PMI Indemnity Limited (No 2) [2005] FCA 1842

[2005] FCA 1842

Federal Court of Australia|2005-12-08|Before: Lindgren J

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At a glance

Source facts

Court

Federal Court of Australia

Decision date

2005-12-08

Before

Lindgren J

Source

Original judgment source is linked above.

Judgment (57 paragraphs)

[1]

Introduction 1 The first applicant, PMI Indemnity Limited ('Indemnity') and the second applicant, PMI Mortgage Insurance Limited ('Mortgage'), apply pursuant to Division 3A of Part III of the Insurance Act 1973 (Cth) ('the Act') for confirmation of a scheme ('the Scheme') pursuant to which Indemnity's insurance business will be transferred to Mortgage.

[2]

The applicants 2 Indemnity and Mortgage are both incorporated in New South Wales, and are indirectly, but wholly owned, subsidiaries of The PMI Group Inc ('PMI Group'), a company listed on the New York Stock Exchange. 3 Indemnity was acquired by PMI Group's Australian holding company, PMI Mortgage Insurance Australia (Holdings) Pty Limited ('Holdings') in September 2001. Prior to the acquisition, Indemnity was known as 'CGU Lenders Mortgage Insurance Limited'. At various earlier times, it was known by other names. 4 Indemnity and Mortgage are authorised general insurers under the Act, but are limited in the type of insurance they may write by a condition placed on their authorisations, that they carry on only the business of lenders' mortgage insurance ('LMI'). Generally speaking, LMI policies insure financial institutions and other entities that lend money for the purchase of real property against the risk of loss arising from default by the borrower. 5 Indemnity and Mortgage have written LMI policies in Australia and New Zealand. With two exceptions, Indemnity's New Zealand policies were written through Indemnity's New Zealand branch. 6 Indemnity was placed into run-off on 1 July 2002. It has no employees. Its operations are conducted by employees of Mortgage, whose services are contracted to it. 7 As at 31 December 2004, Indemnity had total assets of $181,728,000 and total liabilities of $29,604,000, giving a net asset position of $152,124,000. 8 Indemnity is rated AA by Fitch, Aa3 by Moody's and AA- by Standard & Poor's. 9 As at 31 December 2004, Mortgage had 206 full time employees, and 15 contractors working for it, and total assets of $854,483,000 and total liabilities of $428,831,000, giving a net asset position of $425,652,000. 10 Mortgage is rated AA by Fitch, Aa2 by Moody's and AA by Standard & Poor's.

[18]

Discretion to confirm the scheme 23 The Court's discretion to confirm a scheme for the transfer of an insurance business is conferred by s 17F. The discretion is a general one, and the Act does not specify any criteria to be satisfied: cf Re Reward Insurance Ltd [2004] FCA 151 at [3]. 24 The decided cases (including those under the comparable provisions of the Life Insurance Act 1995 (Cth)) reveal as the critical consideration, whether affected policyholders will be detrimentally affected by the implementation of the scheme: Re Insurance Australia Limited (2004) 139 FCR 450 at [76]; Re GIO Personal Investment Services Ltd [2000] FCA 1871 at [27]. 25 In Re Insurance Australia Limited (2004) 139 FCR 450 I held that an 'affected policyholder', defined in s 17C(1) as 'the holder of a policy affected by a scheme' is a holder of a policy being transferred under the scheme (at [25]). In this case, therefore, the affected policyholders are financial institutions and other entities that hold LMI policies issued by Indemnity, not of those issued by Mortgage. As I also held in that case, however, as part of the Court's discretion, the Court may take into account the effect of the Scheme on other policyholders, such as the holders of policies issued by Mortgage in the present case. 26 In order to assess whether the Scheme detrimentally affects a policyholder, it is necessary to examine the Scheme in some detail. 27 Broadly speaking, the Scheme is part of the reorganisation of the PMI group of companies' Australian operations, and seeks to consolidate all of Indemnity's and Mortgage's policies in the one entity, Mortgage. 28 There are several benefits intended to be achieved through the transfer: (a) Mortgage will have greater financial size and strength, and the risks carried by it will be more widely spread. (b) There will be a saving (estimated to be approximately $500,000 each year) in administrative and regulatory compliance costs, such as accounting, audit, taxation, actuarial and other services. (c) The transfer of Indemnity's insurance liabilities to Mortgage will permit the more efficient use of capital within the PMI group by facilitating the release of capital superfluous to the reasonable estimate of the total amount of those liabilities. (In due course, that superfluous capital will be distributed to members of the PMI group where it may be most beneficially deployed.) 29 Indemnity intends, following the transfer under the Scheme, to ask APRA under s 16(1) of the Act to revoke its authorisation under s 12 of the Act, and then to be wound up.

[34]

Financial condition of Indemnity and Mortgage pre- and post-Scheme 38 Indemnity's statutory balance sheet shows that at 30 June 2005 it had total assets of $178,614,211 and total liabilities of $19,262,325. Adjusting those accounts to take into account the cancellation of a 'reinsurance debtors' asset by a doubtful debt provision, and the settlement of intercompany balances between Mortgage and Indemnity, Indemnity had total assets of $181,370,445 and total liabilities of $22,018,559, giving it a net asset position of $159,351,886. 39 On the basis of those adjusted accounts (and applying the new APRA capital adequacy rules), Indemnity's net capital allowed for solvency purposes was 189 percent of its Minimum Capital Requirement ('MCR'). 40 Mortgage's statutory balance sheet shows that at 30 June 2005 it had total assets of $905,739,196 and total liabilities of $429,255,307. Adjusting those accounts to take into account a change to Mortgage's reinsurance arrangements and the settlement of intercompany balances between Mortgage and Indemnity, and the making of the $55,000,000 capital injection by Holdings required under the Capital Management Plan, Mortgage has total assets of $971,528,736 and total liabilities of $439,999,135, giving it a net asset position of $531,529,601. 41 On the basis of those adjusted accounts (and applying the new APRA capital adequacy rules), Mortgage's net capital allowed for solvency purposes was 124 percent of its MCR. 42 It is expected that following completion of the Scheme and of all steps of the Capital Management Plan, Mortgage will have total assets of $1,071,125,628 and total liabilities of $477,596,027, giving it a net asset position of $593,529,601. Its net capital allowed for solvency purposes is anticipated to be 122 percent of its MCR. 43 Accordingly, Indemnity's policyholders will be transferred from a company with a solvency ratio of 189 percent to a company with a solvency ratio of 122 percent, while Mortgage's policyholders will find that the solvency ratio of their insurer is reduced slightly from 124 percent to 122 percent.

[35]

The 'Fair Value' financial condition of Indemnity and Mortgage 44 Gregory Clive Taylor is the approved actuary appointed by Indemnity and Mortgage. He has been an actuary for the past 37 years and has been engaged substantially or wholly in the insurance industry for approximately the last 29 years. Dr Taylor is a Fellow of the Institute of Actuaries of Australia, a Fellow of the Institute of Actuaries in the United Kingdom, and a Fellow of the Institute of Mathematics and its Applications. He is a director of Taylor Fry Pty Ltd, trading at 'Taylor Fry Consulting Actuaries'. He has provided a report dated 13 October 2005 ('the Taylor Report'). 45 In the Taylor Report, Dr Taylor states that in his view the statutory accounts of Indemnity and Mortgage do not, in certain ways, represent 'fair value'. 46 The adjustments which, in his opinion, are required to be made to those accounts to reflect 'fair value' are described in detail in Appendix D to his report. 47 The most significant changes relate to the substituting of 'premium liability' for 'unearned premium'. 48 'Unearned premium' (used in statutory accounting) apportions the premium associated with a policy to the periods of coverage provided by that policy in proportion to the expected cost of claims arising in those periods. The profit component of the premiums is recognised, not immediately, but gradually over the lifetime of the policy. 49 'Premium liability', on the other hand, reflects the costs of claims arising out of future events covered by past premiums. APRA requires premium liability to be calculated to include a risk margin that the provision has a 75 percent probability of sufficiency, and to be discounted at a risk free rate of return. Dr Taylor considers that premium liability should be calculated only on the basis of expected claim costs (ie, excluding any risk margin) and discounted at a risk-adjusted rate of return. 50 The effect of the adjustments outlined by Dr Taylor in Appendix D to his report are set out in Appendix B4 to that report. 51 In substance, that effect is that on the basis of the assumption underpinning the 'adjusted' accounts described above, Indemnity's pre-transfer total assets decrease to $178,014,895, its total liabilities increase to $34,241,342, and its net assets, after allowing for a taxation consequence of the change in accounting, decrease to $148,447,053. 52 On the same basis, Mortgage's pre-transfer total assets decrease to $919,633,692, its total liabilities decrease to $107,424,589, and its net assets, after allowing for the taxation consequence of the change in accounting, increase to $728,005,252. 53 Following the transfer, Mortgage would have total assets of $1,015,875 (a decrease compared to the statutory accounts), total liabilities of $141,665,930 (a decrease compared to the statutory accounts), and net assets of $790,005,252 (an increase compared to the statutory accounts).