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Part VII transfers part 2

n the first article (December 2006) we provided an overview of the typical timeline for a Part VII transfer (figure 1). In this article we consider the main challenges from a life perspective in achieving this timescale. The process has been made considerably more complicated by changes in the regulatory regime over recent years.

Life perspective
Our points are primarily based on a Part VII transfer of with-profits business for a company that calculates a realistic balance sheet. This tends to be more complex than a Part VII transfer for non-profit business.
The two main challenges from a life perspective are:
– projecting capital requirements in the future, both on a Pillar 1 (peak 1 and 2) and Pillar 2 basis; and
– delivering against tight and complex project plans with multiple stakeholders.

Projecting capital requirements
A main requirement of the Part VII project will be to demonstrate to a number of stakeholders that the transferring policyholders (and indeed remaining policyholders if applicable) will not be financially disadvantaged through the transfer. This in turn is an important factor in designing the scheme of transfer.
In order to demonstrate this, projections of future solvency are likely to be required.

– Pillar 1 The company’s published solvency information will be determined by comparing the regulatory and realistic peak calculations. Work is, however, likely to be required to project the balance sheets into the future. Complications will probably be encountered in following areas.
– Projecting realistic balance sheets into the future is an intensive calculation. At one extreme it may require nested stochastic calculations. There are alternative methods that can be used as a proxy for the full nested stochastic approach (eg closed-form solutions or a replicating portfolio approach) but these also require work to validate their appropriateness.
– Projecting regulatory and realistic balance sheets together and observing their relative levels over time. This is complicated for firms that use separate financial models for realistic and regulatory balance sheets.
– To the extent that management actions are not incorporated into the projection model, consideration will need to be given to their impact together with the appropriateness of the size of management action given the projected scenario.
– Demonstrating that results are sufficiently robust and credible for the interested stakeholders. This is likely to be the case for information that is already produced for external publication, although more granularity may be required for other stakeholder purposes.

– Pillar 2 In addition to the considerations under Pillar 1, companies will be required to assess the implications for their own internal assessment of capital requirements and take into account individual capital guidance that may have been received from the regulator. The company’s ICA capability will have evolved rapidly over recent years and there are likely to be known focuses for refinement of the current methodology and/or approach. Typical challenges to overcome include:
– identifying a workable solution to address known deficiencies in the current ICA methodology/approach that are critical from the stakeholders’ perspective. An example is the determination of the appropriate diversification allowance to include in the aggregation of individual risk components;
– demonstrating that the ICA is understood and can be reconciled to published financials. Providing a reconciliation of ICA between two dates can be helpful but is challenging. Discussing the level of granularity of information required by the regulator and other stakeholders can help to avoid overengineering the solution. Any solution should take account of the limitations in data to avoid spurious accuracy;
– as with the projection of the realistic balance sheet the impact of management actions will be an important consideration. The scale of management actions assumed in the ICA is likely to be a focal point for stakeholders.
The use of approximations can simplify the work required within the Pillar 2 calculations.
Ultimately the information provided in relation to Pillar 1 and Pillar 2 will be used to assess the implications of the Part VII transfer on the security of future policyholder benefits. The results of the financials are likely to influence the scheme design, in particular introducing mechanisms which provide additional policyholder security where deemed necessary.

Project management considerations
In addition to the technical complexities described above, a major challenge will be completing what is likely to be a complex project to demanding timescales. Typically once a Part VII project is decided as the most appropriate way to achieve the intended strategy then the company will be keen for a speedy conclusion.
The time for completion depends on the company’s circumstances and the complexity of the intended scheme, but will also be affected by the quality of existing information available. A quick Part VII project could be completed within one year of starting, although some projects have run over several years. Transfers involving only non-profit business can be implemented more quickly.
As previously mentioned, the project will involve multiple stakeholders who will need information at specific points in time. A strong project manager who can appreciate the important interactions between several work streams can be critical to the timely delivery of the project. Areas of focus for the programme will include:
– identifying experts within the business who need to be involved in the project and any critical resource shortages;
– quickly identifying the critical path for the project and effective monitoring of progress will ensure efficient management of delays as they occur;
– being aware of the important interdependencies in the project, for example between the scheme design team, the independent actuary, the FSA, and with profit committees. There will also be close working between the legal, tax, actuarial and communication work streams, which will benefit from detailed planning throughout the duration of the project.
– the requirement to communicate the Part VII project to customers is likely to be a project in its own right, often involving mailing millions of policyholders. While a Part VII transfer does not typically require a vote from policyholders, the content of the mailing can affect the response rate from policyholders.

Other considerations
Separate from the completion of the Part VII itself, the company will need to consider what the implications of the Part VII will mean for ongoing operations. This may be a fundamental part of the strategy behind the Part VII project but if the reason for the Part VII is capital efficiency or tax then there is a risk that the future operation of the combined business receives insufficient consideration.
From an operational perspective there may be synergies to be gained in the ongoing operation of the merged funds. Areas for consideration include:
– rationalisation of administration platforms from the previous entities may provide a source of long-term savings;
– the structure of the finance functions after the Part VII: at one extreme a change may be implemented to form one reporting team for the new combined fund. At the other extreme the previous finance functions may remain unchanged, with an additional team created to consolidate the results for external presentation purposes.
The restructuring may also present an opportunity to improve the relationship with customers. The company may decide to use the Part VII to change its branding in order to reconnect with customers or to provide a new brand on which to build the proposition to future new policyholders.

The future
Our two articles on the use of Part VII transfers cannot do justice to the many varied ways in which they can and have been used in the UK. Although we expect the rules surrounding Part VII transfers to continue to evolve, the continued focus on extracting value from existing insurance businesses means that there will be many more Part VII transfers over the next few years.

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