Chief Actuary Report on the proposed variation of the Standard Life Scheme of Demutualisation

Transcription

1 Chief Actuary Report on the proposed variation of the Standard Life Scheme of Demutualisation 27 April Purpose of report and conclusion 2. Credentials and assurances 3. Background 4. Description of proposed variation 5. Effect on SLAL policyholders 6. Communication to SLAL policyholders 7. Conclusion 1. Purpose of report and conclusion The purpose of this report is to describe the impact on the policyholders of Standard Life Assurance Limited ("SLAL") of a proposed variation to the scheme pursuant to Part VII of, and Schedule 12 to, the Financial Services and Markets Act 2000 under which substantially all of the long-term business of The Standard Life Assurance Company was transferred to SLAL ("Scheme"). The report is written for the SLAL Board in my current capacity as Chief Actuary. In considering the effect of the variation on policyholders I have based my understanding on the legal documents that are being drafted for submission to the court and information from internal staff. In addition this report has been reviewed by SLAL's internal and external lawyers and they have confirmed that my description of the variation, to the extent set out in this report, is correct. I conclude that the proposed variation does not materially and adversely affect the benefit security or reasonable expectations of any of SLAL's policyholders. 2. Credentials and assurances I am a Fellow of the Institute and Faculty of Actuaries. I was appointed Chief Actuary for SLAL in March 2016 having been the Actuarial Function Holder for SLAL since December I am an employee of Standard Life Employee Services Limited, a wholly-owned subsidiary of the ultimate parent company, Standard Life Pic, which provides all employee-related services to SLAL. As an employee, I have benefits including share options (which are contingent on performance conditions) and also hold policies and other products with Standard Life companies. I am a shareholder of Standard Life Pic. I confirm that I have not considered my personal interest in reaching any of the conclusions detailed in this report. This report has been prepared in accordance with the relevant Technical Actuarial Standards ("TAS") that have been issued by the Financial Reporting CounciL These are those for Data, Modelling, Reporting and Insurance (TAS-D, TAS-M, TAS Rand Insurance TAS respectively). 3. Background The Scheme provides a framework in which SLAL operates. It contains the core principles for the operation of the With Profits Fund (now known as the Heritage With Profits Fund, "HWPF"). It also defines the payments between this fund and the remainder of SLAL.

2 The motivation for the proposed variation to the Scheme is the replacement of the previous insurance regulatory regime (known as "Solvency I") with a new regime from 1 January 2016 ("Solvency II"). The Scheme foresaw the introduction of Solvency II (and other regulatory change} and contains various provisions to cover the changes this would necessarily bring to the Scheme. Some of these changes can be made without return to the Court of Session ("Court"). However the introduction of Solvency!I has caused a more radical change to the required capital framework than covered by paragraph 5. of Schedule 1 of the Scheme. This means that the variation to the core principles (contained in Schedule 1) can only be made with Court consent under paragraph 70.2(0). As will be seen below the changes to Schedule 1 interlink with changes to other parts of the Scheme and therefore SLAL has chosen to make the majority of the changes needed to allow the Scheme to continue to operate effectively under the Solvency II regime using paragraph 70.2(0) (rather than paragraph 70.2(C)). The Scheme has already been varied twice since It was varied under paragraph 70.2(0) in connection with the transfer of insurance business from Standard life Investment Funds Limited to SLAL on 31 December 201 and it was varied under paragraph from 1 January 2016 to reflect the immediate changes needed to continue to operate the Scheme in the intended manner under Solvency II. 4. Description of proposed variation I will group the proposed changes as follows: 1. the definition of the residual estate 2. the calculation of shareholder cashflows including the transitional amount 3. the construction of the Notional Company 4. the test for the payment of the shareholder cashflows 5. other changes All of the changes are designed to modify the operation of the with profits business no more than necessary and thus maintain the reasonable expectations of the with profit policyholders. I consider the impact on SLAL policyholders in more detail below. 4.1 Residual estate At demutualisation policyholders' benefit expectations changed to include the distribution of the residual estate to the extent it is not required for its primary role (which is to ensure a prudent amount is retained within the HWPF in respect of any amounts which may be charged to that fund under the Scheme), although without entitlement to any specific amount or distribution pattern. The regulatory references in the definition of the residual estate are proposed to be updated such that it remains on a "best estimate" basis- that is without any margins for prudence, risk or adverse deviation. The estate is defined in the Scheme: ""realistic surplus" or "residual estate" means the excess of the realistic value of the assets of the With Profits Fund over the realistic value of the liabilities of the With Profits Fund and "realistic deficit" shall be construed accordingly (and, in calculating the quantum of the realistic surplus or residual estate, any liability to distribute the residual estate in the future shall be disregarded)" The supporting definitions are: "realistic value of the assets" shall have the meaning given in the Integrated Prudential Sourcebook issued by the then regulator, the Financial Services Authority, ("PRU") in R;

3 "realistic value of the liabilities" comprises the sum of the with-profits benefit reserve, the future policyrelated liabilities and the realistic current liabilities; "with-profit benefits reserve" shall be calculated in accordance with PRU R to G. "future policy-related liabilities", in relation to the With Profits Fund, shall be calculated in accordance with PRU R to PRU G "realistic current liabilities" shall be calculated in accordance with PRU R PRU was only in force until 31/12/2006. These rules (covering the calculation of the realistic balance sheet) moved to the Prudential Sourcebook for Insurers ("INSPRU") with for example INSPRU R replacing PRU R. The Scheme references are deemed to refer to these replacement rules pursuant to paragraph 2.2(1)(ii) of the Scheme. These rules give a "best estimate" definition of the residual estate. None of the assessments contain margins for prudence or any form of risk margin. Prudence is however a feature of the distribution of the estate. Paragraph 4.1 of Schedule 1 states the "primary role of the residual estate is to ensure a prudent amount is retained in the With Profits Fund in respect of any amounts which may be charged to the With Profits Fund in accordance with this Scheme". Paragraph 42 then covers the distribution: "To the extent that the SLAL Board is satisfied that the residual estate exceeds that required to meet its primary role as set out in paragraph 4.1 of this Schedule 1 (Core Principles), the excess residual estate shall be distributed over time.. " Thus the amount available to distribute is only that remaining after a prudent assessment of the risks that the estate is covering. The prudence here is decided by the SLAL Board rather than in any specific regulatory measure. Therefore the change proposed is the natural change from existing regulations to those under Solvency II keeping best estimates of assets and liabilities. The PRA definition of surplus funds gives an appropriate and simple regulatory reference for the estate definition. There will be some changes to the measurement of the estate arising from the "contract boundary" rules (which limit the credit that can be taken for future premiums for some policies) and the risk-free yield curves (which are used to discount future cashflows) assumed for Solvency II compared with the realistic balance sheet. The effect of these will be taken into account in assessing the prudent amount to be retained in the distribution. Therefore the amount to be distributed to policyholders and the pattern of this distribution will continue to be set by SLAL and the introduction of Solvency II is not expected to have a material effect on this distribution. The enhancement will continue to be determined broadly as the increase that would have arisen if a small annual percentage addition had been made to "asset shares" from the date of demutualisation as is currently the case and described in paragraph 52.2 of the current Principles and Practices of Financial Management for the Heritage With Profits Fund ("PPFM"). 4.2 Shareholder cashflows The shareholder is entitled under paragraph 30 of the Scheme to the shareholder cashflows arising on specific blocks of business in the HWPF. The calculation for the shareholder cashflows is set out in Schedule 3 of the Scheme. The aim of the proposed changes is to maintain a gradual emergence of shareholder cashflows. The Recourse Cashflow ("RCF") is the key determinant of the shareholder cashflows. The RCF is calculated separately for the various defined blocks that cover most of the HWPF business apart from conventional with profits, immediate annuity and German business. The calculation can be represented at a very general level for all business as charges - expenses + reserve adjustment.

4 The charges minus expenses, or cashflow element, will not be materially changed by the introduction of Solvency IL There is an interest adjustment to allow for the cashflows occurring throughout the year. There are some technical changes needed to this as the current interest adjustment (based on the current Peak 1 Pillar 1 valuation yield under the Solvency I regime) allows for tax and investment expenses implicitly. Under Solvency II these elements need to be made explicit and the appropriate defined for the interest rate as Solvency II uses a full yield curve in contrast to the previous level valuation yield. Currently unitised business is treated differently depending on whether it is unitised with profits (UWP) or unit-linked. For UWP business the only reserve adjustment made to the cashflow element is for riders (which are essentially conventional non-profits business). For unit-linked business currently there is also a reserve adjustment for "sterling reserves" - these are prudent provisions established for possible future expenses that will not be covered as they arise by future margins at an individual policy level. It is proposed that this adjustment is removed as the concept of "sterling reserves" only applies under Peak 1 which is one aspect of the current Pillar 1 of the Solvency I regime. It was included in the original formula to ensure that there was no need under the Solvency I regime to reserve for RCF on Peak 1. This consideration no longer applies under Solvency II and therefore all unitised business can be treated the same. Thus for all unitised business the shareholder cashflow for a given year will be the charges less expenses for that year. The reserve adjustment (for conventional non-profit and rider business) is currently based on the mathematical reserves as defined under the Solvency I regime. Its effect is that any reduction in reserves is transferred to the shareholder and any increase in reserves is funded by the shareholder (through a reduction in the total shareholder cashflow). This applies for all changes other than those linked to interest rates. This mechanism is one of the means by which business risk was transferred from policyholders to shareholders at demutualisation. If experience matches that expected, the RCF for this business is the release of the prudence in the reserves over time. The proposed change to the reserve adjustment reflects the structure of the Solvency II balance sheet and the regulatory requirements for with profit funds. Revised UK regulation in connection with the introduction of Solvency II requires with profit funds to have sufficient assets to cover the best estimate liabilities. There is no requirement to cover the risk margin in the fund. The RCF reserve adjustment keeps the reserves needed by the HWPF within the fund for as long as they are needed. The change in UK regulation (from with profits funds being required to cover a prudent assessment of liabilities (mathematical reserves) to needing to cover the best estimate assessment of liabilities) allows any prudence in the reserves to be released at the point the regulation changes. This means that best estimates (as defined in the PRA Rulebook) replace mathematical reserves in the RCF reserve adjustment. Following this change the expected value of RCF on the business with a reserve adjustment will be zero. However, as experience is never identical to that expected, there will be profits and losses from this business reflecting those differences- for example if expectations of future longevity improvements for deferred annuitants reduce there will be a profit (a positive contribution to the shareholder cashflow). The RCF will therefore be calculated using different formulae under Solvency II from those applying to date. In order to preserve the balance between shareholder and policyholder interests it is necessary to define a Transitional Amount. The change of regulatory regime from Solvency I to Solvency II is the type of change envisaged by paragraph 31.5 of the Scheme which places such releases of prudence into the Further Capital Support Account. The total amount released as a result of moving from Solvency I prudent reserves to Solvency II best estimates and the release of sterling reserves is a mixture of releases of prudence that would have been paid in the future to the shareholder and releases that would have fallen into the HWPF estate. The changes to reserves caused by Solvency II are a mixture of changes to the "valuation interest rate" (that in general would have fallen to the HWPF estate) and other changes (that would have been paid to the shareholder). In order to treat

5 our customers fairly we need to ensure that the introduction of Solvency II does not transfer value to the shareholder that would have otherwise formed part of the HWPF estate. Equally to keep the existing balance between policyholders and shareholder we need to ensure that if any reserve strengthening is required the shareholder does not pay for strengthening that will be released to the estate. The Transitional Amount for the reserve adjustment business is the total release of reserves less the policyholder share of the prudence in the interest rate assumed. This policyholder share of the prudence in the interest rate assumed is 100% for all business other than deferred annuities. For deferred annuities, the operation of the Scheme means that the prudence for the period after the annuity comes into payment falls to shareholders as the current RCF formula effectively transfers the mathematical reserve when the annuity payment starts and the policy leaves the HWPF. The reserve release reflected in the Transitional Amount is therefore the difference between the mathematical reserves held at 31 December 2015 and the Solvency II best estimates at that date calculated using the Solvency I valuation interest rate. (For deferred annuities, Solvency I interest rates are used until the date of vesting only.) The balance of the reserve release - that is the release on moving from Solvency I valuation interest rates to the Solvency II yield curve -falls to the HWPF estate. For the unit-linked business the whole sterling reserve is released. The bulk of this release falls to the shareholder and this element of the Transitional Amount is calculated by using the 31 December 2015 valuation basis but removing all elements of prudence from the valuation interest rate. The Transitional Amount is the amount that the varied paragraph 31.5 will cause to be recorded in the Further Capital Support Account. (The Further Capital Support Account is a protection provided by the Scheme that spreads over ten years the effect on the HWPF's investment policy and bonus philosophy of an increased shareholder transfer following a regulatory regime change.) An indicative calculation suggests a Transitional Amount of around 30m. The release of prudence in the reserves for conventional non-profit business (other than deferred annuities) generates over half of this amount and the release of sterling reserves for unit-linked business generates around 1Om. The remainder arises from the deferred annuity business where the release of prudence in the noneconomic assumptions is largely balanced by the shareholder share of the strengthening of reserves caused by the move to the Solvency II yield curve. The Transitional Amount represents advancing future reserve releases which would have been expected to form part of future shareholder cashflows. If experience proves adverse, then the formula will cause these releases to be reversed and the required best estimate strengthening will reduce the cashflow payable - there is no fundamental change to the risks or rewards of the shareholder, merely the timing of the payments from the HWPF. 4.3 Notional Company The Core Principles ensure that the HWPF investment policy and bonus philosophy are appropriate to a Notional Company (that is a mutual) taking into account the nature of the liabilities and the duty to treat with profits customers fairly. Some details of the Notional Company need to change to ensure it is suitable for use under Solvency II as together with the rest of the Core Principles it provides "a crucial protection for with-profits policyholders' interests" (from 7.35 of the With Profits Actuary's report on the demutualisation). Notional capital background The Notional Company is defined to have certain notional capital in addition to the assets and liabilities of the HWPF. The With Profits Actuary's report on the demutualisation contains a note to paragraph 7.24 that states: "The purpose of this assumption, that the Notional Company has additional capital as specified, is to ensure that the With Profits Fund is managed as if it continued to benefit from broadly the same financial support as the subordinated bonds described. even though

6 SLAL's liabilities in respect of them, and the assets to back the liabilities, will be allocated to the Shareholder Fund." Further in paragraph 10.8 it states "The construction of the Notional Company in the Core Principles is, however, such as to require that the management of the With Profits Fund recognises the financial support that the subordinated debt would have continued to provide in the mutual." The Scheme defines the regulatory treatment for the three tranches of notional capital but does not define bonds with specific features (such as coupon, term and ability to absorb losses (that is the circumstances in which the debt does not need to be repaid)). In line with the With Profits Actuary report on the demutualisation, SLAL took the approach of ascribing the characteristics of the subordinated bonds pre-demutualisation to the notional capital. However SLAL considered this approach could not continue indefinitely as some of the bonds had fixed terms. This led to the notional capital being considered in detail by the SLAL Board, with the advice of the With Profits Committee and the With Profits Actuary, in (By this time the lower tier two capital that SLAL had held and which had been issued before demutualisation had been repaid.) The lower tier two debt held SLAL (and assumed previously for the Notional was not loss absorbing as it could not be deferred indefinitely. It also reduced the loss absorbency of the upper tier two debt as any previously deferred interest on the upper tier two debt became payable when any payments were made on the lower tier two debt. Thus although these tranches of capital provided regulatory capital they did not provide equivalent economic capital that would support the taking of investment risk in the fund. Standard Life pic had restructured its lower tier two debt to improve its loss absorbency and other companies had also issued "new-style" lower tier two debt This new-style lower tier two capital was more loss absorbing and also aimed to qualify as tier 2 own funds under Solvency II. In 2013 the SLAL Board considered the form of debt that a mutual company such as the Notional Company might have issued to optimise its capital position in the run up to Solvency II implementation and the amount of new-style lower tier two debt that has a cost of servicing broadly equivalent to that of the 526m original lower tier two tranche was calculated. The equivalent face value of new-style lower tier two debt was found to be 218m. The assumption made for assessing capital needs thereafter is that the original lower tier two debt has been restructured into a form of lower tier two debt that has a face value of 526m (in line with the Scheme) and loss absorbency equivalent to 218m of new-style lower tier two debt. It is also assumed not to encumber the upper tier two capital. This assumption gives the Notional Company greater capital, and thus ability to take investment risk, than continuing to assume the characteristics of the original lower tier two debt, recognising that a mutual company could reasonably have sought to restructure its capital. In 2013 the SLAL Board also considered the run-off of the notional capital. The Scheme links the amount of capital to a given percentage of the capital resources requirement. However this mechanism, although designed to ensure that the notional capital declined as the liabilities in the fund declined, had proved erratic. The Board considered various alternative mechanisms and concluded that a link to the "with-profits benefit reserve" (asset shares) plus the present value of "contractual guarantees (other than financial options)" would be preferable both elements included on the realistic balance sheet. This gave a much more stable run-off pattern and was also intended to be appropriate after the introduction of Solvency II with the of to materially change its calculation. Proposed changes to notional capital Solvency II introduces new rules and tiering of capital. It also contains "grandfathering" provisions. These allow capital that does not qualify under the new Solvency II rules to be included for ten years - innovative tier one and upper tier two capital is included as Solvency II tier 1 own funds and lower tier two capital is included as Solvency II tier 2 own funds. The proposed allocation of the notional

7 to Solvency II tiers reflects this grandfathering and thus will need to change again with effect from 2026, i.e. ten years after 1 January As innovations in the capital markets in the next decade are unpredictable, the appropriate tiering and amounts for the grandfathered capital from 2026 are left to the future SLAL Board to propose under the existing framework of paragraph 5 of Schedule 1 It is to be expected that the regulatory capital position of the Notional Company will weaken at that time (in respect of both the tiering and the amount of own funds) as the requirements for Solvency II own funds are stricter than those applying under Solvency I and during the grandfathering period. The proposed variation ensures that the Notional Company benefits from the grandfathering provisions contained within Solvency II. The approach to investment policy and bonus philosophy will not change when the Scheme is varied as these will continue to be primarily set through an economic capital assessment and the approach to the notional capital will continue to be as agreed in 2013 and described above. It is also proposed to change the run-off mechanism to that considered by the Board in 2013 and described above. The original mechanism is linked to a Solvency I capital requirement and therefore needs to be changed. It is appropriate to move to a more stable mechanism that is expected to be able to continue to be used irrespective of regulatory regime changes in future. It is also more in line with the descriptions of the run-off given at the time of demutualisation such as in paragraph 4.61 of the Independent Export's report on the demutualisation where he states "the amount of additional Tier 1 and Tier 2 capital assumed to be available to the Notional Company will decline because the liabilities of the WPF will decline". The proposed mechanism is directly linked to liabilities of the fund whereas the original mechanism was not Other proposed Notional Company changes An additional exclusion is proposed in paragraph 2.2(A)(i) of Schedule 1 to clarify the treatment of shareholder support in the construction of the Notional Company. It's important that any last resort shareholder support (that is the support in the circumstances that the HWPF is unable to meet policyholder liabilities as they fall due and they are met from elsewhere in SLAL) is excluded from the definition of the Notional Company. However the Notional Company needs to recognise any specific support in place under the Scheme- either additional support under paragraph 32 or expected future negative shareholder transfers. It also needs to recognise the contingent liability to repay such support. This change is a clarification of the existing Scheme but is important for the avoidance of any future doubt Counterparty risk has more emphasis under Solvency II and so it is proposed to take the opportunity to make the absence of counterparty risk on Notional Company transactions with the rest of SLAL explicit in the Scheme as new paragraph 2.2(A)(iii) of Schedule 1. As the With Profit Actuary wrote in 7.49 of his report on the demutualisation: "One of the objectives of the demutualisation is to transfer business risks from policyholders to shareholders." This transfer would be less effective if the investment policy for the HWPF was set allowing for a possibility of business risks (for example the longevity risk on annuities in payment) returning to it. The risks on liabilities allocated outwith the HWPF no longer affect the with profits policyholders unless there is a current Capital Event. The Scheme defines Capital Event in 27 and it is the adverse circumstances in which the management of the HWPF can take into account the position of SLAL as a whole. As described in 4.2 above, for the defined block business subject to a reserve adjustment (conventional non-profit business and riders to unit-linked business) the expected future shareholder cashflows will be zero as the formula uses best estimates. The use of best estimates needs to be reflected in the construction of the Notional Company through removing the need for it to hold a risk margin for this business. This definition is needed to ensure we treat our customers fairly as

8 otherwise the Notional Company would have a risk margin liability without the assets to cover it, as they will have already been released from the HWPF. There are substantial expected future shareholder cashflows from the unitised defined block business which are an asset of the Notional Company. If the Notional Company excluded risk margins from its technical provision calculations for this business then this would unduly strengthen the Notional compared to SLAL (and also compared to an actual mutual company). This is because the Notional Company would have the full value of the future profits without recognising the reduction represented by the risk margin reflecting the cost of the capital needed to cover the risks taken in generating those profits. For the business in the HWPF that does not form part of any defined block (and for which no RCF is calculated), again it is appropriate for Solvency II to apply as it would to an actual mutual company. Therefore the Notional Company's technical provisions for this business will include a risk margin. In summary it is proposed in new paragraph of Schedule 1 that the Notional Company has no to include a risk margin in the calculation of its technical provisions for business subject to a reserve adjustment in the RCF calculation. A risk margin will be held for all other business. These proposed changes ensure that the Notional Company will continue to perform its vital role in determining HWPF investment policy and bonus philosophy. 4.4 Test for payment of shareholder cashflows This is laid out in paragraph 30 of the Scheme. The test is, and will continue to be, based on the regulations applying to with profit funds. It is currently complicated by the existence of the two peaks (or aspects, generally referred to as regulatory (peak 1) and realistic (peak 2)) of Pillar 1 under Solvency I Under Solvency II, Pillar 1 will only have a single measure; however there are two regulators to consider. Both the Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA) have new rules on the assets required in a with profit fund. However if the FCA rule is kept, the PRA rules are automatically kept Therefore it is the FCA rule that underlies the test The proposed Scheme rule is based on rule C: C R Afirm must not make a distribution a unless;_ if it is a Solvencv II{! rm: ill if it is not a Solvencv II firm, the whole of the cost of that distribution can be met without eliminating the surplus in that with- profits fimd: and eliminating the >vith-pro(its f/md surplus in that >vith-pro{its [imd; and following any distribution that is made to meet a liability for which allowance has been made in technical provisions or other liabilities the firm is able to demonstrate that it reasonably expects to be able to continue to comply with the requirements in COBS 20.1A.5R (Governance arrangements for the with-profits fund).

9 "With-profits fund surplus" is defined by the FCA. It differs from the PRA defined "surplus funds" used to define the residual estate (as described in 4.1 above) as it includes the distribution of the estate as a liability. The Notional Company needs to cover greater technical provisions than the best estimates that need to be covered in the HWPF, as the Notional Company needs to hold a risk margin on some of its business. This raises the theoretical possibility that the test for the payment of shareholder cashflows could allow a payment that left the Notional Company unable to cover its liabilities. This is not possible under the current regulatory framework and current Scheme. It is hard to see how this would be consistent with treating our customers fairly. As the With Profit Actuary wrote in 7.22 of his report on the demutualisation regarding the value of the shareholder cashflows: "its availability to support policy benefits in adversity has a crucial influence on the management of the with-profits business, for example in the extent to which its assets can prudently be invested in equities. Under the terms of the... Scheme the shareholder cash flows will be an asset in which both the shareholders and the With Profits Fund policyholders have interests, and it is therefore important that policyholders are adequately protected." In order to remove this possibility and to demonstrate the continuing protection of policyholder interests it is proposed to include in paragraph 30 an explicit block on a transfer out of the HWPF that would leave the Notional Company being unable to cover its liabilities immediately following the transfer (unless there is a current capital event). 4.5 Other changes The eventual cessation of the HWPF is covered in paragraph 25 of the Scheme. All references in the paragraph have been updated to their Solvency II equivalents but no other changes have been made. The paragraph contains its own variation provisions that can be used if at the time of cessation the existing drafting proves inappropriate. Paragraph 33 covers the allocation of surplus in the Non Profits Fund and this is varied to remove specific regulatory references. There are minor changes to other paragraphs to update regulatory references or to allow for the changes already described above. There are no changes proposed to the sections of the Scheme that only operated at the time of demutualisation such as those covering the transfer of the business and the compensation for members - and some historic regulatory definitions are left in place for those sections. 5. Effect on SLAL policyholders In their respective reports on the proposed variation, the Independent Expert considers the effect of the proposed variation on holders of Transferred Policies (as defined in the Scheme and broadly those policies that transferred into SLAL at demutualisation) and the With Profits Actuary considers with profits policyholders. I consider the effect on all of SLAL's policyholders. The changes do not materially change the risks that SLAL will take or the allocation of risks or returns between policyholder and shareholder interests. There is no immediate change to the overall financial strength of SLAL and thus no change to the benefit security of any policyholder. The most significant change financially is a slight acceleration of shareholder cashflows from the HWPF to the remainder of SLAL. However the Scheme anticipated such an effect and the Further Capital Support Account provides a transitional period to smooth over ten years the effect on the Notional Company and thus the HWPF with profits policyholders. This slight acceleration of shareholder cashflows could also result in a similar slight acceleration of the expected dividend flow from SLAL to Standard Life Pic. However the amount is modest in the context of SLAL's overall financial resources and any distribution is subject to an assessment of SLAL's financial strength at that time.

10 will consider the policyholders in three groups: HWPF with profits policyholders (the vast majority of whom are holders of Transferred Policies) other HWPF the vast of whom are holders of Transferred other policyholders (which group includes some with profits policyholders (who are not holders of Transferred Policies) and some who are holders of Transferred Policies)) 5.1 HWPF with profits policyholders This group of policyholders are those that are most affected by the operation of the Scheme. Their benefits depend on the discretion exercised by SLAL in line with the Scheme's Core Principles. However the proposed variation has been developed to ensure that their reasonable expectations are not materially and adversely affected. The distribution of the inherited estate will continue with distribution occurring when there is an excess over that prudently required for any amounts chargeable to the HWPF. The measurement used in the definition of the inherited estate does not affect its distribution. The fundamental allocation of value between the HWPF with profits policyholders and the shareholder is not changed by the changes to the definition of shareholder cashflows. There is a transitional amount payable which advances some cashflows that would have been expected to be payable from the HWPF at a later date if the regulatory regime and Scheme had not changed. If experience proves adverse, then the RCF formula will cause these releases to be reversed and the required best estimate strengthening will reduce the cashflow then payable to the shareholder- there is therefore no fundamental change to the risks or rewards of the shareholder or policyholders, merely the timing of the payments. The effect on investment policy and bonus philosophy is smoothed as the additional amount transferred is recorded in the Further Capital Support Account and then amortised over ten years. The Notional Company is assumed to have additional assets to the value of the Further Capital Support Account The changes to the Notional Company ensure that its construction is appropriate for use under Solvency IL Those elements that have been made explicit in its construction help ensure its robustness in protecting HWPF with profits policyholder interests. The exclusion of a risk margin on the defined block business subject to a reserve adjustment in the calculation of shareholder cashflows ensures that policyholders do not need to reduce the risks that they take to cover risks borne elsewhere in SLAL The revised run-off of the notional capital better represents the description of the run-off given in the actuarial reports on the demutualisation and provides a more stable basis for investment and bonus decisions. The allocation of the notional capital to the various tiers of Solvency II own funds reflects the Solvency II grandfathering rules and the arrangements for this to be revisited at the end of the grandfathering period are appropriate. The revised Notional Company continues to offer appropriate protection for the HWPF with profits policyholders in line with their reasonable expectations. The test on the payment of shareholder cashflows continues to be in line with regulation and ensures that no transfer is made if the HWPF cannot cover its liabilities. This protection is now extended to explicitly ensure the Notional Company can also cover its liabilities- this was implicit in the previous regulatory structure. This is in line with policyholders' reasonable expectations that the shareholder cashflows are only paid if not required by the HWPF to meet its liabilities. The other changes are in line with policyholders' reasonable expectations that the Scheme will be updated to reflect the current regulatory regime. The updating has used the natural equivalent in the Solvency II regime to ensure the Scheme continues to operate in the intended manner.

11 Therefore I conclude that the proposed variation does not materially and adversely affect the benefit or reasonable expectations of the HWPF with profits policyholders. 5.2 Other HWPF policyholders There is no material effect on HWPF policyholders who are not with profits policyholders. There is no change to any contractual or discretionary terms for such policyholders. Some of these policyholders are able to switch into with profits and thus become with profits policyholders and hence they have an interest in the effects on HWPF with profits policyholders. Therefore I conclude that the proposed variation does not materially and adversely affect the benefit security or reasonable expectations of any HWPF policyholders. 5.3 Policyholders outwith the HWPF These policyholders include those holders of Transferred Policies that were allocated to the Non Profit Fund at demutualisation. There is no material effect on these policyholders. There is no to any contractual or discretionary terms for such policyholders. Therefore I conclude that the proposed variation does not materially and adversely affect the benefit security or reasonable expectations of any SLAL policyholders. 6. Communication to SLAL policyholders It is proposed not to contact SLAL policyholders individually to notify them of this proposed variation to the Scheme for the following reasons: I conclude that the proposed variation does not materially and adversely affect the benefit security or reasonable expectations of any SLAL policyholders and the Independent Expert and With Profits Actuary have reached similar conclusions for those policyholders they have considered. Notices are to be published in the relevant Gazettes and other newspapers with further details available by post and on the website as set out in SLAL's publicity proposals which I have seen. There are no changes to any of the Principles contained within the PPFM. If the variation is approved, there will be some consequent changes to Practices contained within PPFM and the relevant policyholders will be informed of these in line with the established process. I agree with the publicity proposals. 7. Conclusion I conclude that the proposed variation is an appropriate updating of the Scheme to operate effectively in the revised regulatory regime. I conclude that the proposed variation does not materially and adversely affect the benefit security or reasonable expectations of any of SLAL's policyholders. I conclude that it is appropriate not to notify SLAL policyholders individually of the proposed variation. Jonathan Pears Chief Actuary of SLAL