Court of Appeal overturns the High Court’s decision in Prudential-Rothesay transfer

Process

During a Part VII scheme affected policyholders have to be consulted (but not granted a right of veto or vote), regulatory approval must be sought from the PRA and the FCA and an independent expert must produce a report to confirm that policyholder benefits will not be compromised. In two or more hearings, a judge receives submission regarding policyholder objections and determines whether or not the scheme satisfies the statutory criteria, following which he or she will exercise his or her discretion to sanction the scheme.

Initial Judgment

It is common ground that the role of the judge is not simply confirmatory, however, the scope of the judge’s discretion has never been fully crystallised. In 2019 Mr Justice Snowden declined to sanction the transfer of a £12.9 billion book of annuities from The Prudential Assurance Company Limited (“PAC”) to Rothesay Life PLC (“Rothesay”), and in doing so sought to demonstrate the role the court should play in such matters, concluding:

• While the transferee and transferor had similar Solvency Capital Requirement (“SCR”) levels and the independent expert and PRA were supportive of the transfer, the capital management policies and parent company support available to the parties was critical when assessing the security of policyholder benefits.
• When considering the solo financial strength of the transferee, the SCR, and so the independent expert who focused on SCR, did not take into account certain relevant future risks to policyholders.
• PAC was more likely to receive parent company support than Rothesay because of PAC’s position in a listed group even though neither company had any written support arrangement in place with its parent, whereas Rothesay’s private owners might be less likely to support Rothesay.
• The Prudential group was more likely to be able to access external funding to support PAC because it was listed.
• Annuities were distinguished from accumulation products because annuities are non-transferable. An annuity provider is a “choice for life”, annuitants had chosen PAC because of Prudential’s name and history, had not anticipated any transfer to another provider, and so should not be transferred.
• The related reinsurance moving the risk in the transferring business from PAC to Rothesay meant that the economic objective of the transfer had been achieved and therefore the decision to refuse the transfer would not prejudice PAC or Rothesay.

Appeal

The appeal decision in the case delivered on 2 December 2020 before Sir Geoffrey Vos, Lord Justice David Richards and Sir Nicholas Patten represents a return to the status quo of the court’s role prior to the Snowden decision:

• The SCR is the definitive metric for solo capital strength. It takes into account potential and projected future shocks and is therefore highly relevant when considering whether to give weight to exogenous factors.
• While it remains appropriate for the court to consider exogenous factors, significant weight should be given to the Independent Expert and the regulators’ view.
• Where there are no written arrangements between parent and transferee, it is not appropriate to make a judgment about the likely behaviour of a parent or group.
• Mature listed groups are not automatically financially stronger than private groups.
• The non-transferable nature of annuities should not result in different treatment under Part VII.

A key exception is that the court of appeal was partially supportive of Snowden’s position on the existing reinsurance. This may alter the structure of future Part VII reinsurances.

Key conclusions

Predictably, the court did not create a new comprehensive framework of factors for judicial discretion. The judgment is corrective, potentially narrowing the scope of judicial discretion, without fully extinguishing it. However, when considering execution risk, transacting parties should give significant weight to the SCR position of the transferee/transferor and reduce any weighting given to unwritten group commitments (like internal capital frameworks or reputational matters). Without statutory intervention, the law will continue to steadily evolve a list of relevant and less relevant factors.

Transferring “institutional” policyholders, like reinsurers and trustees, may benefit from the renewed focus on the solo position of the transferee if they are concerned about counterparty financial strength, while any thesis placing too much weight on unwritten group commitments or reputation, rather than actual solo financial strength should be treated with caution.

The FCA already looks at the operational and customer facing impacts of a Part VII transfer (e.g. interface, functionality and reporting). It is possible that the FCA may take up the baton from Snowden with regard to the consumer protection issues raised regarding annuities.

The UK life market remains an important destination for investors, whether through consolidation vehicles, pension risk transfer, reinsurance or specialist annuity providers. At the same time, the boom in pension risk transfers, the gentle retreat of some venerable names and the rise of new entrants point to a need for such capital and legal flexibility, and certainty about transferring risks. This decision appears to slam the door shut on a differentiation favouring public over private capital and old over new names, this is important if the UK life market is to remain open for business.