Zurich Australia Limited & Macquarie Life Limited Independent Actuarial Report

Transcription

1 Zurich Australia Limited & Macquarie Life Limited Independent Actuarial Report See the unforeseen. 15 August 2016

2 Deloitte Actuaries & Consultants Limited ACN AFSL Bourke Street Melbourne VIC 3000 GPO Box 78 Melbourne VIC 3001 Australia Tel: Fax: +61 (0) Tim Howell Chief Actuary Zurich Australia Limited 5 Blue Street North Sydney NSW 2060 Daniel Longden Head of Product & Actuarial Macquarie Life Limited 1 Martin Place Sydney NSW August 2016 Dear Tim and Daniel Re: Independent Actuarial Report Macquarie Life Limited has entered into a transaction to transfer the Life Risk Insurance Liabilities within Statutory Fund No. 4 ( Business ) of Macquarie Life Limited ( Macquarie Life, MLL ) to Zurich Australia Limited ( Zurich, ZAL ). Macquarie Life and Zurich (the Companies ) have engaged Deloitte Actuaries & Consultants Limited ( Deloitte ) to prepare an independent actuarial report ( the Report ) to provide an opinion in relation to the policyholder implications of the proposed Part 9 transfer of the Macquarie Life Business to Zurich ( the Proposed Transfer ). Our Report considers the nature and impact of the Proposed Transfer on policyholders of MLL and ZAL including whether the Proposed Transfer: (a) Properly and adequately safeguards their contractual benefits and other rights; and (b) Is expected to result in any adverse impact. In preparing our opinions in regards to the Proposed Transfer, we consider the effect of the Proposed Transfer on the following areas for MLL and ZAL Policyholders: Contractual benefits and other rights, Reasonable benefit or other policyholder expectations, Benefit security (including capital position, investment strategy, reinsurance arrangements and risk management framework), and Any other matters that arise in the course of our review of the Proposed Transfer which have the potential to impact on either group of policyholders. Our Report is subject to Reliances and Limitations which are set out in Section 8 of the Report. Yours sincerely Caroline Bennet Liability limited by a scheme approved under Professional Standards Legislation. Member of Deloitte Touche Tohmatsu Limited

3 Contents 1 Executive Summary Scope of report Summary of the Proposed Transfer Approach Opinion on Macquarie Life policyholders Opinion on Zurich policyholders Reliances and limitations 4 2 Introduction Scope of report Terminology The Independent Expert Reliances and sources of information Form of the Report 8 3 Overview of Macquarie Life business Statutory Funds Products Financial position Investment strategy and asset allocation Expense allocation Underwriting of sum insured increases Risk Management Framework Reinsurance arrangements Proposed dividends and transfers Recent significant events 13 4 Overview of Zurich business Statutory Funds Products Financial position Investment strategy Expense allocation Underwriting of sum insured increases Risk Management Framework Reinsurance arrangements 17 Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee, and its network of member firms, each of which is a legally separate and independent entity. Please see for a detailed description of the legal structure of Deloitte Touche Tohmatsu Limited and its member firms. Liability limited by a scheme approved under Professional Standards Legislation Deloitte Actuaries & Consultants Limited

4 4.9 Proposed dividends and transfers Recent significant events 17 5 Overview of the Proposed Transfer Scheme of Arrangement ZAL Strategic Rationale Product and pricing transition plan Claims management and philosophy Customer service Changes to reinsurance arrangements Financial position Capital management / dividend strategy Expenses and transition costs 24 6 Impact of the proposal on Macquarie Life policyholders Impact on MLL Transferring Policyholders Impact on MLL Remaining Policyholders 30 7 Impact of the proposal on Zurich policyholders Impact on contractual benefits and rights Reasonable expectations Benefit security Conclusion 34 8 Reliances and Limitations 35 Appendix A Glossary 36 Appendix B Information Relied Upon 39 Appendix C Product Summaries 41 MLL Product Summary 41 ZAL Product Summary 42 Appendix D Reinsurance Summaries 43 MLL Reinsurance Summary 43 ZAL Reinsurance Summary 43 Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee, and its network of member firms, each of which is a legally separate and independent entity. Please see for a detailed description of the legal structure of Deloitte Touche Tohmatsu Limited and its member firms. Liability limited by a scheme approved under Professional Standards Legislation Deloitte Actuaries & Consultants Limited

5 1 Executive Summary Executive Summary 1.1 Scope of report Deloitte ( we, us ) have been engaged by Macquarie Life Limited ( Macquarie Life, MLL ) and Zurich Australia Limited ( Zurich, ZAL ) to prepare an independent actuarial report ( the Report ) which provides an opinion in relation to the policyholder implications of the proposed Part 9 transfer of the Macquarie Life Business to Zurich ( the Proposed Transfer ). Our Report considers the nature and impact of the Proposed Transfer on policyholders of MLL and ZAL including whether the Proposed Transfer: Properly and adequately safeguards their contractual benefits and other rights; and Is expected to result in any adverse impact. In preparing our opinion in regards to the Proposed Transfer, we consider the effect of the Proposed Transfer on the following areas for MLL and ZAL Policyholders, both those that are transferring and those that are remaining: Contractual benefits and other rights, Reasonable benefit or other policyholder expectations, Benefit security (including capital position, investment strategy, reinsurance arrangements and risk management framework ( RMF )), and Any other matters that arise in the course of our review of the Proposed Transfer which have the potential to impact on either group of policyholders. The policyholders referred to throughout this report includes the members of any trust of which a policyholder is a trustee and members of any group insurance scheme of which the policyholder holds the policy. In preparing this report, we have considered the interest of both policyholders and underlying beneficiaries. In preparing the opinion, we have focussed on the changes that arise as a result of the Proposed Transfer, rather than changes that might arise in the ordinary course of business. 1.2 Summary of the Proposed Transfer MLL and ZAL have entered into a transaction to transfer the MLL Policies and the Life Risk Insurance Liabilities from Statutory Fund No. 4 of MLL ( the Business ) as at the date of the Proposed Transfer to ZAL. The Proposed Transfer will be effected via a Scheme of Transfer ( the Scheme ) under which: The MLL Policies and the Life Risk Insurance Liabilities from MLL Statutory Fund No. 4 will be transferred to Zurich s Statutory Fund No. 2 ( SF2 ). The Proposed Transfer will involve the transfer of all the liabilities that relate to MLL Statutory Fund No. 4 (the Life Risk Insurance Liabilities ), except for various tax and Macquarie Group Independent Actuarial Report 1

6 Executive Summary related liabilities. Assets of MLL s Statutory Fund No. 4 ( SF4 ) will be transferred or assigned to ZAL s SF2. All rights and liabilities under the life insurance policies and contracts relating to MLL s SF4 will transfer to ZAL, and MLL SF4 policyholders will become policyholders of ZAL. This includes the obligations in relation to claims, regardless of when the claim was incurred, and in relation to commissions. Claims, customer service, and other in-scope MLL staff will be transferred and integrated into ZAL s team during a transition period. Existing reinsurance arrangements for in-force MLL business will be transferred to ZAL. All costs associated with the Proposed Transfer will be borne by the shareholders of ZAL and the shareholders of MLL. The details of the Proposed Transfer are more fully described in Section 5. It is anticipated that the Scheme will be effective 1 October Approach In order to assess how the Proposed Transfer may affect the contractual benefits and other rights, policyholder expectations and benefit security it is necessary to identify the activities and decisions that may be taken which may impact on policyholders. In particular, there are areas of the benefits provided which involve discretion being applied by the company. We consider how MLL applied such discretions historically and our understanding of ZAL s future intentions in these areas. In assessing the potential policyholder impact of the Proposed Transfer we consider: The potential differences in management of policies and policyholders in the future. This will be assessed by reviewing historical and intended management approach of both ZAL and MLL for the different groups of policyholders (including particularly product strategy, underwriting and claims management); The transition period, and potential impact on customer service level, claims management and sales/lapse impacts; The readiness of the ZAL management team to successfully execute the integration between the two companies and potential impact on the existing ZAL Policyholders; The management of risk and capital including Target Surplus and dividend policy and the resulting financial position/strength of ZAL post transfer; The management of participating policyholders 1.4 Opinion on Macquarie Life policyholders Transferring Policyholders The summary of observations in relation to policyholder impact of the Proposed Transfer for MLL Transferring Policyholders is: 1. There will be no changes to the contractual benefits and other rights of MLL Transferring Policyholders. 2. In relation to areas where decisions are being made which could impact transferring policyholder expectations, the decisions taken by ZAL to date result in no material changes to MLL Transferring Policyholders. 3. ZAL acknowledges that there are a range of decisions that will be required in future that arise Independent Actuarial Report 2

7 Executive Summary from the Proposed Transfer. Some of these issues have been addressed, and there are some for which the proposed approach is yet to be finalised. ZAL intends that all issues will be addressed in a manner that ensures no adverse impact on policyholders directly as a result of the Proposed Transfer. 4. Service provided to MLL Transferring Policyholders in future by ZAL should be at least at levels experienced while policyholders of MLL as a result of the Proposed Transfer given ZAL s commitment to take on staff and systems and to execute on a comprehensive integration plan. 5. MLL Transferring Policyholders will not be exposed to the costs of transition as a result of the Proposed Transfer being implemented. Costs relating to the Proposed Transfer will be met by MLL and ZAL shareholders. 6. Security of policyholder benefits should not be adversely impacted by the Proposed Transfer. The capital position of ZAL after the Proposed Transfer is sound with the merged capital position indicating that after the Proposed Transfer benefit security is maintained. Further, it can be seen that ZAL s penultimate parent (Zurich Insurance Company Ltd ( ZIC )) which is the main operating company of Zurich Insurance Group Ltd) also provides a relatively stronger shareholder, as measured by their S&P credit ratings is as follows: Holding company Macquarie Group Limited Zurich Insurance Company Ltd S&P Long Term Credit Rating BBB/stable AA-/stable Figure 1: Credit Rating 7. ZAL has an interest in enhancing their scale and overall capability in life insurance market with an increased presence in Australia. In actively working towards these goals, ZAL will continue to meet policyholder expectations and act in the interests of MLL Transferring Policyholders. Given the above, it is concluded that the Proposed Transfer will not materially adversely affect any group of MLL Transferring Policyholders in respect of: Contractual rights Reasonable benefit or other policyholder expectations Benefit security Remaining Policyholders The summary of observations in relation to impact of the Proposed Transfer for MLL Remaining Policyholders is: 1. There will be no changes made to the contractual policy terms and conditions of the MLL Remaining Policyholders. 2. There will be no material changes to the management of the MLL Remaining policies. Therefore, the Proposed Transfer will not have any adverse impact on the reasonable expectations of the MLL Remaining Policyholders. 3. The benefit security of the MLL Remaining Policyholders will not be materially adversely affected by the Proposed Transfer with the statutory funds and entity overall continuing to operate within the regulatory and Macquarie Group frameworks for risk and capital management. Independent Actuarial Report 3

8 Executive Summary Given the above, it is concluded that the Proposed Transfer will not materially adversely affect any group of MLL Remaining Policyholders in respect of: Contractual rights Reasonable benefit or other policyholder expectations Benefit security. 1.5 Opinion on Zurich policyholders The summary of observations in relation to policyholder impact of the Proposed Transfer on ZAL s existing policyholders is: 1. There will be no changes to the contractual benefits and other rights of ZAL Policyholders. 2. There are no adverse changes proposed to the ZAL products, product strategy, customer service levels or claims management. Changes may arise where Zurich plans to implement better features or practices of MLL which should not see ZAL Policyholders disadvantaged by the Proposed Transfer. 3. All the costs associated with the transfer will be allocated to the ZAL Shareholder s Fund ( SHF ) and will be met via a capital injection. Ultimately, successful integration is expected by ZAL to lead to unit cost savings due to economies of scale. 4. ZAL participating policyholders will continue to be managed via a separate sub-fund with no changes to investment policy, profit allocation approach, expense allocation approach and bonus policy. In addition, ZAL participating policyholders may benefit from any expense synergies achieved post the Proposed Transfer, subject to the operation of the existing unit cost cap. 5. The capital position of ZAL, for each Statutory Fund and the entity overall, post transfer is expected to remain sound after completion of the Proposed Transfer with no diminution in benefit security for policyholders. Given the above, it is concluded that the Proposed Transfer will not materially adversely affect any group of ZAL Policyholders in respect of: Contractual rights Reasonable benefit or other policyholder expectations Benefit security. 1.6 Reliances and limitations In forming the opinions contained in this Report, we have relied on the accuracy and completeness of information provided to us by MLL and ZAL, both orally and in writing, without independently verifying it. The detailed reliances and limitations are set out in Section 8. This Report should be considered in its entirety. This Executive Summary is intended to provide an overview of this Report and does not cover all of the issues addressed in the Report. This Report is solely for the purpose set out in the Scope section of the Report and is not to be used for any other purpose. This report has been prepared at the request of MLL and ZAL in accordance with the terms of our engagement letter dated 24 March Third parties who use this Report acknowledge that they are not a party to the engagement letter dated 24 March Deloitte shall not be liable for any losses, claims, expenses, actions, demands, Independent Actuarial Report 4

9 Executive Summary damages, liabilities or any other proceedings arising out of any reliance by the third parties on this Report. Independent Actuarial Report 5

10 2 Introduction Introduction 2.1 Scope of report With reference to Section 192 of the Life Insurance Act 1995, Deloitte has been engaged by ZAL and MLL to prepare an independent actuarial report, which provides an opinion in relation to the policyholder implications of the proposed Part 9 transfer of the Macquarie Life Business to Zurich. The Proposed Transfer arises because MLL has entered into a transaction to sell the risk insurance business within Statutory Fund No. 4 of Macquarie Life to Zurich. Our Report considers the nature and impact of the Proposed Transfer on policyholders of Macquarie Life and Zurich including whether the Proposed Transfer: Properly and adequately safeguards their contractual benefits and other rights; and Is expected to result in any adverse impact. In preparing our opinions in regards to the Proposed Transfer, we consider the effect of the Proposed Transfer on the following areas for Macquarie Life and Zurich policyholders, both those that are transferring and those that are remaining: Contractual benefits and other rights, Reasonable benefit or other policyholder expectations, Benefit security (including capital position, investment strategy, reinsurance arrangements and Risk Management Framework), and Any other matters that arise in the course of our review of the Proposed Transfer which have the potential to impact on either group of policyholders. We have reviewed the internal Actuarial Reports (jointly the Actuarial Reports ) titled: ZAL Appointed Actuary Report on the Proposed Scheme of Transfer of the Life Risk Insurance Business of Macquarie Life Limited to Zurich Australia Limited ( the ZAL Report ), prepared by Timothy Howell, dated 15 August 2016; and MLL Actuarial Report on the Proposed Scheme of Transfer of the Risk Insurance Life Insurance Business of Macquarie Life Limited to Zurich Australia Limited ( the MLL Report ), prepared by Martin Paino, dated 15 August These Actuarial Reports describe a proposed scheme of transfer ( Scheme ) of the Business and provide an analysis of the impact on the policyholders terms and benefit security. Our opinion is prepared independently of these Actuarial Reports. In preparing our opinions, we have focussed on the changes that arise as a result of the Proposed Transfer, rather than changes that might arise in the ordinary course of business irrespective of the Proposed Transfer. The Report has been prepared in compliance with the requirements of the Institute of Actuaries of Australia including the Code of Professional Conduct and Professional Standard 200, as well as with the Federal Court of Australia s (the Court ) Practice Note CM 7 on Expert witnesses in proceedings Independent Actuarial Report 6

11 Introduction in the Federal Court of Australia. 2.2 Terminology In the remainder of this Report, the different parties and groups of policyholders are to be referred to as per the figure below: Macquarie Life ( Transferor ) Zurich ( Transferee ) MLL Transferring Policyholders (SF4) MLL Remaining Policyholders (SF1-3, 5, Shareholder s Fund) ZAL Policyholders Figure 2: Policyholder Terminology A full glossary of terms is provided in Appendix A. All monetary amounts in this Report are denominated in Australian Dollars, unless otherwise stated. 2.3 The Independent Expert When a scheme for the transfer of insurance business from one company to another is submitted to the Court for approval, the Australian Prudential Regulation Authority ( APRA ) may arrange for an independent actuary to make a written report on the Scheme. This is a provision in Section 192 of the Life Insurance Act 1995, and APRA may give a copy of the report to each company affected by the scheme. We have been appointed jointly by MLL and ZAL (the Companies ), and the appointment has been approved by APRA. This Report has been prepared by a team led by Ms Caroline Bennet, the Independent Expert who provides this Report on a proposed scheme for the transfer of the Macquarie Life business to Zurich. Caroline Bennet is a Fellow of the Institute of Actuaries of Australia, having qualified in She is a Partner of Deloitte Touche Tohmatsu, having been admitted as a Partner in Ms Bennet is the National Leader of Deloitte Australia s actuarial practice and leader of Deloitte Australia s Financial Services Industry Consulting team. Ms Bennet has previously been approved as fit and proper for Appointed Actuary roles. Opinions provided by Ms Bennet are based wholly or substantially on the specialised knowledge acquired through actuarial training and experience as a practitioner. Ms Bennet has read, understood and complied with the Federal Court of Australia s Practice Note CM 7 on Expert witnesses in proceedings in the Federal Court of Australia. Neither Ms Bennet, nor her immediate family, hold any policies, investments, shareholdings or have any other financial interests with either of the Companies, nor has she advised the Companies on any significant projects in the past. Deloitte has previously provided and may continue to provide, a range of services to both Companies. However, we have not acted as external auditor or performed any regulatory roles. We have not acted for the Companies in developing any aspects of the Scheme, and have not carried out any of the calculations (or the development of any of the underlying financial models) connected with the Independent Actuarial Report 7

12 Introduction Scheme. We do not believe that any of these assignments compromise Ms Bennet s ability to report independently on the Proposed Transfer. 2.4 Reliances and sources of information In forming our opinion, we have relied on the accuracy and completeness of information provided to us by MLL and ZAL, both orally and in writing, without independently verifying it. The full list of documents relied upon can be found in Appendix B. We note that projections of future financial position and estimates of insurance liabilities are generally subject to inherent uncertainties. The actual financial position on MLL and ZAL at the Scheme transfer date and beyond is subject to the outcome of events that have not yet occurred. Actual experience could vary significantly from the estimates contained within this Report and the Actuarial Reports. Deviations are normal and are to be expected. The outcome of insurance business and ongoing solvency of ZAL cannot be guaranteed. We note that no absolute guarantee can be provided given the inherent uncertainty in insurance outcomes. 2.5 Form of the Report The remainder of this Report is structured as follows: Section 3 provides an overview of the Macquarie Life business and the transferring statutory fund (SF4) Section 4 provides an overview of the Zurich business and the receiving Statutory Fund No. 2 Section 5 summarises the proposed Scheme and the key changes which are likely to impact policyholders Section 6 explains the impact of the Proposed Transfer on the Macquarie Life policyholders, both those transferring and those remaining. It sets out our analysis and conclusions on how these policyholders are affected by the Scheme in respect of: o o o Contractual benefits and rights Policyholder reasonable expectations Security of policyholder benefits Section 7 explains the impact of the Proposed Transfer on the Zurich policyholders. It sets out our analysis and conclusions on how these policyholders are affected by the Scheme in respect of: o o o Contractual benefits and rights Policyholder reasonable expectations Security of policyholder benefits Section 8 provides the Reliances and Limitations that we place on our Report Further detail is given in the Appendices, including a glossary and the full list of documents and information that have been relied upon in forming our conclusion. Independent Actuarial Report 8

13 Overview of Macquarie Life business 3 Overview of Macquarie Life business MLL is a subsidiary of Macquarie Bank Limited ( MBL ), which itself is a subsidiary of Macquarie Group Limited ( MQG ), the ultimate parent company. MLL is operationally part of the Macquarie Asset Management ( MAM ) and Banking & Financial Services ( BFS ) group divisions. MLL operates only in Australia and all policies (with the exception of the Statutory Fund No. 5 business) are denominated in Australian dollars. 3.1 Statutory Funds MLL has five statutory funds. Statutory Fund No. 1 ( SF1 ) There is a small amount of retail and wholesale superannuation investment linked policies (covering a broad range of investment pool options) remaining in the fund. It is closed to new members. Statutory Fund No. 2 ( SF2 ) This fund is dormant as at 31 December Statutory Fund No. 3 ( SF3 ) There is a small amount of retail and wholesale superannuation investment linked policies (focusing on short term fixed interest investment pools) remaining in the fund and is closed to new members. Statutory Fund No. 4 ( SF4 ) This fund contains MLL s risk insurance business, including Death/Terminal Illness, Total and Permanent Disability ( TPD ), Trauma, and Disability Income. It also contains consumer credit insurance business, including Mortgage Protection, Consumer Credit Insurance, and Involuntary Unemployment cover. Statutory Fund No. 5 ( SF5 ) This fund is dormant as at 31 December MLL previously reinsured a share of the risk associated with direct marketed accident death and disability products issued in Japan. The product was closed to new business and the existing business recaptured from 31 March Under the terms of the recapture agreement MLL retains a residual Incurred But Not Reported ( IBNR ) liability that expired on 31 March The Shareholder s Fund ( SHF ) is maintained separately from the Statutory Funds as required by the Life Insurance Act. The main activities of the SHF include the investment of the assets of SHF and the management of a portfolio of investment linked products known as the True Indexing Swap portfolio. During 2015, the True Indexing Swap business was sold to a related Macquarie entity. The True Indexing Swaps will continue to be issued by MLL until investor consultation in respect of the transfer has occurred. The Scheme is in respect of the transfer of the business held within SF4. The other Statutory Funds SF1, SF2, SF3, SF5 and the SHF remain with MLL and are expected to continue to be managed in line with the existing plan for these parts of the business. MLL issues individually underwritten insurance products from SF4, distributed predominantly through independent financial advisers and risk specialists. For the 9 months ended 31 December 2015, the key financial metrics were: Independent Actuarial Report 9

14 Overview of Macquarie Life business Measure SF1 SF2 SF3 SF4 SF5 SHF Profit (NPAT) In-force annual premium (IFAP) Gross Premium Income Figure 3: MLL Financial Metrics Note that the NPAT for the Shareholder s Fund excludes a one-off profit resulting from the sale of the True Index business to another Macquarie Group entity, and the NPAT for SF1 excludes a one-off profit resulting from the sale of investment management rights to another Macquarie Group entity. 3.2 Products The MLL insurance business strategy from inception has been to avoid product commoditisation and pure price competition and establish a market position based on: Innovation, in both product and service High quality service and ease of doing business for advisers Sustainable product design, remuneration structures and pricing The three core products in SF4 are FutureWise, Active and Sumo. There are no participating products, and MLL does not participate in the group insurance market. A full list of MLL products can be found in Appendix C. Product Description Status FutureWise Active The product is sold through risk writers, the Macquarie Investment Management Wrap platform, and independent financial advisers to self-managed superannuation arrangements and individuals. The product provides death, TPD, trauma and disability income benefits. Active is distributed through licensed independent risk advisers on an advice basis and direct to clients on a nonadvice basis. The product provides severity based lump sum benefits, disability benefits and child trauma benefits. Open to new business Open to new business Sumo Sumo is sold to individuals and self-managed superannuation arrangements. The product is specifically targeted a high net worth individuals who have a need for insurance cover in excess of current market maximum limits. The product provides death, TPD, trauma and disability income benefits. Open to new business Figure 4: MLL Key Products Key features of MLL s products are: Guaranteed product upgrades: MLL maintained a single series for each of its product suites, with all existing policies upgraded to the current policy terms. Within this framework different pricing series did exist. Limited re-pricing: Since inception, MLL has re-priced its in-force disability income book only once, and this repricing was implemented in Independent Actuarial Report 10

15 Overview of Macquarie Life business Plans for product development: Prior to the agreement to sell the Business to ZAL, MLL had no current plans to develop or launch new product lines or business activities within the current business plan period (FY16-FY18). No changes are proposed to product or distribution strategy. MLL expected to change product remuneration structures in line with the proposed industry framework applying from 1 July Financial position The financial position of MLL SF4 as at 31 December 2015 is shown below including Net Assets, Regulatory Capital requirements and capital in excess of these requirements: Summary of Capital Position as at December 15 SF1 SF2 SF3 SF4 SF5 SHF ($'m) Assets Policy Liabilities (net of reinsurance) (440.7) 0.0 (353.8) (5.0) Other liabilities (10.9) (0.6) (6.3) (25.7) (0.5) (9.1) Net Assets Assets and liabilities adjustments (109.8) Capital Base Prescribed Capital Amount (PCA) Capital in excess of PCA Figure 5: MLL Financial Position Note that the Shareholder s Fund in the table above largely reflects the profits arising from the True Index Swap portfolio, prior to the sale of this business. The PCA amount shown in the table does not include any capital held in respect of the True Index Swap portfolio. Regulatory Capital requirements (the PCA) are established by APRA and described in a series of Prudential Standards. The Australian Regulatory Capital requirements are targeted so that the insurer will be able to withstand a 1 in 200 year loss event and still remain solvent (i.e. the remaining assets would be sufficient to cover the Policy Liabilities and other liabilities of the fund at the end of the year). APRA may also specify supervisory adjustments on top of the PCA. APRA also expects life insurers to hold additional capital in addition to these Regulatory Capital amounts which is known as Target Surplus. Target Surplus aims to minimise the probability of the Regulatory Capital requirements being breached. Target Surplus policy is defined by the Board of the life insurer. In order to meet these capital requirements, the Capital Base of the life insurer must be sufficient to cover (at least) the PCA, while companies aim to ensure it is sufficient to cover their Target Surplus too. The Capital Base is based on the net assets within each fund, adjusted for certain restrictions based on the quality of the support provided by the various forms of capital ( assets and liabilities adjustments in the table above). At December 2015, MLL forecast that the main capital strain over the next three years would be due to new business capital strain as a result of increased volumes. SF4 was projected to require a small additional capital contribution in FY16 driven by a change in basis for disability income claims. A capital transfer from another fund within MLL was made in November 2015 to meet this additional expected capital requirement. MLL is well capitalised, meeting both internal and Regulatory Capital benchmarks. MLL was expected to generate strong capital surpluses across all business lines over each of the next three years. Independent Actuarial Report 11

16 Overview of Macquarie Life business 3.4 Investment strategy and asset allocation For SF4, MLL adopts a conservative investment strategy with assets backing capital requirements and uncommitted capital invested in cash. The two primary investment structures used by the statutory and shareholders funds are: Cash management accounts held with MBL. Units in the Macquarie Treasury Fund ( MTF ). The MTF is an AAA rated cash management trust with an investment target to match the Bloomberg AusBond Bank Bill Index (previously named the UBS Bank Bill Index). Statutory Funds other than SF4 contain unit linked business and therefore the asset allocation of assets backing Funds Under Management ( FUM ) depends on policyholder investment options. 3.5 Expense allocation MLL s basic policy administration, sales and marketing, business management, finance, investment management and reporting functions are substantially conducted in-house by the MAM and BFS divisions of Macquarie Group. Some claims management and underwriting support services are performed externally by International Life Insurance Solutions Pty Limited ( ILIS ), which is a Macquarie Group company located in South Africa. These services are provided on a cost-recovery basis plus a margin of up to 10% (15% for ILIS). This accounts for both direct expenses and a share of overheads. Expenses are allocated between products, functions and cost categories by splitting up direct product expenses and overheads (which are allocated according to timesheets, head count or policy count). 3.6 Underwriting of sum insured increases MLL has a heavily reinsured life insurance portfolio. Its underwriting standards are based on a combination of internal rules and rules published by MLL s reinsurers. Therefore MLL is limited in its underwriting flexibility regarding sum insured increases on existing business as underwriting rules for the reinsurer predominantly apply. 3.7 Risk Management Framework MLL s Risk Management Framework ( RMF ) is designed to support MLL s risk management strategy, which is to identify and manage the material risks faced by MLL consistent with MLL s risk appetite, and ensure that sufficient capital is held against the residual risk exposure to MLL. MLL s key risk statements include the following risk categories: Insurance risk: MLL has limited appetite for insurance risk with strong controls regarding reinsurance. Operational risk: Framework for assessment of residual risk is applied and Board involvement is required where the assessed level of residual risk is above a defined level. Risk ratings are based on the methodology detailed within the MLL Risk Management Strategy. Profit volatility: MLL has appetite to accept short term profit volatility (subject to appropriate return on capital and shareholder and policyholder security levels) and absolute stability of earnings therefore is not a primary objective. Cross subsidies and loss making business: In some circumstances MLL may accept losses or returns below the defined profitability targets for new business lines or particular products within a broader business portfolio. Independent Actuarial Report 12

17 Overview of Macquarie Life business 3.8 Reinsurance arrangements MLL uses reinsurance heavily to transfer a material proportion of its insurance claims and persistency risk to reinsurers. The MLL reinsurance strategy is to maintain a high level of reinsurance to manage ongoing profit volatility, gain greater capital efficiencies and leverage return on capital. The reinsurance arrangements for core products are summarised in Appendix D. 3.9 Proposed dividends and transfers Under MLL capital management policy, assets in excess of Target Surplus are available for distribution Recent significant events We understand that there have been no significant events since the 31 December 2015 numbers and information contained in this Report that would change the conclusions of the Report. Independent Actuarial Report 13

18 Overview of Zurich business 4 Overview of Zurich business Zurich Australia Limited is a direct wholly owned subsidiary of Zurich Financial Services Australia ( ZFSA ), which is itself a wholly owned subsidiary of ZIC incorporated in Switzerland. ZIC is wholly owned by Zurich Insurance Group Ltd, the ultimate holding company. ZAL operates only in Australia and all policies are denominated in Australian dollars. 4.1 Statutory Funds ZAL has two Statutory Funds: Statutory Fund No. 2 ( SF2 ) - which contains ordinary and superannuation insurance business covering both mortality and morbidity risks. It also contains both participating and non-participating traditional and investment account business. A full list of Related Product Groups ( RPG ) is provided in Appendix C. Statutory Fund No. 3 ( SF3 ) - which contains ordinary and superannuation investment linked business. The Shareholder s Fund ( SHF ) is maintained separately from the Statutory Funds as required under the Life Insurance Act. The main activity under the SHF is the investment of assets of the SHF. For the 12 months ended 31 December 2015, SF2 and SF3 had: Measure SF2 ($m) SF3 ($m) SHF ($m) Detail Profit (NPAT) In-force annual premium (IFAP) n/a n/a SF3 contains unit linked business. Retail FUM was $1.36bn during 2015 and Wholesale FUM was $0.138bn Gross Premium Income Figure 6: ZAL Financial Metrics 4.2 Products The existing business in each Statutory Fund is summarised in the table below. These products include, amongst others, participating business as well as Group business. Statutory Fund No. 2 Statutory Fund No. 3 Individual Traditional Business (Par & Non-Par) Retail Investment Linked Business Regular & Single premium Investment Account Business Regular & Single Premium (Par & Non-Par) Term Certain Annuity Independent Actuarial Report 14

19 Overview of Zurich business Life Annuity Term Insurance Income Protection Insurance TPD Insurance Trauma Insurance Corporate Investment Account Business Wholesale Investment Linked Business Group Life Assurance Group Salary Continuance Figure 7: ZAL Key Products ZAL has a track record of maintaining a single product series for a long time period and passing on any benefit upgrades to the inforce book, though the benefit upgrades are not guaranteed. In May 2014, ZAL announced that it would exit the Group life insurance market, and its Group Risk business is now in run-off. Therefore, only the term, TPD, trauma and income protection insurance business are still open to new business. 4.3 Financial position The table below summarises the Policy Liabilities, Regulatory Capital requirements, and excess assets of the Statutory Funds (including the split between participating and non-participating policies within SF2) and SHF as at 31 December SF2 Summary of Capital Position as at Total Par Non-par December 15 ($'m) SF2 SF3 SHF Assets , Policy Liabilities (net of reinsurance) (238.9) (1,351.5) 0.0 Other liabilities (54.8) (9.8) (0.9) Net Assets Assets and liabilities adjustments 5.3 (532.7) (527.5) - (5.6) Capital Base PCA Capital in excess of PCA Figure 8: ZAL Financial Position Regulatory Capital requirements (the PCA) are established by APRA and described in a series of Prudential Standards. The Australian Regulatory Capital requirements are targeted so that the insurer will be able to withstand a 1 in 200 year loss event and still remain solvent (i.e. the remaining assets would be sufficient to cover the Policy Liabilities and other liabilities of the fund at the end of the year). APRA may also specify supervisory adjustments on top of the PCA. APRA also expects life insurers to hold additional capital in addition to these Regulatory Capital amounts which is known as Target Surplus. Target Surplus aims to minimise the probability of the Regulatory Capital requirements being Independent Actuarial Report 15

20 breached. Target Surplus policy is defined by the Board of the life insurer. Overview of Zurich business In order to meet these capital requirements, the Capital Base of the life insurer must be sufficient to cover (at least) the PCA, while companies aim to ensure it is sufficient to cover their Target Surplus too. The Capital Base is based on the net assets within each fund, adjusted for certain restrictions based on the quality of the support provided by the various forms of capital ( assets and liabilities adjustments in the table above). The excess assets are expected to reduce through 2016 as the sales of new business continue to consume capital. However from 2017 onwards, as a result of the Life Insurance Framework (industry reform proposals on adviser remuneration and quality of advice within retail life insurance), the excess assets are expected to increase as new business capital consumption reduces due to lower initial commissions. 4.4 Investment strategy ZAL adopts a relatively conservative investment strategy that is commensurate with their low risk appetite for market risk and asset/liability mismatch. We consider the Risk Management Framework in section 4.7. SF2 contains both short term risk business and longer term traditional/capital guaranteed business. The assets backing liabilities are invested so that they match the characteristics of the size and nature of the liabilities. These assets are managed via sub funds. Assets in excess of policyholders and other liabilities in SF2 have a target investment of 12% in equities and property assets with the remainder invested in a mixture of fixed interest securities and a small percentage in cash. SF3 fund contains unit linked investment business with the assets invested according to the asset allocation for each prospective investment option available to policy owners. Assets in excess of policyholders and other liabilities are invested in cash and medium term (duration of 2.5 years) fixed interest securities in order to minimise balance sheet risk. The majority of assets within the Shareholder s Fund are invested in medium term fixed interest securities (96%), with the remainder in cash (4%). 4.5 Expense allocation ZAL s basic policy administration, sales and marketing, business management, finance, investment management and reporting functions are substantially conducted in-house by employees of ZFSA through a resources agreement with ZAL. Claims management and underwriting services are also conducted in-house by employees of ZFSA through a resource agreement with ZAL Acquisition and maintenance expenses are paid by the Statutory Funds to ZFSA for product related expenses, and by the Shareholder s Fund for non-product related expenses. Where appropriate, expenses are allocated between acquisition, maintenance and investment expenses, and to products, according to time spent. 4.6 Underwriting of sum insured increases ZAL has a strong underwriting philosophy and management is focussed on making decisions that are fair and reasonable for the customer. Due to its higher retention levels, ZAL s underwriting process is less driven by reinsurer rules on underwriting than MLL s. ZAL management believes it has a strong commitment to customer service standards. 4.7 Risk Management Framework ZAL has an integrated RMF that it uses to promote a risk aware culture and embed risk management into its strategic decision making. By risk type, ZAL s key risk statements include: Independent Actuarial Report 16

21 Overview of Zurich business Insurance risk: to only take on risks that are well understood, quantifiable and provide a reasonable opportunity to earn an acceptable profit. Market risk: for balance sheet assets the ZAL Board does not authorise: o o o o o Market Asset Liability Management ( ALM ) risk to exceed the defined limits. Interest rates exposure to go outside a range consistent with the defined limits. Asset class exposures to go outside a range of defined limits. Investments in derivatives instruments to be undertaken neither for speculative nor for hedging purposes. Investments in foreign currency other than to cover foreign currency liabilities. Investment and Reinsurance Credit risk for balance sheet assets: the ZAL Board does not authorise: o o o Single counterparty investments to exceed agreed levels. Excessive investment in poor credit quality assets and, in any case, investment in credit instruments rated below investment grade (BBB). Reinsurance treaties to be written with providers that are not included in Authorised List of life insurance reinsurers. Operational risk: the Board does not authorise any decision or activity which is illegal, regulatory non-compliant, imprudent, in violation of Board policy, or out of alignment with ZAL s business plan, and variations as agreed with the Board. Liquidity risk: the ZAL Board does not authorise liquid assets to fall below the maximum net cumulative cash outflow forecast over the next 3 months, allowing for minimum regulatory cash requirements, capital considerations and target asset allocation. Reputation risk: the ZAL Board does not authorise any damage to ZAL s reputation by: o o The contravention of its documented core values; or Failing to promote a sound culture of risk awareness and informed risk taking. 4.8 Reinsurance arrangements ZAL prefer to take on insurance risk up to their risk appetite levels. They aim to regularly review reinsurance service providers to ensure that ZAL is getting the best possible value for money. A summary of major reinsurance treaties is provided in Appendix D. 4.9 Proposed dividends and transfers When excess assets are above Target Surplus, ZAL look to pay dividends from the excess assets. ZAL did not pay any dividends to its parent ZFSA during Within ZAL, there was one transfer of $15m from the Shareholder s Fund to SF2, to fund the business growth in SF2. We understand that two capital injections will be made to the Shareholders Fund to fund costs related to the transaction and also the purchase price to be paid for the Business Recent significant events We understand there have been no significant events since the 31 December 2015 numbers and information contained in this Report, aside from the transfer mentioned above, that would change the Independent Actuarial Report 17

22 Overview of Zurich business conclusions of the Report. In February 2016, a transfer of $25m was made from the Shareholder s Fund to SF2. This transfer is not reflected in the 31 December 2015 financial position in section 4.3. Independent Actuarial Report 18

23 Overview of the Proposed Transfer 5 Overview of the Proposed Transfer This section of the Report outlines the details of the Proposed Transfer and the plans which ZAL has made in respect of the key areas that may impact contractual terms and rights, policyholder expectations and benefit security. 5.1 Scheme of Arrangement The Scheme will result in the Business in SF4 of MLL being transferred into SF2 of ZAL. The Proposed Transfer will involve the transfer of the Life Risk Insurance Liabilities of MLL SF4, except for various tax and Macquarie Group related liabilities. The assets of the MLL SF4 will be transferred to ZAL SF2. No assets or liabilities are to be transferred to ZAL s other Statutory Funds under the Proposed Transfer. All rights and liabilities under the life policies and contracts relating to MLL s SF4 and existing MLL SF4 policyholders will become policyholders of ZAL. MLL s products will continue to be offered to new customers under the Macquarie brand for a period post completion, before transitioning to ZAL branded products only. The figure below illustrates which Statutory Funds (and products and policies within them) will be transferred to ZAL as part of the Scheme and which will remain with MLL, as well as the proposed fund structure under the Scheme. Independent Actuarial Report 19

24 Overview of the Proposed Transfer Figure 9: Proposed Structure 5.2 ZAL Strategic Rationale The market announcement by ZAL in relation to the Proposed Transfer noted that the rationale for undertaking the acquisition of the Business was as follows: Acceleration of the Zurich Group strategy to drive growth from a balanced portfolio in the Asia-Pacific region Consistency with the long term strategic intent regarding Australian market presence Enhancement of scale and capability 5.3 Product and pricing transition plan The table below summarises the approach that ZAL plans to take to the MLL product suite as it transfers into ZAL. Current company Product Product / pricing implication MLL Sumo and Active Existing Sumo and Active business will be rebranded as a ZAL product, with no immediate changes in product features or terms and conditions. Products will remain open. MLL Legacy business Legacy business product features and terms and conditions will be maintained. Independent Actuarial Report 20

25 Overview of the Proposed Transfer MLL FutureWise (FW) FW will not be available on quote and application software shortly after the Proposed Transfer. It will remain notionally open (its Product Disclosure Statement ( PDS ) will remain open) such that the existing MLL Transferring Policyholders will have the flexibility to upgrade or make changes to their policies. Product features and terms and conditions will be maintained, including the FW PDS guarantee that future product improvements that do not result in any additional cost will be passed on to existing customers (where the improvement does result in a premium rate increase, policyholders have the option to upgrade or not). Policyholders who wish to move to the ZAL Wealth Protection (WP) product will be required to be reunderwritten. ZAL Wealth Protection The equivalent ZAL product set, WP, will be enhanced in Q to include any superior features of FW, to make the product more flexible. MLL FW MLL is currently reviewing trauma definitions for the FW product. MLL and ZAL plan to work together on a review of these trauma definitions, acknowledging that the next PDS issue date would be 1 October 2016 when Zurich PDSs are issued for the on-sale products. MLL MLL All products sold in 2016 All products with optional sum insured increases ZAL has a guarantee for their policyholders that all policies sold in 2016 will not see an increase in premium rates during 2016 and This guarantee will be extended to the new business written by MLL during 2016 on successful transfer. Where MLL Transferring Policyholders currently have the option to increase their sum insured, they will continue to be able to do so after the Proposed Transfer. The application will initially be assessed against MLL s existing underwriting standards, and will be transitioned to ZAL s underwriting standards over time (incorporating MLL s standards where possible). Figure 10: Proposed Product Changes 5.4 Claims management and philosophy At the transition date, the two claims teams will initially be largely independent. The teams will transition into one team over time (expected 2017), with appropriate training to ensure consistent approach. Over time, the processes and teams will be merged bringing any enhancements from MLL s claims processes and philosophies into the combined team. 5.5 Customer service The relevant MLL staff (e.g. contact centre staff) will be transferred to ZAL if they accept the position offered by ZAL. ZAL has noted that it will leverage and implement any areas where MLL s processes, practices or approaches are seen to be superior. ZAL has been recently acknowledged for its customer service standards by external industry awards. Neither entity has a formally documented customer service philosophy, however ZAL management believe that the overall approach and attitude to customer service is not dissimilar. Independent Actuarial Report 21