UK: Insurance Business Transfer Schemes – An Alternative to RITC?

The insurance business transfer procedure under Part VII FSMA provides for the first time the option of novating (rather than merely reinsuring), without policyholders’ consent, business written by a Lloyd’s syndicate to an insurance company. Consequently the Part VII procedure provides a possible alternative to RITC as a means to finalise the affairs of a Lloyd’s syndicate.

Changes to the law governing insurance business transfer schemes (especially as regards general business) were introduced by the Financial Services and Markets Act 2000 ("FSMA") extending the regime formerly set out in Schedule 2C to the Insurance Companies Act 1982.

An insurance business transfer scheme requires Court approval and provides a way for an insurer to transfer all or part of its insurance business to another party without the consent of any policyholder.

Under a scheme, the contractual liabilities of the insurer to policyholders pass by operation of law from the transferor to the transferee. Reinsurance of the business may have the same economic effect but legal responsibility is not transferred, so the original insurer remains subject to regulation and cannot be liquidated until the business has been run off or each contract novated or cancelled. Insurance business transfer schemes are generally used in the context of intra-group reorganisations and sales of businesses. As a consequence of changes made by the FSMA they may also be useful to members of Lloyd’s syndicates.

In order to finalise the affairs of a Lloyd’s syndicate for a given year of account it has traditionally been necessary to purchase a Reinsurance to Close ("RITC"). In return for payment of a premium, usually to the members constituting the relevant syndicate for the next year of account (but otherwise to another syndicate), RITC is the mechanism by which economic (but not legal) responsibility for business written by the members of the syndicate being closed is transferred.

The procedure under Part VII FSMA (a "Part VII transfer") provides for the first time the option of transferring business written in Lloyd’s to an insurance company. Potentially the Part VII transfer procedure could be used not only to remove the residual risk of having to pay claims on reinsurer default but also to finalise the affairs of a Lloyd’s syndicate for a given year of account as at or earlier than the third anniversary of the start of the year (being the earliest date under current Lloyd’s regulations at which an RITC can be effected).

Just as a managing agent is expected to consult with the members of a syndicate before purchasing RITC from a third party syndicate, Lloyd’s would expect a similar consultation process to be undertaken in respect of a proposed Part VII transfer. The consultation process provides an opportunity to ensure that any genuine concerns can be taken into account in the preparation of the appropriate transfer proposal and therefore to minimise the chances of members of the syndicate turning up in court to object to the transfer. Lloyd’s managing agents have a fiduciary duty to act in the interests of the members they represent; accordingly the virtues of any Part VII transfer proposal must be considered against the alternatives available, including continuation of the run-off of the business of the syndicate for the year of account concerned and a potential third party RITC.

The FSA must be kept informed of plans for a proposed Part VII transfer and will offer informal advice and guidance. For a transfer from members of Lloyd’s the approval of Lloyd’s is effectively required (although, strictly speaking, the legislation only requires Lloyd’s to have authorised one person to act, in connection with the transfer for the members concerned, as transferor).

The FSA will give effect to the legal requirement of notifying any relevant EEA regulators (ie regulators in EEA states in which any of the risks proposed to be transferred are situated) of a proposed transfer. Those regulators will then have a three month period in which to object to the proposed transfer.

In practice, before the Court approves a transfer from Lloyd’s members it must be satisfied:

• as to the solvency of the transferee;
• that neither the FSA nor Lloyd’s object to the transfer;
• that any relevant EEA regulators have not objected; and
• that the transferee has the necessary authorisations in place to carry on the business to be transferred.

Additional information that is required includes a report from an appointed independent expert (usually an actuary). The purpose of the report is to provide the Court with expert evidence on matters which are outside its experience by commenting on the terms of the Scheme and its likely effect on the affected policyholders.

The timetable for a Scheme depends on its complexity but is unlikely to be achieved within a period of less than six months. Time constraints include the mandatory period for consulting EEA regulators, the need to give appropriate notices relating to the proposed Scheme and the time required to prepare the relevant documents and information which must be submitted to the Court.

The FSA will be keen to ensure policyholders receive clear and pertinent information sufficient for them to appraise the Scheme and determine whether their position is likely to be adversely affected.

The process contained in Part VII FSMA and in the predecessor legislation has always been a useful tool for reorganising an insurance business. It now provides a possible alternative to RITC as a means to finalise the affairs of a Lloyd’s syndicate. At least one such scheme (upon which BLG is advising) is under development. More are bound to follow.