HSBC Life (UK) Ltd, Re

This is the hearing of a Part 8 claim form issued on 7 ^th April 2015 by HSBC Life (UK) Limited (“HLUK”) and ReAssure Limited (“ReAssure”), which seeks an order under s.111 of the Financial Services and Markets Act 2000 (“FSMA”) sanctioning an insurance business transfer scheme (“the Scheme”), together with ancillary orders under s.112 FSMA. The Scheme effects the transfer of HLUK’s pensions business to ReAssure.

HLUK, as its name suggests, is a wholly owned and indirect subsidiary of HSBC Holdings plc and is part of the HSBC banking group. It distributes its products predominantly through HSBC Bank plc. In January 2013, HLUK, after a strategic review, decided to cease to accept new personal customers or new schemes for its pensions business, although it still accepted new joiners to existing schemes and ongoing contributions to all existing policies. The pensions business was, henceforth, to be regarded as a non-core activity in the UK for the wider HSBC banking group.

Thereafter, on 11 ^th June 2014, an agreement (“the Framework Agreement”) was entered into between HLUK, ReAssure and HSBC Bank plc, by which it was agreed to transfer HLUK’s pensions business to ReAssure. Pending this court’s decision whether to approve the transfer, the parties also entered into reinsurance arrangements, so that the economic risk of the business would be with ReAssure with effect from 1 ^st January 2014. If the Scheme is not sanctioned and no other method of transfer can be found, the reinsurance arrangements will unwind and ReAssure will have no further economic exposure to the business.

The business to be transferred consists of HLUK’s pensions business and comprises seven types of individual pension policies, five types of group pension policies, four types of pension life assurance policies, one type of pension protection policy and one type of annuity policy. The business to be transferred includes £4.32billion of assets under management. The linked funds attributable to the transferring business amount to £3.8billion, of which 95% is managed by HSBC Global Asset Management Limited (“HGAM”).

One unusual feature of this case is that, in parallel with the Scheme, another company in the HSBC banking group, namely HSBC Trust Company (UK) Limited, has also taken steps to wind up its unit trust pensions business. Unit trust policyholders who are affected have the option of transferring the value of their policies to another provider. However, if they do not so elect, HLUK will issue them with what are known as “section 32a” insurance policies, which will immediately then be transferred to ReAssure under the Scheme. I was told that most of the unit trust holders have not chosen to move to another provider and hence will be issued with policies by HLUK and will transfer to ReAssure.

The total number of policies to be transferred under the Scheme (including the unit trust holdings, on the assumption that they all are issued with section 32a policies and transferred) amounts to something in excess of 415,000 policies. HLUK’s non-transferring policies amount to some 550,000 policies.

ReAssure is a wholly owned indirect subsidiary of Swiss Re Life Capital Ltd. and part of the Swiss Re group of companies. The Swiss Re group is one of the world’s largest insurance and reinsurance groups. ReAssure was, for many years, known as Windsor Life and has been the transferee under a number of insurance business transfer schemes and has considerable experience in integrating books of business. It does not currently write new business, other than for existing pension policyholders and incremental business for their existing policies. The future of ReAssure is anticipated to be by means of further purchases and transfers of businesses similar to the transactions contemplated by this Scheme.

The long term fund of ReAssure comprises a non-profit fund, 100% of the surplus of which is attributable to its shareholders, and two with-profits funds. The entirety of the transfer of HLUK’s business is to be allocated to the non-profit fund and the unit-linked funds are to be replicated by mirror image linked funds in ReAssure. As the transferred business is mainly linked business, most of the investment risk is with the policyholders.

After the transfer to ReAssure, the management of the transferred funds will continue to be the responsibility of HGAM, at least for an initial period. An investment management agreement will be entered into between ReAssure and HGAM for an initial period of five years after the Scheme, although the agreement is capable of being determined at an earlier time. ReAssure has the ability to terminate given specific breaches of the agreement, or upon payment of an exit fee on 30 days’ notice. HGAM may terminate without cause with six months’ notice. The investment management agreement requires HGAM to provide its services to a standard at least as high as provided to HLUK in the year before the effective date of the transfer. The fees will be paid under an agreement by ReAssure, according to the level of assets under management, and there will be no changes to the charges to the transferring policyholders.

ReAssure has a similar existing investment management agreement with Aberdeen Asset Management (“AAM”), under which AAM provides investment management services to most of the other policyholder funds held by ReAssure. This has been in place since 2001. During that period, ReAssure has placed the money from a number of the previous schemes which it has acquired under management by AAM. It is anticipated that if the investment management agreement with HGAM were to terminate or run its course, there is at least a realistic likelihood that AAM would be appointed to take over the investment management of the funds transferred under the Scheme.

I will now set out how the terms and conditions of the policies that are to be transferred are to be either replicated or varied by the terms of the new policies with ReAssure. I preface that analysis by noting that the Scheme will not alter the terms and conditions of any of the policies that are not transferring and which will remain in HLUK. It will also not alter the terms and conditions of any existing ReAssure policies.

Following the transfer, ReAssure will be entitled to merge, divide or wind up the unit linked funds and close the funds to further investment or modify their investment objectives to permit investment in assets that are similar in nature to those allowed by the existing investment mandate. If a linked fund is closed, the affected policyholders are to be given new units of an equal value in a different linked fund, which, in the opinion of the ReAssure board, will provide a reasonably similar investment exposure. In addition, during the 12 months after the fund is closed, each affected policyholder is entitled to a free switch into one or more of the funds which are available to their policy. The Scheme also provides that ReAssure will have to consider whether any compensation should be paid to policyholders who are disadvantaged by the closure notices, merger or alteration of the unit-linked funds. These provisions reflect the current terms and conditions of the policies issued by HLUK.

In taking such decisions, ReAssure will, as HLUK was, be bound to operate under all generally applicable regulations, including its obligations under the FCA’s Treating Customers Fairly regime. However, the Scheme also includes a new requirement, in clause 16, that if ReAssure is contemplating making changes to the unit-linked funds it is obliged to consider the advice of an independent sub-committee of ReAssure’s board, called the “Fairness Committee”. This has been set up along similar lines to committees often established in relation to with-profits funds. It is charged with the oversight of the firm’s business from the perspective of policyholders. Its first general duty is to monitor, review and challenge the application and evidence of the delivery of fair outcomes to policyholders. In argument, its role was likened to that of a guard dog for policyholders, which, if the need arose, could bark loudly at the board and, if necessary, bark loudly enough to attract the attention of the regulators.

The Scheme will also change the pricing basis of the funds from what is described as a “single-swinging price” to what is termed a “dual pricing basis”. Both methods of pricing are used in the industry in an attempt to ensure that the amount paid out to policyholders is fair to both policyholders who are leaving the fund and those who remain in the fund. In argument, it was clarified that the somewhat confusing industry jargon does not mean that a move to dual pricing will be to a bid/offer spread or to two prices for policyholders buying or selling units. There will still only be one applicable price at any time and both models fix the price according to whether the fund in question is expanding or contracting. The only difference is that under the dual pricing model the period of time that is taken into account is longer by up to a year or so, whilst under the single-swinging model it is only the very immediate daily history that is taken into account. This may result in a change to the amount that a particular policyholder receives on a particular day in the future, depending on whether more units have been created or destroyed on a particular day and how that relates to the long term trend in the fund. As I shall indicate, the independent expert did not believe that this would result in any systemic unfairness to any particular body of policyholders.

The Scheme will also result in changes to the time at which unit prices applicable to a given transaction are calculated. That is because ReAssure and HLUK have different cut-off times for the valuation of assets in the calculation of unit prices. These changes will have the practical result of moving the time and date at which asset prices are extracted for the purpose of calculating the unit price for a particular transaction, forwards or backwards by approximately half a business day.

The operation of the Scheme to transfer the business from HLUK to ReAssure will also give rise to a series of what have been described as integration issues. First, the timing of the migration of data regarding customers from HLUK’s systems to those of ReAssure will involve the transfer of a considerable amount of data. Unless and until the Scheme is approved, data protection issues have meant that ReAssure has not been able to have full access to that data. The parties have, however, focused on a number of potential difficulties in this area and there is confidence on the part of ReAssure that it can achieve a migration of the considerable volume of data from HLUK by 31 ^st August 2015, which is the anticipated effective date for the Scheme.

Some contingency planning has been undertaken in conjunction with the FCA and PRA to deal with the situation that would arise if it proves necessary, in practice, to extend the effective date. The respective boards of the two companies can agree between themselves to extend the effective date of the Scheme until 2 ^nd November 2015. However, if they do so, they must consider whether any further communications to policyholders are necessary and they must inform the regulators of that decision and the reasons for the delay, together with the steps that they have taken to remedy any issues arising. They will also provide the regulators and the independent expert with up to date financial information in such an event.

If an extension is sought for an effective date after 2 ^nd November 2015, then the matter must be brought back to the court for its approval. The regulators will be entitled to be notified and to appear on the application for an extension. There will also need to be a further supplementary report from the independent expert, confirming that the extension will not materially adversely affect the benefit expectations or benefit security of any policyholder. Finally, there will need to be in-house actuarial reports confirming that the extension will not materially adversely affect the security of the policyholder.

If, for any reason, the court was to refuse the extension or the transfer of policies were not possible, the Scheme contains a long-stop date of 1 ^st January 2016, by which, if not effective, it will lapse, unless extended by further agreement and the approval of the court. Orders to give effect to this regime would, in my judgment, be permissible under s.112(1) FSMA. The regime appears to me to be satisfactory to address any practical concerns that may arise.

Other implementation changes affecting policyholders include a change to policies with a so-called “lifestyle option”. These are policies where a policyholder who is, for example, approaching retirement, has the ability to switch the funds that are the subject of the policy to new target funds as the policy approaches maturity, so as, for example, to lower the risk profile of the investment. At present, HLUK effects these switching changes over a five year period on the basis of monthly switches. ReAssure will also effect the changes over a five year period, but only on the basis of five annual switches, rather than 60 monthly switches.

A number of further practical difficulties, which will be the result of the Scheme, relate to some of the services provided to policyholders. These have been of particular concern to many policyholders who have voiced their opinions of the Scheme and have been closely considered by the independent expert and by the FCA. At present, HLUK policyholders can access information concerning their policy, make fund switches and make additional contributions online, at the same time as dealing with their HSBC bank accounts. Although it will be possible for ReAssure policyholders to access unit prices on the ReAssure website, so as to calculate the value of their fund, and ReAssure will continue to accept regular payments electronically, ReAssure is not intending to offer the same online facility in relation to switching and the making of additional contributions. As a matter of policy, such changes will have to be made in written correspondence or following a telephone call to a call centre, which is to be open during business hours on week days.

A final practical change which policyholders will notice is that, as is obvious, ReAssure does not have a branch network of banks in the same way that the HSBC banking group does. Accordingly, HLUK policyholders who are transferred will lose the local HSBC bank branch as a means of communicating with HLUK. That said, it should be pointed out that even with HSBC the staff at the local branch are not able to offer a walk-in service, but make appointments for policyholders to see an advisor at the branch.

Finally, and for completeness, I should note that the intention is that there will be a separate scheme in Guernsey for policyholders residing there. That is conditional upon the English Scheme becoming effective.

After that introduction to the Scheme, I turn to the approach adopted by the court and to the role of the independent expert, the FCA and the PRA. Section 111 FSMA provides as follows:

The background to the statutory regime was outlined by David Richards J in Re Royal & Sun Alliance Insurance plc . & Ors [2008] EWHC 3436 (Ch) at paras. 3 and 4:

I can deal with the procedural requirements of s.111 very shortly. I am satisfied, on the evidence, that all necessary steps have been taken to enable me to sanction the Scheme. In particular, I am satisfied that all necessary notices have been published in accordance with the order of Chief Registrar Baister, dated 14 ^th April 2015, and that the FCA and PRA were duly served with all necessary documents, including the report of the independent expert, in accordance with the relevant regulations. There were two minor hitches in the communications with a small number of policyholders, but I am satisfied that all appropriate steps were taken to remedy those difficulties, and that policyholders have had appropriate notice of this application. I am also satisfied that the necessary certificates referred to in s.111(2)(a) and the authorisations referred to in s.111(2)(b) have been obtained from and confirmed by the PRA.

The appropriate approach to the exercise of the court’s discretion under s.112(3) FSMA has been considered in a number of cases over the years. In London Life Association Limited (unreported, 21 ^st February 1989) Hoffmann J (as he then was) said:

In the subsequent case of AXA Equity & Law Life Assurance Society plc. [2001 ] 1 All ER (Comm) 1010, Evans-Lombe J referred to Hoffmann J’s judgment and summarised the following principles which he derived from that decision:

Those two authorities were referred to, again, by David Richards J in Re Royal & Sun Alliance Insurance plc . & Ors [2008] EWHC 3436 (Ch). David Richards J also endorsed a statement made in the skeleton argument of counsel who then appeared, Mr. Moore QC, which is equally applicable in the case of the transfer of pensions business in this case, namely:

Against that background, I turn to the Scheme in this case. The independent expert appointed to report upon the Scheme is Dr. David Hare of Deloitte. He is a fellow of the Institute and Faculty of Actuaries and a senior partner in Deloitte. He was the President of the Institute and Faculty of Actuaries from June 2013 until June 2014. He is a member of the Institute and Faculty’s Life Board and one of the UK’s representatives on the Actuaries Association of Europe. He has provided two reports: a main report, dated 2 ^nd April 2015, and a supplemental report, dated 14 ^th July 2015. In para. 2.13 of his first report, Dr. Hare set out the main considerations that he had given regard to:

Dr. Hare considered all three groups of affected policyholders, namely those whose policies were being transferred, those who were remaining with HLUK and those who were already at ReAssure. His clear conclusion was that he was satisfied that the Scheme will not materially affect the benefit expectations or benefit security of any group of policyholders.

In addition, each of the PRA and FCA, who were both represented by counsel at the hearing, filed reports and supplemental reports dealing with a number of issues arising. The PRA concluded, having regard to its statutory objectives of promoting the safety and soundness of PRA authorised persons, and contributing to the securing of an appropriate degree of protection for those who are or may become policyholders, that the PRA was not aware of any issue that would cause it to object to the Scheme. Hence, it did not do so.

The FCA expressed itself to be satisfied that the Scheme was within the range of reasonable and fair schemes available to the transferor and transferee. Accordingly, it also did not object to the Scheme.

I place considerable weight upon those expressions of satisfaction or, at least, non-objection to the Scheme. However, as Briggs J said in Re Pearl Assurance (Unit Linked Pensions) Limited & Ors at para. 6:

To that, I would add that in this case I had the opportunity to read a number of objections and observations upon the Scheme from individual policyholders, who had asked that their views be communicated to the court. Those views were conscientiously communicated to me by the applicants, and they, and a significant number of others expressing similar views, were also the subject of analysis and consideration by Dr. Hare, by the FCA and, to a lesser extent, by the PRA in their own reports.

I also had the benefit of three such policyholders, Mr. John Buston, Mr. Steven Smith and Mr. Philip Hydes, appearing at the hearing, who made submissions on the Scheme. I was grateful to them for their contribution. I think it is important to echo what Briggs J said and to make clear that these hearings are not a rubber stamp or a foregone conclusion. Policyholders who are affected by changes and who express genuine concerns are not a nuisance. Their participation in the hearings is to be encouraged and welcomed. Attendance is not a free day out, but they should not be discouraged by concerns over costs. In that regard, after a little judicial prompting, Mr. Moore indicated that the applicants would pay the reasonable travel and accommodation costs of these policyholders who had taken the trouble to appear and make submissions. In the circumstances of this case, he was, in my judgment, entirely right to do so.

Therefore, I turn to consider the points raised as to the benefit security and benefit expectations. At the start of the hearing, I was concerned that a transfer for policyholders to ReAssure might involve a transfer to a company less able to meet an important test of solvency than HLUK and, hence, that policyholders’ benefit security might be adversely affected by the transfer. My concerns arose from statements in paras. 2.45-2.52 of the independent expert’s supplementary report, that ReAssure intended to apply to the PRA for permission to use a so-called “matching adjustment” in calculating the technical provisions for certain blocks of business under the new Solvency II regime that is due to come into force in 2016. Dr. Hare stated that whether or not the PRA chose to approve this element of the calculation would have a significant effect on the solvency position of ReAssure and that, as a consequence, it was not possible for him to be certain of the pre and post Scheme solvency position of ReAssure under Solvency II.

Dr. Hare also indicated that although ReAssure would propose to use certain measures to meet its internal capital policy target, in the event that the PRA did not approve a matching adjustment those measures were, themselves, dependent upon approval from the PRA and that, if such approval was not forthcoming, ReAssure would face an increased capital shortfall. In contrast, it was said that HLUK was not planning to apply for permission to use a matching adjustment or transitional measures.

Dr. Hare stated that such a capital shortfall for ReAssure, in the event of non-approval, could represent a material adverse effect for the benefit security of transferring policyholders, but only if ReAssure was unable to meet its internal capital target for any extended period. Dr. Hare continued,

At the hearing I questioned whether it was satisfactory that the court should be being asked to approve the Scheme whilst the result of an application to the PRA for permission to use a matching adjustment or transitional measures was unknown. I was also concerned that there was no detail of the actions that ReAssure might take, and no positive commitment on the part of Swiss Re to provide support to ReAssure in the event that PRA permission was not granted.

In the event, however, I was persuaded by Mr. Moore that I could be satisfied that the proposed transfer results in no material adverse effect to the benefit security of transferring policyholders. Mr. Moore first pointed out that, notwithstanding his reservations, Dr. Hare had indicated that ReAssure expected to be able to meet its solvency capital requirement under Solvency II, regardless of whether it obtained permission to use a matching adjustment or transitional measures. He also pointed out that Dr. Hare had stated that there was no reason to believe that the PRA would not grant the necessary permissions; not least because ReAssure had engaged in and addressed any issues arising out of an informal pre-application process with the PRA. Mr. Moore added that I should not draw any adverse inferences as regards ReAssure from the fact that it had not yet obtained such permission, because the PRA had not yet in fact granted any such permissions to any company.

For its part, the PRA steadfastly refused to be drawn on the possible outcome for ReAssure’s formal application. However, it did not give me any reason to believe that the PRA dissented from Dr. Hare’s assessment of its prospects, or from Mr. Moore’s submissions relating to them.

Mr. Moore also told me (on instructions) that actions which might be taken by ReAssure would include a sale of credit assets to enable it to meet its capital buffer, and that the volume of credit sales required would be less than the amount that had been switched into credit in the recent past.

Finally, Mr. Moore submitted that the overarching point was that whatever the position in relation to ReAssure’s ability to meet its internal solvency capital requirement under Solvency II, the simple point was that ReAssure easily met and exceeded the regulatory requirements under the existing Pillar 1 and Pillar 2 requirements, the latter of which is designed to set a strong standard, so that a company has enough capital to continue to meet the best estimate of policyholders’ liabilities, following an event or combination of events of a severity only expected to occur once in every 200 years.

He also pointed to the fact that it was noted in Dr. Hare’s supplementary report at para. 2.37, that:

These considerations should also be put into context. In Norwich Union Life Assurance Limited [2004] EWHC 2802, Lindsay J was concerned with the extent to which a transferee insurance company exceeded the required minimum margin (“RMM”). He said, at para. 15:

In my view, that quotation, or the principles which it espouses, appear equally applicable to the concerns over Solvency II in this case, bearing in mind that ReAssure comfortably meets the existing Pillar 1 and 2 requirements. To that I would also add the comment made by David Richards J in Re Royal & Sun Alliance Insurance plc . & Ors [2008] EWHC 3436 (Ch) at para. 11:

Applying those tests, I am satisfied that I can accept the view of the independent expert and conclude that the Scheme gives rise to no material adverse effect upon the benefit security of policyholders and, in particular, the transferring policyholders.

Turning to the reasonable expectations of policyholders, I was much assisted both by the independent expert and by the FCA. In conspicuously concise and clear submissions, Miss Eborall, who appeared for the FCA, drew my attention to the FCA’s particular concern for the reasonable expectations of policyholders and the requirement that the independent expert should also have regard to these under SUP.18.2.36(4)(b).

Taking the points that were made in sequence, firstly, as regards the ability of ReAssure to merge, close and divide unit linked funds, Mr. Moore pointed out that the ability of ReAssure to do this is no different than the ability that HLUK currently has, but with the additional safeguard for policyholders that the decision of ReAssure will be overseen by the Fairness Committee, to which I have referred. In my judgment, there is no material disadvantage to policyholders and, indeed, it may be said that there is some additional benefit from the involvement of the Fairness Committee.

Secondly, I also do not think the policyholders will be prejudiced by the change to the pricing of units from single-swinging to dual pricing. Both are industry standards and, as the independent expert has pointed out, one cannot anticipate how the change will affect any individual policyholder or group of policyholders at any particular time. The independent expert has also confirmed that there is no systemic effect or impact upon the value of policies. I, likewise, do not think that any change to the timing of the determination of prices by half a day can be said to have any systemic effect, one way or the other, upon policyholders.

Thirdly, I do not think that the change in the frequency of shifting for lifestyle policyholders, from 60 monthly switches spread over five years to five annual switches, has any obvious material adverse effect upon policyholders. Again, the effect of that change will depend upon prevailing conditions at the time. It is not going to have a systemic effect and, again, I note that the independent expert does not consider that it materially prejudices the reasonable expectations of policyholders.

Fourthly, as regards the changes in online functionality, the independent expert makes the point that the take-up of such facilities is, in fact, remarkably low among existing HLUK policyholders. As a result, neither he nor the FCA believes that this amounts to a material adverse change to the expectations of policyholders. There was also a suggestion, at least so far as the applicants are concerned, that policyholders have no contractual rights to such online functionality in any event. Whilst contractual rights may not be the touchstone in this regard, I agree that the change is, in any event, relatively small. I accept the points made by Mr. Moore that there are some rational policy reasons for thinking that policyholders may be equally well served by the opportunity to speak to an adviser, who can at least tell them of the consequences of their proposed action before they make the necessary payments or changes. Finally, the continued operation of the call centre will, of course, be subject to the Treating Customers Fairly regime in any event.

Similar points can be made about the lack of availability of a branch network. For the reasons that I have already outlined, in practice, though convenient, this has limited practical benefit to HLUK policyholders. I certainly do not think that the change to the use of a call centre amounts to a sufficiently material adverse effect upon policyholders that should lead me to decline to sanction the Scheme.

Other points raised included the loss of the HSBC brand and the relative unfamiliarity of policyholders with ReAssure. Those points were dealt with comprehensively, in my judgment, by the independent expert in his supplementary report at paras. 4.17 and 4.18. Dr. Hare said this:

Mr. Buston and Mr. Smith raised the possibility that the applicants should have paid some compensation to policyholders for the inconvenience and for any possible prejudice that they might encounter in the hands of ReAssure after the transfer. However, HLUK has arranged a suitable replacement for policyholders on its decision to exit from the pensions business. The transition arrangements anticipate that this will be achieved smoothly and neither policyholder could point to any specific loss or prejudice that either has been, or would definitely be, caused to him. I also note that neither the independent expert nor the FCA considered that any such payment was necessary to render the Scheme fair to policyholders. I agree.

Mr. Hydes had concerns about the speed with which the transition was being achieved. However, in my view, it is important that the transition is achieved as quickly as possible, consistent with accuracy. Otherwise, financial information and data, and the report from the independent expert and actuaries, would become out of date. The FCA noted, and it is right, that there will be no moratorium or interruption of rights to policyholders during the transition and, hence, no prejudice to their expectations whether the transition takes the anticipated period or slightly longer.

Last but not least, Mr. Buston had an overarching objection that HLUK should not have chosen to sell its business to a company that operated closed funds, like ReAssure. He was concerned that performance of closed funds is less good than the performance of open funds, due to the incentives which open funds have in order to attract new business from new customers. This point was dealt with, to some extent, by the independent expert in the paragraphs of his report to which I have just referred. In addition, Mr. Moore pointed out that this represented no change for policyholders in any event, because HLUK had decided to close its funds in 2013.

In reality, it seemed to me that what Mr. Buston wanted was for HLUK to have done another deal with somebody else on what he would regard as better terms for himself and others who shared his views. That is an understandable aspiration, but it takes me back to the role of the court in these matters, as explained by Hoffmann J in London Life in the passage to which I have referred. My role is not to see if a better scheme could have been found. My role is to say whether the Scheme which is currently before the court is fair to all affected policyholders. In my judgment it is, and I propose to sanction it.