Insurance Regulatory Update October 2019
This is the October edition of the Arthur Cox Insurance Regulatory Update, the monthly bulletin of the Arthur Cox Insurance Group focused on recent developments in insurance regulation, law and practice.
In this issue, topics covered include: the UK High Court’s surprise refusal to sanction the transfer of a £12 billion annuity portfolio, CBI’s new commission disclosure requirements for financial intermediaries, Insurance Europe calls for a delay in the application of the EU regulation on sustainability disclosures, and the theme of Big Data Analytics continues with news from the IAIS and EIOPA.
Rubber stamp? Think again: UK High Court rejects scheme to transfer Prudential annuities
The English High Court’s surprise refusal to sanction the transfer of an approximately £12.4 billion annuity portfolio from Prudential Assurance Company Limited (PAC) to specialist annuity insurer, Rothesay Life Limited (Rothesay) in August this year has caused concern for industry on both sides of the water. Does this unprecedented refusal mark a new era of judicial activism in these type of transfers or is the decision of limited import, specific to its own facts? We examine the reasons for the decision, its potential consequences, and its relevance in an Irish context.
As part of a Prudential Group demerger in 2018, PAC agreed with Rothesay to undertake a Court transfer of a large portfolio of in payment and deferred annuity policies under Part VII of the UK Financial Services and Markets Act (FSMA). As is common in these deals, Rothesay agreed to reinsure the risks associated with the portfolio pending the transfer. Under the reinsurance agreement, PAC transferred assets supporting the liabilities as premium, which then formed collateral for Rothesay’s obligations. If the Scheme was not sanctioned, the Reinsurance Agreement would remain in place.
Notwithstanding that an Independent Expert had opined that the transfer under the terms of the Scheme would not “materially adversely affect the reasonable expectations and security of benefits of policyholders” and the UK PRA and FCA had each reported on the transfer, raising no objection; Snowdon J rejected the Scheme, using the discretion given to the Court under s111 of the FSMA to consider “all the circumstances of the case” when considering whether to approve a Scheme. He agreed that many of the arguments raised by circa 1000 policyholders (representing a mere 0.4% of the transferring policyholders) were valid circumstances that the Court should take into account.
Key aspects of his judgment
- The Court’s role in the process is unique and goes beyond “rubber stamping” regulatory decisions or actuarial analysis. The Court can take “a wider set of factors” into account when striking a balance between policyholders interests and the commercial interests of the insurers.
- The seminal case Re London Life Association Limited should be considered as “ a convenient summary of principles derived from one case and should not be treated as if it were statute”. (Those principles, which influence the approach to date on Irish Court sanctioned Schemes, set the standard for the Court’s discretion. It placed significant emphasis on both the commercial judgment entrusted to a company’s board in designing the proposed Scheme and the fact that the Scheme does not have to be the best Scheme for all stakeholders but as a whole, fair as between the various interests affected).
- The Court rejected that PAC had made a contractual commitment to provide the annuity to policyholders for life. However, the Court would take into consideration the reasonable assumption of policyholders that PAC would not transfer their policies because the policy documentation did not mention PAC might transfer policies under a Scheme.
- Given that policyholders had no right to transfer or encash their policies and were reliant on the annuity provider for their retirement income, the Court would give due regard to the fact that they had chosen PAC based on its size, history, reputation, and presence within the Prudential group, while they did would not have selected Rothesay, a relatively new entrant with a less established reputation.
- The Court was not convinced that Rothesay’s shareholders, predominantly private equity investors, would have the same financial resources and concern for reputational risk as Prudential might have, to support the business in financial difficulty.
- The insurer’s commercial interests were the sole motivation for the Scheme; PAC had achieved the targeted release of regulatory capital through the Reinsurance Agreement, which would remain in place if the Scheme was rejected.
- Rothesay and PAC could not presume that the transfer would be sanctioned. In this case, the policyholders’ interests outweighed the commercial interests of PAC and Rothesay.
For the parties involved, Rothesay remains the reinsurer, it cannot benefit from direct reinsurance and it has a large amount of assets tied up in the provision of the collateral for the arrangement. To this, Snowdon J simply said that Rothesay should not have assumed the Scheme would be sanctioned.
PAC remains the provider of the annuities and is justifiably concerned about its ability to transfer them in the future. Snowdon J was keen to point out that annuities could be transferred, noting that UK Courts had previously sanctioned transfers to Rothesay from both Zurich Assurance Limited and Scottish Equitable Plc. However, in these circumstances, he viewed the policyholders interests as outweighing the insurers’ interests. While the circumstances that led to the decision seem to be based on the specific nature of annuities and the nature of Rothesay, the potential for Schemes to be blocked has clearly increased and the reasons harder to predict.
The Irish position
The impact this decision will have in Irish Courts in the future is hard to gauge, particularly given the uncertainty regarding Brexit. While the English Courts decisions are only of persuasive authority in this jurisdiction, the fact is that until now, the approach of insurers to getting Schemes through the Irish and English Courts have been completely aligned. Snowden J’s decision was strongly influenced by the wording of the FSMA which requires the court to consider “all the circumstances of the case”. By contrast, the Irish statutory test is that “no sufficient objection” to the transfer has been made but the Court has inherent discretion in any case before it. In practical terms, the Courts may actively look beyond the actuarial analysis and regulatory approvals in future, particularly for long term business. At a minimum, insurers planning transfers need to focus on contingency planning for unapproved Schemes.
New requirements for financial intermediaries to disclose commission arrangements to consumers
The Central Bank has published an addendum to the Consumer Protection Code 2012 (available here), relating to the payment of commission to financial intermediaries. It amends the sections of the Code on Conflicts of Interest and the Provision of Information. The Central Bank will be supervising firms’ compliance with these new rules when they come into effect on 31 March 2020.
The new rules aim to ensure transparency of commission arrangements between financial intermediaries and product producers and to minimise the risk of conflicts of interest relating to commissions arising when consumers are getting financial advice from the intermediary.
Under the new rules, intermediaries will be required to publish details of commissions they receive from product producers on their website. Certain commission arrangements are prohibited, as is free hospitality (for example sports tickets). A higher threshold will have to be met in order for the Central Bank to permit intermediaries to describe themselves and their regulated activities as ‘independent’, where they accept and retain commission in the context of providing advice.
Insurance Europe calls for delay in the application of regulation on sustainability disclosures
On 20 September 2019, Insurance Europe, together with other trade associations, wrote to the Commission requesting it to consider timings for the application of the proposed European Regulation on disclosures relating to sustainable investments and sustainability risks (2018/0179(COD)).
The European Parliament adopted the Regulation at first reading in April 2019 and the next step is for the Council to adopt the regulation.
In the letter, the trade associations support the EU Commission’s objectives of financing a more sustainable economy through implementing this Regulation. However, they are concerned that the Regulation will become applicable before the related, final Level 2 measures are adopted, which will create significant compliance challenges and liability risks for market players, as well as confuse investors.
They suggest the application of the new requirements in the Regulation takes effect at least one year after all the Level 2 texts are published in the Official Journal of the EU to address this.
The other signatories to the letter are the Association for Financial Markets in Europe (AFME), the Alternative Investment Management Association (AIMA), the Association of Mutual Insurers and Insurance Cooperatives in Europe (AMICE), the European Association of Cooperative Banks (EACB), the European Banking Federation (EBF), the European Fund and Asset Management Association (EFAMA), Insurance Europe, and Pensions Europe.
IAIS seeking feedback on draft issues paper on the use of big data analytics in insurance
The paper builds on the IAIS Issues Paper on Increasing Digitalisation in Insurance and its Potential Impact on Consumer Outcomes (November 2018) ‘by focusing more specifically on issues relating to the use of personal and other data by insurers as a result of digitalisation’.
The scope of the paper focuses on the use of algorithms and advanced analytics capabilities by insurers to make decisions based on patterns, trends and linkages and the availability to insurers of new alternative data sources, collectively referred to as “big data analytics” (BDA).
The paper explores the potential benefits and risks of the use of BDA by insurers and makes observations about the potential implications for supervisors as a result of the use of BDA in insurance.
It notes that the increased availability of data and enhanced processing capabilities now accessible to insurers can result in a number of benefits. However the complexity of algorithm technology brings risks that insurers need to consider and understand.
The IAIS is seeking the feedback, through public consultation, by 16 October 2019 at 24:00 CET (Basel time).
EIOPA report on ‘cyber risks for insurers – challenges and opportunities’
EIOPA has published a report analysing cyber risk as an operational risk for insurers and the opportunities it presents for insurers from an underwriting perspective. The report is based on responses from 41 large (re)insurance groups across 12 European countries. The report was published with the aim of further enhancing the level of understanding of cyber risk for the European insurance sector.
The findings confirm the need for a sound cyber resilience framework for insurers. The report also highlighted the need for clear, comprehensive and common requirements on the governance of cybersecurity to help ensure the safe provision of insurance services.
In relation to the cyber insurance market, the report identified the key challenges faced by cyber underwriters but indicated that the European cyber insurance industry, while still small, is growing rapidly. Enhanced data collection on cyber incidents and losses should allow insurers to manage their own cyber risk and also price cyber risks more effectively.
EIOPA consultative expert group on digital ethics in insurance
Following its recent thematic review on the use of big data analytics in motor and health insurance, EIOPA has established a Consultative Expert Group on digital ethics in insurance.
The thematic review showed that while there are many opportunities arising from the use of big data analytics for insurers, there are still some risks that need to be addressed. The Consultative Expert Group will assist EIOPA in the development of digital responsibility principles in the Insurance sector.
These digital responsibility principles will address the use of new business models, technologies and data sources in insurance and from the perspective of fairness, will take into account ethical considerations. In this regard, specific focus will be given to pricing and underwriting.
The Consultative Expert Group may also act as a sounding board for EIOPA in other related policy initiatives in the area of InsurTech.