Report of the Independent Expert on the terms of the proposed Insurance Business Transfer Scheme

Transcription

1 (UK Branch) and ReAssure Limited Report of the Independent Expert on the terms of the proposed Insurance Business Transfer Scheme 11, Old Jewry London, EC2R 8DU United Kingdom Tel +44 (0) Fax +44 (0) Prepared by: JL McKenzie, FFA milliman.co.uk

2 TABLE OF CONTENTS SUMMARY OF ACRONYMS 3 1. INTRODUCTION 5 2. BACKGROUND OUTLINE OF THE SCHEME ASSESSMENT OF THE SCHEME SUMMARY OF CONCLUSIONS CERTIFICATE OF COMPLIANCE 67 APPENDIX 1 TERMS OF REFERENCE 68 APPENDIX 2 PILLAR 1 SOLVENCY POSITION 70 APPENDIX 3 ALICO UK WITH-PROFITS CONVERSION TERMS 71 APPENDIX 4 SUMMARY OF THE UK REGULATORY REGIME FOR LONG TERM INSURANCE BUSINESS 76 APPENDIX 5 OUTLINE OF SOLVENCY II 80 ReAssure Limited 2

3 SUMMARY OF ACRONYMS AFH AIG Alico Alico UK AMSL ARUK BLAC CEIOPS CGT CHF CI COBS CRR DDOI ECR EMB ERP FSA Actuarial Function Holder American International Group, Inc. (UK Branch) Alico Management Services Limited Admin Re UK Barclays Life Assurance Company Committee of European Insurance and Occupational Pensions Supervisors Capital Gains Tax Swiss Franc Critical Illness Conduct of Business Sourcebook (FSA Handbook) Capital Resources Requirement Delaware Department of Insurance Enhanced Capital Requirement Executive Management Board Equity Risk Premium Financial Services Authority (or any successor body) FSMA Financial Services and Markets Act 2000 ICA ICG IGR IRS LAHC LP LTBF LTICR MCR Individual Capital Assessment Individual Capital Guidance Intra Group Reinsurance Internal Revenue Service Life Assurance Holding Corporation Liquidity Premium Long Term Business Fund Long Term Insurance Capital Requirement Minimum Capital Requirement ReAssure Limited 3

4 MI MVR NM NMLL NMPL NMPL NMF NMWPF NPA NPF OEIC PPFM PRE PRIN PRP QIS 5 RCM RCR Management Information Market Value Reductions National Mutual National Mutual Life Limited National Mutual Pensions Limited National Mutual Pensions Limited National Mutual Fund National Mutual With-Profits Fund Non-Profit Account Non-Profit Fund Open Ended Investment Company Principles and Practices of Financial Management Policyholders Reasonable Expectations Principles for business (from the FSA Handbook) Property Risk Premium Fifth quantitative impact survey (CEIOPS) Risk Capital Margin Resilience Capital Requirement ReAssure ReAssure Limited (Windsor Life Assurance Company prior to December 2011) SHF SRGB Shareholder Fund Swiss Re GB Ltd SUP18 FSA Handbook of Rules and Guidance, Supervision Manual, Section 18 TB TCF UK UL US WPA WPF WPICC ZAL Terminal Bonuses Treating Customers Fairly United Kingdom Unit Linked United States of America With-Profits Actuary With-Profits Fund With-Profits Insurance Capital Component Zurich Assurance Limited ReAssure Limited 4

5 1. INTRODUCTION Instructions 1.1 I have been instructed by ReAssure Limited ( ReAssure ) and American Life Insurance Company ( Alico ) to report pursuant to Section 109 of the Financial Services and Markets Act 2000 ( FSMA ) (as amended from time to time) in the capacity of Independent Expert on the terms of the scheme for the proposed transfer of part of the insurance business of Alico s UK Branch ( Alico UK ) to ReAssure. ReAssure was named Windsor Life Assurance Company Limited until December Admin Re UK ( ARUK ) is the parent company of ReAssure. ARUK is a UK company and is part of Swiss Re Limited ( Swiss Re ), a major reinsurance group domiciled in Switzerland. MetLife, Inc., ( MetLife ) a major life insurance group domiciled in the United States of America ( US ), is the ultimate parent company of Alico, which it acquired in Scheme of Transfer 1.2 The Scheme of Transfer will be presented to the High Court of Justice in England and Wales for sanction under Section 111 of FSMA and for related orders under Section In order to comply with local requirements, schemes of transfer similar to the scheme presented to the Court will also be presented to the relevant courts in Jersey and Guernsey ( Overseas Schemes ). 1.4 Throughout the remainder of this report, the term the Scheme is used to cover all the proposals in the scheme of transfer, including any documents referred to therein relating to the proposed implementation and operation of the scheme of transfer. Unless necessary to do so, I do not address matters relating to the Overseas Schemes separately in the report and include consideration of them within the context of the Scheme. My conclusions apply equally to policyholders transferred under the terms of these schemes. Purpose of the Report Scope 1.5 My appointment as the Independent Expert has been approved by the Financial Services Authority ( FSA ) which has also approved the form of my report (the Scheme Report ). The Scheme Report has been prepared in compliance with applicable rules on expert evidence. My terms of reference, which include rules on expert evidence, are set out in Appendix 1. I have interpreted my instructions and terms of reference to require me to consider primarily the likely effects of the Scheme on the policyholders of ReAssure and Alico UK. 1.6 In preparing the Scheme Report, I have had regard to the equity of the proposals amongst the various groups of policyholders (reflecting the varying nature of the contractual rights which policyholders have, the operation of their policies and the jurisdiction in which the contract was entered into), the security of the benefits in each company both before and after the implementation of the Scheme, the policyholders reasonable expectations created by the past practices employed or statements made by ReAssure or Alico UK, and more generally, the fairness of the proposals insofar as they affect the treatment of policyholders. 1.7 In assessing the impact of the Scheme on policyholders reasonable expectations, and whether policyholders are being treated fairly in the implementation of the Scheme, I have had regard to the reports of the With-Profits Actuary ( WPA ) and Actuarial Function Holder ( AFH ) of each of ReAssure and Alico UK on the Scheme. 1.8 As far as I am aware, there are no matters which I have not taken into account in undertaking my assessment of the Scheme and in preparing the Scheme Report but which nonetheless should be drawn to the attention of policyholders in their consideration of the terms of the Scheme. ReAssure Limited 5

6 1.9 I have also reviewed and considered the communication policy being adopted and the contents of the documents describing the proposals (the Communications Pack ) which, subject to the dispensations sought being granted by the Court, will be despatched to the holders of the Alico UK policies which are to be transferred under the Scheme. An advanced draft of the Communications Pack was available to me at the date of the Scheme Report. Regulatory and Professional Guidance 1.10 The Scheme Report has been prepared under the terms of the guidance contained in Section 18 of the Supervision Manual ( SUP 18 ) contained in the FSA Handbook of Rules and Guidance ( the FSA Handbook ) to cover scheme reports relating to transfers of long term insurance business The Scheme Report has also been prepared subject to the terms of the Technical Actuarial Standard: Transformations ( Transformations TAS ) issued by the Board for Actuarial Standards ( BAS ). In my opinion, the Scheme Report complies with the Transformations TAS and is compliant with those elements of the Technical Actuarial Standards ( TAS ) on Data, Modelling, Reporting and Insurance (TAS-D, TAS-M, TAS-R and the Insurance TAS, respectively) which are applicable to transformations. In complying with these requirements, I note that a number of the key documents listed in 1.26 which I have considered have been prepared or reviewed by individuals who have been subject to professional standards in undertaking their work, including, where appropriate, TAS requirements. Qualifications and Disclosures 1.12 I am a Fellow of the Institute and Faculty of Actuaries, and have been so since I am a Principal of Milliman Inc ( Milliman ) based in its London office. I have more than 35 years experience in the UK life insurance industry, including experience as an AFH, WPA and as an Appointed Actuary, and have acted previously in the capacity of an independent expert under the terms of FSMA, and as an independent actuary under the Insurance Companies Act 1982, the legislation replaced by FSMA I was retained as the Independent Expert to review the transfer of the long term business of Barclays Life Assurance Company Limited ( BLAC ) to ReAssure in I have undertaken no other assignments on behalf of ReAssure or Alico UK or any of its subsidiaries in the last 5 years. I am not a policyholder of ReAssure or Alico UK, nor do I have any financial interests in Swiss Re or MetLife or any of their subsidiary companies Milliman is a global consulting firm and has undertaken a number of assignments on behalf of Swiss Re and MetLife and/or their subsidiary companies over the last 5 years. These assignments have been undertaken primarily for the US subsidiaries of these companies. The scale and nature of the work undertaken globally has been disclosed to the FSA in approving my appointment as the Independent Expert I do not believe that these other assignments prejudice my independence in reviewing the Scheme. Structure of the Scheme Report 1.17 In Section 2 of the Scheme Report, I discuss the current structure, operations, products and financial condition of each of Alico UK and ReAssure and identify the similarities and differences in these which may influence the circumstances of policyholders if the Scheme becomes effective In Section 3, I set out my understanding of the proposed Scheme In Section 4, I set out my assessment of the terms of the Scheme and its implications for their security of the benefits of the policyholders of Alico UK and ReAssure and their benefit expectations In Section 5, I summarise my conclusions. ReAssure Limited 6

7 1.21 In Section 6, I set out my certification of compliance with Court rules applicable to an expert witness Appendix 1 shows the agreed terms of reference for my review Appendix 2 contains summaries of the financial information considered by me in undertaking the review Appendix 3 sets out a summary of the methodology, assumptions and indicative results of the conversion of the Alico UK with-profits policies to non-profit policies Appendices 4 and 5 set out a summary of the current prudential regulatory requirements and the proposed new EU regime for insurance companies ( Solvency II ). (The summaries shown there apply equally to Alico UK and ReAssure, as long term insurance companies.) Reliances and Limitations 1.26 In preparing the Scheme Report, the principal documents and other information which I have reviewed are: Alico Public documents Alico UK Returns to the FSA for 2010; Alico Annual Accounts for 2010; Principles and Practices of Financial Management ( PPFM ) for Alico UK with-profits business; and, The Scheme, Communications Pack and actuarial reports (prepared by Alico UK s AFH and WPA) relating to the transfer of the long term business of Alico UK to ReAssure. Alico Internal documents Outline of the legal structure of Alico and its branches, the effects of the Separate Account and the Floating Charges on its UK Branch assets; Reports of the AFH of Alico UK on the valuation basis and methodology for the year ending 30 November 2010 and the results of the supporting investigations; Recent correspondence between Alico UK and the FSA; Recommendations and Reports on the Actuarial Valuations for Alico UK for 2010 produced by its AFH; Individual Capital Assessment ( ICA ) for Alico UK produced in September 2011 as at 31 May 2011; Recommendations and reports setting out the terms of the conversion of UK branch with-profits policies to non-profit policies; Recommendations and report for bonus recommendations and the operation of the smoothing account; Draft report Conversion of UK Branch with-profits policies to non-profit policies as at 31 August 2011 prepared by Towers Watson; Report of the Independent Person (for with-profits review) on the terms of the withprofits conversion; Report on the management and administration of the in force business of Alico UK Closed Book Review; Estimated figures for the effect of Solvency II on Alico UK; and, ReAssure Limited 7

8 Risk Appetite Framework adopted by Alico UK. ReAssure Public documents ReAssure Returns to the FSA for 2010; ReAssure Annual Report and Accounts 2010; The Scheme, Communications Pack and actuarial reports relating to the transfer of the long term business of Alico UK to ReAssure; Principles and Practices of Financial Management ( PPFM ) for the ReAssure withprofits sub-fund and the National Mutual With-Profits Fund ( NMWPF ); The Scheme, Communications Pack and actuarial reports relating to the transfer of the long term business of the NM Transfer Scheme and the ZAL Transfer Scheme ; and, The Scheme and the communications to be sent to policyholders (the Communications Pack ) and the reports prepared by each of the AFH and the WPA of ReAssure advising its Board on the effects of Scheme on ReAssure and its policyholders. ReAssure Internal documents Recent correspondence between ReAssure and the FSA; Recommendations and Reports on the Actuarial Valuations for ReAssure for 2010 produced by its AFH; The Framework Agreement and the Reinsurance arrangement agreed between ARUK and MetLife regarding the management and transition of business to be transferred by the Scheme prior to the Effective Date of the Scheme; Estimates of the financial position of ReAssure allowing for the transfer of BLAC and the reinsurance of the business of Alico UK to ReAssure; ICA for ReAssure produced in June 2011 as at 31 December 2010; Solvency II Internal Model Application Process ( IMAP ) documents for ReAssure; Estimated figures for the effect of Solvency II on ReAssure; and, Capital Management Policy and Risk Appetite Framework adopted by ARUK I have been given free access to the additional documentary evidence held by Alico UK and ReAssure as requested by me to allow me to investigate all aspects of the Scheme. In addition, I have had access to and discussions with management and their professional advisers to assist in the completion of this report. I have relied on the accuracy of the information which has been provided to me, and have not verified it independently. I have considered, and am satisfied with, the reasonableness of this information from my own experience in the insurance industry The Scheme Report, and any extract or summary thereof, has been prepared particularly for the use of the bodies or persons listed below: The Court; The Board of Directors of ReAssure; The Management Board of Alico UK; The FSA or any other government department or agency having responsibility for the regulation of insurance companies in the UK, Jersey or Guernsey and, to the extent necessary, the insurance regulator of any EEA country, the State of Delaware or the State of Connecticut, who requests a copy of the Scheme Report; and, ReAssure Limited 8

9 The professional advisers of the above Copies of the Scheme Report may be made available for inspection by policyholders, either in physical form or on Alico UK s and ReAssure s websites and may be provided to any person requesting the same in accordance with legal requirements. I will provide a summary of the Scheme Report for inclusion in the Communications Pack Neither the Scheme Report nor any extract from it may be published without my specific written consent having been given, save as set out in In addition, no summary of the Scheme Report may be made without my express consent The Scheme Report has been prepared within the context of the assessment of the terms of the Scheme. No liability will be taken for application of the Scheme Report to a purpose for which it was not intended or for the results of any misunderstanding by any user of any aspect of the Scheme Report. In particular, no liability will be accepted for any application under the terms of the Contracts (Rights of Third Parties) Act Nothing contained in the Scheme Report should be taken as investment advice, either regarding the products of Alico UK or ReAssure, the products of any companies in the Swiss Re Group or MetLife Group, or any financial instruments issued by them I am available to assist any of the parties listed in 1.28 above in interpreting the Scheme Report. ReAssure Limited 9

10 2. BACKGROUND Motivation for the Scheme 2.1 MetLife is seeking to reorganise its European business. The major reasons for implementing the reorganisation are: the need to integrate the acquired Alico business; the need to satisfy an agreement with the US Internal Revenue Service ( IRS ) regarding the application of withholding tax to payments made to Alico s policyholders. Alico plans to satisfy this agreement by modifying its branch structure such that a material proportion of its branches will be converted to subsidiaries or transferred to branches of domestic insurers by December (Details of this IRS requirement are discussed further in sections 2.13 to 2.14); the desire to reduce the risk that the unit costs related to the management of Alico UK s business will increase as the in-force declines since the UK branch is closed to new business; and, the desire to introduce a more efficient capital structure for all of its European businesses (including the acquired Alico business) in the light of the new EU-wide regulatory regime for insurance companies which is expected to come into force in MetLife has transferred its economic interest, but not legal ownership, in part of the business of Alico UK to ReAssure as a first step in the process to wind up the Alico UK branch. 2.3 ReAssure s business model is the acquisition of blocks of long term insurance business and bulk insurance or reinsurance contracts. On 1 July 2011, ReAssure acquired the economic interest, but not legal ownership, of this part of the Alico UK business which has been reinsured to ReAssure from that date. 2.4 The Scheme will finalise the disposal of the business sold by transferring it to ReAssure. MetLife History 2.5 MetLife which is the holding corporation for Metropolitan Life Insurance Company, a long established life insurance company, is quoted on the New York Stock Exchange. Metropolitan Life Insurance Company was founded in 1868, became a mutual in 1915 and demutualised in On 1 November 2010, MetLife completed the acquisition of Alico from American International Group, Inc. ( AIG ). 2.7 The acquisition of Alico transformed MetLife, Inc. into a global provider of insurance, annuities and employee benefit programs, serving 90 million customers in over 60 countries. 2.8 A high level overview of MetLife s corporate structure is shown in the chart below. MetLife Europe Limited, MetLife Assurance Limited, MetLife Limited and MetLife Insurance Limited are all wholly owned subsidiaries of MetLife based in Europe. These companies will not be affected by the current Scheme but they are highlighted at this stage since a second scheme (the MetLife Part VII Transfer ) is being developed which will effect the transfer to them of that part of Alico UK s business which is not subject to the current Scheme. ReAssure Limited 10

11 Chart 1: Current Group Structure (Omits Some Intermediary Holding Companies and Non-UK Business) MetLife, Inc (US Delaware) Metropolitan Life Insurance Company (US New York) MetLife International Holdings, Inc (US Delaware) American Life Insurance Company (US Delaware) MetLife Insurance Company of Connecticut (US) MetLife Insurance Limited (UK) MetLife Limited (UK) MetLife Europe Services Limited (Ireland) MetLife Europe Insurance Limited (Ireland) UK Branch MetLife European Holdings LLC (US) MetLife Europe Limited (Ireland) MetLife Assurance Limited (UK) UK Branch Alico History 2.9 Alico was established in 1921 in China, but is now a company incorporated in the State of Delaware, in the US. Alico UK was established as a branch in Alico is licensed by the Delaware Department of Insurance ( DDOI ). Although Alico is permitted to sell insurance in Delaware, Alico is unusual in that it does not sell insurance in the US. Instead it conducts all of its insurance business through its overseas branches and subsidiaries. Alico has operations primarily in the UK, Japan, Europe, the Middle East, Latin America and parts of Africa and the Caribbean. The US operation is generally referred to as home office Under the Delaware Insurance Code, Alico maintains a separate account for the entirety of its UK branch businesses and for certain business conducted by other Alico branches. The effect of the separate account mechanism for the UK branch is to ring-fence the assets of the UK branch from the rest of Alico s worldwide business and to give the policyholders of the UK branch greater protection. In practice, the UK branch operates as if it was a standalone entity although legally still part of Alico. In addition, in order to provide a further layer of protection for the benefit of the Alico UK branch policyholders, a floating charge agreement over the assets of the UK Branch was set up in 2006 with the agreement of the FSA. This is described in more detail in 2.17 to Alico has approximately 15 million policyholders worldwide. Assets under management for the whole of Alico (including all branches but excluding subsidiaries) were $94.6 billion at year end 2010, equivalent to 60.7 billion. Assets under management for Alico UK were 5.5 billion at year end ReAssure Limited 11

12 IRS Closing Agreement 2.13 As noted above, Alico has conducted all of its business outside of the US. In 2004, the IRS issued a ruling requiring US insurance companies to withhold US tax on certain payments to foreign policyholders Prior to the acquisition by MetLife, Alico did not withhold tax, pursuant to the then-existing exemptions under US tax rules. As part of the acquisition, MetLife required certainty with regards to the payment of withholding tax and, as a result, Alico entered into a Closing Agreement with the IRS whereby the IRS agreed not to seek to apply withholding tax to Alico until the end of In return, Alico agreed to modify its branch structure and materially eliminate the issue by the end of It is expected that this requirement will necessitate all of Alico s major branches to be restructured, in particular, the UK and Japan branches. Alico UK History 2.15 Alico UK is authorised by the FSA to carry on life insurance business in the UK under the terms of FSMA. It is authorised to undertake long term insurance business in Classes I, III, IV, VI and VII 1. Alico UK is also authorised to undertake general insurance business in Classes 1 and Alico UK has operated primarily in the UK but also has a very small number of policies written in Jersey, where it is also authorised. It also has a small number of policies written in Guernsey and is able, as a recognised insurer, to conduct business there under the Insurance Business (Bailiwick of Guernsey) Law, Structure and Operation Separate Account and Floating Charge 2.17 As noted in 2.11, Alico has designated the UK branch as a separate account (the Separate Account ), the effect of which is to ring-fence the UK operations from the rest of its worldwide business; the funds in the Separate Account are required to be applied in priority to liabilities of the UK branch, and income of the UK branch is required to be held in that account. Assets not required to meet the UK branch liabilities may be released to be used generally by Alico (subject to UK capital requirements being met). Conversely, it is also noted that Alico UK may not rely on assets of Alico held in other branches which are subject to this type of arrangement. This is a long standing arrangement having been established in Alico UK operates effectively as if it was a standalone company and has to satisfy FSA requirements on management, conduct of business and reserving in line with the FSA Handbook. These topics are addressed later in the Scheme Report It is likely that the protection afforded by the Separate Account would only be beneficial to the policyholders of Alico UK in the event that Alico as a whole was in financial difficulties. However, when winding up rules for insurance companies were introduced in the UK (reflecting EU directive requirements), it was noted that these rules effectively removed some of the intended policyholder protection given by the Separate Account. To restore the intended position, a floating charge agreement was set up in The floating charge agreement has been executed over the assets of Alico UK in favour of a trustee company which will hold these assets for the benefit of Alico UK policyholders if a specified trigger 1 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. 2 Classification of general insurance business: 1 Accident and 2 Sickness. ReAssure Limited 12

13 event occurs. In those circumstances, the trustee can only release the charged assets once the rights of Alico UK policyholders have been met. UK Operations 2.20 Alico UK maintains two separate funds: the Long Term Business Fund ( Alico UK LTBF ); and, the Other than Long Term Business Fund ( Alico UK OLTBF ) The Alico UK OLTBF represents those assets not allocated to the Alico UK LTBF and consists of general insurance business and shareholder assets and liabilities maintained in the UK. The Alico UK OLTBF is however available to support the Alico UK LTBF The Alico UK LTBF represents the assets and liabilities of the long-term insurance contracts issued by Alico UK All profits arising within the long-term business fund (apart from those allocated to with-profits policyholders) accrue to the shareholder. These profits may be retained in the Alico UK LTBF or transferred to the Alico UK OLTBF where they may then be available for repatriation to home office and be used to pay a dividend to the shareholders or reapplied to Alico s other business needs. This is discussed further in Although Alico UK has transacted withprofits (participating) business, unusually, it does not maintain a separate with-profits subfund. Administration and Outsourcing Arrangements 2.24 Policy administration in respect of the business transferring under the Scheme of Transfer for Alico UK has been conducted by a related service company. As part of the Insurance Intermediary Administration Agreement ( IIAA ) between MetLife and ARUK, responsibility for the administration of the business reinsured from Alico UK (including the collection of premiums and the handling of claims) is undertaken by ARUK The terms of these arrangements are such that Alico UK is charged specified unit costs for policy administration. These charges are (as specified in the IIAA): nil until 31 December 2012; fixed, apart from inflationary increases based on the Retail Prices Index excluding mortgage interest payments ( RPIX )+ 1% p.a. at the start of 2013; and, permitted to increase should the migration of the services, systems and data covered under the IIAA in relation to the reinsured business not be completed as planned The agreement requires ARUK to perform these outsourcing services with reasonable care, skill and diligence, to a level that is consistent with the services previously provided to policyholders by Alico UK For the lines of business that are not covered under the IIAA, the following arrangements are currently in place (the business lines are as described in 2.47): General Insurance business, administration is mainly carried out by Alico UK with a small block administered by UNAT Direct Insurance Management Limited ( UNAT ); Group Employee Benefits, administration is carried out by an in-house MetLife team based in Brighton; Living Time business, administration is outsourced to a third party company, Paymaster; PAX and related business, administration is carried out by the Ministry of Defence and UNAT; Bulk Annuity business administration is outsourced to a third party company, RPMI ReAssure Limited 13

14 Limited. It is the intention that Jardine Lloyd Thompson Benefit Solutions Limited ( JLT ) will take over the outsourcing arrangement on this business from 1 June 2012; and, Wealth Management business administration (e.g., premium collection, claim handling and administration) has been carried out by ARUK since 1 July 2011 and is covered by the IIAA detailed in For the Wealth Management business, investment management is handled by: AIG Asset Management Group for the Protected Recovery Fund ( PRF ). This arrangement will cease on the closure of the PRF which will occur on 1 July 2012; and, MetLife Investments Limited for the Standard Fund, a unit-linked fund that invests mainly in conventional short term cash or near-cash instruments For business other than Wealth Management, the majority of investment management is handled by MetLife Investments Limited and unit administration is carried out within the Fund Administration Team, which also carry out the transactions for certain types of assets ( such as collective investments, index options and futures). Governance/Risk Appetite Framework 2.30 Alico UK has a number of committees/functions in place with clearly defined roles and responsibilities to ensure that the branch conducts business in a manner that is in line with its risk appetite framework. In particular they are responsible for developing, proposing, recommending, approving, implementing, adhering to, monitoring and reporting on the risk appetite framework. These committees/functions are: The Supervisory Committee; Chief Executive Officer ( CEO ); and, The TCF Business Line Committees The Supervisory Committee provides over-arching governance and is responsible for the oversight, management and review of the risk framework. It has oversight of the branch activities and is supported by the following sub-committees:- The Overarching Risk Committee (ORC); The Investment Committee; and, The Regulatory Compliance Committee The Chief Executive Officer is supported by the Executive Committee and the Economic Capital Steering Group The TCF Business Line Committees have oversight of the branch s requirement to treat its customers fairly ( TCF ) Alico UK has chosen to provide independent oversight of with-profits business required by FSA rules (COBS 20) via the Independent Person, currently Carus Consulting Actuaries Ltd, instead of a With-profits committee. Additionally, the Supervisory Committee also includes independent non-executive directors with specific responsibility to provide oversight on withprofits business The risk appetite framework considers the extent to which Alico UK is prepared to accept adverse outcomes in the execution of its strategy and takes into account the considerations of relevant stakeholders. The risk appetite framework of Alico UK will align with, and will not exceed, the risk appetite of Alico and MetLife The risk appetite framework also details a Capital Management Policy which sets out the capital margin to be maintained in excess of the level of statutory and risk capital, even as a result of the crystallisation of the risks to which it is exposed. This is covered in further detail ReAssure Limited 14

15 in Capital Management Policy 2.37 Alico UK s Capital Management Policy sets target capital at a level higher than the statutory capital requirements which must be maintained under the FSA Rules (as summarised in Appendix 4) The measures used by Alico UK address the additional amounts of capital to be held relative to each of the statutory basis (Pillar 1) and the risk assessed basis (Pillar 2). Table 2.1 shows Alico UK s current target capital management levels: Table 2.1: Alico UK Capital Management Constraint Pillar 1 Pillar 2 Target Ongoing Solvency Level Minimum Required Solvency Level If solvency level drops below Target Ongoing Solvency Level, maximum targeted period before a return to operation at that level Minimum monetary amount of capital above 100% 165% 165% 150% 150% Various management actions considered restore levels within 12 months Various management actions considered restore levels within 12 months Largest undiversified required capital amount arising from a single stress as calculated in Alico UK s quarterly Economic Capital calculations 2.39 Alico UK has considered a wide range of management actions that could be taken in the event of a breach in its target solvency levels. In such circumstances, it would implement those management actions considered to be most appropriate at the time so as to restore its target solvency position within the maximum timeframe permitted by its risk appetite framework Alico UK does not pay dividends to its home office since it is a branch operation and not a subsidiary. Profits arising are held in the Alico UK OLTBF as part of Alico UK s capital base but may be repatriated to Alico s home office or applied for any other purpose of Alico, subject to the Capital Management Policy continuing to be satisfied for the UK branch. The Supervisory Committee would only consider repatriating capital if sufficient surplus remained such that the minimum solvency level was projected to remain above the target level over the 12 months following the capital repatriation. In December 2011 US$ 239 million of Alico UK s capital was repatriated to home office which is discussed further in Reinsurance Arrangements 2.41 As at 30 November 2010, Alico UK had two material reinsurance contracts in place (as shown in the 2010 FSA Returns). These were with: Marias Falls Insurance Co Ltd (DHL Captive) covering the group insurance business. As at 30 November The exposure under this agreement is mitigated by a Letter of Credit issued by Deutsche Bank; and, Swiss Re Life & Health UK covering the group insurance business Alico entered into an agreement with ReAssure to reinsure from 1 July 2011 its whole interest in a substantial proportion of the Alico UK business in return for a ceding commission. As a ReAssure Limited 15

16 result of the agreement the economic interest in the business reinsured has transferred from Alico UK to ReAssure. To limit Alico UK s counterparty exposure to ReAssure, assets in respect of the reinsured business are deposited with Alico UK in accordance with the reinsurance agreement. The reinsurance agreement has a longstop date of 31 December 2012, although the term can be extended to 2013 under certain conditions, and beyond this with further conditions, in accordance with the reinsurance agreement. Taxation 2.43 A tax sharing agreement is currently in place whereby all of the tax liability arising in the UK on Alico UK s business is settled by its home office on a cash basis. As a result, Alico UK does not include any amounts in its FSA Return for the taxes incurred on the UK branch s business. Alico benefits from the agreement as the full UK tax cost is available as a credit against its ultimate US tax liability This tax sharing agreement is assumed to run on a two-year rolling basis as part of the Alico Board resolution and can affect the assumptions used to value and price the products sold by Alico UK This feature has had an impact on the pricing of the High Net Worth, Standard Fund and Protected Recovery Fund business transacted by Alico UK as a portion of the tax benefit gained from the agreement has been reflected in premium rates, particularly for single premium business This agreement has also influenced the reserving requirements for business issued on such enhanced terms but the AFH of Alico UK has confirmed that the valuation assumptions have been changed for the 2011 year-end investigation to remove the allowance for the tax sharing agreement. The change in this tax basis may result in a slight reduction in returns for some contract types, but the impact is not expected to be material and the change would apply even in the absence of the Scheme. Products 2.47 Alico UK classifies its products into the following lines of business: Annuities consists of a range of individual deferred and immediate annuities, some with guaranteed payment periods and spouse benefits; Affluent consists of non-profit and property-linked savings products including whole of life policies, guaranteed income bonds, deferred annuities and group pensions (trustee invested personal pension plans). Some property-linked products declare bonus units that may be varied at the discretion of the company, and guaranteed levels of investment performance; Individual Protection consists of non-profit whole of life and term assurance business, critical illness and income protection policies. Some products have premiums/benefits that can be reviewed at the discretion of the company with 30 days notice and/or a return of premium at the end of the term if a claim has not been made; Closed-Book consists of conventional with-profits whole of life, endowment and deferred annuity products (with guaranteed annuity rates). It also contains non-linked term assurance contracts and linked savings policies; General business consists of accident and health products. Most of the products are reviewable with 30 days notice and are also cancellable. Almost 80% of the business is inwards reinsurance accepted on a 50% quota share basis. This line of business, including the reinsurance treaty, is closed to new business but is accepting renewals. General Business also includes the group protection business ( Group Protection ) in relation to medical expenses; Living Time consists of non-profit fixed short term annuities; PAX consists of personal accident insurance, legal protection insurance and optional ReAssure Limited 16

17 life insurance (which includes accelerated critical illness cover for cancer, heart attack and strokes) through: i. a Group scheme for members of HM Regular Armed Forces; and, ii. individual protection policies covering optional life and critical illness cover for ex-members of HM Regular Armed Forces (XPAX) and members of the HM Reserve Forces (RPAX). There is also CPAX which is PAX for the administration staff employed by the Ministry of Defence. Spouses and children may also be covered under these policies. Employee Benefits consists of non-profit group life and health protection business with premium rates guaranteed for two years; Wealth Management consists of non-linked and property-linked savings products. Policies can be invested in Guaranteed Funds that have a guaranteed minimum value each quarter depending on the performance of the assets underlying the fund. A number of policies may also have investments in the PRF which is discussed in more detail below; and, Bulk Purchase Annuities consists of non-profit deferred and in payment pensions, which may be subject to guaranteed payment periods and have attaching spouse benefit, bought out from final salary pension schemes by means of a bulk premium Table 2.2 below summarises the in-force long-term business of Alico UK as at 30th November The table also splits the business between that which is intended to be transferred under the Scheme (the Transferring Policies ) and the business that is planned to remain in Alico UK after the Scheme (the Excluded Policies ). It is convenient at this stage to show the split of Alico UK s business reflecting the intentions of the Scheme. Table 2.2: Alico UK Long-term Business Breakdown as at 30 November 2010 No. of Contracts /Scheme Members Annual Office Premium, million Gross Mathematical Reserve, million Transferring Policies Annuities 2, Affluent 29,657-1,114.1 Protection 228, Closed Book 23, Excluded Policies Living Time 13, PAX 4, Employee Benefits 251, Wealth Management 3, ,377.8 Bulk Annuities 2, Sub Total (Transferring) 283, ,655.1 Sub Total (Excluded) 276, ,025.3 Total 560, ,680.4 Source: Alico UK Branch 2010 FSA Returns 2.49 There are approximately 47 Guernsey policies and 84 Jersey policies included in the ReAssure Limited 17

18 Transferring section of Table 2.2, comprising mostly of individual protection business The in-force with-profits business consists of with-profits conventional endowment, whole of life and annuity business. Alico UK actively marketed with-profits business from the 1960s until 1992 at which point it closed to new with-profits business A summary of the with-profits business as at 30 November 2010 is given in Table 2.3 below. Table 2.3: Alico UK With-Profits Product Breakdown as at 30 November 2010 No. of Contracts Annual Office Premium, million Mathematical Reserve, million With-Profits Whole of Life Endowments 2, Deferred Annuity Paid Up - Life Paid Up - Pensions 1, Total 5, Table 2.3 above indicates that the with-profits mathematical reserves amounted to approximately 76 million at the last financial year end and, therefore, with-profits business represents a small part of Alico UK s overall business A number of products have guaranteed minimum annual bonus rates, guaranteed surrender values and the Homemaker product has a guaranteed minimum sum assured on death and maturity. Also, the deferred annuity products have guaranteed annuity rates, the reserve for which amounted to 14.6 million as at 30 November Table 2.4 below summarises the in-force general business of Alico UK as at 30th November The table also splits the business between that which is intended to be transferred under the Scheme (the Transferring Policies ) and the business that is planned to remain in Alico UK after the Scheme (the Excluded Policies ). It is convenient at this stage to show the split of Alico UK s business reflecting the intentions of the Scheme. Table 2.4: Alico UK General Business Breakdown as at 30 November 2010 No. of Policies/ Members Annual Office Premium, million Reserve, million Transferring Policies Direct Business 13, Reinsurance Accepted 55, Excluded Policies Group Protection 50, Sub Total (Transferring) 69, Sub Total (Excluded) 50, Total 119, Alico UK has progressively ceased to transact new business since its acquisition by MetLife. Most of the product lines closed to new business immediately on acquisition on 1 November The individual and group protection lines of business closed to new business in August The Living Time business was mostly closed to new business in September 2011 but Alico UK continued to accept new premiums until 31 December 2011 for quotes issued prior ReAssure Limited 18

19 to the closure of Living Time. Some of these product lines have been re-branded as MetLife products and are now being written within other MetLife companies. Alico UK ceased writing new business in respect of all other product lines with effect from 30 December 2011, apart from the PAX and XPAX business, which ceased from 1 January 2012 and 1 March 2012 respectively. However, options under existing annuity contracts may still result in new contracts being issued. Approach to Financial Management & Policyholders Reasonable Expectations Overarching Conditions 2.56 Under the FSA regime, a concept of treating customers fairly ( TCF ) should be applied. This requires actions to be considered not only by reference to the way such actions may have applied in the past but also in an absolute sense. The concept of TCF goes much further than simply recognising policyholders reasonable expectations ( PRE ). The key features which I believe should be considered in addressing TCF and PRE are: security of benefits: this is the expectation that benefits will be paid as they fall due; and, fair treatment: this must be assessed in the context of the effects which actions may have on different classes or generations of policyholders or on shareholders and should have regard to contractual terms and the way in which the contracts have been promoted and managed not only in the past but in absolute terms To some extent, PRE will have been formulated by the communications given to customers both at the point of sale and subsequently, or by other statements of practice. A detailed description of the financial management of with-profits business is set out in the statement of Principles and Practices of Financial Management ( PPFM ) which with-profits insurers in the UK must maintain and make available to policyholders. I have taken the PPFM maintained by Alico UK for its with-profits business as the starting point in my assessment of PRE for its with-profits policyholders I have considered the documented operating arrangements for non-profit and property-linked policies in my assessment of the PRE for the non-profit and property-linked policyholders In the following sections reference is made to asset shares and it will be useful to describe what these are and the role they play in the management of with-profits business Generally speaking, the asset share of a policy is an accumulation of the premiums paid, allowing for the investment returns earned, after tax if appropriate, but also after deducting the costs of administering the contract, commission payments, charges for insurance risks and guarantees, and deduction for shareholders share of profits, where appropriate. The asset share therefore represents broadly the accumulated value related to each policy based on the fund s performance and experience during the policy s period in force. Asset shares can be calculated for each individual policy or may be calculated by reference to modelled or specimen policies and a model created to represent the whole of the in-force business The asset share does not provide the policyholder with any additional rights either to the assets underlying the asset share or, indeed, to any value equivalent to the asset share value as the insurer retains full discretion up to the point of claim to pay a value different from the asset share. In practice, subject to smoothing, the asset share serves as a reference point from which fair payouts could be measured and is a major determinant of PRE and TCF for with-profits contracts. With-Profits Business PPFM 2.62 The with-profits business is operated in accordance with the PPFM. The principles of financial management of the with-profits (participating) business which are most relevant to ReAssure Limited 19

20 the later discussion are: Alico UK does not maintain a separate with-profits fund and therefore there is no distinct approach defined in the PPFM to setting investment policy in respect of the with-profits business. However, Alico UK has formal investment guidelines for the investment of all its assets with the aim to maximize the overall return on assets, subject to an acceptable level of risk. The investment mix is broadly stable with 85% of assets invested in fixed interest securities and 15% in equity-like investments; The amounts payable on maturity will be based on asset shares, with annual reversionary bonus rates and final bonus rates set to target maturity payouts of 100% of unsmoothed asset shares and generally to aim to pay between 90% and 110% of unsmoothed asset share on maturity (the payout ratio ); The amounts payable on maturity are subject to smoothing, which aims to be costneutral over time; Final bonus rates are expected to be more volatile than annual reversionary bonus rates; The charges for mortality and expenses in the asset share calculation are based on actuarially determined expected costs rather than actual costs incurred. Alico UK will aim to ensure that the annual increase to the expense charge applied to asset shares does not exceed the annual rate of increase in the UK Average Weekly Earnings measure in a given year; Shareholders make a charge to compensate them for providing capital to support the with-profits business. There is no unattributed surplus or inherited estate. Participating policyholders do not participate in any surplus or loss generated from non-participating business, nor from any miscellaneous gains or losses arising from deaths of with-profits policyholders; and, In the event that Alico UK considers reviewing the structure of the with-profits business, such as the conversion of with-profits policies to non-participating policies or transferring the with-profits portfolio to an external insurer, then those policyholders that will be affected will be consulted. Management of the with-profits business 2.63 The with-profits business forms a minor part of the Alico UK LTBF but it is not operated within the boundaries of a ring-fenced fund The with-profits policyholders have no entitlement to any surpluses arising elsewhere in the Alico UK LTBF and, given the application of the PPFM, have no interest in mortality or expense surplus (or loss) related to the with-profits business. In practice, only investment returns influence the surplus available for bonus The Alico UK OLTBF may be made available to support the with-profits business, and the extent of this support may vary over time, although no such support is expected to be necessary for the foreseeable future. However, the OLTBF does provide the capital to satisfy the statutory capital requirements of the with-profits business. The asset allocation is set by determining a maximum and a minimum limit for the proportion of the assets which may be invested in real assets such as equity shares or property. This calculation allows for the guaranteed benefits (including attaching annual bonus) inherent in the in-force to be backed by fixed interest investments, whilst real assets are determined by reference to the balance of asset share value (as a minimum) and the balance of value of the expected future benefits, as a maximum Alico UK aims to declare bonus rates that reflect the different policy features and characteristics of the various product lines of business. Bonus rates are determined with reference to the benchmark assets that would be expected to be held if a separate withprofits fund were defined, based on the reserves of the with-profits business. ReAssure Limited 20