Insurance Business Transfer from Eagle Star Insurance Company Limited s Maltese Branch to Zurich Assurance Ltd s Maltese Branch

Transcription

1 Insurance Business Transfer from Eagle Star Insurance Company Limited s Maltese Branch to Zurich Assurance Ltd s Maltese Branch Report of the Independent Expert under Section 109 of the Financial Services and Markets Act 2000 Prepared by: David King, FIA Date: 20 May 2015

2 Contents Contents 1. Executive summary The Independent Expert Qualifications and experience Independence Scope of this Report Terms of reference Reliances Limitations Legal jurisdiction Duty to the Court Statement of truth Summary conclusions General considerations Security of policyholder benefits Benefit expectations Service standards The current regulatory regime Solvency II Eagle Star Insurance Company Limited s Maltese Branch Company ownership and structure History Nature of ESI s business Financial position of ESI before the proposed Scheme Risk profile Ownership of ESI long-term fund surplus assets Zurich Assurance Ltd Company ownership and structure Nature of ZAL s business Financial position of ZAL before the proposed Scheme Risk profile Summary of the proposed ESI Scheme Main features The effect of the Scheme on policyholders Introduction Security of policyholder benefits Rights and expectations of policyholders Other considerations Conclusions Appendix A Terms and definitions Appendix B Information considered Appendix C PS7/15 cross reference EY i

3 Executive summary 1. Executive summary 1.1 The Independent Expert When an application is made to the High Court for an order to sanction the transfer of long term insurance business from one insurance company to another, the application is subject to Part VII of the Financial Services and Markets Act 2000 ( FSMA ) and must be approved by the Court under Section 111. FSMA requires the application to be accompanied by a report on the terms of the scheme ( scheme report ) by an independent expert. I have been appointed by Zurich Assurance Ltd ( ZAL ) pursuant to section 109 of FSMA as the Independent Expert in connection with a scheme (the ESI Scheme or the Scheme ) involving the transfer of all of the long-term insurance business of Eagle Star Insurance Company Limited s ( ESI s ) Maltese Branch to ZAL s Maltese Branch. The shareholders of ESI will be responsible for payment of fees incurred by me in my capacity as Independent Expert for the proposed scheme. 1.2 Qualifications and experience I am a Fellow of the Institute of Actuaries, having qualified in 1988, and am an employee of Ernst & Young LLP, 1 More London Place, London SE1 2AF. I have some 30 years experience in the life insurance industry, 20 years of which in the UK. I hold a current Practising Certificate issued by the Institute of Actuaries. In addition, I have a MBA from London Business School. My appointment as the Independent Expert has been approved by the Prudential Regulation Authority ( PRA ) in a letter dated 31 October 2014 after consultation with the Financial Conduct Authority ( FCA ). ZAL has also consulted with the insurance regulator in Malta, the Malta Financial Services Authority ( MFSA ). 1.3 Independence Within the last five years, I have not worked on any project involving the ESI, ZAL or the Zurich Group and neither has any member of the team (including the peer reviewer) that have supported me on this project. EY has carried out a number of different projects for the Zurich Insurance Group Ltd ( ZIG ), including work on the Group s preparations for Solvency II. However, none of those projects directly relate to the transferring company. In particular, none of those projects relate to valuation or capital modelling work that would affect the conclusion of the Independent Expert. Neither myself nor any of my team were involved in any projects for ZIG completed by EY over at least the past four years, and given that the subject of those engagements is not related to the Transfer, I do not believe that this affects my independence. I have no insurance policies with either of the parties to the proposed transaction and have no financial interest in them or in ZAL. I consider myself to be appropriately independent of both parties for the purposes of the proposed Transfer. 1.4 Scope of this Report As Independent Expert for the ESI Scheme I must have regard to the provisions of Part VII of the Financial Services and Markets Act 2000, and also take account of guidance issued by the PRA and FCA. This means that this Report must consider the consequences of the ESI Scheme for all policyholders affected (ZAL as well as ESI policyholders), including whether the ESI Scheme provides sufficient protection for policyholders interests in the changed circumstances which will apply following implementation. EY 1

4 Executive summary To the best of my knowledge, I have taken account of all material facts in assessing the impact of the Scheme and in preparing this Report. In order to reflect any updated financial information or circumstances nearer to the date of the Sanction Hearing, I expect to provide a Supplementary Report setting out my updated opinions in respect of the Scheme. I am only required to consider the ESI Scheme put to me and hence this Report does not consider possible alternative schemes. 1.5 Terms of reference The PRA has issued guidance on the form of the scheme report which is set out in paragraphs 2.27 to 2.40 of Appendix 2.4 of its Policy Statement 7/15 which will form part of the PRA Rulebook. The terms of reference for my review of the Scheme have been agreed with ESI and ZAL, and reviewed by the PRA. This Report will consider the implications of the ESI Scheme based of the financial position of the relevant companies at 31 December I will produce a supplementary report in advance of the Court hearing which will consider the implications of any more recent financial information in respect of the relevant companies and any other relevant developments, and whether any of the conclusions in this Report would change in the light of that information. I have been assisted by other employees of Ernst & Young LLP working under my supervision in the preparation of this Report. However, I take sole responsibility for the conclusions reached and the opinions expressed. In preparing this Report I have taken into account the following: Part 35 of the Civil Procedure Rules ("CPR"); The Practice Direction Supplement to Part 35 of the CPR; The CPR Code of Guidance for Experts and those instructing them issued by the Academy of Experts; Protocol for Instruction of Experts to give Evidence in Civil Claims; Guidance set out in paragraphs 2.27 to 2.40 of Appendix 2.4 of its Policy Statement 7/15 which will form part of the PRA Rulebook; Discussions about the content of this Report with the PRA and FCA. This Report should be read in conjunction with the full terms of the ESI Scheme. This Report has been prepared in accordance with the following Technical Actuarial Standards (TAS) issued by the Board for Actuarial Standards: TAS D: Data TAS R: Reporting Actuarial Information Insurance TAS Transformations TAS 1.6 Reliances In preparing the Report, I have had access to certain documentary evidence provided by ESI and ZAL, the key elements of which are listed in Appendix B. I have reviewed the information EY 2

5 Executive summary for consistency and reasonableness using my knowledge of the UK life assurance industry but have not otherwise verified it. Furthermore, I have had access to, and discussions with, senior management of ESI and ZAL. I place reliance on statements by the senior management of ESI and ZAL that all policyholders of the Maltese branches of both ESI and ZAL were Maltese residents at the point of sale. My analysis of the solvency position of the Companies is based on estimates of the companies financial position as at 31 December 2014 as set out in their 2014 regulatory returns to the PRA.. I have not checked these financial statements, but have relied on them in carrying out my analysis. I believe this is reasonable since the results, processes and assumptions used to produce them have been audited. Although I did not check the figures, I asked the management for clarification of any results that seemed to me inconsistent or unclear to me, and received satisfactory explanations. In addition, I have had access to other material such as ZAL s ICA Report and the companies Forward Looking Assessment of Own Risk s in assessing policyholder security and these have been subject to PRA scrutiny. In view of this, I have satisfied myself that it is reasonable to for me to rely on the information provided to me without further verification. In coming to my conclusions, I have relied upon the accuracy of the information which has been provided to me in written or verbal form, largely without independent verification. However, where appropriate to do so, I have carried out additional checks. 1.7 Limitations This report, and any extract or summary thereof, has been prepared particularly for the use of the bodies or persons listed below: High Court; Directors and senior management of ESI; Directors and senior management of ZAL; PRA, FCA and MFSA or any other governmental department or agency having responsibility for the regulation of insurance companies in the UK or Malta; Policyholders of ESI and ZAL; Professional advisors of any of the above. This report must be considered in its entirety since individual sections, if considered in isolation, may be misleading. Draft versions of this report and any other interim working papers must not be relied on by any person for any purpose. I have provided a summary of my report for inclusion in the policyholder circular and, other than this, no summary of my report may be made without my express consent. This report has been prepared by Ernst & Young LLP (EY) on an agreed basis (as set out in our engagement letter of 22 September 2014) for ESI and ZAL in the context of the ESI Scheme and must not be relied upon for any other purpose. No liability will be accepted by EY, or me, for any application of this Report for a purpose for which it was not intended, nor for the results of any misunderstanding by any user of any aspect of the report. If other persons choose to rely in any way on the contents of this Report then they do so entirely at their own risk. EY 3

6 Executive summary 1.8 Legal jurisdiction This Report will be governed by and construed in accordance with the English law and the English courts will have exclusive jurisdiction in connection with all disputes and differences arising out of, under or in connection with this Report. 1.9 Duty to the Court I confirm that I am aware of the requirements of Part 35 of the Civil Procedures Rules and the relevant Practice Direction, and the Protocol for Instruction of Experts to give Evidence in Civil Claims. In reporting on the Scheme as the Independent Expert, I recognise that I owe a duty to the Court to assist it on matters within my expertise. This duty overrides any obligation to ZAL and/or ESI. I confirm that I have complied with this duty Statement of truth I confirm that I have made clear which facts and matters referred to in this report are within my own knowledge and which are not. Those that are within my own knowledge I confirm to be true. The opinions I have expressed represent my true and complete professional opinions on the matters to which they refer Summary conclusions I am satisfied that the implementation of ESI Scheme on the Effective Date is not likely to lead to an adverse effect on the security of their guaranteed benefits for either the ESI and ZAL policyholders. I am satisfied that the implementation of ESI Scheme on the Effective Date is not likely to lead to an adverse effect on the reasonable benefit expectations of either the ESI and ZAL policyholders, nor on their being treated fairly in accordance with the FCA s Treating Customers Fairly ( TCF ) regime. I am satisfied that implementation of ESI Scheme on the Effective Date is not likely to lead to an adverse effect on the service levels experience by either the ESI and ZAL policyholders. I see no reason for additional safeguards to be contained within the ESI Scheme to protect the interests of either the ESI or ZAL policyholders. EY 4

7 General considerations 2. General considerations 2.1 Security of policyholder benefits As part of my role as Independent Expert for the ESI Scheme, I must consider the security of policyholder benefits. The policies being transferred are a combination of with-profits and non-profit policies. The with-profits policies have been receiving the same bonus rates as those of the ZAL UK withprofits policies since Security for guaranteed benefits is provided by the amount by which the long term fund assets exceed the long term fund liabilities, and by shareholder net assets. Security is also provided by the margins for prudence in the assumptions used to calculate the long term business fund liabilities which also contribute to policyholder security. The principal consideration regarding security is whether the transferee company will have adequate capital following the transfer of business, and whether this is likely to remain the case. A company s need for capital in future depends on the nature of its in-force business and the type and volume of new business that it expects to write. It also depends on the extent to which the assumptions made in valuing the business (for example, about future investment returns, mortality experience, persistency and expenses) are borne out in practice. The assessment of the security of the transferring policyholders is also affected by the relative sizes of the transferring and transferee businesses. 2.2 Benefit expectations As Independent Expert for the ESI Scheme I must also consider the effect of the Scheme on policyholders benefit expectations, including consideration of the proposals in the context of the FCA s consumer protection objective, specifically principle 6 (Customers Interests): a firm must pay due regard to the interests of its customers and treat them fairly (the so-called TCF regime). For with profits policies, these are primarily determined by the bonus rates declared and the exercise of discretion on matters such as investment policy and surrender values. For nonprofit policies, this involves consideration of areas where discretion is exercised, such as nonguaranteed charges or reviewable premiums. 2.3 Service standards I need to also consider the level of service provided to policyholders in the administration of their policies. 2.4 The current regulatory regime The PRA requires companies to value their assets at market value (albeit subject to certain rules) and their liabilities with allowance for prudence. In addition to holding assets to cover these liabilities, companies must hold capital to cover themselves against adverse deviations in future experience. In addition, for with-profits funds exceeding a certain size, a supplementary calculation must be performed using a realistic valuation basis for liabilities (so-called Peak 2 ). This is the so-called Pillar 1 regime. Over time, this approach was found to be not sufficiently reflective of the risk profiles of companies and, as a result, at end 2004 the FSA introduced a new risk-based capital approach under which management must assess the capital that it deems is sufficient to meet the losses arising from a 1-in-200 year event happening over one year. This so-called Pillar 2 regime requires companies to set aside an amount of capital called the Individual EY 5

8 General considerations Capital Assessment ( ICA ), which is the company s own assessment of its capital requirements. Pillar 2 is intended to provide a more realistic and complete view of the risks to which the company is exposed. When preparing the ICA, the PRA requires companies to identify the major risks they face and to quantify the amount of capital to mitigate those risks. The PRA reviews the ICA and may prescribe an additional amount of capital that must be held by the firm in addition to the ICA. The total amount of Pillar 2 capital prescribed by the PRA is called Individual Capital Guidance (ICG). While the Pillar 2 solvency position is communicated to the PRA, it is not publically disclosed. 2.5 Solvency II Solvency II, the new capital adequacy regime for European insurers is expected to come in force with effect from 1 January This will be will be in many ways analogous to the Pillar 2 calculation described above, but will involve some differences in methodology and has a greater emphasis on the robustness of the assumptions and the overall risk management framework. As part of the implementation of Solvency II, insurers can decide whether to use a standard formula to determine their capital requirements, or whether to opt to build a so-called internal model to calculate them in a way more aligned to their particular risk profile. ZAL intends to use the standard formula for its implementation of Solvency II. EY 6

9 Eagle Star Insurance Company Limited s Maltese Branch 3. Eagle Star Insurance Company Limited s Maltese Branch 3.1 Company ownership and structure ESI is a private limited company incorporated in England and Wales on 15 September 1904 and is a "UK authorised person" as defined in Section 105(8) of FSMA, with permissions, inter alia, to carry out contracts of long term insurance in the UK under Classes of Business I (Life and annuity) and IV (Permanent health), as defined in Part 2 to Schedule 1 of the FSMA 2000 (Regulated Activities) Order 2001 (S.I. 2001/544). ESI is a wholly-owned indirect subsidiary of Zurich Insurance Group Ltd ( ZIG ), a company incorporated in Switzerland which is the ultimate holding company of the Zurich group of companies. 3.2 History ESI is a UK-regulated composite insurer. However, in 1990, due to anticipated changes in regulation, it was decided to stop operating as a composite insurer and to move the long-term business into a separate life company, Eagle Star Life Assurance Company Limited ( ESLAC ). At 31 December 1990, ESI was closed to writing long-term business and as at 1 January 1991, almost all of the long-term business was transferred into ESLAC which was renamed Zurich Assurance Ltd ( ZAL ) in However, there were three portfolios of business that could not be transferred at the time; a Dutch disability portfolio, which has since fully run off, a Cypriot portfolio which has been sold, and a Maltese portfolio which is the subject of this Scheme. I have reviewed the court and board papers relating to the sale of the Cypriot portfolio and it is my understanding that no further liability remains with ESI; management has confirmed this. At the time of the transfer of the long-term business out of ESI, Malta was not a member of the EU and Malta did not have a regulatory framework in place for transferring the business. However, while ESI's Maltese long-term business could not be transferred at that time, the same financial effects were achieved by reinsuring 100% of the business to ZAL on 1 January 1991 and all business has been reinsured to ZAL since then. On 31 December 2013, ESI transferred all of its remaining General Insurance Business to Riverstone Insurance (UK) Limited by way of Part VII Transfer. ESI's only remaining insurance business relates to the Long Term Insurance Business written through its Maltese branch until 31 December The branch has been in run off since that date. 3.3 Nature of ESI s business Liabilities ESI's remaining business is currently comprised of around 1,230 direct Maltese life policies, which ESI ceased underwriting in As at the date of the transfer approximately 1,000 of these policies are expected to still be in force. In Table 3.1 are summarised the mathematical reserves for ESI as at 31 December 2014, as shown in the Company s annual returns to the PRA. EY 7

10 Eagle Star Insurance Company Limited s Maltese Branch Table 3.1: ESI Mathematical Reserves as at 31 December 2014 Number of Policies Gross of Reinsurance Reinsurance Ceded - Intra-Group Net of Reinsurance Non-Linked Business Overseas Business Whole of life (with-profits) 140 2,611 2, Whole of life (non-profit) 78 1,041 1, Endowment assurance (with-profits) 920 9,568 9, Permanent health insurance Miscellaneous ,231 13,480 12, Total mathematical reserves 1,231 13,480 12, While the insurance business has been fully reinsured to ZAL, there was a small residual liability of 666k which consisted of the following: 70k in respect of a provision for the cost of preparation of PRA Returns; 396k in respect of counterparty credit risk arising from the intra-group reinsurance; 200k in respect of possible future policyholder complaints Policies For each policy type I reviewed the key features for a sample of policies, including type of benefit, premium and other policy features. Policy type With-profits endowment assurance Key features Benefits: Sum assured plus profits. Premiums: Fixed for a term of years. Features: After qualifying period, (two years) acquires a surrender value. Can be changed to Paid Up on policy anniversary Non-profit term assurance Benefits: Sum assured (without profits) payable if death occurs within term of policy. Premiums: Guaranteed; non-reviewable. Features: Permanent Health Insurance (PHI) Benefits: Weekly disability benefit. Premiums: Guaranteed; non-reviewable. Features: 26 week deferred period. Convertible term assurance Benefits: Sum assured (without profits) payable if death occurs within term of policy. Premiums: Guaranteed; non-reviewable. Features: On any policy anniversary, or on conversion date, can convert to Whole of Life (with profit or non profit) or EY 8

11 Eagle Star Insurance Company Limited s Maltese Branch Endowment Assurance Mortgage protection Benefits: Decreasing sum assured over mortgage term. Premiums: Guaranteed; non-reviewable. Features: Sum assured is calculated to be sufficient to cover outstanding balances. Non-profit whole of life assurance Benefits: Sum assured (without profits) payable on death. Premiums: Guaranteed; non-reviewable for a term of years or for life Features: After qualifying period, (three years) acquires a surrender value. Can be changed to Paid Up on policy anniversary With-profits endowment plus convertible term assurance plus personal accident plus waiver of premiums Benefits: 1) Sum assured plus profits payable at end of term, 2) Sum assured (without profits) payable if death occurs within term of policy, 3) Sum assured payable upon death within twelve months following an accident, 4) Premiums waived after 26 weeks of disablement until 60 th birthday. Premiums: Fixed. Features: After qualifying period, (two years) acquires a surrender value. Can be changed to Paid Up on policy anniversary. On any policy anniversary, or on conversion date, can convert to Whole of Life or Endowment Assurance. Three months notification period for accidents, thirteen weeks for disability. With-profits whole of life assurance Benefits: Sum assured with profits payable on death. Premiums: Fixed. for a term of years or for life Features: After qualifying period, (three years) acquires a surrender value. Can be changed to Paid UP on policy anniversary Reinsurance All policies written by ESI have been fully reinsured to ZAL since 1 January 1991, with the exception of disability business carried out in the Netherlands which has since run off. Under this agreement, ZAL is responsible for providing accounting data to ESI in order that ESI can complete its statutory returns Memorandum and Articles of Association I have reviewed the Memorandum and Articles of Association of ESI and have not identified any issues in relation to them that might adversely affect the rights and expectations of policyholders with respect to the ESI Scheme Non-Maltese residents Under EU legislation, if a policyholder was a non-maltese resident at the time of taking out the policy then the insurance regulator in the relevant country must be informed of the EY 9

12 Eagle Star Insurance Company Limited s Maltese Branch Scheme. In the event that the regulator was to object to the policy transferring, then that policy would need to remain behind in the transferor company. ESI has undertaken a review of policies in order to gain assurance that it does not have any policyholders who purchased policies whilst being non-maltese residents. This review identified that all policyholders were Maltese residents at the point of sale. Some policyholders have moved since purchasing their policies. There are currently ten policyholders residing in the UK, one in the US, one in Belgium, one in Germany and one in Australia. However, as explained above, this does not necessitate contacting third-country regulators. Following this review, it was concluded by ESI that it was extremely unlikely that there had been other sales to policies to individuals who were non-maltese residents at the time of sale; therefore, it was decided that no special arrangement needed to be put in place in this regard Administration I have considered the administration of the ESI business in order to assess the potential impact of the proposed ESI Scheme on service standards. The policy administration is carried out by a small team in Malta. This will continue to be the case following the proposed transfer. Separately to this transfer, there is a cost reduction exercise about to be carried out that will reduce the number of hours worked by this team. As no staff or systems are being transferred, there is not likely to be an impact on the policyholders as a result of the Scheme. 3.4 Financial position of ESI before the proposed Scheme Table 3.2 summarises the statutory solvency position of ESI at 31 December 2013 and 31 December 2014 as shown in the Company s annual returns to the PRA. Table 3.2: Solvency Position of ESI 31 Dec Dec Long-term fund Regulatory value of assets 6,722 1,365 Mathematical reserves (non-profit) (46) (233) Mathematical reserves (with-profit) after distribution of reversionary bonus (527) (433) Other liabilities (968) (699) Excess of assets over liabilities (A) 5,181 - Shareholders' fund Regulatory value of assets 41,681 35,743 Other liabilities (18,954) (7,860) Shareholder net assets (B) 22,727 27,883 Capital resources (C = A + B) 27,908 27,883 Capital resources requirement (CRR) (D) 12,584 2,902 Excess of capital resources over CRR (E = C - D) 15,324 24,981 Ratio of excess capital resources to CRR (F = E / D) 122% 861% The Capital Resources as at 31 December 2014 were very considerably in excess of the Capital Resources Requirement; as such they demonstrate a strong level of solvency. EY 10

13 Eagle Star Insurance Company Limited s Maltese Branch As discussed in Section 2 above, life companies are required to meet the higher of the PRA s Pillar 1 and Pillar 2 requirements. I have reviewed ESI s Pillar 2 position and can report that ESI s capital resources in excess of its capital requirements under Pillar 2 rules significantly exceed those under Pillar 1. The solvency position is therefore currently constrained by the Pillar 1 calculation which is the one set out in Table 3.2 above. 3.5 Risk profile The risk profile of ESI is characterised by the fact that the whole of its life business is reinsured to ZAL. In respect of the with-profits business in particular, the risks that the policyholders are exposed to are primarily those in the ZAL with-profits fund, and to that extent there will be no change in risk profile. That said, the security of the policyholder benefits is ultimately the responsibility of the ESI. The investments held by ESI are not held to back insurance liabilities and largely short-term money market investments; market risk is therefore limited. While ESI is not exposed to life insurance risks as a result of the reinsurance arrangements, it does have a counterparty risk exposure relating to that reinsurance. In addition, ESI has counterparty risk exposure to ZIC as a result of an inter-company loan of 135m from ESI s shareholder fund to ZIC (which is inadmissible). However, given the financial strength of ZIC (AA- rated), the risk of any potential loss arising from the loan is considered to be significantly lower than the ICA or Solvency II thresholds of 1:200. I have been advised by management that ZIC is due to repay the loan in November 2015 (ie post- Transfer) and may seek PRA approval to repatriate part of the surplus capital that will appear on the ESI s balance sheet (which is currently not shown because of the inadmissibility of the loan). In respect of operational risk, ESI outsources the administration of its Maltese life business to Eagle Star (Malta) Limited (ESM), a wholly owned subsidiary of ZAL. ESI is not directly exposed to pension scheme risk as two management services companies (Zurich Employment Services Limited for Life business staff and Zurich UK General Employee Services Limited for General business staff) are the participating employers in the scheme and ESI is not responsible for making any payments to reduce any deficit for past service. Any risk arising from changes in future service contribution levels is part of expense risk. 3.6 Ownership of ESI long-term fund surplus assets As at 31 December 2014, ESI s long-term fund contained no surplus assets. In prior years, the fund showed surplus assets the source of which dated back to the 1990 Scheme, the original scheme setting up Eagle Star Life Assurance Company Limited (ESLAC) into which the UK long-term business of ESI was transferred in 1991, however, these were transferred to the shareholder fund at the end of The ESI With-Profits Actuary ( WPA ) has investigated the 1990 Scheme which stated that the assets retained in the ESI long-term fund were those attributable to the Dutch disability policies. Furthermore, the Independent Actuarial Report on the1990 Scheme stated that the Dutch policies were non-participating other than on a pooled basis and the last such policy expired during Having taken legal advice, the WPA concurred with the opinion stated by the AFH in his Report that the excess assets over liabilities that were in the long-term fund prior to 31 December 2014 belonged entirely to shareholders. EY 11

14 Zurich Assurance Ltd 4. Zurich Assurance Ltd 4.1 Company ownership and structure ZAL is a private limited company incorporated in England and Wales on 2 January 1990 and is a "UK authorised person" as defined in Section 105(8) of FSMA, with permissions, inter alia, to effect and to carry out contracts of long term insurance in the UK under Classes of Business I (Life and annuity) and IV (Permanent health), as defined in Part 2 to Schedule 1 of the FSMA 2000 (Regulated Activities) Order 2001 (S.I. 2001/544). ZAL is a wholly-owned indirect subsidiary of ZIG, a company incorporated in Switzerland which is the ultimate holding company of the Zurich group of companies. Eagle Star Life Assurance Company Limited ( ESLAC ) was formed in 1990 and the UK longterm business of ESI was transferred into ESLAC in In 2005, other long-term insurance business (that of Allied Dunbar Assurance plc being the largest of these) was transferred into ESLAC. In 2005, the name of ESLAC was also changed to Zurich Assurance Ltd (ie ZAL). The Maltese branch of ZAL sold life business for four years until 31 December 1994; all policies were sold to Maltese residents. 4.2 Nature of ZAL s business Liabilities In Table 4.1 are summarised the mathematical reserves for ZAL as at 31 December 2014, as shown in the Company s annual returns to the PRA. EY 12

15 Zurich Assurance Ltd Table 4.1: ZAL Mathematical Reserves as at 31 December 2014 Non-Linked Business Number of Policies Gross of Reinsurance Reinsurance Ceded - External Reinsurance Ceded - Intra-Group Net of Reinsurance UK Life Business (With-Profits) 16, , ,783 UK Life Business (Non-Profit) 470, ,373 (63,180) 118, ,515 UK Pensions Business (With-Profits) 13, , ,522 UK Pensions Business (Non-Profit) 1,156,446 2,230, ,365 1,187, ,934 Overseas Business (With-Profits) 1,835 31, ,815 Overseas Business (Non-Profit) 42, , ,519 1,701,236 4,161, ,205 1,305,337 2,573,088 Accumulating With-Profits Business UK Life Business (With-Profits) 5, , ,751 UK Pensions Business (With-Profits) 37, , ,012 Overseas Business (With-Profits) 14, , ,878 57, , ,641 Property-Linked Business * UK Life Business (Unit-Linked) 457,937 11,624, ,624,316 UK Life Business (Non-Linked) 196,410 3,033 2, ,571 UK Pensions Business (Unit-Linked) 828,061 27,957,263 9,022,193-18,935,070 UK Pensions Business (Non-Linked) 147,724 (19,652) - 167,376 Overseas Business Unit-Linked) 10, ,382-15, ,318 Overseas Business (Non-Linked) 4, ,337 1,296,800 40,267,721 9,005,574 18,159 31,243,988 Index-Linked Business * UK Life Business (Unit-Linked) , ,830 UK Life Business (Non-Linked) UK Pensions Business (Unit-Linked) ,429 3,595 81,169 8,666 UK Pensions Business (Non-Linked) Overseas Business Unit-Linked) 34 2, ,473 Overseas Business (Non-Linked) ,732 3,595 81,169 26,969 Total mathematical reserves 3,056,972 45,243,724 9,292,374 1,404,665 34,546,685 * Non-linked liability attaches to a linked policy so no policy count is shown under non-linked ZAL writes a full range of life assurance business, but unit-linked business predominates. ZAL consists of four long-term business funds (LTBFs) and a shareholder fund. The four long-term funds are the 90:10 with-profits fund, the 100:0 with-profits fund, the defined charge participating fund and the non-profit fund. The 90:10 with-profits fund contains conventional with-profits and unitised with-profits business. This business was mostly written prior to 1995 and is the fund into which the ESI Maltese business is written. ZAL manages the four funds such that under normal circumstances only the assets of a given fund are used to meet the liabilities of that fund. However, under insurance company law, the LTBFs are counted as one fund and all the assets are theoretically available to meet the liabilities in the fund. The Company recognises this possibility by making financial support available for the 90:10 with-profits fund and/or the 100:0 with-profits fund from the defined charge participating fund and the non-profit fund (or, if necessary, from the shareholder fund) in certain circumstances. EY 13

16 Zurich Assurance Ltd Memorandum and Articles of Association I have reviewed the Memorandum and Articles of Association of ZAL and have not identified any issues in relation to them that might adversely affect the rights and expectations of policyholders with respect to the ESI Scheme. 4.3 Financial position of ZAL before the proposed Scheme Table 4.2 summarises the statutory solvency position of ZAL at 31 December 2013 and 31 December 2014 as shown in the Company s annual returns to the PRA. Table 4.2: Solvency Position of ZAL 31 Dec Dec Long-term fund Regulatory value of assets 35,807,358 35,680,607 Mathematical reserves (non-profit) (32,766,222) (32,698,925) Mathematical reserves (with-profit) after distribution of reversionary bonus (1,813,665) (1,853,081) Other liabilities (719,848) (679,754) Excess of assets over liabilities (A) 507, ,847 Shareholders' fund Regulatory value of assets 522, ,302 Other liabilities (8,183) (10,727) Shareholder net assets (B) 514, ,575 Capital resources (C = A + B) 1,022,139 1,075,422 Capital resources requirement (CRR) (D) 658, ,796 Excess of capital resources over CRR (E = C - D) 363, ,626 Ratio of excess capital resources to CRR (F = E / D) 55% 65% The Capital Resources as at 31 December 2014 are considerably in excess of the Capital Resources Requirement; as such they demonstrate a strong level of solvency. The level of solvency demonstrated by these ratios is significantly about ZAL's target solvency. However, ZAL has paid a dividend of 230m during 2015 which will reduce the Pillar 1 buffer to close to its target level. As discussed in Section 2 above, life companies are required to meet the higher of the PRA s Pillar 1 and Pillar 2 requirements. I have reviewed ZAL s Pillar 2 position and can report that ZAL s capital resources in excess of its capital requirements under Pillar 2 rules significantly exceed those under Pillar 1. The solvency position is therefore determined by Pillar 1 calculation which is the one set out in Table 4.2 above. 4.4 Risk profile The risk profile of ZAL is characterised by the fact it writes a broad range of life insurance business and is exposed to the usual risks, including market risk from the impact of market movements on the assets it holds backing policyholder liabilities, and insurance risks, particularly in respect of mortality, longevity, lapses and expenses. Credit risk exposure is limited. ZAL has operational risk in respect of the administration of its life business which in the case of its Maltese life business, it outsources to Eagle Star (Malta) Limited (ESM), a wholly owned subsidiary of ZAL. In addition, it is exposed to strategic execution risk in respect of the Group s initiatives to transform ZAL s business. EY 14

17 Zurich Assurance Ltd ZAL is not directly exposed to pension scheme risk as two management services companies (Zurich Employment Services Limited for Life business staff and Zurich UK General Employee Services Limited for General business staff) are the participating employers in the scheme and ZAL is not responsible for making any payments to reduce any deficit for past service. Any risk arising from changes in future service contribution levels is part of expense risk. EY 15

18 Summary of the proposed ESI Scheme 5. Summary of the proposed ESI Scheme 5.1 Main features Background When ESI transferred the bulk of its long-term business to ZAL on 1 January 1991 (at which date all other long-term business of ESI, other than the transferring Maltese policies, a the Dutch disability portfolio (which has since fully run off) and a Cypriot portfolio (which has since been sold), was transferred to ZAL under the Companies Act 1982), Malta was not a member of the EU and the Maltese supervisor did not have a regulatory framework to govern the transfer of insurance businesses. There is now such a regulatory framework in place in Malta (see Part VIII of the Insurance Business Act (1998)) and prior to the implementation of Solvency II, Zurich wishes to transfer the remaining long-term business in ESI to ZAL. This will simplify the implementation requirements of Solvency II and improve the capital efficiency of the Group Scheme summary Under the proposed ESI Scheme, all of the long-term business of ESI will be transferred to ZAL on the proposed Scheme Effective Date ( SED ). All of the assets covering ESI gross technical provisions (except for a small provision covering the costs of preparing PRA Returns) will be transferred to the ZAL long-term business fund on the SED. Since the Malta with-profits policies have been fully reinsured into ZAL since the time of the 1990 Scheme when the bulk of ESI with-profits business was transferred to ZAL, the estate pertaining to the Malta with-profits policies exists as part of the ZAL 90:10 with-profits fund, and no part is contained within the ESI with-profits fund. Following the ESI Scheme, Zurich plans to de-authorise the company. No changes will be made to the terms and conditions of any policies as a result of the ESI Scheme. The reinsurance arrangement currently in place with ZAL will terminate on the SED; there are no other reinsurance arrangements currently in force. It is intended that the existing administration arrangements in respect of the ESI policies will continue unchanged as at the SED. The administration is carried out by Eagle Star (Malta) Limited (ESM), which is a wholly owned subsidiary of ZAL. Under the terms of the existing reinsurance agreement, Eagle Star (Malta) Limited was given the right to carry out the administration for ZAL and thus ESI. The rights and obligations of the third party administration agreements will in respect of the transferring policyholders will be transferred with the business with effect from the SED. Noting the significant reduction in workload, both past and future, ESM has carried out a review of its operations. Following consultation with the MFSA on 16 September 2014 and a 6 month consultation period with staff, the working hours of the Maltese office have been reduced with effect from 1 April However, this was a consequence of the decline in the number of in-force policies and not as a result of the proposed Scheme. The legal and other costs incurred in preparing and implementing the ESI Scheme will be met by the shareholder funds of ESI. EY 16

19 The effect of the Scheme on policyholders 6. The effect of the Scheme on policyholders 6.1 Introduction In this section I consider the impact of the Scheme on the policyholders of both ZAL and ESI. The key issues to consider are twofold: Security of policyholder benefits The security of policyholders depends principally on: The risk profile of ZAL after implementation of the Scheme; The amount of surplus capital in the Company to cover its capital resources requirements; The governance of the business after the Effective Date. Rights and expectations of policyholders, including the companies interpretation of TCF. In addition, I have considered: Service standards Taxation Safeguards 6.2 Security of policyholder benefits Risk profile Since both with-profits and non-profit policyholders of ESI are already fully reinsured into ZAL, the Scheme will not have a materially adverse impact on the risks to which either the ESI or ZAL policyholders are exposed to. Indeed, there would be some benefit to ESI policyholders from the reduction in reinsurance counterparty risk to ZAL which would fall away post-transfer. The Zurich group in the UK adopts a shared service model pursuant to which UK employees are employed by a shared service company and supplied to other companies within the group in accordance with operational requirements. The employees of both ZAL and ESI that participate in defined benefit pension arrangements belong to the same pension scheme, but neither ZAL nor ESI are the participating employers in this scheme which is sponsored by the service companies that employ the staff (Zurich Employment Services Limited for Life business staff and Zurich UK General Employee Services Limited for General business staff). As such, neither ZAL nor ESI is directly responsible for any pension scheme deficit. ZAL and ESI are responsible, however, for changes in future service contribution levels. This risk is directly captured as part of both ZAL and ESI s Solvency I Pillar 2 calculations, but since the capital position of both companies is constrained by their Pillar 1 capital requirements, the capital requirements are insensitive to this risk, and which for ESI significantly exceeds its Pillar 2 capital by reason of the minimum capital requirements applying. In my view, by transferring from ESI to ZAL, the ESI policyholders are not exposed to any materially different risk in respect to any pension scheme deficits. EY 17

20 The effect of the Scheme on policyholders Pillar 1 solvency position ESI Table 6.1 sets out how the Capital Resources and Capital Resources Requirement of ESI at 31 December 2014 would have changed had the ESI Scheme taken effect at that date. The actual post-scheme position will reflect movements in both markets and the portfolio over the period from 31 December 2014 until the SED. Table 6.1: Pro Forma 'Pillar 1' Solvency Position of ESI at 31 Dec 14 assuming Part VII effected on that date Pre-ESI Scheme Post-ESI Scheme Long-term fund Regulatory value of assets 1,365 - Mathematical reserves (non-profit) (233) - Mathematical reserves (with-profit) (433) - Other liabilities (699) - Excess of assets over liabilities (A) - - Shareholders' fund Regulatory value of assets 35,743 36,703 Other liabilities (7,860) (8,612) Shareholder net assets (B) 27,883 28,091 Capital resources (C = A + B) 27,883 28,091 Capital resources requirement (D) 2,902 2,902 Excess of capital resources over CRR (E = C - D) 24,981 25,189 Ratio of excess capital resources to CRR (F = E / D) 861% 868% ESI's long-term business is fully reinsured into the ZAL 90:10 fund; the net mathematical reserves shown of 666k consist of: 70k in respect of a provision for the cost of preparation of PRA Returns; 396k in respect of counterparty credit risk arising from the intra-group reinsurance; 200k to due to ZAL in respect of it assuming the liability for any life assurance misselling risk associated with ESI. As part of the ESI Scheme, it is intended that the assets and liabilities currently in the longterm fund will be transferred to the shareholders' fund in preparation for the de-authorisation of the company. In this context, please see Section 3.6 on the ownership of the assets in the long-term fund. From these assets transferred to the shareholder fund, two payments will be made to ZAL: 218k in respect of ESI s liability for any life assurance mis-selling. This item relates to a comfort letter provided by ESI to ZAL, the absence of which would have transferred the liability to ZAL as a consequence of the 1990 scheme. During 2015, ESI and ZAL agreed that ESI would pay 218k (ie slightly more that the 200k provided for) to ZAL in return for agreeing to cancel the comfort letter. This transaction will be carried out prior to the SED. EY 18

21 The effect of the Scheme on policyholders Following an investigation carried out in 2012, ZAL has held a 600k provision for possible complaints in Malta. In , the WPA revisited the 2012 investigation and identified those cases relating to ESI policies and those to ZAL policies. The 600k provision was then used as the basis for calculating the 218k payment to ZAL by apportioning it between the companies based on the policies which are still in force at year-end This pro rata approach seems reasonable given the relatively small magnitude of the provision. 187k, to be paid to ZAL on the SED and contingent on Transfer, to compensate ZAL for the increased Maltese tax it will incur as a result of taking on the ESI business. The liabilities transferred to the shareholder fund will comprise: Other liabilities of 699k in the long term fund (which are mainly in respect of tax balances) moved to the shareholder s fund post-transfer in anticipation of subsequent de-authorisation; Tax of 20.25% due on the 261k of mathematical reserves released ( 666k after deducting the mis-selling and contingent tax liability payments to ZAL), namely 53k. These result in the increase seen in other liabilities of 752k. For long-term business, the PRA would typically expect directors of a firm to set a capital management policy requiring excess working capital over the Capital Resources Requirement to be held of some 25-50% of the CRR. At 861%, the level of excess assets over those required to meet the Capital Resources Requirement would be very significantly in excess of this indicative level. However, it should be noted that since capital can be withdrawn by shareholders and utilised for other purposes provided that there is sufficient excess capital to meet the CRR and additional working capital requirements, the exact level of excess assets of the CRR is of limited significance except in the short term. Indeed, since ZIG s capital management approach is to optimise capital efficiency by holding capital resources at the highest level within the Group structure, the surplus assets are likely to be paid up to Group during ZAL Table 6.1 sets out how the Capital Resources and Capital Resources Requirement of ZAL at 31 December 2014 would have changed had the ESI Scheme taken effect at that date. The actual post-scheme position will reflect movements in both markets and the portfolio over the period from 31 December 2014 until the SED. EY 19

22 The effect of the Scheme on policyholders Table 6.2: Pro Forma 'Pillar 1' Solvency Position of ZAL at 31 Dec 14 assuming Part VII effected on that date Pre-ESI Scheme Post-ESI Scheme Long-term fund Regulatory value of assets* 35,680,607 35,681,012 Mathematical reserves (non-profit)** (32,698,925) (32,699,143) Mathematical reserves (with-profit) (1,853,081) (1,853,081) Other liabilities*** (679,754) (679,941) Excess of assets over liabilities (A) 448, ,847 Shareholders' fund Regulatory value of assets 637, ,302 Other liabilities (10,727) (10,727) Shareholder net assets (B) 626, ,575 Capital resources (C = A + B) 1,075,422 1,075,422 Capital resources requirement (D) 651, ,796 Excess of capital resources over CRR (E = C - D) 423, ,626 Ratio of excess capital resources to CRR (F = E / D) 65% 65% The pro forma regulatory value of assets is increased by a transfer of 405k from ESI in respect of ZAL taking on ESI s life assurance mis-selling risk ( 218k) and the contingent tax liability ( 187k) to compensate it for the increased Maltese tax it will incur as a result of taking on the ESI business. The non-profit mathematical reserves will increase by 218k in respect of taking on ESI misselling risk and the other liabilities by 187k for the contingent tax liability. Capital management policy ZIG s capital management approach is to optimise capital efficiency by holding capital resources at the highest level within the Group structure. As such, surplus capital retained within subsidiaries tends to be at the lower end of typical industry practice. ZAL's target solvency levels are defined as a ratio of excess capital resources to capital requirements on both a Solvency I Pillar 1 and Solvency I Pillar 2 basis. Its current level of solvency is significantly above these target levels, but ZAL has paid a dividend of 230m during 2015 which has reduced the Pillar 1 buffer to close to its target level. ZAL has not yet determined its Solvency II capital buffer. As a consequence of a capital reduction exercise undertaken in November 2005 a funding agreement was put in place between the ZAL and ZIG, the ultimate parent undertaking, under which ZIG has committed to provide funding, under certain circumstances, to a maximum amount of 833m. The funding will be provided by way of a subordinated loan or, at ZIG's discretion, equity subscription to ZAL through a number of tranches, which are triggered by specific conditions arising. The funding agreement in place for ZAL does not apply to ESI Contagion risk Where several funds exist in the same company or group of companies, it may be possible for capital resources to flow from one to another in the event that one of the funds has EY 20