Milliman Client Report

Transcription

1 Milliman Client Report Transfer of non-profit annuity business from The Equitable Life Assurance Society to Canada Life Limited. The report of the Independent Expert 7 October 2015 Prepared by: Nick Dumbreck, FIA October 2015

2 CONTENTS 1. Introduction... 4 The Independent Expert... 4 The purpose and scope of my report... 4 Qualifications and disclosures... 5 Limitations... 5 Technical Actuarial Standards ( TAS )... 6 The Actuarial Profession Standards ( APS )... 6 The structure of my report General considerations of the Independent Expert... 7 The role of the Independent Expert... 7 Security of policyholder benefits... 7 Treating customers fairly... 8 The conclusions of the Independent Expert... 8 The supplementary report The UK Life Insurance market and regulatory environment... 9 The current UK regulatory regime... 9 Pillar I... 9 Pillar II Governance of UK long-term insurers Solvency II The products and long-term business relevant to this report The financial information in this report Background on the companies concerned in the Scheme ELAS Background ELAS s long-term business Membership Recent relevant events Financial Condition Reinsurance arrangements The risk profile of ELAS With-Profits and Capital Management CLL Background Recent Relevant Events CLL s Structure and Operations October 2015

3 Financial Condition Products Reinsurance and financing arrangements Governance and Risk Appetite Capital Management Administration Unit-Linked Fund Management With-Profits Management Risks Inherent in CLL The proposed Scheme The motivation for the Scheme Summary of the Scheme Transferring assets and liabilities Unit-Linked Annuities Group Pension Policies Excluded policies Administration Costs of the Scheme Tax Other The effect of the implementation of the Scheme on the Transferring ELAS policies Introduction The financial resources available to provide security of benefits The profile of risks to which the transferring ELAS policies are exposed Governance and management of the transferring ELAS policies The administration and service standards applied to the transferring ELAS policies The reasonable expectations of the transferring ELAS policyholders Conclusion for the transferring ELAS policies The effect of the Scheme on the non-transferring ELAS policies Introduction The financial resources available to provide security of benefits Financial strength under Solvency II The profile of risks to which the non-transferring policies in the ELAS Funds are exposed The governance, management and service standards applicable to the non-transferring policies in the ELAS Funds The reasonable benefit expectations of the non-transferring policyholders in ELAS Conclusion for the non-transferring policies in ELAS The effect of the implementation of the Scheme on the CLL policies Introduction The CLL NPF policies October 2015

4 With-profits policies of CLL Other considerations arising from the Scheme The approach to communication with policyholders Consideration of the combined impact of the Reassurance Arrangement and the Scheme The costs of the Scheme Reinsurance where ELAS or CLL is the cedant The preparedness for Solvency II The future operation of the Scheme Tax Financial Services Compensation Scheme ( FSCS ) and Financial Ombudsman Service ( FOS ) Conclusions Appendix 1: Statement of independence Appendix 2: previous transfers for which i have acted as independent expert or equivalent Appendix 3: Data relied upon Appendix 4: Certificate of Compliance Appendix 5: Glossary of Terms Appendix 6: Compliance with PRA Policy Statement and SUP October 2015

5 1. INTRODUCTION The Independent Expert 1.1 When an application is made to the High Court of Justice of England and Wales (the Court ) for an order to sanction the transfer of long-term insurance business from one insurer to another, the application is subject to Part VII of the Financial Services and Markets Act 2000 ( FSMA ) and approval by the Court under Section 111 of FSMA. FSMA requires the application to be accompanied by a report on the terms of the Scheme by an Independent Expert. 1.2 I have been instructed by The Equitable Life Assurance Society ( ELAS ) and Canada Life Limited ( CLL ) to report in the capacity of Independent Expert pursuant to Section 109 of FSMA on the terms of the proposed transfer of certain non-profit annuity insurance business of ELAS to CLL. ELAS is a mutual insurance company and CLL is a proprietary insurance company. 1.3 My terms of reference have been reviewed by the Prudential Regulation Authority ( PRA ) and the Financial Conduct Authority ( FCA ). 1.4 My fees will be met equally by CLL (from shareholder resources) and ELAS (which, being a mutual company, has no shareholders). 1.5 In this report I refer to this proposed scheme as the Scheme and throughout the remainder of this report, this term is used to cover all the proposals included in the scheme of transfer, including any documents referred to therein relating to the proposed implementation and operation of the scheme of transfer. 1.6 It is intended that the majority of the non-profit annuity business of ELAS will transfer pursuant to the terms of the Scheme other than business carried on in Jersey (the Jersey Policies ) which will transfer pursuant to a Jersey scheme of transfer (the Jersey Scheme ) and policies which were issued in the course of carrying on business in or from within the Bailiwick of Guernsey, or issued under Guernsey law or issued to residents of the Bailiwick of Guernsey (the Guernsey Policies ) which will transfer pursuant to a Guernsey scheme of transfer (the Guernsey Scheme ). The Jersey Scheme and the Guernsey Scheme will be similar to the Scheme; however, implementation of the Scheme is not conditional on the approval of the Jersey Scheme or the Guernsey Scheme. 1.7 For the purpose of this report, references to the Scheme also include the Jersey Scheme and the Guernsey Scheme, unless otherwise stated. 1.8 The effective date of the Scheme (the Effective Date ) is expected to be 19 February The purpose and scope of my report 1.9 The purpose of this report is to review the proposed transfer of certain non-profit annuity business of ELAS to CLL following its prior reinsurance (excluding the unit-linked annuities) to CLL. In particular, I consider the effects of the proposed transfer on the security of the benefits and on the reasonable benefit expectations of the transferring and non-transferring long-term policyholders of ELAS and the existing long-term policyholders of CLL. I have also considered the implications for the relevant parties if the Scheme were not to go ahead My report has been prepared under the terms of the guidance set out in the Policy Statement The Prudential Regulation Authority s approach to insurance business transfers (the PRA Policy Statement ) and in Chapter 18 of the Supervision Manual ( SUP 18 ) contained in the FCA Handbook. My report will be presented to the Court and will be made available to policyholders and others via the ELAS and CLL websites. The PRA, in consultation with the FCA, has also approved the form of this report. Holders of transferring policies will be sent a guide to the transfer ( the Guide ) together with a summary of the Scheme and a summary of my report, which I collectively refer to as the Explanatory Booklets. The Explanatory Booklets will also be made available on the ELAS and CLL websites In assessing the impact of the implementation of the Scheme on the policyholders of ELAS and CLL, and whether those policyholders are being treated fairly as a result of the implementation of the Scheme, I have had regard to: The likely effect of the implementation of the Scheme on the security of policyholders contractual benefits and on the benefit expectations of policyholders created by past practices employed, or statements made, by each company; October

6 The reports of the Actuarial Function Holders ( AFHs ) of ELAS and CLL on the impact of the implementation of the proposed Scheme; and The reports of the With-Profits Actuaries ( WPAs ) of ELAS and CLL on the impact of the implementation of the proposed Scheme There are no documents or other items of information that I have requested and have not been provided. Appendix 3 contains a list of the main sources of data upon which I have relied As far as I am aware, there are no matters that I have not taken into account in undertaking my assessment of the Scheme and in preparing my report, which nonetheless should be drawn to the attention of the Court in its consideration of the terms of the Scheme I have only considered the terms of the Scheme presented to me, and am not required to consider possible alternative schemes in forming my opinions I have also reviewed and considered the contents of the letter (the Policyholder Letter ) and Explanatory Booklets describing the proposals which, subject to the waivers sought by ELAS and CLL being granted by the Court, are intended to be sent to all transferring policyholders of ELAS. Non transferring policyholders of ELAS will be sent a version of the Policyholder Letter only Advanced drafts of the Policyholder Letter and Explanatory Booklets were available to me at the date of this report This report and its conclusions apply equally to Jersey Policies and the Guernsey Policies as it does to the other long-term insurance business of ELAS, and may therefore be used to satisfy the requirement for a report by an independent actuary on the terms of the Guernsey Scheme and the Jersey Scheme. Qualifications and disclosures 1.18 I am a Fellow of the Institute and Faculty of Actuaries, having qualified in 1982, and hold a certificate issued by the Institute and Faculty of Actuaries to act as a Life Actuary (including with-profits) I am a partner of Milliman LLP ( Milliman ) and I am based in its UK Life Insurance and Financial Services practice. I am an approved person on the FCA s Financial Register and I am currently Actuarial Function Holder for two UK life companies. I have fulfilled the role of Independent Expert on over 20 insurance business transfers that have been approved by the Court My appointment as the Independent Expert has been approved by the PRA (after consulting with the FCA) in a letter dated 22 April 2015 to ELAS and CLL A statement providing details of all connections between myself and ELAS and CLL, and between Milliman and ELAS and CLL, is attached as Appendix 1. I confirm that I do not have any direct or indirect interest in ELAS, CLL or other related firms that could influence my independence. Limitations 1.22 This report, and any extract or summary thereof has been prepared particularly for the use of the bodies or persons listed below: The Court; The Royal Court of Guernsey; The Royal Court of Jersey; The Directors and senior management of ELAS; The Directors and senior management of CLL; The FCA and the PRA, and any governmental department or agency having responsibility for the regulation of insurance companies in the UK; The Guernsey Financial Services Commission; October

7 The Jersey Financial Services Commission; and The professional advisers of any of the above In accordance with the legal requirements under FSMA, copies of my report may be made available to the policyholders of ELAS and CLL and to other interested parties In preparing my report, I have had access to certain documentary evidence provided by ELAS and CLL and I have had access to, and discussions with, senior management of ELAS and CLL. My conclusions depend on the substantial accuracy of this information without independent verification. The principal documents which I have reviewed in respect of ELAS and CLL are listed in Appendix 3. I have considered, and am satisfied with, the reasonableness of this information based upon my own experience of UK life assurance business This report must be considered in its entirety as individual sections, if considered in isolation, may be misleading. Draft versions of this report should not be relied upon for any purpose. I have provided a summary of my report for inclusion in the Explanatory Booklets and for publication on the ELAS and CLL websites (and, where relevant, distribution to any persons requesting a copy of it); other than this, no summary of my report may be made without my express consent This report has been prepared on an agreed basis for the Court, ELAS and CLL in the context 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 my report to a purpose for which it was not intended, nor 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 Technical Actuarial Standards ( TAS ) 1.27 My report has been prepared having regard to the terms of the TAS applicable to Transformations ( Transformations TAS ) issued by the Financial Reporting Council. In my opinion, my report complies with the Transformations TAS and is compliant with those elements of the TASs on Data, Modelling, Reporting and Insurance that are applicable to transformations. In complying with these requirements, I note that a number of the key documents listed in Appendix 3 have been prepared or reviewed by individuals who were subject to professional standards in undertaking their work, including, where appropriate, TAS requirements. The Actuarial Profession Standards ( APS ) 1.28 APS X2 issued by the Institute and Faculty of Actuaries requires members to consider whether their work requires an independent peer review In my view this report does require independent peer review, and this has been carried out by a senior actuary in Milliman who has not been part of the team working on this assignment. The structure of my report 1.30 Section 2 of this report provides some information on the considerations of the Independent Expert and Section 3 gives some background information on the current regulatory regime in the UK and the UK life insurance market, including a description of the non-profit annuity product types relevant to this report Section 4 of this report provides some background to ELAS and CLL, and Section 5 provides some background to the Scheme and summarises the key aspects of the Scheme The effects of the implementation of the Scheme on the policies of ELAS and CLL and on the holders of these policies are covered in Sections 6, 7 and 8. Section 9 outlines a number of other considerations and Section 10 contains my conclusions on the Scheme. October

8 2. GENERAL CONSIDERATIONS OF THE INDEPENDENT EXPERT The role of the Independent Expert 2.1 I have compiled this report in accordance with paragraphs 2.27 to 2.37 of the PRA Policy Statement and with paragraphs 31 to 41 of section 2 of SUP 18, which give guidance on the form of the Scheme Report. 2.2 In considering the proposed Scheme, the concept of treating customers fairly ( TCF ) should be applied. To ensure that customers are treated fairly in the future, it is necessary to establish the ways in which customers have been treated in the past. From the perspective of the policyholders, the successful implementation of the Scheme must be on the basis that their benefits and fair treatment are not materially adversely affected. 2.3 As described in Section 1 of this report, the Scheme concerns two life insurance companies: ELAS and CLL. I need to consider the terms of the Scheme generally and how the different groups of policyholders of ELAS and CLL are likely to be affected by the implementation of the Scheme. In particular I need to consider: The effect of the implementation of the Scheme on the security of the policyholders contractual rights, including the likelihood and potential effects of the insolvency of the insurer; The effect of the implementation of the Scheme on the reasonable benefit expectations of policyholders; and The effect of the implementation of the Scheme on the service standards and governance applicable to policyholders. 2.4 I am only required to comment on the effects of the implementation of the proposed Scheme on policyholders who enter into contracts with ELAS and CLL prior to the Effective Date of the Scheme. 2.5 In this report I have not restricted my assessment of the Scheme to adverse effects. 2.6 The type of policy held by a policyholder will be a key determinant of the risks to which the policyholder is exposed. Other than this, the key determinants of the policyholder s risk exposure will be the characteristics of the company in which the policy is held, for example: The size of the company; The amount and quality of capital resources available, other calls on those capital resources and capital support currently available to the company; The investment strategy of the company; The mix of business of the company; The company s strategy, e.g. whether the company is open or closed to new business, its acquisitions strategy; and Other factors, such as operational risks faced by the company, reinsurance arrangements of the company, the company s governance framework and its tax position. 2.7 Some of these risks are company-specific, for example risks arising from the particular mix of business written or from the company s strategy, and some are common to various different groups of policyholders across the companies subject to the Scheme. Security of policyholder benefits 2.8 As part of my role as Independent Expert for the Scheme, I need to consider the security of policyholder benefits, that is, the effect of the implementation of the Scheme on the likelihood that policyholders will receive their guaranteed benefits when these are due. 2.9 In considering and commenting upon policyholder security, I shall primarily consider policyholders guaranteed benefits. The amount by which the long-term insurance fund assets exceed the long-term insurance fund liabilities (including the mathematical reserves) of a company provides security for guaranteed benefits. Security is also provided by the margins for prudence in the assumptions used to calculate the long-term insurance fund liabilities and by the capital resources in the shareholders fund (if applicable). October

9 Treating customers fairly 2.10 I also need to consider the proposals in the context of the regulatory obligation on both companies to treat their customers fairly and, in particular, the effect of the implementation of the Scheme on policyholders reasonable benefit expectations This involves considering the effect of the implementation of the Scheme on any areas where discretion is involved on behalf of the relevant insurance company, for example in determining the charges applied to a policy and the benefits granted to the policyholder, as well as consideration of the effect of the implementation of the Scheme on the management, service and governance standards of the company in question. The conclusions of the Independent Expert 2.12 As Independent Expert, my assessment of the impact of the proposed Scheme on the various affected policies is ultimately a matter of actuarial judgement regarding the likelihood and impact of future possible events. Given the inherent uncertainty of the outcome of such future events and that the effects may differ across different groups of policies, it is not possible to be certain in respect of their effect on the policies In order to acknowledge this inherent uncertainty, the conclusions of the Independent Expert in respect of Part VII transfers of long-term insurance business are usually framed using a materiality threshold. If the potential impact under consideration is very unlikely to happen and does not have a large impact, or is likely to happen but has a small impact, then it is not considered to have a material effect on the policies The setting of my conclusions in this framework is a consequence of the Court s consideration of prior schemes. In particular, principles stated by Evans-Lombe J. in Re AXA Equity & Law Life Assurance Society plc and Axa Sun Life plc (2001) (based on principles outlined by Hoffman J. in Re London Life Association Ltd (1989)) are often used as the basis for the consideration of insurance business transfers by the Independent Expert and by the Court In particular, Evans-Lombe J. stated in Re AXA Equity and Law that the court is concerned whether a policyholder, employee or other interested person or any group of them will be adversely affected by the scheme. He went on to state: That individual policyholders or groups of policyholders may be adversely affected does not mean that the scheme has to be rejected by the court. The fundamental question is whether the scheme as a whole is fair as between the interests of the different classes of persons affected. The most common interpretation of these (and other relevant) statements has been that a conclusion that no group of policyholders is materially adversely affected by the Scheme provides a sufficient condition to conclude that the fairness of the Scheme as a whole has been demonstrated This is therefore the framework within which I undertake my consideration of the proposed Scheme. The supplementary report 2.17 As envisaged by paragraph 2.39 of the PRA Policy Statement, I will also prepare a further report (the Supplementary Report ) in January 2016, prior to the final Court hearing, to provide an update for the Court on my conclusions in the light of any significant events subsequent to the date of the finalisation of this report The Supplementary Report will be available on the ELAS and CLL websites. October

10 3. THE UK LIFE INSURANCE MARKET AND REGULATORY ENVIRONMENT The current UK regulatory regime 3.1 Under current UK regulations, UK shareholder-owned life insurance companies, such as CLL, must maintain separate funds in order to segregate the assets and liabilities attributable to shareholders and policyholders: the shareholders fund ( SHF ), and the long-term insurance business fund ( LTF ). 3.2 The LTF contains the liabilities of the long-term insurance contracts issued by the insurance company and the assets allocated to these contracts. The SHF contains the assets and liabilities not allocated to the long-term insurance business. The SHF is available to provide support for the LTF and, in particular, can be used to cover the capital requirements of a particular capital adequacy regime. 3.3 There is no such fund structure requirement for mutual companies such as ELAS, as there are no shareholders. 3.4 Prior to 1 April 2013, regulation of UK insurance companies was the responsibility of the Financial Services Authority ( FSA ). Since 1 April 2013, responsibility for the regulation of such companies has been split between the PRA and the FCA. 3.5 The PRA is part of the Bank of England, and carries out the prudential regulation and supervision of banks, building societies, credit unions, insurers and major investment firms. 3.6 The FCA regulates the conduct of all financial services firms in relation to consumer protection, industry stability and the promotion of healthy competition between providers. 3.7 With respect to the insurers it regulates, the PRA has statutory objectives to promote their safety and soundness, and to contribute to ensuring that policyholders are appropriately protected. More generally, these statutory objectives can be advanced by seeking to ensure that regulated insurers have resilience against failure and that disruption to the stability of the UK financial system from regulated insurers is minimised. 3.8 At the 2004 year end the FSA introduced a new capital framework under which insurance companies are required to assess solvency under two regimes, commonly referred to as Pillar I and Pillar II. Pillar I 3.9 Under Pillar I, assets are, broadly speaking, valued at market value and are subject to various admissibility criteria Long-term insurance liabilities are calculated as the present value of expected future net outgo, where prudent assumptions are used to project future cash flows In addition to holding reserves to cover future expected liabilities, companies must hold additional amounts of capital to protect against adverse future experience and one-off shocks to investment performance. The overall capital requirement under the Pillar I regime is called the Capital Resources Requirement ( CRR ) and, under Pillar I rules, has a minimum of the Base Capital Resources Requirement ( BCRR ) (set at 3.7 million at the date of this report) The CRR is defined to be the sum of the Long-Term Insurance Capital Requirement ( LTICR ) and the Resilience Capital Requirement ( RCR ), subject to a minimum of the BCRR The LTICR is calculated using a formula that takes into account, among other things, the type of business in the company, the reserves (gross and net of reinsurance), the sum at risk and the expense levels of the company The RCR is the amount of capital a company needs to hold in order to be able to withstand a set of shocks to equity values, property values and interest rates, and is calculated in accordance with PRA rules Additional solvency and reporting requirements are imposed under Pillar I on firms that have significant volumes of with-profits business (commonly known as realistic reporting). ELAS is subject to this additional requirement, but CLL is not. October

11 Pillar II 3.16 The capital that must be held under Pillar II is an amount set by the Individual Capital Assessment ( ICA ), which is the company s own assessment of its risk exposures and the amount and type of capital required to mitigate those risks. Pillar II is intended to provide a more realistic and complete view of the risks to which the company is exposed and to establish a framework within which the company should be managed The PRA requires firms, when preparing their ICA, to identify the major risks they face and, where capital is appropriate to mitigate those risks, to determine the amount and type of capital that is appropriate. The PRA expects firms to conduct stress tests and scenario analyses to estimate the losses that might arise in severe adverse circumstances in respect of each risk. The capital requirements so determined are then aggregated, allowing for any diversification benefits deemed achievable between those risks that are not perfectly correlated. These stress tests and scenario analyses, together with the supporting analysis, must be documented and, along with the results, submitted to the PRA (on request) as the ICA. The company is not required to make public the results, or any other details, of its Pillar II exercise The PRA will review the ICA periodically and may prescribe an additional amount of capital that must be held by the firm in addition to the amount determined in the ICA exercise. The total amount of Pillar II capital prescribed by the PRA is usually expressed as a percentage of the ICA capital requirement determined by the firm, and is called Individual Capital Guidance ( ICG ) As part of the ICA exercise, a firm will assess the amount of capital it needs to hold to remain able to meet its liabilities as they fall due in all but the most extreme circumstances. The PRA prescribes ICG taking into consideration the capital requirement 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. Governance of UK long-term insurers 3.20 The Board of Directors of a long-term insurer is the firm s governing body, and is ultimately responsible for setting the strategic direction of the firm, overseeing the activities of the firm s day-to-day management and approving the firm s financial statements Every UK long-term insurer (other than certain categories of friendly society) must appoint an actuary to perform the actuarial function in respect of its long-term insurance business. This individual is known as the Actuarial Function Holder or Head of Actuarial Function ( AFH ), and his/her responsibilities include advising the firm s management on the risks that may have a material impact on the firm s ability to meet its liabilities to long-term policyholders and on the capital needed to support the business. In addition, those firms with with-profits business must appoint an actuary (or actuaries) to perform the with-profits actuary function. This individual is the With- Profits Actuary ( WPA ), and his/her responsibilities include advising the firm s management on the key aspects of the discretion to be exercised affecting those classes of the with-profits business of the firm in respect of which he or she has been appointed The actuary or actuaries performing the AFH and WPA roles must have the required skill and experience to perform the relevant function and should not perform any other role within the firm that could give rise to a significant conflict of interest The responsibilities of the AFH and WPA are set out in the PRA Handbook and FCA Handbook, in section 4.3 of the Supervision Manual ( SUP 4.3 ) In relation to each with-profits fund, firms must appoint a with-profits committee ( WPC ) (or a with-profits advisory arrangement if appropriate given the size, nature and complexity of the fund in question). The WPC s role is to advise and provide recommendations to the firm s governing body on the management of the with-profits business, and to act as a means by which the interests of with-profits policyholders are appropriately considered within a firm s governance structures In the management of with-profits funds the implications of TCF and policyholders reasonable expectations ( PRE ) are likely to be greater than for non-profit business given the more extensive nature of a firm s discretionary powers in relation to with-profits business. PRE can be formalised from a number of different sources, including past practice, communications made to policyholders at the point of sale and ongoing, or by statements of practice. A detailed description of the financial management of with-profits business is set out in the statement of Principles October

12 and Practices of Financial Management ( PPFM ) which with-profits companies must maintain and make available to policyholders In the PPFM, Principles are overarching statements of the intended terms for the management of with-profits business and these are unlikely to change very frequently. If changes (other than minor editorial changes to improve clarity) are required, policyholders must be notified before the changes take effect. The statement of the Practices reflects the application of the Principles currently adopted by the company. Practices may be expected to change more frequently than Principles reflecting changing circumstances. Changes to the Practices must be consistent with the Principles but do not require pre-notification to policyholders. Solvency II 3.27 New regulatory solvency reporting requirements for the European Union ( EU ) insurance and reinsurance industry are due to be introduced with effect from 1 January The new regime is known as Solvency II and aims to introduce solvency requirements that better reflect the risks that insurers and reinsurers actually face and to introduce consistency across the EU. All but the smallest EU insurance companies will be required to adhere to a set of new, risk-based capital requirements and, in contrast to the current UK Pillar II requirements, the results will be shared with the public Solvency II is a principles-based regime and is based on three pillars: Under Pillar 1, quantitative requirements define a market consistent 1 framework for valuing the company s assets and liabilities. Under Pillar 2, insurers must meet minimum standards for their corporate governance and 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 ( ORSA ), and senior management must demonstrate that the ORSA actively informs business planning, management actions and risk mitigation. Under Pillar 3, there are explicit requirements governing disclosures to supervisors and policyholders. In addition to the detailed Pillar 1 financial information required to be publicly disclosed, firms will produce a private annual report to supervisors and a public solvency and financial condition report Under Solvency II, a company s liabilities must include a risk margin, which is an adjustment designed to bring the value of the liabilities up to the amount that another insurance or reinsurance undertaking would be expected to require in order to take over and meet the insurance obligations The Solvency Capital Requirement ( SCR ) under Solvency II is the capital requirement under Pillar 1, and is intended to be the amount required to ensure continued solvency over a 1 year time frame with a probability of 99.5% The Minimum Capital Requirement ( MCR ), which will be lower than the SCR, defines the point of intensive regulatory intervention. The MCR calculation is simpler, more formulaic and less risk-sensitive than the SCR calculation The European Insurance and Occupational Pensions Authority ( EIOPA ) has prescribed a standard formula to be used for the calculation of the SCR. However, Solvency II also permits firms to use their own internal models (or a combination of a partial internal model and the standard formula) to derive their SCR. These internal models and partial internal models are subject to approval the relevant regulator in the UK this is the PRA In order to allow companies, regulators and the European Commission to consider the likely effects of the new regime on insurers and reinsurers, the industry has undertaken a number of trial runs and impact assessments, and has produced results under the Solvency II rules as they have developed On March , the Solvency II Regulations 2015 were published by the UK Government, which, in part, implement the Solvency II Directive and the subsequent Omnibus II Directive into UK law. The remainder of the Solvency II directive will be implemented by the PRA and the FCA. The PRA has issued final rules on the 1 A market-consistent framework requires the values placed on assets and liabilities to be consistent with the market prices of listed securities and traded derivative instruments. October

13 transposition of the Directives into the UK national regulatory framework. These set out its approach to the prudential regulation, and its expectations, of firms subject to Solvency II Consultation by EIOPA on implementing technical standards ( ITS ) and guidelines for the new regime is currently underway and most of the draft ITS and guidelines have now been published and are awaiting endorsement by the European Commission. Once endorsed, these will become legally binding and apply to all national regulators under the scope of Solvency II without any further transposition into local frameworks Any UK firms intending to use an internal model, transitional measures, a matching adjustment or a volatility adjustment must formally apply to the PRA for approval. The PRA has issued a number of consultation papers and other communications which provide further clarity on the approval processes and set out the PRA s expectations of firms. The products and long-term business relevant to this report 3.37 The proposed Scheme provides for the transfer of non-profit annuity business written by ELAS from establishments in the UK, Guernsey, Germany and the Republic of Ireland and consisting of: Conventional (i.e. non-linked) annuities, which pay a level or increasing income (at a fixed rate of increase per annum) for the lifetime of the annuitant(s); Index-linked annuities, which pay an increasing income, but where the increases are calculated with reference to a published index, such as the Retail Prices Index; and Unit-linked annuities, which pay an annuity which may vary according to the investment performance of the underlying unit-linked funds; 3.38 Some of these annuities may include additional optional benefits, such as spouses or other dependants annuities to be paid on the death of the main policyholder, and a guaranteed return on death of the main policyholder during a specified guarantee period (typically 5 to 10 years) For the avoidance of doubt, none of the annuities to be transferred under the Scheme include any profit-sharing or participating features. The financial information in this report 3.40 The Pillar I balance sheets as at 31 December 2014 are shown in Section 4 of this report. Based on discussions with the ELAS and CLL senior management, I am satisfied that these figures are consistent with the published and externally audited financial statements for ELAS and CLL. I am therefore satisfied that it is appropriate to rely on this financial information My comments in this report with respect to Pillar II capital requirements are based on the Pillar II results as at 31 December 2014, including ICG as applicable As noted above, Pillar II financial information is not published and remains private between the PRA and the company. I have therefore not included any Pillar II figures in this report, but have provided qualitative comments on the Pillar II position of each company Solvency II is due to be implemented on 1 January 2016, and so its implementation will fall between the date of this report and the Effective Date. From 1 January 2016, the current solvency regime will no longer apply, and hence the bases of calculation of the financial positions shown in this report will no longer be applicable As noted in paragraphs 3.34 and 3.36, the Solvency II regulations are finalised, but some of the options around methodologies to be used require regulatory approval. Therefore, at the time of preparation of this report, there is still some uncertainty as to precisely how the financial position of ELAS and CLL will be determined. However, ELAS and CLL have shared their internal Solvency II calculations and estimates with me, and we have discussed the possible ranges of outcomes Hence, although my report contains no quantitative Solvency II financial information, I describe briefly, in respect of both ELAS and CLL policies, why I am comfortable that the implementation of Solvency II is unlikely to alter my conclusions concerning the Scheme I intend to comment further on any material developments in respect of Solvency II which are relevant to my assessment of the Scheme in my Supplementary Report. October

14 4. BACKGROUND ON THE COMPANIES CONCERNED IN THE SCHEME ELAS Background 4.1 ELAS was established as a mutual life assurance company in It was set up and run for its members and retains its mutual status today. The company has approximately 515,000 policies in force and around 6 billion of funds under management as at 31 December ELAS closed to new business in December ELAS s strategy is to seek to rebuild policyholder value, and it aims to deliver this by: Reducing risks, leading to lower solvency capital requirements, so increasing the amount available for distribution. Distributing all of the assets among with-profits policyholders as fairly and as soon as possible. Ensuring that with-profits policyholders leaving ELAS receive their fair share of capital, provided there is enough left for those who remain. Carefully managing solvency to enable capital distribution and only then seeking to maximise return. Reducing the cost base in line with run off while delivering a trusted and valued service. ELAS s long-term business 4.4 ELAS s long-term business consists of managing the policies of approximately 340,000 with-profits policyholders, 145,000 unit-linked policyholders and 30,000 conventional non-profit annuity policyholders. 4.5 The business within ELAS comprises protection products (including life cover and critical illness) for groups and individuals, retirement income planning products and annuities. 4.6 The vast majority of ELAS s business was written in the UK, although some business was written by branches in Guernsey, the Republic of Ireland and Germany. 4.7 The Jersey Policies were written through ELAS s branch in Guernsey. 4.8 ELAS currently has one fund, the Ordinary Long Term Fund (the ELAS OLTF ). 4.9 ELAS is authorised by the PRA to undertake long-term insurance business in Classes I, II, III, IV, VI and VII 2, as set out in Part II of Schedule 1 to the Financial Services and Markets Act 2000 (Regulated Activities) Order Membership 4.10 As a mutual company, ELAS has no shareholders and is owned by its members The precise definition of membership is set out in the ELAS Memorandum and Articles of Association, but in broad terms, owners of with-profits policies which are still in force and which continue to participate in the profits of ELAS are members. However, for joint life policies, only the first named policyholder is a member. Membership is nontransferrable, and specifically does not transfer on the death of the original member ELAS is an unlimited company and accordingly its members are liable for its debts. However, the policies issued by ELAS state that ELAS s liabilities cannot exceed its assets. The purpose of this provision is to prevent members being called upon to meet its liabilities to policyholders (whether under with-profits or non-profit policies). However, under certain adverse circumstances, it is possible that policyholders could receive lower benefits under their policies than would normally be guaranteed. 2 Classification of long-term insurance business: I life and annuity, II marriage and birth, III linked long-term, IV permanent health, VI capital redemption contracts and VII pension fund management. October

15 Recent relevant events Closure to new business in ELAS closed to new business in December 2000 following a House of Lords ruling that its approach to guaranteed annuity rates ( GARs ) attaching to with-profits pension policies was unlawful. Since the closure, the only new business has been in respect of increments to existing policies where there was a contractual or regulatory obligation to provide such increments, and in respect of annuities arising out of existing pension policies. Reinsurance of non-profit and unit-linked business to Halifax Life Limited in In 2001, the economic interest in the ELAS non-profit business (other than immediate annuities) and unit-linked business was transferred to Halifax Life Limited (now part of the Lloyds Banking Group) by way of a reassurance agreement. In addition, Halifax Life agreed to acquire the majority of the operating assets of ELAS along with the administration services for the reinsured policies. GAR Compromise Scheme in In 2002, following a vote by members, the Court approved a compromise scheme under which the majority of policyholders with GARs gave up their right to those GARs in return for an uplift to their guaranteed benefits and policy values. Some policies with GARs were excluded and these policies, together with non-gar policies, received a lower uplift. The transfer of ELAS non-profit annuities to CLL in In February 2007, ELAS transferred the majority of its non-profit annuity business to CLL. This represented approximately 4.6bn of non-profit annuities and approximately 130,000 policies. Sale of University Life to Reliance Mutual in In June 2007, ELAS sold University Life Assurance Society, a wholly owned subsidiary, to Reliance Mutual Insurance Society Limited. The transfer of all of ELAS s with-profits annuity business to Prudential in In January 2008, ELAS transferred all of its with-profits annuity business to The Prudential Assurance Company Limited equating to the acquisition of approximately 1.8bn in assets. This transferred approximately 60,000 annuities representing approximately 50,000 annuitants. Recapture of the unit-linked business in In July 2014, ELAS agreed with Halifax Life Limited to recapture the unit-linked business which had previously been reinsured in 2001 (see paragraph 4.14), and this exercise was completed in March Reinsurance of non-profit annuity business in On 2 March 2015, ELAS entered into a reinsurance agreement (the Reassurance Arrangement ) with CLL to reinsure the conventional non-profit annuity business expected to be transferred by the Scheme, but excluding any unit-linked annuities. The Reassurance Arrangement was effective from 1 January 2015, and covered approximately 30,000 policies. The premium payable to CLL under the Reassurance Arrangement comprised assets of approximately 850m. These assets transferred were deposited back with ELAS to provide security to ELAS. In addition, ELAS entered into a transfer agreement ( the Transfer Agreement ) with CLL, which sets out how the business reinsured under the Reassurance Arrangement and the unit-linked annuities of ELAS will transfer to CLL under the Scheme If the Scheme proceeds to completion as intended, the Reassurance Arrangement will terminate and associated assets held on deposit will be transferred to CLL. Any non-profit annuities (including unit-linked) that cannot be transferred to CLL via the Scheme will be reinsured by a Residual Policies Reassurance Arrangement. If the October

16 Scheme has not become effective by 31 December 2016, both ELAS and CLL have the option to terminate the Reassurance Arrangement. Financial Condition 4.22 As mentioned in section 3.15, additional solvency and reporting requirements are imposed under Pillar I on firms that have significant volumes of with-profits business. ELAS is subject to this additional requirement, and therefore is required to publish its solvency position using the twin peaks approach. Under this approach firms are required to carry out a regulatory ( Peak 1 ) and realistic ( Peak 2 ) calculation in respect of its funds that contain with-profits business and hold capital to cover the more onerous of these two peaks. These calculations are therefore required for ELAS s sole fund, the ELAS OLTF As ELAS is a closed with-profits mutual company, the published solvency position within the PRA returns is complex; the company must show liabilities (including capital requirements) equal to its total assets and as a result the reported surplus in both the regulatory and realistic peak is zero. The rationale behind this is that all assets in a closed with-profits fund are earmarked for distribution to the with-profits policyholders. However, for the purposes of this report this is an unhelpful presentation, and hence I use alternative presentations below which better illustrate the company s solvency position ELAS must also report to the PRA under the Pillar II regime on its own risks and capital required to meet those risks I have considered both the Pillar I and Pillar II financial positions in my assessment. However, as the Pillar II disclosures are submitted privately to the PRA, I am unable to directly quote the financial position. Consequently, the financial positions set out in tables 4.1 and 4.2 are on a Pillar I basis only The Pillar I regulatory basis (Peak 1) balance sheet as at 31 December 2014 (and 31 December 2013) for ELAS is shown in Table 4.1 below. Table 4.1: ELAS regulatory balance sheet ELAS Regulatory Balance Sheet ( m) 31 December December 2013 Admissible Assets 5,985 5,627 Non-profit Liabilities With-profits Liabilities 4,497 4,253 Other Liabilities Total Liabilities 5,499 5,177 Excess of assets over liabilities (A) CRR (=LTICR) (B) CRR Cover (A/B) 218% 214% 4.27 The Pillar I realistic basis (Peak 2) balance sheet as at 31 December 2014 (and 31 December 2013) for ELAS is shown in Table 4.2 below. October

17 Table 4.2: ELAS realistic balance sheet ELAS Realistic Balance Sheet ( m) 31 December December 2013 Regulatory Value of Assets 5,985 5,627 Assets backing non-profit business (989) (897) Value of future profits on non-profit business Realistic Value of assets backing with-profits business 5,042 4,754 With-profits benefit reserve (3,004) (3,168) Planned deductions for guarantees Planned deductions for other costs 0 11 Future cost of guarantees (1,188) (877) Future cost of financial options (7) (5) Provisions for other liabilities (238) (223) Realistic value of current liabilities (56) (67) Realistic value of with-profits liabilities (4,246) (4,063) Excess of Assets over Liabilities Risk Capital Margin Surplus Assets as a % of realistic value of with-profits liabilities 17.9% 15.5% Notes to Table 4.2: 1. The with-profits benefit reserve is the starting point for calculating the with-profit business liabilities. It represents the total Policy Values (see section 4.36) or their equivalent measures for the with-profits business. 2. The planned deductions for guarantees represents the present value of projected future deductions from the total Policy Values or their equivalent measures for the cost of guarantees. 3. The planned deductions for other costs represents the present value of deductions for surrenders from the total Policy Values or their equivalent measures. 4. The future cost of guarantees is the present value of the projected future cost of guarantees in excess of the planned deductions for guarantees. 5. The future cost of financial options represents the present value of the future cost of guaranteed annuity rates. 6. The provisions for other liabilities comprise a number of provisions for future liabilities including regular expenses, exceptional expenses and, for 2013 only, legal claims. 7. The Risk Capital Margin ( RCM ) is a regulatory minimum level of capital derived by considering the impact of certain stressed scenarios As noted above, the reported surplus under the realistic peak will be shown as zero in the PRA returns. This is a result of actuarial guidance that requires closed with-profits funds to reclassify any surplus as additional liabilities within the PRA returns under the heading planned enhancements to with-profits benefit reserve. The presentation in table 4.2 shows these planned enhancement liabilities as surplus assets For ELAS, the regulatory peak was the more onerous at 31 December 2014 (and 31 December 2013). October

18 Reinsurance arrangements 4.30 In addition to the recently agreed annuity reinsurance with CLL referred to in paragraph 4.20, ELAS has a number of reinsurance agreements in place with companies in Lloyds Banking Group plc. The reinsurance agreements are placed with Halifax Life Limited, Clerical Medical Managed Funds Limited, and Clerical Medical Investment Group Limited. I understand that Lloyds Banking Group is separately undertaking a restructure of its insurance businesses, but this should have no impact on the considerations for this Scheme, since there is no intended change to the nature or level of reassurance cover and none of these reinsurance agreements is transferring under the terms of the Scheme. The risk profile of ELAS 4.31 ELAS s main risks arise from guarantees to policyholders and: Assets under management: market, credit, and interest rate risk; Counterparty default risk from its reinsurance counterparties; Longevity risk on its annuity liabilities; and Expense risk arising from the need to reduce expenses in line with the run off of the business The Pillar II assessment aims to assess appropriately the risks inherent in the company s business profile, by having regard to the economic capital needs of the firm that arise from a variety of different risk exposures. The Pillar II results are submitted privately to the PRA and it is not appropriate for me to disclose the financial position in detail, but I have considered in detail the nature of the risks and their relative contribution to the risk profile of ELAS. Figure 4.3 shows the pre-diversification profile of ELAS as at 31 December 2014 under its Pillar II basis. Figure 4.3: ELAS Pre-Diversification Pillar II Position as at 31 December 2014 Source: ELAS ICA as at 31 December ELAS reduced its exposure to market and longevity risk in 2013 by means of a buy-out of its staff pension fund liabilities. Apart from this, the risk profile of ELAS has remained broadly stable over recent years in terms of the relative balance between which risks are most material The majority of longevity risk from its non-profit annuity liabilities has been transferred to CLL via the Reassurance Arrangement. This risk transfer will be perfected by the subsequent transfer of the annuity business to CLL under this Scheme. October

19 4.35 Other less material risks include: Inflation risk; Operational risk; Liquidity risk; Strategic risk; and Regulatory risk. With-Profits and Capital Management 4.36 ELAS uses the concept of Policy Values to manage the vast majority of its with-profits policies. A Policy Value normally represents a smoothed investment return (net of charges and other adjustments) applied to the premiums paid into the policy. Policy Values are used to determine payout levels in relation to with-profits benefits and, over the medium to long term would, other things being equal, be related to the growth on the underlying investments Policy Values are not guaranteed, and can be reduced as well as increased, and can be more or less than the value of guarantees under a policy. They are kept regularly under review, and changes are determined by the ELAS Board For a minority of with-profits policies a Policy Value is not calculated, but other equivalent methodologies are applied to achieve a similar effect ELAS intends to distribute all of its assets among with-profits policies as fairly as possible over the lifetime of those policies. In order to ensure fairness between policies leaving and those remaining in the fund, ELAS needs to ensure that payout levels distribute a fair share of the solvency capital of the fund as soon as possible, while also leaving sufficient capital for the remaining policies At least annually, ELAS calculates a Capital Distribution Amount, or enhancement, as a proportion of Policy Values at a certain date, and which is paid on top of Policy Values to determine payouts. This Capital Distribution Amount and the way it is applied represent the ELAS Board s view of the prudent share of solvency capital that can be earmarked for policyholders. The Capital Distribution Amount is not guaranteed, and can be removed, reduced or increased at any time, without prior notice to policyholders The levels of required and available solvency capital are strongly influenced, over the longer term, by the Total With-Profits Policy Values (the sum of Policy Values and equivalent measures for policies for which Policy Values are not calculated) and Capital Distribution Amounts. ELAS expects that the Total With-Profits Policy Values and Capital Distribution Amounts are kept at such a level that it can maintain cover in excess of 120% of its ICA capital requirement (or ICG if higher). In circumstances where the cover falls below 150%, ELAS will consider reducing Total With-Profits Policy Values and Capital Distribution Amounts to restore solvency in line with its target cover. If the ratio fell below 120%, such action would almost certainly be taken ELAS s need for capital is determined by the level of risk it faces from time to time. If its risks increase, it needs to hold more capital and vice versa. This is in contrast to the Policy Values, which tend to grow broadly in line with investment performance Implementation of ELAS s strategy to distribute capital to policyholders is therefore dependent on how successful it is in reducing risks. As risks are reduced or eliminated, capital will be returned to policyholders The ELAS Board acts as the ELAS WPC. October

20 CLL Background 4.45 CLL is a proprietary company that is a wholly owned subsidiary of The Canada Life Group (U.K.) Limited which in turn is owned by Canada Life Financial Corporation. Since July 2003, Canada Life Financial Corporation has been a wholly owned subsidiary of Great-West Lifeco Inc Figure 4.4 shows the organisation structure of Great-West Lifeco Inc. and the position of CLL within that structure. Figure 4.4 Simplified Organisational Structure of Great-West Lifeco Inc. 100% 100% Source: CLL October

21 4.47 CLL offers protection products (including life cover, income protection and critical illness) for groups and individuals, and retirement income planning products, annuities, pension bonds, savings and investments, investment bonds and inheritance tax planning products CLL s UK long-term insurance business consists of business written mainly in the UK, with approximately 650,000 policies in force as at 31 December Recent Relevant Events 4.49 In 2005 CLL purchased a portfolio of 58,000 non-profit annuity policies from Phoenix & London Assurance Limited ( PALAL ) (formerly known as Sun Alliance and London Assurance Company), for a purchase price of 2.2 billion. This was effected by way of a Part VII transfer in December In 2007, CLL acquired the non-profit annuity business of ELAS (see paragraph 4.16) In July 2013, CLL acquired the Irish Life Group Limited. At the same time, an internal group restructuring took place that saw CLL acquire Canada Life Assurance (Ireland) Limited from CLL s parent Canada Life Group (U.K.) Limited. Canada Life Assurance (Ireland) Limited was incorporated into the Irish Life Group, and its long term business was transferred to Irish Life Assurance plc ( Irish Life ) on 1 January In July 2015, Canada Life Group (U.K.) Limited completed the acquisition of Legal & General International (Ireland) Limited As discussed in paragraph 4.20, in March 2015, CLL entered into the Reassurance Arrangement and Transfer Agreement to reinsure almost all of ELAS s non-profit annuities (other than the unit-linked annuities) and subsequently to transfer those annuities, together with the unit-linked annuities, to CLL. CLL s Structure and Operations 4.54 CLL is authorised by the PRA to undertake long-term insurance business in Classes I, II, III, IV, VI and VII, as set out in Part II of Schedule 1 to the Financial Services and Markets Act 2000 (Regulated Activities) Order CLL maintains a shareholder s fund ( CLL SHF ) and a Long Term Business Fund ( CLL LTBF ) The CLL LTBF is divided into three sub-funds: The CLL Non-Profit Fund ( CLL NPF ) contains a range of non-profit non-linked and non-profit linked business; The CLL Manulife Fund contains conventional with-profits savings, with-profits pension business, non-profit protection business and non-profit annuity business originally written by the UK operation of Manulife; and The CLL With-Profits Fund contains conventional with-profits savings and with-profits pension business. The CLL Manulife Fund and the CLL With-Profits Fund are both closed to new business and are in run-off All profits arising in the CLL NPF may be retained in that fund or transferred to the CLL SHF where they may be available to be paid as a dividend to CLL s shareholder, subject to any legal or regulatory constraints which may apply (e.g., there being sufficient distributable earnings under the Companies Act or to ensure that adequate solvency margin coverage is maintained). With-profits policyholders in the CLL Manulife Fund and the CLL With- Profits Fund are entitled to all distributable profits arising in their respective funds. Financial Condition 4.58 CLL reports its statutory financial position to the PRA under the Pillar I Peak 1 regime. CLL is not required to report under the realistic basis ( Peak 2 ) as it does not have with-profits liabilities above the relevant threshold level. CLL must also report to the PRA under the Pillar II regime on its own risks and capital required to meet those risks I have considered both the Pillar I and Pillar II financial positions in my assessment. However, as the Pillar II disclosures are submitted privately to the PRA, I am unable to directly quote the financial position. Consequently, the financial position set out in Table 4.5 is on a Pillar I basis only. October

22 4.60 Pillar I is the more onerous basis for CLL, in that under Pillar I the level of excess assets is lower than under Pillar II. This relative position has been the case in more recent years and is expected to remain so until Solvency II becomes effective. Table 4.5: CLL regulatory balance sheet 31-Dec Dec-13 CLL Regulatory Balance Sheet ( m) NPF* WPF Manulife LTBF SHF TOTAL TOTAL Admissible assets 22, ,566 1,696 24,262 22,506 Mathematical reserves 19, , ,405 17,936 Other liabilities 2, , ,569 2,467 Total Liabilities 21, , ,974 20,404 Excess of assets over liabilities (A) ,684 2,288 2,103 LTICR RCR Irish Life CRR CLL CRR (B) ,378 1,283 CRR Cover (A/B) 166% 164% Notes to Table 4.5: * The above figures assume a cash transfer of 155m from the NPF to the SHF 4.61 The Pillar I coverage for CLL as at end-december 2014 was 166% (31 December 2013: 164%). CLL aims to operate at a level of cover of 140% and within a range of 126% to 154%; as shown, CLL exceeded the upper end of this range at 31 December 2014, partly because of the potential effects of, and uncertainty surrounding, Solvency II The CLL SHF assets shown in table 4.5 include 330 million in respect of subordinated debt provided by other companies within the wider Canada Life group. There are various tranches of this debt, which are subject to different terms and conditions, and with different interest rates payable. The terms of the debt are that interest and repayments can only be made if, in the opinion of the CLL AFH, to do so would not put the company in breach of its required margin of solvency. The debt is immediately repayable in the event of any steps being taken to wind up the company. The lender may only petition for the winding up of the company following the second anniversary of the default of the terms of the agreement by CLL. In a winding up, no amount will be paid in respect of the subordinated debt until all policyholders and other creditors have been paid in full. Other than in these circumstances, the lender cannot call for repayment of the loan within the term of the loan (some is undated). Repayment of the subordinated debt is subject to no objection from the PRA, and for some tranches 5 years notice to the PRA We understand from CLL that the subordinated debt is expected to continue to qualify as capital under Solvency II and I will provide an update on this point in my Supplementary Report. The treatment of the subordinated debt under Solvency II will not be affected by the Scheme Also included in the CLL SHF assets is the regulatory value of Irish Life at 852 million, along with its CRR of 409 million. Therefore Irish Life contributes 443 million to CLL assets in excess of its CRR. If the regulatory value and CRR of Irish Life were excluded, the cover for CLL s Capital Resources Requirement at 31 December 2014 would fall to 148%, still within the target range. October

23 Products 4.65 As mentioned in paragraph 4.47, CLL has a wide range of product types in force The CLL Manulife Fund and the CLL With-Profits Fund contain with-profits business. The CLL NPF is the only fund of CLL that is open to new business Table 4.6 shows the breakdown of CLL s in-force business by fund and broad product category as at 31 December 2014: Table 4.6: CLL In-force Business at 31 December 2014 No. Policyholders/ Members* Annual Office Premium (Gross) m Reserve (Gross) in m Reinsurance ceded in m Reserve (Net) in m With Profit Fund non-linked Life 3, non-linked Pension , Manulife Fund non-linked WP Life 13, non-linked NP Life 1, non-linked WP Pension non-linked NP Pension 2, , Non Profit Fund non-linked Life 601, non-linked Pension 2,250, ,218 1,830 12,388 linked-life 274, , ,492 linked-pension 182, , ,672 3,308, ,463 2,261 19,202 Total 3,329, ,666 2,261 19,405 Source: CLL PRA Returns 2014 * includes individual policyholders and members of group pension policies Table 4.6 shows that the vast majority of CLL s in-force business, representing approximately 99% of reserves (net of reinsurance) of the company, is in the CLL NPF. The largest product line within the CLL NPF is non-profit annuity in payment business, which accounts for approximately 72% of CLL business by reserves (net of reinsurance) Table 4.7 shows the level of new business written by CLL over All of the new business is written into the CLL NPF. The CLL With-Profits Fund and CLL Manulife Fund are both closed to new business. October

24 Table 4.7: CLL New Business 2014 No. Policyholders/ Members* Regular Premium (in '000) Single Premium (in '000) Life non-linked 57,979 15,397 13,689 linked 20,667 5, ,918 78,646 20, ,607 Pension non-linked 193,875 24, ,128 linked 5, , ,896 24, ,732 Total 277,542 45, ,339 Source: PRA Returns 2014 * includes individual policyholders and members of group pension policies CLL continues to write both life and pensions new business, with the majority of the new business sales, approximately 70% on an annual premium equivalent basis (where single premiums are divided by 10 and added to the regular premiums), being in respect of CLL s annuity product in Reinsurance and financing arrangements 4.71 CLL has in place a number of reinsurance arrangements with Canada Life International Re and Canada Life Assurance Company (Barbados branch), both Canada Life group companies, which together represent approximately 90% of CLL s total reinsurance ceded The reinsurance with Canada Life International Re is a quota share reinsurance arrangement covering 60% of CLL s group life business, with ceded mathematical reserves of approximately 50 million as at 31 December The reinsurance with Canada Life Assurance Company (Barbados branch) consisted of two quota share arrangements as at 31 December The first is covered 40% of the PALAL annuities (see paragraph 4.49), while the second covered 40% of the ELAS annuities acquired in 2007 (see paragraph 4.50). The combined mathematical reserves ceded total 1.95 billion as at 31 December CLL has recently (June 2015) increased the percentage reinsured under both of these arrangements to 90% Under each of these intra-group reinsurance arrangements, an amount equal to the ceded reserves is deposited back to CLL by the relevant reinsurer to provide security to CLL in the event of financial difficulty of that reinsurer There are also external reinsurance arrangements with Royal Bank of Canada Insurance Company Limited, Hannover Ruckversicherung, Munich Re and Swiss Re Europe S.A CLL also has in place an analogous non-reinsurance financing agreement with J.P. Morgan Ventures Corporation which limits CLL s longevity exposure until June 2048 on approximately 13% of the ELAS annuities that were acquired in February This type of arrangement is commonly known as a longevity swap, whereby CLL will pay a predetermined amount each year to J.P. Morgan Ventures Corporation based on the expected annuity outgo schedule at the time the agreement was entered into, and will receive in return the actual amounts required to pay the annuities. October

25 Governance and Risk Appetite 4.77 CLL has a risk governance framework in place, which sets out the principles, governance and processes surrounding its risk management. These include setting and monitoring the financial position of the company against its agreed risk strategy and risk appetites. Risk policies and principles are also in place, as well as governance arrangements setting out the roles and responsibilities of the Board and sub-committees and the company s three lines of defence approach to risk management CLL is currently in the process of enhancing its risk management framework and the governance processes that support it in preparation for Solvency II. I have been provided with updated CLL risk management and governance policies. These establish CLL s Enterprise Risk Management ( ERM ) framework by outlining the principles, governance and processes of the company s approach to ERM. This framework includes the roles and responsibilities of the Board, Committees of the Board, executive level risk committees, oversight functions and business areas with respect to ERM I will provide an update in my Supplementary Report on any material developments to CLL s risk management framework and governance processes, if appropriate. Capital Management 4.80 CLL s management aims to ensure that CLL has sufficient capital and reserves to meet its liabilities as they fall due under a range of stressed conditions and to meet its regulatory solvency requirements. CLL aims to manage its solvency position at a level which allows CLL to meet the goals of its strategic and business plan, subject to its risk appetite. CLL s capital management policy directly reflects the capital management policy of Great-West LifeCo Inc, whilst allowing for the requirements of the local regulatory regime. These are codified in target solvency coverage ratios under several bases and CLL maintains total aggregated capital resources sufficient to ensure it satisfies the most stringent of the following requirements: Maintaining a target cover of 140% of the Pillar I CRR, subject to a range of 126% - 154%; Maintaining a target cover of 120%-130% of its ICA capital requirement, where this is the higher of its Pillar II ICG or its Pillar II capital requirement; and Maintaining a target Canadian Minimum Continuing Capital and Surplus Requirements ( MCCSR ) cover of 175%-200% These targets and operating ranges are reviewed regularly, at least annually or at such time as deemed appropriate or necessary by the Chief Financial Officer. In addition the quality of the capital is reviewed to ensure that it remains appropriate. If CLL does not meet the requirements of its capital management policy, then the Board will formalise a plan to restore CLL to a position where these requirements are met. Administration 4.82 The administration of CLL s existing business is undertaken in-house at the company s offices in Potters Bar and Bristol Other functions such as HR, IT, Actuarial, Finance and Marketing are also provided internally within CLL. These functions operate across all product lines Investment management is provided by Canada Life s in-house investment team. Unit-Linked Fund Management 4.85 CLL offers a wide range of unit-linked funds with various investment objectives across a range of unit-linked products. The level of charges which apply vary according to the fund. Unit pricing is carried out by CLL on a daily basis. October

26 With-Profits Management 4.86 The CLL With-Profits Fund and the CLL Manulife Fund are closed to new business and in run-off. As Table 4.6 shows, the volume of business in the Funds, by mathematical reserve, is very small compared to the business in CLL s Non-Profit Fund Both funds are governed by, and managed in accordance with, Court approved schemes of transfer in respect of company reorganisations in the 1990s. In both funds, any distributions of surplus (e.g. regular, final or cash bonuses) are distributed entirely to policyholders, and there is no associated payment to shareholders. These arrangements are commonly referred to as being 100/0 funds The Manulife With-Profits Fund contains non-profit business as well as with-profits business, whereas the CLL With-Profits Fund only contains with profits business All surplus assets within the respective funds will be distributed to the with-profits policyholders as the business runs off In the unlikely event of either fund being unable to meet its guaranteed liabilities, the CLL shareholders will provide the required capital support if the deficit is considered to be of a permanent nature by the Board The scheme of transfer in respect of the CLL With-Profits Fund allows for the fund to be dissolved, subject to regulatory approval, at any time now that the aggregate asset value in the fund has fallen below 100 million. Should this step be taken, the whole of the fund would be distributed to the in force policyholders by way of bonus or benefit increases and the policies would cease to be participating policies. Risks Inherent in CLL 4.92 Figure 4.8 shows the pre-diversification profile of CLL as at 31 December 2014 under its Pillar II basis. Figure 4.8: CLL Pre-diversification Pillar II position as at 31 December 2014 Source: CLL ICA as at 31 December The risk profile of CLL has remained broadly stable over recent years in terms of the relative materiality of the different risk categories. The following section considers qualitatively each of the material risk categories of CLL and their effect on CLL s policyholders. October

27 Market Risk 4.94 CLL is affected by falls in the market value of, and in the income from, the assets that it holds to meet its liabilities (where these falls are not matched by a fall in the corresponding liabilities), or by falls in market values or income from its free assets. In respect of CLL s with-profits and unit-linked business, most or all of the investment risk is passed directly to policyholders. However, there is a consequential impact from a fall in the value of unit-linked assets, as this reduces the fund-related charges received by CLL The three main sub-categories that dominate market risk for CLL are risks caused by unfavourable movements in interest rates, falls in equities and falls in property values. There is a smaller impact of currency risk, which affects the sterling value of management charges levied in respect of non-sterling assets CLL undertakes asset liability management to align liability movements with asset movements, for example through cashflow matching, use of swaptions and investment guidelines specifying the quality and exposure limits to certain asset types and counterparties. Credit Risk 4.97 CLL is exposed to the risk of counterparties failing to meet their obligations; within this category the exposure to corporate bonds, held to match the significant block of annuities in-payment, is the dominant risk. CLL has investment mandates in place that govern the rating mix and individual counterparty limits for bonds in its portfolio There is also exposure to reinsurer default, which is mitigated through the review of the credit worthiness of reinsurers and the use of deposit back arrangements. The majority of CLL s reinsurance is intra-group with deposit back arrangements to provide security to CLL. Longevity Risk 4.99 The substantial block of annuities written by CLL gives rise to a significant exposure to longevity risk that arises from the potential of material mis-estimation of future life expectancy. This can arise from both uncertainty over the level as well as the trend of mortality improvements. CLL has in place underwriting policies to govern the level of risk that the company is willing to accept, and carries out regular monitoring of actual experience. Insurance Risk (Mortality, Expenses and Persistency) CLL faces the risk that mortality, expenses and/or persistency experience are worse than expected. Most of CLL s mortality risk relates to group schemes covering death-in-service benefits provided by employers. Persistency risk is particularly relevant to CLL s linked business due to the potential loss of charges received from policies that lapse or are surrendered. Under expenses, a mis-estimation of the impact of regular expense, new business expense and also the costs of funding the staff pension scheme give rise to expense risk for CLL. As mentioned in section 4.99, CLL has in place underwriting policies and processes that aim to align the risks that it accepts with CLL s risk appetite. Other This includes morbidity and operational risk. Morbidity risk arises on CLL s income protection and critical illness business. Under operational risk CLL considers a range of impacts from failure or inadequate processes in respect of its systems, people or external events CLL is also exposed to other risks because of its ownership of Irish Life. In particular, the value for solvency purposes of CLL s investment in Irish Life is likely to diminish in stressed conditions, and it will also be affected by changes in the euro/sterling exchange rate. In addition, CLL may not be able to access surplus assets within Irish Life should it need to due to internal or regulatory constraints. However, I have gained comfort that CLL can continue to cover its Pillar II capital requirements with a comfortable margin without taking any credit for the value of Irish Life. October

28 5. THE PROPOSED SCHEME The motivation for the Scheme 5.1 As a prelude to the Scheme, ELAS has transferred the economic value of the transferring non-profit annuities, other than the unit-linked annuities, to CLL by means of the Reassurance Arrangement. However, this arrangement involves some inefficiencies (in terms of both capital usage and administration) and leaves residual risks with ELAS. Consequently both companies now wish to transfer the primary obligation to pay the annuities to CLL, so that the reinsurance can be terminated and the management of the business simplified. There have been many transactions involving the transfer of annuity business from one company to another that have followed the same approach that is, a reinsurance agreement followed by a transfer of the policies by means of a court-approved scheme. Summary of the Scheme 5.2 The Scheme is expected to be presented to the Court for a Directions Hearing in October 2015 and for a Final Hearing in February If approved by the Court then it will be implemented with a scheduled Effective Date of 19 February If the Scheme is approved by the Court then, on the Effective Date, certain non-profit annuity business of ELAS, together with the associated assets and liabilities allocated to the non-profit annuity business (the Transferred Business ) will transfer to the CLL NPF. The Transferred Business comprises the majority of the non-profit annuity business of ELAS (non-profit, index-linked and unit-linked annuities) The Jersey Scheme and the Guernsey Scheme will be presented to the relevant courts in Jersey and Guernsey and will be substantially on the same terms as the Scheme. The purpose of these schemes is to ensure the effectiveness of the transfer of the Jersey Policies and the Guernsey Policies. Transferring assets and liabilities 5.5 The number of non-profit annuities to be transferred is approximately 31,000, constituting around 975 million of insurance liabilities (as at 31 December 2014). 5.6 ELAS has reinsured the Transferred Business, other than the unit-linked annuities, to CLL with effect from 1 January In order to protect ELAS from counterparty risk, the premium paid has been deposited back to ELAS. At the Effective Date, the Reassurance Arrangement will be terminated and the balance of these deposited funds will be transferred to CLL upon completion of the transfer. The total assets to be transferred will also include allowance for any new non-profit annuities written by ELAS between 2 March 2015 and the Effective Date, an amount in respect of the unit-linked annuities, plus any other adjustments required. 5.7 The Scheme makes provision for Residual Policies, which are policies intended to be transferred under the Scheme (or the Jersey Scheme or the Guernsey Scheme as appropriate), but which for a limited range of legal reasons cannot be transferred on the Effective Date. It is not expected that there will be any Residual Policies, and I will provide an update in my Supplementary Report if this expectation changes. 5.8 After the implementation of the Scheme, the Reassurance Arrangement will be terminated and, should there be any Residual Policies, those policies (including any unit-linked annuities) will be reinsured from ELAS to CLL under a new reinsurance arrangement (the Residual Policies Reassurance Arrangement ), until such time as either (i) all consents, permissions or other requirements for the transfer of the relevant Residual Policy have been obtained, at which date (each Subsequent Transfer Date ), the Residual Policy will transfer under the terms of the Scheme, or (ii) the Residual Policies Reassurance Arrangement is terminated. Either party may terminate the Residual Policies Reassurance Arrangement by notice in writing at any time after the first anniversary of the Effective Date. 3 There are some ELAS non-profit annuities which are not to be transferred under the Scheme. These are annuities, now in payment, which were deferred annuities at the time the reinsurance with Halifax Life was entered into in 2001 (see paragraph 4.14). October

29 Unit-Linked Annuities 5.9 The ELAS unit-linked annuities in force at the Effective Date will be transferred to CLL under the Scheme ELAS and CLL have agreed which CLL unit-linked investment funds provide broadly equivalent investment exposure to the current ELAS funds. At the Effective Date, CLL will allocate to each transferring unit-linked policy units in the relevant CLL unit-linked funds such that the amount of each annuity payment calculated immediately following the transfer will be the same as the amount of each annuity payment calculated immediately before the transfer Transferring unit-linked policyholders will be allowed to make one investment switch in respect of each unit-linked fund to which each unit-linked policy they hold is linked at no cost within 12 months of the Effective Date. Such switches will be in addition to any rights under the terms of their policy. I note that neither ELAS nor CLL currently charges a fee to switch funds; however both have the right to do so in the future under the terms and conditions of their unit-linked policies. Group Pension Policies 5.12 ELAS has a number of Group Pension Policies, which are group pension schemes written under trust, and which include both pre-retirement savings elements and annuities in payment. Only the annuities in payment at the Effective Date and the associated assets will be transferred to CLL under the Scheme, with the remainder of the policies remaining with ELAS. From a legal point of view, ELAS and CLL will each cover their respective portion of these policies from the Effective Date. This arrangement is the same as was implemented under the 2007 scheme of transfer of non-profit annuities between ELAS and CLL. Excluded policies 5.13 The Scheme identifies Excluded Policies which are ELAS policies which are not to be transferred under the Scheme. These include all policies which are not non-profit annuities, those elements of the ELAS Group Pension Policies which are not to transfer under the Scheme and any policies which both parties agree are not to transfer. Any Residual Policy which is not transferred at a Subsequent Transfer Date will become an Excluded Policy if the Residual Policies Reassurance Arrangement is terminated. Administration 5.14 The ELAS non-profit annuity policies are currently administered in-house at its Head Office in Aylesbury. On the Effective Date, the administration will pass to CLL It is expected that there will be a small number of cases where a policyholder s benefit will be split into two components, one which falls under the transferring business and the other which does not. In this case the annuity will be paid in part by CLL and in part by ELAS if the transfer proceeds. Costs of the Scheme 5.16 CLL and ELAS will each bear their own costs of the Scheme, other than for certain costs such as my Independent Expert fees, Court fees and Counsel s fees which will be shared equally between the parties, as will the costs of advertising the Scheme. In CLL s case, any costs will be met from shareholder resources. Tax 5.17 All appropriate tax clearances will be applied for from the relevant authorities and I have been informed by the management of ELAS and CLL that these are expected to be granted The transfer is conditional on the obtaining of the appropriate tax clearances, however either party may request that the other waives this condition in relation to the certain tax clearances. The other party may not withhold this waiver where the application for these clearances has only received a negative response from the HM Revenue October

30 and Customs in respect of an issue or amount that is immaterial to the Scheme or the party of whom the request is made All tax liabilities and assets of ELAS will remain with ELAS, and will not transfer under the Scheme. Other 5.20 The Scheme provides that any mis-selling liabilities in respect of either the transferring non-profit annuities or in respect of any policies which were used, wholly or in part, to pay the premium to purchase the non-profit annuities will remain with ELAS Any other liabilities which arise or have arisen in respect of any acts or omissions by ELAS before the Effective Date will remain with ELAS All other legal proceedings in connection with the Transferred Business, whether as plaintiff, claimant, applicant or defendant will be continued or commenced by CLL. October

31 6. THE EFFECT OF THE IMPLEMENTATION OF THE SCHEME ON THE TRANSFERRING ELAS POLICIES Introduction 6.1 In this section I consider the effect of the implementation of the Scheme on the transferring policies of ELAS. 6.2 As described in Section 3, the transferring business comprises exclusively non-profit in payment annuities with Pillar I liabilities of approximately 975 million (as at 31 December 2014). This business, excluding any unit-linked annuities and new annuities since March 2015, is currently reinsured to the CLL NPF under the Reassurance Arrangement. 6.3 None of the policies to be transferred under this Scheme carries membership rights of ELAS, although policyholders may be members through ownership of other policies. 6.4 As a result of the implementation of the Scheme, the transferring ELAS policies will transfer into and become direct policies of the CLL NPF. Therefore, the key points to consider are: The financial resources available to provide security for the benefits of the transferring ELAS policies after the implementation of the Scheme compared to those currently available; Any change to the profile of risks to which the transferring ELAS policies will be exposed as a result of the implementation of the Scheme; and The effect of the implementation of the Scheme on the reasonable expectations of the transferring ELAS policyholders, including benefit expectations, service standards, management and governance that these policyholders should expect after the implementation of the Scheme. These are considered in turn below. The financial resources available to provide security of benefits Introduction 6.5 The transferring ELAS policies, other than the unit-linked annuities and any new annuities written since March 2015, are currently reinsured to the CLL NPF. However, ELAS remains responsible for paying the benefits due to policyholders, and can claim an appropriate amount from CLL under the Reassurance Arrangement. Should CLL be unable to fulfil its obligations under the Reassurance Arrangement, ELAS will need to continue to pay the benefits. Therefore the transferring policies currently rely primarily on the resources of ELAS for the security of their guaranteed benefits. That is: Assets backing the liabilities and capital requirements of the ELAS OLTF; and Excess capital resources in the ELAS OLTF (which are intended to be distributed to policyholders in line with company strategy). 6.6 The ability of CLL to fulfil its obligations under the Reassurance Arrangement will affect the strength of ELAS and therefore security for the transferring policies will also be provided by the assets held in CLL. In particular, the assets deposited back under the Reassurance Arrangement have restricted risk exposures and are ring-fenced for the benefit of ELAS, thereby contributing to the financial strength of ELAS and therefore the security of the benefits of the transferring policies. 6.7 I understand that CLL is proposing to reinsure (or retrocede ) 90% of the sterling-denominated transferring annuities (not including the unit-linked annuities) to Canada Life Assurance Company ( CLAC ) (Barbados branch) prior to the Effective Date. This would operate in a similar way to the two existing reinsurance agreements with that company (see paragraph 4.73). Once the Scheme has been implemented, the primary responsibility to pay the transferring annuities will be with CLL, regardless of this onwards reinsurance. I have been informed that this retrocession is expected to be completed in October 2015 with an effective date of 1 January In addition, and principally for ease of administration, it is currently proposed that the Irish and German euro denominated annuities be 100% reinsured to Irish Life Assurance and Canada Life Assurance Europe respectively. However, it is possible that the German euro denominated annuities will instead be administered via an outsourcing October

32 arrangement with Canada Life Assurance Europe rather than via a reinsurance arrangement. The final decision will be confirmed prior to implementation of the Scheme. The ELAS and CLL capital policies 6.9 The capital policy of an insurer sets out the capital that a company has committed to hold and is typically expressed in terms of regulatory capital requirements. The regulatory capital requirements may target a specified probability of remaining solvent over a certain time horizon: for example for both the current Pillar II regime and Solvency II, it is a 99.5% probability of remaining solvent over a one year time horizon. By requiring additional capital to be held on top of the regulatory requirements, the capital policy increases the probability of remaining solvent over a particular timeframe and therefore increases the security of the benefits provided under the relevant policies subject to the capital policy When considering the financial resources available to provide the security of the benefits of a particular group of policies, greater reliance can be placed upon assets held in adherence to the capital policy than on assets in excess of this level, since assets in the latter category are potentially available for distribution (subject to the PRA rules) Capital policies provide a trigger for actions by management with the aim of reducing the likelihood of a breach of required regulatory capital levels and subsequent regulator intervention Currently the security of the benefits under the transferring ELAS policies depends upon the assets of ELAS held in accordance with the ELAS capital policy as set out in Section 4. Following implementation of the Scheme, the transferring business and any residual assets attributed to it will be transferred into the CLL NPF and security for the benefits of the transferring ELAS policies will subsequently be provided by the assets of CLL held in accordance with the CLL capital policy, also set out in Section The proposed transfer will not lead to any change in the risk appetite or capital policies for either ELAS or CLL and therefore a comparison of the relative strengths of the capital policies of ELAS and CLL will be key to the consideration of the effect of the Scheme on the benefit security of the transferring policies. This should be a comparison of both the relative levels of capital required under the two policies, and the qualitative aspects of the capital policies such as the governance of each capital policy and the required response of management to a breach of the capital policy The current ELAS and CLL capital policies are partially set out in terms of the capital requirements under the current Pillar I and Pillar II regimes. As described in Section 3, from 1 January 2016 the Solvency II regime will be in force so I should consider the relative strengths of the capital policies under Solvency II However, neither ELAS nor CLL has finalised its capital policy under Solvency II and such a comparison has not been possible. The companies have both stated that, when rewritten to take account of Solvency II, their capital policies will reflect a similar likelihood of remaining able to pay policyholder benefits and will therefore afford the respective policyholders of ELAS and CLL at least the same level of protection as currently. I therefore set out below an analysis of the relative strengths of the current capital policies as a proxy for an analysis of the capital policies under Solvency II I shall comment in my Supplementary Report on the ELAS and CLL capital policies to apply under Solvency II. The relative strengths of the capital policies 6.17 ELAS s capital policy aims to meet two potentially conflicting objectives: To meet its economic capital and regulatory solvency capital requirements; and To distribute all of its assets amongst the with-profits policies as fairly as possible over the lifetime of those policies In order to meet both of these objectives the ELAS Board has made Risk Appetite statements within its capital policy which are set in terms of a target ICA cover range. On a Pillar II basis ELAS s capital policy currently provides for a target cover in excess of 120% of its ICA capital requirement (including any ICG). This minimum level of cover aims to ensure that the company s economic and regulatory capital requirements are met Furthermore, should the cover fall below 150%, ELAS would consider reducing Policy Values and Capital Distribution Amounts to restore the solvency position. If the ratio fell below 120%, such action would almost certainly be taken. October

33 6.20 CLL s capital policy is targeted such that CLL maintains total aggregate capital resources sufficient to satisfy the most stringent of the following requirements: Maintaining a target cover 140% of the CRR subject to a range of 126%-154% under Pillar I; Maintaining a target cover of 120%-130% of its ICA capital requirement (including any ICG) under Pillar II; and Maintaining a target cover of 175%-200% of its Canadian MCCSR ELAS s capital policy is not readily comparable to CLL s on a Pillar I or Canadian MCCSR basis, but the Pillar II policies can be compared Assuming that the underlying reserves and capital requirements (ICA) are calculated consistently between the two companies, it appears that the CLL and ELAS capital policies are similar in terms of strength on a Pillar II basis as they both target a minimum cover ratio of 120% The ELAS and CLL capital policies currently provide for a buffer over the PRA s capital requirements, and therefore the policyholders of ELAS and CLL will be afforded a greater level of security than that strictly required under the PRA s rules. Holding such a buffer is in line with normal practice within the UK life insurance industry. The required response of management to a breach of the capital policies 6.24 In addition to considering the actual level of capital intended to be held under the relevant capital policies, I also consider what the required management response would be to any breach As a mutual insurer, ELAS does not have easy access to external sources of capital, and therefore should its available capital fall below its target level, the most likely actions would be to reduce the level of risk within its asset portfolio, and to adjust the Capital Distribution Amount or Policy Values for its with-profits policies CLL has a wider range of possible actions available to it in response to any breach of capital policies including, but not limited to: Reduction or suspension of any dividend payments; Requesting capital injections from its parent company; Issuing debt or subordinated debt; Reduction in the level of new business; and Reduction in its risk exposure (e.g. by increasing the level of reinsurance cover). The governance of the capital policies 6.27 The ELAS capital policy is reviewed at least annually by the ELAS Board, and can be amended at any time The CLL capital policy is reviewed annually by the CLL Board, or more frequently if deemed necessary by the CFO. The security provided by the deposit back arrangement 6.29 As described above, there is currently a deposit back arrangement in place, which reduces the counterparty risk exposure to CLL. This provides extra security to all of the ELAS policyholders (including but not limited to the transferring policyholders). In the event that CLL failed to honour its obligations under the Reassurance Arrangement, ELAS could take control of the assets held under the deposit back arrangement. The transferring policyholders would not have any preferential claim on any of these assets, as they would be available to support all of ELAS's business. Accordingly, although the deposit back arrangement plays an important part in reducing the counterparty exposure to CLL, it does not provide any specific additional security to transferring policyholders Following the implementation of the Scheme, the deposit back arrangement will cease and the transferring policies, as direct policies of CLL, will have security provided by the assets in CLL, including those currently covered by the deposit back arrangement. The investment guidelines (covering quality, type and restrictions) that govern the management of the assets which are deposited back to ELAS under the Reassurance Arrangement will no longer apply. October

34 6.31 I am satisfied that the cessation of the deposit back arrangement and associated investment guidelines will not have a material effect on the security of benefits under the transferring business. The financial resources available to provide security for benefits 6.32 Table 6.1 below shows the pre-scheme financial strength of ELAS and the pro-forma post-scheme (including the proposed onward retrocessions to CLAC, Irish Life and Canada Life Assurance Europe as discussed in section 6.7 to 6.8 (collectively, the Retrocessions )) financial strength of CLL as at 31 December 2014 on the Pillar I Regulatory Basis: Table 6.1: Post Reassurance Arrangement ELAS and post-scheme CLL regulatory solvency Regulatory Balance Sheet ( m) 31 December 2014 ELAS Pre- Scheme* CLL Post- Scheme, Retrocessions** Excess of assets over liabilities (A) 546 2,287 Capital Resources Requirement (B) 209 1,408 Notes to Table 6.1: CRR Cover (A/B) 261% 162% *Includes adjustment to the published figures at 31 December 2014 for the recapture of unit-linked business from Halifax Life Limited and the Reassurance Arrangement during 2015, and hence presents a more favourable regulatory solvency position than shown in Table 4.5. A more detailed analysis of the change is included in Table 7.1. **CLL post-scheme solvency position as at 31 December 2014 after the proposed retrocession to CLAC (Barbados branch) and the proposed 100% retrocession of the Irish and German euro-denominated annuities to Irish Life and Canada Life Assurance Europe respectively. In June 2015, CLL reassured an additional amount of its existing annuities to CLAC, but this has not been reflected in above CLL position. I have been informed that the impact of the Scheme allowing for this additional reassurance is expected to be similar Table 6.1 shows that, on the Pillar I Regulatory basis, the CRR cover of CLL post-scheme is significantly lower than that of ELAS pre-scheme. Nevertheless, CLL remains capitalised to a level in excess of that required by its own capital policy on this basis As discussed in paragraph 6.22, on the more relevant, but private, Pillar II basis, both companies have similar levels of minimum target capital. I have been shown the Pillar II solvency positions of both companies before and after the Scheme, which showed that both companies exceeded their minimum target capital on this basis before the Scheme, and also that the Scheme has a minimal impact on the Pillar II basis. The Pillar II basis is more closely aligned to the Solvency II methodology which will apply after 31 December If the planned Retrocessions do not go ahead then CLL s post-scheme solvency ratios will be affected; however, I am satisfied that this would not materially affect my conclusions. Financial strength under Solvency II 6.36 The Solvency II regulations are finalised; however there is still uncertainty regarding the way in which certain provisions will apply to ELAS and CLL. Both ELAS and CLL are applying to the PRA for various approvals under Solvency II which would have a significant effect on the solvency of, and excess capital available within, each company under the new regime. In view of this, the impact of the implementation of the Scheme on the Solvency II position of ELAS and CLL cannot yet be reliably established I have been shown the current draft Solvency II figures for ELAS and CLL as at 31 December 2014, including how they might vary should the various approvals not be granted The figures for ELAS show that it would have been able to cover its SCR comfortably. I understand from the management of ELAS that the impact of the Scheme on the Solvency II position of ELAS is expected to be similar to the effect of the Scheme on the Pillar II position of ELAS and that therefore the Scheme is not projected to have a material effect on the Solvency II financial position of ELAS. October

35 6.39 There is a wide range of possible outcomes for CLL s Solvency II SCR coverage position. Assuming the expected approvals being sought are granted in full, the figures for CLL also show that it would have been able to cover its SCR at 31 December 2014, and that the level of cover at that date is likely to fall broadly in the middle of CLL s expected (but not yet finalised) Solvency II target capital range. I understand from the management of CLL that the transfer is not projected to have a material effect on the company s Solvency II financial position. However, there are some scenarios in which, if certain approvals are not granted in full, CLL would need to take action to strengthen its solvency position before the Scheme takes effect Therefore, the transferring policyholders will be transferring to a company that is expected to exceed its Solvency II capital requirements. I intend to provide an update on CLL s expected Solvency II SCR coverage in my Supplementary Report As noted above, the capital policies that will apply to ELAS and CLL when Solvency II is introduced have not been finalised at this time. However, both companies have stated that it is their intention for their post Solvency II capital policies to reflect a similar likelihood of remaining able to pay policyholder benefits as their current policies, and will therefore provide policyholders with broadly the same level of protection as currently. I understand that it is likely that the CLL capital policy under Solvency II will be less strong than that of ELAS. However, as under the current Pillar II regime, there will be a wider range of options open to CLL if the capital policy is breached than is available to ELAS. I shall comment in my Supplementary Report on the ELAS and CLL capital policies to apply under Solvency II and, subject to this, I am satisfied that there will not be a material effect on the security of the guaranteed benefits of the transferring business Comments in relation to the Solvency II readiness of ELAS and CLL are set out in Section 9. Financial Services Compensation Scheme ( FSCS ) 6.43 The eligibility of holders of long-term insurance policies for compensation from the FSCS, and the amount of compensation payable, are dependent upon the type of policyholder, the type of policy and where the insurer is based. The FSCS will pay compensation to eligible individual holders of long-term insurance policies issued by UK insurers in the UK or another EEA state in the event of the insurer s default. Compensation to eligible holders of annuities in payment is the full amount of the annuity, without limit. Implementation of the Scheme will not adversely affect eligibility for compensation from the FSCS for any transferring or non-transferring policyholders I have been informed by ELAS that the vast majority of policies issued by the Guernsey branch (which includes the Jersey Policies) of ELAS are currently expected to be eligible for compensation from the FSCS, and by CLL that implementation of the Scheme will not affect this eligibility. Some policyholders living outside the UK, Channel Islands or Isle of Man may not currently be eligible for compensation from the FSCS, and the Scheme will not change their eligibility. Conclusion 6.45 In conclusion I am satisfied that: The capital policies of ELAS and CLL are of broadly similar strength on a Pillar II basis, and therefore the security afforded to the transferring business by the applicable capital policy will not change materially as a result of the Scheme. The cessation of the Reassurance Arrangement and the associated restrictions on the deposited back assets will not have a material effect on the security of benefits for the transferring business. While the financial strength of CLL on a Pillar I basis after implementation of the Scheme is expected to be materially lower than that of ELAS currently, it is still sufficient to provide an appropriate level of security for the transferring business. The profile of risks to which the transferring ELAS policies are exposed 6.46 After the implementation of the Scheme, the transferring ELAS policies will be direct policies of the CLL NPF and therefore directly exposed to the risk profile of a different company that has written a different mix of business, October

36 through different distribution channels, to policyholders with different demographic profiles. Approximately 70% 4 of the CLL NPF liabilities (net of reinsurance) as at 31 December 2014 are in respect of annuities in payment The solvency position of CLL under both the current Pillar II regime and Solvency II will reflect the risk profile of the company, its business and its risk concentrations, and this will feed through into the capital that will be held in accordance with the CLL capital policy Therefore I am satisfied that the change in risk profile will not have a material effect on the benefit security of the transferring ELAS policies. Governance and management of the transferring ELAS policies 6.49 The transferring business is currently managed by ELAS, and subject to the governance of the ELAS Board Following the implementation of the Scheme, the transferring business will be subject to the governance of the CLL Board. As noted in section 4.77 to 4.78, CLL is enhancing its risk management and governance frameworks as part of its preparations for Solvency II and is keeping the PRA informed of progress. The PRA will review any developments in these areas as part of its continuing supervision of CLL. If further details are available, I will provide an update in my Supplementary Report CLL currently writes significant volumes of non-profit annuity business, and I consider that the CLL Board is experienced in the management and governance of non-profit annuity business and I have no reason to believe that they will treat the transferring policyholders in a materially different way to the ELAS Board I am satisfied that the implementation of the Scheme will not materially affect the standards of governance and management applicable to the transferring business. The administration and service standards applied to the transferring ELAS policies 6.53 The transferring business consists of conventional, index-linked and unit-linked annuities incorporating a variety of escalation rates. The transferring policies are currently administered directly by ELAS, other than those policies in the Republic of Ireland, which are partly administered by a third party company CLL currently administers over 440,000 annuities in payment, with the majority of the processing being automated and therefore largely insensitive to business volumes. The existing CLL systems will require some development to ensure that they have the capability to support the new features and escalations. To reflect this additional complexity and the potential need for manual interventions, CLL has planned for an increase in support staff and has budgeted accordingly In addition, as noted in Section 6.8, it is currently proposed that the Irish and German euro denominated annuities be 100% reinsured to Irish Life Assurance and Canada Life Assurance Europe respectively, principally for ease of administration. However, it is possible that the German euro denominated annuities will instead be administered via an outsourcing arrangement with Canada Life Assurance Europe rather than via a reinsurance arrangement. A decision will be made before implementation of the Scheme. Both Irish Life Assurance and Canada Life Assurance Europe have existing Irish and German euro denominated annuities in payment. The remaining international policies will be administered in the UK alongside existing manual arrangements for similar Jersey and Guernsey policies CLL has identified the systems and associated development requirements to administer the Transferring Business, and has provided me with details of the proposed contingency plans that will be invoked if any of the systems developments are delayed Although CLL administers significant volumes of unit-linked business, it does not currently administer any unitlinked annuities. I have been informed by CLL that they have specified the changes required to provide the necessary functionality and expect to complete the system development by the end of Contingency plans will be implemented if the system developments are not in place by the Effective Date. 4 This figure does not reflect the Retrocessions or the increase in reinsurance of existing business to CLAC that took place in June October

37 6.58 CLL is not anticipating any reduction in service levels to existing or new clients, and has a contingency budget in place to allow for additional temporary support staff should this be required. Given that a gap analysis has taken place; system developments are in progress; contingency plans have been identified; and that ELAS has confirmed to CLL that it will provide administration, investment and custodian service assistance for a period of up to 6 months if required, I am satisfied that the proposed transfer is unlikely to have a material adverse impact on service standards. I will provide an update on the progress of the systems developments in my Supplementary Report, and will provide an assessment of the contingency plans if appropriate There will be no changes to the transferring policies terms and conditions, except that the policies will become policies of CLL. There will be no change to the benefits under the transferring policies. The reasonable expectations of the transferring ELAS policyholders 6.60 The transferring ELAS policies are all non-profit in-payment annuities, and therefore policyholders reasonable expectations in respect of their policies are principally that: They receive their income as guaranteed under the policy, or for unit-linked annuities as determined in accordance with the terms of their policy, on the dates specified, from the point of purchase; The administration, management, and governance of the policies are in line with the contractual terms under the policies; and The standards of service received are at least as good as those they currently receive. Unit-Linked Annuities 6.61 In addition to the points identified in paragraph 6.60 which are relevant for all transferring policyholders, there are a number of specific considerations in respect of the expectations of the unit-linked annuity policyholders. In determining the mapping of each ELAS unit-linked fund to the most appropriate CLL unit-linked fund the following areas were compared: The objectives of the fund; The applicable charges; The historical performance of the fund; and The historical volatility of the fund. These areas are considered in further detail below: i. The range of investment funds available to policyholders and how these compare to the current ELAS fund choice: ELAS and CLL have agreed which CLL unit-linked investment funds provide reasonably equivalent investment exposures and annual management charges to the current ELAS funds. The proposed mapping of ELAS funds to the CLL funds is shown in Appendix 3 of the Guide. At the Effective Date, units in the ELAS unit-linked funds for each transferring unit-linked policy will be cancelled and units will be allocated in the appropriate CLL funds. The number of new units will be determined so that the amount of each annuity payment calculated immediately following the transfer will be the same as the amount of each annuity payment calculated immediately before the transfer. The range of funds available to the annuitants will be wider after implementation of the Scheme and will consist of funds managed by either CLL or external fund managers. All transferring unit-linked policyholders will be allowed to make one switch in respect of each unit-linked fund to which their policy is linked at no cost within 12 months of the Effective Date. Such switches will be in addition to any rights under the terms of their policy. Both ELAS and CLL have informed me that they do not currently charge a fee to switch funds; however, both have the right to do so in the future under the terms and conditions of the unit-linked policies. CLL has confirmed that it has no current plans to introduce such a fee. October

38 The total charges for a unit-linked fund, known as Total Expense Ratio ( TER ) incorporate any explicit annual management charge plus any specific fund related charges. All ELAS funds currently have the same TER of 0.50% per annum, while the selected CLL funds have TERs which vary between 0% (for money market funds) and 0.85%. The majority of the funds by value will have TERs which are lower than or equal to the ELAS charges, and so on average the transferring unit linked annuitants will benefit from a reduction in overall charges. There are five funds where the mapping to the most appropriate fund would incur higher TERs; these are: the CLL F&C UK Responsible Income Fund at 0.81% (mapped from the ELAS Ethical Fund, in which 51 ELAS unit-linked annuities held units as at 30 June 2015) the CLL Investec UK Smaller Companies Fund at 0.84% (mapped from the ELAS Smaller Companies Fund, in which 80 ELAS unit-linked annuities held units as at 30 June 2015) the CLL Investec UK Special Situations Fund at 0.85% (mapped from the ELAS Special Situations Fund, in which 58 ELAS unit-linked annuities held units as at 30 June 2015) the CLL Asia Pacific Fund at 0.56% (mapped from the ELAS Far Eastern Fund, in which 269 ELAS unit-linked annuities held units as at 30 June 2015) the CLL UK Equity Income Fund at 0.52% (mapped from the ELAS High Income Fund, in which 220 ELAS unit-linked annuities held units as at 30 June 2015) In each of these cases unit-linked annuity policyholders will be compensated for the excess of the CLL fund charge over the corresponding ELAS fund charge for as long as the ELAS charges remain lower. ELAS is intending to review its unit-linked fund charges in 2016, and it is likely that some of the charges will be increased as a result. The mechanics of the compensation are being developed and I will provide an update in my Supplementary Report. ELAS will write to all unit-linked annuity policyholders before the end of For unit-linked policyholders who will be allocated units in any of these five funds that have higher charges, the letter will inform them that: the CLL funds to which some or all of their benefits will be linked following implementation of the Scheme have higher charges than the corresponding ELAS funds if they remain invested in those funds, they will receive compensation sufficient to cancel out the impact of the higher charges for as long as the ELAS charges remain lower following the Effective Date, and they have the right to make one switch in respect of each unit-linked fund to which their policy is linked, without charge, within 12 months of the Effective Date. For all other ELAS unit-linked annuity policyholders the same letter will set out the matters they should take into account when considering the appropriateness of the new CLL fund(s) to which their policies will be linked. Furthermore, CLL has undertaken that, at or around the Effective Date, it will write to all policyholders with unit-linked annuities reminding them of their ability to make one switch in respect of each unitlinked fund to which their policy is linked, without charge, within 12 months of the Effective Date. The new funds will not have precisely the same investment mandate as the existing ELAS funds, and their performance is likely to differ from that of the existing funds. Both the ELAS and the CLL fund ranges have a mixed past performance record. I am satisfied that the proposed arrangements provide a reasonably equivalent match to the current fund choice, and give the policyholder the option to change their investment choice if they wish to do so. ii. The methodologies and systems used to determine the unit prices and the governance of the unit pricing process: Unit pricing is a complex process, and requires a wide range of asset data and valuations on a daily basis, together with a number of pricing assumptions. October

39 ELAS unit funds invest exclusively in open-ended investment companies (OEICS) which have a single unit price. Consequently, the prices at which units in the ELAS funds are allocated and redeemed do not depend on whether the fund is expanding or contracting. A total of sixteen CLL funds have been proposed to provide the unit links for the transferring unit-linked annuities, of which thirteen have a single unit price. The remaining three CLL unit funds, namely the UK Equity, British Blue Chip and UK Property, are priced on one of two bases if the fund is expanding, then the unit prices are set allowing for the cost of buying assets (the offer basis), whereas if the fund is contracting, the unit prices are set allowing for the sale of assets (the bid basis). If these funds move from an offer basis to a bid basis, then there can be a one off reduction in the unit fund price as a result of the change and vice versa. For the UK Equity and British Blue Chip Funds, this is typically of the order of 1%, however it can be significantly higher (potentially up to almost 8%) for the UK Property Fund. Both the UK Equity and British Blue Chip Funds are currently priced on a bid basis. The one-off inflow of money as a result of the transfer could in theory cause either or both of these funds to need to buy assets and hence move temporarily to an offer basis. Should this be the case, CLL has undertaken to maintain the bid pricing basis for these funds and to absorb any costs to ensure that neither existing CLL policyholders nor transferring ELAS policyholders are disadvantaged. Should either of these funds subsequently move to an offer basis, there may be a small benefit to policyholders whose annuities are linked to the relevant fund at that time. The UK Property fund price is currently calculated on an offer basis. Therefore transferring policyholders could incur a one-off unit price reduction at some point in the future, potentially of around 8% 5, which they would not have incurred in the ELAS Property Fund, if this fund moves from an offer basis to a bid basis during their lifetime. It should be noted that this fund did move from an offer basis to a bid basis and then back to an offer basis during the recent financial crisis. Currently there are positive cashflows into the fund as it is being used for the CLL income drawdown product. I also note that: the CLL UK Property fund has outperformed the ELAS Property Fund over the most recent 1, 3 and 5 year periods; the TERs are lower for the CLL UK Property Fund than for the ELAS Property Fund, at 0.21% per annum compared to 0.5% per annum; arguably a larger and growing property fund can offer better growth opportunities and benefit from economies of scale; and the single pricing approach underlying the majority of the other CLL funds and the ELAS funds does not enable policyholders to avoid the costs of buying and selling assets entirely; it just spreads them in a different way. There were 85 policyholders as at end June 2015 whose annuity payments were linked to the ELAS Property Fund, and for 13 of those policyholders that fund accounted for more than half the value of their annuity payments. CLL has undertaken that, at or around the Effective Date, it will write to all of these policyholders informing them of the potential impact of pricing moving from an offer basis to a bid basis in the future, and of their ability to make one switch in respect of each unit-linked fund to which their policy is linked without charge within 12 months of the Effective Date. Therefore although there is a possibility of some limited detriment to transferring policyholders whose annuity payments are linked to the ELAS Property Fund, I consider that the proposed specific communication to policyholders, to inform them of the changes and allow them to consider their options, is an appropriate response. In addition, there are approximately 19 policies which have benefits which are determined according to the price of a specific Halifax Open-Ended Investment Company ( OEIC ) or to a Guaranteed Equity Fund, and these policies will not be linked to CLL unit funds after the Scheme. The benefit payment links to the Halifax OEIC and to a Guaranteed Equity Fund price will be maintained after the Scheme, 5 This reflects the high cost of buying and selling property, including Stamp Duty Land Tax at 6% in the UK. October

40 and so there will be no change in the method of determining the benefit payments for these policyholders. I have discussed the unit pricing processes and governance with the management of ELAS and CLL, and do not consider that there will be any material changes to the reasonable expectations of the transferring unit-linked policyholders as a result of these aspects. Future Treatment of Annuities 6.62 The UK Government is in the process of developing plans to allow existing annuitants to assign or cash in their annuities, and it is currently expected that any new measures would take effect from April However, the details of the proposals are not yet known; accordingly it is too early for either CLL or ELAS to be in a position to confirm how they might respond to such changes, and therefore whether the proposed transfer will affect the availability of, or proceeds from, this additional flexibility for transferring policyholders. Conclusion 6.63 As discussed above, I am satisfied that: The implementation of the Scheme will not have a material effect on the security of the guaranteed benefits of the transferring ELAS policies; The implementation of the Scheme will not lead to any change to the contractual benefits under any of the transferring ELAS policies; The majority of transferring unit-linked annuitants will benefit from lower charges. Those unit-linked annuitants moving to CLL funds with higher charges will be appropriately compensated; Although there is a possibility of some limited detriment to transferring policyholders whose annuity payments are linked to the ELAS Property Fund, I consider that the proposed specific communication to policyholders is an appropriate response; The implementation of the Scheme will not materially affect the administration and service standards applicable to the holders of the transferring ELAS policies; and The implementation of the Scheme will not have a material effect on the management or the governance of the transferring ELAS policies For these reasons I am satisfied that the Scheme will not have a material effect on the reasonable expectations of the transferring ELAS policyholders. Conclusion for the transferring ELAS policies 6.65 I am satisfied that the implementation of the Scheme will not have a material effect on: The security of benefits under the transferring ELAS policies; The reasonable expectations of the transferring ELAS policyholders; or The service standards and governance applicable to the transferring ELAS policies. October

41 7. THE EFFECT OF THE SCHEME ON THE NON-TRANSFERRING ELAS POLICIES Introduction 7.1. The non-transferring ELAS policies include: Conventional and accumulating with-profits policies; Conventional non-profit policies (principally deferred non-profit annuities); and Unit-linked policies. There are also small volumes of other policy types such as index-linked policies, and with-profits annuities written in Germany. The financial resources available to provide security of benefits 7.2. The non-transferring policies in ELAS currently achieve security for their guaranteed benefits from: Assets backing the liabilities and capital requirements of the non-transferring policies; and Excess capital resources in the ELAS OLTF (which are intended to be distributed to policyholders in line with company strategy) As discussed above in Section 6, the ability of CLL to fulfil its obligations under the Reassurance Arrangement will affect the financial strength of ELAS and therefore security for the non-transferring policies will also be provided by the assets held in CLL. In particular, the assets deposited back to ELAS have restricted risk exposures as a result of the investment guidelines within the Reinsurance Agreement and are ring-fenced for the benefit of ELAS Under the Scheme, the non-transferring policies in the ELAS OLTF, and the assets of the ELAS OLTF, other than those assets attributed to the transferring business, will remain in the ELAS OLTF Table 7.1 below shows the current strength and the pro-forma post-scheme strength of ELAS as at 31 December 2014 on the Pillar I Regulatory Basis: Table 7.1: ELAS projected post transfer regulatory solvency ELAS Regulatory Balance Sheet ( m) Published* 31 December 2014 Admissible Assets 5,985 Pre- Reassurance and Pre- Scheme** Reassurance Arrangement Effect *** Pre- Scheme Total Scheme Effect Post- Scheme Total Non-profit Liabilities 946 With-profits Liabilities 4,497 Other Liabilities 56 Total Liabilities 5,499 Excess of assets over liabilities (A) (2) 544 CRR (=LTICR) (B) (15) 209 (24) 185 CRR Cover (A/B) 218% 204% 58% 261% 33% 294% Notes to Table 7.1: * Published solvency figures from the ELAS PRA returns as at 31 December 2014, as per Table 4.1 ** ELAS position following the recapture of business from Halifax Life Limited completed in March 2015 *** Effect of the Reassurance Arrangement (March 2015) upon the published solvency figures as at 31 December 2014 October

42 7.6. This table shows that, on this basis, the Scheme results in an increase in the capital coverage ratio for ELAS. This is because it removes a restriction on the credit that can be taken for the reinsurance under the Reassurance Arrangement. However, I note that, while this is a valid conclusion under the current Pillar I Regulatory Basis calculations, it is a somewhat artificial effect as this restriction itself only applies as a direct result of the Reassurance Arrangement The Pillar II position of the ELAS Funds at 31 December 2014 would also be improved marginally by the implementation of the Scheme, through a reduction in capital requirements for reinsurance counterparty exposure and expense risk The proposed transfer will not lead to any change in the risk appetite or capital policy in accordance with which ELAS is managed and it is unlikely that ELAS s ability to comply with its capital policy will be materially changed as a result of the implementation of the Scheme I am therefore satisfied that the proposed Scheme will not have a material adverse effect on the financial resources available to support the security of the benefits of the non-transferring policies in the ELAS Funds and may have a small positive effect. Financial strength under Solvency II As noted in Section 6, the Solvency II regulations are finalised but there remains uncertainty regarding the way in which certain provisions will apply to ELAS, depending on whether it obtains certain approvals from the PRA. These approvals will have a significant effect on the solvency of, and excess capital available within, the company under the new regime. As such the impact of the implementation of the Scheme on the Solvency II position of ELAS cannot yet be reliably established I have been shown the current draft Solvency II figures for ELAS as at 31 December 2014 and these show that ELAS would have been able to cover its SCR comfortably. I understand from these figures that, for the nontransferring policies of ELAS, the implementation of the Scheme is expected to have a small but positive effect on the Solvency II position of ELAS and therefore on the security of the benefits of the non-transferring policyholders I am satisfied that, were Solvency II to be in force now, my conclusions in paragraph 7.9 in respect of the financial resources available to provide security for the non-transferring ELAS policies would remain valid The capital policy that will apply to ELAS when Solvency II is introduced has not been finalised at this time but senior management have stated that the company s post Solvency II capital policy will reflect a similar likelihood of remaining able to pay policyholder benefits, and will therefore provide policyholders with at least the same level of protection as currently I shall comment in my Supplementary Report on the ELAS capital policy which will apply after the introduction of Solvency II ELAS s readiness for Solvency II is discussed in Section 9. The profile of risks to which the non-transferring policies in the ELAS Funds are exposed The Reassurance Arrangement has already removed the longevity and investment risk associated with these reinsured policies from ELAS. However, following the implementation of the Scheme, the residual expense and some of the operational risks will also be removed. In addition, the Scheme will remove the counterparty risk, and the longevity risk in respect of the unit-linked annuities that were not reinsured Moreover, following the proposed transfer, ELAS will not incur administration costs in relation to the existing Reassurance Arrangement Due to the deposit back arrangement, there is currently no material counterparty default risk associated with the Reinsurance Arrangement. In the event that CLL becomes insolvent, the assets transferred from ELAS to CLL, in respect of the reinsured annuities, will revert to ELAS and hence be unavailable to meet the liabilities of existing CLL policyholders The removal of the residual expense risk and some of the operational risks (but not mis-selling risk) does represent a small reduction in the risks to which the non-transferring policies in ELAS are exposed. October

43 7.20. Hence I am satisfied that the implementation of the Scheme will not have a material adverse effect on the risk profile to which the non-transferring policies in the ELAS Funds are exposed. The governance, management and service standards applicable to the non-transferring policies in the ELAS Funds No changes are being proposed to the terms and conditions of the non-transferring policies in ELAS. Furthermore, there will be no change to the operation of ELAS No changes are being proposed to the unit-linked funds in which the non-transferring unit-linked policies are invested as a result of the Scheme. The policies will have the same number and value of units and the pricing principles, fund charges and range of funds available will remain unchanged. However, we understand that ELAS is intending to review its unit-linked fund charges in 2016, whether or not the Scheme is implemented The non-transferring policies in ELAS will continue to be serviced and administered under the same arrangements and will therefore not experience any change to service standards Asset management arrangements will continue unchanged The governance of the non-transferring policies will continue to be the responsibility of the ELAS Board including in its capacity as the ELAS WPC Hence I am satisfied that the implementation of the Scheme will not have a material effect on the governance, management and service standards of the non-transferring policies in ELAS. The reasonable benefit expectations of the non-transferring policyholders in ELAS In relation to the non-transferring with-profits policies in ELAS, the implementation of the Scheme will not lead to any changes in: The principles and practices used in the management of the with-profits policies; The rights of the with-profits policies to future distributions, via the Capital Distribution Amount; The risk appetite to which ELAS is managed; The methodology used to calculate Policy Values and surrender values of with-profits policies; The asset allocation and asset management of the ELAS OLTF; The bonus and pay-out policies applied to the ELAS OLTF; The calculation of the divisible profits of the ELAS Funds; or The charges applied to policies in the ELAS Funds A marginal reduction in the risks to which ELAS is exposed and a small increase in capital coverage following the implementation of the Scheme gives rise to slightly larger surplus capital in ELAS, and the potential for a marginal acceleration in their distribution to with-profits policyholders. I note that ELAS has increased the capital distribution from 1 April 2015 from 25% to 35%, in part due to the reinsurance and planned transfer of the annuity business. I also note the opinion of the ELAS WPA that the reinsurance and planned transfer are beneficial to the with-profits policyholders within the ELAS OLTF, even allowing for the associated costs and for the loss of future profits that could have been expected to emerge over time. I agree with the ELAS WPA s opinion. This release of capital and early realisation of part of the expected future profit will allow all current with-profits policyholders to benefit, not just those remaining in the ELAS OLTF for longer. The alternative would be to allow profits (or losses), which emerge naturally over the lifetime of the annuity business, to be shared only among those ELAS with-profits policies that remain in force at the time the profits (or losses) are realised. The terms of the transaction were agreed following a competitive bidding process, and can be considered to represent fair value for ELAS with-profits policyholders The Scheme will have no effect on the benefits payable under non-profit policies remaining in ELAS. In particular, the terms for cancellation of units under unit-linked annuities should have no effect on the value of units held for other unit-linked policyholders. October

44 7.30. For these reasons I am satisfied that the Scheme will not have a material adverse effect on the reasonable benefit expectations of the non-transferring policyholders in ELAS and, as described above, may have had a small positive effect on the ability of the ELAS Board to accelerate the distribution of capital to with-profits policyholders. Conclusion for the non-transferring policies in ELAS I am satisfied that the implementation of the Scheme will not have a material adverse effect on: The security of benefits under non-transferring policies in ELAS; The reasonable benefit expectations of non-transferring policyholders in the ELAS Funds; or The service standards and governance applicable to non-transferring policies in the ELAS Funds. October

45 8. THE EFFECT OF THE IMPLEMENTATION OF THE SCHEME ON THE CLL POLICIES Introduction 8.1. In this section I consider the effect of the implementation of the Scheme on the existing CLL policies, which can be divided into the following groups: Existing policies in the CLL NPF; and Other CLL policies in the CLL LTF, namely those in the CLL With-Profits Fund and the CLL Manulife Fund For each group of policies, I consider the likely effects of the implementation of the Scheme on the security of the guaranteed benefits and on the benefit expectations of the holders of those policies. The CLL NPF policies Introduction 8.3. Currently the transferring business is reinsured into the CLL NPF. Under the provisions of the Scheme, the transferring ELAS policies will be transferred into the CLL NPF. In this section I consider the effect of the implementation of the Scheme on the security of benefits and on the reasonable expectations of the existing policyholders of the CLL NPF The key issues to consider are: The financial resources available to provide security for the benefits of the existing CLL NPF policyholders after the implementation of the Scheme compared to those currently available; The effect on the existing CLL NPF policies of any change in the risk profile of CLL as a result of the implementation of the Scheme; and The effect of the implementation of the Scheme on the reasonable expectations of the existing CLL NPF policyholders. The financial resources available to provide security of benefits 8.5. CLL s capital policy, which sets out a target level of capital buffer in excess of regulatory requirements, is not changed by the implementation of the Scheme and thus the security of existing policyholder benefits will only be affected by any changes to the company s continuous ability to comply with this policy Currently, security for the guaranteed benefits of the existing policyholders in the CLL NPF is provided by: The assets in the CLL NPF backing the reserves held to meet the guaranteed benefits of the existing CLL policies; The assets backing the regulatory capital requirements of the CLL NPF (excluding those assets backing the capital requirements of the business reinsured from ELAS); and Excess capital resources in the CLL NPF and the CLL SHF. After the implementation of the Scheme, the security of the guaranteed benefits of the existing policyholders in the CLL NPF will continue to be provided by these three elements The implementation of the Scheme will have no impact on the reserves held in relation to the current CLL NPF policies. It should be noted that, alongside the termination of the Reassurance Arrangement, the deposit back arrangement will also cease. As a result, the existing CLL NPF business will effectively have a wider pool of assets to provide security Table 8.1 below shows the Pillar I Regulatory Basis balance sheet as at 31 December 2014: October

46 Table 8.1: CLL Pillar I Regulatory Basis balance sheet as at 31 December 2014 CLL Regulatory Balance Sheet ( m) 31 December 2014 Published* Reassurance Arrangement Effect Pre -Scheme after Reassurance Arrangement** Scheme Effect Post-Scheme before Retrocession to CLAC *** Post Scheme after Retrocession to CLAC **** Admissible assets 24,262 Mathematical reserves 19,405 Other liabilities 2,569 Total Liabilities 21,974 Excess of assets over liabilities (A) 2,288 (10) 2, ,278 2,287 LTICR RCR Irish Life CRR CLL CRR (B) 1, , ,416 1,408 CRR Cover (A/B) 166% -5% 161% 0% 161% 162% Notes to Table 8.1: * Published solvency figures from the CLL PRA returns as at 31 December 2014 **CLL pre-scheme solvency position after effect of the Reassurance Arrangement with ELAS as at 31 December 2014 ***CLL post-scheme solvency position as at 31 December 2014 before the proposed reinsurance to CLAC (Barbados branch), Irish Life and Canada Life Assurance Europe. ****CLL post-scheme solvency position as at 31 December 2014 after the proposed reinsurance to CLAC, Irish Life and Canada Life Assurance Europe During 2015, CLL reassured an additional amount of its existing annuities to CLAC, but this has not been reflected in the above CLL position. I have been informed that the impact of the Scheme allowing for this additional reassurance is expected to be similar to that indicated in Table 8.1. On this basis, I am satisfied that this change does not materially affect my assessment or conclusions in this section The table shows that if the Scheme had been effective as at 31 December 2014 there would have been little change to the excess assets in the CLL NPF and SHF and thus that these funds would have remained in a strong position If the planned Retrocessions do not go ahead then CLL s post-scheme solvency ratios will be affected; however, I am satisfied that this would not materially affect my conclusions I am satisfied that the implementation of the Scheme will not have a material effect on the financial strength of the CLL NPF, and hence on the security of the benefits of the existing CLL NPF policies. Financial strength under Solvency II There is still some uncertainty regarding the precise requirements of Solvency II and consequently the impact of the implementation of the Scheme on the Solvency II position of CLL cannot yet be reliably established I have been shown the current draft Solvency II figures for CLL as at 31 December 2014, including how they might vary should some or all of the various approvals not be granted. There is a wide range of possible outcomes for October

47 CLL s Solvency II SCR coverage position. Assuming the expected approvals being sought are granted, CLL would have been able to cover its SCR at that date, and would have complied with its expected capital policy. However, there are some scenarios in which CLL may need to take action to strengthen its solvency position before the Scheme takes effect. CLL will reinsure approximately 90% of the transferring annuity liabilities to other Canada Life group companies; this means that the impact of the Scheme on the Solvency II position of CLL is likely to be small, and I am satisfied that my conclusions in relation to financial strength in paragraph 8.12 would remain valid if Solvency II were in-force The capital policy that will apply to CLL when Solvency II is introduced has not been finalised at this time but senior management have stated that CLL s post Solvency II capital policy will reflect a similar likelihood of remaining able to pay policyholder benefits, and will therefore provide policyholders with at least the same level of protection as currently I shall comment in my Supplementary Report on the CLL capital policy to apply once Solvency II is in-force Information on CLL s readiness for Solvency II is discussed in Section 9. The profile of risks to which the CLL NPF policies are exposed The CLL NPF included a substantial amount of annuity business before the Reassurance Arrangement was implemented, although the business reinsured in from ELAS may have arisen from different sources and through different sales channels, and the underlying policyholder group may have different demographics from the existing policyholder group. The Reassurance Arrangement will have increased the direct exposure of the CLL NPF to longevity risk and credit risk Since the transfer of these risks from ELAS to CLL has already occurred under the Reassurance Arrangement, implementation of the Scheme will not add to these risks Following the Effective Date, CLL will assume responsibility for administering the transferring business and thus will take on additional expense and operational risk. However, these risks are small in relation to the existing risk profile of the CLL NPF In addition, under the Scheme, any mis-selling liabilities, or other liabilities which have arisen in respect of any acts or omissions by ELAS before the Effective Date will remain with ELAS Therefore, I am satisfied that the implementation of the Scheme will not have a material effect on the profile of risks to which the existing CLL NPF policyholders are exposed. The governance, management and service standards applicable to the CLL NPF policies The Scheme will not alter the terms and conditions of existing policies in the CLL NPF CLL management has discretion over the level of charges on existing unit-linked business in the CLL NPF. The extent of this discretion will not be affected by the Scheme The implementation of the Scheme will not lead to any changes to the servicing and administration arrangements and existing CLL NPF policies will continue to be serviced by the CLL administration team. CLL currently administers over 440,000 annuities in payment, with the majority of the processing being automated and therefore largely insensitive to business volumes. No change is therefore expected to service standards for the existing CLL NPF policies as a result of the Scheme; nevertheless, CLL has a contingency budget in place to allow for additional temporary support staff should this be required Asset management will continue to be provided by Canada Life Investments following the implementation of the Scheme The governance of the existing non-profit policies will continue to be the responsibility of the CLL Board Hence I am satisfied that the implementation of the Scheme will not have a material effect on the governance, management and service standards of the policies in the CLL NPF. October

48 The reasonable expectations of the CLL NPF policyholders As discussed in Section 4, the CLL NPF comprises a wide range of products including protection products (including life cover, income protection and critical illness) for groups and individuals, retirement income planning products, annuities, pension bonds, savings and investments, investment bonds, inheritance tax planning products and offshore investments Policyholders reasonable expectations in respect of their benefits under such products are: For annuity policies, that policyholders receive their income as guaranteed under the policy, on the dates specified; For other non-profit policies, that policyholders receive their benefits as guaranteed under the policy; The level of charges for unit-linked policies remains fair and in line with the contractual terms of the policies; and The administration, servicing, management, and governance of the policies are in line with the contractual terms of the policies and regulatory and legal requirements As discussed above, I am satisfied that the implementation of the Scheme will not have a material effect on the security of the guaranteed benefits of the CLL NPF policies. Furthermore, having discussed these matters with the senior management of CLL, I am satisfied that: The implementation of the Scheme will not lead to any change to the charges on unit-linked business in the CLL NPF; and, The implementation of the Scheme will not lead to any change to the contractual benefits under any of the CLL NPF policies I note also that the management of the CLL NPF is carried out in accordance with a risk appetite that considers the regulatory solvency of the CLL NPF with full account taken of any benefits attributable to the reinsured transferring business I am satisfied that the implementation of the Scheme will not have a material effect on the reasonable expectations of the CLL NPF policyholders. Conclusions for the CLL NPF policies I am satisfied that the implementation of the Scheme will not have a material effect on: The security of benefits of the policyholders of the CLL NPF; The reasonable expectations of the policyholders of the CLL NPF; or The service standards and governance applicable to the policyholders of the CLL NPF. With-profits policies of CLL Under the Scheme no assets or liabilities will be transferred into, or out of, the CLL With-Profits Fund or the CLL Manulife Fund. Therefore, the only potential change in the risk exposure of these funds, as a result of the Scheme, is from the possibility that there may be extra calls on the capital in CLL due to the business being transferred into the CLL NPF and which might have a consequential impact on either or both of the with-profits funds However, the CLL NPF is already exposed to the risks of the transferring business. As Table 8.1 shows, the implementation of the Scheme would not have a material effect on the financial strength of the CLL NPF and therefore no material impact on the likelihood of extra calls on the capital in CLL that also provides support for the CLL With-Profits Fund and the CLL Manulife Fund It is expected that, in all but the most extreme scenarios (more remote than a 1-in-200 year event), the CLL NPF should continue to be able to meet its regulatory capital requirements for non-profit business without calling on capital outside the CLL NPF and CLL SHF. Furthermore, assets in the CLL With-Profits Fund and the CLL Manulife Fund are ring-fenced and thus unavailable to support business outside of the respective funds, except in the most October

49 extreme scenarios (for example, on insolvency of the company when it is possible, but by no means certain, that the ring fencing may break down) I am satisfied that the transfer of the ELAS annuities into the CLL NPF will not have a material effect on the security of the benefits of the other CLL policyholders of the CLL With-Profits Fund or the CLL Manulife Fund The policy servicing (administration and investment management) arrangements for the CLL policies in the CLL With-Profits Fund and the CLL Manulife Fund will not change as a result of the Scheme There will be no change to the management and governance of the CLL With-Profits Fund and the CLL Manulife Fund After the implementation of the Scheme, the CLL Board will remain responsible for the governance of with-profits business in the CLL With-Profits Fund and the CLL Manulife Fund and its actions in relation to with-profits business will continue to be reviewed by the CLL WPC. The implementation of the Scheme will not lead to any change to the terms of reference of the Board or the CLL WPC in relation to the governance of with-profits business I am satisfied that the implementation of the Scheme will not affect the service standards, management or governance of the policies in the CLL With-Profits Fund and the CLL Manulife Fund and that the implementation of the Scheme will not have a material effect on the benefit security or reasonable expectations of the policyholders of the CLL With-Profits Fund and the CLL Manulife Fund. October

50 9. OTHER CONSIDERATIONS ARISING FROM THE SCHEME The approach to communication with policyholders 9.1 Regulations made under FSMA require a communication regarding the proposed transfer to be sent to every policyholder of the parties under the Scheme. However, this requirement may be waived at the discretion of the Court, which will give consideration to issues such as the practicality and costs of sending notices against the likely benefits for policyholders of receiving such communications. In order to comply with SUP G, the companies would be expected to notify the policyholders, or interested persons, at least six weeks before the date of the Court hearing at which the application to sanction the Scheme will be heard. 9.2 ELAS will publish a notice in a form approved by the PRA in the London Gazette, the Edinburgh Gazette, the Belfast Gazette and in three national newspapers in the UK, as well as in national newspapers in other EEA countries where a material number of transferring policyholders are resident. 9.3 ELAS has asked the PRA to provide notification of the proposed Scheme to the insurance regulators in all EEA states. 9.4 Policyholders and other interested parties will be able to obtain information from the ELAS and CLL websites which will contain documents regarding the Scheme including the full Scheme document, this report, a summary of the terms of the Scheme and this report, and the communications pack regarding the Scheme. 9.5 ELAS proposes to send the Policyholder Letter to all ELAS policyholders for which it has a valid address. For group pension policies this will be either to the Trustee for forwarding on to individual members, or directly to members where ELAS makes direct payments to them. 9.6 For transferring policies, the Explanatory Booklets will also be included which will include the formal notice of the transfer and a summary of my report. The Explanatory Booklets will include information on the options available to the policyholder if they have any concerns about the transfer. In addition, before the end of 2015, as noted in paragraph 6.61(i), ELAS will write to each unit-linked annuity policyholder with payments linked to any of the five funds which will incur higher fund charges. 9.7 ELAS intends to seek a waiver from the requirement to send the Explanatory Booklets to non-transferring policyholders. This is in line with feedback from ELAS policyholders that they only wanted to receive targeted mailings. Furthermore, in the view of ELAS management, the benefit of informing non-transferring policyholders does not justify the cost that the with-profits fund would have to bear. 9.8 CLL intends to seek a waiver from the requirement to notify all existing CLL policyholders on the grounds that they will not be materially affected by the Scheme, and therefore that any notification would be of limited value, but would incur significant costs. I note that the financial impact of the transfer on CLL is comparable to that from acquiring a relatively small amount of new business, which would not require any notification to policyholders. 9.9 I consider these to be valid reasons and am satisfied that the proposed approach to communication with policyholders is fair and reasonable. Consideration of the combined impact of the Reassurance Arrangement and the Scheme 9.10 In preparing my report, I have considered the impact of the Scheme in isolation on the various categories of policies. This approach assumes that the existing Reassurance Arrangement would continue in force in the absence of the Scheme, and that the status quo position for comparison is therefore with the reinsurance in place. I note that the Reassurance Arrangement does not cover the unit-linked annuities, nor new annuities written since March An alternative approach would have been to have considered the combined impact of the Reassurance Arrangement and the Scheme, which would have assumed that the most likely course of action by either or both of ELAS and CLL would be to terminate the reinsurance if the Scheme is not approved. The terms of the Reassurance Arrangement specifically allow (but do not require) either party to terminate if the Scheme is not approved by 31 December In the following paragraphs, I consider whether I would have reached any different conclusions had I taken this alternative approach. October

51 9.13 For non-transferring ELAS policies, the effect of the Reassurance Arrangement is to reduce the risks and hence capital requirements in ELAS, and to accelerate the recognition of the value of the transferring policies. This is in line with ELAS s strategy. The reinsurance has also contributed to the increase in the Capital Distribution Amount from 25% to 35% from April Therefore considering the combined impact of the Reassurance Arrangement and the Scheme would have presented a more compelling position compared to the one discussed in the rest of this report, and I would not have altered my conclusions in respect of these policies. For example the Pillar I solvency coverage ratio for ELAS as at 31 December 2014 would have increased from 204% to 294% as a result of the Reassurance Arrangement and Scheme combined, compared to an increase from 261% to 294% from the Scheme alone For transferring ELAS policies, other than the unit-linked annuities, the reduction in the Pillar I solvency coverage ratio would have been from 204% to 162% as a result of the Reassurance Arrangement and Scheme combined, compared to a reduction from 261% to 162% from the Scheme alone. The effect of the Reassurance Arrangement is to accentuate the difference in Pillar I solvency between ELAS and CLL. Consideration of the combined effect of the Reassurance Arrangement and Scheme on transferring ELAS policyholders would not alter the conclusions set out in Section 6 in respect of these policies For the transferring ELAS unit-linked annuities, which are not covered by the Reassurance Arrangement, there is by definition no change to the approach, since they are impacted by the Scheme in isolation and not at all by the Reassurance Arrangement For the CLL policies, the key issue to consider is whether looking at the combined impact of the Reassurance Arrangement, the Scheme and onward Retrocession would leave CLL in a materially less financially secure position compared to the situation prior to the reinsurance and Scheme. Essentially, this leads to a consideration of whether the price paid by CLL for the transferring business is reasonable, specifically when taken in conjunction with the actions of the CLL shareholder to hold capital in CLL. Or to put it another way, I need to consider whether the transferring assets, together with any CLL shareholder capital retained in CLL to support the transfer are sufficient to cover the liabilities and associated risks of the transferring business I have been provided with information on the amount of assets received under the Reassurance Arrangement and the estimated premium in respect of the unit linked annuities to assist in my assessment. I have compared the pre-scheme, pre-reassurance Arrangement and post-scheme, post-reassurance Arrangement and after the planned Retrocession solvency positions under Solvency I Pillar I, Solvency I Pillar II and Solvency II. I am satisfied that, taken together, the Reassurance Arrangement and the Scheme are not expected to lead to a material change to the solvency coverage ratio. Furthermore, CLL is expected to continue to maintain compliance with its internal capital management policy Overall, I am satisfied that my conclusions would not have been different had I considered the combined impact of the reinsurance and the Scheme. The costs of the Scheme 9.19 ELAS and CLL will each bear their own costs of the Scheme, other than for certain costs such as my Independent Expert fees, and Court fees and Counsel s fees which will be shared equally between the parties, as will costs of advertising the Scheme. In CLL s case, any costs will be met from shareholder resources I am satisfied that this is reasonable. Reinsurance where ELAS or CLL is the cedant 9.21 Under the terms of the Scheme, there will be no change to the reinsurance contracts for which either ELAS or CLL is the cedant I am satisfied that the Scheme will not have a material effect on the reinsurers of the ELAS and CLL policies. The preparedness for Solvency II 9.23 Both ELAS and CLL have projects underway to enable them to meet the requirements of Solvency II. As for all insurance companies across Europe, Solvency II presents a significant challenge both in terms of changes to financial requirements and governance arrangements, with a number of the detailed rules being finalised only October

52 relatively recently. In particular, as noted elsewhere in this report, there are various aspects which require regulatory approval, and this approval process will continue throughout the remainder of I anticipate being able to comment further on the preparedness for Solvency II for both companies in my Supplementary Report. The future operation of the Scheme 9.25 If the Scheme is approved by the Court (and subject to any subsequent amendment of the Scheme, as considered below), the Directors of CLL are committed to implementing the Scheme as set out in the Scheme document (and reflected in this report) At any time after the Court s sanction of the Scheme, ELAS and CLL may jointly apply to the Court for sanction of any amendments to it, provided that prior notice is given to the PRA and FCA and a certificate obtained from an independent actuary regarding the impact of the proposed amendment on policyholders. However no application is required to be made to the Court in respect of either: (i) (ii) a minor or technical amendment, subject to non-objection by the PRA and FCA, or changes considered necessary to ensure the provisions of the Scheme operate in the intended manner in light of a regulatory change, subject to certification from an independent actuary in addition to non-objection by the PRA and FCA The various balance sheet figures for mathematical reserves and asset values requires to implement the Scheme will be calculated by the firms actuaries and accountants. The business being transferred consists of non-profit business and therefore the most important aspect is that CLL will continue to meet any guaranteed liabilities, including the annuities in payment, and that sufficient resources are put aside to enable this In my opinion the safeguards noted in section 9.26 are reasonable safeguards to ensure that, if approved by the Court, the Scheme will be operated as presented to the Court. Tax 9.29 ELAS and CLL have jointly drafted the necessary tax clearances and these will be submitted shortly. ELAS and CLL expect to receive such clearances. If clearances are not received then the Scheme will not proceed. I will provide an update, if required, in my Supplementary Report ELAS and CLL do not expect there to be any adverse policyholder tax impacts for Transferring Policyholders. I will provide an update in my Supplementary Report if this changes. Financial Services Compensation Scheme ( FSCS ) and Financial Ombudsman Service ( FOS ) 9.31 The FSCS provides compensation to individual holders of long-term insurance policies issued by UK insurers in the UK or another EEA state who are eligible for compensation under the FSCS in the event of the insurer s default. Compensation to eligible holders of annuities in payment is the full amount of the annuity, without limit. Implementation of the Scheme will not adversely affect eligibility for compensation from the FSCS for either transferring or non-transferring policyholders The FOS is an independent public body that aims to resolve disputes between individuals and UK financial services companies, and may make compensation awards in favour of policyholders. Only holders of policies that constitute business carried on in the UK are permitted to bring complaints to the FOS. In circumstances where ELAS currently refers policyholders to the FOS, CLL will continue to do so following implementation of the Scheme Implementation of the Scheme will not adversely affect access to the FOS for either transferring or non-transferring policyholders For the avoidance of doubt, CLL will continue to offer FOS referral rights to both all Guernsey and Jersey policyholders. October

53 10. CONCLUSIONS 10.1 I am satisfied that the implementation of the Scheme will not have a material adverse effect on: The security of benefits of the policyholders of ELAS and CLL; The reasonable benefit expectations of the policyholders of ELAS and CLL; or The service standards and governance applicable to the ELAS and CLL policies I am satisfied that the Scheme is equitable to all classes and generations of CLL and ELAS policyholders. Nick Dumbreck 7 October 2015 Fellow of the Institute and Faculty of Actuaries October

54 APPENDIX 1: STATEMENT OF INDEPENDENCE The Equitable Life Assurance Society ( ELAS ) has agreed to reinsure the majority of its non-profit annuity business to Canada Life Limited ( CLL ), a wholly owned subsidiary of Great-West Lifeco ( Great-West ). It is proposed that the reinsured business should subsequently be transferred to CLL under section 109 of the Financial Services and Markets Act 2000 by means of a scheme to be submitted to High Court in England and Wales for approval. I have been appointed as the Independent Expert to report on the proposed transfer. My appointment has been approved by the PRA in consultation with the FCA. I am a Principal and member of Milliman LLP, based in its UK Life Insurance practice in London. The purpose of this statement is to disclose all connections between myself and ELAS, CLL and Great-West including any respective subsidiaries (together the Companies ), and between Milliman and the Companies. I am not a shareholder in the Companies. Until recently I held a non-profit term assurance policy with ELAS for a sum assured of 100,000; this policy expired in May I have no other policies with ELAS, and no policies with CLL. I have not carried out any work directly for the Companies in the past ten years. In 2013 I undertook a peer review of an independent report on fairness in the operation of the closed with-profits funds of CLL conducted by Eckler, an actuarial consulting firm in Canada with which Milliman has an association. In 2013 other consultants from Milliman s London office assisted CLL to assess its readiness for implementation of Solvency II. In 2012 and 2013 consultants in Milliman s Dublin office acted as independent actuary for two transfers of business involving other subsidiaries of Great-West operating in Ireland; I acted as peer reviewer in both cases. Fees payable to Milliman by Great-West and its subsidiaries have not exceeded 0.1% of the firm s total revenues in any recent year. I do not believe that any of the above adversely affects my ability to act independently in my assessment of the proposed scheme. Nick Dumbreck October

55 APPENDIX 2: PREVIOUS TRANSFERS FOR WHICH I HAVE ACTED AS INDEPENDENT EXPERT OR EQUIVALENT 1995: Demutualisation of Provident Mutual 1997: Demutualisation of Norwich Union 1998: Demutualisation of Sanlam (South Africa) 1998: Transfer of the business of GAN Life & Pensions and Aegon UK to Windsor Life 1999: Transfer of business from Northern Assurance to CGU Linked Life 2001: Transfer of the pooled pensions business of Norwich Union Linked Life and General Accident Managed Pension Funds to Morley Pooled Pensions 2004: Transfer of business from 8 companies within the Aviva Group to Norwich Union Life & Pensions and Norwich Union Annuities 2004: Transfer of business from Allied Dunbar and Zurich Assurance to Eagle Star Life 2005: Transfer of business from Phoenix Assurance, Swiss Life (UK) and Bradford Insurance to Royal & Sun Alliance Linked Insurances 2005: Transfer of annuity business from Phoenix & London Assurance to Canada Life (UK) 2005: Transfer of business from Reassure (UK) and Virgin Money Life to Windsor Life 2005: Transfer of business from Allied Dunbar International Assurance to Zurich International Life (Isle of Man) 2006: Transfer of annuity business from Phoenix Life & Pensions to Prudential Retirement Income 2006: Transfer of business from Halifax Life to Clerical Medical and St Andrew s Life 2006: Transfer of long-term business from GE Frankona Re to Swiss Re Life & Health and Swiss Reinsurance Company 2007: Transfer of business from Swiss Re Life & Health to Swiss Re Europe 2007: Transfer of business from NM Life and NM Pensions to Windsor Life 2008: Transfer of immediate annuity business from Zurich Assurance to Windsor Life 2009: Transfer of business from CGNU Life, Commercial Union Life and Norwich Union Life (RBS) to Aviva Life and Pensions and associated inherited estate reattribution 2010: Transfer of business from Aberdeen Asset Management Pooled Pensions Limited to Aberdeen Asset Management Life and Pensions Limited 2011: Transfer of business from SLFC Assurance (UK) Limited to Sun Life Assurance Company of Canada (UK) Limited 2013: Transfer of the Hong Kong branch business of Prudential Assurance Company Limited to Prudential Hong Kong Limited October

56 APPENDIX 3: DATA RELIED UPON In addition to discussions (both verbally and electronically) with ELAS and CLL staff, I have relied upon the following principal documents in formulating my conclusions: Document Scheme of transfer Report of the AFH of ELAS and CLL on the Scheme Report of the WPA of ELAS and CLL on the Scheme Reinsurance Arrangement between ELAS and CLL Principles and Practices of Financial Management of ELAS and CLL Capital policies of ELAS and CLL Pre- and post-scheme financials as at Q for CLL and ELAS (covering Pillar II and Solvency II) End-2014 ICA report of ELAS and CLL, including details of any ICG End-2014 Returns to the PRA of ELAS and CLL End-2014 Report and Accounts of ELAS and CLL Unit Linked Annuities Analysis of fund mapping and associated changes October

57 APPENDIX 4: CERTIFICATE OF COMPLIANCE I understand that my duty in preparing my report is to help the Court on all matters within my expertise and that this duty overrides any obligations I have to those instructing me and / or paying my fee. I confirm that I have complied with this duty. I confirm that I am aware of the requirements applicable to experts set out in Part 35 of the Civil Procedure Rules, the Practice Direction and the Protocol for Instruction of Experts to give Evidence in Civil Claims. As required by Part 35 of the Civil Procedure Rules, I hereby confirm that I have understood my duty to the Court. I confirm that I have made clear which facts and matters referred to in my 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. Nick Dumbreck 7 October 2015 Fellow of the Institute and Faculty of Actuaries October

58 APPENDIX 5: GLOSSARY OF TERMS A glossary of abbreviations used throughout the report is given below. A AFH Actuarial Function Holder B BCRR Base Capital Resources Requirement C CRR CLL CLAC Capital Resources Requirement Canada Life Limited Canada Life Assurance Company E EEA European Economic Area Effective Date The date on which the transfer is effected (expected to be 19 February 2016) EIOPA The European Insurance and Occupational Pensions Authority ELAS The Equitable Life Assurance Society ERM Enterprise Risk Management EU European Union F FCA Financial Conduct Authority FSA Financial Services Authority FSMA Financial Services and Markets Act 2000 I ICA ICG Individual Capital Assessment Individual Capital Guidance L LTBF LTF LTICR Long Term Business Fund (CLL) Long Term Insurance Business Fund Long Term Insurance Capital Requirement October

59 M MCCSR MCR Minimum Continuing Capital and Surplus Requirements Minimum Capital Requirement O ORSA OLTF Own Risk and Solvency Assessment Ordinary Long Term Fund (ELAS) P PRA PALAL PPFM Prudential Regulation Authority Phoenix and London Assurance Limited Principles and Practices of Financial Management Q QIS Quantitative Impact Studies R RCM RCR Risk Capital Margin Resilience Capital Requirement S SCR SHF SUP Solvency Capital Requirement Shareholders Fund Supervision Manual T TAS TCF Technical Actuarial Standards Treating Customers Fairly W WPA WPC With-Profits Actuary With-Profits Committee October

60 APPENDIX 6: COMPLIANCE WITH PRA POLICY STATEMENT AND SUP 18.2 The table below indicates how I have complied with the provisions of the PRA Policy Statement ( The Prudential Regulation Authority s approach to insurance business transfers, dated April 2015) and SUP 18.2 (Insurance business transfers) that pertain to the form of the Scheme Report. PRA Policy Statement reference 2.30 (1) 2.30 (2) 2.30 (3) 2.30 (4) 2.30 (5) 2.30 (6) 2.30 (7) 2.30 (8) 2.30 (9) SUP 18.2 reference SUP (1) SUP (2) SUP (3) SUP (4) SUP (5) SUP (6) SUP (7) SUP (8) SUP (9) Requirement Scheme Report paragraph reference Who appointed the Independent Expert and who 1.2, 1.4 is bearing the costs of that appointment Confirmation that the independent expert has 1.20 been approved or nominated by the appropriate regulator. A statement of the independent , Appendix 2 expert's professional qualifications and (where appropriate) descriptions of the experience that fits him for the role Whether the independent expert, or his 1.21, Appendix 1 employer, has, or has had, direct or indirect interest in any of the parties which might be thought to influence his independence, and details of any such interest The scope of the report The purpose of the scheme 5.1 A summary of the terms of the scheme in so far as they are relevant to the report What documents, reports and other material information the independent expert has considered in preparing his report and whether any information that he requested has not been provided The extent to which the independent expert has relied on: (a) information provided by others; and (b) the judgment of others , Appendix , 1.24, Appendix (10) 2.30 (11) SUP (10) SUP (11) The people on whom the independent expert has relied and why, in his opinion, such reliance is reasonable His opinion of the likely effects of the scheme on policyholders (this term is defined to include persons with certain rights and contingent rights under the policies), distinguishing between: (a) transferring policyholders; 1.24, (b) policyholders of the transferor whose contracts will not be transferred; and 7.31 October

61 (c) policyholders of the transferee 8.34, (12) 2.30 (13) 2.30 (14) 2.32 (1) 2.32 (2) 2.33 (1) 2.33 (2) 2.33 (3) SUP (11A) SUP (12) SUP (13) SUP (1) SUP (2) SUP (1) SUP (2) SUP (3) His opinion on the likely effects of the scheme on any reinsurer of a transferor, any of whose contracts of reinsurance are to be transferred by the scheme What matters (if any) that the independent expert has not taken into account or evaluated in the report that might, in his opinion, be relevant to policyholders' consideration of the scheme For each opinion that the independent expert expresses in the report, an outline of his reasons. The summary of the terms of the scheme should include a description of any reinsurance arrangements that it is proposed should pass to the transferee under the scheme The summary of the terms of the scheme should include a description of any guarantees or additional reinsurance that will cover the transferred business or the business of the transferor that will not be transferred The independent expert's opinion of the likely effects of the scheme on policyholders should include a comparison of the likely effects if it is or is not implemented The independent expert's opinion of the likely effects of the scheme on policyholders should state whether he considered alternative arrangements and, if so, what The independent expert's opinion of the likely effects of the scheme on policyholders should, where different groups of policyholders are likely to be affected differently by the scheme, include comment on those differences he considers may be material to the policyholders The independent expert's opinion of the likely effects of the scheme on policyholders should include his views on: Not applicable Not applicable , , 6.7 to (a) the effect of the scheme on the security of policyholders' contractual rights, including the likelihood and potential effects of the insolvency of the insurer; 2.33 (4) SUP (4) (b) the likely effects of the scheme on matters such as investment management, new business strategy, administration, expense levels and valuation bases in so far as they may affect: (i) the security of policyholders' contractual rights; (ii) levels of service provided to policyholders; or (iii) for long-term insurance business, the reasonable expectations of policyholders; and (c) the cost and tax effects of the scheme, in so far as they may affect the security October

62 of policyholders' contractual rights, or for longterm insurance business, their reasonable expectations 2.35 (1) 2.35 (2) 2.35 (3) 2.36 (1) 2.36 (2) 2.36 (3) SUP (1) SUP (2) SUP (3) SUP (1) SUP (2) SUP (3) For any mutual company involved in the scheme, the report should describe the effect of the scheme on the proprietary rights of members of the company, including the significance of any loss or dilution of the rights of those members to secure or prevent further changes which could affect their entitlements as policyholders For any mutual company involved in the scheme, the report should state whether, and to what extent, members will receive compensation under the scheme for any diminution of proprietary rights For any mutual company involved in the scheme, the report should comment on the appropriateness of any compensation, paying particular attention to any differences in treatment between members with voting rights and those without. For a scheme involving long-term insurance business, the report should describe the effect of the scheme on the nature and value of any rights of policyholders to participate in profits For a scheme involving long-term insurance business, the report should, if any such rights will be diluted by the scheme, how any compensation offered to policyholders as a group (such as the injection of funds, allocation of shares, or cash payments) compares with the value of that dilution, and whether the extent and method of its proposed division is equitable as between different classes and generations of policyholders; For a scheme involving long-term insurance business, the report should describe the likely effect of the scheme on the approach used to determine: (a) the amounts of any non-guaranteed benefits such as bonuses and surrender values; and 6.3 Not applicable Not applicable 7.28 Not applicable 8.24 (b) the levels of any discretionary charges 2.36 (4) SUP (4) For a scheme involving long-term insurance business, the report should describe what safeguards are provided by the scheme against a subsequent change of approach to these matters that could act to the detriment of existing policyholders of either firm (5) SUP (5) For a scheme involving long-term insurance business, the report should include the independent expert's overall assessment of the likely effects of the scheme on the reasonable expectations of long-term insurance business policyholders , , October

63 2.36 (6) SUP (6) For a scheme involving long-term insurance business, the report should state whether the independent expert is satisfied that for each firm the scheme is equitable to all classes and generations of its policyholders (7) SUP (7) For a scheme involving long-term insurance business, the report should state whether, in the independent expert's opinion, for each relevant firm the scheme has sufficient safeguards (such as principles of financial management or certification by a with-profits actuary or actuarial function holder) to ensure that the scheme operates as presented October