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