Proposed Transfer of the Insurance Business of Calliden Insurance Limited to Great Lakes Reinsurance (UK) SE (Australian Branch)

Transcription

1 Proposed Transfer of the Insurance Business of Calliden Insurance Limited to Great Lakes Reinsurance (UK) SE (Australian Branch) Munich Holdings of Australasia Pty Limited 22 December 2016

2 Ernst & Young 200 George Street Sydney NSW 2000 Australia GPO Box 2646 Sydney NSW 2001 Tel: Fax: ey.com/au Mr Nicolas Carro Chief Financial Officer Munich Holdings of Australasia PTY Limited PO Box H35 Australia Square 143 Macquarie Street NSW December 2016 Private and confidential Proposed Transfer of the Insurance Business of Calliden Insurance Limited to Great Lakes Reinsurance (UK) SE (Australia Branch) pursuant to Division 3A of Part III of the Insurance Act 1973 Dear Nicolas, Please find enclosed my report on the proposed Transfer of the Insurance Business of Calliden Insurance Limited to Great Lakes Reinsurance (UK) SE (Australia Branch) pursuant to Division 3A of Part III of the Insurance Act If you have any questions please do not hesitate to contact me on (02) Yours sincerely Warrick Gard, FIAA Partner Financial Services A member firm of Ernst & Young Global Limited Liability limited by a scheme approved under Professional Standards Legislation

3 Table of contents 1. Executive summary Introduction Outline of the Proposed Transfer Methodology Effective date Future operation of GLA post Proposed Transfer Assets and liabilities to be transferred from CIL to GLA Conclusion Reliances and limitations Background and outline of the Proposed Transfer Introduction Timing An outline of the Proposed Transfer Calliden Insurance Limited Business overview CIL insurance liability reserve CIL balance sheet CIL solvency position CIL Internal Capital Adequacy Assessment Process ( ICAAP ) CIL claims handling, policies and operations Great Lakes Reinsurance UK SE (Australian Branch) Business overview GLA insurance liability reserve GLA balance sheet GLA solvency position GLA Internal Capital Adequacy Assessment Process ( ICAAP ) GLA s approach to CIL claims and policies Impact of Proposed Transfer on solvency Insurance liability reserve after the Proposed Transfer Pro forma balance sheet after the Proposed Transfer Reinsurance recoveries Pro forma solvency position after the Proposed Transfer Forecast capital position after the Proposed Transfer Scenario test of the forecast capital position after the Proposed Transfer Conclusions Expert witnesses in the Federal Court of Australia Practice Note CM Reliances and limitations Appendix A Warrick Gard s CV Appendix B Listing of documents relied upon Appendix C CIL s reinsurance recoveries Appendix D ReAC outstanding claims EY i

4 1. Executive summary 1.1 Introduction It is proposed that the insurance and reinsurance business of Calliden Insurance Limited ( CIL ) is transferred to Great Lakes Reinsurance (UK) SE (Australian branch) ( GLA ) pursuant to Part III Division 3A of the Insurance Act 1973 ( Proposed Transfer ) by a Scheme of Arrangement ( Scheme ). GLA is a branch of Great Lakes Reinsurance (UK) SE (GLUK) and CIL is a subsidiary of Munich Holdings of Australasia ( MHA ). Both GLUK and MHA are part of the Munich Re Group. MHA has engaged Ernst & Young ( EY, we, us ) to provide an actuarial review of the Proposed Transfer pursuant to section 17C of the Insurance Act This actuarial report on the Proposed Transfer has been prepared by me, Warrick Gard, a Fellow of the Institute of Actuaries of Australia. I acknowledge that I have read, understood and complied with Practice Note CM7 issued by the Federal Court of Australia, which covers the responsibilities of expert witnesses in proceedings in the Federal Court of Australia. The declarations required by the Practice Note are covered in Section 7. Attached as Appendix A is my CV. This provides an outline of my expertise and recent experience, and demonstrates my suitability to provide this expert actuarial report on the Proposed Transfer. 1.2 Outline of the Proposed Transfer It is proposed that the insurance business of CIL be transferred to GLA pursuant to a Scheme confirmed by the Federal Court pursuant to Division 3A of Part III of the Insurance Act The terms used below are consistent with the terms used in the Deed of Transfer of Insurance Business between CIL and GLA. The key elements of the Proposed Transfer are outlined below. The Insurance Liabilities and other liabilities related to all insurance business written or assumed by CIL ( Assumed Liabilities ) will be liabilities of GLA; All premiums and other amounts payable to, or recoverable by, CIL under the Insurance Contracts will be payable to and recoverable by GLA instead of CIL; The Insurance Contracts will be vested to GLA with the same benefits, obligations and conditions that applied before the Scheme; Any policyholder or beneficiary under the Insurance Contracts or other person who has a claim on or obligation to CIL pursuant to the Insurance Contracts or the Reinsurance Contracts, will have the same claim on or obligation to GLA; In return for GLA assuming and taking over the Assumed Liabilities, CIL will pay to GLA an amount equal to the net value of CIL's insurance liabilities, adjusted for any insurance related payables and receivables; In return for the transfer to GLA of the assets used by CIL to conduct its insurance business, GLA will pay to CIL an amount equal to the business assets being transferred; and GLA will bear all costs and expenses incurred in the preparation and confirmation of the scheme and its implementation. EY 1

5 Definitions and interpretations (as per the draft Scheme Document dated 11 November 2016) o Insurance Liabilities are calculated in accordance with Prudential Standard GPS 320: Actuarial and Related Matters made under the Insurance Act. Insurance Liabilities are discounted central estimates with allowance for reinsurance and non-reinsurance recoveries, claims handling expense, policy administration expense and risk margin to secure the liabilities at a 75% probability of adequacy o Insurance Contracts means all contracts of insurance and all contracts and treaties of reinsurance issued or entered into by CIL as the insurer or reinsurer in the conduct of its Business prior to the Effective Date o Reinsurance Contracts means the contracts and treaties of reinsurance entered into or assumed by CIL as reinsured in respect of its liabilities under the Insurance Contracts o Business Assets means the assets used by CIL for the purpose of conducting the Business, including the Claims Trust Account, but excluding the Receivables and the Investment Assets. After the transfer, CIL intends to apply to the Australian Prudential Regulation Authority ( APRA ) for revocation of its APRA authorisation. 1.3 Methodology In this report, I have considered whether the Proposed Transfer will have a materially adverse impact on the policyholders of either CIL or GLA, primarily focusing on two issues: capital and operations Capital I have considered the issue of financial strength and policyholder security in terms of the capital adequacy and solvency position. My approach to this has been to review the solvency coverage of both CIL and GLA before the Proposed Transfer and GLA after the Proposed Transfer. I have also considered the financial impact on the policyholders of Great Lakes (UK) SE ( GLUK ) as GLA is a branch of GLUK Operations From an operational perspective, I have considered how the claims handling philosophy of GLA would impact the policyholders of CIL. I considered if there are any unique CIL issues that could adversely impact CIL policyholders when GLA s operational approach is adopted. 1.4 Effective date The current effective date for the approval of the Scheme is intended to be on 1 April 2017 ( Effective Date ) or such other date that the Federal Court of Australia ( the Court ) may specify as the commencement date of the Scheme, should it be confirmed by the Court. The analysis presented in this report is primarily based on data as at 30 June 2016, which is the as at date of the latest available Insurance Liability Valuation Report ( ILVR ). A listing of all documents and other materials that I have considered is attached as Appendix B. EY 2

6 1.5 Future operation of GLA post Proposed Transfer On 15 June 2016 MHA announced that it intends to pursue divestment of its primary insurance arm GLA. No timeframe to achieve this has been stated and the timing and impact of such a divestment is not known. It is important to note that should a divestment not proceed then the intention for the combined entity (i.e. GLA and CIL post transfer) is to run-off the combined insurance liabilities. As GLA is a branch, the only way the insurance liabilities could be divested would be by way of another Scheme. At such time, details of the impact of the divestment would be known and the impacts on policyholders affected by that scheme would have to be considered again at that time prior to any transfer occurring. Thus, the impact of the GLA divestment decision is not discussed further in this report in the context of the proposed scheme of transfer. However, should the divestment not proceed, GLA post the Proposed Transfer, has the option to either: go into run off and cease to write new business; or continue as an insurer on an ongoing concern basis The current intention and basis of the Scheme Report is GLA will be placed into run off post Scheme, and cease writing new business from 1 April 2017 for all business except Travel, which is assumed to cease from 1 October An alternative option of continuing as an insurer on a going concern basis for a limited number of lines of business is currently being considered by the GLUK management, but the business plan is yet to be approved by the Board. I have included the financial projection under this option to illustrate the impact on CIL and GLA policyholders in Section Assets and liabilities to be transferred from CIL to GLA Table 1 sets out the assets and liabilities to be transferred from CIL to GLA. Table 1: Assets and liabilities to be transferred from CIL to GLA as at 30 June 2016 ($m) Amount ($m) Insurance Assets Cash and investments 46.1 Reinsurance recoveries Unearned premium recoveries 2.4 Deferred acquisition cost 0.0 Other -0.0 Total assets Assumed Liabilities Gross outstanding claims Unearned premium 2.5 Other 1.6 Total liabilities Net assets 0.0 Source: Balance sheet pro forma 30 June 2016 As shown in the table above, GLA will assume the full gross risk of CIL s insurance liabilities and other liabilities related to CIL s insurance business, increasing GLA s total liabilities by $156.6m after the Proposed Transfer. EY 3

7 As an offset, GLA will gain assets equal to the value of the transferred liabilities, increasing GLA s assets by an amount of $156.6m, i.e. the net asset position of GLA is not affected by the Proposed Transfer. Thus, the Proposed Transfer will have a zero impact on the net assets of GLA as the insurance business assets transferred from CIL will be equal to the value of the insurance business liabilities transferred. The capital positions for CIL and GLA pre and post the Proposed Transfer as at 30 June 2016 are shown in Table 2 below. Table 2: Pro forma capital position for CIL, GLA and GLA after the Proposed Transfer as at 30 June 2016 ($m) CIL GLA GLA after the Proposed Transfer Prescribed capital amount ( PCA ) Capital base Target capital* Target capital coverage ratio^ PCA coverage ratio^^ Source: Balance sheet pro forma as at 30 June 2016 * Target capital for CIL is 1.4 x PCA and GLA is 1.4 x PCA ^ Target capital coverage ratio = Capital base / Target capital ^^ PCA coverage ratio = Capital base / PCA The Proposed Transfer results in increases in the Prescribed Capital Amount ( PCA ) and target capital levels for GLA. Since the capital base of GLA remains unchanged but the PCA increases as a result of the Proposed Transfer, the PCA coverage ratio of GLA reduces from 1.66 to Conclusion I have concluded that the Proposed Transfer will not have a materially adverse impact on the policyholders of either CIL or GLA for the following reasons. CIL s PCA coverage ratio at 30 June 2016 is 2.48, and based on the pro forma balance sheet as at 30 June 2016 following the Proposed Transfer, the PCA coverage ratio for GLA is estimated to be Whilst the PCA coverage ratio for GLA is lower: o It should be noted the PCA coverage ratio remains within GLA s (and CIL s) target Capital Management Zone. CIL policyholders transferring to GLA continue to be protected by the extensive reinsurance protection as well as having access to a larger capital base after transfer which will be beneficial in the event of significant adverse run-off development. o It is my view that there will not be a materially adverse impact on the policyholders of CIL by the reduction in the PCA coverage ratio of GLA after the Proposed Transfer relative to CIL. There is no material adverse impact to GLA s policyholders from a capital perspective arising from the Proposed Transfer as a result of the Proposed Transfer. GLA policyholders continue to be protected by the extensive reinsurance contracts that GLA has in place and the PCA coverage ratio is still within GLA s ICAAP target. EY 4

8 GLA intends to maintain CIL s claims management process following the Proposed Transfer. As a result, for the CIL policyholders transferring to GLA, there will be no materially adverse impact on the management of claims following the Proposed Transfer. All contracts subject to the scheme (including reinsurance) are to be transferred from CIL to GLA without any change to their terms and conditions other than the substitution of GLA for CIL as the licensed insurer. So there will be no adverse impact on policy terms and conditions as a result of the Proposed Transfer. By the Effective Date, CIL will be in run-off, that is, no policy will have been written for twelve months. There will be a number of policies in force comprised of builders warranty and some consumer credit policies which will be managed by the same external claims staff. Given these measures I don t foresee any adverse impact to CIL policyholder administration or CIL policyholders following the Proposed Transfer. In addition, o I have reviewed the solvency position and APRA returns of both CIL and GLA at 30 September My review suggests there has been no material change in the level of security afforded to policyholders of either entity compared to the position as at 30 June o GLA is a branch of Great Lakes Reinsurance (UK) SE ( GLUK ). As such the GLA policyholders have a contract with GLUK and therefore GLUK is legally required to meet its obligations to GLA policyholders. GLUK is financially robust as demonstrated by the level of excess shareholders assets and has an S&P rating of AA GLUK has an S&P rating of AA-. At the time of writing this report, a public announcement was made that Berkshire Hathaway Speciality Insurance (BHSI) is close to finalising agreement with Cover-More in replacing Great Lakes Australia as the primary underwriter. This may impact the run off date of the travel portfolio which is assumed to be 1 October 2017 in this report. I have not allowed for this potential change as the agreement between BHSI and Cover-More has not been finalised however it is my assessment that this is unlikely to make a material difference to my assessment Overall, based on the above, it is my view that the Proposed Transfer will not have a materially adverse impact on the policyholders of either CIL or GLA. 1.8 Reliances and limitations I have performed the analysis herein and prepared this report in conformity with its intended utilisation by persons technically familiar with the areas addressed and for the stated purposes only. I note that in preparing this report, I have relied upon the information provided to us by GLA and CIL. Judgements based on the data, methods and assumptions contained in the report should be made only after studying the report in its entirety, as conclusions reached by a review of a section or sections on an isolated basis may be incorrect. This report has been prepared with care and diligence and the statements made and opinions are given in good faith and in the belief based on reasonable grounds that such statements and opinions are correct and not misleading. Members of EY staff involved in the preparation of this report are available to explain or amplify any matter presented herein. In accordance with normal professional practice, neither EY, nor any member or employee thereof undertakes responsibility in any way whatsoever to any person other than GLA and CIL in respect of this report. EY 5

9 I disclaim all liability to any other party for all costs, loss, damage and liability that any third party may suffer or incur arising from or relating to or in any way connected with the contents of our advice, the provision of our advice to the other party or the reliance upon our advice by the other party. I am providing specific advice only for this engagement and for no other purpose and I disclaim any responsibility for the use of our advice for a different purpose or in a different context. I understand that as part of the Division 3A process, this report will be made available to a number of third parties, including: CIL s auditors and professional advisers in respect of the Proposed Transfer; GLA s auditors and professional advisers in respect of the Proposed Transfer; APRA; Munich Re Group; the Federal Court of Australia considering the Proposed Transfer; and policyholders of CIL and GLA who may be affected by the Proposed Transfer ( Affected Policyholders ) including persons who allege to be Affected Policyholders (including without limitation, homeowners covered by builders warranty insurance written by CIL) and seek an inspection of documents either at the website of CIL or at one of the inspection sites. This report has been prepared solely in connection with the transfer of CIL s insurance business to GLA. This report does not take into account the individual circumstances of GLA and CIL policyholders. Policyholders may wish to seek independent professional advice regarding their own position. EY 6

10 2. Background and outline of the Proposed Transfer 2.1 Introduction It is proposed that the insurance business of Calliden Insurance Limited ( CIL ) is transferred to Great Lakes Reinsurance (UK) SE (Australian branch) ( GLA ) pursuant to Part III Division 3A of the Insurance Act 1973 ( Proposed Transfer ) by a Scheme of Arrangement ( Scheme ). GLA is a branch of Great Lakes Reinsurance (UK) SE (GLUK) and CIL is a subsidiary of Munich Holdings of Australasia ( MHA ). Both GLUK and MHA are part of the Munich Re Group. MHA has engaged EY to provide an actuarial review of the Proposed Transfer pursuant to section 17C of the Insurance Act Timing The scheme is intended to take effect at 12:00am 1 April 2017, or such other date that the Federal Court of Australia may specify as the commencement date of the scheme should the scheme be confirmed by the court ( Effective Date ). 2.3 An outline of the Proposed Transfer A summary of the Proposed Transfer is outlined below. CIL will transfer and GLA will assume the following: All the insurance business written by CIL. This includes business acquired from Australian Unity in 2007 and subsequently re-branded as CIL The run-off reinsurance business which have been in run-off since The Insurance Liabilities and other liabilities related to the insurance contracts from the abovementioned businesses are collectively termed as Assumed Liabilities From the Effective Date, The Assumed Liabilities will be liabilities of GLA All premiums and other amounts payable to, or recoverable by, CIL under the Insurance Contracts will be payable to and recoverable by GLA instead of CIL The Insurance Contracts will be vested to GLA with the same benefits, obligations and conditions that applied before the Scheme Any policyholder or beneficiary under the Insurance Contracts or other person who has a claim on or obligation to CIL pursuant to the Insurance Contracts or the Reinsurance Contracts, will have the same claim on or obligation to GLA In return for GLA assuming and taking over the Assumed Liabilities, CIL will pay to GLA an amount equal to the net value of CIL's insurance liabilities, adjusted for any insurance related payables and receivables In return for the transfer to GLA of the assets used by CIL to conduct its insurance business, GLA will pay to CIL an amount equal to the business assets being transferred EY 7

11 GLA will bear all costs and expenses incurred in the preparation and confirmation of the scheme and its implementation Definitions and interpretations Insurance Liabilities are calculated in accordance with Prudential Standard GPS 320: Actuarial and Related Matters made under the Insurance Act. Insurance Liabilities are discounted central estimates with allowance for reinsurance and non-reinsurance recoveries, claims handling expense, policy administration expense and risk margin to secure the liabilities at a 75% probability of adequacy Insurance Contracts means all contracts of insurance and all contracts and treaties of reinsurance issued or entered into by CIL as the insurer or reinsurer in the conduct of its Business prior to the Effective Date Reinsurance Contracts means the contracts and treaties of reinsurance entered into or assumed by CIL as reinsured in respect of its liabilities under the Insurance Contracts Business Assets means the assets used by CIL for the purpose of conducting the Business, including the Claims Trust Account, but excluding the Receivables and the Investment Assets. After the transfer, CIL intends to apply to APRA for revocation of its APRA authorisation. EY 8

12 3. Calliden Insurance Limited 3.1 Business overview CIL is authorised by APRA to conduct general (non-life) insurance business in Australia and is effectively an amalgamation of the following three insurance companies/portfolios which have merged over time through multiple insurance portfolio transfers. Calliden Limited (CL) which began operations in 2005, and was a subsidiary of Calliden Group Limited (CGL). The CL insurance portfolio was transferred into CIL in The reinsurance business of CGL began operations, as Reinsurance Australia Corporation (ReAC) in 1993 and entered into run off in This portfolio was transferred into CL in As noted above the CL insurance portfolio was transferred into CIL in Australian Unity s (AU) insurance business which was acquired by CGL in 2007 and renamed CIL. CIL has underwritten a mixture of short tail (Motor, Householders) and long tail (Public liability, Professional indemnity, Builders warranty) business, and previously reinsurance under ReAC. CIL s exposure to the impact of poor claims experience is mitigated through extensive reinsurance. As at 30 June 2016 this includes material recoveries against non-munich Re Group reinsurers. Further discussions on CIL s reinsurance arrangements are provided in section 3.5. On 23 December 2014 the ownership of CIL changed from CGL to MHA. Munich Re Australia Branch (MRAU), another member of the Munich Re Group, is the major reinsurer of CIL. In 2015, CIL transitioned the underwriting of its insurance operations to other licensed insurers and as at 31 December 2015 ceased writing new business. CIL has not written new business during CIL has also reinsured almost all retained risk exposed during 2015 to MRAU, hence the net insurance liabilities for claims arising in 2015 is nil for most classes CIL retains net liabilities for the run-off of claims arising from 2014 and earlier, though this too is protected from the risk of down-side deterioration through additional reinsurance Nature of CIL s written business Currently, over 90% of CIL s outstanding claims liabilities relate to Builders Warranty and Liability classes of business. Given the long tail nature of these classes and claims experiences to date, these two portfolios contribute to the greatest source of uncertainty to the future run off of the CIL s reserves. With respect to latent claims exposure, such as Asbestos and Molestation claims, I understand There are asbestos claims exposure from a small residual liability portfolio relating to inwards treaty arrangements underwritten between 1967 and 1972 with Australian World Underwriters by Australian Natives. The gross case estimate as at 30 September 2016 for CIL s share of the Australian World Underwriters portfolio is $20k (of which $12k relates to Asbestos exposure). Given the deep run off of these claims, the incurred movement in the past five years has been insignificant. As such, the gross IBNR allowance, 1.5 times of gross case estimates, appears reasonable. In addition, any adverse development is reduced by a 50% quota share reinsurance arrangement. The outstanding claims reserve held for these liabilities is immaterial relative the overall CIL claims liabilities. EY 9

13 There are no molestation claims reported to date in the CIL portfolio. In addition, I have been advised CIL s policy wordings include a molestation exclusion clause since it started operation in With respect to the inwards treaty, there are two main outstanding claims and details of these claims are set out in Appendix D. Based on the advice provided by CIL, I believe the reserves for these claims are sufficient. The net impact of these uncertainties and potential latent claims development is significantly limited by the extensive reinsurance arrangements which will continue post the Proposed Transfer. 3.2 CIL insurance liability reserve The discounted net insurance liabilities of CIL have been valued as at 31 December 2015 and 30 June 2016 by the Appointed Actuary, Susan Ley CIL insurance liability reserve as at 31 December 2015 Table 3 shows the results of the insurance liabilities valuation as at 31 December 2015 for CIL. The figures are based on the ILVR as at 31 December 2015 prepared by Susan Ley as the Appointed Actuary Calliden Insurance Limited Report on Insurance Liabilities dated 29 March I understand no material issues on the insurance liabilities were noted by the auditors of CIL. Table 3: CIL discounted net insurance liabilities as at 31 December 2015 at 75% Probability of Sufficiency ( PoS ) ($ m) Central estimate Risk margin Provision Margin as a % of central estimate Claims liabilities % Premium liabilities % Total % The total discounted net insurance liabilities provision at 31 December 2015 was $58.3m. This includes a risk margin of $6.3m, or 12.2% of the net central estimate, to establish a 75% PoS in accordance with APRA requirements. I understand that the liability estimates in CIL s ILVR at 31 December 2015 were adopted by CIL in preparing its 2015 APRA return CIL insurance liability reserve as at 30 June 2016 Table 4 shows the results of the insurance liabilities valuation as at 30 June 2016 for CIL. The figures are based on the ILVR as at 30 June 2016, prepared by Susan Ley as the Appointed Actuary Calliden Insurance Limited Update report on value of insurance liabilities as at 30 June 2016 dated 2 September I have reviewed the methodology, assumptions and results presented in the CIL 2016 ILVR and they appear reasonable. Table 4: CIL discounted net insurance liabilities as at 30 June 2016 at 75% Probability of Sufficiency ( PoS ) ($ m) Central estimate Risk margin Provision Margin as a % of central estimate Claims liabilities % Premium liabilities % Total % The total discounted net insurance liabilities provision at 30 June 2016 was $52.2m. This includes a EY 10

14 risk margin of $5.3m, or 11.3% of the net central estimate, to establish a 75% PoS in accordance with APRA requirements. There was a decrease of $6.1m in the total discounted net insurance liabilities central estimate over six months to 30 June 2016 primarily due to CIL ceasing to write business from 31 December The decrease in the risk margin from 12.2% to 11.3% is due to a change in the mix of the net outstanding claim reserves and appears reasonable. I understand that the liability estimates in CIL s ILVR at 31 December 2015 were adopted by CIL in preparing its 2015 APRA return. 3.3 CIL balance sheet CIL s assets and liabilities as at 31 December 2015 and 30 June 2016 are shown in Table 5. Table 5: CIL Balance Sheet as at 31 December 2015 and 30 June 2016 ($m) Assets 31 December June 2016 Cash and investments Reinsurance recoveries Unearned premium recoveries Other Total assets Liabilities Gross outstanding claims Unearned premium Other Total liabilities Net assets APRA Capital base Source: CIL APRA returns 3.4 CIL solvency position Table 6 shows CIL s PCA and capital base as at 31 December 2015 and 30 June EY 11

15 Table 6: CIL s APRA Solvency Requirements as at 31 December 2015 and 30 June 2016 ($ m) Prescribed Capital Amount 31-December June-2016 Insurance risk charge Insurance Concentration risk charge Asset risk charge Asset Concentration risk charge Operational risk charge Less Aggregation Benefit Prescribed Capital Amount Capital Base Net assets Less net assets outside Australia Plus net surplus/deficit relating to insurance liabilities (1) Outstanding claims provisions surplus/deficit (2) Premium liabilities surplus/deficit (3) Less tax effect of net outstanding claims provisions and premium liabilities surplus/deficit Total net surplus/deficit relating to insurance liabilities Less deferred tax assets (net of any deferred tax liability) Total Capital Base Capital surplus PCA coverage ratio* Target capital ^ Target capital coverage ratio # Source: CIL APRA returns * PCA coverage ratio = Total capital base / PCA ^ Target capital = 1.4 x PCA # Target capital coverage ratio = Total capital base / Target capital At 31 December 2015, the PCA for CIL was $9.6m with a capital surplus of $10.7m. At 30 June 2016, the PCA was $7.5m with a capital surplus of $11.1m. The PCA coverage ratio increased from 2.12 at 31 December 2015 to 2.48 at 30 June The increase is due to the following: Greater amount of net assets as a result of lower Insurance liabilities. CIL creased writing new business from 31 December Thus, its insurance liabilities is expected to reduce over time as it is in run-off; and A reduction in the asset concentration risk charge where the term deposits which were breaching the concentration threshold at 31 December 2015 have since matured, and have not been reinvested (and so the asset concentration risk charge has reduced to nil). EY 12

16 CIL s insurance risk charge and Insurance Concentration Risk Charge ( ICRC ) are nil as at 31 December 2015 and 30 June APRA approved this treatment due to CIL s extensive reinsurance arrangements (which includes an Adverse Development Cover and 100% Quota Share) put in place post MHA purchase. APRA has also approved this treatment to continue post Scheme 3.5 CIL Internal Capital Adequacy Assessment Process ( ICAAP ) As documented in its ICAAP report, CIL determines its required minimum capital, the Prescribed Capital Amount ( PCA ), based on APRA prudential standards. It also holds additional capital, as further protection against claims uncertainty, in accordance with its Capital and Risk Management Policy (CRMP). The CRMP defines the target solvency coverage ratio (SCR) i.e. the ratio of the capital base (actual capital) to the PCA, via Capital Management Zones (CMZ). These target CMZs have been determined by the Board and Management which reflect CIL s risk appetite and the solvency range it wishes to operate in. CIL aims to maintain a PCA coverage ratio of above 1.4. The PCA coverage ratio of 2.12 at 31 December 2015 and 2.48 at 30 June 2016 are above this. According to CIL s capital management plan, this PCA ratio would result in no action being taken. CIL is adequately capitalised and is able to meet its policyholder obligations. 3.6 CIL claims handling, policies and operations Claims handling process Based on the advice provided to me by CIL, I do not believe that there will be any material changes to claims handling processes as a result of the transfer and so no adverse impact on affected policyholders. Specifically, Over the period since CIL was purchased by the Munich Re Group the CIL claims handling process has been aligned to that of the Group. This includes processes for setting and approving changes to case estimates. Claims will continue to be managed on the same underlying claims systems. These vary by agency. Claims will continue to be handled by the same claims staff. I note that in a run-off scenario as the number of claims reduces in the normal course of operations claims management headcount would also reduce. Given the use of external parties to manage many of the claims there is an extensive review process that monitors their claims handling performance. Should there be material performance issues with an external party it is possible that claims handling may be brought in house but this would be a business as usual decision and not as a result of the transfer. Claims will continue to be paid using existing processes. Therefore, in my opinion, there will be minimal impact on the management of claims following the Proposed Transfer. EY 13

17 3.6.2 Policy terms and conditions All contracts subject to the scheme are to be transferred from CIL to GLA without any change to their terms and conditions other than the substitution of GLA for CIL as the licensed insurer. So there will be no adverse impact on policy terms and conditions as a result of the transfer Policy administration By the date of the transfer CIL will be in run-off, that is, no policy will have been written for twelve months. Either a snap-shot of the old policy administration systems or live versions will be available to provide policy information for policies which have expired. However there will still be a number of policies in force comprised of builders warranty and some consumer credit policies. Consumer credit policies will continue to be managed by the external MGA that currently manages them Builders Warranty policies once issued are not subject to change and hence the snapshot of the policy details will be sufficient for GLA to administer the policies post transfer. Given these measures I don t foresee any adverse impact to CIL policyholder administration or CIL policyholders following the transfer. EY 14

18 4. Great Lakes Reinsurance UK SE (Australian Branch) 4.1 Business overview GLA is the Australian branch of Great Lakes Reinsurance (UK) SE and has been in operation since It is authorised by APRA to conduct general insurance business in Australia. Under the terms of Article 8 of the European SE Regulations, Great Lakes Reinsurance (UK) SE will be transferring its registered office from London to Munich, Germany at the start of This re-domiciliation will not have any impact on GLA or CIL policyholders. In order to optimise the use of capital within the Munich Re Group, GLA is heavily reinsured with MRAU, an APRA authorised reinsurer, via a mixture of proportional and non-proportional reinsurance. On 15 June 2016 MHA announced that it intends to pursue divestment of its primary insurance arm GLA. No timeframe to achieve this has been stated and the timing and impact of such a divestment is not known. It is important to note that should a divestment not proceed then the intention for the combined entity (i.e. GLA and CIL post transfer) is to run-off the combined insurance liabilities. As GLA is a branch, the only way the insurance liabilities could be divested would be by way of another Scheme. At such time, details of the impact of the divestment would be known and the impacts on policyholders affected by that scheme would have to be considered again prior to any transfer occurring. Thus, the impact of the GLA divestment decision is not discussed further in this report in the context of the proposed scheme of transfer. The financial projections discussed in this report are based on the assumption that GLA will cease writing new business from 1 April 2017 for all business except travel, which is assumed to cease from 1 October Nature of GLA s written business GLA writes a variety of classes of (mainly commercial) business (liability, fire, engineering, motor) through managing general agents with a small volume of corporate risk written directly (liability, fire, professional indemnity, engineering). With respect to latent claims exposure, such as asbestos and molestation claims, I understand There are no known asbestos exposure as advised by GLA claims management. This is reasonable given GLA started operation in Any unexpected asbestos exposure will be minimized by the extensive reinsurance contracts GLA has in place. There is potentially some exposure to molestation claims from the public liability portfolio in the Munich Reinsurance of America Company (MRAm) relating to underwriting years 2002 and prior (MRAm liabilities were transferred to GLA from 1 December 2010). As at 30 September 2016, there are no notified molestation claims. A gross IBNR allowance of $2.8m (excluding risk margins) is held. This IBNR allowance is intended to cover potential costs should any matters be notified as well as allowing for potential uncertainty in respect of the quantum of any claims that arise. The net impact of these uncertainties and potential latent claims development is significantly limited by the extensive reinsurance arrangements which will continue post the Proposed Transfer. EY 15

19 4.2 GLA insurance liability reserve The discounted net insurance liabilities of GLA have been valued as at 31 December 2015 and 30 June 2016 by GLA's Appointed Actuary, Susan Ley GLA insurance liability reserve as at 31 December 2015 Table 7 shows the results of the insurance liabilities valuation as at 31 December 2016 for GLA. The figures are based on the ILVR as at 31 December 2015 prepared by Susan Ley as the Appointed Actuary Great Lakes Australia (GLA) Report on Insurance Liabilities dated 29 March I understand no material issues on the insurance liabilities were noted by the auditors of CIL. Table 7: CIL discounted net insurance liabilities as at 31 December 2015 at 75% Probability of Sufficiency ( PoS ) ($ m) Central estimate Risk margin Provision Margin as a % of central estimate Claims liabilities % Premium liabilities % Total % The total discounted net insurance liabilities provision at 31 December 2015 was $87.3m. This includes a risk margin of $10.2m, or 13.2% of the net central estimate, to establish a 75% PoS in accordance with APRA requirements. I understand that the liability estimates in GLA s ILVR at 31 December 2015 were adopted by GLA in preparing its 2015 APRA return GLA insurance liability reserve as at 30 June 2016 Table 8 shows the results of the insurance liabilities valuation as at 30 June 2016 for GLA. The figures are based on the ILVR as at 30 June 2016, prepared by Susan Ley as the Appointed Actuary Great Lakes Australia Update report on value of insurance liabilities at 30 June 2016 dated 2 September I have reviewed the methodology, assumptions and results presented in the CIL 2016 ILVR and they appear reasonable. Table 8: GLA discounted net insurance liabilities as at 30 June 2016 at 75% Probability of Sufficiency ( PoS ) ($ m) Central estimate Risk margin Provision Margin as a % of central estimate Claims liabilities % Premium liabilities % Total % The total discounted net insurance liabilities provision at 30 June 2016 was $83.6m. This includes a risk margin of $9.6m, or 13.0% of the net central estimate, to establish a 75% PoS in accordance with APRA requirements. There was a decrease of $3.7m in the total discounted net insurance liabilities central estimate over six months to 30 June The relatively neutral movement in the insurance liabilities is a result of the offsetting movements between general run-off of reported claims and strengthening of reserves in the Travel portfolio to better reflect the recent claims experience. EY 16

20 4.3 GLA balance sheet GLA s assets and liabilities as at 31 December 2015 and 30 June 2016 are shown in Table 9. Table 9: GLA Balance Sheet as at 31 December 2015 and 30 June 2016 ($m) Assets 31 December June 2016 Cash and investments Reinsurance recoveries Unearned premium recoveries Other Total assets Liabilities Gross outstanding claims Unearned premium Other Total liabilities Net assets APRA Capital base Source: GLA APRA returns 4.4 GLA solvency position Table 10 shows GLA s PCA and capital base as at 31 December 2015 and 30 June EY 17

21 Table 10: GLA APRA Solvency Requirements as at 31 December 2015 and 30 June 2016 ($m) Prescribed Capital Amount 31-December June-2016 Insurance risk charge Insurance Concentration risk charge Asset risk charge Asset Concentration risk charge Operational risk charge Less Aggregation Benefit Prescribed Capital Amount Capital Base Net assets Less net assets outside Australia Plus net surplus/deficit relating to insurance liabilities (1) Outstanding claims provisions surplus/deficit (2) Premium liabilities surplus/deficit (3) Less tax effect of net outstanding claims provisions and premium liabilities surplus/deficit Total net surplus/deficit relating to insurance liabilities Less deferred tax assets (net of any deferred tax liability) Total Capital Base Capital surplus PCA coverage ratio* Target capital ^ Target capital coverage ratio # Source: GLA APRA returns * PCA coverage ratio = Total capital base / PCA ^ Target capital = 1.3 x PCA at 31 December 2015 and 1.4 x PCA at 30 June 2016 # Target capital coverage ratio = Total capital base / Target capital At 31 December 2015, the PCA for GLA was $39.9m with a capital surplus of $23.2m. At 30 June 2016, the PCA was $41.1m with a capital surplus of $27.1m. The PCA coverage ratio increased from 1.58 at 31 December 2015 to 1.66 at 30 June The increase is mainly due to a one off adjustment regarding reinsurance recoveries which increased the capital base. EY 18

22 4.6 GLA Internal Capital Adequacy Assessment Process ( ICAAP ) Similar to CIL and as documented in its ICAAP report, GLA determines its required minimum capital, the Prescribed Capital Amount ( PCA ), based on APRA prudential standards. It also holds additional capital, as further protection against claims uncertainty, in accordance with its Capital and Risk Management Policy (CRMP). The CRMP defines the target solvency coverage ratio (SCR) i.e. the ratio of the capital base (actual capital) to the PCA, via Capital Management Zones (CMZ). These target CMZs have been determined by the Board and Management which reflect GLA s risk appetite and the solvency range it wishes to operate in. GLA s target CMZ is to maintain a PCA coverage ratio between 1.4 and 1.8. The PCA coverage ratio of 1.58 at 31 December 2015 and 1.66 at 30 June 2016 are within the target CMZ. According to GLA s capital management plan, this PCA ratio would result in no action being taken. GLA is adequately capitalised and is able to meet its policyholder obligations. 4.7 GLA s approach to CIL claims and policies GLA s approach to handling CIL claims will be largely unchanged from CIL s existing approach. There will be no adverse impact on affected policyholders. All contracts subject to the scheme are to be transferred from CIL to GLA without any change to their terms and conditions other than the substitution of GLA for CIL as the licensed insurer. EY 19

23 5. Impact of Proposed Transfer on solvency 5.1 Insurance liability reserve after the Proposed Transfer It is expected that, due to diversification benefits in the risk margins, GLA s insurance liabilities after the Proposed Transfer will be slightly lower than the sum of CIL s insurance liabilities and GLA s insurance liabilities before the Proposed Transfer. However, it has been assumed that there are no diversification benefits in the pro forma calculations of the risk margins included in the insurance liabilities for the purpose of the Proposed Transfer. This is a conservative approach but not unreasonable given the size of CIL s liabilities. Therefore, the net insurance liabilities for GLA at 30 June 2016 after the Proposed Transfer will increase by CIL s net insurance liabilities at 30 June 2016 of $52.2m (predominantly outstanding claims liabilities as CIL is in run off). 5.2 Pro forma balance sheet after the Proposed Transfer The pro forma balance sheets assuming the Proposed Transfer had occurred on 30 June 2016 displaying the assets and liabilities for CIL, GLA and GLA after the Proposed Transfer are shown in Table 11. Table 11: Pro forma balance sheets of CIL and GLA after the Proposed Transfer ($m) Assets 30 June 2016 Before the Proposed Transfer 30 June 2016 After the Proposed Transfer CIL* GLA** CIL GLA Cash and investments Reinsurance recoveries Unearned premium recoveries Other Total assets ,019.3 Liabilities Gross outstanding claims Unearned premium Other Total liabilities Net assets Source: balance sheet pro forma as at 30 June 2016 * From Table 5 ** From Table 9 As shown in column 4 in Table 11 above, GLA will assume the full gross risk of CIL s insurance liabilities and other liabilities related to CIL s insurance business, increasing GLA s total liabilities by $156.6m after the Proposed Transfer. As an offset, GLA will gain assets equal to the value of the transferred liabilities, increasing GLA s assets by an amount of $156.6m. Thus, the Proposed Transfer will have a zero impact on net assets of GLA after the transfer from EY 20

24 CIL. The net assets for CIL total $18.5m after the Proposed Transfer. I understand that on revocation of CIL s license, CIL will settle outstanding non-underwriting liabilities and repatriate the remaining capital to CIL s parent. 5.3 Reinsurance recoveries Treatment of CIL s existing reinsurance arrangements I understand that CIL undertook a process to identify all material inforce reinsurance treaties and their respective reinsurers for the CIL portfolio. The reinsurance treaties relating to the REAC portfolio and prior to 1 March 2005 have not been reviewed. However, the underlying claims liabilities relating to these treaties are minimal and any potential adverse development from these claims will be limited by the Adverse Development Cover. Appendix C shows CIL s reinsurance recoveries balance at 30 June 2016 by reinsurer. Each of CIL s reinsurance contracts will be transferred to GLA, so that GLA will receive the recoveries and associated benefits that CIL previously received. Based on advice provided to me by CIL that unless the reinsurer is domiciled overseas and the legal jurisdiction specified in the contract is outside Australia (or not specified) then as part of the scheme orders the following will also occur: CIL's rights and obligations under the reinsurance treaties will transfer to GLA, and The reinsurance agreements to which CIL is a party will be amended to substitute GLA for CIL. Notwithstanding this, APRA has requested and CIL has agreed to arrange for contracts with material exposure to non-apra authorised reinsurers (i.e. the liability excess of loss contracts) to have novation deeds put in place prior to the court approving the scheme. This will be undertaken in the period December 2016 to January Based on the analysis provided by CIL, I am satisfied that a robust process has been undertaken to identify material reinsurance arrangements and their respective reinsurers in relation to CIL s liabilities to be transferred Recoverability of CIL s reinsurance recoveries after the Proposed Transfer For CIL, the composition of the reinsurance recoveries and receivables as at 30 June 2016 is as follows: Approximately 92.5% is with APRA authorised reinsurers, of which 80% is with MRAU which is an APRA authorised reinsurer with an S&P rating of AA-. MRAU has agreed to novate its reinsurance contracts from CIL to GLA at the Transfer Date. Approximately 5% is with Australian State governments (arising from the Builders Warranty business) or is collateralised The remaining 2.5% ($2.6m) is with non APRA authorised reinsurers and not collateralised. In the scenario where these are not recoverable, the SCR will reduce but still remain within the target CMZ. In addition, APRA has requested novation deeds to be put in place for non APRA authorised reinsurers with material exposures prior to court approval The reinsurance arrangements for ReAC and Australian Unity business have not been reviewed due to materiality grounds. Non-recoverability of these recoveries will not materially impact the SCR. EY 21