American Home Assurance Company, in the matter of American Home Assurance Company (No 2) [2011] FCA 316

American Home 4 American Home is incorporated in the state of New York in the United States. It carries on property and casualty general insurance business both in the United States and through branches elsewhere, including, through its Australian branch, in Australia. Australian Home is registered as a foreign company in Australia under the Corporations Act 2001 (Cth) (the Corporations Act) and has been authorised under the Act to carry on insurance business in Australia since 1959. 5 Although Australian Home is registered as a foreign corporation, the branch is not a separate legal entity in Australia. The provisions of the Insurance Act require, in effect, that the assets and liabilities of the Australian branch be treated as a separate entity, although in legal terms that branch is not a separate entity. The effect of the provisions of the Insurance Act is, in a sense, to quarantine the assets and liabilities of the Australian branch from claims in respect of liabilities of American Home incurred outside Australia. 6 The fiction of a separate entity in the form of the Australian branch is carried through by the preparation of accounting records, including a balance sheet, for the Australian branch, as though the assets and liabilities of the insurance business in Australia were the only assets and liabilities of American Home. 7 As at 31 December 2010, a balance sheet of the Australian branch that satisfies the requirements of the Australian Prudential Regulation Authority (APRA) shows that the Australian branch had total assets of $2,925,823,000 and total liabilities of $2,468,324,000, giving a net asset position of $412,408,000. The minimum capital requirement of American Home's Australian branch for the purposes of APRA is $180,955,000. The capital of American Home recognised for the purposes of APRA's requirements is $387,067,000. That indicates that the capital accepted by APRA is some 214 per cent of the minimum capital requirement.

Chartis 8 Chartis is a wholly owned subsidiary of Chartis Singapore Insurance Pte Limited, a company incorporated in Singapore which is also a wholly owned indirect subsidiary of AIG. Chartis is incorporated in Victoria and is authorised under the Insurance Act to carry on insurance business in Australia. However, it is not at present carrying on any insurance business. It will commence carrying on insurance business upon the scheme becoming effective.

The Relevant Statutory Provisions 9 Section 17B(1) of the Insurance Act, which is contained in Div 3A, 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. Under s 17E, a party to a scheme may apply to the Court for confirmation of the scheme. However, such an application may not be made until the steps outlined in s 17C(2) have been taken. 10 By s 17E, an application for confirmation must be made in accordance with the Prudential Standards published by APRA. Under s 17F, the Court may confirm a scheme or refuse to confirm a scheme. Under s 17F(1A), in deciding whether to confirm a scheme, the Court must have regard to the interests of the policyholders of any body corporate affected by the scheme, any report under s 62ZI, and any other matter that the Court considers relevant. There is no report under s 62ZI in relation to this application. Under s 17F(2), the Court may make such orders as it thinks fit in relation to reinsurance. 11 The steps required to be taken prior to the making of an application for confirmation of a scheme need only be taken prior to the time at which the court is moved for the relevant order. They are not required to have been taken prior to the commencement of the proceeding. The first step that must be taken before an application for confirmation can succeed is that the applicant must provide a copy of the proposed scheme to APRA. That was done on 10 December 2010. 12 Next, the applicant must provide a copy of any actuarial report on which the scheme is based. That must also be provided to APRA. American Home provided a copy of the actuarial report of Mr Geoffrey Atkins of Finity Consulting Pty Limited (Finity) to APRA on 10 December 2010. 13 Third, the applicant must obtain APRA's approval of its summary of the scheme, which, under s 17C(2)(c), must be given to every affected policyholder. APRA approved American Home's scheme summary on 13 December 2010. 14 Fourth, the applicant must obtain APRA's approval of its notice of intention as provided for in Prudential Standard GPS 410: Transfer and Amalgamation of Insurance Business for General Insurers (Prudential Standard GPS 410). American Home received APRA's approval of its notice of intention by letter of 13 December 2010. 15 Fifth, the applicant must publish a notice of intention to make the application, which must contain information specified in Prudential Standard GPS 410. The notice must be published in the Government Gazette and in one or more newspapers, approved by APRA, circulating in each State and Territory in which affected policyholders reside. The requirement that a copy of the notice of intention be published in the Government Gazette was satisfied on 22 December 2010. By its letter, 13 December 2010, APRA approved publication of the notice of intention in The Australian, The Sydney Morning Herald, The Age, The Courier Mail, The Advertiser, The West Australian, The Canberra Times, The Northern Territory News, The Mercury and The Australian Financial Review. American Home caused a copy of the notice of intention to be published in each of those newspapers on 7 January 2011. 16 Sixth, the applicant must give to every affected policyholder the scheme summary. That requirement was dispensed with by an order made on 10 November 2010 under s 17C(5). The order was made on the condition that certain further action was taken by American Home. 17 Seventh, the applicant must make a copy of the scheme available for public inspection from 9am until 5pm for a period of at least 15 days, at an office of the applicant or some other location approved by APRA in each State and Territory in which an affected policyholder resides. By its letter of 13 December 2010, APRA approved locations in all States and Territories where American Home conducts its business. Copies of the scheme and the actuarial report, as well as the scheme summary and notice of intention, were made available at American Home's offices in the relevant capital cities. Because of the floods in Queensland, certain special arrangements were made, which I am satisfied adequately provided the opportunity for affected policyholders to obtain access to the material. 18 During the course of the public inspection period, American Home became aware that there was a typographical error in the scheme summary, in that an intended reference to a payment by Chartis to American Home mistakenly referred to a payment by American Home to Chartis. After correspondence between American Home's solicitors and APRA, a correction sheet in relation to the error was made available at each of the public inspection sites from 28 January 2011. 19 American Home's solicitor, Mr John Morgan, who was named as a contact on the scheme summary and notice of intention, received correspondence in relation to the scheme from several persons, including notifications from Mr John Richardson and Mr Wayne Arthur that they intended to appear at the hearing of the application for confirmation of the scheme. Both Mr Richardson and Mr Arthur indeed appeared, and made submissions to which I shall refer shortly. 20 In the order made on 10 November 2010, a number of steps were specified as conditions of dispensation with strict compliance with the terms of s 17C. Those steps included copies of the scheme summary being sent to various categories of policyholders, and to third party agents who were responsible for the submission of applications for policies to American Home. I am satisfied from the evidence that all of the required steps were taken by American Home.

Consideration 21 The critical factor governing the exercise of a discretion under Div 3A is whether policyholders will be materially detrimentally affected by the implementation of the scheme. An affected policyholder is a holder of a policy being transferred under the scheme. Accordingly, in the present case, it is the policyholders of the Australian branch who are affected policyholders for the purposes of s 17C. Nevertheless, that does not mean that the potential effect of the scheme on other policyholders is irrelevant to the exercise of the Court's discretion. For example, if there were already policyholders of Chartis, the possible effect of the scheme on those policyholders would be a relevant consideration. That is not the case here. 22 The discretion conferred by s 17F is a general one, and the Act does not specify all of the criteria that are to be considered. A prime consideration is the nature of the actual and potential claims to which the transferor insurer is subject, and the financial viability of the transferee insurer. The critical consideration is whether the affected policyholders would be detrimentally affected. There are, of course, policyholders of American Home in other parts of the world. However, the interests of those policyholders whose policies are not written through the Australian Branch are irrelevant. 23 The proposed scheme is part of the rationalisation or consolidation of the AIG Group's Australian operations, which in turn are part of a worldwide corporate restructuring. So far as the AIG group is concerned, there may be some benefits achieved by the transfer, namely, the simplification of the organisational structure, greater transparency through the use of a locally incorporated subsidiary, and capital efficiencies. Those benefits may also accrue to policyholders. Following the transfer under the scheme, if it is confirmed, American Home proposes to apply to APRA to have its insurance authorisation revoked. 24 As I have already said, the Australian branch has a capital adequacy multiple as at 31 December 2010 well above APRA's minimum requirements. All assets and liabilities of the Australian branch of American Home will be transferred to Chartis under the proposed scheme, with minor, immaterial exceptions. Thus, as a matter of principle, the financial condition of Chartis will be identical to that of the Australian branch following the transfer, assuming that the price to be paid for the business is funded through its share capital. Because of differences in the applicable requirements for calculating regulatory capital for a locally incorporated subsidiary, as compared with a branch, Chartis's capital adequacy multiple for regulatory purposes will in fact be higher than that of the Australian branch. 25 That is not a significant issue, because the financial and legal security for policyholders will be largely unchanged. The reason for the difference is that approximately $75 million of reinsurance assets of the Australian branch are classed as being outside Australia. They are, therefore, inadmissible as assets for the purposes of s 116A of the Insurance Act. They therefore do not count towards the Australian branch's regulatory capital position. However, all of those assets would count towards Chartis's regulatory capital position following the transfer, because, as a locally incorporated insurer, Chartis is required to determine its capital adequacy on a total company basis. If all overseas assets are admitted, the capital adequacy multiple for Chartis as at 30 June 2010 would have been 235 per cent. 26 The actuarial report by Finity concludes that, given that the American Home Australian branch policies will be taken over by Chartis, with no change to terms and conditions, the scheme will not adversely impact upon the interests of policyholders of the Australian branch. The report also concludes that, given that the financial position of Chartis after the transfer will be materially the same as that of American Home prior to the transfer, with the group ownership of the business unchanged, the scheme provides adequate financial security to the policyholders, although the report observes that there is always uncertainty as to the outcome of insurance business, and ongoing solvency cannot be guaranteed. 27 Finally, the report concludes that, given that claims management practices after the transfer are expected to be unchanged, there will not be any detriment to policyholders in that regard. The report concludes that the actuaries who signed the report are satisfied that the interests of policyholders should not be adversely affected in any material way as a consequence of the scheme. Mr Ian Reed, who became the appointed actuary of the Australian branch on 1 December 2010, reviewed the report and observed the improvement in the capital adequacy multiple compared with that as at 30 June 2010 referred to in the original actuarial report of Finity. 28 Reinsurance currently held by the Australian branch is an important part of the security presently enjoyed by its policyholders. It is proposed that reinsurance with the Australian branch liabilities will be transferred to Chartis. If the reinsurance is not transferred, the result would be a reduction in security for policyholders and a benefit to reinsurers. Approximately 67 per cent of the Australian branch's reinsurance recoverables is comprised of treaties with other entities within the AIG Group. It is proposed that deeds of novation will be executed to effect the transfer of those reinsurances to Chartis. Some of the Australian branch's reinsurance is ceded to foreign reinsurers or is governed by the laws of an overseas jurisdiction. In order to mitigate the possibility that the orders that American Home is seeking might not be recognised, the Australian branch has undertaken a programme to novate the material reinsurances. 29 To that end, personnel from the Australian branch undertook an extensive review between June and November 2010 of its current and historical reinsurance program. As a result of that review, a methodology was developed to ensure that all material outwards reinsurance agreements would be novated, either by way of novation deed or novation consent letter. In accordance with that methodology, the Australian branch has sent out novation deeds, novation consent letters or notices of the transfer to all of its reinsurers. The novation program continues. 30 Assuming the novation of reinsurance ceded internally within the AIG Group is a mere formality, the Australian branch has effectively obtained agreement from reinsurers to novate their respective reinsurance agreements, representing approximately 83 per cent of total recoverables due to the Australian branch as at 31 October 2010. No reinsurer has yet indicated that it opposes the transfer, or that there would be any difficulty with the transfer. In order to avoid any possible doubt, American Home also seeks an order under s 17F(2), which provides that the court may make such orders as it thinks fit in relation to reinsurance. The order sought is one that, as from the effective date of the scheme, all reinsurance treaties or other reinsurance agreements are taken to be valid, effective and continuing agreements between Chartis, in place of American Home, and the parties other than American Home to those reinsurance contracts. It is appropriate to make such an order.

Submissions by policyholders 31 As I have said, two policyholders appeared to make submissions in relation to the present application. First, Mr Richardson drew the Court's attention to administrative difficulties that he has experienced in the administration of his policy with American Home over some years. His complaints are not, however, it seems to me, such as would be relevant to the task presently before me. For example, Mr Richardson said that he was not provided with a copy of his policy, that his premium was increased without notice, and that terms of his policies were changed without notice. They are doubtless matters of significance and importance. If they indicated a culture of maladministration on the part of American Home, that may be a factor to be considered by APRA in relation to the authority for American Home to continue to conduct insurance business in Australia. That is not a question before the Court. 32 Further, there is nothing, apart from the administrative difficulties experienced by Mr Richardson, to suggest that there is a culture of maladministration on the part of American Home. The evidence is that there are many thousands of policyholders and none apart from Mr Richardson, and Mr Arthur, to whom I shall refer shortly, has lodged such a complaint. Even if there were deficiencies in administration, those deficiencies would continue whether or not the scheme is confirmed. 33 Mr Arthur also drew the Court's attention to the absence of any evidence from American Home as to the funding of the purchase price for the transfer of the business. Under the scheme and the transfer agreement entered into between American Home, Chartis and Chartis Singapore Insurance Pte Limited on 17 December 2010 (the Transfer Agreement), the purchase price for the business of the Australian branch of American Home is to be $485 million, adjusted in accordance with the Transfer Agreement to achieve a final fair market value of the business as at the effective date. The effective date is to be 1 March 2011. Under clause 4 of the Transfer Agreement, Chartis must pay the initial purchase price of $485 million to American Home on or immediately prior to the effective date. The concern expressed by Mr Arthur was that the purchase price may be provided from the assets that are to be transferred by American Home to Chartis. 34 In order to assuage any concerns, evidence was called from Mr John Briffa, a solicitor, who is the general counsel for Australasia of American Home. Mr Briffa explained that the purchase consideration of $485 million, together with any adjusted amount if the price were to be increased, is to be provided by subscription of share capital from the immediate holding company of Chartis, namely Chartis Singapore Insurance Pte Limited. The consideration would be provided by subscription for share capital of Chartis. The net effect will be negligible, so far as the cash position of Chartis is concerned. That is to say, the total consideration would be provided by a subscription for shares, and the price would then be paid to American Home in satisfaction of the obligations under the Transfer Agreement, and under the scheme. 35 It would have been desirable for those details to be set out in the material that was sent to affected policyholders, to explain that there was no question as to the reduction of the security available to those policyholders. In the light of the evidence and the provisions of the Transfer Agreement, I do not consider that there is any risk that the security of affected policyholders will be detrimentally affected by the payment of the purchase price. 36 Mr Arthur also drew attention to the fact that the result of the scheme is to place two more Singapore entities between the business being carried on in Australia and the United States head office. While such an observation is justified, I do not consider that there is a risk that the interposition of two further companies would in any way detrimentally affect the possibility that the ultimate holding company, the ultimate holder being the government of the United States, would be more reluctant to provide financial support for Chartis than for the Australian branch of American Home. 37 Mr Arthur also complained that the letter to policyholders did not adequately describe the reasons for the scheme. I have indicated already the justification advanced on behalf of American Home for the scheme. There are reasons why the reorganisation is appropriate, and while the benefits to policyholders may not be highly significant, I do not consider that there is any detriment. There is no reason, therefore, why the absence of further information means that the court's discretion should not be exercised in favour of the application. 38 Finally, Mr Arthur observed that the question of whether or not the scheme is fair and reasonable is one that might have been dealt with by an accountant rather than an actuary. However, the concern of the Court is not whether the consideration is fair and reasonable. The concern of the Court is whether or not affected policyholders will be detrimentally affected, apart from the other considerations to which I have referred. An actuary is an appropriately qualified expert to express an opinion as to whether or not the interests of policyholders will be affected. In relation to schemes that come before the court under the Corporations Act, of course, it is common for an independent expert to be retained, to express an opinion as to whether the consideration for a takeover is fair and reasonable. That is a consideration, as I have said, that does not arise in relation to the application for confirmation under the Insurance Act. 39 I am satisfied that the evidence before the Court indicates that the matters which must be taken into account by the court have been adequately explained to the Court. I am satisfied that the interests of policyholders are adequately protected. In summary, the terms and conditions of the transferred policies will remain unaltered, save for the substitution of Chartis as the insurer. The claims managing procedures in respect of the transferred policies will be unaltered. Finally, Chartis will hold adequate capital to protect policyholders, being capital of more than 200 percent of the minimum requirement. 40 APRA is represented at the hearing. The authority was charged with the responsibility of protecting the interests of policyholders. APRA has indicated that it has no objection to the proposed scheme. The scheme has been considered by APRA and APRA has given its approval in relation to various documentation to the extent that I have indicated. 41 In all of the circumstances, I consider that the Court should exercise its discretion to confirm the scheme. 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.