Pearl Assurance (Unit Linked Pensions) Ltd, Re

This is an application under Part VII of the Financial Services and Markets Act 2000 (“the Act”) for an order sanctioning a scheme (“the Scheme”) for the transfer of the entire long term insurance businesses carried on by three companies, all of which are subsidiaries of Pearl Group Ltd (“PGL”) to another PGL subsidiary. The transferor companies are Pearl Assurance (Unit Linked Pensions) Limited (“PAULP”), Pearl Assurance (Unit Funds) Limited (“PAUF”) and London Life Linked Assurances Limited (“LLLA”). The proposed transferee company is NPI Limited (“NPIL”).

Part VII of the Act gives the court a discretionary power to sanction such a scheme if a number of jurisdictional and procedural conditions are satisfied. Apart from the obvious requirement that the Scheme fall within the class of schemes in relation to which the sanction power has been conferred, the court must also be satisfied that certificates have been obtained from the Financial Services Authority (“FSA”) as to the necessary solvency margin of the transferee company, its authorisation to enable it to carry on the business which is to be transferred to it, and as to the communication of the Scheme to, and the approval or lack of objection from certain EEA Regulators in cases where (as here) one or more EEA States other than the UK is the “State of the commitment” in relation to one or more policies affected by the Scheme.

Section 109 of the Act requires than an application for sanction be accompanied by a report on the terms of the Scheme from a suitably qualified and independent expert, and that both his or her identity and the form of his or her report be approved by the FSA. Further, section 110 gives the FSA a right to be heard on an application for sanction. Such a right is also afforded to any person who alleges that he would be adversely affected by the carrying out of the Scheme.

The procedural requirements include a regime designed to ensure that the terms of the scheme are communicated in an appropriate manner and form prior to a hearing to all policy holders affected by the proposed Scheme, albeit that there is power in the court in appropriate circumstances to waive in whole or (more usually) in part certain of the detailed provisions designed to bring the proposed scheme to the attention of the policy holders. A limited waiver in relation to this proposed Scheme was directed by Mr. Registrar Simmonds at a directions hearing.

All the jurisdictional conditions precedent to the exercise of the court’s discretion to sanction the Scheme have been shown to be satisfied by the evidence before the court. Subject to two matters to which I must return, the procedural requirements have also been proved to have been satisfied.

Notwithstanding that detailed perusal of a proposed Scheme both by an independent expert and by the FSA are conditions precedent to the exercise of the court’s discretion to sanction it, the discretion remains nonetheless one of real importance, not to be exercised in any sense by way of rubber stamp. The principles to be applied by the court in considering whether to exercise its discretion are well settled. They were first set out by Hoffmann J. (as he then was) in the unreported decision Re: The London Life Association Limited and others on 21^st February 1989, albeit then under section 49 of the Insurance Companies Act 1982, and more recently reaffirmed by Evans-Lombe J. in Re: AXA Equity and Law Life Assurance Society plc and another [2001] 2 BCLC 447, in particular at paragraph 6 of his judgment. The relevant principles are concisely summarised in the following passage from the judgment of Mr. Justice Rimer in Re: Hill Samuel Life Assurance Limited [1998] 3 All ER 176, at 177:

“Ultimately what the court is concerned with is whether the scheme is fair as between different classes of affected persons, and in arriving at a conclusion as to whether or not it is, amongst the most important material before the court is material which the Act requires to be before it, namely the report of an independent actuary as to his opinion on the scheme.”

Before considering the question of discretion, I return to the two outstanding procedural points to which I have already referred. The first is that, due to an administrative oversight, some 25 of the affected policy holders (out of a total constituency in excess of 200,000) only received notification of the Scheme by information packs posted as late as 1^st September 2006. Since the period between then and now is well within the prime holiday season, it is probable that at least some of those will not in practice have had their minds directed to the proposed Scheme by the time of the hearing. In my judgment that is not a reason for declining to sanction the Scheme if it is otherwise suitable to be sanctioned. The process whereby the proposed Scheme has been communicated to policy holders has, apart from that slip up, been comprehensive and thorough, and amply sufficient in my judgment as a means of canvassing the opinions of policy holders to a degree sufficient to enable the court to discharge its discretionary task. If necessary, the late service on those few policy holders may be the subject of a further limited waiver under paragraph 4(2) of the Financial Services and Markets Act 2000 (Control of Business Transfers) (Requirements on Applicants) Regulations 2001 (SI 2001/3625), and I so direct.

The second question is whether an important aspect of the Scheme has been sufficiently brought home to the attention either of the FSA or of policy holders. Mr Robert Hildyard QC who appeared for all the applicants, invited me to treat this as a matter going to the exercise of discretion, rather than as a purely procedural matter. In my judgment he was right to do so, and I shall therefore revert to it in due course.

The business rationale for the Scheme is relatively straightforward, and was best expressed in the papers before me in the opening paragraphs of the letter from PGL to a Professor David Williams, one of the affected policy holders, and the only one of the small number of objectors to the Scheme who attended the hearing in person. Under the heading “Rationale for the Scheme” the letter dated 8^th September 2006 continued as follows:-

“As the four companies NPIL (NPI Limited), PAUF (Pearl Assurance (Unit Funds) Limited), PAULP (Pearl Assurance (Unit Linked Pensions) Limited) and LLLA (London Life Linked Assurances Limited) are all closed to new business, their unit linked funds would be expected to shrink over time.

In the absence of the Scheme, this would mean that the fixed cost incurred by each of the companies, expressed as a cost per policy, would increase over time at a rate faster than inflation. As a consequence, it would either become necessary to close unit funds when they became too small to manage or to increase the charges passed onto policyholders through the annual management charge.

The Scheme gives NPIL the flexibility to combine funds in the future when they become too small to manage. This means that NPIL may be able to offer the same choice of unit funds for longer than would have been the case without the transfer.

The consolidation of the businesses of the four companies into a single company is also expected to result in longer term savings in relation to efficiencies of management and administration of the business.

In the short term policyholders are unlikely to see any benefits, however in the longer term, the likelihood of future increases to policy charges should be lower for the merged business than it would have been had the businesses remained in each of the four companies.”

As is apparent from that letter, the Scheme involves not merely a rationalization achieved by the concentration of what have up until now been four separate businesses into one company but also by the creation of the ability of NPIL, not immediately, but as and when appropriate, to achieve further cost savings and efficiencies by amalgamating one or more of its linked funds which, as a result of the Scheme will include “mirror image” funds set up to replicate those linked funds presently operated by the three transferor companies. This is reflected in paragraph 16.4 of the Scheme Document itself, which provides as follows:

“Subject always to the provisions of the Act the rules made by the FSA thereunder (including those rules which require NPIL to have due regard to the interests of its policyholders and to treat its policyholders fairly), NPIL shall be entitled at any time and from time to time, having taken such advice as it considers appropriate from the NPIL Actuarial Function Holder:

(a)

to establish new Linked Funds as part of any fund for the time being maintained in its Long Term Business Fund, to close existing Linked Funds, to amalgamate any Linked Fund or any part or parts thereof with any other Linked Fund or any part or parts thereof, to change the name or designation of any Linked Fund or to divide any Linked Fund into one or more Linked Funds, or to effect any combination of the above on such terms and conditions as may be approved by the NPIL Board;

(b)

notwithstanding paragraph 3 of Schedule 2 and paragraph 1 of Schedule 3, to enable the holders of any Linked Policy written by NPIL (including any Existing NPIL Policy that is a Linked Policy or, from the Effective Date, any Transferring Policy that is a Linked Policy) to Switch to or between additional Linked Funds (including, from the Effective Date, New Linked Funds) maintained by NPIL from time to time to those which such holders are entitled to Switch to or between as at the Effective Date; or

(c)

to modify or enlarge the investment objectives of any of its Linked Funds to permit investment in classes of assets which are reasonably similar to, or provide reasonably similar investment exposure to, those already held or permitted to be held in that Linked Fund.”

It became apparent to me during the course of the hearing that some, but not all of the policies enjoyed by the affected policyholders already contained provisions which, as a matter of contract, enabled the relevant issuing company to make such changes to its Linked Funds structure as are contemplated by paragraph 16.4 of the Scheme Document. Accordingly, the conferral upon NPIL of a power in the paragraph 16.4 form exercisable in relation to all affected policyholders will involve a unilateral variation of the contractual rights of those policyholders whose policies do not already permit such steps to be taken.

After initial hesitation, for which see the judgment of Rattee J. in Re: Lincoln Assurance Ltd (unreported) 6^th December 1996, the Judges of the Chancery Division have reached a reasonable degree of unanimity that Part VII of the Act does permit the court to bring about a variation of policyholders’ contractual rights which goes beyond the mere substitution of the transferee of the relevant business for the transferor as the obligor under the relevant policy: see in particular Re: Hill Samuel Life Assurance Ltd (unreported) 10^th July 1995, per Knox J.; Re: Consolidated Life Assurance Co. (unreported) 11^th December 1996, per Harman J.; Re: Hill Samuel Life Assurance Ltd [1998] 3 All ER 176, per Rimer J., in particular page 178(d) and Re: Norwich Union Linked Life Assurance Ltd [2004] EWHC 2802 (Ch), [2005] BCC 586, per Lindsay J. at paragraphs 9 to 13 of his judgment.

The rationale for so concluding has varied over time, but I am not concerned with its detail. It is sufficient for present purposes that I have jurisdiction to sanction a scheme which would have the consequence of effecting such changes to policyholders’ contractual rights. The question for me is however whether I should as a matter of discretion do so.

This aspect of the Scheme (namely the creation of a power to close, amalgamate or otherwise restructure NPIL’s Linked Funds in due course or to change investment objectives), was briefly addressed both in the Report of the Independent Expert, Mr Mike Arnold FIA dated 6^th June 2006, and in the information packs sent to policyholders. This is what Mr Arnold said about it, in paragraph 10.2.5 of his Report, under the heading “Merging of Linked Funds”:

“The Scheme allows for the Unit Linked Funds to be merged and for reasonable changes in investment objectives to be made in due course. Any such decision would be subject to approval by the NPIL Board after receiving advice from the NPIL Actuarial Function Holder to ensure that the proposal is in line with policyholder expectations and permitted by the relevant policy terms and conditions and supporting documentation. NPIL will inform the policyholders concerned in writing.” (My underlining).

The Report was, as it was required to be, considered and approved as to its form by the FSA and, in providing the relevant Certificates, and declining to exercise its right to attend and be heard at this hearing, it is evident that the FSA is content with the Scheme having regard in particular to the terms of Mr Arnold’s Report.

The information to policyholders took the form of an introductory letter, a Scheme Guide and a set of frequently asked questions and answers headed “Consolidating Our Business Your Questions Answered”. The parts of those documents relevant to this issue are as follows. First, the introductory letter stated in terms:

“Your policy terms and conditions will not change as a result of the Scheme.”

The Scheme Guide included a brief description of the proposed power in the future to amalgamate Linked Funds or modify investment objectives at paragraph 7.5, in the following form:

“Future changes to our unit-linked funds

One way we may seek to achieve efficiencies in the future is by combining or closing some of our unit-linked funds. For example:

•

if two unit-linked funds have similar investment objectives, we may wish to combine them.

•

if a particular unit-linked fund is considered too small to remain viable, we may wish to close that fund.

The Scheme gives NPIL flexibility to combine or close its unit-linked funds in the future. It also enables NPIL:

•

to divide or change the name of its unit-linked funds; and

•

to modify the investment objectives of its unit-linked funds so that they can invest in reasonably similar asset classes (or asset classes with reasonably similar returns) to those already permitted.

We believe that having the flexibility to deal with our unit-linked funds in these ways may benefit our policyholders, because it may enable certain funds to operate for longer than would otherwise have been the case.

If we wish to take any of these steps, the terms of the Scheme are designed to protect our policyholders’ rights. In particular, we must comply with the FSA’s rules which require us to treat our customers fairly and to pay due regard to our customers’ interests.

If we decide to close any of our unit-linked funds, we will write to affected policyholders and set out your options. We will give you a reasonable amount of time to decide what you want to do.” (My underlining)

Finally under the frequently asked question “What changes will I notice?” the FAQ Document included the following bullet point:

“For unit-linked policies:

•

the same funds will be available for you to invest in.

•

the number, value and type of units you hold will not change as a result of the Scheme.”

I should add that in addition to the specific documents sent to policyholders, they were also entitled free of charge upon request to a copy of Mr Arnold’s Report.

Two existing NPIL policyholders objected in writing to the proposed Scheme, specifically because the proposals appeared to the objectors “to make it easier for NPI to reduce the choice of funds available to me yet further, thereby worsening my prospects of achieving a satisfactory level of return on my fund”. PGL’s response to each was to point out that:

“In relation to your policy specifically and your reasonable benefit expectations, please note that clause 5 of your policy document explains that NPIL has the right to manage its unit-linked funds, divide them into whatever units it decides, vary their number and nature, create any type of unit, put units together and sub-divide units, as long as this does not alter the value of your contract. Thus your policy terms do in fact contemplate changes to the structure of the unit-linked funds available for you to invest in.”

As I have noted, it became apparent during the course of the hearing that by no means all of the policies of the affected policyholders contained such a provision, although it does not appear that any detailed research has been done sufficient to ascertain the extent to which the proposed power to amalgamate Linked Funds or change investment objectives goes beyond the issuers’ contractual rights under the relevant policies.

On the evidence before the court at the beginning of the hearing therefore, it appeared to me that whether or not Mr Arnold was aware that some affected policyholders’ policies contained terms which did not permit the issuer to amalgamate or vary Linked Funds or change investment objectives, his opinion that the Scheme provided fair treatment and reasonable benefit expectations for the affected policyholders which would not be materially affected by the Scheme was conditioned upon his assumption, stated in my judgment unambiguously in paragraph 10.2.5 of his Report, that no proposal for the merger of Linked Funds or for changes in investment objectives would be approved by the NPIL Board unless, after advice, the Board was satisfied that (inter alia) the proposal was permitted by the relevant policy terms and conditions. In the absence of any evidence or submissions to the contrary from the FSA, I also therefore assume that the Report would have been similarly understood by the FSA when deciding to approve the Scheme, and similarly understood by any policyholder who chose to exercise his right to obtain a copy of the Report.

Furthermore, it seems to me that the effect of the standard form documentation sent to policyholders, and in particular the passages which I have described, would have been in all probability to create a reasonable assumption in the mind of any reasonably careful reader that those powers would not or would not in any event be exercised in such a way as to depart from the scope of what was permitted by their relevant existing policy terms and conditions.

It is true that, read on its own, paragraph 16.4 of the Scheme Document itself would appear to create a wider power, unfettered by the terms of existing policies, at least to a reader sufficiently versed in the partially unreported decisions in the Chancery Division which have, but not without hesitation, come to the conclusion that such a power is conferred by the Act, and by its predecessors.

Mr Hildyard QC tried valiantly to persuade me that my interpretation of those documents was wrong, and contrary to common sense. Furthermore he proffered, on instructions, a further approved draft witness statement from Mr Arnold, who assisted the court by attending the hearing, to the effect that he did not intend paragraph 10.2.5 of his Report to have the meaning which I have attributed to it, and, on the contrary, considered that the Scheme would operate fairly in relation to policyholders even if the power to merge Linked Funds or change investment objectives was exercised otherwise than in accordance with applicable existing policy conditions. Inevitably, those further views of Mr Arnold have yet to reach any policyholders who have taken the trouble to read the existing Report. They have since the hearing been communicated to the FSA, but it is too soon to expect any considered response.

Professor Williams, who as I have described was the only policyholder who exercised his right to attend the hearing, and who made a number of well intentioned and avowedly friendly criticisms of the Scheme and of the applicants’ conduct of the application included the observation that if the Scheme was intended unilaterally to vary policyholders’ contractual rights, he would have expected some research to be carried out by or for the Independent Expert both as to the relevant terms of current policies in force and as to the terms upon which they had been marketed, before expressing an opinion whether a unilateral variation of those terms was fair. I have some sympathy with those observations, although I acknowledge that it is possible that an expert would regard the power to amalgamate Linked Funds and to change investment objectives as so obviously beneficial as to call for no such research, and it appears that Mr Arnold holds precisely that opinion. Nonetheless it is inevitable from the way in which this issue has emerged that neither the FSA nor any policyholders were aware at the time of the hearing that he holds that opinion, and I am by no means satisfied, despite Mr Hildyard’s submissions, that either the FSA or any policyholders have actually addressed that question. The policyholders have not had it placed before them as a question arising from the terms of the Scheme, and the FSA have been presented with it only after the hearing.

Nothing in this judgment should be taken as expressing any view of mine adverse to the suggested good business sense and fairness of the inclusion of such a power extending as it intended that it should, to overriding any contractual restrictions to the contrary contained in current policy terms and conditions. It may well be, and in the light of Mr Arnold’s proposed further evidence, probably is a power which if properly exercised pursuant to the terms and conditions of the Scheme which must be satisfied before it is exercised, will be beneficial to policyholders.

It seems to me nonetheless that before the Court should exercise its discretionary power to vary contractual rights on a significant scale to an extent beyond what is essential in a business transfer scheme, (namely the substitution of one obligor for another under the relevant policies), the fact that a proposed scheme is intended to bring about the exercise of such a power ought properly to be brought home to all those concerned, including in particular the policyholders and the FSA. I am not satisfied, for the reasons that I have given, that it has been brought home to the policyholders, and it seems to me an essential part of the statutory regime pursuant to which the court is given such a power, that it ought to be.

Save for the inclusion of that power, I am otherwise satisfied that this is a Scheme which as a matter of discretion ought to be sanctioned. The business rationale is to my mind compelling, and the other objections to it come nowhere near to shifting the balance against an order sanctioning the Scheme. I must briefly describe those objections, both as given orally by Professor Williams in his helpful address and in writing by other objectors who declined to attend the hearing.

Some objections consisted of complaints about the quality of service provided by one or more of the applicant companies. Whether well founded or not, as to which I express no opinion, those objections do not in my judgment go to the desirability of the Scheme. All the companies concerned pursuant to the Scheme will be wholly owned subsidiaries of PGL. Their affairs are managed by the Group and, although the proposed merger will effect some streamlining which may marginally improve service standards, it is in my judgment unlikely that they will significantly change by reason of the Scheme itself, one way or the other. Similarly, the investment management of the underlying funds is not by the Scheme proposed to be changed.

Another complaint, by Professor Williams and others, is as to the inevitable distancing which occurs whenever a merger or restructuring of the type proposed takes place. The policyholder, it is said, finds himself with a new counterparty, often with a new policy number, a new administrative office to deal with, so that, it is said, mergers of this type are bad in principle for that reason.

While not ruling out the possibility that there is some substance in this rather general form of objection, it is in my judgment of little force, when set against the simple business advantages of an appropriately structured merger, as a means of dealing with the adverse financial and other consequences that flow from the inevitable contraction of closed funds.

Next, Professor Williams criticised the haste with which he suggested that this Scheme had been promulgated. Save only for the unfortunate error which led to the late notification of 25 policyholders, I reject that criticism. It is true that the communication of the Scheme to the vast majority of policyholders occurred shortly before the summer holidays, and that this hearing comes on before those holidays are over. Nonetheless I am satisfied that with the exception of the 25 policyholders, policyholders have had sufficient notice of the proposals to consider and exercise their rights of objection. There is of course no complaint of undue haste by the FSA.

Professor Williams also criticised the lack of any persuasive statement in Mr Arnold’s Report of the proposed benefits of the merger, and the lack of any particularity in the suggestion that the merger of these four closed funds could lead to a streamlining which would reduce or at least prevent the avoidable increase of policy charges. I can see force in both those observations, but the first is essentially presentational, and was albeit at a late stage remedied by the cogent presentation of the business advantages of the Scheme in the letter to Professor Williams from which I have quoted the relevant extract. As to the second point, it seems to me that the quantum of any advantage to be derived from merging closed funds must be essentially a matter of speculation. All that can be said is that there is a real prospect that such savings will ensue and no obvious countervailing disadvantage.

I am therefore minded to sanction the Scheme as proposed, but with the proviso that the power in paragraph 16.4 of the Scheme Document should not be exercised if and to the extent that it would be contrary to the terms and conditions of the policies of affected policyholders, without a further application to the court, supported by a further witness statement of Mr Arnold in accordance with the approved draft, and evidence that it has been communicated to and approved by the FSA, and further supported by evidence that the proposal to confer upon NPIL the power to act inconsistently with affected policyholders’ terms and conditions has been sufficiently drawn to the attention of policyholders themselves.

I have chosen to take this course rather than either simply to refuse sanction or adjourn the application for the following reasons: