Report of the Independent Expert on the proposed transfer of certain Italian
branch insurance business from Sompo Japan Insurance Company of Europe
Limited to Berkshire Hathaway International Insurance Limited
Prepared for:
Sompo Japan Insurance Company of Europe Limited and Berkshire Hathaway International Insurance Limited
Prepared by:
CONTENTS
1. Introduction ... 1
2. Regulatory Background ... 5
3. Background on SJE ... 9
4. Background on BHII ... 13
5. The Proposed Scheme ... 15
6. General Considerations of the Independent Expert ... 19
7. The Effect of the Scheme on the Transferring Policyholders ... 21
8. The Effect of the Scheme on the BHII Policyholders ... 33
9. The Effect of the Scheme on the Non-Transferring Policyholders of SJE ... 35
10. Other Considerations ... 36
11. Conclusions ... 41
APPENDIX 1. Defined Terms... 42
APPENDIX 2. List of Previous Transfers for which I have Acted as the Independent Expert or Equivalent .... 43
APPENDIX 3. Terms of Reference ... 44
APPENDIX 4. Key Sources of Data ... 45
APPENDIX 5. Minimum Capital Requirement ... 47
1.
INTRODUCTION
Purpose of Report1.1. It is proposed that certain Italian branch business of Sompo Japan Insurance Company of Europe Limited (“SJE”) be transferred to Berkshire Hathaway International Insurance Limited (“BHII”) by an insurance business transfer scheme (the “Scheme”) as defined in Section 105 of the Financial Services and Markets Act 2000 (“FSMA”).
1.2. A list of terms defined in this report is shown in Appendix 1. Otherwise I use the same defined terms as are in the Scheme.
1.3. Section 109 of FSMA requires that an application to the High Court of Justice in England and Wales (“the Court”) for an order sanctioning an insurance business transfer scheme must be accompanied by a report on the terms of the scheme (the “Report”) by an independent person having the skills necessary to make the report and who is nominated or approved by the Financial Services Authority (“FSA”). The Report is required in order that the Court may properly assess the impact of the proposed transfer, including the effect on policyholders of the insurance companies in question. SJE has nominated me to act as an independent expert to provide the Report and the FSA has approved my appointment.
1.4. This Report describes the proposed transfer and discusses its possible effects on the policyholders of SJE and BHII, including effects on security and levels of service.
The Proposed Scheme
1.5. The business to be transferred under the Scheme (referred to henceforth as the “Transferring Business”) consists of the contracts of insurance written and issued by the Italian branch of SJE for the underwriting years 2003 and prior; and medical expense business that continued to be renewed on a compulsory basis from business written during underwriting years 2003 and prior (these policies will now have expired). Notwithstanding that the Transferring Business excludes insurance contracts relating to commercial risks of Japanese entities, which is the on-going business of the branch and two medical expense contracts, which are still in force and therefore not in run-off (together the “Excluded Policies”). The Transferring Business is intended only to transfer business that is in run-off hence the Excluded Policies are not part of the transfer. The other business of SJE will remain in SJE.
1.6. I note that SJE is currently in litigation with three brokers (defined as "Broker Litigation" under the Scheme) and it is expected that these cases will be concluded in the near future. Furthermore, the Broker Litigation falls outside the ambit of Transferring Business.
1.7. The Effective Date of the transfer is expected to be 31 December 2012. The transfer is intended to have the effect that all the liabilities under the policies comprising the Transferring Business, and appropriate assets (including reinsurance), will pass under the Scheme to BHII.
1.8. The business involved, the arrangements for the transfers and the effect of the transfers are discussed in more detail in Sections 3 to 11 of this Report.
The Independent Expert
1.9. I, Gary Wells, have been appointed by SJE as the Independent Expert to consider the Scheme under Section 109 of FSMA. My appointment has been approved by the FSA; this is confirmed in a letter dated 2 May 2012 from the FSA to SJE.
less than 0.1% of the firm’s fee income over each of the last 5 years in respect of each group.
1.13. I do not believe that the involvement with the Sompo Group or the Berkshire Hathaway Group of other consultants within Milliman affects my ability to act independently in my assessment of the Scheme.
1.14. This scheme is subject to sanction by the Court under Section 111 of FSMA.
1.15. SJE will be responsible for payment of all fees in respect of my work as Independent Expert.
The Scope of my Report
1.16. My terms of reference have been reviewed by the FSA and are set out in Appendix 3.
1.17. I have considered the terms of this Scheme only and have not considered whether any other scheme may provide a more efficient or effective outcome.
1.18. The Report describes the proposed transfer and the likely effects on policyholders of SJE and of BHII, including effects on security and levels of service. These factors are contrasted to the position which will apply after the completion of the proposed transfer. This Report should be read in conjunction with the full terms of the proposed Scheme.
1.19. My work has required an assessment of the liabilities of SJE and BHII, for the purposes of describing the effect of the transfer. My review of the liabilities was based on actuarial reserve assessments conducted by internal and/or external actuaries of SJE or BHII (as the case may be). I have reviewed the methodology and assumptions used in their work and assessed the key areas of uncertainty in relation to these liabilities. I have not attempted to review in detail the calculations performed by the internal and/or external actuaries (as the case may be) or to produce independent estimates of the liabilities.
1.20. In addition to the liabilities, I have assessed the appropriateness, in nature and amount, of the assets to be transferred under the Scheme, and the capital position of SJE and BHII pre and post the proposed transfer. Again, I have not attempted to review in detail the calculations performed for/by SJE or BHII, or to produce independently my own capital estimates.
1.21. As far as I am aware, there are no matters which I have not taken into account in undertaking my assessment of the Scheme and in preparing this Report, but which nonetheless should be drawn to the attention of policyholders in their consideration of the Scheme.
1.22. In reporting on the Scheme as the Independent Expert, I recognise that I owe a duty to the Court to assist the Court on matters within my expertise. This duty overrides any obligation to the companies involved in the Scheme. I confirm that I have complied with this duty.
1.23. I am aware of the requirements regarding experts set out in Part 35 of the Civil Procedure Rules, Practice Direction 35 and the Protocol for Instruction of Experts to give Evidence in Civil Claims.
1.24. I confirm that I have made clear which facts and matters referred to in this report are within my own knowledge and which are not. Those that are within my own knowledge I confirm to be true. The opinions I have expressed represent my true and complete professional opinions on the matters to which they refer. 1.25. Shortly before the date of the Court hearing at which an order sanctioning the Scheme will be sought, I will
prepare a supplementary report covering any relevant matters which might have arisen since the date of this Report. It is intended that the supplementary report will be published on the SJE website at least one week before the date of that Court hearing.
The Structure of my Report
1.26. The remainder of the Report is set out as follows
In Section 2, I provide some background to the regulatory environment in which the companies involved in the Scheme operate.
In Sections 3 and 4, I provide some background to SJE and to BHII, i.e. the companies involved in the Scheme.
Section 5 summarises the key provisions of the Scheme.
Section 6 describes the matters I need to consider as Independent Expert.
In Section 7, I consider the likely effects of the Scheme on the group of transferring policyholders. In Section 8, I consider the impact of the Scheme on the current policyholders of BHII.
In Section 9, I consider the impact of the Scheme on the policyholders remaining in SJE. In Section 10, I cover more general issues relating to the Scheme.
My conclusions are summarised in Section 11.
Reliances and Limitations
1.27. In carrying out my review and producing this Report I have relied, without detailed verification, upon the accuracy and completeness of the data and information provided to me, in both written and oral form, by SJE and BHII, and can confirm, in accordance with SUP18.2.33(8) (see paragraph 1.40 below), that all the information that I have requested has been provided. Reliance has been placed upon, but not limited to, the information detailed in Appendix 4. My opinions depend on the substantial accuracy of this data, information and the underlying calculations.
1.28. The Report has been prepared for the purposes of the Scheme in accordance with Section 109 of FSMA. A copy of this Report will be sent to the FSA and will accompany the Scheme application to the Court.
1.29. This Report must be considered in its entirety, since individual sections, if considered in isolation, may be misconstrued.
1.30. Neither the Report, nor any extract from it, may be published without my specific written consent having been given, save that copies of the Report may be made available for inspection by policyholders and copies may be provided to any person requesting the same in accordance with legal requirements. I also consent to the Report being made available on the website to be operated by SJE in connection with the transfer.
1.31. No summary of the Report may be made without my express consent. I will provide a summary of the Report for inclusion in a document that will be made available to policyholders of SJE and the policyholders of BHII under the Scheme (the “Report Summary”).
1.32. The Report has been prepared within the context of the assessment of the terms of the Scheme and must not be relied upon for any other purpose. No liability will be accepted by Milliman, or me, for any application of the Report to a purpose for which it was not intended or for the results of any misunderstanding by any user of any aspect of the Report. In particular, no liability will be accepted by Milliman or me under the terms of the Contracts (Rights of Third Parties) Act 1999.
1.36. At the date of this Report, I am not aware of any material changes in circumstances since 31 December 2011 other than those referred to in this Report. This Report also takes no account of any information that I have not received, or of any inaccuracies in the information provided to me.
1.37. The use of Milliman’s name, trademarks or service marks, or reference to Milliman directly or indirectly in any media release, public announcement or public disclosure, including in any promotional or marketing materials, websites or business presentations is not authorised without Milliman’s prior written consent for each such use or release, which consent shall be given at Milliman’s sole discretion.
Professional and Regulatory Guidance
1.38. I am required to comply with relevant professional standards and guidance issued by the Board for Actuarial Standards and the Institute and Faculty of Actuaries. I have complied with such standards, subject to the principles of proportionality and practicability.
1.39. The Report has been prepared in accordance with the following applicable Technical Actuarial Standards (“TAS”) issued by the Board for Actuarial Standards: Transformations TAS (“T-TAS”); Insurance TAS (“I-TAS”); TAS for Reporting (“TAS-R”); and to the extent relevant, TAS for Data (“TAS-D”); and TAS for Modelling (“TAS-M”).
1.40. The Report has been prepared under the terms of the guidance set out in Chapter 18 of the Supervision Manual (“SUP18”) contained in the FSA Handbook of Rules and Guidance to cover scheme reports on the transfer of insurance business.
2.
REGULATORY BACKGROUND
Introduction2.1. General insurers, as well as other financial services organisations, are regulated by the FSA, which has approximately 4,000 employees and an annual budget of over £400 million.
2.2. The FSA is a statutory body set up under FSMA, and has various strategic aims including: Promoting efficient, orderly and fair markets;
Helping retail consumers achieve a fair deal; and
Improving the FSA’s business capability and effectiveness.
2.3. Under its consumer protection strategic aim, the FSA places great emphasis on achieving fair outcomes for consumers and seeks to ensure that firms adhere to its conduct principles.
2.4. The FSA also sets the regulations governing the amount and quality of solvency capital held by firms; these are summarised below. The solvency regime is designed to protect the benefit security of policyholders, as well as the stability of the insurance industry.
2.5. In June 2010, the UK government announced that the FSA will be broken up by the end of 2012. It will be replaced by the Financial Conduct Authority (“FCA”) and the Prudential Regulation Authority (“PRA”). The FCA will be responsible for regulating conduct, while the PRA (as part of the Bank of England) will have responsibility for the prudential regulation of individual insurance companies along with banks, investment banks and building societies.
2.6. For the purposes of this report I refer to the FSA as the sole regulator of the UK general insurance industry. Where I refer to the FSA this should be taken to implicitly refer also to the FCA and PRA as appropriate. 2.7. In the UK, the taxation regime taxes general insurance companies based on profits achieved by those
companies at the main rate of corporation tax (24% for tax year 2012/131).
FSCS
2.8. Consumer protection is also provided by the Financial Services Compensation Scheme (“FSCS”). This is a statutory “fund of last resort” which compensates customers in the event of the insolvency (or other defined default) of a financial services firm. Insurance protection exists for private policyholders and small businesses (annual turnover less than £1 million) in the situation when an insurer is unable to meet its liabilities. For non-life insurance business, the FSCS will pay 100% of any claim incurred before the default under compulsory insurance (such as motor third party liability) and 90% of the claim incurred before the default for non-compulsory insurance (such as home), without any maximum. The FSCS is funded by levies on firms authorised by the FSA.
2.9. The FSCS covers EEA risks written by UK insurers through branches in other EEA countries. Therefore, the transferring Italian branch policyholders of SJE are protected by the FSCS to the extent they meet the qualifying criteria.
FOS
2.10. The Financial Ombudsman Service (“FOS”) provides private individuals (and micro-enterprises2) with a free, independent service for resolving disputes with financial companies. It is not necessary for the private
Risk-Based Capital Framework
2.12. At the end of 2004 the FSA introduced a risk-based capital framework (known as the ICAS framework) under which companies are required to assess solvency under two regimes, referred to as Pillar I and Pillar II.
PILLAR I
2.13. Under Pillar I, general insurers have to meet statutory requirements based on EU Directives and, for the time being, provide their more risk-based Enhanced Capital Requirement (“ECR”) calculation to the FSA in private. This includes setting up Technical Provisions in accordance with those Directives and having sufficient available capital to meet at least the Minimum Capital Requirement (“MCR”). Details of the calculation of the MCR are given in Appendix 5.
2.14. The Technical Provisions required under the EU Directives are:
The Unearned Premium Reserve (“UPR”) – the UPR is the amount set aside from premiums written before the valuation date to cover risks incurred after that date;
The Unexpired Risk Reserve (“URR”) – the URR is the amount held in excess of the UPR, to allow for any expectation that the UPR will prove to be insufficient as at the valuation date to cover the cost of claims and expenses incurred during the period of unexpired risk; and
The claims outstanding provision – the reserve set up in respect of the liability for all outstanding claims at the valuation date, whether reported or not.
2.15. The UPR is typically calculated on a daily basis (but alternative methods may be acceptable where the daily basis is not appropriate) and makes no allowance for the time value of money (i.e. discounting).
2.16. The claims outstanding provision is typically made-up of the case reserves plus the amount, if any, for claims incurred but not reported (“IBNR”) at the valuation date. Case reserves are the amounts estimated on a case-by-case basis to settle reported (open) claims. The IBNR reserve is the amount estimated (typically using statistical techniques) to provide for claims in respect of claim events that have occurred before the valuation date, but had still to be reported to the insurer by that date (plus any projected deficiencies in the case reserves).
2.17. Under UK regulatory practices, the claims outstanding provision estimate cannot normally include any allowance for the time value of money. Therefore, all other things being equal, a margin exists in the provision to cover (at least in part) adverse claims development. It should be noted that there are some limited circumstances under UK regulations where the claims outstanding provision may be discounted for the time value of money.
PILLAR II
2.18. The capital that must be held under Pillar II is an amount based upon the Individual Capital Assessment (“ICA”), which is the company’s own assessment of its capital requirements. Pillar II is intended to provide a more realistic and complete view (than under the Pillar I regime) of the risks to which the company is exposed and to provide a framework within which the company should be managed.
2.19. The FSA requires firms, when preparing their ICA, to identify the major risks they face and, where capital is appropriate to mitigate those risks, to quantify how much (and what type) of capital is appropriate. The FSA
they fall due in all but the most extreme circumstances. The FSA has indicated that ICG will be given taking into consideration capital resources consistent with a 99.5% confidence level that the firm will be able to meet its liabilities over a one year timeframe or, if appropriate to the firm’s business, an equivalent lower confidence level over a longer timeframe.
FSA Conduct Principles
2.22. The FSA has set out the high-level requirement to treat customers fairly in Principle 6 of its Principles for Businesses (PRIN 2.1.1) which states that “a firm must pay due regard to the interests of its customers and treat them fairly”. Principle 7 outlines that “a firm must pay due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair and not misleading” while Principle 8 states that “a firm must manage conflicts of interest fairly, both between itself and its customers and between a customer and another client”.
2.23. These Principles have been developed further in the FSA’s document “Treating customers fairly – towards fair outcomes for consumers” published in July 2006. This provides 6 outcomes that set out firms’ regulatory obligations for the fair treatment of customers. These are as follows:
Outcome 1: Consumers can be confident that they are dealing with firms where the fair treatment of customers is central to the corporate culture;
Outcome 2: Products and services marketed and sold in the retail market are designed to meet the needs of identified consumer groups and are targeted accordingly;
Outcome 3: Consumers are provided with clear information and are kept appropriately informed before, during and after the point of sale;
Outcome 4: Where consumers receive advice, the advice is suitable and takes account of their circumstances;
Outcome 5: Consumers are provided with products that perform as firms have led them to expect, and the associated service is of an acceptable standard and as they have been led to expect; and
Outcome 6: Consumers do not face unreasonable post-sale barriers imposed by firms to change product,
switch provider, submit a claim or make a complaint.
Solvency II
2.24. The regulatory solvency reporting requirements for EU insurers and reinsurers are due to undergo a major overhaul from 30 June 20133. This new regime is commonly referred to as Solvency II and aims to introduce solvency requirements that reflect better than the existing solvency regimes the risks that insurers and reinsurers actually face and to introduce consistency across the European Union. UK companies will be required to adhere to a set of new, risk based capital requirements and, in contrast to the position under the current UK Pillar II requirements, some of the results will be shared with the public.
2.25. Solvency II will be a principles-based regime and will be based on three pillars:
Under Pillar I quantitative requirements define a market consistent4 framework for valuing the company’s assets and liabilities;
Under Pillar II, insurers must meet minimum standards for their corporate governance, and also for their risk and capital management. There is a requirement for permanent internal audit and actuarial functions. Insurers must regularly complete an Own Risk and Solvency Assessment;
2.26. The Solvency Capital Requirement (“SCR”) in Solvency II is the amount of capital required to ensure continued solvency over a 1 year time frame with a probability of 99.5%. The SCR is calculated based on the particular risks to which the insurer is exposed.
2.27. The Minimum Capital Requirement under Solvency II (“MCR2”), which will be lower than the SCR, defines the point of intensive regulatory intervention. The MCR2 calculation is more formulaic and less risk sensitive than the SCR calculation.
2.28. The basis for the Solvency II calculations has not yet been finalised, although some illustrative calculations have been prepared separately by SJE and BHII to assess the likely impact of the new regime. I have discussed in broad terms the likely impact of the Scheme on a Solvency II basis separately with the senior management of SJE and BHII. Through these discussions, consideration has been given to the likely change in financial strength under Solvency II as a result of the Scheme.
The Insurers (Reorganisation and Winding Up) Regulations 2004
2.29. Under UK law, direct policyholders rank equally and above all other unsecured/non preferential creditors in the event that an insurer is wound up.
The Financial Information in this Report
2.30. The ICAS framework Pillar I balance sheet items as at 31 December 2011 shown in this Report have been published, externally audited and approved by the respective Boards of SJE and BHII.
2.31. As stated above, under the ICAS framework, Pillar II financial information is not published and remains private between the FSA and the company. I have therefore reviewed this information, and commented on it in general terms, but have not included any Pillar II figures in this report.
3.
BACKGROUND ON SJE
3.1. SJE is a UK insurance company registered in England (registered number: 2846429). It is authorised and regulated by the FSA with permission under Part IV of FSMA to effect and carry out contracts of general insurance for the following classes of business of Part I of Schedule I of Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (“the RAO”): Accident, Aircraft, Aircraft Liability, Credit, Damage to Property, Fire and Natural Forces, General Liability, Goods in Transit, Land Vehicles, Legal Expenses, Liability for Ships, Miscellaneous Financial Loss, Motor Vehicle Liability, Ships, Sickness and Suretyship. 3.2. SJE’s principal activity relates to the underwriting of general insurance risks of Japanese-owned commercial
enterprises located in the European Union and to provide a stable supply of general insurance services to such businesses. The main classes of the on-going business written by SJE are:
Accident;
Employers Liability;
Marine (mainly Cargo, also Hull from the 2008 underwriting year); Motor (discontinued after the 2007 underwriting year);
Property; and
Public/Product Liability.
3.3. SJE has branches established across Europe, including in Italy, Germany, Belgium, France, Spain and the Netherlands.
3.4. During 2011, SJE wrote gross premiums of £40.8 million (split roughly 40:60 between the UK and mainland Europe) and net premiums of £14.9 million. On an earned basis, gross premiums were £39.9 million and net premiums were £14.6 million. The net incurred loss ratio was 131%, and the combined ratio was 171% producing a loss after tax of £4.5 million (2010: loss £6.3 million) while Total Recognised Losses (i.e. allowing for pension commitments) came to £5.4 million (2010: loss £6.6 million).
3.5. SJE wrote two tranches of now discontinued non-Japanese business, namely UK local business and Italian branch legacy business as outlined in paragraphs 3.6to 3.9 below.
3.6. The UK local business was discontinued after the 2001 underwriting year. The main classes of the discontinued UK local business are:
Accident;
Employers Liability; Motor;
Property; and
Public/Product Liability.
3.7. The UK local business is at an advanced stage of development, with small claim reserves (circa £54k). 3.8. The Italian branch legacy business was discontinued after the 2003 underwriting year, except for a small
amount of Medical Expense business that continued to be renewed on a compulsory basis (these policies have now expired and remain in run-off, save for two medical expense policies, which are still in force and not transferring under the Scheme). The main classes of the discontinued Italian branch legacy business
Property; and Public Liability.
3.9. Despite the maturity of the Italian branch legacy business there is a substantial volume of reported claims reserves, particularly for the very long-tailed medical malpractice and public liability classes. As at 31 December 2011, SJE carried reserves for the Italian branch legacy business of £85.3 million (£66.6 million net of reinsurance). Many of these claims are in litigation in southern Italy, where it can often take many years before a judicial ruling is made (and there remains significant scope to appeal).
3.10. As at 31 December 2011, the authorised share capital of SJE was £128,700,000 divided into 12,870,000 ordinary shares of £10 each, all of which was issued and fully paid.
3.11. On 27 February 2012, SJE’s share capital was increased by £45.0 million and 4,500,000 ordinary shares of £10 each were allotted. On the same date SJE sold a material amount of listed fixed interest securities. The sales proceeds were £58.4 million. The book value of these investments at the time was £56.4 million, giving rise to a gain on sale of £2.0 million.
3.12. At the date of this Report, SJE enjoys a Standard & Poor’s credit rating of A (stable), while its immediate parent company, Sompo Japan Insurance Inc. (“SJII”), a company incorporated in Japan, enjoys a Standard & Poor’s credit rating of A+ (stable).
3.13. On 1 April 2010, SJII became a wholly owned subsidiary of NKSJ Holdings Inc, which became the ultimate parent company of SJE.
Reinsurance
3.14. For 2011, SJE had a 40% Quota Share arrangement with SJII covering Property, Casualty and Marine risks. For the remaining portion of the risks there is reinsurance protection from a whole account excess-of-loss arrangement providing cover of 60% of £4.0 million excess £1.0 million (or 60% of €6.0 million excess €1.5 million). Above the whole account excess-of-loss arrangement there is comprehensive per risk excess of loss coverage. The effect of such reinsurance arrangements is that SJE should not suffer total net insurance losses beyond its Maximum Net Retention per risk per event of £600,000.
3.15. All reinsurance (with a few exceptions, in particular in respect of fronting for captives) is placed with reinsurers with a Standard & Poor’s credit rating of A or better (including SJII). SJE has a number of external reinsurers providing the reinsurance protections described above. For the financial year ended 31 December 2011, their share of gross written premiums was £25.9 million (or 63.6%). As at 31 December 2011, the major external treaty reinsurers were Lloyd’s syndicates, Munich Re, Ark Re (another subsidiary of SJII), Swiss Re and Odyssey America Re. Major facultative reinsurers were Concord Enterprises Insurance, Evergreen Re, Mitsui Sumitomo, Pool Re and Tokio Marine.
3.16. It is anticipated that all reinsurers with outstanding claims will be advised as part of the communication process under the Scheme (see Section 10 for further details).
NICO Agreement
3.17. SJE has entered into a reinsurance agreement protecting the Transferring Business (the “NICO Agreement’’). The reinsurer under this agreement is National Indemnity Company (NICO), which is part of the Berkshire Hathaway group. The NICO Agreement covers only certain types of business written by SJE, but all of the business being transferred (as described in paragraph 1.5 above).
3.21. SJE remains responsible for administering the run-off of the business. This includes administering, settling and paying claims. Under the terms of the NICO Agreement, SJE is obliged to delegate the administration to a claims servicer approved by NICO. SJE, pursuant to a Run-off Management Agreement, appointed Resolute Management Limited, an affiliate of NICO within the Berkshire Hathaway Group, to conduct the administration of the run-off from the commencement of the NICO Agreement.
3.22. The NICO Agreement is governed by UK law, and should therefore transfer under the Scheme, and furthermore, NICO has assured me that it will honour its obligations under the NICO Agreement post-transfer.
3.23. As described in paragraph 3.21 above, SJE is responsible for administering the run-off of the business under the direction of NICO and it assigns/sub-contracts this work to Resolute Management Limited pursuant to a Run-off Management Agreement. At the Effective Date, the Run-off Management Agreement will terminate, and the administration and servicing of the Transferring Business will continue to be undertaken by Resolute Management Limited on behalf of BHII in accordance with the existing Berkshire Hathaway UK Group Shared Services and Cost Sharing Agreement. Therefore there will be no change in administration and servicing of the Transferring Business as a result of the Scheme, and furthermore BHII has assured me that this will be the case.
Risks
3.24. SJE is exposed to a large number of risks in the course of its operations. The key risks may be classified under the headings of insurance, market, liquidity, credit, operational, group and pension scheme risk. 3.25. Insurance risk relates to the inherent uncertainties in the occurrence, amount and timing of insurance
liabilities, both in the existing business and in the on-going underwriting. This covers the risk of reserve deteriorations on the existing liabilities, inappropriate pricing methodologies leading to inadequate premiums; the risk of catastrophes (e.g. earthquakes), and the risk of increased expenses.
3.26. Market risk relates to SJE’s investment portfolios, and arises mainly from exposure to changes in interest rates, foreign exchange rates and changes in the market value of equities and other assets. A decrease in the value of the assets backing the insurance contracts could adversely affect the financial position of SJE to the extent that a movement (in particular, a fall) in asset values is not matched by a corresponding movement in liability values.
3.27. Liquidity risk relates to the inability of SJE to meet its cash outflows as they fall due as a result of a mismatch in the timing of cash inflows and outflows.
3.28. Credit risk relates to the risk of default by counterparties such as reinsurers and of corporate and government bonds. Operational risks are the risks to which SJE is exposed during its day to day operations, mainly arising from possible failures of internal processes, people and systems, or from external events. 3.29. SJE is exposed to risks from other parts of the NKSJ Group. Group risk could, for example, arise from
reputational issues resulting in lower than anticipated new business volumes.
3.30. SJE operates a defined benefit pension scheme in the UK. The funding position of the pension scheme is sensitive to the assumptions made from time to time (including inflation, interest rate, investment return and mortality) to determine its long-term liabilities relative to the corresponding market value of the pension fund’s assets. In particular, the financial position of the pension fund is highly sensitive to changes in bond yields and will also be impacted by changes in equity markets.
3.31. There is a range of actions that SJE management can take and has taken to mitigate the risks facing the business. For example, SJE uses techniques which include asset liability management strategies,
3.33. SJE has in place a number of controls to ensure that the six outcomes for the fair treatment of customers (see paragraph 2.23 above) are met. These include “production” manuals for both SJE and the UK detailing SJE’s policy for providing excellent customer service; complaints handing policies, set with regard to FSA and local regulatory requirements; and a conflicts of interest policy.
3.34. All UK staff are required to complete training in the fair treatment of customers, regional branch staff are expected to have training bearing in mind any local standards. UK staff and senior branch staff receive an induction course by the Compliance Department covering the fair treatment of customers as one of the most important regulatory topics.
3.35. Details of complaints are reported to the Executive Committee on a quarterly basis, and summarised and presented to the Audit and Risk Committee. The Compliance Director separately reports to the Audit and Risk Committee on key risk issues, including any breaches or weaknesses in controls relating to the fair treatment of customers.
3.36. SJE has assessed its risk in relation to the fair treatment of customers to be low, given its small number of retail clients and the small number of complaints or issues identified.
4.
BACKGROUND ON BHII
4.1. BHII is a UK insurance company registered in England (registered number: 03230337). It is authorised and regulated by the FSA with permission under Part IV of FSMA to carry out contracts of general insurance for the following classes of business of Part I of Schedule I of Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (“the RAO”): Accident, Aircraft, Aircraft Liability, Credit, Damage to Property, Fire and Natural Forces, General Liability, Goods in Transit, Land Vehicles, Legal Expenses, Liability for Ships, Miscellaneous Financial Loss, Motor Vehicle Liability, Railway Rolling Stock, Ships and Sickness.
4.2. BHII’s operations are directed from London but it also has branch offices in Switzerland and Italy. 4.3. BHII has three significant areas of underwriting activity:
its participation in the Global Aerospace Underwriting Managers (GAUM) aviation pool;
writing Energy business through agreements with major energy brokers in the London Market; and writing high level US Liability coverages through an in-house underwriting team.
4.4. BHII has also been developing an Italian Medical Malpractice business.
4.5. During 2011, BHII wrote gross premiums of £176.9 million and net premiums of £30.0 million. Of the gross premiums, 26% were in respect of Aviation business, 60% Property and 14% Liability. The vast majority of these premiums were in respect of direct business, with less than 1% in respect of Liability inwards reinsurance. On an earned basis, gross premiums were £155.4 million and net premiums were £26.5 million. The net incurred loss ratio was 102%, and the combined ratio was 119% producing a loss after tax of £0.9 million (2010: profit £2.4 million). BHII’s 2011 result was adversely affected by the large Maersk Gryphon Floating Production and Storage Facility loss which has an estimated market loss of $1 billion, of which BHII’s share is $100 million gross ($7.9 million net).
4.6. As at 31 December 2011, the authorised share capital of BHII was £59,716,169 divided into 59,716,169 ordinary shares of £1 each, all of which was issued and fully paid.
4.7. BHII’s immediate parent company is NICO, a company incorporated in the US state of Nebraska. Its ultimate parent company is Berkshire Hathaway Inc., a company incorporated in the United States of America. As at the date of this Report, BHII enjoyed a Standard and Poor’s credit rating of AA+, together with the other insurance companies in the Berkshire Hathaway group.
NICO
4.8. NICO is a major US insurer. It has 750,000 shares of $10 par value common stock authorised and 550,000 shares issued and outstanding, i.e. capital paid-up of $5.5 million.
4.9. NICO writes a wide variety of business, predominantly on a reinsurance assumed basis. During 2011, NICO wrote $6.1 billion of gross premiums of which over 98% was reinsurance assumed (about 20% being reinsurance of affiliates). Written premiums were dominated by non-proportional property and liability assumed reinsurance. The main direct lines written were commercial auto liability and aircraft.
4.10. As at 31 December 2011, NICO had admitted assets (excluding protected cell business) of $115.4 billion, and total liabilities (excluding protected cell business) of $45.3 billion. The excess admitted assets were therefore $70.1 billion.
Reinsurance
4.11. BHII has two significant reinsurance contracts with NICO for new business. The first is a 100% quota share agreement whereby BHII cedes the first 15% of its 23.39% share in the GAUM pool to NICO (which is retroceded to SCOR SE). The second reinsurance treaty provides quota share protection by business line and covers Aviation (65%, for business not ceded under the first reinsurance), Energy, Casualty and Construction (each 80%). For each line, BHII is also protected by the following additional reinsurance protections from NICO:
Risk specific cover for each and every claim above £5 million retained by BHII after the quote share; and
An account wide excess of loss protection of 200% in excess of 110% of net retained premium (after quota share and risk specific protections).
4.12. These arrangements are automatically renewed on an annual basis unless either party gives notice. Ceding commissions are paid to the reinsurer to pay its quota share proportions of all expenses associated with the business.
Risks
4.13. BHII is exposed to a large number of risks in the course of its operations. The key risks may be classified under the headings of insurance, market, liquidity, credit, operational, and group risk (as per SJE – see Section 3 for a general discussion thereof).
4.14. The insurance risk for BHII is magnified at a gross of reinsurance level as it is exposed to very large gross claims (as seen recently in the case of the Maersk loss mentioned above). However, as noted in paragraph 4.11 above, insurance risk is mitigated at a net level by the extensive use of reinsurance.
4.15. Credit risk relates to the risk of default by counterparties such as reinsurers and on corporate and government bonds. BHII is extensively reinsured, in particular by NICO, and as such has a heavy exposure to credit risk.
4.16. BHII is exposed to risks from other parts of the Berkshire Hathaway Group.
Governance – FSA Conduct Principles
4.17. BHII is committed to the fair treatment of customers, and to ensure that fair outcomes are delivered to customers. The key components of this framework are culture and governance.
4.18. Staff are required to be fair in all their dealings with clients and others.
4.19. There are processes in place to report and deal with any shortcomings in maintaining the open and honest culture, of which the fair treatment of customers is an integral part.
4.20. The Board has overall responsibility for ensuring that the “fair treatment of customers” objective is met. A governance structure has been implemented to enable the objectives to be met and to embed a culture which ensures that the fair treatment of customers’ objective is met throughout the business.
5.
THE PROPOSED SCHEME
Motivation for the Scheme5.1. SJE is seeking the elimination of the future uncertainty associated with its Italian branch legacy business. This would provide a reduction in the risk of claim volatility; relief from the burden of run-off management; and the opportunity to reconfigure SJE’s business in Italy.
5.2. Accordingly, the Scheme has been formulated to transfer the Italian branch legacy business (as specified in paragraph 1.5 above) of SJE to BHII. To accomplish this transfer the Court’s consent is needed.
Outline
5.3. Under the proposed Scheme the Transferring Business will be transferred from SJE to BHII. All general insurance liabilities in respect of the Transferring Business, and appropriate assets of the same value, will be transferred on the Effective Date.
5.4. All future income (other than premiums) and outgoings arising from the Transferring Business will pertain to BHII (together with all future income and outgoings of the BHII insurance business).
5.5. The liability for the policies issued by SJE that form part of the Transferring Business, which currently rests with SJE, will be transferred to BHII. Existing policyholders of SJE in respect of the Transferring Business will become policyholders of BHII.
5.6. The Scheme includes a provision that is designed to effect the transfer of each applicable reinsurance protection, including the NICO Agreement, from SJE to BHII.
5.7. Table 5.1 below shows the balance sheet for BHII pre and post the proposed Scheme as at 31 December 2011. The figures are based on BHII’s 31 December 2011 accounts and an assessment by SJE’s external actuaries of the value of the liabilities of the Italian branch that will be transferred to BHII. This assessment estimated gross outstanding claims at €102.3 million. The technical provisions post-scheme shown in Table 5.1 include an amount of £85.3 million (i.e. €102.3 million converted to pounds at £1 = €1.2). As the existing external reinsurance and the NICO Agreement are planned to transfer to BHII, the net increase in liabilities will be nil and hence reinsurers’ share of Technical Provisions shown in Table 5.1 also increase by €102.3 million post transfer.
Table 5.1: Simplified Balance Sheets for BHII as at 31 December 2011
£'000 Pre-Scheme Post-Scheme
Assets
Investments 171,839 171,839
Reinsurers' share of technical provisions 415,294 500,544
Debtors 39,373 39,373
Cash in hand 3,626 3,626
Pre-payments and accrued income 3,749 3,749 633,881 719,131
Liabilities
Capital and reserves 70,866 70,866
Technical provisions 518,629 603,879
Creditors 44,386 44,386
5.8. Table 5.2 below illustrates the effect both of the Scheme and of the NICO Agreement on SJE’s balance sheet. The “pre-Scheme” figures are as per SJE’s 31 December 2011 audited accounts. The “pre-Scheme post NICO Agreement” figures show, approximately, the effect on the balance sheet (as at 31 December 2011) of entering into the NICO Agreement, as well as the increase in capital and sale of investments (as described above in paragraph 3.11 above) and SJE’s commutation with SJII in respect of the Transferring Business (see paragraph 10.14 below). These post balance sheet date events were recorded in a note to SJE’s audited accounts. The post-Scheme figures reflect the transfer of technical provisions and the corresponding reinsurers’ share of Technical Provisions to NICO as a result of the Scheme. The figures also reflect the expected costs of the Scheme.
Table 5.2: Simplified Balance Sheets for SJE as at 31 December 2011
5.9. Post the proposed transfers, the administration and management of the Transferring Business will be undertaken by Resolute Management Limited in the same manner as currently (see paragraph 3.23 above). 5.10. No compensation will be paid to the policyholders (or to the shareholders) of SJE in consideration of the
transfer of the Transferring Business (and appropriate assets) to BHII, although BHII will assume the insurance liabilities in respect of the Transferring Business.
5.11. The external costs of the transfer will be met by SJE.
5.12. Nothing in this Report should be regarded as providing a legal opinion on the effectiveness of the proposed transfer.
5.13. I have not considered any alternative scheme.
Policyholders Affected
5.14. I have considered the effects of the Scheme on three main groups of policyholders, namely: 1. those policyholders of SJE whose policies are to be transferred;
£'000 Pre-Scheme Pre-Scheme, Post NICO Agreement Post-Scheme Assets Investments 133,858 97,802 97,802
Reinsurers' share of technical provisions 44,480 111,546 26,148
Debtors 10,749 10,749 10,749
Cash in hand 7,677 7,677 6,927
Pre-payments and accrued income 3,078 3,078 3,078
Tangible assets 1,599 1,599 1,599
201,441 232,451 146,303
Liabilities
Capital and reserves 56,215 87,225 86,475
Technical provisions 133,079 133,079 47,681
Creditors 8,057 8,057 8,057
Accruals 2,014 2,014 2,014
Pension scheme liabilities 2,076 2,076 2,076
continue to be protected by the FSCS if the Scheme is sanctioned.
5.17. The Scheme will have no effect on the eligibility of any group of policyholders to bring complaints to the UK FOS. If, as described in Section 2, they are currently able to bring complaints to the FOS, this will remain the case after the implementation of the Scheme. If they are currently not eligible to complain to the FOS this will also remain the case after the implementation of the Scheme.
FSA Conduct Principles
5.18. As noted in Section 2 the FSA places great emphasis on firms achieving fair outcomes for consumers, i.e. in this case that SJE and BHII provide fair treatment to their respective customers. This fair treatment requirement will still apply with respect to policyholders in SJE and BHII after the proposed transfer.
5.19. Under the separate SJE and BHII approaches to the fair treatment of customers, service delivery involves: Claims being handled fairly, consistently and promptly in line with customer expectations and
product promises;
Products performing as designed and as expected by third parties and customers; and Sales and service being in line with customer expectations and product promises.
5.20. SJE’s current approach to the fair treatment of customers is outlined in Section 3 and that of BHII in Section 4. I have no reason to believe that implementing the Scheme will affect the way in which the claims are currently being handled and the management of BHII and SJE have separately assured me that there will be no change.
Administration
5.21. After implementation of the proposed Scheme, the remaining business of SJE will continue to operate as it currently does. This includes underwriting, claims, operations, risk management and systems.
5.22. The management of BHII has assured me that, following the proposed transfer under the Scheme, there will be no change to the approach to managing and administering BHII’s business, including the approach to managing and administering the Transferring Business which will continue to be administered by Resolute Management Limited a (see paragraph 3.23 above).
Excluded policies
5.23. Any policies which are not capable of being transferred for legal reasons will be treated as Excluded Policies and will be fully reinsured to BHII with effect from the Effective Date.
The Capital Policy after the Scheme
5.24. Following the implementation of the Scheme, BHII and SJE will continue, as required by UK regulation, to maintain capital for the entirety of their businesses to support their respective ICAs.
5.25. Capital in both SJE and BHII is currently maintained using a risk-based approach in line with the ICA, as set out in Section 2, such that each company remains solvent relative to regulatory confidence levels over a one year (new business) time horizon.
5.26. The capital policy set out above will be replaced by a suitable alternative following the implementation of Solvency II, currently due to take effect for firms from 1 January 2014.
The Approach to Communication with Policyholders
5.27. SJE and BHII have set out the approach they intend to take in communicating information about the proposed transfer of business to the affected policyholders and other parties.
5.28. The main objectives of the SJE and BHII communications are to:
Give policyholders the information they need to understand the proposed changes; Inform affected policyholders about the implications for them of the proposed changes;
Give affected policyholders access to further information (beyond that in the communications pack); Let affected policyholders know how to object to the proposed changes;
Maintain customers’ confidence in SJE and BHII (as appropriate) to continue to meet their obligations under transferring and non-transferring policies; and
Meet legal and regulatory requirements.
5.29. SJE proposes to contact transferring policyholders/potential claimants and third parties areas as described in Section 10. SJE does not intend to notify any of its non-transferring general insurance policyholders of the proposed transfer.
5.30. BHII proposes to contact brokers as described in Section 10. BHII does not intend to notify any of its general insurance policyholders directly.
5.31. The overall approach proposed by BHII and SJE to communication with policyholders has been constructed to be proportionate to the expected impact of the Scheme on affected policyholders. I comment on this proposed approach to communications with policyholders in Section 10.
6.
GENERAL CONSIDERATIONS OF THE INDEPENDENT EXPERT
Introduction6.1. I have compiled my report in accordance with Chapter 18 of the Supervision Manual of the FSA Handbook. 6.2. Under applicable FSA rules, the concept of the fair treatment of customers should be applied. To help
ensure that customers are treated fairly in the future it is necessary to understand how they have been treated in the past. From the policyholders’ perspective, the acceptability of the Scheme must be on the basis that it will not have a materially adverse effect on their benefits or fair treatment.
6.3. I need to consider the terms of the Scheme generally and how the different groups of policyholders are likely to be affected by the Scheme and, in particular:
The effect of the Scheme on the security of the policyholders’ contractual rights, including the likelihood and potential effects of the insolvency of the insurer; and
The likely effects of the Scheme on policyholder servicing levels (e.g. claims administration). 6.4. As described in Section 4 of this report, there are 2 insurance companies involved in the Scheme, each of
which has a different mix of business.
6.5. It is therefore important that I consider whether this change in the size and nature of the companies involved will have any impact on the security of benefits or reasonable expectations of affected policyholders.
6.6. The main factors that determine the risks to which a policyholder of an insurance company is exposed are: Size of the company;
Amount of capital held, other calls on that capital and capital support currently available to the company;
Reserve strength; Investment strategy; Mix of business written; and
Company strategy – for example, whether it is open or closed to new business.
Security of Policyholder Benefits
6.7. As part of my role as Independent Expert for the Scheme, I need to consider the security of policyholder benefits; that is, the likelihood that policyholders will receive their benefits when due, e.g. the payment of claims.
6.8. In considering and commenting upon policyholder security I shall consider the financial strength of each entity. Financial strength is provided by the margins for prudence in the assumptions used to calculate the Technical Provisions, by the shareholder capital and by any specific arrangements for the provision of financial support. In considering policyholder security it is also necessary to take into account the potential variability of future experience (including claim frequency and severity). Security is also affected by the nature and volume of future new business.
6.9. The nature of the assets which constitute each company’s capital and surplus is also relevant. The shareholder is able to withdraw surplus shareholder assets (i.e. retained profits, but not share capital) in the
levels of service to policyholders.
FSA Conduct Principles
6.12. As Independent Expert for the Scheme I need also to consider the proposals in the context of the FSA’s conduct principles and in particular the impact on levels of service provided to policyholders.
6.13. This involves consideration of areas where discretion is involved on behalf of the relevant insurance company with regard to charges applied to a policy and the benefits granted to the policyholder, and also to service standards applied.
Development of the Scheme
6.14. In the following sections I comment on the Scheme as it will be presented to the Court. During the development of the proposed terms of the transfer I have commented on drafts of the Scheme.
7.
THE EFFECT OF THE SCHEME ON THE TRANSFERRING POLICYHOLDERS
Introduction7.1. 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
Gross Net
Claims outstanding 59,299 39,855
IBNR 61,518 42,832
Unearned premium reserve 9,726 3,376 Claim handing expenses 1,545 1,545 Equalisation provision 991 991
Total technical provisions 133,079 88,599
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
Japanese 5,418 8,644 14,062 2,326 4,216 6,542 Non-Japanese 27 27 54 27 27 54 Branches Japanese 11,879 7,900 19,779 4,031 4,650 8,681 Japanese 951 273 1,224 364 167 531 Non-Japanese 40,718 44,553 85,270 32,928 33,683 66,610 Total 58,993 61,397 120,389 39,676 42,742 82,418 Gross Net UK Italy
Region Japanese/ non-Japanese
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
Gross Net
Claims outstanding (inc. IBNR) 383.1 66.2
Unearned premium reserve 102.4 20.5
Claim handing expenses 4.6 1.9
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 assumptions and results of the actuarial and other analyses used by BHII to set reserves as at
£m Gross Net GAUM 168.0 28.9 Energy 126.5 16.3 Casualty 63.7 11.5 Holdsure 13.1 3.6 Liability 3.7 3.5 Medical Malpractice 5.1 0.9 Others 3.0 1.5 Total 383.1 66.2 Claims Outstanding
