Gordian RunOff Limited, in the matter of Insurance Australia Limited (No 2) [2011] FCA 1116

REASONS FOR JUDGMENT 1 This is an application under division 3A of Part 3 of the Insurance Act 1973 (Cth) ("the Act") for confirmation of a scheme under which the inwards reinsurance business of the Australian branch of Insurance Australia Ltd ("Insurance Australia") is to be transferred to Gordian Runoff Ltd ("Gordian"). 2 Insurance Australia is a wholly owned subsidiary of a publicly listed company, Insurance Australia Group Ltd ("IAG Group"). Insurance Australia was formerly known NRMA Insurance Limited. Insurance Australia is authorised under the Act as a general insurer. It underwrote inwards reinsurance during the period from 1982 to 2001. It did so under the well-known NRMA brand. 3 The portfolio comprises the business which Insurance Australia proposes to transfer under the scheme to Gordian. Insurance Australia ceased writing inwards reinsurance business from 2001, and accordingly the portfolio went into runoff at that time. Much of the evidence upon which the present application is based is to be found in the actuarial reports to which I was taken extensively this morning. It is sufficient to say at this point that as at 30 June 2011, Insurance Australia had a solvency coverage ratio of approximately 1.97 in respect of the minimum capital requirements imposed by the Australian Prudential Regulation Authority ("APRA"). 4 Insurance Australia held, as at 30 June 2011, assets in Australia for the purposes of the APRA assessment of $2,132,695,000. Its minimum capital requirement at that date, as determined by APRA, was $1,364,470,000, which gave rise to the solvency ratio that I have mentioned at [3]. 5 Gordian is an Australian corporation which is owned indirectly by a Bermuda based insurer, Enstar Group Limited. Gordian is authorised by APRA to conduct in Australia a runoff general insurance business. It is not authorised to carry on any other type of insurance business. Gordian has been in runoff since September 1999. Its principal business is the acquisition of insurance portfolios that are in runoff and their management. 6 Gordian does not employ any staff itself, but its business is managed by employees of Enstar Australia Limited pursuant to a service agreement. The most recent returns filed by Gordian with APRA show that it had, as at 30 June 2011, a solvency coverage ratio of approximately 5.22. It is unnecessary to set out the figures which demonstrate that ratio. 7 For the purposes of the present application, it is necessary to take into account two capital reductions which are dealt with in the actuarial reports. The first capital reduction was approved by APRA on 9 February 2011. At that time, APRA approved a capital reduction of $36 million to Gordian's capital base, but as at 30 June 2011 Gordian had not paid the full amount of the dividend to its shareholders. It had paid the sum of $34,100,000 on 30 June 2011. 8 The second capital reduction was approved by APRA on 13 July 2011 when APRA approved a capital reduction of $15,100,000. On 24 August 2011 the sum of $17 million, which comprised the balance of the first capital reduction and the full amount of the second capital reduction, was paid to Gordian's shareholders. The payment of $17 million was paid as a dividend to the shareholders of Gordian. The effect of the first and second capital reductions has reduced Gordian's solvency coverage ratio. Even when taking the capital reductions into account, the solvency ratio stood at approximately 4.64. 9 The legislative framework under which the present application is made is to be found in ss 17A to 17F of the Act. It is sufficient for present purposes to say that s 17B(1)(a) provides that: No part of the insurance business of a general insurer may be transferred to another general insurer except under a scheme confirmed by the Federal Court. 10 The term "insurance business" includes reinsurance, and accordingly, the provisions of Division 3A of Part III of the Act are enlivened. 11 Section 17C sets out some of the procedural requirements which must be complied with unless a dispensation order is made by the Court under section 17C(5). 12 Section 17F confers on the Court a discretion whether to confirm a scheme. Section 17F was recently amended by the insertion of section 17F(1A) to which I will refer later. The principles upon which the discretion to confirm a scheme are applied are stated by Lindgren J in Re Westport Insurance Corporation (No 2) (2009) 181 FCR 530 ("Re Westport"), commencing at [32]. 13 His Honour there reviews the principal authorities which deal with this question. As his Honour pointed out at [32]: A review of some of the decided cases…suggests that, in general terms, the Court has treated the critical factor governing the exercise of its discretion as being whether "policyholders" will be materially detrimentally affected by the implementation of the scheme: Re Insurance Australia Ltd at [76]; In the matter of GIO Personal Investment Services Ltd and AMP Life Ltd [2000] FCA 1871 at [27]. 14 He went on to point out at [33] that, in Re Insurance Australia Limited (2004) 139 FCR 450 at [19]-[24] ("Re Insurance Australia"), an affected policy holder within the meaning of section 17C is a holder of a policy being transferred under the scheme. 15 His Honour also observed in Re Insurance Australia at [25] that: This does not mean that the effect of the scheme will have on other policy holders is irrelevant to the exercise of the Court's discretion. 16 Lindgren J, at [34] of Re Westport, also referred to the decision of Heerey J in Re Reward Insurance Limited [2004] FCA 151, in which his Honour described the nature of the actual and potential claims to which the transferor insurer is subject and the financial viability of the transferee insurer as a prime consideration on such an application. 17 As Lindgren J went on to observe, the position is now to be considered in light of s 17F(1A) of the Act which was enacted following comments by Emmett J in Re Mercantile and General Reinsurance of Australia Limited [2004] FCA 1773, that it may be desirable for there to be legislative amendment to make consideration of the interest of the existing policy holders of the transferee insurer a mandatory requirement. 18 Section 17F(1A)(a) now provides that in deciding whether to confirm the scheme, the Court must have regard to the interest of the policy holders of a body corporate affected by the scheme. As is apparent from the authorities mentioned above, actuarial evidence is critical to the question of the exercise of the Court's discretion. As mentioned earlier, I was taken in some detail to the actuarial reports which are relied upon today. The principal report is an independent actuarial report prepared by Ms Lisa Simpson of PricewaterhouseCoopers. Ms Simpson prepared a report dated 15 June 2011, but she updated that report in an addendum to which I will also refer at [25]. 19 Ms Simpson's report was based upon the returns filed with APRA as at 30 September 2010. That date was chosen because it was the latest date for which APRA balance sheets of Insurance Australia and Gordian were available at the time of preparing the report. Ms Simpson prepared the report for the purposes of the transfer of the Australian portfolio of Insurance Australia to Gordian, as well as for a similar proposed transfer which is to take place between a New Zealand subsidiary of the IAG Group, which is now known as State Insurance New Zealand ("SINZ"), and Gordian. It is unnecessary for me to set out the details of Ms Simpson's report, but it is sufficient for present purposes to say that as at 30 September 2010, Insurance Australia had estimated liabilities in respect of the inwards reinsurance business of $12.138 million, as reported in the APRA returns. 20 The consideration for the transfer is to be $10.7 million which, on the face of it, is less than the amount of the liabilities. However, the liabilities' figure was calculated by Insurance Australia and it appears that the calculation contained a buffer so that Gordian proposes to acquire the portfolio upon the basis that the true amount of the liabilities will prove to be less than that which was estimated by Insurance Australia. Importantly, the tables to which I was taken this morning demonstrate the solvency ratios that I have previously referred to. The table in the 15 June report shows that the impact of the transfer of the Australian portfolio is expected to be immaterial on the assets and liabilities of Insurance Australia. The assets transferred will be $10.7 million out of a total of a much larger pool of assets held by Insurance Australia which is a large general insurer. 21 The total amount of its assets as at that date was $11.227 billion. Ms Simpson concludes that given the immaterial nature of the transfer, on the balance sheet of Insurance Australia, the transfer will not have a material impact on any policy holders of other entities within the IAG Group. So far as Gordian policy holders are concerned, the table prepared by Ms Simpson shows that the net assets will be unchanged following the transfer. The increase in cash of $10.7 million has been assumed to be offset by an increase in liabilities of the same amount. That is to say, Gordian has assumed that the liabilities of $12.138 million will be less than that figure. Ms Simpson has confirmed that the assumptions are reasonable. 22 For completeness, Ms Simpson considered a scenario under which only the Australian business is transferred to Gordian and approval is not given for the transfer of the New Zealand business which, on that assumption, would remain with Insurance Australia. The amount involved in the New Zealand transfer is only approximately $1 million, and accordingly, the effect is minimal. Ms Simpson concludes that even on this scenario, the impact is expected to be immaterial on the assets and liabilities of Insurance Australia. The assets transferred will be $9.76 million out of a total of $11.227 billion. She says that given the immaterial potential impact of the balance sheet of Insurance Australia, she would again conclude that the impact of the scenario would not be material on any policy holders or other entities within the IAG Group. 23 Upon the basis of the 30 September APRA returns, Gordian had a solvency coverage of 3.89, which would be reduced to 3.77 following the transfer. Ms Simpson said that she did not consider this reduction to be significant, given that the overall solvency level remains more than the required minimum of APRA. The impact of the transfer on this basis would result in a slight reduction in solvency coverage ratio, but no material impact on the security of their overall solvency position. Ms Simpson does refer in her report to what might be considered to be some disadvantages of the transfer. In particular, policy holders have the benefit of being covered by Insurance Australia which has a continuing business and which should therefore be able to restore capital levels in the event of future deterioration. 24 By contrast, Gordian, as a runoff insurer, does not have that advantage. Ms Simpson also points out that Insurance Australia is a much larger insurer than Gordian and the result of the transfer would be in Insurance Australia policy holders joining a smaller, runoff insurer, but notably, one which has a higher proportional level of solvency coverage. Bearing these matters in mind, Ms Simpson concludes that the Insurance Australia policy holders' interests will not be materially impacted by the transfer. I do not need to refer to anything else in Ms Simpson's report other than to say that her conclusion noted at Section 6 is that she has considered the scheme and its likely effect on the policy holders of Insurance Australia and Gordian. She has concluded that no policy holders (or third party claimants who rely on their policies) would be adversely affected by the proposed transfer in total, and with respect to the Australian and New Zealand schemes, in isolation. 25 Ms Simpson's supplementary report is dated 30 August 2011. The report is in the form of a letter which confirms that Ms Simpson has carried out "a high level" review of the APRA returns of the companies as at 30 June 2011. Importantly, she confirms that her conclusions in her report of 15 June 2011 are unchanged. It is not necessary for me to refer to the detail of the addendum report, save to mention that it takes into account the two capital reductions to which I referred earlier. Ms Simpson observes that the lower capital base would result in a solvency coverage ratio of approximately 4.6 times the minimum capital requirement and that this is in fact higher than the coverage ratio as at 30 September 2010. Ms Simpson observes that the coverage ratio would be anticipated to reduce slightly to approximately 4.42 times following the transfer of the Insurance Australia policies, but this is also higher than the corresponding ratio in her initial report. 26 As Ms Simpson observes, the increase in the solvency coverage ratio since 30 September 2007, both before and after transfer of liabilities, improves the security of transfer and policy holders, and hence in her view confirms the conclusion in her report. Ms Simpson's report was subject to an independent peer review conducted by Mr Warwick Gard who was a partner of Ernst & Young. Mr Gard appears to have conducted a thorough review of Ms Simpson's report. He concludes that Ms Simpson's conclusions are reasonable based on the material provided to him. He also states that in his view the interests of policy holders will not be adversely affected to any material degree by the proposed transfer in total, and the Australian and New Zealand schemes considered in isolation. 27 The procedural requirements which the court is to take into account in the exercise of its discretion are found in s 17C(2) of the Act and APRA's Prudential Standard GPS 410 - Transfer and Amalgamation of Insurance Business for General Insurers ("Prudential Standard GPS 410"). Section 17C(2) provides that an application for confirmation of a scheme may not be made unless: A copy of the scheme and any actuarial report on which the scheme is based have been given to APRA in accordance with the relevant prudential standards; Notice of intention to make the application has been published by the applicant in accordance with the prudential standards; and An approved summary of the scheme has been given to every affected policy holder. 28 Mr Owens, who appears for the plaintiff, has provided me with helpful written submissions, which I will mark as MFI-1. He makes a useful summary of the procedural requirements drawn from the provisions of s 17C(2) and the relevant provisions of Prudential Standard GPS 410. I do not think that I need to set out each of the steps. It is sufficient to say that in addition to the provisions of s 17C(2) of the Act, the procedural requirements drawn from Prudential Standard GPS 410 are to be found in paragraphs 5, 8, 9, 11 and 16. The requirement of s17(2)(c) that an approved summary of the scheme be given to every affected policy holder was dispensed with by Stone J in orders which her Honour made on 16 June 2011: see Gordian RunOff Limited, in the matter of Insurance Australia Limited [2011] FCA 691. 29 The dispensation order was granted on condition that certain other actions were taken. I am satisfied that all of the procedural requirements set out in s 17C(2) and Prudential Standard GPS 410, as modified by the orders made by Stone J, have been satisfied. The evidence for this is to be found in a number of places in the material to which I was taken. 30 The first is a letter dated 26 July 2011 from APRA to Mr Steven Girvann, the chief executive officer of Gordian. The second is a number of affidavits which were read on the application. These were the affidavits of Ms Lucy Cooper, Mr Vu Tran Pham, Mr Steven Girvan and Mr Edward Martin. 31 It seems to me that on the basis of the matter which I have referred to above, I ought to exercise my discretion to confirm the scheme. I should mention that I have also taken into account the fact that APRA appeared in this morning's application and does not object to an order confirming the scheme. It is well established that the attitude of APRA is an important matter to be taken into account and in the exercise of discretion. The relevant principles and the authorities are set out in the judgment of Katz J in Re Royal & Sun Alliance Life Assurance Ltd (2000) 104 FCR 37 at [24]-[27]. 32 For these reasons, I propose to make orders in accordance with the draft order handed to me this morning. I certify that the preceding thirty-two (32) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Jacobson.