ARTICLE
26 April 2002

Insurance Business Transfers: the New Regime Under the Financial Services and Markets Act 2000

United Kingdom Finance and Banking

Part VII of the Financial Services and Markets Act 2000 (the "Act") contains a new regime for the transfer of insurance business (both long term and general), replacing the previous transfer process under Schedule 2C to the Insurance Companies Act 1982. As a result, the Schedule 2C procedure is no longer available for the transfer of either general or long term business (save where the legal process was commenced under Schedule 2C prior to 1 December 2001). Part VII also makes provision, for the first time, for a similar process in relation to the transfer of banking business.

Part VII will be highly significant to the insurance industry. Although there are many similarities with the old Schedule 2C provisions, there are also some important developments and differences. This article provides some thoughts on how the new regime will work in practice, and deals with the most significant changes from the old Schedule 2C procedure. We also deal briefly with the similar procedure in Part VII in respect of banking business transfers.

Sources of the new regime

There are three main sources for the new insurance business transfer regime:

  • Part VII of, and Schedule 12 to, the Act
  • The Financial Services and Markets Act 2000 (Control of Business Transfers) (Requirements on Applicants) Regulations 2001 (the Regulations")
  • Guidance from the Financial Services Authority (the "FSA") set out in Chapter 18 of the Supervision Manual (the "Guidance")

Further regulations may be made in the future under Section 108 and/or Section 117 of the Act.

The mandatory nature of the new regime

Under the Part VII regime, it is important to note that, in relation to both long term and general business, it is not possible to effect an insurance business transfer scheme, other than by obtaining an order of the Court under Part VII (this is the effect of Section 104 of the Act). Accordingly, companies should now be particularly careful if they are planning the transfer of general business, since such transfers previously did not require the Court’s sanction.

A unified treatment for long term and general insurance business

One of the most important things about the new regime is that it has for the first time resulted in a substantially similar law and practice for both long term and general business.

Previously, under Schedule 2C, the procedure for long term business and general business had been quite different. The latter had involved approval by the FSA alone, and had not required production of a report on the effect of the scheme by an expert.

The procedure has now been unified for the two types of business, in a form substantially similar to the former procedure for long term business. Therefore, in addition to the requirement for Court sanction, a scheme report must be produced, irrespective of whether the insurance business being transferred is long term or general.

The key concept - an "insurance business transfer scheme"

The expression used in Section 105 of the Act is "insurance business transfer scheme". The underlying concept is similar to that which had existed under Schedule 2C, but the Act provides additional clarity and detail.

First, the scheme must result in the business transferred being carried on from an establishment of the transferee in an EEA State. Section 105(2) of the Act then imposes additional conditions, any one of which may apply, so that there will be an insurance business transfer scheme if the whole or part of the relevant business is to be transferred to another body and:

a the transferor is a "UK authorised person" (i.e. an authorised person which is incorporated in the United Kingdom or is an unincorporated association formed under the law of any part of the United

Kingdom); or

b the business is reinsurance carried on in the United Kingdom; or

c the business is carried on in the United Kingdom and the transferor is neither a UK authorised person nor an EEA firm (a term defined in Schedule 3 of the Act to mean, essentially, an insurance company authorised in an EEA State to carry on direct insurance business).

Under the new regime, there are certain categories of excluded scheme, where (except in the case of schemes by a friendly society) use of the Court procedure is permitted, but not compulsory.

When is a scheme a scheme?

Although the term "scheme" is used in Section 105 of the Act (in the expression "insurance business transfer scheme"), it is not considered to have any particular meaning or to denote any particular form of transfer instrument. For example, the FSA states in the Guidance (at paragraph 18.1.5) that a novation or a number of novations could constitute an insurance business transfer governed by the legislation if their number or value were such that the novation can be properly regarded as amounting to a transfer of "part of the business". It is not clear, however, what the scope of the expression "whole or part of the business", as it appears in Section 105 of the Act, is intended to be. The Guidance does not assist in this regard, and none of the reported cases on the old Schedule 2C process helps to explain the concept. It is therefore sensible to assume that the expression has a very wide meaning, and that any portion of the business identifiable by reference to any particular criteria is likely to be caught by the legislation.

UK and EEA States

For the purposes of Part VII, "UK" means England, Wales, Scotland and Northern Ireland; the Channel Islands, the Isle of Man and Gibraltar do not form part of the UK. Gibraltar is treated as an EEA State by virtue of paragraph 4(3) of the Financial Services and Markets Act (Gibraltar) Order 2001.

The term "EEA State" is defined by Schedule 3 to the Act, and currently the EEA States (other than the UK) are:

  • Austria
  • Norway
  • Iceland
  • Germany
  • Belgium
  • Portugal
  • Italy
  • Gibraltar
  • Denmark
  • Republic of Ireland
  • Liechtenstein
  • Greece
  • Finland
  • Spain
  • Luxembourg
  • Holland
  • France
  • Sweden
  •  

    The transferee

    Section 111(2) of the Act provides that the transferee must have the authorisation required (if any) to enable the business which is to be transferred to be carried on in the place to which it is to be transferred, not later than the date on which the scheme is to take effect. Subject to this requirement, and an additional requirement to obtain certain certificates of solvency (Parts I and II of Schedule 12), there is no restriction on the legal nature of the transferee or indeed the country in which it is established. For the first time, therefore, it is possible (subject to any limitation under the relevant local law) to transfer insurance business carried on by a UK authorised person to a body which has neither a UK nor an EEA authorisation.

    Process

    The Act, the Regulations and the Guidance, together with the rules of Court at Part 49 of the Civil Procedure Rules 1998, contain the procedural requirements for the new regime.

    Those who have used the Schedule 2C procedure previously will have little difficulty in recognising the broad outline of the old method in the new regime, but the Act and the Regulations do contain some significant changes. Many of these changes are relaxations of the requirements of the old Schedule 2C regime, although in practice, and partly as a result of provisions contained in the Guidance, it is by no means certain how useful the relaxations will be, or how frequently the promoters of insurance business transfer schemes will wish to take advantage of them.

    (i) The role of the FSA Under the new regime, one of the first formal steps in planning an insurance business transfer scheme is to notify the FSA of the proposal.

    The FSA (and indeed any person who alleges that he would be adversely affected by the carrying out of the scheme) is entitled under Section 110 of the Act to attend and be heard at the final Court hearing. The Guidance contains a considerable amount of information about how the FSA would expect to exercise its discretion in deciding whether to attend. The matters it will take into account include both substantive matters such as the effect of the scheme on the security of policyholders’ rights and (in the case of long term business) reasonable expectations, as well as procedural matters such as whether policyholders have been properly notified, have had adequate information and adequate time to consider that information.

    The FSA is not required under its regulatory objectives set out in Section 2(2) of the Act to object to a scheme merely because some other scheme might have been in the better interests of policyholders, if the scheme itself is not adverse to their interests. However, the Guidance indicates that there may be circumstances where the requirement to treat customers fairly would require the parties to consider or to implement an alternative scheme.

    (ii) Consultation with regulatory authorities in EEA States As in the case of the old regime under Schedule 2C, one of the major determinants of the likely timetable is whether any consultation with regulatory authorities in other EEA States is required in order that one or more of the appropriate certificates under Section 111(2) (regulatory authorisations) and Schedule 12 (solvency) can be obtained.

    (iii) Scheme Report

    Section 109(3) of the Act provides that a scheme report must be made in a form approved by the FSA. In addition, the person making that report must appear to the FSA to have the skills necessary to enable him to make a proper report, and must be nominated or approved for the purpose by the FSA (Section 109(2)). These provisions effectively replace the former requirement under Schedule 2C that a report be prepared by an independent actuary. As mentioned above, under Schedule 2C, a report by an independent actuary was only required in relation to the transfer of long term insurance business.

    The Guidance sets out the FSA’s requirements for approval. The main areas to be covered include a description of the purpose of the scheme, a summary of the terms of the scheme (so far as relevant to the report), the expert’s opinion of the likely effects of the scheme on all relevant classes of policyholders (both as to the security of their contractual rights and, for long term business, their reasonable expectations) and an outline of the reasons for that opinion.

    The Guidance also sets out the criteria which the FSA expects to apply to nomination or approval of an independent expert. The expert should be an actuary in the case of transfers of long term business, but need not be an actuary in the case of a transfer of general business. The suitability of a particular individual will depend on the nature of the scheme and the parties to it.

    It should be noted that for the time being there will be no change to Guidance Note 15 of the Faculty and Institute of Actuaries – "Transfer of Long Term Business of an Authorised Insurance Company – Role of the Independent Actuary". The Guidance Note sets out criteria and compliance issues for independent actuaries on a Schedule 2C Scheme, and it will continue for the time being to apply, mutatis mutandis, in respect of the new Part VII regime.

    (iv) Appointed Actuary’s Report

    Although it is not a requirement of the Act or the Regulations, nor has it ever been a requirement of Schedule 2C, that a report be prepared by the appointed actuary of either the transferor or the transferee on the terms of a scheme for the transfer of long term business, this has become customary, and the Guidance indicates that the FSA would expect to receive such a report at an early stage.

    (v) "Circular" to policyholders

    Here there has been, in principle at least, a major change.

    The requirement under Schedule 2C was that a statement be sent to policyholders and members of the companies concerned:

    (a) setting out the terms of the scheme;

    and

    (b) containing a summary of the independent actuary’s report.

    (In practice, this almost always meant that the company concerned prepared and sent to its members and policyholders a "Schedule 2C Circular". Such circulars invariably contained, in addition to the required elements above, a chairman or chief executive’s letter, financial and other information and, where a vote was to be taken, the requisite explanation and notice to members.)

    The requirement of Schedule 2C to send a statement to policyholders and members has not been reproduced in the new regime. Instead, the Regulations state that the only thing which must be sent to policyholders (but not members) is a short formal notice, in a form approved by the FSA. This notice is effectively in the same form as that required to be published in newspapers (Regulation 3(2)).

    One might think that, as a result, far less information needs to be posted under the new regime. However, there are some important considerations, discussed below.

    First, notwithstanding the apparent relaxation of the requirements, the Guidance states that it would normally be appropriate to send to policyholders a statement setting out the terms of the scheme and containing a summary of the scheme report. In essence, therefore, the Guidance would have us return to the old position of sending out a circular, notwithstanding the apparent relaxation contained in the Regulations.

    Secondly, under the Regulations, companies are still required to give a statement setting out the terms of the scheme, together with a copy of the scheme report and a summary of the scheme report, to any person who requests them (Regulation 3(4)). Therefore, such information needs to be prepared, even if it is not sent to every policyholder and member. The Regulations state that the summary of the scheme report must be sufficient to indicate the opinion of the expert of the likely effects of the scheme on the policyholders of both the transferor and the transferee, and the Guidance contains the FSA’s views on this requirement.

    Thirdly, because under Schedule 2C, it was customary to apply at the preliminary Court hearing for the circularisation requirement generally to be disapplied, on the basis that the companies would send out a circular in the form produced to the Court, it has never been clear, as a legal matter, what precisely is meant by the expression "statement setting out the terms of the scheme".

    Until a Judge gives clear guidance in this area, most companies will be likely to prepare a full summary of the terms of the scheme in the same manner as has been customary under Schedule 2C. In addition, the circular is likely to contain other related information and disclosures. It is less than certain, therefore, that one stated aim of the FSA, to make circulars shorter and more easily understood, will be achieved.

    (vi) Access to Scheme Documents

    Unlike under Schedule 2C, there is no requirement for documents to be placed on display, or for the Court application or the scheme to be made available on request. It is quite significant that a person no longer has the right to receive such key documents. Under the new regime, any objector who requires the full terms of the scheme in order to be able to frame his objection properly would need to apply to the Court for a copy, unless the parties are prepared to provide these documents voluntarily.

    (vii) The Court Application

    Proceedings are started by way of a Claim Form with a supporting Affidavit, detailing the background to and reasons for the scheme (see Practice Direction 49B). A hearing for directions (the preliminary Court hearing) is requested in the usual way by Application Notice and papers are filed with the Court approximately three to four days before the hearing of the Application Notice.

    It should be noted that under the new regime, there is no longer a requirement to prepare and lodge a Petition - the contents of this document are now split between the very short Claim Form (which merely states the order being sought and refers to supporting evidence) and the Affidavit (which will now be a far longer document than before, incorporating much of the detail of the former Petition).

    (viii) Notification to policyholders and others

    Following the preliminary Court hearing, the companies will arrange for the delivery and publication of notices and, if thought appropriate, circulars to policyholders. The Guidance indicates that it may also be appropriate to notify other persons affected, in particular reinsurers of the transferor (where it is proposed benefits or liabilities under reinsurance contracts should pass to the transferee) and any other person with an interest in the policies being transferred who has notified the transferor of his interest.

    Although this is not specified in the Regulations, the Guidance indicates that the FSA would normally expect this notification to occur at least six weeks before the date set for the final Court hearing to approve the scheme; in circumstances where no shareholder vote is to be taken, this is significantly longer than the period under Schedule 2C. The only formal timetabling requirement under the Regulations, on the other hand, is that the application to the Court, a copy of the scheme report, a "statement setting out the terms of the scheme" and a summary of the scheme report should have been given to the FSA at least 21 days before the final Court hearing. It would seem likely that the Court will have considerable regard to the longer period imposed under the FSA’s Guidance.

    (ix) Third party consents

    A question which typically arises is the scope of the Court’s ability to make an order which transfers assets and contracts which require the counterparty’s consent to their transfer. This is particularly an issue in relation to reinsurance contracts: while reinsurers have generally been content to transfer or novate contracts in the context of transfers of long term business, they may be reluctant to do so on a transfer of general business. The procedure under Schedule 2C gave companies no power to include outwards reinsurance contracts within the scope of a transfer of general business.

    As regards the new regime, however, the Guidance states that in the opinion of the FSA, the Court has the power to transfer, on such terms as may be appropriate, the benefit of reinsurance contracts protecting the transferring business and to make such amendments to the terms of those contracts as may be necessary to give effect to that transfer of benefits. It remains to be seen whether a Court will agree with this view in the face of opposition from a reinsurer. It is questionable whether a Court would override a clause in a reinsurance contract which explicitly required the reinsurer’s consent to the transfer of the contract.

    Even if the Guidance is relied upon in relation to reinsurance contracts, as regards consent in relation to other sorts of contract, it is likely that third party consents will continue to be sought in relation to contracts which contain an explicit requirement for consent to assignment or transfer. This is particularly so in the case of significant contracts.

    (x) The decision of the Court and the right of persons to be heard Section 110 of the Act provides that both the FSA and any person (including an employee of the transferor or the transferee) who alleges that he would be adversely affected by the carrying out of the scheme is entitled to be heard at the Court hearing to sanction the scheme. A similar provision was, of course, contained in Schedule 2C in relation to long term business transfers.

    Section 111(3) of the Act provides that, if it is to sanction an insurance business transfer scheme, the Court must satisfy itself that the procedural and jurisdictional requirements described above have been complied with. The Court must also consider that, in all the circumstances of the case, it is "appropriate" to sanction the scheme. This latter requirement was not included in Schedule 2C but is not expected to give rise to any material change to the tests which the Court will apply in a typical case (being, principally, those originally enunciated in Re: London Life Association in 1989), although it is likely to be used by the FSA to justify any objections it has which are of a procedural nature.

    Application of the new regime to banking business

    Part VII allows, for the first time, the transfer of specified banking business, in much the same way as for insurance business. Previously, such transfers needed to be effected either by way of a Private Act of Parliament or by the novation of specific contracts. The key issues for banking business transfer schemes, and the differences from the insurance regime, are briefly discussed below.

    First, Section 104 of the Act (which, on its face, makes the Court’s approval mandatory for both insurance business transfer shemes and banking business transfer schemes) has not yet been brought into force in relation to banking business transfers. Consequently, for the time being it remains possible to transfer banking business by other means.

    Section 106 of the Act provides that a scheme is a "banking business transfer scheme" if it is one under which the whole or part of the business to be transferred includes the accepting of deposits. There are the following further conditions:

    (a) the whole or part of the business carried on by a UK authorised person who has permission to accept deposits is to be transferred to another body; or

    (b) the whole or part of the business carried on in the UK by an authorised person who is not a UK authorised person but who has permission to accept deposits is to be transferred to another body, which will carry it on in the UK.

    As with the insurance regime, there are certain categories of excluded scheme.

    The principal differences from the insurance regime are as follows:

    • On a banking business transfer scheme, there is no requirement for an expert, or any person, to prepare a scheme report (although there must still be prepared a statement setting out the terms of the scheme, which must be made available free of charge to any person who requests it).
    • Although a short formal notice must be placed in the Gazettes and national newspapers, it need not be sent to customers or other persons concerned (in contrast to the new insurance regime, where the formal notice must be sent to every policyholder).

    Although the FSA has produced the Guidance in relation to insurance business transfers, there is very little equivalent guidance on banking transfers. It remains to be seen how the new banking business transfer procedure will be received. It is true to say that it creates a system capable of providing relative simplicity and certainty, especially when one thinks of the private Acts of Parliament used previously for many such transfers. It is also likely, however, that clarification will be needed regarding the Court’s jurisdiction to transfer banking contracts which contain express provision as to assignment or transfer. This is particularly relevant in the banking context, because banking applicants may be seeking to transfer wholesale, rather than retail, banking business. Retail customers are unlikely to be able to stop the transfer of a banking business by withholding consent, but wholesale banking contracts, in particular standard form commercial agreements (ISDA documents, for example), usually contain some form of consent mechanism specifically designed to deal with transfers of a business or its assets. For the benefit of wholesale banking businesses, it would be helpful if the FSA were able to produce clarifying Guidance in due course.

    © Herbert Smith 2002

    The content of this article does not constitute legal advice and should not be relied on as such. Specific advice should be sought about your specific circumstances.

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