Reorganising a giant
This article first appeared in the Journal of International Banking and Financial Law in April 2012
- Largest Part VII transfer in the UK ever, involving 22 million policy holders
- Simplified the business, and helped prepare for the implementation of Solvency II
- Involved an innovative communications plan
The reorganisation of the Direct Line Group was the biggest of its type ever sanctioned in the UK, and paved the way for other similar moves from large insurance groups.
Background to scheme
On 5th December 2011, Mr Justice Peter Smith granted an order sanctioning the consolidation of the non-life business of RBS Insurance (now called the Direct Line Group) by the transfer of the insurance businesses of Direct Line, Churchill and NIG into UK Insurance Limited. The order brought to a close almost 2 years of structuring and preparatory work by RBS Insurance and their advisers. The scheme, which involved around 22 million policyholders, was the largest, by number of policyholders, ever sanctioned in the UK. Eleven million letters were posted to policyholders, over 80 adverts were placed in various publications and special call centres were set up for over three months to field customer queries. The project took almost two years.
So why embark on this time-consuming and labour-intensive project?
- Capital efficiencies - One of the main drivers for the reorganisation of the RBSI group was the upcoming implementation of the Solvency II Directive. Under the directive, an insurance group would face significant capital inefficiencies if it held a number of separate insurance companies within its group.
- Simplification of structure - Having just one non-life insurer would simplify the group structure and reduce the regulatory and compliance burdens of the group - one set of accounts, one set of regulatory returns and a clear and consistent governance structure.
- Consistency of customer experience - the consolidation was not designed to change the customer experience. The brands - particularly Churchill and Direct Line in the retail sector - are well known and fundamental to the success of the group and would be retained post-reorganisation. However, a consolidation would enable a more transparent management view of the underwriting organisation with a view to ensuring a consistent customer experience across the portfolio.
For those reasons, the decision was made to start work. Norton Rose LLP was appointed as legal advisers, and they instructed Martin Moore QC as Counsel.
What is the legal process?
The transfer of the insurance business had to be implemented through the process set out in Part VII of the Financial Services and Markets Act 2000 (“FSMA”) and the Financial Services and Markets Act 2000 (Control of Business Transfers) (Requirements on Applicants) Regulations 2001 ("COBTRA"). There is supplementary guidance set out in chapter 18 of the Supervision Manual (“SUP 18”) of the FSA Handbook. This process enables insurance companies to transfer their businesses without the need for individual policyholder consent, indeed without the need either for consent of third parties such as reinsurers and service providers whose contracts are also part of the transferring business. In contrast to the equivalent procedure in many European jurisdictions, which usually only transfer the insurance policies, it can be used to transfer all of an insurer's business and override both statutory and contractual provisions in doing so.
The transfer requires the sanction of the court and (at least) two hearings are necessary - the first is a directions hearing to obtain the court sanction to the notification process (see below) and the second is the final hearing at which the court considers whether or not it is appropriate to sanction the transfer.
Part VII of FSMA contains safeguards to protect the interests of policyholders throughout the process:
- an Independent Expert is appointed to deliver a report on the extent to which the policyholders of either the transferring companies or the transferor would be prejudiced as a result of the transfer. SUP 18 provides guidance on what the FSA expects to be covered by the report.
- the FSMA and COBTRA set out certain advertisement and notification requirements so policyholders and other affected parties are given the opportunity to raise objections and attend the final court hearing to make representations.
- the FSA is involved at all stages of the process and is entitled to attend and be heard at the Court hearings. It also provides a report to the Court setting out its view on the proposals and whether it has any objections.
First, the project involved a due diligence exercise to agree on the legal architecture of the transfer and for each of the working groups to understand and plan their own processes. This included a review of whether any third party consents would be beneficial to the transfer and which counterparties may raise objections and why. The reinsurance programme was reviewed to analyse whether any reinsurances were not capable of being transferred pursuant to the court order.
Brief description of businesses:
Direct Line - retail book, predominantly motor but also home, travel and others. Around 5.6 million policyholders.
Churchill - retail book (motor, home, travel and others), but also including partnership book with white labelled products. Around 4.1 million policyholders.
NIG - wide range of SME commercial business through brokers. 800,000 policyholders.
UKI - around 11.3 million policyholders. Mainly a partnership book, significant part of which was sold by the RBS Banking group as white labelled product. Included white labelled products for other financial institutions, car manufacturers and credit card organisations.
The due diligence process also considered communications, including the costs of the communication plan and logistics. The challenge was to balance these significant costs against the requirements to ensure that policyholders are treated fairly and that they receive the information they need to understand the consequences for them.
FSMA, COBTRA and the Handbook - under COBTRA, notices are required to be published in the Gazettes and various other national newspapers in relevant EEA member states and also sent to every policyholder of the insurance companies involved (whether they be in a transferring or in the transferee company).
The requirement to notify every policyholder of all four insurance companies was a considerable concern. The sheer number of policyholders involved had a significant impact on the potential costs and time involved. As a result of the fact that a major portion of the book was white-labelled and sold through partners, there were also difficulties in obtaining policyholder addresses or dealing with contractual provisions limiting the insurers’ rights to contact policyholders. The RBS Group, with advice from Norton Rose LLP, put in place a proposed notification plan and therefore an application for various waivers which, in time, it would put before the Court at the Pre-Directions and Directions hearing.
FSA involvement - One of the first steps in considering waiver applications, after the due diligence, was to discuss the proposals with the FSA. It had been recognised that there had been a hardening of the attitude of the regulator towards waiver applications as the FSA has been keen to ensure widespread notification of policyholders, even for intra-group transfers and policyholders whose policies are not transferring. Please see [box] below on the Ecclesiastical decision which may have contributed to the change in FSA attitude. SUP 18 sets out some guidance on waivers in the FSA handbook which refers to balancing the practicality and costs of notifying policyholders with the likely benefits to policyholders of such notification and alternative arrangements being made to notify them. Historically, this has meant that waivers have been granted for reasons other than impossibility of notification, but without any clear rules on the point.
Despite it being ultimately a matter for the court, RBS was understandably reluctant to apply to the Court for waivers in the absence of FSA support. It had been felt that the Court would tend to follow the FSA view on a particular issue and would therefore need a compelling reason for a waiver to be granted against the FSA’s wishes.
In Ecclesiastical Life Ltd v FSA  EWHC 3871 (Ch), Floyd J noted that "... the importance of the notice provisions cannot be underestimated", a comment which perhaps explains the court's increased interest in this area. These comments have been taken to mean that the courts would exercise greater scrutiny before granting a waiver in respect of notification of an entire class of policyholders. The FSA appear to have considered this decision in detail and taken the view that all policyholders should be individually notified unless there are very good reasons to the contrary.
Waiver application to FSA - RBS submitted a waiver application to the FSA which it discussed with them over a number of weeks as RBS sought to address some of the FSA concerns over the communications plan. During this process, it became apparent that RBS and the FSA would not be able to reach agreement in two key areas:
- Notification to the Transferee policyholders - RBS was seeking a waiver from individually notifying the UKI policyholders on the basis that the overall costs of notifying (around £10m) was disproportionate to the benefits. It was noted that over half of the policies were “packaged” accounts and that the identity of the underwriter was extremely unlikely to have been relevant to the customer when taking out the policy. The FSA view was that, since UKI was going to triple in size post-transfer, policyholders should be notified in order that they could decide whether to object.
- Notification where the Insurers operate through third parties (white labelled brands or brokers) - The COBTRA notification requirements raised significant commercial and practical issues for RBS in relation to white labelled products since it often did not hold the relationship with the policyholders (and in some cases did not hold the contact details for policyholders). Again, most policyholders may not have been aware of the identity of their insurer since such products are often very heavily branded by the third party. RBS therefore sought a waiver on the basis that they would request the third party either to make the notification on its behalf or to provide it with the data to make the notification, but if they chose not to do so, a waiver would be granted. The FSA felt that RBS should go further and should provide all financial and operative assistance if the third party declined to notify.
Decision to go to pre-directions hearing - As a result of this impasse, RBS was left in the difficult position of not having certainty on the notification requirement. The notifications were a huge logistical exercise and they needed to know the position as soon as possible in order to meet the stipulated timetable and understand the budget requirements (note the question of proportionality of the £10m cost of the UKI notification). As a result a decision was made to follow the approach (which was first taken in November 2008 in the Part VII transfer of liabilities from Names at Lloyd's) of approaching the Court on the question of waivers at an unusually early stage in the proceedings even before the independent expert report was available. The case was also unusual since the applicants were applying for a waiver which was not supported by the FSA.
There was a great deal of uncertainty about how the Court would deal with the issues before it. There was a lack of precedent and therefore clarity in the area partly due to the fact that most directions hearings (at which applicants ask the Court to grant them waivers from the various COBTRA requirements) are held before a registrar.
As a result of the unique nature of this application, RBS listed to have it heard before a judge.
Summary of Floyd's two decisions
The Directions hearing was held before Mr Justice Floyd and comprised two separate hearings as further evidence was required by Floyd J before he could come to his final decision.
On the two specific issues:
a. Transferee notification - The Court agreed to waive the COBTRA requirement to notify each individual policyholder of UKI, the transferee, despite the FSA’s view to the contrary. Floyd J’s decision to grant the waiver was based on the following factors (i) RBS agreed to publish extensive adverts in newspapers and journals specifically targeted at its customer base (and took advice from a media agency to support this position) (ii) certain of the advertisements would be targeted to make specific reference to the brand under which the products were sold (iii) the business was short term so could easily move elsewhere at renewal (and therefore distinct from life products) (iv) notification would incur significant costs; and (v) the identity of the underwriter was unlikely to have played a large part for the policyholder in the decision to take out the policy.
A key comment from his judgment:
“Given the nature of the insurance (that it is not life or long term insurance) and given the potential size and complexity, there is a very great deal to be said for the waiver, provided that the court is satisfied the advertisement will be sufficient to bring home to a significant proportion of the Transferee’s policyholders”.
b. Third party books - The Court considered that there was a strong case for a waiver where the policy is sold through a third party brand and the policyholder is not that concerned with the precise identity of the insurer. This case would be strengthened further where the insurer did not have the policyholder data in a useable format and the third party had resisted making notification itself and had demonstrated a good reason for doing so. The Court considered that it needed evidence of the discussions with the third parties so that they could consider the case for an actual waiver with all facts before them.
As a result of the waiver granted at (a) above and further discussions with third parties, the waiver requested of the court at (b) was limited to circumstances where the insurer had no right to the policyholder data and the relevant third party was not co-operating.
In order to protect the policyholders, a report by an independent expert (the "IE") is required (covering the effect of the transfer on policyholders). Stuart Shepley of KPMG was the appointed IE. The FSA is heavily involved in the process and engages in discussion with the IE throughout the process. SUP 18 sets out the FSA view on the requirements of the IE report, but, as with the notification issues, the FSA has also recently required the IE to go into far greater detail in its report and to consider various issues which could impact on policyholders as a result of the transfer.
In this case, the IE sought external legal advice as appropriate (and as requested by the FSA) to analyse various issues arising on the transfer including the impact of any potential claims against the insurers for the underwriting of payment protection insurance. Ultimately, the IE concluded that the risk of any policyholder being adversely affected was sufficiently remote that it would be appropriate to sanction the transfer.
Experience on customer prior to sanction hearing
RBS set up a dedicated website and call centre to deal with the questions which could be raised by the 22 million policyholders and other interested parties. The project was largely unprecedented in size. It was impossible to predict the scale of customer contact and whether there would be any objections to the transfer.
As it transpired, the contact from policyholders was relatively limited and often related to their customer experience as a policyholder rather than raising any particular concern with the terms of the transfer scheme. It also appeared that Floyd J was right in a number of his comments, in particular that the policyholder may not set great store by the identity of the ultimate underwriter when it is taking out a packaged or a white labelled product.
a. Due diligence is a fundamental part of the process in preparing for a large scale Part VII and the importance of preparation cannot be underestimated. In this case, the due diligence exercise allowed RBS and their advisers to react to issues which they had anticipated could arise - rather than facing a series of surprises.
b. The decision of Floyd J (and the subsequent decision of Norris J in the Aviva Part VII transfer) has provided some clarity for subsequent applicants on the attitude of the courts to waiver applications and provides a list of factors that a court may take into consideration when deciding to grant a waiver. These include:
- utility to the policyholder and the court
- other information channels
- proportionality (and, therefore, cost)
- collateral commercial interests
However, each Part VII will raise new issues on communications and it may be that the FSA will continue with their viewpoint that all policyholders should be individually notified, unless there are compelling reasons to the contrary. It should be remembered that it is ultimately a decision for the Court; not the FSA.
c. Insurance groups will continue to use the Part VII procedure as they look to consolidate their businesses in preparation for Solvency II. The law and regulation around Part VIIs is dynamic - each application will present new challenges; the FSA will be heavily involved in each transfer application; and the Courts will continue to seek to balance the interests of applicants, policyholders and the regulator.