Updated regulatory guidance on Part VII transfers for companies in run off
After last year's consultation exercises, the PRA and FCA have now finalised updated guidance on Part VII transfers (PRA Policy Statement 1/22 and FCA Guidance FG22/1, respectively). This post focuses on a provision in the PRA guidance which is of particular interest to companies which are in run off.
To recap, the proposals potentially require a Section 166 Report by a skilled person in relation to the operational readiness of the transferee of a run off business. The finalised guidance is broadly in line with the draft proposals, with some clarifications to address responses received in the consultation process (it would appear from the PRA's response to the Consultation Paper that this proposal generated the bulk of the responses to that CP).
So, for a proposed transfer of non-life insurance business in run off with gross technical reserves of over £100m and where the transfer would increase the transferee's technical provisions by over ten per cent, the PRA have indicated that they would expect to require a Section 166 Report by a skilled person into the operational readiness of the transferee to receive that book of business.
This has practical implications in relation to timing, certainty and cost.
The skilled person's report would have to be dealt with before the Part VII scheme Independent Expert (IE) is nominated, meaning that it would be difficult to begin on the actuarial work in relation to the Part VII. If a Section 166 Report finds, any significant deficiencies, these will have to be remedied before the IE is nominated.
There is no specified timetable or statutory process for a Section 166 Report, so the scope of the report, the identity of the skilled person and the timing of its delivery all need to be discussed with the PRA on case by case basis. This means that the appointment of skilled person would lead almost inevitably to a delay to a Part VII process, could potentially require a re-negotiation of the terms, could be made conditional on findings from the Section 166 Report being addressed or in the worst case, could even be cancelled. In addition, the transferee will be bearing the costs of the skilled person.
What can boards do to mitigate these risks? It will be important to clarify at an early stage of any potential transaction whether the guidance applies, and this will be a factor for transferors to consider when considering bids in a competitive process. If parties have different views on the value of the technical provisions, the higher one is to be used.
If the provisions apply, the transferor and transferee may wish to consider whether the transaction could be structured instead as an interim or permanent reinsurance instead of a Part VII transfer. This could allow a transfer of the economics, while leaving operational risk / control with the transferor. However, it does not achieve legal finality for the transferor.
Thought should also be given to terms of contractual compensation, allocating the risks of the financial consequences of any delay or cancellation or the scheme.
For a transferee who is likely to be engaged in competitive or frequent Part VII processes, one consideration may be to pre-empt the potential requirement.
The PRA Guidance states that the PRA will not need to commission a Section 166 Report if it can satisfy itself on the transferee's operational readiness by other means. That could be a recent Section 166 assessment in the same area, or an equivalent assessment by an independent body or regulator. This would allow a potential transferee to commission a report from an independent consultant, covering the relevant ground in advance of any transaction, meaning that it could deal with operational readiness issues and an early stage. Whether or not the PRA would accept this in any particular case would be a matter for discussion with them, so early engagement with the regulators is recommended.
An additional consideration is that if an external report is commissioned, it is likely that the firm conducting that exercise (or the skilled person mandated by the PRA under Section 166) would find it difficult to satisfy the regulators of their independence to be eligible for appointment as the IE in respect of the proposed scheme.