ASIC v Plymin [2003] NSWSC 1031 | Case summary

2545/02 IN THE MATTER OF UNITED MEDICAL PROTECTION LTD (PROVISIONAL LIQUIDATOR APPOINTED) 2543/02 IN THE MATTER OF AUSTRALASIAN MEDICAL INSURANCE LTD (PROVISIONAL LIQUIDATOR APPOINTED) 2541/02 IN THE MATTER OF MDU AUSTRALIA INSURANCE CO PTY LTD (PROVISIONAL LIQUIDATOR APPOINTED) 4506/02 IN THE MATTER OF UNITED MEDICAL PROTECTION OF NSW LTD (PROVISIONAL LIQUIDATOR APPOINTED) JUDGMENT (Revised 10 November 2003) 1 HIS HONOUR: David Lombe, the provisional liquidator of the five companies in the UMP Group, has applied to the Court for orders terminating his appointment as provisional liquidator of four of them, and for leave to discontinue winding up proceedings against those four companies. In addition to these principal applications, there are ancillary applications which will be the subject of a separate judgment. 2 The four companies are United Medical Protection Limited ("UMP"), Australasian Medical Insurance Limited ("AMIL"), MDU Australia Insurance Co Pty Ltd ("MDUAIL") and United Medical Protection of New South Wales Limited ("UMPNSW"). UMP is an unlisted public company, which is limited by guarantee. It commenced business on 1 July 1997. It is the largest of seven medical defence organisations currently operating in Australia. It conducts business on a not-for-profit basis and is not an insurer under the Insurance Act 1973 (Cth). It derives capital from annual membership subscriptions. The members of UMP are doctors and certain other health professionals. The members obtain professional indemnity insurance from AMIL. An important part of UMP's business has been to offer its members discretionary assistance. 3 AMIL is a licensed general insurer formed in 1989. UMP owns all of its issued share capital. AMIL has provided insurance policies to members of UMP (and its predecessor) since 1996. AMIL is supported by a parental guarantee from UMP. 4 MDUAIL is also a licensed general insurer, formed in 1995 and now in run-off. It was formed to provide insurance policies to members of The Medical Defence Union Limited, a UK based medical defence organisation formerly operating in Australia. On 1 January 1999 AMIL acquired the share capital of MDUAIL, and since that time AMIL has managed the run-off of the MDUAIL business. In January 2002 MDUAIL issued shares to UMP representing 34.78% of its capital, diluting AMIL's percentage interest to 65.22%. 5 Prior to 1 July 1997 UMPNSW carried on business as a medical defence organisation offering discretionary assistance to its members, who were medical practitioners, for claims arising from their practice. It traded as "United Medical Defence". On 1 July 1997 the members of UMPNSW became members of UMP, which continued to offer discretionary assistance in substitution for the assistance formerly offered to them by UMPNSW. UMP entered into a claims run-off agreement with UMPNSW under which UMP agreed to manage the run-off and assume obligations for outstanding claims and IBNR. Since 1 July 1997 UMPNSW has only acted in its capacity as the landlord of real property which it owns, located in Crows Nest in New South Wales. There are no shareholders of UMPNSW, which is a company limited by guarantee. Members are divided into voting and non-voting members, with UMP the only voting member. As at June 1998 UMPNSW held all of the issued shares in AMIL, but UMP acquired shares in AMIL over time, and is now AMIL's sole shareholder. 6 Apart from dormant companies, the only other company in the UMP Group is UMP Queensland. It has not made an application for termination at this stage, but such an application has been foreshadowed. 7 The four applications have been served on the Australian Prudential Regulation Authority ("APRA"), the Australian Securities and Investments Commission ("ASIC") and the Commonwealth of Australia. Each of them was heard on the applications, pursuant to leave granted under Rule 2.13 of the Corporations Rules. The applications were also advertised in the press and notices of the applications were given to members and creditors of the companies. A number of doctors have expressed interest in the applications and a few have made written or oral representations, to which I shall return. None of them sought leave to be heard at the hearing of the applications. Background facts 8 Three of the companies brought proceedings for winding up on 3 May 2002, pursuant to resolutions of their boards of directors, after the insurance regulator APRA had appointed an inspector to AMIL under s 52 of the Insurance Act. The application by UMPNSW was made later. On 3 May 2002 I made orders for the appointment of Mr Lombe as liquidator of the three companies provisionally, and I made a corresponding order in the case of UMPNSW on 9 September 2002. 9 I decided to appoint a provisional liquidator after considering whether it would have been more appropriate to appoint a receiver and manager: Re United Medical Protection Limited (2002) 41 ACSR 623; [2002] NSWSC 413. Having decided to prefer the appointment of a provisional liquidator for practical reasons, I made the appointments on the basis that a real prospect had been shown that at the hearing of the winding up proceedings, the companies would be ordered to be wound up on the just and equitable ground, and it was proper and desirable in the public interest to make the provisional appointments (at paragraph [11]). I pointed out that the winding up applications were not made on the ground of insolvency (at paragraph [12]). I then said: "13. What seems to be emerging in the circumstances of this corporate group is that, because of a combination of developments, rather than any one particular development, the Group's capital reserves are declining while, at the same time, a demand for increased capital is to be made by the regulator, and foreshadowed changes to accounting standards will also affect the need for capital. 14. All of this is happening in the context of world developments which include the contraction of the medical insurance market, the effects of September 11 on investments by general insurers, and the effects of those events on the cost of reinsurance. To that one adds, in Australia, the specific effects of removing one of the principal reinsurers in this category of insurance, namely the HIH Group. Those circumstances presage a further capital decline unless something can be done, and therefore, a risk that the company will be unable to continue to operate in the manner envisaged by the corporators and by the present membership. That is so regardless of whether, at some future time, the company comes to be clearly insolvent, in the sense in which that word is used in the Corporations Act." 10 On 26 June 2002 APRA issued, on the application of Mr Lombe, an authorisation for AMIL to carry on insurance business, under s 12 of the Insurance Act 1973 (Cth). The authorisation was issued after APRA had approved AMIL's auditor and actuary, its "Reinsurance Management Strategy" and the methodology for setting its "Maximum Events Retention". The authorisation was subject to conditions, including strict reporting requirements including an actuarial financial condition report, a requirement that the appointment of the inspector would continue to have effect, a requirement for the company to base its 2003 annual premiums on advice obtained from its Approved Actuary and in consultation with APRA, and a requirement for the company to ensure the separation of the roles of the Approved Auditor and Approved Actuary. AMIL and its Approved Actuary were required to consult with APRA and Mr Peter Martin, the Australian Government Actuary, on all high-level actuarial matters. 11 On the same day APRA determined, under sub-item 4(1) of Schedule 2 to the General Insurance Reform Act 2001 (Cth), that relevant provisions of the Insurance Act 1973 would continue to apply to AMIL during a transition period. APRA also declared, under subregulation 11(2) of the Insurance Regulations 2002, that a general prudential standard called "GPS 110" would not apply to AMIL during the exemption period. The exemption period expires on 30 June 2008. 12 On 31 October 2002 APRA wrote to Mr Lombe requiring, by 1 January 2003 and thereafter annually, a written unconditional guarantee by UMP to meet unfunded liabilities or regulatory capital deficits for AMIL and MDUAIL, and also an unconditional undertaking to comply with any APRA directions relating to the recapitalisation or overall soundness of AMIL and MDUAIL (including any direction to make a call of specified size and timing that APRA might consider necessary). Mr Lombe provided the latter undertaking as provisional liquidator, and APRA agreed to accept the existing parental guarantee as satisfying its first requirement. A financial condition report was provided to APRA in November 2002. Another one has been prepared more recently. 13 Mr Lombe's undertaking to cause UMP to raise new capital by making a call on members, if required by APRA, is limited by the arrangements now in place under the Medical Indemnity Act 2003 (Cth), according to which AMIL now issues insurance policies direct to UMP's members, and therefore UMP's annual income is significantly reduced. That, in turn, reduces the amount for which a call could be made under the terms of UMP's constitution. 14 During the 17 months since his initial appointment, Mr Lombe has negotiated with the Commonwealth for a measure of financial and other support. The negotiations have produced a Deed of Indemnity made by the Commonwealth, AMIL, UMP and Mr Lombe dated 30 July 2002, which formalised the provision of financial assistance by the Commonwealth to UMP and AMIL. The Deed was varied by a Deed dated 9 December 2002, which extended the Commonwealth's financial support until December 2003. On 5 June 2003 to the Deed was further varied to accommodate an increase in the policy limit of up to $25 million for insurance policies written by AMIL in 2003. A further Deed was entered into by the Commonwealth, MDUAIL and Mr Lombe on 19 November 2002, enabling MDUAIL to pay claims on "claims made" policies written before the appointment of the provisional liquidator. Mr Lombe sought and obtained the Court's approval under s 477(2B) of the Corporations Act for him to enter into these Deeds. 15 The Commonwealth has also enacted legislation as a framework for financial and other support for medical defence organisations ("MDOs") and medical indemnity insurers, including specific support for the UMP Group: Medical Indemnity Act 2002 (Cth); Medical Indemnity (IBNR Contribution) Act 2002 (Cth); Medical Indemnity (Prudential Supervision and Product Standards) Act 2003 (Cth). 16 The Medical Indemnity Act 2002, which commenced on 1 January 2003, establishes the IBNR Indemnity Scheme, providing a Commonwealth indemnity for "participating MDOs" for all their unfunded IBNR liabilities as at 30 June 2002. The Government's proposal, currently the subject of political debate, is that the cost of funding these liabilities will be met through a levy on the members of those MDOs which have unfunded IBNR liabilities. The same Act establishes the High Cost Claims ("HCC") Scheme, under which the Commonwealth is to pay 50% (or such other percentage as prescribed by regulation) of claims made by MDOs or insurers greater than the HCC threshold, which is currently $2 million, up to the insured amount. The Scheme applies only to claims notified on or after 1 January 2003. The Act also authorises the Minister to formulate a subsidy to assist doctors in particular areas of practice to meet the cost of purchasing medical indemnity insurance. 17 The Medical Indemnity (Prudential Supervision & Product Standards) Act 2003 (Cth) commenced on 1 July 2003. It prescribes minimum standards for medical indemnity insurance (for example, requiring a minimum level of medical indemnity cover of $5 million per claim and in the aggregate). Medical indemnity cover must be offered by way of a contract of insurance issued by a regulated insurer, and MDOs will no longer be permitted to offer discretionary cover. The Act permits a MDO to apply to APRA for a determination that the minimum capital requirements for insurance companies do not apply during a transition period that ends on 30 June 2008. It states that APRA must determine that the minimum capital requirements do not apply to the insurer during the transition period if (a) the insurer does not or would not satisfy the prudential standards, to the extent to which they impose minimum capital requirements; and (b) the insurer lodges a complying funding plan certified by an independent auditor and an independent actuary; and (c) the insurer complies with other guidelines issued by APRA in respect of the funding plan. 18 The introduction of the Medical Indemnity (Prudential Supervision & Product Standards) Act has made it necessary for Mr Lombe to engage in some restructuring of the UMP Group. As from 1 July 2003 UMP was prohibited from providing discretionary assistance to its members, and only the authorised insurers in the Group could provide medical indemnity insurance. The Group now operates as two distinct companies, UMP conducting a consulting business by providing medical services such as professional development programs, management programs and assistance with coronial and disciplinary matters. AMIL is a licensed insurer, operating under the Act and providing members with medical indemnity insurance and legal services and expenses insurance. 19 Tort law reform legislation has been acted enacted in some States and is proposed in a Commonwealth Bill. It is unnecessary to summarise the legislation here. No single uniform approach has been adopted, and instead the legislation adopts a variety of strategies, including the capping of various categories of liability and alterations of principles of recoverability: see, for example, Health Care Liability Act 2001 (NSW); Civil Liability Act 2002 (NSW) (as amended by the Civil Liability Amendment (Personal Responsibility) Act 2002); Personal Injuries Proceedings Act 2002 (Qld); Civil Liability Act 2003 (Qld); Justice and other Legislation Amendment Bill 2003 (Qld); Trade Practices Amendment (Personal Injuries and Death) Bill 2003 (Cth). 20 On 10 October 2003 the new Minister for Health and Ageing, the Hon Tony Abbott MP, made an announcement after discussions with doctors who had expressed concern about the imposition of the IBNR levy proposed by the Government to recoup some of the cost of its financial support of medical insurers. Mr Abbott announced that the current IBNR levy notices would be withdrawn and existing payments would be refunded. There would be a policy review process and new levy notices would be issued after it had been completed. During the hearing of these applications, I expressed concern that the policy review might have some impact on the existing IBNR and HCC Schemes of a kind that might be detrimental to the present applications. 21 The Minister responded to this concern by writing to Mr Lombe on 14 October 2003. He said: "I understand that the future of the IBNR indemnity has been raised in proceedings. I would like to assure you that the Australian Government is committed to maintaining the indemnity and has no intention of withdrawing from its assumption of these liabilities. It is not my intention that the Policy Review, which I announced on 10 October 2003, will address this element of the Government's policy in relation to medical indemnity." 22 I am satisfied that this letter removes the concern that I had expressed. 23 Mr Lombe has made numerous interlocutory applications to the Court during the course of his extensive work. The applications were partly driven by the requirement for judicial approval to contracts for a period of more than three months (Corporations Act, s 477(2B)), and partly because at various times he has been advised to seek directions in the nature of judicial advice. 24 On many occasions Mr Lombe's applications were relatively urgent and it was necessary for the Court to hear them outside normal sitting hours. On some occasions it was practicable for the Court to give reasons for its decisions on the applications, but on other occasions reasons were not required or given. It is worth noting here that one of the applications involved the establishment of an Advisory Committee to assist Mr Lombe to manage the business and affairs of the UMP Group. The Advisory Committee has been established and has been functioning for the whole of this year. The applications to terminate - relevant legal principles 25 In the case of each of the four companies, Mr Lombe seeks an order that his appointment as liquidator provisionally be terminated, and an order that the originating process for winding up be dismissed. If the orders are made, he intends to exercise his powers as provisional liquidator to appoint directors to UMP. One of the ancillary applications is for a direction that he would be justified in doing so. Broadly speaking, the principal applications raise the question whether the Court should permit the UMP Group companies to be returned to the control of their boards of directors, freshly constituted with new directors, so that the business and affairs of the companies may be conducted in future without any ongoing supervision of the Court. 26 The Court's power to appoint a liquidator provisionally is conferred by s 472(2) of the Corporations Act. The Corporations Act, s 482, expressly authorises the Court to terminate the winding up of a company after an order for winding up has been made, and s 467(1) authorises the Court on hearing a winding up application to dismiss the application or make any other order it thinks fit. There is no express power in the Corporations Act for the Court to make an order terminating the appointment of a provisional liquidator, but the Court has the power to set aside or vary any interlocutory order under its own rules: Supreme Court Rules, Part 40 rule 9. 27 It is unusual for a company to remain in provisional liquidation for any length of time, and highly unusual that the UMP Group companies have been under the control of a provisional liquidator for over 17 months. Not surprisingly, therefore, there is very little guidance in reported cases as to the criteria to be applied by the Court in dealing with such an application. 28 The only case cited to me where the appointment of a provisional liquidator was terminated is Garden Mews-St Leonards Pty Ltd v Butler Pollnow Pty Ltd (No 4) (1984) 2 ACLC 682. McLelland J did not set out to give any comprehensive statement of principles, but he took into account that, in circumstances where the provisional liquidator's administration was not active and there were no assets in his possession other than the company's books and records, it was appropriate to terminate the appointment upon the basis that the provisional liquidator would then be required to retain custody of the financial records of the company until the final determination of the proceeding. His Honour observed (at 683) that the purposes for which the provisional liquidator was originally appointed had been exhausted, bearing in mind that the primary function of a provisional liquidator is to preserve the assets of the company for the benefit of those who may ultimately be found entitled to them. 29 Counsel for Mr Lombe, whose submissions were supported and expanded by counsel for ASIC, contended that, in the absence of directly applicable case law, the Court should apply by analogy the principles according to which a winding up or receivership is terminated. 30 As to termination of a winding up, I was taken to Re Data Homes Pty Ltd (in liq) [1972] 2 NSWLR 22, at 26-27; Re Mascot Homes Furnishers Pty Ltd [1970] VR 593, at 598; and Mercy & Sons Pty Ltd v Wanari Pty Ltd (2000) 35 ACSR 70, at paragraphs [47]-[51]. Those cases show that in considering an application to terminate a court-ordered winding up under s 482, the Court has regard to the effect of the proposal on various categories of interests: the interests of creditors (including future creditors who might be prejudiced if the company is released from winding up in an encumbered state); the interests of the liquidator, particularly with respect costs; the interests of contributories; and the public interest (including the public interest in upholding commercial morality), the Court taking the initial approach that insolvent companies should be wound up. 31 As to termination of the office of a court-appointed receiver, Kerr on Receivers and Administrators (17th edition by Sir Raymond Walton and Muir Hunter, 1989) states (at 250) that "a receiver will be discharged when the object of his appointment has been fully effected" (citing Tewart v Lawson (1974) LR 18 Eq 490). A qualification to that proposition is found in H Picarda, The Law Relating to Receivers, Managers and Administrators (2nd edition, 1990), at 416, where the author says that "a receiver will not be discharged so long as any relevant claim remains unsatisfied or unadjudicated or any question of title to the property in receivership remains outstanding" (citing Largan v Bowen (1803) 1 Sch & Lef 296 and Reeves v Neville (1862) 10 WR 335). Both the general proposition and its qualification have been recognised in the Australian cases. In Re Merchant Nurseries Pty Ltd (1985) 10 ACLR 143 Lunn AJ made it clear that a court-appointed receiver is not to be automatically discharged as soon as the object of the appointment has been fully effected. In Re ASC Timber Pty Ltd (1992) 10 ACSR 525 Cohen J affirmed that proposition and said (at 531) that if there is a reasonable anticipation that a claim will be made against a person over whose assets the receiver was appointed, it may be necessary to leave the receivership in place to provide security until the claim has been dealt with. 32 These principles are not directly applicable to termination of the appointment of a provisional liquidator. In the Butler Pollnow case, McLelland J observed (at 683) that "whether there should be a provisional liquidator in control of the company is quite a different question in my opinion, from whether a winding up ought to continue or be stayed after an order for winding up has been made." Termination of the office of a court-appointed receiver and manager is a little closer, in the sense that the appointment of a receiver and manager, like the appointment of a provisional liquidator, is an interlocutory step taken to preserve assets, but there still are important differences in the nature of the respective offices and the purposes of appointments to those roles. 33 Nevertheless, it is reasonable to take the view that the cases on termination of winding up and receivership are helpful by analogy, because they identify factors relevant to the exercise of the Court's discretion. When coupled with McLelland J's observations in Butler Pollnow, those cases suggest that the following issues are relevant to an application to terminate the appointment of a provisional liquidator: · whether the purposes for which the appointment was made have been exhausted, and whether there is a reasonable prospect that matters may arise in future with which the provisional liquidator should deal; · whether the termination might put at risk the interests of creditors, contributories and the provisional liquidator; · whether it is in the public interest that the appointment be terminated. 34 Mr Lombe has invited the Court to make certain findings of fact for the purpose of determining the applications. In particular, he submits that the Court should find that the companies are now solvent. Insolvency is not itself a ground for the appointment of a provisional liquidator, even where the application for winding up is based on the insolvency ground. The Court should be satisfied, before appointing a provisional liquidator, that there is a particular need to do so, either because the assets of the company are in need of protection or for some other reason: see the cases assembled in Lubavitch Mazal Pty Ltd v Yeshiva Properties No 1 Pty Ltd [2003] NSWSC 535, paragraphs [105] and [106]. In the present case, the winding up applications were made on the just and equitable ground, and the provisional liquidator was appointed on the basis that there was a real prospect that this ground would be established on the hearing of the winding up application. The issue of insolvency was not directly raised when the appointments were made, and one might therefore expect that it would not be necessary to make a determination of insolvency at the present stage. 35 However, it now appears that both UMP and AMIL had a deficiency of net assets at the time of the making of the winding up applications ($38.6 million for AMIL and $49.869 million for UMP excluding IBNR - MDUAIL and UMPNSW had net positive assets of $2.162 million and $2.367 million respectively). "Balance sheet insolvency" does not establish insolvency for the purposes of the Corporations Act, but a deficiency of net assets raises a question about whether the company is able to pay its debts as and when they fall due. 36 Given the need to consider, inter alia, the interests of creditors in an application to terminate the appointment of a provisional liquidator, and given that there is evidence before the Court that for a time during the term of the provisional liquidator's appointment some of the companies had a substantial deficiency of net assets, it seems to me that the Court must make an assessment as to whether the companies are solvent for the purpose of deciding whether to exercise its discretion to terminate the appointment. I therefore agree with the submission of counsel for Mr Lombe, supported by counsel for ASIC, that it is centrally important for the Court to address the question of solvency. 37 Another important issue, related to but not the same as the question of solvency, concerns prudential supervision. AMIL and MDUAIL hold licences as insurers under the Insurance Act 1973 (Cth). It will be necessary for them to maintain their licences if they are to continue to carry on business. The Insurance Act is administered by APRA as regulator, and APRA has adopted substantial standards relating to capital adequacy and other matters for general insurers. As noted above, APRA's capital adequacy requirements must be complied with by AMIL by no later than 30 June 2008. It is appropriate for the Court, having regard to the interests of creditors (including members who are creditors) and the public, to consider the prospects of compliance with APRA's requirements. The Court's approach to the evidence 38 Following the approach adopted by Mr Lombe in his principal affidavit made on 22 September 2003, I shall consider the case for termination of the appointment of the provisional liquidator of the four companies under the following headings: · summary of reasons advanced to terminate appointment of provisional liquidator; · the submission that the reasons for appointment of the provisional liquidator no longer exist; · the submission that the reasons for failure of the UMP Group have been remedied to the extent possible; · the submission that the UMP Group is solvent; · Mr Lombe's financial projections and the proposal to meet minimum capital requirements; · the submission regarding compliance with APRA's prudential standards; · steps taken to regularise the business of the UMP Group for its transition to normal trading. 39 The evidence presented to me has been very extensive. Mr Lombe has prepared a substantial document entitled "Final Report Into Solvency & Financial Position of Australasian Medical Insurance Ltd (Provisional Liquidator Appointed)", as at 30 June 2003 ("AMIL Report"). He has prepared similar reports for each of the other three companies ("UMP Report", "MDUAIL Report", and "UMPNSW Report"). The audited accounts for the UMP Group as at 30 June 2003 are also in evidence. 40 There are several reports going to the question whether the UMP Group will comply with applicable prudential standards within the timeframe set by APRA. First, the approved actuary for AMIL and MDUAIL, the two licensed general insurers, is Adrian Gould of Taylor Fry. He has prepared a lengthy Financial Condition Report for the UMP Group, dated 19 September 2003, upon which Mr Lombe relies for the purposes of the present applications ("Financial Condition Report"). 41 The UMP Group has finalised a strategic plan for the period from January 2003 to June 2006, and a business plan for the period from January 2003 to June 2004, which have also been included in the evidence. 42 Although I have had the benefit of very helpful submissions from the Commonwealth of Australia and the two relevant regulators, APRA and ASIC, the applications for termination of the appointment of the provisional liquidator are not contested applications. As I have said, during the course of the provisional liquidation and in consequence of an interlocutory application, Mr Lombe established an Advisory Committee to assist him in the administration of the UMP Group. It was thought that the establishment of an Advisory Committee would assist preparation of the Group for transition to normal business activities, should termination of Mr Lombe's appointment as provisional liquidator be possible, by giving experience of the Group's operations to some people who would be suitable for appointment to the board of directors of UMP. As I shall explain, most of the individuals who have served on the Advisory Committee have accepted Mr Lombe's invitation to serve on the board of directors in the event that the applications are successful. But two of them have declined offers of appointment on the ground that they are uncertain about aspects of the financial future of the Group. 43 The combination of absence of a contradictor to Mr Lombe's applications, and the doubts expressed by two members of the Advisory Committee, have made it particularly important for the Court to examine the evidence carefully. That said, the Court must, in a case where the issues are financial and regulatory and are necessarily complex, place very considerable reliance on the opinions of the provisional liquidator, the Approved Actuary and the regulators. Mr Lombe has sought assistance during the course of his administration from various experts, including experts in actuarial matters, investments, valuation, risk management and reinsurance. Summary of reasons advanced to terminate appointment of provisional liquidator 44 Mr Lombe has advanced the following reasons for terminating his appointments as provisional liquidator: (a) that the "confluence of factors" resulting in his appointment no longer exists; (b) the causes for the failure of the UMP Group have been remedied to the extent possible; (c) each company in the UMP Group is solvent on both a cash flow basis and a balance sheet basis; (d) AMIL and UMP are able to meet APRA's prudential requirements going forward; (e) during the course of his appointment, he has taken steps to regularise the affairs of the UMP Group, and now the UMP Group is able to operate and compete in normal trading conditions, including the transition of control back to a board of directors; (f) based on financial projections, the risk of the Group becoming insolvent in the future appears to be limited. 45 I shall consider each of these issues. The submission that the reasons for appointment of the provisional liquidator no longer exist 46 The applications for the appointment of a provisional liquidator to UMP, AMIL and MDUAIL were made by the companies themselves, pursuant to resolutions of their respective boards of directors. In his affidavit supporting the applications, made on 2 May 2002, Charles Quayle (a UMP director) described what Mr Lombe refers to as a "confluence of events" which caused the companies to make the decision to approach the Court. Those events were: (a) difficulty experienced by the UMP Group in maintaining capital adequacy, due to the following series of events: (i) in October 2000 UMP levied a call against its members to improve capital levels, a decision that proved unpopular with some of its members and led to a reduction in membership numbers; (ii) there was a withdrawal of commercial insurers from the medical malpractice insurance market in 2001; (iii) just prior to the commencement of the Health Care Liability Act 2001 (NSW), there was a dramatic increase in the number of litigated claims being notified to AMIL, presumably because plaintiffs sought to avoid the Act by commencing their proceedings before it began; (iv) the collapse of the HIH Insurance Group reduced the value of AMIL's reinsurance recoveries; (v) the terrorist attack on the World Trade Centre in New York on 11 September 2001 led to investment losses and escalated reinsurance costs; and (vi) there had been a general increase in the frequency and quantum of claims against medical practitioners; (b) in February 2002, APRA directed AMIL to increase its capital by $30 million by 30 June 2002, and the UMP board formed the view that it was unlikely this could be achieved; (c) the Urgent Issues Group of the Australian Accounting Standards Board directed medical defence organisations to bring into account incurred but not reported claims ("IBNRs"), a step that would severely affect the reported financial position of the UMP Group, which at 30 June 2001 had an estimated IBNR liability of approximately $455 million; and (d) the directors of UMP and AMIL were unable to secure directors' and officers' liability insurance beyond 30 June 2002. 47 Mr Lombe's evidence is that these factors either no longer exist, or have been resolved during the course of his administration of the companies. He makes the following claims, each of which I accept on the evidence: (a) The depletion of capital which resulted in the "call" on UMP members in October 2000 has been arrested. Since Mr Lombe's appointment as provisional liquidator, the net assets of UMP valued by him on a "going concern" basis have increased by $103.7 million, and the net assets of AMIL valued by him on a "going concern" basis have increased by $82.477 million (I shall return to these figures when I come to consider the question of solvency). Mr Lombe attributes these improvements largely to Commonwealth Government support (including the Government's IBNR and HCC Schemes), tort law reform, and resolution of the UMP Group's tax position. (b) The claims spike in August 2001, resulting from the foreshadowed commencement of the Health Care Liability Act, is unlikely to be repeated, having regard to the tort law reforms that were subsequently introduced. (c) Mr Lombe has expressed the opinion that the collapse of one of AMIL's major reinsurers (such as HIH in 2001) is unlikely to be repeated. Be that is that may, he has limited the effect of any collapse of a major reinsurer by spreading AMIL's exposure. Additionally, he has confined AMIL's reinsurance arrangements to contracts with higher-rated reinsurers, with the assistance of expert advice from AMIL's reinsurance broker. (d) The investment losses and increased reinsurance costs that resulted from the terrorist attack on 11 September 2001 had been absorbed by the UMP Group and appropriate premium adjustments have been made. Although the possibility of a similar event occurring in the future cannot be ruled out, Mr Lombe's opinion is that the effect of such an event may not be so substantial in today's insurance market as it was in 2001. (e) Tort law reform has reduced the number and quantum of claims and the UMP Group has increased its provisioning of reserves. (f) The decision by the Urgent Issues Group to require medical defence organisations to bring to account IBNRs had exacerbated UMP Group's capital adequacy problems. This is no longer a factor impacting on the UMP Group's financial position, due to the implementation of the Government IBNR Scheme. Further, the UMP Group no longer accrues IBNRs, because AMIL issues its policies on a claims made basis rather than an incidents basis. Moreover, UMP can no longer offer discretionary assistance having regard to the provisions of the Medical Indemnity (Prudential Supervision & Product Standards) Act 2003 (Cth). (g) Under transitional arrangements adopted by APRA, medical malpractice insurers are not immediately subject to APRA's capital adequacy requirements. Mr Lombe expects that AMIL will meet APRA's minimum capital requirements well before 30 June 2008, when it will be required to do so. (h) The new boards of directors of the UMP Group will have in place directors' and officers' indemnity insurance. (i) In Mr Lombe's opinion, the UMP Group now has a strong management team, and there are disciplines and protocols in place to ensure that provisioning and preserving are dealt with appropriately and in a timely manner, with adjustments to premium pricing where required. The submission that the reasons for failure of the UMP Group have been remedied to the extent possible 48 Mr Lombe has identified three major factors contributing to the failure of the UMP Group. The first is the lack of reserving for long-term liabilities, and consequently insufficient premium pricing and failure to account for IBNR risk. That problem has been addressed by various measures set out above, including the Government's IBNR Scheme, AMIL's change from incidents-based policies to claims-made policies, and the adoption of disciplines and protocols to ensure appropriate provisioning and reserving and consequent adjustments to premium pricing. 49 The second factor is lack of management experience. That has been addressed by the appointment of qualified people to the Advisory Committee, most of whom will accept appointments to the UMP board of directors if the provisional liquidator's appointment is terminated, and by the implementation of measures to strengthen the management team. 50 The third factor is the adverse impact of the amalgamation which created the UMP Group. This requires further explanation. 51 UMP merged with UMPNSW and Medical Protection Society Limited ("MPS", a Queensland-based medical defence organisation) in 1997. In each case the merger involved a claims run-off agreement effective on 1 July 1997, under which UMP gave an indemnity for the open or known claims of UMPNSW and MPS respectively. Under the respective agreements UMPNSW was required to pay UMP $9.774 million, and MPS paid UMP $63.732 million (in two tranches). During the period from July 1997 to June 2003 UMP in fact paid approximately $165 million in respect of known claims of UMPNSW, with an estimated $23.6 million still outstanding. Some recoveries have been made from reinsurers, but Mr Lombe is unable to determine the amount of recoveries without a significant amount of manual reconstruction of claims paid, and therefore cannot determine whether UMP gained any net benefit from the payment received from UMPNSW. UMP paid approximately $50 million in respect of known claims of MPS, providing it with a net benefit (after deducting assumed handling expenses) of $4.7 million. 52 Under the claims run-off agreements UMP also acquired the IBNR claims of UMPNSW and MPS for incidents occurring before July 1997 but not notified by that date. Apparently UMP did not receive any additional monetary consideration for acquiring these liabilities. Subsequently, when IBNRs were notified UMP did not record whether they related to UMPNSW or MPS members before July 1997, and so Mr Lombe is not able to calculate what amount UMP has paid in relation to these IBNR liabilities without manually reviewing every claim. However, due diligence performed prior to the mergers estimated the IBNR amount for UMPNSW at $124.3 million, and for MPS at between $50 and $65 million. 53 In the absence of a great deal of additional manual work, Mr Lombe has been unable to make a comprehensive determination as to whether the claims run-off agreements were of benefit to the UMP Group. On the information available to him, however, his view is that UMP assumed significant liabilities, in the form of the IBNR liabilities of UMPNSW and MPS, and received little or no consideration for doing so. He sees this as a factor contributing to the failure of the UMP Group. 54 I find Mr Lombe's analysis of the principal factors contributing to the failure of the UMP Group to be plausible and consistent with the other evidence before me. The submission that the UMP Group is solvent 55 Section 9 of the Corporations Act provides that "insolvent" has the meaning given by s 95A(2). The latter provision says that a person who is not solvent is insolvent. Section 95A(1) provides that a person is solvent if, and only if, the person is able to pay all the person's debts, as and when they become due and payable. This has been described as the "cash flow test" of insolvency, rather than a "balance sheet" test: Melbase Corp Pty Ltd v Segenhoe Ltd (1995) 17 ACSR 187; ASIC v Plymin (2003) 46 ACSR 126 at 212. The following points emerge from Mandie J's review of the authorities at paragraphs [370]-[380] of the latter case: · "whether or not a company is insolvent … is a question of fact to be ascertained from a consideration of the company's financial position taken as a whole", and is a question to which "commercial realities will be relevant" (Southern Cross Interiors Pty Ltd (in liq) v DCT (2001) 53 NSWLR 213, 224 per Palmer J); · "it is useless to say that if its assets are realised there will be ample to pay 20 shillings in the pound: this is not the test. A company may be at the same time insolvent and wealthy" (Re Tweed Garages Ltd [1962] Ch 406, 410 per Plowman J); · it is thus of no consequence, of itself, that assets exceed liabilities, the important point being whether the company can pay its way in carrying on its business (see AR Keay, "The insolvency factor in the avoidance of antecedent transactions in corporate liquidations," (1995) 21 Monash Univ LR 305, 307); · "the question is not whether the debtor would be able, if time were given to him, to pay his debts out of his assets, but whether he is presently able to do so with moneys actually available" (Bank of Australasia v Hall (1907) 4 CLR 1514, 1528 per Griffith CJ); · "It is the debtor's inability, utilising such cash resources as he has or can command through the use of his assets, to meet his debts as they fall due which indicates insolvency" (Sandell v Porter (1966) 115 CLR 666, 670 per Barwick CJ; · "If, as a matter of substance, the company is not able to pay its debts as they become due, the circumstance that the relevant creditors may give the company some time before they actually seek to enforce their remedies, and the company may well be able to pay them out given that time, will not negative the application of the section" (Standard Chartered Bank of Australia Ltd v Antico (Nos 1 & 2) (1995) 38 NSWLR 290, 331 per Hodgson J); · for the purpose of assessing insolvency, a contractual debt is taken to be payable at the time stipulated for payment in the contract, unless there is evidence of an express or implied agreement between the company and creditor for extension of time, or a course of conduct sufficient to give rise to an estoppel against the creditor, or an established practice in the industry or between the company and its creditors whereby debts are taken to be payable at some other time than provided for in the contract (Southern Cross Interiors, at 225). 56 One aspect of the question for determination in the present case is whether the four companies are now solvent, so that the interests of unsecured creditors will not be put at risk by termination of the provisional liquidator's appointment, beyond the risks that such creditors inevitably bear in supplying and keeping available unsecured credit to a business company in normal operation. An assessment of whether a company is solvent at a particular time may call for a degree of forward analysis. Indeed, s 459D(1) provides (in the context of determining whether a company is insolvent for the purposes of winding up) that the Court may take into account contingent or prospective liabilities. Nevertheless, the question insolvency is normally considered to be a question about the present condition of the company. 57 Here, however, the future prospect of insolvency is a matter relevant to my determination. If I were to hold that the companies satisfied the cash-flow test of insolvency at the present time, but that it was nevertheless likely that they would be unable to pay their debts as and when they fell due at some future time, because of an identified future reduction or absorption of cash flow, I would not in the exercise of my discretion make an order for termination of the appointment of the provisional liquidator, because of the damage that would be done to creditors at that future time. It is therefore necessary for me to be satisfied not only that the companies are presently solvent, but that there are a reasonable grounds for predicting that they will remain so. 58 Mr Lombe has formed the opinion that each of the four companies is solvent. His opinion is expressed for each of UMP, AMIL, MDUAIL and UMPNSW in his respective Reports on those companies. His Reports include a cash flow analysis up to 30 June 2008, and then analysis of Mr Gould's conclusions in his Financial Condition Report. His affidavit made on 22 September 2003 provides a summary of his opinions on the solvency of each of the companies. I shall consider the position of each company in turn. UMP 59 Mr Lombe says that according to his calculations, when he was appointed on 3 May 2002, UMP had a net deficiency of assets in the sum of $49.869 million on a "going concern" basis, excluding IBNR. According to the audited accounts for the year to 30 June 2002, UMP had a net deficiency of $5.571 million, and a net loss before tax of $89.058. By 31 March 2003 the net deficiency on a going concern basis was $17.261 million, and the net profit for the nine months to that date was $45.173 million. The audited accounts for the year to 30 June 2003 show net assets of $53.830 million and net profit of $57.653 million. 60 Unaudited financial statement spreadsheets indicate that UMP achieved an operating profit before tax of $19.079 million for the three-month period to 30 September 2003, and at that date had a surplus of assets over liabilities of $72.461 million. 61 Mr Lombe attributes the dramatic improvement in UMP's net asset position on a going concern basis (an improvement of $103.7 million from Mr Lombe's appointment on 3 May 2002 to 30 June 2003) to the following main factors: · the benefits derived from the Government's IBNR Scheme and various legislative reforms including tort law reform, which have resulted in claims not being borne by UMP; · a reduction in the frequency and quantum of claims liabilities; and · the resolution of UMP's tax affairs. 62 Mr Lombe's evidence is that if the company were to be valued on a "close down" basis on 30 June 2003, rather than on a "going concern" basis, it would have a net deficiency of $80.881 million. The difference between the "close down" and "going concern" valuations is explained by two factors. First, the "close down" valuation assumes that UMP's investment in AMIL, shown in the balance sheet as at 30 June 2003 at $43.877 million, would be worthless. Secondly, as a result of liquidation, reinsurance recoveries on a close-down basis would reduce by half from $155.966 million to $77.983 million. Collection of call instalments could also be adversely affected, and in a close down there may be additional calls on the parental guarantee, which would worsen the results of UMP. Mr Lombe has expressed the opinion that there is no reason to adopt a "close down" valuation, because UMP and the other companies in the Group are able to continue trading and there is no good reason to incur the substantial loss in value from an immediate close down. I agree with Mr Lombe's opinion on this point. The law of insolvency, summarised above, does not require the adoption of a "close down" valuation. 63 Using the "base scenario" group of assumptions that I shall discuss later, Mr Lombe has projected profits for UMP ranging from a high of $66 million for the year to June 2004, to a low of $19.3 million for the year to June 2008. His balance sheet projections show net assets increasing from $53.8 million in June 2003 to $228.4 million in June 2008. 64 A very important part of Mr Lombe's analysis is his assessment of present and future cash flow. In consequence of the Commonwealth legislative package summarised above, which prevents MDOs from providing discretionary cover, Mr Lombe and his team have prepared a new business model, under which the cash flow for UMP is essentially the subscriptions received for members' services and legal expenses insurance policies (plus the balance of the call made in the year 2000), less the expenses incurred by UMP in providing those services. Under the new business model UMP does not accrue any future net claims liabilities. Mr Lombe's evidence is that the net incurred claims cost of UMP is the run-off of the IBNR liability net of indemnities under the Commonwealth schemes, which he has assumed to produce close to a nil cash-flow effect. In his Report he sets out figures supplied by Taylor Fry, estimating the UMP Group's IBNR claims liability for post-1 July 2002 incidents (not covered by the Government's IBNR Scheme) to be $3.5 million. 65 Cash flows for the next five years have been projected. For the year to June 2004, a deficit of $44.1 million in cash flow is projected, with investment assets of $144.5 million ($52.8 million excluding equity in subsidiaries). For the year to June 2005, the projection is for a positive net cash flow of $9.3 million, with investment assets increasing to $188.1 million ($62.1 million excluding subsidiaries). For the year to June 2006, the projection is for cash flow of $6.7 million, with investment assets up to $214.4 million ($68.8 million excluding subsidiaries). For the year to June 2007, a deficit in cash flow of $3.2 million is projected, with investment assets up to $234 million ($65.6 million excluding subsidiaries). For the year to June 2008, a cash flow deficit of $5 million is projected, with assets of $243.7 million ($60.5 million excluding subsidiaries). 66 The large cash flow deficiency in the year to June 2004 includes Mr Lombe's proposal for payment by UMP to AMIL of outstanding intercompany balances. This has the effect of reducing UMP's total cash and investments to $52.8 million as at June 2004, but the projection is that over the next five years that figure will increase, standing at $60.5 million in June 2008. 67 In the UMP Report, page 56, Mr Lombe comments on the negative cash flow projected for the 2007 and 2008 years. After noting that this will start to erode cash reserves, he comments that "management will need to ensure that appropriate action is taken to rectify this negative cash flow prior to the 2007 year." 68 Mr Lombe's calculations rely upon an actuarial assessment of the claims liabilities of the UMP Group, as at 30 June 2003, provided by Taylor Fry to Mr Lombe in their report dated 22 August 2003. Taylor Fry gave estimates of liabilities at both central estimate (50%) and 75% probability of sufficiency. Under APRA regulations imposed from 1 July 2002, general insurers are required to use claims estimates at a minimum of 75% probability of deficiency in their solvency returns. On this basis, Taylor Fry estimated the net outstanding claims liabilities of UMP Group for incidents notified as at 30 June 2003 at $310.7 million, of which $67.8 million was allocated to UMP. 69 Mr Lombe's evidence is that the net present value of all future claims is approximately $45 million. On that basis his conclusion is that UMP should have sufficient cash to pay all claims in the future, provided it continues to operate profitably. In the UMP Report, page 55, Mr Lombe says: "Even if the company is generating negative cash flows, given its investment reserves it is likely that an insurance company will be able to continue to meet its debts well into the future by exhausting these reserves." That is correct, subject to the obvious qualifications that Mr Lombe's remark assumes that the investment reserves are represented by sufficiently liquid assets to permit their timely realisation, and is made on the basis that APRA has exempted UMP from complying with minimum capital requirements that might otherwise interfere with the realisation of reserves to meet current debts. 70 Particular care must be taken using the estimate of future claims. Taylor Fry notes the inherent uncertainty involved in the projection of future claim costs, which is exacerbated by several factors. One factor is the high degree of uncertainty regarding the effects that recent legislative changes to tort law will have on claims costs. Another is an increased level of public awareness of the UMP Group, which may have changed the behaviour of UMP Group members in notifying incidents, and claimants and their legal representatives in pursuing and negotiating claims. Taylor Fry have emphasised that estimates of IBNR are subject to even greater uncertainty than estimates of future claims costs. 71 The point is reinforced in the audit report for UMP, AMIL and MDUAIL for the year to 30 June 2003, signed by PricewaterhouseCoopers as auditors on 19 September 2003. While the audit report contains an unqualified opinion, it draws attention to the following matter: "As a result of the matters described in note 1(b) of the financial report, there is significant uncertainty surrounding the estimation of provisions for known outstanding claims, IBNR claims, associated reinsurance and other recoveries and reinsurance premiums payable for the company and the United Group." Note 1(b) of the financial report refers at some length to Taylor Fry's statement regarding the uncertainty of estimates of claims liabilities. 72 Taylor Fry's emphasis on the uncertainty of claims estimates demands careful attention. On the other hand, the Court needs to have the best available financial information with respect to UMP's present position and future prospects, and that information necessarily involves making use of Taylor Fry's estimates, however uncertain they may be. The reasoning supporting the estimates is disclosed in the evidence before me and I can see no basis for challenging that reasoning. Mr Lombe and Mr Gould have special expertise in this area, and their work has been reviewed by APRA. Mr Gould has had discussions with Mr Martin, the Australian Government Actuary. No one has disagreed with Taylor Fry's methodology or conclusions. In these circumstances I am prepared to accept Taylor Fry's estimates for the purpose of considering the solvency and prospects of the companies in the UMP Group. AMIL 73 Mr Lombe says that on 3 May 2002 AMIL had a net deficiency on a "going concern" basis of $38.6 million, although its audited accounts for the year to 30 June 2002 showed net assets of $8.27 million. The audited accounts for the 12 months to 30 June 2003 showed net assets of $43.877 million and a net profit before tax of $40.223 million. 74 Unaudited financial statement spreadsheets indicate that AMIL achieved an operating profit of $16.958 million for the three-month period ending 30 September 2003, and at that date had net assets of approximately $60.835 million. 75 The going concern value of the net assets of AMIL has increased, according to these figures, by $82.477 million between 3 May 2002 and 30 June 2003. Mr Lombe has attributed this increase principally to the introduction of the Government's IBNR and HCC Schemes, the resolution of AMIL's tax affairs, and the restructuring of the UMP Group. 76 If AMIL were to be valued on a "close down" basis rather than a going concern basis, it would have a net deficiency of $67.134 million rather than net assets of $43.877 million. Mr Lombe explains that the main reasons for the variance are the assumptions in the "close down" scenario that the intercompany loan accounts/indemnities would realise 50% of their book value, reinsurance recoveries would be applied to meet claim liabilities and would not be available in the general pool for unsecured creditors, and a significant reduction in reinsurance recoveries would be likely on a liquidation basis. 77 Mr Lombe has performed cash flow modelling using the "base scenario" referred to above. His projections are for cash flow surpluses for each of the years from June 2004 to June 2008, ranging from $26 million for the year to June 2007 to $61.7 million for the year to June 2008, with net investment assets ranging from $427.7 million in the year to June 2004 to $608.6 million in the year to June 2008. 78 These projections show income and payments each growing steadily, with a cash surplus generated in each year. They take into account relatively high payments in the year to June 2007, produced by the payment of a large sum for a reinsurance "burning cost" premium which becomes payable under the terms of certain multi-year stop-loss contracts for 2000-2002. 79 AMIL's position is rather more straightforward than the position of UMP, because no negative cash flow years are projected for AMIL. My observations with respect to the uncertainty of actuarial estimates are, however, equally apposite. 80 Mr Lombe has reached the conclusion that AMIL is solvent. I see no reason to disagree with him. 81 My conclusion has been reinforced by Mr Thompson's evidence. He is the officer of APRA who was responsible for the on-site review discussed below. Having considered and assessed documents substantially the same as the evidence before the Court, Mr Thompson gives evidence that: "APRA has concluded that the company: i. is financially solvent, ii. has the capacity to operate as an insurance company; iii. has the capacity to meet regulatory capital requirements within the transitional period; and iv. is able to meet other prudential requirements." MDUAIL 82 According to Mr Lombe, MDUAIL had net assets of $2.162 million on a going concern basis on 3 May 2002. The audited accounts for 30 June 2002 showed net assets of $4.099 million and a loss of $1.319 million. The audited accounts for the year ending 30 June 2003 showed net assets of $4.391 million and a profit of $0.699 million. MDUAIL's net assets on a "close down" basis would be $2.870 million. 83 Unaudited financial statement spreadsheets indicate that the company had an operating profit of $0.016 million during the three-month period to 30 September 2003, and at that date had net assets of approximately $4.407 million. 84 As far as cash flow analysis is concerned, since MDUAIL is in run-off and its claims are administered by UMP/AMIL, its main expense item is its cost of claims and its major sources of income are reinsurance recoveries associated with those claims, and its investment income. Mr Lombe's projection is for negative cash flow of $49,000 in the year to June 2004, $18,000 to June 2005, $5,000 to June 2006, and then positive cash flow of $20,000 to June 2007 and $59,000 to June 2008. Mr Lombe's evidence is MDUAIL is fully reinsured, after taking into account the default by HIH. The company is projected to maintain a surplus of net assets over the period. 85 Mr Lombe expresses the opinion that MDUAIL is solvent, as it is able to meet its debts as and when they fall due for the foreseeable future. I see no reason to disagree with his conclusion. UMPNSW 86 Mr Lombe's evidence is that at the time of his appointment on 31 October 2002, UMPNSW had net assets on a going concern basis of $2.367 million, although the audited accounts for the year to 30 June 2002 showed a net deficiency of $5.794 million and a net loss before tax of $23.715 million. The audited accounts for the year to 30 June 2003 showed net assets of $5.189 million and a net profit of $12.001 million. The claims business of UMPNSW is in run-off, and its only business is the ownership of land and buildings at Crows Nest, which are rented to a third party. 87 Unaudited financial statement spreadsheets indicate that the company achieved a net profit of $0.040 million during the three months to 30 September 2003, and at that date had a surplus of assets of approximately $5.226 million. 88 If the company were valued on a "close down" basis on 30 June 2003, Mr Lombe says the valuation would be a net deficiency of $6.139 million. The main reasons for the variance between this figure and the positive figure of $5.189 million on a going concern basis are that the "close down" basis assumes that an intercompany indemnity would realise 50% of its value, and reinsurance recoveries available to creditors would be reduced by 50%. I see no reason to challenge these assumptions or to prefer the "close down" basis of valuation. 89 As to cash flow, UMPNSW has an indemnity from UMP for open and potential claims that had been notified as at 1 July 1997, under a claims run-off agreement. Claims liability, when due, is in fact paid by UMP, and therefore Mr Lombe has assumed that claims liabilities have no impact on the company's cash flow. It has a positive cash flow from its trading activity, namely ownership of the Crows Nest property, which is rented to an independent third party under a formal lease agreement. 90 Mr Lombe expresses the opinion that this company is solvent, and I agree. Mr Lombe's financial projections and the proposal to meet minimum capital requirements Financial Condition Report 91 With the approval of APRA, Mr Lombe appointed Adrian Gould of Taylor Fry as the Approved Actuary of AMIL and MDUAIL as from 26 June 2002. Mr Gould is a highly qualified actuary with substantial experience in the field of general insurance and the estimation of long-tail liabilities. 92 Mr Gould has given evidence that his role has been, and continues to be, to act independently in making assessments, providing actuarial services and preparing reports for AMIL, MDUAIL and UMP. His reports have been made available to the Group's auditors, PricewaterhouseCoopers, and to APRA. 93 Mr Gould has prepared a Financial Condition Report dated 19 September 2003 in respect of AMIL, building on earlier report of November 2002. The 2003 Report, which is in evidence, has been delivered to APRA. Attachments to it include the actuarial assessment of claims and premium liabilities of the Group as at 30 June 2003. Mr Gould has given evidence that statements of fact in the Report of which he has direct knowledge at true, and that he reasonably believes statements of fact in the Report provided to him by another person. His evidence is that the assumptions made in the Report are in his opinion reasonable and appropriate assumptions, and the opinions expressed in the Report are his own opinions and are faithfully held by him. He says that his valuation of claims and premium liabilities for the purposes of the Report complies with the requirements of the Institute of Actuaries of Australia's Professional Standard 300. 94 Mr Gould has made his work available to the auditors in electronic form and has had meetings and other communications with them, at which the key assumptions and methodology he has used were discussed and reviewed. The scope of the Report was agreed with APRA's staff and Mr Gould has responded to numerous oral and written requests from APRA. 95 In the Report, Mr Gould describes the assumptions underlying his financial projections as the "main scenario". That scenario shows that the capital base for APRA's purposes is predicted to reach 100% of minimum capital requirements during 2004, and subsequently capital is projected to increase to approximately 140% of minimum capital requirements. Mr Gould's evidence is that the assumptions upon which these projections are based are reasonable, and he expresses the opinion in his affidavit that "there is a reasonable prospect that the UMP Group will be able to recapitalise substantially in the way illustrated by the main scenario." Mr Lombe's financial projections 96 During 2002 Mr Lombe constructed a "model office" that makes projections for balance sheets, profit and loss statements and cash-flow statements for six-month periods. His model adopted a base scenario, following the "main scenario" in the Financial Condition Report, which made assumptions on various matters. The assumptions include assumptions about membership levels, premium rates, claims costs, expenses, reinsurance arrangements and future tax liability. The assumption with respect to membership is that the current membership level will reduce by a stated percentage at 1 January 2004 and then stabilise at that level. The assumption for premium rates is that they will increase from current levels at a specified overall rate per annum effective from 1 January 2004, while UMP's subscription fee will increase by the same rate effective 1 January 2004 and thereafter a lesser rate. There is an assumption that the cost of reinsurance arrangements will be as predicted. A return on investments of about 5.25% per annum is assumed. 97 The "main scenario" assumptions were adopted by the Approved Actuary in consultation with APRA. APRA is also aware of their adoption by Mr Lombe in his Reports to the Court in respect of the four companies. Mr Lombe has given evidence that the key assumptions are reasonable and appropriate. I see no reason to disagree. There is evidence that a fall in the membership level has been arrested as past members are seeking to renew memberships, and there are grounds for believing that after another short-term decline in renewals, removal of the stigma of provisional liquidation will enable membership numbers to stabilise. As to premiums, Taylor Fry have forecast that the cost of claims will increase annually by a specified rate, and it is rational to assume that AMIL will continue to match premiums with the cost of claims, to avoid the eroding of capital reserves. There is evidence, noted below, supporting the assumption that the cost and nature of the 2004 reinsurance program will be similar to 2003. As to the investment return, Mr Lombe has taken and acted on the advice of external consultants in respect of the investment mix for the investments of the UMP Group. The bulk of the investments are in cash or cash-type securities, returns for which are expected to increase from the 2003 rates. 98 My conclusion that the assumptions are reasonable is supported by Mr Thompson's evidence. He says that APRA has assessed the assumptions used by AMIL and its Approved Actuary in the Financial Condition Report, inter alia, in relation to policyholders, premium rates and capital generation, and that the assumptions "are considered to be plausible". 99 Apart from producing balance sheet, profit and cash flow projections, Mr Lombe has used the base scenario to assess the prospect of AMIL satisfying APRA's minimum capital requirements by June 2008. The result is presented in a graph at page 58 of the AMIL Report. The graph shows AMIL's capital base exceeding APRA's required funding level of 120% of the minimum capital requirement, during the year 2004-2005, and then gradually increasing above that level through to June 2008. AMIL's net asset position is projected to improve significantly, mainly because the Government's IBNR Scheme picks up a large proportion of the claims which would otherwise be expenses of AMIL in the next few years. The graph also shows a decrease in the minimum capital requirement during the 2003-2004 year, because of the elimination of a large proportion of the inter-company loans, which attract a high capital charge under the APRA standards. The gradual improvement in the net asset position of the company reflects the stable net growth to be achieved if net claims are matched by premium increases. 100 In order to "stress test" AMIL's future performance and its ability to satisfy the minimum capital requirements, Mr Lombe instructed Taylor Fry to prepare models on various permutations of the base scenario assumptions. Taylor Fry prepared a further 13 scenarios, which project cash flows and total investment assets up to 30 June 2008. Each model takes into account variations of the assumptions made in the base scenario. The results of this "sensitivity analysis" appear in a series of graphs at pages 60-66 of the AMIL Report. 101 The exercise indicates that AMIL's performance is not particularly sensitive to membership numbers. Mr Lombe explains this by saying that the cost of claims and the minimum capital requirement both change directly with membership. However, AMIL will fall below achieving the minimum capital requirement in three scenarios. 102 The first (Scenario F) assumes a one-off large increase in the net cost of all future notified claims, and then increases in claims costs at the base scenario rate each January, with premium increases at a somewhat higher rate. The graph shows that AMIL's capital base is just below 100% of the minimum capital requirement in June 2008, and while it is still rising, it is not rising at the same rate as the minimum capital requirement. 103 The second (Scenario L) also assumes a one-off large increase in the cost of claims, followed by annual increases at the base scenario rate but premiums are assumed to increase by only the base scenario rate. The graph shows that AMIL's capital base is well short of the minimum capital requirement in June 2008, and tending further away from it. Indeed, by 2007 the capital base begins to decline, while the minimum capital requirement gradually rises. 104 The third (Scenario M) assumes that claims costs and premiums increase as in Scenario F, and also that general and administration expenses increase to 20% higher than the base scenario in all future years. The graph shows that AMIL's capital base is well below the minimum capital requirement in June 2008, and tending further away from it, though not as dramatically as in Scenario L. The capital base line is flat, whereas the minimum capital requirement is increasing. 105 The evidence includes some comments on Scenarios L and M, given by the Australian Government Actuary, Mr Peter Martin, in his report to APRA dated 29 September 2003. Mr Martin notes that there can be no guarantee that AMIL will reach its capital target by June 2008. He says the two scenarios represent plausible (but not necessarily likely) examples of how the actual claims experience might turn out to be different from the main scenario. Because AMIL has a poor capital position, it is easy to construct realistic scenarios where its capital target will not be achieved. However, even under moderately adverse scenarios, the capital position is projected to improve over the next couple of years, and the other scenarios, including the base scenario, suggest that the capital target is quite achievable. 106 Mr Lombe draws the important conclusion that it is critical for long-term viability for premiums to respond to and match the cost of claims. He says that these three alternative scenarios are somewhat "pessimistic". It should be noted that the other 10 alternative scenarios all produce capital bases which satisfy the minimum capital requirement. In my opinion, since the base scenario assumptions are reasonable on the grounds explained above, they provide a more reliable foundation for net asset projections for capital adequacy purposes, than any of Scenarios F, L and M. There is no reason to believe, after the legislative reforms that have taken place, that there will be a large one-off spike in claims costs. Nor is there any reason to believe that general and administrative costs will increase to such a high percentage. While one can expect member resistance to increases in premium, and business pressures in a highly competitive market, a responsible board of directors would wish to ensure that premium rates respond to cost of claims experience, and therefore there is no reason to believe that premium rates will lag behind costs in the manner envisaged in the three alternative scenarios. 107 Mr Thompson expresses the opinion that various assumptions adopted in the base scenario, including the assumptions adopted for membership, premium rate increases, and claims escalation, are all reasonable. 108 As to the financial projections as a whole, Mr Thompson says in his affidavit: "APRA's view is that if released from provisional liquidation, AMIL has a reasonable prospect of reaching its required capital targets within the transition period, 1 July 2003 to 30 June 2008. The key risks to AMIL's ability to achieve its capital funding plan targets are: i. a significant drop in policyholders or a significant change in the risk profile of insureds; ii. AMIL being unable to charge adequate premiums to generate the required capital; and iii. the impact of tort reform in NSW and Queensland not providing the outcomes projected in the [Financial Condition Report] and Funding Plan." 109 It seems to me that the first of these risks has been adequately addressed by Mr Lombe's evidence of an anticipated further decline in membership numbers followed by stabilisation. The ability to charge adequate premiums to cover costs is an essential commercial matter which will be in the hands of the new board of directors. I agree that the impact of the tort reform is difficult to assess but it strikes me that the approach taken to them by Mr Lombe and Mr Gould is a sensible one. 110 Mr Thompson's statement that AMIL has a "reasonable prospect" of reaching its capital target might be regarded, if read in isolation, to mean no more than that AMIL has a non-negligible chance of doing so. However, I take Mr Thompson's statement to be stronger than that. Later in his affidavit (at paragraph 102) Mr Thompson says that APRA is "reasonably confident, on the basis of the actuarial financial projections in the FCR and the Funding Plan, that AMIL is likely - under a range of reasonable assumptions - to reach its regulatory capital target of 1.2 times MCR (or roughly $160 million) by June 2008." The failure of the HIH Group reinsurers 111 For some time prior to Mr Lombe's appointment as provisional liquidator, AMIL had looked to companies in the HIH Group to participate in its reinsurance program. Recently the liquidator of the HIH companies gave notice to AMIL, purporting to terminate reinsurance contracts covering incidents notified during the calendar years 1991, 1992 and 1993. Mr Lombe challenges the validity of the terminations, and asserts the right to prove in the HIH and FAI liquidations. Nevertheless, he instructed Mr Gould to quantify the potential financial implications of the terminations. Mr Gould reported to Mr Lombe on 24 September 2003. 112 Mr Gould's actuarial assessment of claims liabilities for the UMP Group as at 30 June 2003 was based on estimates of reinsurance recoveries in respect of outstanding liability for incidents notified by 30 June 2003. For that purpose Mr Gould assumed that the HIH Group insurers would default on 90% of the estimated recoveries, and so in his calculations credit was taken for only the remaining 10% assumed to be paid as an outcome of the HIH Group liquidation. Mr Gould stated that, for the years 1991-1993, his calculation of AMIL's outstanding claims liabilities made provision for $0.756 million for estimated reinsurance recoveries for those contracts. Mr Gould's estimates had also taken into account an additional general provision of $4.5 million for possible default by reinsurers. He noted that the provision for recoveries from HIH reinsurance amounted to only 17% of that additional general provision. The submission regarding compliance with APRA's prudential standards 113 APRA is the regulatory authority responsible, under the Insurance Act 1973 (Cth), for regulating general insurance companies in Australia, and is therefore responsible for regulating AMIL and MDUAIL. APRA monitors financial performance and capital adequacy of insurers. UMP is not an insurer and is not regulated by APRA. APRA has authority to regulate a non-operating holding company of an insurer, but UMP does not fall into this category because one of the requirements for licensing an entity as a non-operating holding company is that there not be liabilities on the entity's balance sheet, and UMP does not fit this requirement. APRA has nevertheless required UMP to continue its parental support for AMIL and MDUAIL. Mr Lombe has given APRA a written acknowledgement of the existing parental guarantee by UMP, and an undertaking that the guarantee will not be revoked or cancelled without reasonable notice to APRA. 114 AMIL has applied to APRA for a determination under s 13(3) of the Medical Indemnity (Potential Supervision & Product Standards) Act, that the minimum capital requirements set out in the prudential standard GPS 110 do not apply during the transition period to 30 June 2008. APRA has decided to grant that determination should the appointment of the provisional liquidator to be terminated. 115 One of APRA's prudential requirements is that, regardless of its minimum capital requirement, an insurer must have not less than $5 million capital. As at 30 June 2003 MDUAIL had $4.391 million in net assets and accordingly did not meet the minimum level. Mr Lombe has made an application to APRA to permit MDUAIL to continue to trade in run-off mode notwithstanding its failure to meet the minimum requirement. In his affidavit, Mr Thompson says that APRA does not have any significant prudential concerns regarding the operation of the company, even though it does not meet the minimum capital requirement of $5 million, given that it is in run-off and has limited liabilities. APRA's on-site review 116 APRA conducted an on-site review of AMIL's business during the period from 24 June to 4 July 2003. The review was conducted under the direction of Mr Thompson. 117 The review involved numerous meetings and the inspection of documents on-site. AMIL's Approved Auditor and its Approved Actuary participated. It covered such matters as company strategy and the business plan, reporting structures, management systems, network security, staffing arrangements and outsourcing, board and committee structure, issues and challenges for the business, risk management strategy and risk monitoring, the roles of internal audit and the Approved Actuary and their relationship with board committees, compliance management, capital management and review of performance, investment strategies and management, financial controls, pricing policies and procedures, underwriting arrangements, claims and payment processes, and reinsurance strategy and decision-making. 118 The evidence includes a bundle of documents entitled "APRA On-site Review" prepared by AMIL. The documents show that very substantial work was done by Mr Lombe and staff of the UMP Group for the on-site review. The documents comprise: · a governance manual; · a transitional plan; · a statement of objectives and interdependencies of the Group's business plan, and they ranking of priorities; · an implementation project plan; · documents identifying and assessing risk during the 2003-2004 business planning period, and proposing a risk management strategy and internal audit selection criteria; · a review of "Maximum Event Retention (MER)" for AMIL; · a draft capital funding plan. 119 After completion of the review, APRA wrote a long letter to Mr Lombe dated 24 July 2003. The letter explained that "for APRA to make a positive recommendation [to the Court] it will need to be satisfied that the company is a potential going concern without the support currently provided by the Provisional Liquidator and has the capacity to accumulate the necessary capital during the allowed transition period." The letter made recommendations with respect to four matters, namely corporate governance, the strategic plan, operational risk management and capital management. Amongst the more significant recommendations were the urgent establishment of an internal audit function and the development of an updated risk management strategy. 120 APRA's recommendations were considered by the Advisory Committee and then Mr Lombe wrote to APRA on 15 August 2003, responding in detail to APRA's comments and recommendations. He indicated, for example, that an internal audit function was being established and that workshops would be conducted to review risk analysis for report to the Audit and Risk Committee and incorporation into the internal audit plan. The letter attached a project sheet designating responsibility for tasks and showing the status of the work. APRA wrote to Mr Lombe on 19 August 2003 seeking further information, including target completion dates for the tasks to be carried out before termination of the appointment of the provisional liquidator. On 26 August 2003 Mr Lombe supplied APRA with a revised project sheet which indicated deadlines for each of the tasks that were listed. By that time a draft internal audit plan had been completed. 121 Mr Lombe's evidence is that he is confident that all areas of the review report have been addressed appropriately to satisfy APRA's requirements. He says that he has continued to work closely with APRA, furnishing them with monthly financial reports, annual financial statements and returns, an updated the Capital Management Plan, the Reinsurance Management Strategy and the Risk Management Strategy for the year to June 2004, and he has responded to the issues raised in the on-site review. 122 Mr Thompson's evidence is that the on-site review, which he describes as "comprehensive", revealed no material weaknesses that would prevent AMIL from coming out of provisional liquidation. The on-site review did not give rise to any "significant prudential concerns", although a number of improvements were recommended in the letter to which I have referred. In Mr Thompson's view AMIL and Mr Lombe have reacted positively to the issues raised by APRA, and have addressed or put in place processes to ensure that these matters are successfully resolved. 123 APRA supports Mr Lombe's applications to terminate his appointment as provisional liquidator of AMIL and MDUAIL, provided that those two companies and UMP "exit provisional liquidation" together, intercompany balances are cleared as proposed, and UMP undertakes to maintain the parental guarantee in relation to exposure to the HIH-related companies. More specific details as to the conditions of authorisation are given by Mr Thompson in paragraph 126 of his affidavit, and in paragraph 128 he specifies some additional requirements to be met on an ongoing basis. I am informed that the parties have agreed on the appropriate text of the undertakings, and on the forms of instrument that APRA will issue conditional on the Court approving the applications. 124 APRA has considered the following factors: the reliability of the data and the actuarial estimates; capital strength and growth; reinsurance prospects; APRA's frontline analysis and on-site review; resolution of taxation issues; board and management qualities; future regulatory arrangements; and future risks. Mr Thompson's affidavit addresses APRA's work on these matters, showing that it has been extensive and, so far as I can see, thorough. He expresses the opinion that APRA is satisfied that the financial statements fairly reflect the position of the companies in the UMP Group as at 30 June 2003, indicating an improvement in the capital position over the last year. Mr Thompson says that AMIL's capital stands around $50 million and is trending steadily upward. He says APRA is satisfied that the actuarial advice on AMIL is sound and can be relied on, and that no additional certainty would be obtained by having the whole of the Approved Actuary's work reviewed by an independent actuary. 125 Mr Thompson says that APRA agrees with the logic and conclusions expressed by Mr Lombe in his affidavit with respect to the various scenarios, including his remark that Scenarios F, L and M are somewhat pessimistic. Although those scenarios are conceivable, they are "not of sufficient probability of occurrence and severity of outcome to be a material cause for concern provided AMIL is able to implement the strategies outlined in the Funding Plan in a timely manner." 126 I regard APRA's attitude to the applications as a matter of very considerable significance. It is a public regulator acting in the public interest, possessed of the necessary financial and actuarial skills to consider not only the solvency of the regulated entities within the group but their capacity to meet prudential requirements over time. 127 Another very useful piece of evidence has been provided by the Australian Government Actuary, Mr Martin, in his report to APRA dated 29 September 2003. He has conducted a review of the methodology and assumptions of the Approved Actuary for AMIL. Although the review was limited in scope, Mr Martin's conclusions, looking at the matter independently in the public interest, are clear and useful. He says that the liability valuation assumptions adopted by Taylor Fry appear to be "realistic to conservatively realistic". He emphasises that the main source of new capital will be margins in AMIL's indemnity insurance premiums, and says that premiums must be set with this firmly in mind. He observes that competitive considerations should be a second rather than a first-order factor in the premium setting process. He identifies some risks to the chances of success, including, in the short term, dramatic loss of membership, and in the medium term, an undetected blow-out in claims cost experience. These thoughts have obviously influenced Mr Thompson's decisions and recommendations. Steps taken to regularise the business of the UMP Group for its transition to normal trading Reinsurance 128 Mr Lombe has engaged JLT Risk Solutions Ltd, a London broker, for expert assistance with AMIL's reinsurance program. He has been assisted on reinsurance matters by Peter Yates, one of his partners at Deloitte Touche Tohmatsu, working with Stephen James, the financial controller AMIL. 129 In about August 2003 Darryl Roberts, a senior officer of APRA, and Michael McLeod, chief executive of the UMP Group, visited AMIL's current European reinsurers. Then, during the week commencing 8 September 2003, Paul Voller (a partner in JLT Risk Solutions) accompanied Mr Yates and Mr James on visits to those companies to commence negotiations for the UMP Group 2004 reinsurance program. A number of new reinsurance markets were also approached. They presented a company profile and underwriting submission, which gave information about the membership, loss record, and incurred cost development. They informed the reinsurers that they hoped that the process of provisional liquidation would be finalised shortly after the Court hearing on 14 and 15 October 2003, with a view to the 2004 reinsurance program being approved by the newly appointed board of directors. 130 Mr Yates has given evidence that in none of the meetings did any of the representatives of the reinsurer indicate that they would not be able to submit their proposal for reinsurance in calendar 2004 during November 2003, and none of them indicated a reinsurance program would not be offered. Each of the three reinsurers to whom presentations were made subsequently wrote to APRA, in August or September 2003, indicating their current intention was to continue to support the company through calendar 2004, under normal, commercial policy terms and conditions. 131 Subsequently JLT Risk Solutions has given written advice to the effect that AMIL will be able to renew its reinsurance program for the year 2004 on a structure similar to that which is already in place, and it will also be able to explore alternative structures, at premium levels consistent with those of 12 months ago. Transition plan 132 Mr Lombe has developed a transition plan to identify the steps which must be taken to enable the companies of the UMP Group to operate in their own right. There are four main components to the transition plan, relating to corporate governance, strategic and business planning, operational risk and management, and capital management. 133 Mr Lombe has liaised with potential directors for each company within the Group, operating through Malcolm Irving, chairman of the AMIL Advisory Committee. He has arranged for the establishment of various board subcommittees, and has prepared a documentary transition plan to hand to the new board and executive. 134 Transitional arrangements for strategic and business planning are recorded in the Strategic Plan and the Business Plan to which I have referred. It is unnecessary to deal with the detail of those plans here. Mr Lombe has conducted an extensive strategic and business planning process within the UMP Group, holding sessions with individual business units to review their plans and objectives and project charts, to determine priorities and to eliminate unrealistic goals. 135 Operational risk and management matters are recorded in one of the documents prepared for APRA's on-site review, to which I have referred. Workshops have been held with individual business units to review risk analysis and remediation findings. Those workshops have been reported through the Audit and Risk Committee and incorporated into the internal audit plan. A risk identification and assessment plan has been prepared and provided to APRA. The internal audit function required by APRA is in the course of being established. An internal audit plan has been established, encompassing the review and selection of a third party provider, and a framework for reporting through to the Audit and Risk Committee. A review has also been undertaken to document key personnel, in order to identify key personnel risk. 136 The transition plan for capital management is recorded in the Capital Funding Report, which is located in the Financial Condition Report. Taylor Fry is to prepare a pricing model, and be asked to express their professional opinion on it. Taylor Fry have also recalculated the maximum event retention which is included in the Financial Condition Report. The Financial Condition Report and Funding Plan have been lodged with APRA, together with a comprehensive stress-testing program. 137 Mr Lombe has expressed the opinion that the management of the UMP Group, including the current chief executive, are competent and capable of trading the business into the future. His opinion is that the current management team were not responsible for the deterioration of the Group which led to his appointment as provisional liquidator. Mr Lombe's opinion is that responsibility lies with the previous senior management, who failed to recognise the IBNR issue to be as serious as it was, and failed to have in place appropriate pricing policies. The chief executive and the management team, working with Mr Lombe, had developed what Mr Lombe regards as a credible Strategic Plan to rebuild UMP's brand and provide members with the highest quality medical indemnity insurance products. 138 Immediately upon the Court making orders, assuming it does so, the new board of directors will have to address several pressing issues, including reinsurance negotiations and the policy renewal process. 139 Mr Lombe's evidence on the transition plan is sufficient to satisfy me that careful thought has been given to the transition, and all reasonable steps will be taken to make it a smooth process if orders are made. The interests of creditors and "early" termination of the provisional liquidator's appointment 140 ASIC has provided the Court with a thoughtful submission with respect to the effect of the proposed termination of the provisional liquidator's appointment on separate interests of various classes of creditors. The submission considers separately interests of pre-appointment creditors (including inter-company creditors); post-appointment creditors (distinguishing post-appointment priority creditors whose priority stems from s 556(1)(a) of the Corporations Act, and post-appointment indemnity creditors in respect of whom the provisional liquidator has an indemnity against the assets of the companies and a lien over those assets to secure the indemnity); and future creditors (post-termination of the administration).

ASIC v Plymin

At a glance

Court

Decision date

Before

Source

Judgment (19 paragraphs)

Parties

Legislation Cited (11)

Cases Cited (6)

Cited By (3)