Colonial Portfolio Services Ltd v APRA

The Scheme 6 The Scheme comprises the Scheme document and the annexed (amended) transfer deed. Under the Scheme as agreed by NMLA and Challenger on 3 June 2008, Challenger assumes NMLA's liabilities and obligations and is obliged to make all future benefit payments in respect of all NMLA's Australian immediate annuity policies still in force at the completion of the Scheme. Along with NMLA's liabilities and obligations, assets referable to NMLA's SF4 were also to be transferred and become part of Challenger's SF2. On completion of the Scheme NMLA would be relieved of its obligations in respect of the transferred policies. Challenger would be substituted for NMLA as insurer under the transferring policies so that references in those policies to NMLA would be read as references to Challenger, references to NMLA's SF4 would be read as references to Challenger's SF2, and any policy owner or other person having a claim on, or obligation to, NMLA under a transferring NMLA policy would have the same claim on, or obligation to, Challenger in substitution for NMLA. 7 The Scheme was based on an actuarial report dated 26 September 2008 (First Joint Report) prepared jointly by the appointed actuaries of NMLA and Challenger, respectively Mr Michael Thornton and Mr Anthony Bofinger. Mr Thornton is a Fellow of the Institute of Actuaries (UK) and an accredited member of the Institute of Actuaries of Australia. Mr Bofinger is a Fellow of the Institute of Actuaries of Australia. The report states that the opinions expressed in it are the opinions of both Mr Thornton and Mr Bofinger except that Mr Thornton takes responsibility for the commentary on NMLA's history, practice and future intentions and Mr Bofinger takes responsibility for the commentary on Challenger's history, practice and future intentions. 8 An Independent Actuarial Report (First Independent Report) prepared by Mr Clive Aaron of Towers, Perrin, Forster & Crosby Inc and dated 26 September 2008 was commissioned by both applicants. Mr Aaron is a Fellow of the Institute of Actuaries of Australia and a Fellow of the Institute of Actuaries (London). The First Joint Report and the First Independent Report, along with updates to both reports, are discussed below at [24] et seq. 9 Subject to one exception the NMLA policies were to be transferred to Challenger without amendment. The exception, which relates to taxation, is incorporated in clause 5.1 of the Scheme. It applies to certain annuity policies purchased after 9 December 1987. As Mr Hollo of Counsel, who appeared for NMLA, explained in his written submissions: The amendment aims to ensure that transferring NMLA policies unambiguously meet the immediate annuity definition requirements of the Income Tax Assessment Act 1997 and as a result, ensure that the investment income on the assets held to back the immediate annuities will continue to be exempt from income and capital gains tax. This tax exempt status is reflected in the basis upon which the transferred policies were originally priced and issued and are currently managed by NMLA. 10 There is one other change which, although it is not part of the Scheme, should be noted. This is the proposal that NMLA's Memorandum of Demutualisation (MoD) be modified so that it no longer applies to the transferring NMLA policies. The MoD was established on the demutualisation of NMLA and contains rules for the management of NMLA's life-insurance business following its demutualisation. In relation to this proposal, the First Joint Report notes at 9.2.3: If Challenger were to undertake to observe the MoD rules in relation to the NMLA Policies, then the only requirement would be to maintain a separate sub account for these policies. Accordingly, the Appointed Actuary of NMLA has advised the directors of NMLA that NMLA policies will not be materially adversely affected if the Rules of the MoD are not applied by Challenger upon transfer. 11 In relation to the taxation amendment and the proposal concerning the NMLA MoD, the First Joint Report concludes that neither change will reduce the contractual benefits or rights of the transferring policyholders.

12 The relevant provisions are to be found in Part 9 of the Life Insurance Act and in the Life Insurance Regulations 1995 (Cth). Section 190(3) of the Act provides that a scheme must set out the terms of the proposed transfer and the particulars of any arrangement necessary to give effect to the scheme. The procedural steps to be taken before seeking the Court's approval are laid down in s 191(2) which provides that an application for confirmation may not be made unless: (a) a copy of the scheme and any actuarial report on which the scheme is based have been given to APRA in accordance with the regulations; and (b) notice of intention to make the application has been published by the applicant in accordance with the regulations; and (c) an approved summary of the scheme has been given to every affected policy owner. 13 Subsection 191(5) permits the court to dispense with the need for compliance with paragraph (2)(c) if it "is satisfied that, because of the nature of the scheme or the circumstances attending its preparation, it is not necessary that the paragraph be complied with".

14 Sections 192 and 193 provide that APRA may arrange for an independent actuary to make a written report on the scheme and is entitled to be heard on an application for confirmation. The application for confirmation must be made in accordance with the regulations. Section 194(1) provides that the Court may confirm a scheme with or without modification or refuse to confirm a scheme. Section 194(2) provides that in making its decision the Court must have regard to: (a) the interests of the policy owners of a company affected by the scheme; and (b) if a report relevant to all or part of the scheme has been filed with the Court under section 175 - that report; and (c) any other matter the Court considers relevant. 15 The Court's discretion is very wide but, as Edmonds J pointed out, "it is not unfettered, and must be exercised on the evidence and having regard to the objects of the Act, principally, the protection of the interests of policyholders and prospective policyholders"; In the Application of Commonwealth Insurance Holdings Ltd and The Colonial Mutual Life Assurance Society Ltd [2007] FCA 1012 at [12]. At [13] his Honour identified two aspects to the protection of the interests of policyholders: 1. First, there are the procedural aspects in which the Court is concerned to see that the process undertaken has been properly executed in accordance with the requirements of the Act and the Life Insurance Regulations 1995 (Cth) ('the Regulations'); and 2. Second, there is a substantive aspect in which the Court is concerned to see that the Scheme will not be prejudicial to the interests of policyholders and that policyholders are properly safeguarded, i.e., there is not likely to be any material detriment to policyholders affected by the Scheme (see NuLife Insurance Ltd v Norwich Union Life Australia Ltd [2005] FCA 1635 at [24] per Emmett J; MLC Lifetime Company Ltd & Anor (No. 2) [2006] FCA 1367 at [5] per Bennett J; Colonial Portfolio at [25] per Matthews J)

Procedural steps 16 On 8 October 2008, Jacobson J allowed an application to dispense, in part, with the need for compliance with s 191(2)(c). The dispensation related to policyholders for whom the parties had no record of a current mailing address and to the need to provide an approved summary of the Scheme to those who became policy owners less than 15 days prior to the hearing of the application and up to the completion date as defined in the Scheme.

17 I am satisfied that the detailed affidavit evidence concerning the procedural steps taken by both applicants establishes that the remaining procedural requirements have been met. In short:

· In accordance with s 191(2)(a) copies of the Scheme and the First Joint Report have been given to APRA. Mr Michael Vrisakis, a partner of Freehills who acted for Challenger deposed that APRA was initially provided with drafts of the Scheme, the Scheme Summary, the First Joint Report, the First Independent Report, the Notice of Intention, the Transfer Deed, the Federal Court Application and the covering letters proposed to be sent with the Scheme Summary to owners of the NMLA policies that are to be transferred to Challenger and owners of Challenger policies in SF2. APRA was also given a list of newspapers in which it was proposed to publish the Notice of Intention and the details of locations which are not offices of NMLA and Challenger at which it was proposed that a copy of the Scheme would be available for public inspection. Mr Bofinger gave evidence that he lodged the updated documents with APRA on 26 September 2008.

· A notice of intention to make the present application was published in the Special Notices Commonwealth of Australia Gazette on 17 October 2008 and in approved newspapers on 18 October 2008. The newspapers were The (Weekend) Australian, The Sydney Morning Herald, The Canberra Times, The Courier Mail, The Northern Territory News, The West Australian, The Advertiser, The Age, The Mercury and The Examiner. · Subject to the exemptions granted by a Jacobson J, a summary of the Scheme was provided to every affected policyholder of NMLA and Challenger. This included evidence from an analyst programmer explaining how he developed a computer program to extract and compile the data required for mailing of the Scheme documents; evidence concerning the sending by mail and courier to overseas-based policy owners; and evidence of the steps taken to make a copy of the Notice available on the AXA website. All letters were prepared and dispatched by 17 October 2008. · The Scheme documents were made available for public inspection by any policy holder of AXA or Challenger for various specified periods during October and November 2008. In Sydney the documents were available for inspection at the offices of Challenger in Pitt Street and the offices of AXA Australia in Kent Street. In Melbourne the documents were available at the offices of Challenger in Collins Street and the offices of AXA, also in Collins Street. In Adelaide, Brisbane, Canberra, Darwin, and Perth the documents were available for inspection at the offices of Minter Ellison, Lawyers in those cities. In Hobart, the documents could be inspected at the office of Murdoch Clarke, Solicitors in Victoria Street.

18 Evidence was also given of enquiries and objections made by policyholders in relation to the Scheme. In her affidavit sworn on 18 November 2008 Angela Bourke summarised the nature of the objections or complaints raised by callers. Ms Bourke is the Product Champion, Investment Products of AXA Australia Limited. In relation to the Scheme she was responsible for managing and documenting the return mail procedures, ensuring that correct processes were followed and handling and reporting complaints. Ms Bourke said that most of the objections fell into one of the following six categories: (a) a concern that they will be financially disadvantaged by the transfer; (b) a desire for the transfer not to take place at all and for the status quo to be maintained; (c) negative sentiment about Challenger; (d) a concern based on an apparent misunderstanding of the process involved in a scheme of transfer; (e) the unattractiveness of the proposed transfer, given the current volatility in the financial markets; and (f) a desire to retain a diversified investment portfolio across more than one company. 19 In my view Ms Bourke's summary is accurate and applies not only to the complaint reports to which she refers but also to the complaints received by Minter Ellison and by Challenger, to the objections raised by policyholders who appeared at the confirmation hearing and those who raised their concerns by letter directed to the Court. These complaints and objections are discussed below.

Objections to the Scheme 20 It is in the nature of applications for approval under s 194 that they are brought jointly by companies that have agreed to participate in a scheme for the transfer of insurance policies. Consequently there is no formal contradictor. Nevertheless the provisions of the Life Insurance Act that require publication of a notice of intent, the distribution of a summary of the Scheme to affected policyholders and opportunities for public inspection of the proposed Scheme not only envisage, but invite, comments and objections by policyholders. In this case, in addition to the complaints and objections referred to above, 5 NMLA policyholders attended the first day of the confirmation hearing seeking to make oral submissions to the Court. All policyholders who indicated a wish to make submissions were permitted to do so. 21 The 5 policyholders who made oral submissions were: Mr Michel Gompes, Mr John Cameron, Mr James Josephson, Mr Egon Kampgaard and Ms Anna Yeats. Another, Mr Jim Kemp, was represented by Mr Michael McHugh of Counsel. In addition the Court reviewed a number of letters sent by policyholders who objected to the transfer including letters from Mr AJ Fitzgerald, Ms MK Byrnes and Mr JG Vandenberg. Common themes ran through the reasons given by each objector for opposing the transfer. In general they fell into the categories identified by Ms Bourke (see [18] above). 22 It is entirely understandable that people who had invested in one company should be concerned and even resentful when, without their consent, their investment is transferred to another company. It is also understandable that these concerns should be exacerbated in the current climate of severe financial instability. Nevertheless, Parliament in providing in the Life Insurance Act for such transfers clearly regarded them as consistent with the principal object of the Act which, as set out in s 3(1) of the Act, is: … to protect the interests of the owners and prospective owners of life insurance policies in a manner consistent with the continued development of a viable, competitive and innovative life insurance industry.

23 Section 3(2) lists the principal means adopted for the achievement of the objects of the Act and includes, in subsection (2)(f), "providing for the supervision of transfers and amalgamations of life insurance business by the Court". As noted above at [14], the Court is directed to have regard to "the interests of policy owners of a company affected by the scheme". Consistent with the principal object of the Act, however, the Court is not directed to consider only the interests of policyholders or to consider the interests as paramount. Their interests must be considered in the context identified in s 3(1). Moreover, it should not be assumed that the interests of policyholders are necessarily identical with their preferences. As Edmonds J observed, in In the Application of Commonwealth Insurance Holdings Ltd and The Colonial Mutual Life Assurance Society Ltd [2007] FCA 1012 at [14]: The question of whether policyholders would be adversely affected by the Scheme is largely actuarial and involves a comparison of their security and reasonable expectations without the Scheme with what they would be if the Scheme were implemented. This leads me to a consideration of the actuarial reports.

Actuarial Reports 24 The First Joint Report was based on a consideration of relevant factors as at 30 June 2008. Mr Thornton and Mr Bofinger prepared further reports in which they updated their consideration of financial information relevant to the Scheme, first to 31 October 2008 (Second Joint Report) and then to 19 November 2008. Mr Aaron also updated the First Independent Report, providing a Second Independent Report dated 19 November 2008 and a Third Independent Report dated 24 November 2008. These updates were essential in the current economic climate.

25 The reports of the appointed actuaries are the First Joint Report, the Second Joint Report and the updates to those reports provided by Mr Bofinger in his affidavit of 24 November 2008 and Mr Thornton in his affidavit sworn on the same date. The First Joint Report reviewed the basis and terms of the proposed transfer of policies from NMLA to Challenger with a view to identifying and commenting upon the effect of the proposed transfer on existing Challenger policyholders, transferring NMLA policyholders and remaining NMLA policyholders being those in SF4 as well as the other NMLA statutory funds. The authors noted that they had focussed on: the changes that arise as a result of the proposed transfer, rather than changes that might arise in the ordinary course of business irrespective of the occurrence of the proposed transfer. 26 The First Joint Report considered the proposed Scheme in some detail, and in the context of the Australian life insurance regulatory regime. It stated in its conclusions that the Scheme would have no material adverse impact on the benefit security of Challenger's existing policyholders, NMLA's remaining policyholders or NMLA's transferring policyholders. They found that each of the statutory funds of Challenger and NMLA would remain in a "sound financial position" as would Challenger and NMLA as a whole. They also concluded that there would be no material impact on the contractual benefits or rights of any of these three groups of policyholders. The Report also noted that: Challenger's intended basis of determining and implementing the non-contractually specified and/or discretionary aspects of the transferring policies will continue to meet the overall reasonable benefit expectations of the transferring policyholders. 27 The appointed actuaries considered both Capital Adequacy Reserves and Enterprise Capital Reserves of both NMLA and Challenger. It is clear that between the date of the First Joint Report (30 June 2008) and the final updates to the First Joint Report (19 November 2008) market volatility significantly affected the financial position of both companies. 28 In his supplementary report in relation to Challenger's position, Mr Bofinger estimated that at the close of business on 21 November 2008 "Challenger would have had assets in excess of its Enterprise Capital Reserves of around $15 million, assuming that the NMLA Policies had transferred to Challenger at that time". Mr Bofinger noted that this compared with the position of $34 million excess estimated on the same basis as at 31 October 2008 but stated that, nevertheless, "Each of Challenger's statutory funds continues to satisfy its Capital Adequacy requirements and the Shareholders Fund continued to satisfy its Management Capital requirements". Mr Bofinger also observed that Challenger's Subordinated Debt, which had raised concerns among some who objected to the transfer, actually contributes to policyholders' security "because the assets held in respect of the Subordinated Debt liability are available to support the fund's obligations to the policyholders as a first priority". Mr Bofinger also commented on the nature of Enterprise Capital Reserves: While it is estimated that Challenger had assets above its Enterprise Capital Reserves as at the close of business on 21 November 2008, and would have continued to do so assuming that the NMLA Policies had transferred to Challenger at that time, it is important to note that there is no express requirement under the Life Act to maintain Enterprise Capital Reserves or to maintain a minimal level of excess assets … Enterprise Capital Reserves are targets set by the company for the prudent management of its capital position, and it is reasonable that a life insurance company may be at or below its target at various times. Mr Bofinger concluded that the opinions he expressed in the First Joint Report remained unchanged. 29 In the updated report annexed to his affidavit of 24 November 2008 Mr Thornton expressed similar views about the nature of Enterprise Capital Reserves. He further noted that while both NMLA's SF4 and NMLA as a whole had net assets above Enterprise Capital Reserves that this was not true of some individual NMLA Statutory Funds. He pointed out, however, that each Statutory Fund and the Shareholders Fund continued to hold net assets above Capital Adequacy requirements. Mr Thornton also stated that the opinions he expressed in the First Joint Report remained unchanged.

The reports of the independent actuary 30 In the First Independent Report, Mr Aaron expressed conclusions consistent with the conclusions expressed by the appointed actuaries in the First Joint Report. In the Third Independent Report annexed to his affidavit of 24 November 2008, he commented on the supplementary report of Mr Bofinger as follows: The results shown in the report are based on estimated financial data as opposed to audit accounts or unaudited management accounts. The update indicates that Challenger would have had sufficient assets in aggregate to meet the regulatory Capital Adequacy Requirements in its statutory funds, the regulatory Management Capital Requirement in its Shareholder's fund and its internal Enterprise Capital reserves after implementation of the Scheme, if implementation had taken place as at 21 November 2008. However, the level of assets in excess of its regulatory and internal Enterprise Capital requirements would have fallen from $34 million as at 31 October 2008 to $15 million as at 21 November 2008. 31 Mr Aaron made a similar comment in relation to Mr Thornton's supplementary report in relation to NMLA except that in the case of NMLA "the level of assets in excess of its regulatory and internal Enterprise Capital requirements would have fallen from $173 million as at 31 October 2008 to $53 million as at 21 November 2008". Despite this reduction in excess assets, Mr Aaron concluded that as both companies would have met their regulatory capital requirements "the level of security of policy owners' benefits should remain adequate. Further, both companies would also, in aggregate, have met their internal Enterprise Capital Reserve requirements as at 21 November 2008, which provides an additional level of support". This being so, Mr Aaron concluded that the change in capital position to 21 November 2008 did not cause him to change the opinions expressed in the First Independent Report.

32 In his Second Independent Report Mr Aaron considered some of the objections raised by policy owners in connection with the Scheme including concerns about the relative financial security of the two companies and the loss of diversification benefits for some policyholders. In relation to concerns expressed about the financial security of Challenger when compared with NMLA, Mr Aaron accepted that there would be some reduction in the security of benefits for transferring NMLA policy owners but that the reduction would not be material. He noted that: Challenger's No 2 Fund adopts an investment strategy that generates significantly greater market risk exposure than NMLA's No 4 Fund, but at the same time, holds significantly higher capital reserves to support the strategy. 33 In relation to a concern expressed by policy owners who had invested in annuities with both NMLA and Challenger in order to gain the advantage of diversification, he considered that the benefit of the strategy was small because of the extremely low risk of default for NMLA and Challenger and "the systemic nature of many of the risks faced by the two companies".

The position of APRA 34 APRA has considered the application and the material upon which it is based and has indicated that it has no objection to the Scheme or to the confirmation application. APRA did not exercise its right under s 192 of the Act to instruct an independent actuary. Ms J Gleeson of Counsel who appeared for APRA at the confirmation hearing confirmed APRA's position. The importance of APRA's attitude towards the Scheme is well established. The comments of Matthews J in Colonial Portfolio Services Ltd v APRA [1999] FCA 1779 at [28] are applicable to the present Scheme: It is relevant to note that APRA, which operates as something of a watchdog in relation to transfers under part 9 of the Act, had no objection to the confirmation of the scheme. Nor did APRA arrange for an actuarial report on the scheme, as it is entitled to do under s 192 of the Act. It can be inferred that APRA regarded the reports furnished by the applicants as adequate.

35 In the context of the present economic climate, evidence of support for Challenger by the Challenger Group was an element in my decision. In an affidavit affirmed on 24 November 2008, Mr DJ Stevens, the Chief Executive Officer of Challenger stated: Challenger Group is committed to supporting the business of Challenger, as was demonstrated in October 2000 via the injection of capital during difficult market conditions. On Friday 21 November 2008, I consulted with the board of Challenger Group and confirm that Challenger Group remains committed to ensuring Challenger is able to continue to meet its regulatory requirements and maintain its capital position consistent with Challenger's capital management policies to the extent of Challenger Group's ongoing capacity to do so. At 21 November 2008, Challenger Group had substantial assets, including cash, that could be made available to Challenger if required.

36 I am satisfied that all the procedural and notice requirements of the Life Insurance Act and Regulations have been met.

37 In concluding that the impact of the Scheme on the interests of policyholders is not such as should preclude its confirmation, I took into account the clearly expressed views of both the appointed actuaries and the independent actuary that: (a) there will be no material adverse impact on the benefits, rights or expectations of any of the NMLA or Challenger policy owners; (b) the statutory funds of NMLA and Challenger and the positions of NMLA and Challenger as a whole remain in a sound financial position; and (c) the benefit security of all policy owners should remain adequate and that there should be no material adverse impact on the benefit security of policy owners of either NMLA or Challenge.

38 I also took into account the fact that NMLA no longer accepts new business in the annuity market whereas Challenger has a substantial business in this market and is intending to expand that business. I also gave some weight to the expression of Challenger Group support for Challenger described in [35] above. I am supported in my conclusion that the Scheme should be confirmed by the fact that APRA has stated it has no objection to the Scheme and has not felt the need to instruct an independent actuary. 39 As indicated above I also considered the objections raised by individual policyholders, however I concluded that these objections do not outweigh the factors that support confirmation of the Scheme. 40 It is for these reasons that I made orders confirming the Scheme. I also ordered that the applicants pay APRA's costs of the proceedings. I certify that the preceding forty (40) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Stone.

Associate: Dated: 9 January 2009 Counsel for the First Applicant: R S Hollo

Solicitor for the First Applicant: Minter Ellison, Lawyers

Counsel for the Second Applicant: F Gleeson SC

Solicitor for the Second Applicant: Freehills

Counsel for Australian Prudential Regulation Authority: JS Gleeson

Solicitor for Australian Predential Regulation Authority: D Sun, APRA

Counsel for Intervenor (Mr J Kemp): M McHugh

Solicitors for Intervenor (Mr J Kemp): Kemp & Co, Solicitors