Sphere Drake Insurance Limited, in the matter of Sphere Drake Insurance Limited
[2009] FCA 854
•9 June 2009
FEDERAL COURT OF AUSTRALIA
Sphere Drake Insurance Limited, in the matter of Sphere Drake Insurance Limited [2009] FCA 854
Corporations Act 2001 (Cth)
Insurance Acquisition and Takeovers Act 1991 (Cth)
Insurance Act 1973 (Cth)SPHERE DRAKE INSURANCE LIMITED (ARBN 001 263 001), IN THE MATTER OF SPHERE DRAKE INSURANCE LIMITED (ARBN 001 263 001)
NSD 1881 of 2008
EMMETT J
9 JUNE 2009
SYDNEY
IN THE FEDERAL COURT OF AUSTRALIA
NEW SOUTH WALES DISTRICT REGISTRY
NSD 1881 of 2008
IN THE MATTER OF SPHERE DRAKE INSURANCE LIMITED (ARBN 001 263 001)
SPHERE DRAKE INSURANCE LIMITED (ARBN 001 263 001)
PlaintiffJUDGE:
EMMETT J
DATE OF ORDER:
9 JUNE 2009
WHERE MADE:
SYDNEY
THE COURT ORDERS THAT:
1.Pursuant to section 17F(1) of the Insurance Act 1973 (Cth), the scheme for the transfer of the general insurance business of the Australian branch of Sphere Drake Insurance Limited to Gordian Runoff Limited (Gordian), in the form of Exhibit 1 tendered on 9 June 2009, be confirmed.
2.The Plaintiff pay the costs of APRA as agreed or, if agreement cannot be reached, as assessed.
3.The Plaintiff shall have liberty to apply on 24 hours notice.
Note:Settlement and entry of orders is dealt with in Order 36 of the Federal Court Rules.
The text of entered orders can be located using eSearch on the Court’s website.
IN THE FEDERAL COURT OF AUSTRALIA
NEW SOUTH WALES DISTRICT REGISTRY
NSD 1881 of 2008
IN THE MATTER OF SPHERE DRAKE INSURANCE LIMITED (ARBN 001 263 001)
SPHERE DRAKE INSURANCE LIMITED (ARBN 001 263 001)
PlaintiffJUDGE:
EMMETT J
DATE:
9 JUNE 2009
PLACE:
SYDNEY
REASONS FOR JUDGMENT
The applicant Sphere Drake Insurance Limited (SDI), has applied, pursuant to s 17F of the Insurance Act 1973 (Cth) (the Act), for confirmation of a scheme for the transfer of the general insurance business of the Australian branch of SDI to Gordian Runoff Limited (Gordian). On the hearing of the application today SDI was represented by senior counsel and Australian Prudential Regulatory Authority (APRA) appeared by its solicitor.
Section 17B(1) of the Act relevantly provides that no part of the insurance business of a general insurer may be transferred to another general insurer, except under a scheme confirmed by the Federal Court.
Section 17B(3) provides that a scheme must set out the terms of the agreement or deed under which the proposed transfer is carried out and particulars of any other arrangements necessary to give effect to the scheme. Under s 17C(2) an application for confirmation of a scheme may not be made unless:
(a)A copy of the scheme and any actuarial report on which the scheme is based have been given to APRA in accordance with the Prudential Standards, as defined in the Act,
(b)Notice of intention to make the application has been published by the applicant in accordance with the Prudential Standards, and
(c)An approved summary of the scheme has been given to every affected policyholder.
However, s 17C(5) provides that the Federal Court may dispense with the need for compliance with s 17C(2)(c) in relation to a particular scheme if it is satisfied that, because of the nature of the scheme or the circumstances attending its preparation, it is not necessary that the paragraph be complied with. On 12 December 2008, the Court made orders pursuant to s 17C(5) that the need for SDI to comply with s 17C(2)(c) be dispensed with, provided that SDI complies with the other orders made on that day.
Under s 17E of the Act, any of the bodies corporate affected by a scheme may apply to the Court for confirmation of the scheme. Any such application must be made in accordance with the Prudential Standards and APRA is entitled to be heard on such an application. Under s 17F, the Court may confirm a scheme without modification, or confirm the scheme subject to such modifications as it thinks appropriate, or refuse to confirm the scheme. In deciding whether to confirm a scheme with or without modifications, the Court must have regard to the interests of the policyholders of a body corporate affected by the scheme and any other matter the Court considers relevant.
SDI was incorporated in England on 27 February 1953. It adopted its present name on 1 October 1999. SDI is registered in Australia as a foreign corporation pursuant to Part 5B.2 of the Corporations Act 2001 (Cth). SDI is a wholly owned subsidiary of RiverStone Holdings Limited, a company also incorporated in England and Wales. It is part of the RiverStone Group. SDI’s ultimate parent company is Fairfax Financial Holdings Limited (Fairfax). Fairfax is a financial services holding company which, through its subsidiaries, is engaged in property, casualty and life insurance and reinsurance investment management and insurance claims management.
At present, SDI has no employees. Its affairs are conducted by its directors and its local agent in Australia. The run-off of SDI’s insurance business is managed by RiverStone Management Ltd, another entity within the Fairfax Group. SDI is a general insurer as defined in s 11 of the Act. It is authorised to carry on general insurance run-off business in Australia. Although registration of SDI as a foreign corporation in Australia does not create a new or separate legal entity in Australia, for various purposes it is relevant to distinguish between its Australian operations and its operations in the United Kingdom.
One such purpose concerns the regulation of SDI’s Australian operations by APRA. APRA regulates only the Australian operations of SDI and none of its other operations. APRA therefore requires a division to be made between SDI’s Australian operations and its other operations. APRA treats SDI’s Australian branch as the relevant entity required to comply with the various requirements of Australian law, including the Act, that are designed to protect the interests of policyholders. In particular, for the purposes of determining whether the ratio of assets to liabilities of SDI satisfies APRA’s requirements, APRA has regard only to the assets and liabilities of SDI’s Australian branch. The assets and liabilities of SDI elsewhere are disregarded.
SDI’s assets that are attributed to SDI’s Australian branch are not available for SDI to apply to its non-Australian liabilities. SDI is prohibited from moving from Australia, or applying towards its non-Australian liabilities, any of the assets of SDI in Australia without APRA’s approval. APRA thus ensures that SDI holds in Australia sufficient assets to meet its liabilities to Australian policyholders. For that reason it is convenient to speak of SDI’s Australian branch as if it were a separate legal entity.
The business of SDI’s Australian branch consisted of polices written by six different entities as follows.
· Vesta Gruppan AS,
· Vesta Reinsurance Company of Australia Ltd,
· Skandia Insurance Company Ltd, (Skandia),
· Skandia International Insurance Corporation, known as INSA Insurance Corporation (INSA),
· Sphere Drake Underwriting Management Australia Ltd (SDUL), and
· SDI itself.
The policies written by Skandia were assumed by INSA in the 1980s. Those policies, and the policies written by INSA itself, consisted of direct workers compensation insurance policies written no later than 1976, direct fire, loss of profits, burglary, public liability, construction all risks and engineering policies written up until 1980, and marine, aviation and non-marine reinsurance, including facultative reinsurance, written up to 1992.
The policies written by the two Vesta companies were assumed by INSA in approximately 1991. Those policies were written up to 1991 and consisted of marine, aviation and non-marine reinsurance policies. Pursuant to a deed of sale made on 21 November 2001, SDI assumed the insurance liabilities of INSA’s insurance branch. Thus the policies written by the Vesta companies and the INSA companies, including Skandia, came to be owned by SDI.
The policies written by SDUL on behalf of SDI consisted of direct construction all risks, industrial all risks and professional indemnity insurance policies written up to 1984, and marine and non-marine reinsurance policies written up to 1984. The policies written by SDI’s Australian branch itself consisted of direct marine hull and cargo insurance policies written up to 1993, and marine and non-marine reinsurance written up to 1993. No new business has been written by SDI’s Australian branch since 1993, and the business of SDI’s Australian branch has been entirely run-off business since then.
The run-off of the policies written directly by SDI has been managed by RiverStone Management Ltd since 1993. That company has also managed the run-off of the other policies acquired by SDI from 2000. In order to rationalise the portfolios of various insurers in the Fairfax Group into one regulated insurance company, Fairfax arranged for a series of portfolio transfers to be carried out in the United Kingdom and other overseas jurisdictions between 2002 and 2005. As part of that consolidation exercise, the majority of the portfolios within SDI in the United Kingdom were transferred to another Fairfax entity, RiverStone Insurance UK Ltd (RIUK).
Following the completion of that transfer, the only recognised insurance liabilities remaining within SDI consisted of participation in a marine and non-marine pool between 1952 and 1967, aviation business written between 1969 and 1979 and the Australian branch of SDI. Subject to the satisfactory implementation of the scheme presently before the Court, SDI plans to close down its Australian operations in 2009 and its UK operations later in 2009 or early in 2010. As at 31 December 2008, the assets of SDI’s Australian branch were valued at $6,498,000 and its liabilities totalled $2,378,000, resulting in a capital surplus of $4,120,000.
Gordian is a company limited by its shares incorporated in Australia. Gordian is authorised under the Act to carry on general insurance runoff business in Australia. Its business consists of both direct insurance and inwards reinsurance. Gordian does not have any employees. Its business is entirely operated by employees of Enstar Australia who currently handle all claims made in respect of insurance written by Gordian in accordance with a service level agreement with Enstar Australia. Gordian is ultimately a subsidiary of Enstar Group Limited, a company incorporated in Bermuda. Enstar Group Limited acquires and manages insurance and reinsurance businesses in runoff. Its shares are publicly listed for trade on the NASDAQ share market in the United States. Enstar Holdings is the parent company of Enstar Australia, which is the holding company of Gordian. It is a non-operating holding company in Australia for the purposes of the Act and it is a subsidiary of Enstar Group Limited.
Gordian intends to apply to APRA for authorisation from time to time to release certain of its capital. Gordian has been in runoff since 1999 and has managed portfolios in runoff since that date. As a result, Gordian’s claims team has developed expertise in the management and settlement of claims arising from a portfolio in runoff. Its current claims practice is to pay all valid claims in full as they are presented after subjecting them to a thorough investigation. Gordian intends to apply its expertise with respect to any business that it might acquire pursuant to the proposed scheme.
Gordian recently acquired two other portfolios in runoff, one from Municipal Mutual Insurance Limited and the other from Cavell Insurance Company Limited. Both acquisitions were pursuant to schemes approved by the Court pursuant to the Act. It is proposed that the insurance business of SDI’s Australian branch will be transferred to Gordian on the Transfer Date, being the date 28 days after the scheme is confirmed by the Court, along with Transferring Assets, as defined in the scheme, including all rights, powers, benefits and claims of SDI under Transferring Policies, as so defined, together with Transferring Liabilities, as defined. Following the transfer, the terms of the Transferring Policies will be unaltered except for the fact that Gordian, rather than SDI, will be liable under them. The transfer will not apply to any business of SDI that is not part of its Australian branch. All business written by or on behalf of or assumed by SDI outside Australia will remain with SDI.
The consideration to be paid by SDI to Gordian for the assumption by Gordian of the Transferring Business is to be the sum of $2,486,000 subject to adjustments as contemplated by the scheme. That sum will be paid by SDI to Gordian on the Transfer Date. At the Transfer Date Gordian will assume responsibility for managing the runoff of the Transferring Business including administering claims.
The portfolio of SDI is covered by numerous contracts of reinsurance placed with a mixture of Australian and foreign reinsurers external to the Fairfax Group. Much of the external reinsurance has been commuted. Of the small proportion that remains in force, little of it is of any value because of the insolvency or dissolution of the reinsurers. There is little prospect of recovering further sums under external reinsurance.
SDI currently has the benefit of two reinsurance contracts with a company in the Fairfax Group. That reinsurance was only ever intended to apply to companies within the Fairfax Group and is not taken into account by APRA in determining whether SDI maintains sufficient assets in Australia for the purpose of compliance with APRA’s minimum capital requirements. As the external reinsurance is of little value and the internal reinsurance within the Fairfax Group was not intended to cover outside companies, no outwards reinsurance will be transferred to Gordian under the scheme. Should the scheme become effective, SDI will cancel the internal reinsurance to the extent that it applies to the Transferring Business.
The main objective of the proposed transfer is to enable SDI to achieve finality in relation to the Transferring Business in light of the age of the runoff and minimal business remaining in SDI generally and then to close the Australian branch. It is thought that the scheme will provide a number of benefits to policy holders, to SDI, to Gordian, and APRA. By consolidating portfolios, policy holders of SDI who hold Transferring Policies will benefit from a substantially larger balance sheet without detriment to the existing policy holders of Gordian. Both SDI and Gordian are currently incurring costs for runoff management, audit, and regulatory compliance. Combining the portfolios will result in cost savings for both.
If the scheme is confirmed, SDI intends, following the transfer, to apply to APRA to have its insurance authorisation revoked. It will then close its Australian branch. It is intended that, in due course, the capital remaining in SDI’s Australian branch following the transfer will be repatriated to SDI in the United Kingdom. However, any surplus capital will not be repatriated unless APRA’s formal approval is obtained, or until SDI’s insurance authorisation in Australia has been revoked.
Gordian and SDI entered into a deed of transfer of insurance business on 3 February 2009. Under that agreement, SDI agrees to transfer and Gordian agrees to accept the transfer of the insurance business on the Transfer Date.
Drafts of the proposed scheme, the proposed scheme summary to be sent to affected policyholders, and notice of intention to make the application were provided to APRA, which has approved the final version of those documents. However, for reasons that I shall explain shortly, there have been some material changes.
SDI instructed Mr Warwick Gard, a Fellow of the Institute of Actuaries of Australia and a director of Ernst and Young ABC Pty Ltd to prepare an actuarial report as to whether the policyholders of SDI or Gordian will be detrimentally affected by the scheme. Mr Gard provided a report of 3 February 2009 in which he concluded that the transfer of the business from SDI to Gordian will not materially adversely impact the policyholders of either SDI or Gordian for three reasons. First, the capital benefit to SDI policyholders is evidenced by the fact that SDI’s solvency coverage ratio was 2.13, whereas following the transfer to Gordian, the solvency coverage will be similar to, if not the same as, Gordian’s solvency ration, which was then 5.55. That would reduce to 4.53 if certain capital reductions proceeded.
Mr Gard considered there was an additional benefit to SDI policyholders that arises from being part of a larger organisation with significantly more net assets. That benefit arises because the occurrence of one unusually large claim could have a material impact on the policyholders of SDI whereas, after the proposed transfer, such a claim would have a negligible impact on the net assets of the merged entity. Thirdly, there is no detrimental impact to Gordian policyholders from the capital perspective arising from the transfer because of the size of Gordian’s capital base.
SDI also requested an independent peer review of Mr Gard’s report by Mr Geoffrey Atkins, also a Fellow of the Institute of Actuaries of Australia and a director of Finity Consulting Pty Ltd. In his report of 5 February 2009, Mr Atkins outlined the scope of the work that he undertook, which included a review of the methodology adopted by Mr Gard in considering whether the conclusions reached by him were soundly based and a consideration of whether there were any other issues or views to which he should draw attention. Mr Atkins reviewed Mr Gard’s report. It is his opinion that the report is sound and, on the basis of the information presented in the report, Mr Atkins concurs with Mr Gard’s opinion that there is no material detriment or disadvantage to the policyholders of SDI or Gordian from the proposed transfer.
APRA requested that, in addition to the independent peer review by Mr Atkins, Gordian’s approved actuary, Mr David Finnis of Ernst and Young, also a Fellow of the Institute of Actuaries of Australia, be asked to review Mr Gard’s report and to provide a letter setting out any relevant observations on Mr Gard’s finding. In his report of 6 February 2009 Mr Finnis said that there were, in his opinion, only two areas of potential underestimation of the liabilities of SDI’s Australian branch that could affect the combined liability of the merged group to a significant extent. Mr Finnis considered that both areas were covered by Mr Gard’s report. As to both matters he is satisfied that there is no potential for any material effect on Gordian policyholders. He concluded that he supported the findings of Mr Gard’s report that there are no detrimental effects on the Gordian policyholders as a result of the proposed transfer.
Under Part 3 of the Insurance Acquisition and Takeovers Act 1991 (Cth), Gordian is required to notify and obtain, from the Minister administering that Act, a go ahead decision for the proposed transfer of SDI’s insurance business to Gordian pursuant to the scheme. The Minister’s powers are delegated to APRA. The proposed transfer has been approved for the purpose of s 38 of that Act.
I am satisfied from the evidence consisting of affidavits by Mark Thornton, sworn 18 March 2009, Ingrid Barbaresco, sworn 17 March 2009, Leslie Byrne, sworn 16 March 2009, James Makin, sworn 18 March, 2009, Leslie Byrne, sworn 1 June 2009, Steven Girvan, sworn 4 June 2009, Robert Brauer, sworn 5 June 2009 and John Edmond, sworn 5 June 2009 that the procedural requirements of the Prudential Standards and the orders previously made by the Court in connection with the dispensation of compliance with s 17C(2)(c) have been satisfied, subject to minor immaterial matters to which it is not necessary to make reference.
However, there are three matters of substance to which the Court’s attention has been drawn by SDI in connection with the proposed scheme. They are:
·a novation arrangement entered into with policyholders of SDI, QBE Insurance (Australia) Limited, QBE Insurance (International) Limited and RIUK,
·a deed of indemnity entered into between RIUK and Gordian and
·proposed return of capital by Gordian.
Following the notification of the proposed scheme to the QBE companies, they were concerned to reconcile the policies written both by SDI’s Australian branch and by the Fairfax Group generally. QBE wished to identify which reinsurance applied to which of its insurance policies, so that it could understand the effect of the transfer on its business. A process undertaken to that end could not be concluded within a reasonable time frame and did not result in the definite identification of any additional SDI Australian branch policies beyond the records of SDI. Accordingly, an arrangement was put in place whereby all policies held by QBE with SDI, whether issued by the Australian branch or any other part of the Fairfax Group, would be novated to RIUK. The effect of the novation, and a standstill agreement also entered into relevant to the scheme, is that any policies that QBE held with SDI’s Australian branch will cease to be so held as of one minute prior to the scheme being confirmed by the Court.
The relevant operative part of the deed of novation of 29 May 2009 entered into between SDI, RIUK and the two QBE companies is that, with effect from that time, RIUK is substituted for SDI ab initio as a party under certain reinsurance contracts and the reinsurance contracts take effect as agreements on the same terms as previously, except that references to SDI will be read and construed as if they were references to RIUK. Secondly, with effect from the same time, each of the QBE companies releases SDI from all of its obligations and liabilities under the reinsurance contracts and all actions, claims or proceedings that any QBE entity may have against SDI under or in respect of the reinsurance contracts.
Thus at the time when the scheme becomes effective, the policies in favour of QBE will no longer comprise Transferring Policies and will not be transferred under the scheme to Gordian. However, there is no corresponding reduction in the money to be transferred from SDI’s Australian branch to Gordian. To that extent, there will be a benefit to the policy holders whose policies are being transferred. On the other hand, there is to be a reduction in the Transfer Sum for the reasons that I shall briefly explain. I do not consider that the deed of novation should stand in the way of the Court’s confirmation of the scheme. The policy holders affected by the scheme remain affected in precisely the same manner as under the scheme as originally proposed. In fact, their position is improved for the reasons that I have indicated. I do not consider that any equality of opportunity has been denied affected policy holders. It was open to any policy holder notified of the proposed scheme to approach SDI and negotiate with SDI along the lines undertaken by the QBE companies.
The second matter concerns a deed of indemnity of 1 June 2009 between RIUK and Gordian, whereby RIUK agrees to indemnify Gordian against any amount of outstanding claims liabilities that should be recorded by Gordian in relation to any of the policies issued to QBE, any of the Skandia direct policies, as defined, and any unreported Transferring Policy. The indemnity will also extend to any payment that Gordian makes to a person who is insured or reinsured under any of those policies and against any defence or investigation costs reasonably incurred by Gordian with any professional third party advisers with respect to any claim under those policies.
The indemnity is to operate for a term of 10 years following the transfer. In exchange for the indemnity, Gordian has agreed to accept a reduction in the consideration payable under the scheme for accepting the transferring Liabilities in the sum of $300,000. In a further affidavit of 2 June 2009, Mr Gard expressed the opinion that there would be no material adverse impact on the policy holders of either Gordian or the policy holders of SDI as a result of the deed of indemnity and the variation in the consideration payable. I do not consider that the change from the proposed scheme as notified to affected policy holders should stand in the way of the Court’s confirmation of the scheme.
The third matter concerns proposed return of capital of Gordian and the effect that the proposed return of capital will have on the solvency ratio of the merged entity. On 18 September 2008, APRA approved a capital reduction for Gordian. The actual amount of the capital reduction was $86.2 million. In addition, on 25 March 2009, APRA provided its consent and authorised the release of a further $80.7 million from Gordian’s capital. Gordian proposes a third reduction of its capital in the sum of $106.8 million. Thus the total amount of capital either released or, pending approval from APRA, to be released from Gordian since 30 June 2008 will be $273.7 million.
The effect of the first two reductions of capital would be that the solvency coverage of Gordian policyholders, including the SDI policyholders, as at 31 March 2009 would be 5.3932. Following the proposed third reduction of capital, the solvency coverage as at 31 March 2009 will be 4.0566. Mr Gard, in his affidavit of 2 June 2009, has expressed the opinion that, on the basis of the solvency ratio following the actual or proposed capital reductions after 30 June 2008, those reductions have not, and will not, have a material adverse impact on the policyholders of either Gordian or SDI. He confirms his opinion that, having regard to the fact that APRA will only authorise a release of capital if it is satisfied that Gordian has capital in excess of 99.5 per cent sufficiency, while the sum of $273.7 million is a reasonably substantial amount, there will be no material adverse impact on the policyholders of either Gordian or SDI arising from the actual capital reductions or the proposed capital reductions of both. I do not consider that the proposed capital reductions are sufficiently material to stand in the way of the confirmation of the scheme.
In the summary of the scheme provided to affected policyholders, the transfer consideration was stated to be $2,786,000, subject to adjustment should certain developments occur between the date of the transfer agreement and the date the transfer takes effect. However, that figure has been reduced by $300,000 in the circumstances to which I have referred. Further, the summary stated that the scheme was based on the actuarial report prepared by Mr Gard, in which Mr Guard had expressed the opinion that, for four reasons, the transfer of SDI’s Australian insurance and inwards reinsurance policies to Gordian would not materially adversely impact the policyholders of either of them. The first reason was the capital benefit to SDI policyholders, evidenced by the fact that the solvency coverage of SDI as at 30 June 2008 was 2.13, whereas following the transfer, Gordian’s solvency ratio would be nominally 4.53. For the reasons that I have indicated, following the proposed further reduction of capital, that solvency coverage will be closer to 4.05. I do not consider, in the light of the opinion expressed by Mr Gard, and the lack of any opposition to this application from APRA, that that reduction should be considered to be material so as to require further notification to any affected policyholder.
The changes to which I have referred have prompted an amendment to the scheme as it was made available for inspection, and as had originally been foreshadowed on behalf of SDI. The proposed amendments are to give effect to the matters to which I have referred, being the three matters to which the Court’s attention has been drawn. Exhibit 2 is a marked up version of the scheme showing the proposed amendments. I do not consider that any of the modifications should stand in the way of the approval of the confirmation of the scheme as modified in the way shown in that exhibit.
In all of the circumstances I am satisfied that the scheme should be confirmed pursuant to s 17F(1) of the Act. SDI is prepared to pay the costs of APRA for its appearance today and it is appropriate to order SDI to pay APRAs costs as agreed, or if agreement cannot be reached as taxed.
I certify that the preceding forty-one (41) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Emmett. Associate:
Dated: 9 June 2009
Counsel for the Plaintiff: Mr JT Gleeson SC with Mr NJ Owens Solicitor for the Plaintiff: Allens Arthur Robinson Solicitor for APRA: Mr R Claxton
Date of Hearing: 9 June 2009 Date of Judgment: 9 June 2009
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