The judges’ summary, in allowing the Appeal by The Prudential Life Assurance Company Ltd and Rothesay Life PLC for the Part VII transfer, is partly transcribed below. Note (i) it is my transcript, I can’t guarantee its accuracy and (ii) as the Chancellor says, the summary forms no part of the judgment.
Eumaeus’s verdict is below.
The judges’ point that parent companies can never be required to support their subsidiaries’ capital for reputational reasons or on any other basis, and that the parents of insurers are always at liberty to sell their regulated subsidiaries seems obvious and can hardly be disputed.
But the crux of the matter is the one I have emphasised in bold italics. Is it true that, for either PAC or Rothesay, there is only a remote chance of parental support being needed in the future? If so, and given that the judges rightly ask whether the transfer would have a material adverse effect on the policyholders, then if there is any significant probability that either firm will default, policyholders should stick with PAC, which has the potential for greater parental support.
There was protracted and painful discussion about the ‘remote chance’ question during the Appeal. But why didn’t the lawyers ask a statistician? Regulatory solvency is assessed on a probability of default – in any one year – of 1 in 200, which is equal to an 0.995 probability of survival. Given that, what then is the probability of default over, say, 25 years. Statisticians (and credit officers) 101 says that you raise 0.995 to the power of 25 to get the probability of survival over 25 years, then subtract from 1 to get the corresponding probability of default.
But 1-0.995^25 is nearly 12%. Over 30 years, almost 14%. That is not ‘remote’, and I rest my case, my lordships.
I did raise that point, and two others, with the Court at the time as a McKenzie friend of one of the policyholders, but the Court ruled it was inadmissible evidence, as tends to happen.
Such is the judicial system.
Note also the judges emphasis on giving adequate weight “to the conclusions of the Independent Expert”, and the non-objection of the PRA. The problem here, as I noted before, is the single point of failure.
“A single point of failure is a part of a system that, if it fails, will stop the entire system from working”. Right. You try to avoid this in any decent system, building in redundancy at every critical point. The classic example is a chain, where any single link is a single point of failure. You can build in redundancy by, e.g., adding a second chain. So long as each chain on its own can support the weight, nothing bad will happen if one chain breaks (bad luck if both break, though).
The Independent Expert relies entirely on the calculations of the regulator. The calculations of the regulator rely mostly on forms of horse trading with potentially affected firms. “We must not impose more than a firm can withstand”, as one respected colleague told me.
But more on that subject later.
—SUMMARY BY SIR GEOFFREY VOS
The central issues raised by the Appeal then were first whether the judge was wrong to conclude that there was a material disparity between the external support potentially available for each of PAC and Rothesay, and whether he failed to accord adequate weight to the conclusions of the independent expert that the risk of PAC or Rothesay needing external support in the future was remote. The second issue was whether the judge failed to accord adequate weight to the regulator’s lack of objection to the scheme, and to the continuing future regulation of Rothesay. The third issue whether the judge accorded to much weight to the fact that the objecting policyholders chose PAC on the basis of its age, venerability and established reputation, and reasonably assumed that PAC would provide their annuity throughout its lengthy term.
In its judgment, the Court of Appeal began by explaining the proper approach that the Court should adopt in considering the sanction of schemes under Part VII. On the first and second issues, the Court decided that the Judge [Snowden] had been wrong to think that the independent expert and the Prudential Regulation Authority were not justified in looking at the solvency metrics at a specific date to support their opinion that there was only a remote chance of parental support being needed in the future. They were judging the metrics of the companies on the basis of an analysis of their likely resilience to a 1 in 200 year stress event within the coming year. The fact that Rothesay would continue to be regulated under the same rules from year to year into the foreseeable future meant that the present conclusion of the expert and the Prudential Regulation Authority were valid parameters for R’s future security. And the judge had been wrong to find that there was a material disparity between the non-contractual external financial support potentially available for each of the two companies. The likely of non-contractual parental support being available in the future was anyway simply not a relevant factor for the judge to take into account. Parents could never be required to support their subsidiaries’ capital for reputational reasons or on any other basis. Moreover, the parents of insurers were always at liberty to sell their regulated subsidiaries to others with lesser resources. The judge, the Court had decided, had not accorded adequate weight to the conclusions of the Independent Expert that the risk of PAC or Rothesay needing external support in the future was remote. The judge had failed to accord adequate weight also to the regulators’ lack of objection to the scheme and the continuing future regulation of Rothesay.
On the 3rd issue, the Court of Appeal concluded that the judge ought not to have accorded any weight to the facts that the objecting policyholders chose PAC on the basis of its age and venerability and established reputation, nor to the reasonable assumption that PAC would provide their annuity throughout the length term. The question was whether the scheme would have a material adverse effect on the policyholders. If the policyholders prospects of being paid were essentially the same, with and without the scheme, it was hard to see how there could be any material adverse effect on the policyholders security of benefits caused by the scheme. Accordingly, for the reasons given, the Appeal was allowed, and the renewed application for the sanction of the scheme would be remitted to another judge sitting in the insolvency and companies list of the business and property courts of England and Wales.