RE TRANSAMERICA OCCIDENTAL LIFE INSURANCE CO AND ANOTHER

HCMP2132/2006

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 2132 OF 2006

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REASONS FOR JUDGMENT

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Introduction

1. This is the petition by Transamerica Occidental Life Insurance Company (“TOLIC”) and Transamerica Life (Bermuda) Ltd (“TLB”) pursuant to section 24 of the Insurance Companies Ordinance, Cap. 41 (“the Ordinance”) for the sanction by the court for a scheme involving the transfer of certain policies of insurance to TLB as defined in the scheme constituting part of the long term business of TOLIC carried on by TOLIC in Hong Kong.

1. On 11 December 2006, I allowed the petition.  These are the reasons for my judgment.

The petitioners

3. TOLIC is incorporated under the laws of Iowa, USA.  It is authorized by the insurance regulator in the USA to transact life insurance business.  TOLIC is also registered under Part XI of the Companies Ordinance, Cap. 31 (“CO”) in Hong Kong and is authorized to carry on Class A (life and annuity) and Class C (linked long term) Long Term Businesses in Hong Kong.  It is also regulated by the Hong Kong Insurance Authority (“HKIA”).

4. TLB is a wholly owned subsidiary of TOLIC.  It is incorporated under the laws of Bermuda.  It has a paid up capital of US$40 million and is authorized by the Bermuda Monetary Authority to transact long term business of the same classes as the policies to be transferred under the scheme.  TLB is registered under Part XI of CO in Hong Kong and authorized by HKIA to carry on Class A and Class C long Term Business.

The need for the scheme

5. By virtue of a ruling made by the USA Internal Revenue Service in July 2004, certain distributions received by non-US policyholders from life insurance contracts issued by foreign branches of USA life insurance companies would be subject to withholding tax from 1 January 2007.  Policies purchased through TOLIC’s Hong Kong branch by non-US policyholders will or may thereafter by subject to withholding tax levied on distributions after 1 January 2007, even though those non-US policyholders may be an individual who is not a resident or citizen of the US or is an entity that is organized outside the US.  As at 31 December 2005, TOLIC had approximately 7.5 million ordinary insurance policies in issue globally comprising long term business.  As at 5 December 2006, TOLIC had 15,948 long term insurance policies issued by its Hong Kong branch and recorded on its Hong Kong register.  In order to protect the interests of those policyholders, TOLIC proposed a scheme to transfer them to TLB.

Salient features of the scheme

6. Three of the salient features of the scheme are worth noting.

7. First, TOLIC has provided to policyholders and will provide to all transferring policyholders a Claims Payment Guarantee Letter.  This Letter guarantees that, should TLB be unable to pay a valid claim solely as a result of TLB becoming insolvent, then TOLIC, to the extent permitted by applicable insolvency laws, shall pay the amount of such valid claim.

8. Second, TOLIC has signed a Tangible Net Worth Maintenance Agreement with TLB, in which it has undertaken to maintain level of capital in TLB.  The Tangible Net Worth Maintenance Agreement cannot be cancelled by TOLIC until such time as :

(1)     TLB is able to achieve a financial strength rating from Standard & Poor’s without the support of the Tangible Net Worth Maintenance Agreement which is at least as high as its rating with support from the Agreement; or

(2)     TLB is sold or its entire business is transferred to an entity with a Standard & Poor’s rating at least as strong as TOLIC’s then rating, or AA whichever is lower.

9. Third, for policies that receive benefits or are subject to premiums or charges that can be varied at the discretion of TOLIC, the scheme provides that TLB will provide identical discretionary benefits to transferring policyholders as those that would have been available had they possessed an identical policy in TOLIC :

(1)     for a period of 10 years after the transfer for universal life policies and term insurance policies with non guaranteed premiums; and

(2)     for the future lifetime of the policy for participating policies.

For universal life and term insurance polices with non guaranteed premiums, after this 10-year period, the scheme provides that TLB will follow practices and methodologies which TOLIC applies with regard to discretionary benefits, for so long as TLB considers it appropriate or necessary to meet the reasonable expectations of the transferred policyholders.

10. Further, the Re-insurers (as defined in the scheme) have agreed to re-insure the obligations of TLB under the transferred policies on the same or substantial identically terms of those set out in the original re-insurance arrangements.  And the Insurance Commissioner and Attorney of the State of Iowa, USA has approved the proposed transfer.

The independent actuary’s report

11. As required by section 24(2) of the Ordinance, this petition is supported by a report prepared by an independent actuary, who had considered in length the terms of the scheme and its impact.

12. In gist, the independent actuary opined :

(1)     Because of the Claims Payment Guarantee Letter and the Tangible Maintenance Agreement, the security of the contractual rights of transferring policyholders will not be materially adversely affected.

(2)     Because of the protections offered to discretionary benefits, the future benefit expectations of transferring policyholders will not be materially adversely affected.

(3)     The expected future service levels for transferring policyholders will not be materially adversely affected.

(4)     There will no adverse impact on other rights of transferring policyholders.

(5)     There will be no material impact on the policies remaining in TOLIC as a result of the transfer.

(6)     The size and scale of TLB’s operations as a company will increase and this help to transfer it into an established business.  Even though there may be some small dilution of its substantial current free assets as a result of the transfer, the Tangible Net Worth Maintenance Agreement and Claims Payment Guarantee Letter will protect the security of existing TLB’s policyholders.  There will be no material adverse impact on TLB’s existing policyholders prior to the transfer as a result of the transfer.

13. Accordingly, the independent actuary concluded that “no group of policyholders will be materially adversely affected as a result of the transfer of the transferred business”.

Directions

14. The Ordinance envisages a two stage process :

(1)     an application under section 24(3)(b) and (d) by summons for directions; and

(2)     the substantive hearing of the petition.

15. On 1 November 2006, I gave directions for the future conduct of the petition.  They all have since been complied with.  This fulfilled the pre-conditions for sanction as required by section 24 of the Ordinance.

Enquiries received since the Directions hearing

16. As at 30 November 2006, TOLIC had received 138 enquiries from policyholders concerning the proposed transfer.  Most had been dealt with apparently to the satisfaction of the policyholders.  But as will be seen below, some were not satisfied and did oppose the petition.

The petition hearings

17. The petition hearing first took place on 5 December 2006.  Mr John Scott, SC appeared for TOLIC and TLB.  Mr Johnny Chan, SGC appeared for HKIA and did not oppose the petition.  Mr Stephen Kwok Yan Kit, an insurance broker and agent of Alliance Brokers Limited, purported to appear on behalf of 9 policyholders.  Mr Sin Wing Sang, a policyholder appeared on his and his wife’s behalf.  Both Mr Kwok and Mr Sin opposed the petition.  After hearing the parties, I adjourned the matter to 11 December 2006.  At the resumed hearing, two more policyholders appeared.  They were Cheng Koon Wing and Mr Peter Luk Kin Yu.  They also opposed the petition.

The approach of the court

18. It is convenient to first set out the approach of the court in considering petitions of this kind.  In Re Winterthur Life [2005] 3 HKC 34, Kwan J had this to say at paragraph 17 at pp.41-42 :

“The approach of the court

17.  Section 24 of Cap. 41 is based on the former section 49 of the Insurance Companies Act 1982 in the United Kingdom. Although this provision has been amended, the amendments do not make any material difference as regards the function and approach of the court in the exercise of its power under this provision. The leading authority in this respect is the judgment of Hoffmann J (as he then was) in Re London Life Association Ltd., 21 February 1989, unreported. The principles to be derived from that judgment have been helpfully summarised by Evans-Lombe J in Re AXA Equity and Law Life Assurance Society plc [2001] 2 BCLC 447 at 468e to 469b:

‘[6]  It seems to me that the following principles emerge from the judgment of Hoffmann J which should govern the approach of the court to applications of this type.  I gratefully adopt those principles. They are:

(1)   The 1982 Act confers an absolute discretion on the court whether or not to sanction a scheme but this is a discretion which must be exercised by giving due recognition to the commercial judgment entrusted by the company's constitution to its directors.

(2)   The court is concerned whether a policyholder, employee or other interested person or any group of them will be adversely affected by the scheme.

(3)   This is primarily a matter of actuarial judgment involving a comparison of the security and reasonable expectations of policyholders without the scheme with what would be the result if the scheme were implemented. For the purpose of this comparison the 1982 Act assigns an important role to the independent actuary to whose report the court will give close attention.

(4)   The FSA [the Financial Services Authority; the Hong Kong equivalent is the Insurance Authority] by reason of its regulatory powers can also be expected to have the necessary material and expertise to express an informed opinion on whether policyholders are likely to be adversely affected. Again the court will pay close attention to any views expressed by the FSA.

(8)   It seems to me to follow from the above and in particular paras (2), (3) and (5) that the court, in arriving at its conclusion, should first determine what the contractual rights and reasonable expectations of policyholders were before the scheme was promulgated and then compare those with the likely result on the rights and expectations of policyholders if the scheme is put into effect.’”

19. With these principles in mind, I now turn to consider the petition and the grounds of objection.

The petition and the grounds of objection

20. Having regard to all the evidence before me, especially the evidence of the independent actuary, I am satisfied that the scheme is commercially justified and well intentioned.  The contractual rights and interests and reasonable expectations of the policyholders concerned are well protected and remain substantially the same after the transfer.  I also give due weight to the stance of HKIA which has made a fully informed decision of not opposing the petition.

21. On the other hand, I do not find the various grounds of objection raised by the opponents valid.  I will deal with them in turn below.

(1)     Comfort letters

22. Mr Kwok referred to a “comfort letter” in which, subject to certain conditions, TOLIC proposed to pay or contribute to or indemnify a policyholder in relation to the US withholding tax.  Some of the objecting policyholders he represented had received such a letter and others had not.  Mr Kwok alleged this was “discriminatory” and questioned why the independent actuary had not referred to these letters.

23. Contrary to Mr Kwok’s query, the independent actuary has in fact referred to these comfort letters expressly in his report at paragraphs 5.2.9 to 5.2.11.  They are also referred to in the scheme document.  The essential point noted by the independent actuary is that, without a scheme of transfer, different policyholders have different forms of letter and many policyholders have no letter of this kind.  This creates a confusing and unequal picture which is dependent on many variables and gives rise to potentially difficult points of construction.  The independent actuary is thus of the view that the implementation of the scheme would eliminate these complex problems and enable all non-US tax payers to be treated in the same way, thereby avoiding any suggestion that there has been any alleged discrimination.  I agree.

(2) Conversion

24. Mr Kwok next said that certain policies (term life policies) may not be subject to US withholding tax on distribution unless they were converted into other types of policies which would attract withholding tax.  This is accepted by Mr Scott.  Mr Scott went on to submit that as pointed out by the independent actuary, the US Inland Revenue practice in relation to the withholding tax on distribution does not apply to benefits payable to death.  However, the right of conversion is a valuable right enjoyed by 8,000 of the approximately 16,000 policyholders whose policies are to be transferred.  Just because Mr Kwok has indicated that the objecting policyholders who he claimed to represent may not be interested in a transfer at present, this does not mean this is a valid objection to apply to all term life policyholders.  If any term life policyholder exercised his or her rights to convert to permanent plans of insurance, then (without this scheme of transfer) the withholding tax would apply to any distribution and the detriment to such policyholder would be obvious.  Therefore the transfer safeguards the current and future financial interests of all these term life policyholders, who all have rights of conversion.  I agree.

(3) Guaranteed premium

25. The opponents asked why policyholders holding term policies should agree to have the policies transferred to TLB, where TLB does not guarantee premium renewal rates after 10 years.  However, as rightly pointed out by the independent actuary, it is not correct that these policyholders will lose their existing guaranteed premium renewal after 10 years.  Guaranteed premium renewal rates will still apply after transfer.  The opponents relied on clause 8.3(b)(i) of the scheme but any purported reliance is misplaced because the clause refers to premium rates which are not guaranteed.  As rightly concluded by the independent actuary, the term policyholders will not be materially affected as a result of the transfer.

(4) Section 13(6) Married Persons Status Ordinance, Cap. 182

26. Mr Sin referred to section 13(6) of the Married Persons Status Ordinance, Cap. 182 and argues that his wife’s interest is materially adversely affected.  Section 13 provides :

“(1) This section applies to a policy of assurance or endowment expressed to be for the benefit of, or by its express terms purporting to confer a benefit upon, the wife, husband or child of the insured.

(2)   The policy shall create a trust in favour of the objects therein named.

(3)   The moneys payable under the policy shall not, so long as any part of the trust remains unperformed, form part of the estate of the insured or be subject to his or her debts.

(4)   If it is proved that the policy was effected and the premiums paid with intent to defraud the creditors of the insured, they shall be entitled to receive, out of the moneys payable under the policy, a sum equal to the premiums so paid.

(5)   The insured may by the policy, or by any memorandum under his or her hand, appoint a trustee or trustees of the moneys payable under the policy, and from time to time appoint a new trustee or new trustees thereof, and may make provision for the appointment of a new trustee or new trustees thereof, and for the investment of the moneys payable under any such policy.

(6)   In default of any such appointment of a trustee, such policy, immediately on its being effected, shall vest in the insured and his or her legal personal representatives, in trust for the purposes aforesaid.

(7)   The receipt of a trustee or trustees duly appointed, or in default of any such appointment, or in default of notice to the insurer, the receipt of the legal personal representative of the insured, shall be a discharge to the insurer for the sum secured by the policy, or for the value thereof, in whole or in part.”

27. Mr Scott submitted that the scheme of transfer makes no changes at all to the vested rights of a policyholder.  The policyholder is not issued with a new policy.  Under Clause 17.1 of the scheme all existing rights are preserved in the following terms :

“Every person being a Transferred Policyholder shall on and from the Effective Date become entitled, to the exclusion of any rights which he may have had against TOLIC under or in respect of the Transferred Policies to the same right or rights against TLB as was or were available to him or in respect of such Policies against TOLIC.”

It follows that any vested trust arising out of the effect of this Ordinance remains unaltered by the scheme of transfer.  The transfer here is effected pursuant to section 24 of the Ordinance.  The beneficiary and policyholders’ rights remain unchanged.  I agree.

(5) The scheme forces non-US tax payers to transfer

28. The opponents complained that the scheme forces non-US tax payers to transfer.  There is no evidence before me that the treatment of transferring policyholders under TLB is worse than under TOLIC.  I am satisfied that no policyholders as a group would be materially adversely affected.

(6) TLB is in Bermuda and governed by Bermuda law

29. The opponents raised concerns about TLB being incorporated under the Bermuda law.  However, as rightly submitted by Mr Scott, Bermuda is a recognised international insurance centre and some of the largest insurers in Hong Kong operate via branches of Bermuda incorporated companies.  TLB will still be regulated in Hong Kong by the Insurance Authority and the terms and conditions of the policy once they have transferred to TLB will remain identical to the current terms and conditions.  The place of incorporation of TLB as transferee has no impact on the security, rights and expectation of policyholders.

(7) TLB is not sufficiently well developed

30. Mr Sin said that he feels uncomfortable with TLB as being the insurer.  He said the pledge to keep 165% of US risk-based capital and 150% Hong Kong solvency margin does not give him adequate assurance.  As to this, the independent actuary said it is not correct that all insurance companies in Hong Kong are required to keep a 150% solvency margin in their long term business fund.  It is also not true that the US requires all insurers to keep the bench mark of 165% risk-based capital.  Further, one must also bear in mind the overall protection given to the transferred policyholders including the Claims Payment Guarantee and the Tangible Net Worth Maintenance Agreement.  I am unable to accept Mr Sin’s concern.

(8)             TOLIC reserves the right to sell the portfolio

31. The opponents said that the independent actuary is silent on this point.  This is incorrect.  Section 6.5.2 of his report refers expressly to the possibility of a sale of TLB by TOLIC.  If a sale were made to a company that is less financially strong than TOLIC, the Tangible Net Worth Maintenance Agreement would still apply and TOLIC would continue to have to ensure that TLB is adequately capitalised.  In addition, the Claims Payment Guarantee would still apply.  I accept Mr Scott’s submission that these factors would protect policyholders of TLB even in the unlikely event of a sale of TLB by TOLIC, which is not in contemplation.

(9)             Other alleged rights

32. Mr Cheng referred to the right to bring a class action against TOLIC in the USA if necessary.  After the transfer, the right will be lost.  I do not think the alleged right to bring a class action is a contracted right under his policy or a reasonable expectation that the court should take into account.

33. Mr Kwok said that he might wish to use his TOLIC policy in connection with his affairs in the USA including applications for mortgage and green card.  There is no evidence that a TLB policy will not achieve the same result.  In any event, I do not think his intended use of the policy is a reasonable expectation that the court needs to take into account.

34. Finally, I would say this.  For one reason or another, the opponents may well have their own concerns as to whether their interests as policyholders may be adversely affected by the transfer.  But even if they, as individual policyholders, may be adversely affected, it does not mean that the scheme has to be rejected by the court.  The fundamental question is whether the scheme as a whole is fair as between the interests of the different classes of persons affected.  As I have said above, I am satisfied that it is the case here.

ADJOURNMENT

35. At the end of his submission on 11 December 2006, Mr Sin applied for an adjournment to seek legal advice.  I refused his application for two reasons.  Firstly, it was too late to apply for an adjournment.  Mr Sin ought to have sought legal advice much earlier.  Secondly and more importantly, as I have demonstrated above, the grounds of objection raised by Mr Sin were not valid.  It would be a waste of time to adjourn the matter any further.

Conclusion

36. For the above reasons, I sanction the scheme.