Securities Commission - Discussion on Life Insurance and Law Practices


	PART II - LIFE INDUSTRY LAW AND PRACTICES Main Contents Glossary Part I - Background Part II - Life Industry Law and Practices Part III - Public Policy Discussion Appendices	THE SEGREGATION OF POLICYHOLDERS' FUNDS Our experience of life insurance industry practice The legal provisions relating to the pledging of life insurance assets The pledging of policyholder assets in Australia and the United Kingdom Comment

Our experience of life insurance industry practice

6.1
We have seen instances where life companies' policyholder funded assets have been pledged as security to financiers with claims either ranking ahead of, or in competition with, those of the policyholders themselves. In many cases it was not apparent that the policyholders had gained from the pledging of the assets to third parties.

6.2 These instances included:

a case where a life insurer had guaranteed the obligations of its parent entity to a bank under a mortgage advance by the bank to the parent. The amount of the advance was nearly equal to the life insurer's total assets. The ability of the bank to call on the guarantee would have been of serious concern to policyholders if it had been brought to their attention;

a case where a life insurer had guaranteed the obligations of its overseas parent to the parent's bankers;

a case where a life insurer had co-guaranteed certain obligations of a subsidiary company to its customers. These guarantees were long-term in nature and the life insurer could not readily be released from them;

a case where a life insurer borrowed funds from a bank to help finance a significant acquisition, with the bank taking a debenture security over the assets of the acquiring life insurance company that ranked in priority to the claims of the company's policyholders. The life insurance policies of the acquiring (borrowing) life insurance company were non-participating and primarily investment- linked.

The legal provisions relating to the pledging of life insurance assets

6.3
There are no specific provisions in the Life Act dealing with the giving of security over policyholder-funded assets. The principal section of relevance is section 15 which states:

LIFE FUNDS SEPARATE--

(1) In the case of a company established before or after the coming into operation of this Act transacting other business besides that of life insurance, a separate account shall be kept of all receipts in respect of the life insurance and annuity contracts of the company, and the said receipts shall be carried to and form a separate fund (to be called the Life Insurance Fund of the company); and such fund shall be as absolutely the security of the life policy and annuity holders as though it belonged to a company carrying on no other business than that of life insurance, and shall not be liable for any contracts of the company for which it would not have been liable had the business of the company been only that of life insurance.

(2) ....

6.4 Section 15 refers only to those life insurance companies which carry on business other than that of life insurance, and provides that in such cases the company should keep separate account of all moneys received in respect of its life insurance business and these moneys will form a separate Life Insurance Fund which will be "as absolutely the security of the life policy and annuity holders as though it belonged to a company carrying on no other business than that of life insurance...".

6.5 Section 15 does not expressly deal with the giving of security over life fund assets. However there is relevant case law on the subject. Barker J, in ACL Insurance Limited v ACL Insurance Limited (In Liquidation) HC, Auckland M2121/89 6 March 1995, a case involving a company which carried on both life and general business, said:

Section 15 does require the formation of a separate Life Insurance Fund into which premiums from life insurance and annuity contracts and other receipts from that class of business are paid.

The section also requires that those receipts "shall be carried to and form a separate fund to be called the Life Insurance Fund of the company".

The formation of the separate fund and the requirement that the Fund be the security of the life policyholders also implies that the assets of the fund (including any investments deriving from those assets) be retained in separately identifiable form.

The Fund is available only to meet the proper liabilities of a company carrying on no other business than that of life insurance. In other words, to the extent that liability is incurred to outside creditors in connection with the business of life assurance, those creditors may property [sic] claim against the Fund. However, to the extent that the creditors relate to business other than that of a life assurance company, they may not claim against the assets of the Fund.

To the extent that a separate fund is required to be formed and provide security, a trust in favour of the policyholders arises but on terms as outlined in the previous sub-paragraph. In other words, the Life Insurance Fund is not to be applied exclusively to the claims of the life insurance policyholders. Creditors relating to the life insurance business of the company are also to be recognised. If secured, then depending on the terms of the security, they may have priority over the life policyholders.

In effect, a statutory preference in relation to the life insurance business is created. This is to be recognised both during the existence of the company and in a winding-up by exonerating the Life Insurance Fund from liability in connection with debts not connected with the life insurance business. Thus, if a Bank lends money to the company for some purpose other than the life insurance business, the assets representing the Life Insurance Fund would not be liable for that debt (or such part as did not relate to the life insurance business). The opening words of section 15(2) give further support to this analysis.

6.6
In the particular case the company had not maintained a separate fund of assets for the life insurance policyholders, despite carrying on other business. Barker J declined to make an order giving any priority to the life insurance policyholders. They would rank as unsecured creditors along with the company's other creditors (other than a bank, which had security over a property owned by ACL). Barker J commented:

That seems a somewhat contrary result to what the legislature tried to achieve on [the policyholders] behalf. There does not seem to have been any effective policing of these statutory requirements. I was informed from the Bar that there were auditors of the company and that the company was required to provide an actuarial report annually when filing its annual statement. The company did show in its statement filed in terms of the Act, that it had at 31 March 1989 (9 months before it was placed in judicial management) a Life Insurance Fund of some $12.5 million. Anyone reading the published balance sheet might have thought that that sum was being kept separate for life insurance creditors. However, that apparently was not the case because of the intermingling of accounts.

It is still not clear that the legislation requires a separate bank account for the life insurance fund. I should hope that in any revision of the Life Insurance Act there will be a number of reforms to which attention should be given. Some have been demonstrated in this case. I list them as follows -

The legislation should make it clear whether there should be a separate bank account for the Life Insurance Fund.

There should be something in the statute akin to s.29 of the current English legislation which states in effect that the assets represented in the fund should be applicable only for the purposes of the life insurance business and not available for other purposes of the company.

The archaic wording and format of the Schedules to the Act (which included reference to Indian and Colonial securities and other unlikely forms of security) should be overhauled; far more accountable information should be provided for the public and policyholders;

S.28(1) which deals with non compliance reads as follows -

"Every company which makes default in complying with any of the requirements of this part of this Act, where no other penalties are expressly provided, is liable to a fine not exceeding Ł100 for every day during which the default continues; and in the case of a foreign company the general agent shall be liable as to such fine as well as the company."
There should be a much greater maximum penalty fixed than Ł100 a day as an indication to those responsible for running life insurance companies that they have serious obligations to those from whom they take premium income.

6.7
Two issues arise from the application of section 15 of the Life Act and Barker J's judgment:

the extent to which assets of a life insurance company are available to satisfy the debts incurred by the company in business other than that of life insurance; and

whether a life insurance company is free to pledge its policyholders' assets to financiers in priority to the claims of policyholders to support borrowings regardless of the purpose for the which the proceeds of the borrowings are used.

6.8 The ACL case was concerned primarily with the claims of policyholders versus the claims of other unsecured creditors, not those of secured creditors. In the absence of a separate "Life Fund" the policyholders lost any protection they might have otherwise had. The question of the purpose of other borrowings did not arise.

6.9
Requirements for the segregation of policyholders' funds, and the security position of policyholders more generally, are not clearly stated in the legislation.

The pledging of policyholder assets in Australia and the United Kingdom

6.10 Australian life insurance legislation provides that all life insurance business must be conducted by life insurance companies within separate "statutory funds". Section 30 of the LIA(Aust) states:
The principal requirements of this Part in relation to statutory funds may be summarised as follows:

all amounts received by a life company in respect of the business of a fund must be credited to the fund;

all assets and investments related to the business of a fund must be included in the fund;

all liabilities (including policy liabilities) of the company arising out of the conduct of the business of a fund must be treated as liabilities of the fund;

the assets of a fund are only available for expenditure related to the conduct of the business of the fund;

statutory funds may not be divided or amalgamated without the approval of the [Insurance and Superannuation] Commissioner;

profits and losses of a statutory fund may only be dealt with in accordance with Divisions 5 and 6 (the object of those Divisions being to ensure that such profits and losses are dealt with in a manner that protects the interests of policy owners and is consistent with prudent management of the fund).

6.11 Every Australian life insurance company is required to have at least one statutory fund, but may have more than one fund.

6.12 Under the LIA (Aust) it is not permissible for a life insurer to mortgage or charge any asset of a statutory fund except to secure a bank overdraft or else with the approval of the Insurance and Superannuation Commissioner ("the Commissioner").

6.13 In the United Kingdom the ICA (UK) requires the separation of the "long-term business" (life insurance) assets from the "general business" assets of any company which carries on both life and general insurance. Separate "funds" must be maintained for each type of business. All receipts relating to the respective types of business are paid into the respective funds. In addition, life offices must separate the assets and liabilities relating to their insurance business and their shareholders' funds. We understand that many life offices have at least two long-term funds, one for their with-profit (participating) business and one for their non-profit (linked) business while others have a single fund covering both with-profit and non-profit business.

6.14 The ICA(UK) restricts the uses to which the long-term assets of a company may be put. In general terms they may only be used for the purposes of the long-term business. An exception is provided for the "free reserves" i.e. the extent to which the long-term assets exceed the long-term liabilities as disclosed by an actuarial valuation, which may be used for the purposes of the company's business generally. In addition, long-term assets of the company may be exchanged for other assets of the company provided the exchange is at fair market value. As a further protection no dividend may be declared by any company authorised to conduct long-term business unless it has established, by a valuation, that its long-term assets are at least equal to its long-term liabilities.

6.15 There appear to be no express constraints on the ability of an United Kingdom life office to mortgage or charge its assets. However the requirements in the ICA(UK) for the segregation of business appear to mean that a life company's assets can only be pledged where it is for the purpose of the life business. It would not seem possible for life (long-term) assets to be secured for the benefit of the shareholders. Barker J drew attention to the United Kingdom provisions in the ACL case (see para 6.6).

Comment

6.16 Some New Zealand life insurance companies have pledged their assets as security to third parties in priority to or in competition with the claims of policyholders. There are currently no constraints on life companies acting in this manner, except to the extent that section 15 of the Life Act may apply.

6.17 Australia has direct controls over external borrowing by life companies and achieves separation of life company business through the use of statutory funds. The United Kingdom requires segregation of long-term (life insurance) business.

6.18 We think there are a number of questions to be addressed concerning the segregation of policyholders' funds and the capacity of life insurance companies to pledge their assets to third parties in priority to, or in competition with, the claims of policyholders, including the relevance of any perceived direct benefits to policyholders. We identify these questions in the final section of the paper.

Main Contents
Glossary
Part I - Background
Part II - Life Industry Law and Practices
Part III - Public Policy Discussion
Appendices
INDEX || BACK || FORWARD

Our experience of life insurance industry practice
6.1	We have seen instances where life companies' policyholder funded assets have been pledged as security to financiers with claims either ranking ahead of, or in competition with, those of the policyholders themselves. In many cases it was not apparent that the policyholders had gained from the pledging of the assets to third parties.
6.2	These instances included: a case where a life insurer had guaranteed the obligations of its parent entity to a bank under a mortgage advance by the bank to the parent. The amount of the advance was nearly equal to the life insurer's total assets. The ability of the bank to call on the guarantee would have been of serious concern to policyholders if it had been brought to their attention; a case where a life insurer had guaranteed the obligations of its overseas parent to the parent's bankers; a case where a life insurer had co-guaranteed certain obligations of a subsidiary company to its customers. These guarantees were long-term in nature and the life insurer could not readily be released from them; a case where a life insurer borrowed funds from a bank to help finance a significant acquisition, with the bank taking a debenture security over the assets of the acquiring life insurance company that ranked in priority to the claims of the company's policyholders. The life insurance policies of the acquiring (borrowing) life insurance company were non-participating and primarily investment- linked.
The legal provisions relating to the pledging of life insurance assets
6.3	There are no specific provisions in the Life Act dealing with the giving of security over policyholder-funded assets. The principal section of relevance is section 15 which states: LIFE FUNDS SEPARATE-- (1) In the case of a company established before or after the coming into operation of this Act transacting other business besides that of life insurance, a separate account shall be kept of all receipts in respect of the life insurance and annuity contracts of the company, and the said receipts shall be carried to and form a separate fund (to be called the Life Insurance Fund of the company); and such fund shall be as absolutely the security of the life policy and annuity holders as though it belonged to a company carrying on no other business than that of life insurance, and shall not be liable for any contracts of the company for which it would not have been liable had the business of the company been only that of life insurance. (2) ....
6.4	Section 15 refers only to those life insurance companies which carry on business other than that of life insurance, and provides that in such cases the company should keep separate account of all moneys received in respect of its life insurance business and these moneys will form a separate Life Insurance Fund which will be "as absolutely the security of the life policy and annuity holders as though it belonged to a company carrying on no other business than that of life insurance...".
6.5	Section 15 does not expressly deal with the giving of security over life fund assets. However there is relevant case law on the subject. Barker J, in ACL Insurance Limited v ACL Insurance Limited (In Liquidation) HC, Auckland M2121/89 6 March 1995, a case involving a company which carried on both life and general business, said: Section 15 does require the formation of a separate Life Insurance Fund into which premiums from life insurance and annuity contracts and other receipts from that class of business are paid. The section also requires that those receipts "shall be carried to and form a separate fund to be called the Life Insurance Fund of the company". The formation of the separate fund and the requirement that the Fund be the security of the life policyholders also implies that the assets of the fund (including any investments deriving from those assets) be retained in separately identifiable form. The Fund is available only to meet the proper liabilities of a company carrying on no other business than that of life insurance. In other words, to the extent that liability is incurred to outside creditors in connection with the business of life assurance, those creditors may property [sic] claim against the Fund. However, to the extent that the creditors relate to business other than that of a life assurance company, they may not claim against the assets of the Fund. To the extent that a separate fund is required to be formed and provide security, a trust in favour of the policyholders arises but on terms as outlined in the previous sub-paragraph. In other words, the Life Insurance Fund is not to be applied exclusively to the claims of the life insurance policyholders. Creditors relating to the life insurance business of the company are also to be recognised. If secured, then depending on the terms of the security, they may have priority over the life policyholders. In effect, a statutory preference in relation to the life insurance business is created. This is to be recognised both during the existence of the company and in a winding-up by exonerating the Life Insurance Fund from liability in connection with debts not connected with the life insurance business. Thus, if a Bank lends money to the company for some purpose other than the life insurance business, the assets representing the Life Insurance Fund would not be liable for that debt (or such part as did not relate to the life insurance business). The opening words of section 15(2) give further support to this analysis.
6.6	In the particular case the company had not maintained a separate fund of assets for the life insurance policyholders, despite carrying on other business. Barker J declined to make an order giving any priority to the life insurance policyholders. They would rank as unsecured creditors along with the company's other creditors (other than a bank, which had security over a property owned by ACL). Barker J commented: That seems a somewhat contrary result to what the legislature tried to achieve on [the policyholders] behalf. There does not seem to have been any effective policing of these statutory requirements. I was informed from the Bar that there were auditors of the company and that the company was required to provide an actuarial report annually when filing its annual statement. The company did show in its statement filed in terms of the Act, that it had at 31 March 1989 (9 months before it was placed in judicial management) a Life Insurance Fund of some $12.5 million. Anyone reading the published balance sheet might have thought that that sum was being kept separate for life insurance creditors. However, that apparently was not the case because of the intermingling of accounts. It is still not clear that the legislation requires a separate bank account for the life insurance fund. I should hope that in any revision of the Life Insurance Act there will be a number of reforms to which attention should be given. Some have been demonstrated in this case. I list them as follows - The legislation should make it clear whether there should be a separate bank account for the Life Insurance Fund. There should be something in the statute akin to s.29 of the current English legislation which states in effect that the assets represented in the fund should be applicable only for the purposes of the life insurance business and not available for other purposes of the company. The archaic wording and format of the Schedules to the Act (which included reference to Indian and Colonial securities and other unlikely forms of security) should be overhauled; far more accountable information should be provided for the public and policyholders; S.28(1) which deals with non compliance reads as follows - "Every company which makes default in complying with any of the requirements of this part of this Act, where no other penalties are expressly provided, is liable to a fine not exceeding Ł100 for every day during which the default continues; and in the case of a foreign company the general agent shall be liable as to such fine as well as the company." There should be a much greater maximum penalty fixed than Ł100 a day as an indication to those responsible for running life insurance companies that they have serious obligations to those from whom they take premium income.
6.7	Two issues arise from the application of section 15 of the Life Act and Barker J's judgment: the extent to which assets of a life insurance company are available to satisfy the debts incurred by the company in business other than that of life insurance; and whether a life insurance company is free to pledge its policyholders' assets to financiers in priority to the claims of policyholders to support borrowings regardless of the purpose for the which the proceeds of the borrowings are used.
6.8	The ACL case was concerned primarily with the claims of policyholders versus the claims of other unsecured creditors, not those of secured creditors. In the absence of a separate "Life Fund" the policyholders lost any protection they might have otherwise had. The question of the purpose of other borrowings did not arise.
6.9	Requirements for the segregation of policyholders' funds, and the security position of policyholders more generally, are not clearly stated in the legislation.
The pledging of policyholder assets in Australia and the United Kingdom
6.10	Australian life insurance legislation provides that all life insurance business must be conducted by life insurance companies within separate "statutory funds". Section 30 of the LIA(Aust) states: The principal requirements of this Part in relation to statutory funds may be summarised as follows: all amounts received by a life company in respect of the business of a fund must be credited to the fund; all assets and investments related to the business of a fund must be included in the fund; all liabilities (including policy liabilities) of the company arising out of the conduct of the business of a fund must be treated as liabilities of the fund; the assets of a fund are only available for expenditure related to the conduct of the business of the fund; statutory funds may not be divided or amalgamated without the approval of the [Insurance and Superannuation] Commissioner; profits and losses of a statutory fund may only be dealt with in accordance with Divisions 5 and 6 (the object of those Divisions being to ensure that such profits and losses are dealt with in a manner that protects the interests of policy owners and is consistent with prudent management of the fund).
6.11	Every Australian life insurance company is required to have at least one statutory fund, but may have more than one fund.
6.12	Under the LIA (Aust) it is not permissible for a life insurer to mortgage or charge any asset of a statutory fund except to secure a bank overdraft or else with the approval of the Insurance and Superannuation Commissioner ("the Commissioner").
6.13	In the United Kingdom the ICA (UK) requires the separation of the "long-term business" (life insurance) assets from the "general business" assets of any company which carries on both life and general insurance. Separate "funds" must be maintained for each type of business. All receipts relating to the respective types of business are paid into the respective funds. In addition, life offices must separate the assets and liabilities relating to their insurance business and their shareholders' funds. We understand that many life offices have at least two long-term funds, one for their with-profit (participating) business and one for their non-profit (linked) business while others have a single fund covering both with-profit and non-profit business.
6.14	The ICA(UK) restricts the uses to which the long-term assets of a company may be put. In general terms they may only be used for the purposes of the long-term business. An exception is provided for the "free reserves" i.e. the extent to which the long-term assets exceed the long-term liabilities as disclosed by an actuarial valuation, which may be used for the purposes of the company's business generally. In addition, long-term assets of the company may be exchanged for other assets of the company provided the exchange is at fair market value. As a further protection no dividend may be declared by any company authorised to conduct long-term business unless it has established, by a valuation, that its long-term assets are at least equal to its long-term liabilities.
6.15	There appear to be no express constraints on the ability of an United Kingdom life office to mortgage or charge its assets. However the requirements in the ICA(UK) for the segregation of business appear to mean that a life company's assets can only be pledged where it is for the purpose of the life business. It would not seem possible for life (long-term) assets to be secured for the benefit of the shareholders. Barker J drew attention to the United Kingdom provisions in the ACL case (see para 6.6).
Comment
6.16	Some New Zealand life insurance companies have pledged their assets as security to third parties in priority to or in competition with the claims of policyholders. There are currently no constraints on life companies acting in this manner, except to the extent that section 15 of the Life Act may apply.
6.17	Australia has direct controls over external borrowing by life companies and achieves separation of life company business through the use of statutory funds. The United Kingdom requires segregation of long-term (life insurance) business.
6.18	We think there are a number of questions to be addressed concerning the segregation of policyholders' funds and the capacity of life insurance companies to pledge their assets to third parties in priority to, or in competition with, the claims of policyholders, including the relevance of any perceived direct benefits to policyholders. We identify these questions in the final section of the paper.