FEDERAL COURT OF AUSTRALIA

PMI Indemnity Limited (No 2) [2005] FCA 1842

INSURANCE – intra group transfer of business of general insurer – application for Court’s confirmation of scheme – part of business conducted in Australia and part in New Zealand – Held: scheme confirmed subject to approval of arrangement under Pt XV of the Companies Act 1993 (NZ) and subject to the injection of further capital into the transferee company.

Insurance Act 1973 (Cth) Pt III, Div 3A

THE APPLICATION OF PMI INDEMNITY LIMITED AND

PMI MORTGAGE INSURANCE LIMITED

NSD 1379 OF 2005

LINDGREN J

8 DECEMBER 2005

SYDNEY

THE COURT ORDERS THAT:

1.         Pursuant to s 17F(1) of the Insurance Act 1973 (Cth), the scheme for the transfer of the general insurance business of PMI Indemnity Limited to PMI Mortgage Insurance Limited, a copy of which is Exhibit MWS12 to the affidavit of Michael West Savery affirmed on 5 December 2005, be confirmed without modification.

2.         The order in paragraph 1 is made on the following conditions:

(a)       The condition in cl 2(b) of the Transfer Agreement dated 20 October 2005 between PMI Indemnity Limited and PMI Mortgage Insurance Limited, a copy of which is Exhibit MSW11 to the affidavit of Michael West Savery affirmed on 5 December 2005, remains to be satisfied;

(b)      In the event that the condition in cl 2(b) of the Transfer Agreement is not satisfied on or before 3 January 2006, the scheme will have no operation;

(c)       Pursuant to the terms of the Capital Management Plan, a copy of which is Confidential Exhibit 5 to the affidavit of Michael West Savery affirmed on 5 December 2005, PMI Mortgage Insurance Australia (Holdings) Pty Limited is required to:

(i)            inject capital of $55,000,000 into PMI Mortgage Insurance Limited on or before  31 December 2005; and

(ii)          inject capital of $62,000,000 into PMI Mortgage Insurance Limited on 3 January 2006.

(d)      In the event that PMI Mortgage Insurance Australia (Holdings) Pty Limited does not make the injections of capital described in paragraph 2(c)(i) and (ii) above on or before 31 December 2005 and 3 January 2006 respectively, to the reasonable satisfaction of APRA, the scheme will have no operation;

(e)       The applicants will file and serve on APRA affidavit evidence setting out whether the condition in cl 2(b) of the Transfer Agreement has been satisfied and whether the capital injections described in paragraph 2(c)(i) and (ii) above have been made (and the reasonable satisfaction of APRA in relation thereto), on or before 13 January 2006.

3.         The applicants pay the costs of APRA as agreed, or if agreement cannot be reached, as assessed.

4.         There be liberty to apply on 24 hours’ notice.

5.         Without prejudice to paragraph 4 above, APRA have liberty to apply on 24 hours’ notice for a variation in the confidentiality order made yesterday.

6.         Any exhibits, including confidential exhibits, which were not tendered in evidence may be returned to the solicitors for the applicants.

Note:  Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.

REASONS FOR JUDGMENT

Introduction

1                     The first applicant, PMI Indemnity Limited (‘Indemnity’) and the second applicant, PMI Mortgage Insurance Limited (‘Mortgage’), apply pursuant to Division 3A of Part III of the Insurance Act 1973 (Cth) (‘the Act’) for confirmation of a scheme (‘the Scheme’) pursuant to which Indemnity’s insurance business will be transferred to Mortgage.

The applicants

2                     Indemnity and Mortgage are both incorporated in New South Wales, and are indirectly, but wholly owned, subsidiaries of The PMI Group Inc (‘PMI Group’), a company listed on the New York Stock Exchange.

3                     Indemnity was acquired by PMI Group’s Australian holding company, PMI Mortgage Insurance Australia (Holdings) Pty Limited (‘Holdings’) in September 2001.  Prior to the acquisition, Indemnity was known as ‘CGU Lenders Mortgage Insurance Limited’.  At various earlier times, it was known by other names.

4                     Indemnity and Mortgage are authorised general insurers under the Act, but are limited in the type of insurance they may write by a condition placed on their authorisations, that they carry on only the business of lenders’ mortgage insurance (‘LMI’).  Generally speaking, LMI policies insure financial institutions and other entities that lend money for the purchase of real property against the risk of loss arising from default by the borrower.

5                     Indemnity and Mortgage have written LMI policies in Australia and New Zealand.  With two exceptions, Indemnity’s New Zealand policies were written through Indemnity’s New Zealand branch.

6                     Indemnity was placed into run-off on 1 July 2002.  It has no employees.  Its operations are conducted by employees of Mortgage, whose services are contracted to it.

7                     As at 31 December 2004, Indemnity had total assets of $181,728,000 and total liabilities of $29,604,000, giving a net asset position of $152,124,000.

8                     Indemnity is rated AA by Fitch, Aa3 by Moody’s and AA- by Standard & Poor’s.

9                     As at 31 December 2004, Mortgage had 206 full time employees, and 15 contractors working for it, and total assets of $854,483,000 and total liabilities of $428,831,000, giving a net asset position of $425,652,000.

10                  Mortgage is rated AA by Fitch, Aa2 by Moody’s and AA by Standard & Poor’s.

Legislative framework

11                  Subsection 17B(1) of the Act provides that a general insurer’s business may not be transferred to another general insurer except under a scheme confirmed by the Federal Court.

12                  Subsection 17(4) excepts from that requirement a transfer where the insurance business being transferred is carried on outside of Australia and will be carried on outside Australia after the transfer.

13                  Subsection 17E(1) (read in conjunction with s 17A) provides that:

·        any party to a scheme may apply to the Court for confirmation of the scheme;

·        an application for confirmation must be made in accordance with the prudential standards (determined by APRA under s 32 of the Act);

·        APRA is entitled to be heard on the application.

14                  An application for confirmation may not be made unless the steps referred to in s 17C(2) of the Act have been taken.

15                  Subsection 17F(1) provides that the Court may confirm the scheme (with or without modifications) or refuse to confirm it.

The New Zealand component of the Scheme

16                  The part of Indemnity’s insurance business written through its New Zealand branch will be transferred to Mortgage through its New Zealand branch.  Accordingly, both before and after the transfer, that part of Indemnity’s insurance business will be carried on outside of Australia.  The transfer of Indemnity’s New Zealand business is therefore not part of the Scheme, and may be transferred to Mortgage without confirmation by the Court.

17                  An arrangement relating to Indemnity’s New Zealand business, comparable to the Scheme, is the subject of an application for approval to the High Court of New Zealand, under Pt XV of the Companies Act 1993 (NZ), which is to be heard on 13 December 2005.

18                  Because the approval of the New Zealand High Court is a condition precedent to the transfer of Indemnity’s Australian business to Mortgage (see below), if that Court refuses to confirm the New Zealand arrangement, the Scheme will have no operative effect.

Preconditions to making the application for confirmation

19                  The steps required to be taken prior to the making of an application for confirmation need be taken only prior to the time at which the Court is moved for the order: they are not required to be taken prior to the filing of the application in the Court’s registry:  Re Armstrong Jones Life Assurance Ltd (1997) 74 FCR 160 at 163, per Emmett J;  Re Royal & Sun Alliance Life Assurance Ltd (2000) 104 FCR 37 at 39, per Katz J;  Re Insurance Australia Ltd (2004) 139 FCR 450 at [30]-[37], per Lindgren J.

20                  Subsection 17C(2) of the Act and Prudential Standard GPS 410 have the effect that the following steps must be taken before an application for confirmation may be made.

(a)        The applicant must provide a copy of the scheme to APRA (s 17C(2)(a)) before the steps identified in (e) and (f) below are taken (Prudential Standard GPS 410 para 5).  A copy of the Scheme was provided to APRA on 25 October 2005.

(b)        The applicant must provide a copy of any actuarial report on which the scheme is based to APRA (s 17C(2)(a)), also  before the steps identified in (e) and (f) below are taken (Prudential Standard GPS 410 para 5).  The relevant actuarial report was provided to APRA on 17 October 2005.

(c)        The applicant must obtain APRA’s approval of its summary of the scheme (s 17C(1) – ‘approved summary’) before the step outlined at (e) below is taken (Prudential Standard GPS 410 para 8).  APRA gave that approval on 25 October 2005.

(d)        The applicant must obtain APRA’s approval of its notice of intention (Prudential Standard GPS 410 para 9).  APRA approved of the applicants’ notice of intention on 25 October 2005.

(e)        The applicant must publish a notice of its intention to make the application in accordance with the prudential standards (s 17C(2)(b)) containing at least the information specified in Prudential Standard GPS 410 para 10.  The notice of intention must be published in (a) the Government Gazette, and (b) one or more newspapers, approved by APRA, circulating in each State and Territory in which an affected policyholder resides (Prudential Standard GPS 410 para 9), before the step mentioned in (g) below is taken (Prudential Standard GPS 410 para 11).  The applicants’ notice of intention was published in the Government Gazette, The Australian, and The Australian Financial Review on 2 November 2005.

(f)         The applicant must give to every ‘affected policyholder’ the approved scheme summary (s 17C(2)(c)).  Under s 17C(5) of the Act, I dispensed with the need for compliance with this provision by an order made on 30 September 2005, on condition that certain other steps (set out below) were taken:  PMI Indemnity Ltd [2005] FCA 1473.

(g)        The applicant must make a copy of the scheme available for public inspection from 9.00 am until 5.00 pm every day (except weekends and public holidays) for a period of at least 15 days at an office of the applicant or another location approved by APRA in writing, in each State and Territory in which an affected policyholder resides:  Prudential Standard GPS 410 para 16.  The Scheme, the approved summary of the Scheme, the actuarial report and the Transfer Agreement (referred to below), were available for public inspection in Indemnity’s offices or other APRA-approved locations from 9.00 am until 5.00 pm every business day from 3 November 2005 to 23 November 2005 inclusive.

21                  My order of 30 September 2005 was to the effect that the need for the applicants to comply with s 17C(2)(c) was dispensed with provided the applicants:

1.         caused a copy of the Scheme Summary to be sent by prepaid post to the principal place of business of:

(a)        all of Indemnity’s policyholders other than:

(i)         holders of policies listed in Indemnity’s ‘inactive lender’ files, where the policies were written on or before 31 December 1989;

(ii)        holders of policies listed in Indemnity’s ‘inactive lender’ files, where the policies were written on or after 1 January 1990, but only if:

(a)       there has been a change in the registered proprietor of the property the subject of the policy since the date of the policy; or

(b)       the identity of the policyholder was not discovered after performance of the searches described in the affidavit of Linda Quatermass affirmed on 23 September 2005; and

(b)        all authorised deposit-taking institutions listed in the ‘List of Authorised Deposit-Taking Institutions’ maintained by APRA that were not otherwise notified pursuant to (a) above; and

2.         where the applicants were unable to determine the address of the principal place of business of each person to whom a copy of the Scheme Summary was to be sent in accordance with 1. above, sent the Scheme Summary by pre-paid post to the last known address of that person indicated in the applicants’ records.

22                  I am satisfied that a copy of the Scheme Summary was sent to the persons described in [21] above on 28 October 2005 at their principal places of business, or, if the applicants were unable to determine that address, to the last known address of that person contained in the applicants’ records.

Discretion to confirm the scheme

23                  The Court’s discretion to confirm a scheme for the transfer of an insurance business is conferred by s 17F.  The discretion is a general one, and the Act does not specify any criteria to be satisfied:  cf Re Reward Insurance Ltd [2004] FCA 151 at [3].

24                  The decided cases (including those under the comparable provisions of the Life Insurance Act 1995 (Cth)) reveal as the critical consideration, whether affected policyholders will be detrimentally affected by the implementation of the scheme:  Re Insurance Australia Limited (2004) 139 FCR 450 at [76];  Re GIO Personal Investment Services Ltd [2000] FCA 1871 at [27]. 

25                  In Re Insurance Australia Limited (2004) 139 FCR 450 I held that an ‘affected policyholder’, defined in s 17C(1) as ‘the holder of a policy affected by a scheme’ is a holder of a policy being transferred under the scheme (at [25]).  In this case, therefore, the affected policyholders are financial institutions and other entities that hold LMI policies issued by Indemnity, not of those issued by Mortgage.  As I also held in that case, however, as part of the Court’s discretion, the Court may take into account the effect of the Scheme on other policyholders, such as the holders of policies issued by Mortgage in the present case.

26                  In order to assess whether the Scheme detrimentally affects a policyholder, it is necessary to examine the Scheme in some detail.

27                  Broadly speaking, the Scheme is part of the reorganisation of the PMI group of companies’ Australian operations, and seeks to consolidate all of Indemnity’s and Mortgage’s policies in the one entity, Mortgage.

28                  There are several benefits intended to be achieved through the transfer:

(a)        Mortgage will have greater financial size and strength, and the risks carried by it will be more widely spread.

(b)        There will be a saving (estimated to be approximately $500,000 each year) in administrative and regulatory compliance costs, such as accounting, audit, taxation, actuarial and other services.

(c)        The transfer of Indemnity’s insurance liabilities to Mortgage will permit the more efficient use of capital within the PMI group by facilitating the release of capital superfluous to the reasonable estimate of the total amount of those liabilities.  (In due course, that superfluous capital will be distributed to members of the PMI group where it may be most beneficially deployed.)

29                  Indemnity intends, following the transfer under the Scheme, to ask APRA under s 16(1) of the Act to revoke its authorisation under s 12 of the Act, and then to be wound up.

Outline of the Scheme and Transfer Agreement

30                  The Scheme is to the effect that:

·        On 3 January 2006, in accordance with the terms of the ‘Transfer Agreement’ (see below), Indemnity will transfer to Mortgage its Australian insurance business (Scheme, cl 2);

·        In consideration of Mortgage assuming Indemnity’s Australian insurance business liabilities, Indemnity will also transfer to Mortgage, cash or investments equal to the ‘transfer value’ described in the Transfer Agreement (Scheme, cl 3); and

·        On and from 3 January 2006, Mortgage will assume all of Indemnity’s liabilities in respect of the transferred policies (Scheme, cl 4).

31                  The Transfer Agreement (between Indemnity and Mortgage, dated 20 October 2005), provides relevantly that:

(a)        It is to have no effect unless and until both the Scheme is approved by the Court and the New Zealand arrangement is approved by the High Court of New Zealand (cl 2);

(b)        On 3 January 2006, Indemnity will transfer to Mortgage all contracts of insurance issued or entered into by Indemnity, and the assets used by Indemnity to conduct its insurance business (cl 3);

(c)        On and from 3 January 2006, Mortgage will assume all of Indemnity’s liabilities in respect of the transferred policies (cl 5);

(d)        In consideration of Mortgage’s assuming those liabilities, Indemnity will pay to Mortgage $31,978,455, which is the ‘transfer value’ as at 30 June 2005 (cll 4 and 7.2); and

(e)        Ten business days after the completion of Indemnity’s audited statutory accounts for 2005, there will be an adjustment to reflect the movement in the ‘transfer value’ between 30 June 2005 and 3 January 2006 (cl 8.1).

32                  There will be no change in the terms of any of the transferred policies other than the substitution of Mortgage for Indemnity.

The Capital Management Plan

33                  Indemnity, Mortgage and Holdings have entered into a capital management plan (‘the Capital Management Plan’).  The Capital Management Plan does not form part of the Scheme, but is of central importance in the assessment of what will be the financial condition of Mortgage following the transfer.

34                  The purpose of the Capital Management Plan is to ensure that Mortgage meets certain new capital adequacy standards which are imposed by APRA on LMI insurers, with effect on and from 1 January 2006.  Even if the transfer were not to proceed, Mortgage would require additional capital in order to meet these new standards.

35                  The Capital Management Plan provides that:

(a)        Before 31 December 2005, Holdings will inject $55,000,000 into Mortgage;

(b)        Mortgage will arrange for additional reinsurance with another member of the PMI group (PMI Mortgage Insurance Co) to take effect from 1 January 2006;

(c)        Subject to confirmation of the Scheme by the Court, on 3 January 2006 the insurance business of Indemnity will be transferred to Mortgage, along with cash and assets equal to the fair value of the assumed liabilities;

(d)        On 3 January 2006, Indemnity will remit $39,000,000 to Holdings;

(e)        On 3 January 2006, Holdings will transfer $62,000,000 to Mortgage; and

(f)         A minimum of $5,000,000 will remain in Indemnity until APRA revokes its authorisation to carry on business as a general insurer.

36                  Therefore, in addition to the fair value of the liabilities being transferred from Indemnity to Mortgage (currently estimated to be $31,978,455), Mortgage will receive a further $117,000,000, and will increase its reinsurance coverage.

37                  The Capital Management Plan plays an important role in ensuring that Mortgage will have adequate capital in respect of the policyholders of both Indemnity and Mortgage, to which Mortgage will be the entity liable following the transfer.

Financial condition of Indemnity and Mortgage pre- and post-Scheme

38                  Indemnity’s statutory balance sheet shows that at 30 June 2005 it had total assets of $178,614,211 and total liabilities of $19,262,325.  Adjusting those accounts to take into account the cancellation of a ‘reinsurance debtors’ asset by a doubtful debt provision, and the settlement of intercompany balances between Mortgage and Indemnity, Indemnity had total assets of $181,370,445 and total liabilities of $22,018,559, giving it a net asset position of $159,351,886. 

39                  On the basis of those adjusted accounts (and applying the new APRA capital adequacy rules), Indemnity’s net capital allowed for solvency purposes was 189 percent of its Minimum Capital Requirement (‘MCR’).

40                  Mortgage’s statutory balance sheet shows that at 30 June 2005 it had total assets of $905,739,196 and total liabilities of $429,255,307.  Adjusting those accounts to take into account a change to Mortgage’s reinsurance arrangements and the settlement of intercompany balances between Mortgage and Indemnity, and the making of the $55,000,000 capital injection by Holdings required under the Capital Management Plan, Mortgage has total assets of $971,528,736 and total liabilities of $439,999,135, giving it a net asset position of $531,529,601. 

41                  On the basis of those adjusted accounts (and applying the new APRA capital adequacy rules), Mortgage’s net capital allowed for solvency purposes was 124 percent of its MCR.

42                  It is expected that following completion of the Scheme and of all steps of the Capital Management Plan, Mortgage will have total assets of $1,071,125,628 and total liabilities of $477,596,027, giving it a net asset position of $593,529,601.  Its net capital allowed for solvency purposes is anticipated to be 122 percent of its MCR.

43                  Accordingly, Indemnity’s policyholders will be transferred from a company with a solvency ratio of 189 percent to a company with a solvency ratio of 122 percent, while Mortgage’s policyholders will find that the solvency ratio of their insurer is reduced slightly from 124 percent to 122 percent.

The ‘Fair Value’ financial condition of Indemnity and Mortgage

44                  Gregory Clive Taylor is the approved actuary appointed by Indemnity and Mortgage.  He has been an actuary for the past 37 years and has been engaged substantially or wholly in the insurance industry for approximately the last 29 years.  Dr Taylor is a Fellow of the Institute of Actuaries of Australia, a Fellow of the Institute of Actuaries in the United Kingdom, and a Fellow of the Institute of Mathematics and its Applications.  He is a director of Taylor Fry Pty Ltd, trading at ‘Taylor Fry Consulting Actuaries’.  He has provided a report dated 13 October 2005 (‘the Taylor Report’).

45                  In the Taylor Report, Dr Taylor states that in his view the statutory accounts of Indemnity and Mortgage do not, in certain ways, represent ‘fair value’.

46                  The adjustments which, in his opinion, are required to be made to those accounts to reflect ‘fair value’ are described in detail in Appendix D to his report.

47                  The most significant changes relate to the substituting of ‘premium liability’ for ‘unearned premium’.

48                  ‘Unearned premium’ (used in statutory accounting) apportions the premium associated with a policy to the periods of coverage provided by that policy in proportion to the expected cost of claims arising in those periods.  The profit component of the premiums is recognised, not immediately, but gradually over the lifetime of the policy.

49                  ‘Premium liability’, on the other hand, reflects the costs of claims arising out of future events covered by past premiums.  APRA requires premium liability to be calculated to include a risk margin that the provision has a 75 percent probability of sufficiency, and to be discounted at a risk free rate of return.  Dr Taylor considers that premium liability should be calculated only on the basis of expected claim costs (ie, excluding any risk margin) and discounted at a risk-adjusted rate of return.

50                  The effect of the adjustments outlined by Dr Taylor in Appendix D to his report are set out in Appendix B4 to that report.

51                  In substance, that effect is that on the basis of the assumption underpinning the ‘adjusted’ accounts described above, Indemnity’s pre-transfer total assets decrease to $178,014,895, its total liabilities increase to $34,241,342, and its net assets, after allowing for a taxation consequence of the change in accounting, decrease to $148,447,053.

52                  On the same basis, Mortgage’s pre-transfer total assets decrease to $919,633,692, its total liabilities decrease to $107,424,589, and its net assets, after allowing for the taxation consequence of the change in accounting, increase to $728,005,252.

53                  Following the transfer, Mortgage would have total assets of $1,015,875 (a decrease compared to the statutory accounts), total liabilities of $141,665,930 (a decrease compared to the statutory accounts), and net assets of $790,005,252 (an increase compared to the statutory accounts).

The Taylor Report

54                  Dr Taylor notes that there are to be no changes to the terms and conditions of the transferred policies (section 6.2) or to claims handling procedures (section 6.3).

55                  In relation to the post-transfer financial position of Mortgage, Dr Taylor notes that immediately following the Scheme (and implementation of the Capital Management Plan), Mortgage will have a solvency ratio of 122 percent, which shows that it will have assets that ‘amply’ cover its MCR (section 6.4.1).

56                  Dr Taylor observes, however, that as the APRA calculation of MCR coverage calculates premium liability on a basis that Dr Taylor which does not consider represents fair value (section 6.4.2), it is his opinion that the solvency position of the companies is superior to that indicated by APRA’s figures.  He points out, however, that even if a different calculation of fair value were to be adopted, the difference would not be material (section 6.5).

57                  Dr Taylor also observes that changes to the actual position of Mortgage between 30 June 2005 and the date of the transfer are likely to have the effect of increasing Mortgage’s solvency coverage ratio slightly (to 126 percent) (section 6.4.3).

58                  Dr Taylor notes, however, that solvency coverage ratios provide only a ‘relative’ measure of solvency, not an ‘absolute’ measure.  An absolute measure is provided by the probability of survival (section 6.4.2).

59                  Dr Taylor observes (section 6.4.2) that:

(a)        The pre-transfer probability of adequacy of Indemnity’s capital is estimated to lie between 99.9 percent and 99.99 percent (that is, there is between a 1 in 1,000 and 1 in 10,000 chance that Indemnity will not have adequate capital reserves to meet its liabilities in respect of its current policies as those liabilities materialise over time); and

(b)        Both before and after the transfer, the comparable probability of adequacy of Mortgage’s capital is estimated to exceed 99.99 percent (that is, there is a less than a 1 in 10,000 chance that Mortgage will not have adequate capital reserves to meet its actual liabilities in respect of its current policies as those liabilities materialise over time).

60                  Dr Taylor states that in his opinion, these figures indicate that following implementation of the Scheme, Mortgage will be a very well capitalised insurer.

61                  He also notes that APRA requires an insurer to ensure only that it has capital sufficient to ensure that it has a 99.5 percent probability of adequacy over a period of one year (including liabilities on new policies written in that year).  While it is not possible to make a direct comparison of the two probabilities (ie adequacy in respect of current policies over their lifetime, and adequacy in respect of both current and new policies over a one year period), Dr Taylor states that in his opinion, in the case of Indemnity and Mortgage, the ‘lifetime’ basis provides a more stringent test than the ‘one year’ basis, with the result that following the Scheme, Mortgage will comfortably exceed APRA’s requirement.

62                  Dr Taylor notes that as the probability of adequacy increases, it becomes less accurate, particularly in the context of insurance companies that have been operating for only 40 years or so (section 6.4.2).  Nevertheless, it is apparent that Indemnity’s policyholders will be transferred to a company with a higher probability of survival than that of their present insurer, and that Mortgage will be very well capitalised by reference to its insurance liabilities.

63                  For these reasons, Dr Taylor concludes that ‘no material detriment or disadvantage to Indemnity policy holders is likely to result from the Scheme’, and states:

‘my own assessment of the financial strengths of the two companies indicates that the security of Indemnity policy holders is likely to be improved slightly by the Scheme, while the security provided by [Mortgage] to its policyholders continues to be very much at the upper end of the range observed among its peers.’  (section 6.6)

64                  Since preparing his report, Dr Taylor has looked at more recent financial statements of Indemnity and Mortgage.  After reviewing them, Dr Taylor wrote a letter dated 10 November 2005, in which he stated that the positions of both companies had improved slightly since 30 June 2005.  The new figures did not cause Dr Taylor to reconsider his earlier conclusions.

The Pearson Report

65                  The applicants instructed Estelle Elizabeth Pearson, an experienced actuary, to conduct a ‘peer review’ of the Taylor Report.  Ms Pearson is also a Fellow of the Institute of Actuaries of Australia.  She has worked with a wide variety of direct insurers, corporate self-insurers, reinsurers and regulators in the Australian insurance market.  Ms Pearson has also worked with a number of lenders, mortgage insurers and with lenders on mortgage insurance issues.  She was the actuarial expert to the Royal Commission into the collapse of the HIH group of insurance companies.  In 2004 and 2005, Ms Pearson worked with the Insurance Council of Australia in relation to the APRA changes to the capital treatment of LMI.  She provided a ‘peer review’ dated 14 October 2005 (‘the Pearson Report’).

66                  The Pearson Report reviews the methodology underpinning the Taylor Report, comments on whether the Taylor Report’s conclusions are soundly based, and considers whether there were any additional issues to which attention should be drawn.

67                  Ms Pearson states in section 3.1 of her report, that in her opinion:

(a)        The methodology used by Dr Taylor to assess the impact of the Scheme on policyholders ‘correctly addresses the interests of policyholders’;

(b)        Dr Taylor was correct to conclude that policyholders will not be disadvantaged by any change to the terms of their policies or to the claims management procedures to be applied following the Scheme;

(c)        A solvency ratio of over 120 percent is adequate in terms of protection of policyholders;

(d)        Dr Taylor’s conclusions do not depend on the acceptance of his estimates of the probability of survival of Indemnity and Mortgage, because ‘any reasonable alternative estimates would not change the conclusions regarding the adequacy of financial security’; and

(e)        Dr Taylor’s conclusions with respect to the position of the New Zealand policyholders were correct.

68                  While Ms Pearson does not necessarily agree with every aspect of Dr Taylor’s reasoning, she concurs in his opinion that there is no material detriment or disadvantage likely to be suffered by policyholders as a result of the Scheme.

69                  Ms Pearson also notes that it is important to Mortgage to maintain its high credit ratings.  She considers that this ‘gives further comfort that a strong capital position will be maintained in the future to the extent possible’.

70                  In her affidavit, Ms Pearson states (para 11):

‘In summary, in my professional opinion the Actuarial Report is sound and, on the basis of the information contained in the Actuarial Report, I agree with the opinion of Dr Taylor that no material detriment or disadvantage to the Applicants’ policyholders is likely to result from the proposed Scheme.’

Reduction in excess capital

71                  The reduction in the ‘capital buffer’ currently enjoyed by Indemnity policyholders (from 189 percent to 122 percent) may appear at first blush to be a ‘disadvantage’ to them.  As Dr Taylor has stated, however, the actual effect of the transfer may be to move those policyholders to a company with a higher probability of survival.

72                  There is another reason, however, why such a reduction in the ‘capital buffer’ should not be seen as a disadvantage flowing from the Scheme.  This is that Indemnity’s policyholders would not be guaranteed that Indemnity would retain its excess capital, even if the Scheme did not proceed.  Insurance companies are able, subject to APRA approval, to reduce their capital.  It is not implausible that, absent the Scheme, APRA would permit Indemnity to reduce its excess capital to a level of capital comparable to that which will be held by Mortgage following the transfer.

73                  Paragraph 22 of Guidance Note GGN 110.1 provides that APRA approval of a reduction of capital depends upon the insurer satisfying APRA that ‘the company’s capital base after the proposed reduction will remain adequate for its future needs’.  In other words, whether or not APRA will authorise a reduction in capital seems to depend on the adequacy of the amount of capital remaining after the reduction, not on the presence or degree of prejudice caused by the reduction.

74                  Mortgage’s level of capital after the transfer will provide adequate protection to policyholders, as both Dr Taylor and Ms Pearson agree.  Moreover, APRA has appeared in this proceeding and has not objected to the Scheme.  I infer that APRA is satisfied that Mortgage will hold an adequate level of capital for the protection of affected policyholders.  Therefore, I infer that APRA would not have objected to Indemnity’s reducing its capital to the same extent by other means.

New Zealand policyholders

75                  The position of New Zealand policyholders of Indemnity and Mortgage is different from that of the Australian policyholders.  That is because s 116 of the Act provides that, in the event of the winding up of a general insurer, the assets of the company in Australia must not be applied in discharge of its liabilities outside of Australia, until all of its Australian liabilities have been discharged.

76                  The financial condition of both companies’ New Zealand branches is set out in Appendix G to the Taylor Report.  In the case of each company, before (and after) the transfer, its liabilities exceed (and will exceed) its assets.  Dr Taylor notes that in the case of each company, the branch is dependent upon the financial condition of the company as a whole, and not merely on its assets in New Zealand.  This is said to be consistent with the industry practice of Australian insurers carrying on business in New Zealand.

77                  Dr Taylor states that the New Zealand policyholders, like the Australian policyholders, will not experience any change to the terms of their policies (save for the substitution of one insurer for another) nor to the claims handling procedures (section 7.3).

78                  In so far as the solvency of the companies is concerned, Dr Taylor notes that his conclusions with respect to the Australian businesses applies equally to the New Zealand businesses, because his solvency analysis included the companies’ liabilities in New Zealand (section 7.3).

79                  Although the New Zealand policyholders are at a disadvantage compared to Australian policyholders, that is not a disadvantage caused by the Scheme.  It exists now, and will continue to exist following the Scheme.

80                  Ms Pearson agreed with Dr Taylor’s conclusions in this regard.

Conclusion

81                  I am satisfied that the interests of Indemnity’s policyholders will be adequately protected for the following reasons:

(a)        The terms and conditions of the transferred policies will remain unaltered, save for the substitution of Mortgage for Indemnity as the insurer liable on them;

(b)        the claims management procedures in respect of the transferred policies will be unaltered; and

(c)        Mortgage will hold adequate capital to protect policyholders’ interests, being capital equal to approximately 122 percent of the MCR of APRA.

82                  Moreover, APRA, which is charged with the responsibility of protecting the interests of policyholders, has appeared and stated that it raises no objection to the Court’s confirmation of the Scheme.

83                  Finally, no affected policyholder has objected to the Scheme, which, with the right of affected policyholders to object to it, has been widely publicised.

84                  I will confirm the Scheme subject to two conditions mentioned:  approval by the High Court of New Zealand, and injection of capital pursuant to the Capital management Plan.

Associate:

Dated:              20 December 2005