1 shows that, on the Pillar I Regulatory basis, the CRR cover of CLL post-Scheme is significantly lower than that of ELAS pre-Scheme. Nevertheless, CLL remains capitalised to a level in excess of that required by its own capital policy on this basis.
6.34 As discussed in paragraph 6.22, on the more relevant, but private, Pillar II basis, both companies have similar levels of minimum target capital. I have been shown the Pillar II solvency positions of both companies before and after the Scheme, which showed that both companies exceeded their minimum target capital on this basis before the Scheme, and also that the Scheme has a minimal impact on the Pillar II basis. The Pillar II basis is more closely aligned to the Solvency II methodology which will apply after 31 December 2015.
6.35 If the planned Retrocessions do not go ahead then CLL’s post-scheme solvency ratios will be affected; however, I am satisfied that this would not materially affect my conclusions.
Financial strength under Solvency II
6.36 The Solvency II regulations are finalised; however there is still uncertainty regarding the way in which certain provisions will apply to ELAS and CLL. Both ELAS and CLL are applying to the PRA for various approvals under Solvency II which would have a significant effect on the solvency of, and excess capital available within, each company under the new regime. In view of this, the impact of the implementation of the Scheme on the Solvency II position of ELAS and CLL cannot yet be reliably established.
6.37 I have been shown the current draft Solvency II figures for ELAS and CLL as at 31 December 2014, including how they might vary should the various approvals not be granted.
6.38 The figures for ELAS show that it would have been able to cover its SCR comfortably. I understand from the management of ELAS that the impact of the Scheme on the Solvency II position of ELAS is expected to be similar to the effect of the Scheme on the Pillar II position of ELAS and that therefore the Scheme is not projected to have a material effect on the Solvency II financial position of ELAS.
6.39 There is a wide range of possible outcomes for CLL’s Solvency II SCR coverage position. Assuming the
expected approvals being sought are granted in full, the figures for CLL also show that it would have been able to cover its SCR at 31 December 2014, and that the level of cover at that date is likely to fall broadly in the middle of CLL’s expected (but not yet finalised) Solvency II target capital range. I understand from the management of CLL that the transfer is not projected to have a material effect on the company’s Solvency II financial position.
However, there are some scenarios in which, if certain approvals are not granted in full, CLL would need to take action to strengthen its solvency position before the Scheme takes effect.
6.40 Therefore, the transferring policyholders will be transferring to a company that is expected to exceed its Solvency II capital requirements. I intend to provide an update on CLL’s expected Solvency II SCR coverage in my Supplementary Report.
6.41 As noted above, the capital policies that will apply to ELAS and CLL when Solvency II is introduced have not been finalised at this time. However, both companies have stated that it is their intention for their post Solvency II capital policies to reflect a similar likelihood of remaining able to pay policyholder benefits as their current policies, and will therefore provide policyholders with broadly the same level of protection as currently. I understand that it is likely that the CLL capital policy under Solvency II will be less strong than that of ELAS.
However, as under the current Pillar II regime, there will be a wider range of options open to CLL if the capital policy is breached than is available to ELAS. I shall comment in my Supplementary Report on the ELAS and CLL capital policies to apply under Solvency II and, subject to this, I am satisfied that there will not be a material effect on the security of the guaranteed benefits of the transferring business.
6.42 Comments in relation to the Solvency II readiness of ELAS and CLL are set out in Section 9.
Financial Services Compensation Scheme (“FSCS”)
6.43 The eligibility of holders of long-term insurance policies for compensation from the FSCS, and the amount of compensation payable, are dependent upon the type of policyholder, the type of policy and where the insurer is based. The FSCS will pay compensation to eligible individual holders of long-term insurance policies issued by UK insurers in the UK or another EEA state in the event of the insurer’s default. Compensation to eligible holders of annuities in payment is the full amount of the annuity, without limit. Implementation of the Scheme will not adversely affect eligibility for compensation from the FSCS for any transferring or non-transferring policyholders.
6.44 I have been informed by ELAS that the vast majority of policies issued by the Guernsey branch (which includes the Jersey Policies) of ELAS are currently expected to be eligible for compensation from the FSCS, and by CLL that implementation of the Scheme will not affect this eligibility. Some policyholders living outside the UK, Channel Islands or Isle of Man may not currently be eligible for compensation from the FSCS, and the Scheme will not change their eligibility.
Conclusion
6.45 In conclusion I am satisfied that:
The capital policies of ELAS and CLL are of broadly similar strength on a Pillar II basis, and therefore the security afforded to the transferring business by the applicable capital policy will not change materially as a result of the Scheme.
The cessation of the Reassurance Arrangement and the associated restrictions on the deposited back assets will not have a material effect on the security of benefits for the transferring business.
While the financial strength of CLL on a Pillar I basis after implementation of the Scheme is expected to be
While the financial strength of CLL on a Pillar I basis after implementation of the Scheme is expected to be