Introduction
7.1. Under the Scheme, the Transferring Business will be transferred from SJE to BHII.
7.2. The main issues affecting the transferring policyholders of SJE as a result of the Scheme arise from relative differences in:
The financial strength of BHII after the transfer compared to that of SJE currently. Financial strength is derived from the strength of the reserves held, excess assets or capital, and specific capital support arrangements (and the calls on that capital support).
The risk exposures in BHII compared to those in SJE.
The policy servicing levels provided by BHII after the transfer compared to those enjoyed by the policyholders of SJE currently.
7.3. In this section I address each of the issues.
The Change in Financial Strength due to the Scheme
RESERVE STRENGTH OF SJE
7.4. I have been provided with an external actuarial analysis on the technical reserves of SJE as at 31 December 2011. I have also been provided with a separate external actuarial analysis (undertaken by the same actuaries) on the technical reserves for the Italian branch legacy business (the vast majority of which is to be transferred under the Scheme), also as at 31 December 2011. The results of the analysis for the Italian branch legacy business are incorporated into that for SJE as a whole.
7.5. These external actuarial analyses provide details on the methodologies and assumptions used in setting reserves for this business.
7.6. For the purpose of preparing its statutory accounts and regulatory returns as at 31 December 2011, SJE based its selected reserves on the results of the external actuarial review. Table 7.1 below shows SJE’s selected reserves, as per its 31 December 2011 report and accounts.
Table 7.1
SJE Booked Reserves as at 31 December 2011 (£000s)
7.7. The total gross claims reserve (i.e. claims outstanding plus IBNR) projected by the external actuaries was
£120.4 million, as compared to £120.8 million booked by SJE (as shown in Table 7.1 above). On a net of reinsurance basis the external actuaries’ reserve was £82.4 million as compared to £82.7 million booked. I am informed by SJE that the differences relate to slightly different exchange rates being used by the external
£'000s
Table 7.2
Breakdown of External Actuaries Reserve Estimates for SJE as at 31 December 2011 (£000s)
7.10. As can be seen from Table 7.2 above, as at 31 December 2011 SJE’s liabilities were dominated by the local Italian (i.e. non-Japanese) business, the vast majority of which is to be transferred under the Scheme. As described in paragraph 1.5 above, all non-Japanese Italian branch business other than two medical expense policies (for which booked reserves amounted to £70,000 gross of reinsurance and £42,000 net of reinsurance as at 31 December 2011) will be transferred under the Scheme. As described above, since the 2011 year-end SJE has entered into a reinsurance agreement with NICO in respect of the Transferring Business. As a result of this, at the date of this report, SJE’s net liabilities in respect of this business are estimated to have reduced to nil.
7.11. The external actuaries have used generally accepted actuarial methods (predominantly the chain-ladder method) to estimate reserve requirements. Their estimates are intended to represent the expected value or mean (average) value of the claims liabilities. I interpret this measure to be on a basis higher than a 50%
confidence level5 (as the claim distribution is expected to be positively skewed6).
7.12. I have reviewed the work carried out by the external actuaries, in order to satisfy myself that it is reasonable for me to rely on their work. This included reviewing the reports and assessing the appropriateness of the methodologies and major assumptions used.
7.13. I have not attempted to review in detail the calculations performed by the external actuaries. Instead, I have reviewed the process by which reserves are set, the approach followed to assess the key areas of reserve uncertainty and the apparent strength of the reserves based on this review.
Local Italian business
7.14. The liabilities of the Transferring Business are dominated by medical malpractice liability claims (about 75%
of projected claim reserves), but there are also other significant public liability and accident claims outstanding.
7.15. The account has suffered poor claims experience over several years, and continues to do so. The external actuaries’ estimated ultimate claims deteriorated by €14.6 million gross over 2011, driven by adverse claim developments on the medical malpractice book.
7.16. Based on information received from SJE I understand that the legal environment, particularly in southern Italy, from where many of the claims emanate, is such that judicial rulings can take many years to be made and there is considerable scope for appeal. There also appears to be a lack of consistency in judicial rulings and there are issues with the enforceability of notification periods within contracts. These factors lead to a considerable degree of uncertainty in the estimates for the Italian liability claims.
7.17. Furthermore, again based on information received from SJE, I understand that recent changes to the
“Tables of Damages” issued by the Courts of Milan and Rome for assessing the size of damages for liability OS IBNR Reserve OS IBNR Reserve
from the triangles. The external actuaries have attempted to make an assessment of the impact of the introduction of the new Tables on the historic data and have adjusted their results to make an allowance for potentially higher awards in the future.
Other business
7.18. The vast majority of SJE’s other outstanding liabilities is in respect of its Japanese business written in the UK and in its continental European branches.
7.19. SJE continues to write a variety of Liability, Marine, Property and Accident covers for Japanese companies’
European operations.
7.20. Employers’ Liability accounted for around 40% of outstanding claims in the UK operation as at 31 December 2011. This includes some exposure to disease claims, in particular industrial deafness for which the external actuaries have undertaken a separate projection based on a frequency-severity approach.
7.21. SJE also has small outstanding reserves in relation to its UK local business which was discontinued in 2001.
There is apparently no material exposure to asbestos or other disease claims. The external actuaries’
reserves for this business amounted to just £54,000 as at 31 December 2011.
Conclusion
7.22. Notwithstanding the significant degree of uncertainty in the Italian liability claims, I am satisfied that the methodologies, major assumptions and results of the external actuaries (as essentially adopted by SJE) as at 31 December 2011 appear reasonable.
7.23. SJE does not reflect the time value of money in its claims reserves. This gives rise to an off balance sheet asset (safety margin) equivalent to the time value of money inherent in the undiscounted part of the reserves. Such a safety margin increases the security of the policyholders.
7.24. Overall, based on my review as described above as at 31 December 2011, the reserves of SJE appear reasonable. However, the exposures associated with the Italian liability claims mean that there is a considerable degree of uncertainty attached to the ultimate value of claims for SJE gross of reinsurance. The degree of uncertainty associated with the ultimate value of claims for SJE net of reinsurance is substantially reduced by the operation of the NICO Agreement.
RESERVE STRENGTH OF BHII
7.25. I have been provided with minutes from BHII’s 2011 year-end reserving committee meeting, together with associated papers providing a split of the claims reserves by business line and a description of the approach taken to reserving for each line.
7.26. Table 7.3 below shows a breakdown of BHII’s Technical Provisions, as reported in its report and accounts as at 31 December 2011.
Table 7.3
BHII Technical Provisions as at 31 December 2011 (£million)
£m
Table 7.4
BHII Claims Outstanding by Segment as at 31 December 2011 (£million)
7.28. As shown in Table 7.4 above, BHII’s principal lines of business are its participation in the GAUM aviation pool, and its Energy and US Casualty accounts. In addition, BHII has liabilities in relation to a number of other smaller lines of business.
7.29. Reserves in respect of GAUM, which underwrites Airline, Products, General Aviation and Space insurance lines, have been set with reference to an external actuarial review commissioned by GAUM (to which I have had access), GAUM’s own internal actuarial review, and a review undertaken by NICO. The external actuarial review highlights some of the uncertainties to which GAUM is exposed including potentially very long tailed products liability claims.
7.30. The approach to reserving the Energy account, which is composed largely of property risks (with approximately 10% being liability risks), follows a formulaic approach up to the 10th development quarter (to allow for the considerable lags that are anticipated in the reporting of claims), i.e. the reserves are based on defined percentages (dependent on development quarter) applied to premiums corresponding to the development quarter under consideration. From the 10th quarter an actuarial assessment is made based on actual claims experience.
7.31. A formulaic approach, consistent with that used by NICO, is also used to reserve for the Casualty account, based on the policy limits, type of business and type of contract.
7.32. BHII is exposed to very large gross losses from both the Energy and Casualty lines, but, as outlined in Section 4 above, through its reinsurance arrangements with NICO its net exposures are limited.
7.33. Reserves in respect of the other lines written by BHII are mainly assessed by NICO or other parts of the Berkshire Hathaway group, and, in the case of the Swiss branch (for which gross reserves were less than £1 million), by an external actuarial firm.
7.34. BHII sets its reserves on a conservative best estimate basis. I interpret this measure to be on a basis higher than a 50% confidence level (as the claim distribution is expected to be positively skewed).
7.35. I have reviewed the actuarial and other analyses made available to me by BHII and have discussed the liabilities and approach to reserving with key BHII personnel.
7.36. While there is a considerable degree of uncertainty attached to the business written by BHII, this is greatly limited by the reinsurance arrangements in place with NICO. I am satisfied that the methodologies, major
BHII RESERVE STRENGTH POST TRANSFER
7.39. The main risk to consider is the risk that the liabilities of the transferring policies, or of BHII, deteriorate post-transfer to such an extent that BHII’s solvency is threatened. This event could disadvantage policyholders of BHII and/or the transferring policyholders of SJE that might have remained secure had the transfer not taken place.
7.40. Reserves in respect of Italian branch local liabilities to be transferred under the Scheme were assessed by the external actuaries at €102.3 million gross and €79.9 million net as at 31 December 2011. As explained in Section 3 above, in March 2012, SJE entered into a reinsurance agreement with NICO under which NICO reinsured the net liabilities (and any reinsurance bad debt) up to a limit of €200 million (effective from 31 December 2010). During 2011 approximately €10 million net claims were paid and so, as at 31 December 2011, the NICO reinsurance continued to provide more than €100 million of additional protection to SJE, in excess of its net reserves.
7.41. Under the Scheme, the benefit of the NICO Agreement will transfer to BHII. Therefore, while BHII’s gross outstanding claims reserves will increase by around £85 million (about 20%); net of reinsurance they are estimated to remain unchanged. Further, the liabilities reinsured under the NICO Agreement represent a very small proportion (less than 1%) of NICO’s net carried reserve as at 31 December 2011. Therefore, the NICO Agreement is very unlikely of itself to have a material impact on the financial position of NICO.
7.42. The reserving basis adopted by BHII after the Effective Date will continue to be on a conservative best estimate basis. I am satisfied, therefore, that the reserving levels adopted by BHII after the Effective Date will continue to be established on a basis stronger than a 50% confidence level.
7.43. On the basis that outwards reinsurance contracts of the transferring portfolio are transferred to BHII as part of the Scheme the net (of reinsurance) position of BHII should not be adversely impacted as a result of the Scheme.
7.44. Overall, therefore, I would expect BHII to be reasonably reserved after the Effective Date.
Conclusion
7.45. I believe that the Scheme is unlikely to have a materially adverse effect on the reserve strength provided to the transferring policyholders of SJE compared to both their current position and their projected position at the Effective Date.
EXCESS ASSETS OF SJE (PRE TRANSFER)
7.46. At a simple level, one measure of the capital strength of SJE is the ratio of capital resources to net written premiums. This ratio was 400% as at 31 December 2011.
7.47. As at 31 December 2011 the policyholders of SJE enjoyed the security of capital resources (i.e. assets available to meet regulatory capital requirements) as recorded in SJE’s 2011 FSA return of £59.4 million compared with a statutory minimum capital requirement of £10.5 million. The Solvency I cover ratio for the MCR was therefore 5.7 (available regulatory capital divided by the MCR) and the free assets equal to £49.0 million (i.e. capital resources less MCR).
7.48. SJE is protected by SJII under the terms of a “Net Worth Agreement” whereby the parent agrees to cause SJE to have adequate capital resources (at least 250% of the MCR) to meet its obligations as they fall due. I have been provided with a copy of the unconsolidated accounts for SJII for the year ending 31 March 2012.
SJII is a large Japanese general insurer with net premiums written for the year to 31 March 2012 totalling
available to meet regulatory capital requirements) relative to the ECR as at 31 December 2011.
7.50. On the Solvency I and ECR measures, both in terms of the level of free assets and the solvency cover ratio, the capital resources of SJE at 31 December 2011 were satisfactory when considered alongside the risks from its parent. Overall, following these developments, SJE’s available capital has increased since 31 December 2011.
7.52. I have been provided by SJE with a document showing the results of an analysis of the effect of the NICO Agreement on SJE’s solvency margin using a number of different measures. The analysis is as at 30 September 2011. It shows the MCR unchanged as a result of the transaction due to the use of the prior year’s MCR in the calculation (see Appendix 5). As the capital resources in SJE have increased as a result of capital injection, the solvency ratio, measured relative to the MCR, has also increased.
7.53. The analysis also shows a reduction in the ECR as a result of the NICO Agreement. This results from a reduced technical provision charge (which is based on net technical provisions) under the ECR formula. The analysis therefore also shows the solvency ratio improving on an ECR basis.
7.54. In line with regulatory requirements, SJE has made an Individual Capital Assessment (“ICA”) of its capital needs. SJE has made available to me its most recent ICA, undertaken as at 31 December 2011, as well as the previous ICA undertaken as at 31 December 2010. The 2011 ICA has been prepared on two bases: one reflecting the actual position as at 31 December 2011, the other reflecting the post-date NICO Agreement and capital injection. In each case the ICA estimates, the amount of capital required in order to maintain its ability to meet its obligations with a 99.5% confidence interval over a (new business) time horizon of one year. Additionally, SJE has also provided me with a document giving details of projections for its ICA over the next 3 years, incorporating a proposed new line of business, which I discuss further in Section 10.
7.55. The ICA sets out the risks to which SJE is exposed and SJE’s approach to modelling the risks for quantifying the ICA, and its approach to managing risks more generally.
7.56. The main areas of risk to which SJE is exposed are summarised in Section 4. SJE commissions external actuaries to evaluate underwriting and reserving risk. I have been provided with the external actuaries’
reports on underwriting and reserving risk as at 31 December 2010 and draft report as at 31 December 2011. Assumptions on other major areas of risk are provided to SJII for modelling using their internal capital model. The firm has used Correlation (as defined in Appendix 1) assumptions from QIS5 to aggregate the calculations. In assessing the reasonableness of the methodology, assumptions and results, I have considered how they compare against my knowledge of the market.
7.59. The correlation assumptions adopted by SJE for ICA purposes (see paragraph 7.56 above) do not appear
capital requirements of SJE, in particular, the level of capital required so that the company can meet its obligations to the level of confidence specified by the FSA for general insurance companies.
7.62. Based on its ICA as at 31 December 2011 before accounting for the NICO Agreement and increased capital, SJE had capital resources comfortably in excess of its ICA. After allowing for the NICO Agreement, SJE’s ICA reduced overall due to a reduced insurance risk charge for the risks associated with the Transferring Business, although this reduction was offset to some extent by an increased credit risk charge in respect of NICO. The reduced ICA taken together with increased capital resources as a result of the capital injection mean that SJE’s solvency margin (relative to its ICA) is significantly improved on the post-NICO Agreement, post-capital injection basis.
7.63. The FSA provides individual capital guidance (“ICG”) to SJE. This guidance sets out the results of the FSA’s review of the ICA and the minimum level of capital that it would expect SJE to hold based on its view of the ICA and the risk management framework of SJE. The ICG is intended to target the same level of confidence as described above for the ICA, but it represents the FSA’s view rather than that of SJE. The ICG is typically set as a percentage of the ECR. I have been provided with a copy of a letter dated 16 May 2008 from the FSA to SJE confirming the level of ICG (that being the most recent view expressed by the FSA).
7.64. Due to limitations on the degree of disclosure permitted by the FSA, I am not able to provide details of SJE’s ICA or ICG figures in this Report. Nonetheless, the capital of SJE was significantly in excess of its ICG as at 31 December 2011 (on the basis that ICG as at 31 December 2011 remained at the same percentage of ECR as previously confirmed to SJE by the FSA in 2008).
Conclusion
7.65. Overall, based on my review as described above concerning the excess assets of SJE, I believe the policyholders of SJE, including those transferring to BHII under the proposed Scheme, currently enjoy a reasonable level of security.
EXCESS ASSETS OF BHII (PRE AND POST TRANSFER)
7.66. As at 31 December 2011 BHII’s FSA return indicated that it had available capital resources of £68.2 million.
In 2011 it wrote net premiums of £30.0 million, the ratio of available capital to net premiums was therefore 227%.
7.67. At 31 December 2011 BHII’s MCR was £16.6 million, giving free assets of £51.6 million and a solvency ratio of 411%.
7.68. BHII has provided me with its ECR at 31 December 2011, over which it also had significant surplus assets, albeit that the solvency ratio (i.e. available assets divided by ECR) was less than that of SJE.
7.69. Additionally, BHII has made estimates of its capital requirements under the forthcoming Solvency II rules using the QIS5 standard formula. BHII has made these estimates as at year-ends 2009, 2010 and 2011, and has provided the results of each of these. In each case the results showed a significant surplus of capital resources over the capital requirement.
7.70. The FSA last issued BHII with ICG, following its review of BHII’s ICA and its ARROW risk assessment in 2008. As at 31 December 2011, BHII held a significant surplus over the ICG (calculated as the ECR multiplied by the factor selected by the FSA in 2008). BHII has provided me with updated draft ICAs as at 31 December 2010 and 31 December 2011. These ICAs set out the main risks to which BHII is exposed and outline the approach taken to setting its capital requirement. In both cases BHII had a significant surplus of
7.70. The FSA last issued BHII with ICG, following its review of BHII’s ICA and its ARROW risk assessment in 2008. As at 31 December 2011, BHII held a significant surplus over the ICG (calculated as the ECR multiplied by the factor selected by the FSA in 2008). BHII has provided me with updated draft ICAs as at 31 December 2010 and 31 December 2011. These ICAs set out the main risks to which BHII is exposed and outline the approach taken to setting its capital requirement. In both cases BHII had a significant surplus of