Report of the Independent Expert on the proposed transfer ... · 05 May 2015 Milliman Report Report of the Independent Expert on the proposed transfer of the Tower Pool business from

05 May 2015

Milliman Report

Report of the Independent Expert on the proposed transfer of the

Tower Pool business from Royal & Sun Alliance Insurance plc to

Knapton Insurance Limited

Prepared by:

Derek Newton

FIA

Milliman LLP

11 Old Jewry London, EC2R 8DU United Kingdom Tel +44 (0)20 7847 1500 Fax +44 (0)20 7847 1501 uk.milliman.com

Milliman Report

2 Report of the Independent Expert on the proposed transfer of the Tower Pool business from Royal & Sun Alliance Insurance plc to Knapton Insurance Limited 05 May 2015

TABLE OF CONTENTS

1. PURPOSE AND SCOPE 3

2. REGULATORY BACKGROUND 8

3. BACKGROUND ON THE ENTITIES CONCERNED IN THE SCHEME 13

4. THE PROPOSED SCHEME 21

5. GENERAL CONSIDERATIONS OF THE INDEPENDENT EXPERT 25

6. THE IMPACT OF THE SCHEMES ON THE TRANSFERRING POLICYHOLDERS OF RSAI 27

7. THE IMPACT OF THE SCHEME ON THE POLICYHOLDERS OF RSAI WHO WILL REMAIN IN PLACE AFTER THE

TRANSFER 37

8. THE IMPACT OF THE SCHEME ON THE CURRENT KNAPTON POLICYHOLDERS 38

9. OTHER CONSIDERATIONS 39

10. CONCLUSIONS 42

APPENDIX A DEFINITIONS 43

APPENDIX B CV FOR DEREK NEWTON 44

APPENDIX C TERMS OF REFERENCE 46

APPENDIX D KEY SOURCES OF DATA 48

APPENDIX E MINIMUM CAPITAL REQUIREMENT FOR GENERAL INSURANCE BUSINESS AS AT THE 2013 YEAR-

END 50

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1. PURPOSE AND SCOPE

Purpose of the Report

1.1 It is proposed that a particular block of business of Royal & Sun Alliance Insurance plc (“RSAI” or the “Transferor”) be

transferred to Knapton Insurance Limited (“Knapton” or the “Transferee”) by an insurance business transfer scheme

(“the Scheme”) as defined in Section 105 of the Financial Services and Markets Act 2000 (“FSMA”).

1.2 Section 109 of FSMA requires that an application to the High Court of Justice in England and Wales (“the Court”) for

an order sanctioning an insurance business transfer scheme must be accompanied by a report on the terms of the

transfer (“the FSMA Report”) by an independent person (“the Independent Expert”) having the skills necessary to make

the report and who is nominated or approved by the Prudential Regulation Authority (“PRA”), having consulted with the

Financial Conduct Authority (“FCA”). The FSMA Report is required in order that the Court may properly assess the

impact of the proposed transfer, including the effect on the policyholders of the insurance companies in question.

1.3 RSAI and Knapton have nominated me to act as Independent Expert to provide the FSMA Report in respect of the

Scheme, and the PRA has approved my appointment (see paragraph 1.11 below).

1.4 This report (“the Report”) describes the proposed transfer and discusses its possible effects on the policyholders of

Knapton and RSAI (in respect of all business of Knapton and RSAI), including effects on security and levels of service.

As such, the Report fulfils the requirements of the FSMA Report.

1.5 A list of terms defined in the Report is shown in Appendix A. Otherwise I use the same defined terms as are in the

Scheme. Unless otherwise specified, references in the Report to the insurance business / policyholders of RSAI and

Knapton are in respect of all general insurance and reinsurance business / policyholders of RSAI and Knapton.

The Proposed Scheme

1.6 The business to be transferred under the Scheme (“the Transferring Business”) is that business originally underwritten

by Phoenix Assurance plc (“Phoenix”) through its participation in the Tower Pool. As explained further below, this

business has since been transferred to RSAI and is currently 100% reinsured by Knapton. The Transferring Business

is in run-off and comprises a mixture of direct and reinsurance business of all classes, of which the remaining liabilities

are mainly in respect of US direct and reinsurance casualty business.

1.7 Phoenix was previously a subsidiary of RSAI and participated in the Tower Pool between 1967 and 1972. In 2004

Phoenix was acquired as part of the acquisition of the majority of the life insurance business of the RSA Group (which

is defined as the group of companies ultimately owned by RSA Insurance Group plc) by Resolution Life Group Limited.

Following the sale of Phoenix, RSAI reinsured all of Phoenix’s general insurance liabilities, including its share in the

Tower Pool. In 2005 Phoenix’s name was changed to Phoenix Assurance Limited, and then again to PA (GI) Limited

(“PA(GI)”) in 2006. In 2006 RSAI’s liabilities in respect of the Tower Pool via its reinsurance of Phoenix were 100%

reinsured by British Engine Insurance Limited (“BE”), a subsidiary of RSAI. In 2010, RSAI completed the sale of BE to

the Enstar Group, which immediately renamed BE as Knapton. In 2012 all of PA(GI)’s general insurance liabilities,

including its share in the Tower Pool, were transferred to RSAI by means of an insurance business transfer under

Section 105 of the FSMA.

1.8 The run-off of the Transferring Business, together with that of the other members of the Tower Pool, is currently handled

by Downlands Liability Management Limited (“Downlands”).

1.9 The Effective Date of the Scheme is expected to be 30 September 2015. The Scheme is intended to have the effect

that all the liabilities under the policies comprising the Transferring Business will pass under the Scheme to Knapton.

1.10 The business involved in the Scheme, the arrangements for the Scheme and the effect of the Scheme are discussed

in more detail in Sections 3 to 9 of the Report.

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The Independent Expert

1.11 I, Derek Newton, have been appointed by RSAI and Knapton as the Independent Expert to consider the Scheme under

Section 109 of FSMA. My appointment has been approved by the PRA; this was confirmed in a letter dated 27 June

2014.

1.12 I am a Principal of Milliman LLP (“Milliman”) and I am based in its UK General Insurance practice in London. I am a

Fellow of the Institute and Faculty of Actuaries which was established in 2010 by the merger of the Institute of Actuaries

and the Faculty of Actuaries. I became a Fellow of the Institute of Actuaries in 1988. My experience of general

insurance includes the (reserved) roles as the Signing Actuary to Lloyd’s syndicates and Irish non-life insurance

companies, as well as acting as the Independent Expert in an insurance business transfer scheme that was sanctioned

in 2014. I have included my Curriculum Vitae in Appendix B.

1.13 I do not have, and have never had, any policies issued by any part of RSA Insurance Group plc (“RSAIG”), of which

RSAI is a subsidiary, or Enstar Group Limited (“Enstar”), of which Knapton is a subsidiary. I am not a shareholder of

either RSAIG or Enstar. I have undertaken no work for Enstar or, save as noted below, for RSAIG. I note that Milliman

is part of Milliman, Inc., a global consulting firm and, as such, Milliman Inc. practices have worked with parts of RSAIG

and Enstar on assignments globally. The main assignments carried out for RSAIG worldwide over the last six years

were:

Gary Wells, another Principal of Milliman, acted as the Independent Expert for Project Condor which concerned

the transfers of the business of various UK-regulated subsidiaries of RSAIG to a smaller number of UK-regulated

subsidiaries of RSAIG. The transfers were approved by the Court on 12 December 2011.

Gary Wells was the Independent Expert for the transfer of business from PA(GI) Limited to RSAI and to Marine

Insurance Company Limited (a subsidiary of RSAIG). The transfers were approved by the Court on 12 December

2011.

Gary Wells was the Independent Actuary reporting on the proposed closure of the US Trust Fund of PA(GI) Limited.

His final report was dated 25 June 2012.

Gary Wells was the Independent Expert for Project Viking which concerned the transfer of the Irish branch business

of RSAI to EGI and was approved by the Court on 18 December 2008.

Gary Wells acted on two minor engagements as part of Project Eagle (during the second half of 2007).

Neil Cantle, another Principal of Milliman, was seconded to RSA during 2011 to act as the Interim Head of Group

Financial Risk. Other members of Milliman staff assisted him in that role from time-to-time. On one occasion I

provided assistance.

Milliman provides annual claim reserving and pension advice to the Global Aviation Pool of which the British

Aviation Insurance Company Limited ("BAIC") has some shares though none since 2001. BAIC is 57% owned by

RSAI.

1.14 I acted as peer reviewer to Gary Wells’ reports as Independent Expert/Actuary in the above assignments. Otherwise I

was not involved in the assignments.

1.15 A Milliman practice based in the USA carried out an assignment on behalf of Enstar in 2011. The fee income amounted

to less than 0.01% of Milliman’s global fee income for 2011. Otherwise, Milliman has not carried out any work for Enstar

for at least 6 years, although it is possible that it carried out some work for one or more companies that were, at the

time, independent of Enstar but which have since become subsidiaries of Enstar.

1.16 The overall fee income that Milliman Inc. has received from RSAIG and Enstar worldwide in any of the last 6 years

(2008 to year-to-date 2014) has not exceeded 0.4% of Milliman, Inc.’s corresponding annual global revenue.

1.17 I do not believe that the involvement of other consultants within Milliman, Inc. with RSAIG, Enstar or their subsidiaries

affects my ability to act independently in my assessment of the Scheme.

1.18 The Scheme is subject to sanction by the Court under Section 111 of FSMA.

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1.19 I understand that RSAI and Knapton will share the costs of my work as Independent Expert and Independent Actuary,

although RSAI will be responsible for payment of those fees.

The Scope of my Report

1.20 My terms of reference have been reviewed by the PRA and are set out in Appendix C.

1.21 I have considered the terms of the Scheme only and have not considered whether any other scheme might provide a

more efficient or effective outcome.

1.22 The Report describes the Scheme and the likely effects on policyholders of RSAI and Knapton, including effects on

security and levels of service.

1.23 The Report should be read in conjunction with the full terms of the Scheme.

1.24 My work has required an assessment of the liabilities of RSAI and Knapton for the purposes of describing the effect of

the Scheme. My review of the liabilities was based on the actuarial reserve assessments conducted by internal

actuaries of RSAI and Knapton. I have reviewed the methodology and assumptions used in their work and assessed

the key areas of uncertainty in relation to these liabilities. I have not attempted to review in detail the calculations

performed by the internal actuaries of RSAI or Knapton or to produce independent estimates of the liabilities.

1.25 In addition to the liabilities, I have assessed the appropriateness in nature and amount of any assets to be transferred

under the Scheme (which are essentially the outwards reinsurance contracts), and the capital position of RSAI and

Knapton pre and post Scheme. Again, I have not attempted to review in detail the calculations of the capital position

performed by RSAI or Knapton or to produce independently my own estimates.

1.26 As far as I am aware, there are no matters which I have not taken into account in undertaking my assessment of the

Scheme and in preparing the Report, but which nonetheless should be drawn to the attention of policyholders in their

consideration of the Scheme.

1.27 In reporting on the Scheme as the Independent Expert, I recognise that I owe a duty to the Court to assist the Court on

matters within my expertise. This duty overrides any obligation to RSAI and / or to Knapton. I confirm that I have

complied with this duty.

1.28 I am aware of the requirements regarding experts set out in Part 35 of the Civil Procedure Rules, Practice Direction 35

and the Protocol for Instruction of Experts to give Evidence in Civil Claims.

1.29 I confirm that I have made clear which facts and matters referred to in the Report are within my own knowledge and

which are not. Those that are within my own knowledge I confirm to be true. The opinions I have expressed represent

my true and complete professional opinions on the matters to which they refer.

1.30 Shortly before the date of the Court hearing at which an order sanctioning the Scheme will be sought, I will prepare a

supplementary report (“the Supplementary Report”) covering any relevant matters which might have arisen since the

date of the Report. It is intended that the Supplementary Report will be published on the website dedicated to the

Scheme at least one week before the date of the Court hearing.

The Structure of my Report

1.31 The remainder of the Report is set out as follows:

Section 2: I provide some background to the regulatory environment in which the companies involved in the

Scheme operate.

Section 3: I provide some background to RSAI and Knapton, the companies involved in the Scheme, and to

the Tower Pool.

Section 4: I summarise the key provisions of the Scheme.

Section 5: I describe the matters I need to consider as Independent Expert.

Section 6: I consider the likely impact of the Scheme on the transferring policyholders.

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Section 7: I consider the likely impact of the Scheme on the policyholders of RSAI who would remain within

RSAI after the transfer has taken place.

Section 8: I consider the likely impact of the Scheme on the current policyholders of Knapton.

Section 9: I cover more general issues relating to the Scheme and the management of RSAI and Knapton.

1.32 I summarise my conclusions in Section 10.

Reliances and Limitations

1.33 In carrying out my review and producing the Report I have relied, without detailed verification, upon the accuracy and

completeness of the data and information provided to me, in both written and oral form, by Knapton and RSAI. Reliance

has been placed upon, but not limited to, the information detailed in Appendix D. My opinions depend on the substantial

accuracy of this data, information and the underlying calculations. I am unaware of any issue that might cause me to

doubt the accuracy of the data and other information provided to me. All information that I have requested in relation

to my review has been provided.

1.34 The Report has been prepared for the purposes of the Scheme in accordance with Section 109 of FSMA. A copy of

the Report will be sent to the FCA and PRA, and will accompany the Scheme application to the Court.

1.35 The Report must be considered in its entirety as individual sections, if considered in isolation, may be misconstrued.

1.36 Neither the Report, nor any extract from it, may be published without me having provided my specific written consent,

save that copies of the Report may be made available for inspection by policyholders, and copies may be provided to

any person requesting the same in accordance with legal requirements. I also consent to the Report being made

available on the Scheme website.

1.37 No summary of the Report may be made without my express consent. I will provide a summary of the Report for

inclusion in a document that will be made available to policyholders of Knapton and RSAI under the Scheme (the

“Report Summary”).

1.38 The Report has been prepared within the context of the assessment of the terms of the Scheme, and must not be relied

upon for any other purpose. No liability will be accepted by Milliman, or me, for any application of the Report to a

purpose for which it was not intended or for the results of any misunderstanding by any user of any aspect of the Report.

In particular, no liability will be accepted by Milliman or me under the terms of the Contracts (Rights of Third Parties)

Act 1999.

1.39 Actuarial estimates are subject to uncertainty from various sources, including changes in claim reporting patterns, claim

settlement patterns, judicial decisions, legislation, economic and investment conditions. Therefore, it should be

expected that the actual emergence of claims, premiums, expenses and investment income will vary from any estimate.

Such variations in experience could have a significant effect on the results and conclusions of the Report. No warranty

is given by Milliman or me that the assumptions, results and conclusions on which the Report is based will be reflected

in actual future experience.

1.40 This review does not comprise an audit of the financial resources and liabilities of RSAI or Knapton.

1.41 The Report should not be construed as investment advice.

1.42 Nothing in the Report should be regarded as providing a legal opinion on the effectiveness of the Scheme.

1.43 In considering the background to RSAI and to the companies involved in the Scheme, and in considering the likely

impact of the Scheme, I have made extensive use of financial information as at 31 December 2013 as that is the most

recent date at which audited financial information is available. I have also taken into account updated financial

information (as shown in the management accounts of Knapton, as well as details of reserve movements in RSAI)

which has been made available to me, although I note that this updated information has not been audited. At the date

of the Report, I am not aware of any material changes in circumstances since 31 December 2013 other than those

referred to in the Report. The Report also takes no account of any information that I have not received, or of any

inaccuracies in the information provided to me. I will review the audited financial statements as at 31 December 2014

of RSAI and Knapton when available, and will comment on this information in my Supplementary Report.

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1.44 The use of Milliman’s name, trademarks or service marks, or reference to Milliman directly or indirectly in any media

release, public announcement or public disclosure, including in any promotional or marketing materials, websites or

business presentations, is not authorised without Milliman’s prior written consent for each such use or release, which

consent shall be given in Milliman’s sole discretion.

1.45 The Report should not be used or relied upon for any purpose other than as the expression of my opinion on the impact

of the Scheme in accordance with Section 109 of FSMA. I hereby expressly disclaim any liability to any party who

relies or purports to rely on the Report for any other purpose whatsoever.

Professional and Regulatory Guidance

1.46 I am required to comply with relevant professional standards and guidance issued by the Board for Actuarial Standards

(subsequently adopted by the Financial Reporting Council) and the Institute and Faculty of Actuaries, including

Transformations Technical Actuarial Standard (as published in December 2010), Insurance Technical Actuarial

Standard (as published in October 2010), Technical Actuarial Standard D: data (as published in November 2009),

Technical Actuarial Standard M: modelling (as published in April 2010) and Technical Actuarial Standard R: reporting

actuarial information (as published in November 2009). I have complied with such standards, subject to the principles

of proportionality and materiality.

1.47 The Report has been prepared under the terms of the guidance set out in the Statement of Policy entitled The Prudential

Regulation Authority’s approach to insurance business transfers (“the Policy Statement”), issued in April 2015, and in

Section 18 of the FCA Supervision Manual (“SUP18”) contained in the Handbook of Rules and Guidance to cover

scheme reports on the transfer of insurance business.

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2. REGULATORY BACKGROUND

Introduction

2.1 UK insurers, as well as other financial services organisations, are regulated by both the PRA and the FCA using a

system of dual regulation. Between them, the PRA and the FCA have approximately 3,500 employees and an annual

budget of over £600 million. The PRA and the FCA are statutory bodies set up under FSMA 2000 and the Financial

Services Act 2012 ("FinSA") and whose roles and objectives are defined by FSMA 2000 (as amended).

2.2 The PRA is part of the Bank of England and is responsible for:

Prudential regulation of banks, building societies and credit unions, insurers and major investment firms;

Promoting the safety and soundness of the firms it regulates, seeking to minimise the adverse effects that they can

have on the stability of the UK financial system; and

Contributing to ensuring that insurance policyholders are appropriately protected.

2.3 The FCA is a separate institution and is responsible for:

Ensuring that its regulated markets function well;

Conduct regulation of all financial firms; and

Prudential regulation of those financial services firms that are not supervised by the PRA.

2.4 A Memorandum of Understanding ("MoU") has been established between the PRA and the FCA, which sets out the

high level framework by which the two new regulatory bodies will co-ordinate. In particular, the MoU requires the PRA

and FCA to co-ordinate with each other in advance of insurance business transfers under Part VII of FSMA.

2.5 The PRA sets the regulations governing the amount and quality of solvency capital held by firms; these are summarised

below. The solvency regime is designed to protect the security of policyholders, as well as the stability of the insurance

industry.

2.6 The FCA is concerned with achieving fair outcomes for consumers and seeks to ensure that firms adhere to its conduct

principles. Its strategic objective is ensure that the relevant markets function well. To support this, it has three

operational objectives, which are:

To secure an appropriate degree of protection for consumers;

To protect and enhance the integrity of the UK financial system; and

To promote effective competition in the interests of consumers.

2.7 For the purposes of the Report where I refer to the "Regulator" this should be taken to refer to the FCA and/or the PRA

(or their predecessor body, the Financial Services Authority (“FSA”)) as appropriate.

Taxation

2.8 In the UK, general insurance companies are taxed on profits achieved at the main rate of corporation tax (currently

20.25%1 for the calendar year ending 31 December 2015).

_______________________________________________________________________________

1 The UK Corporation Tax rate is expected to reduce to 20% from 2016 onwards.

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Financial Services Compensation Scheme

2.9 As well as through the PRA and FCA regulations, consumer protection is also provided by the Financial Services

Compensation Scheme (“FSCS”). This is a statutory “fund of last resort” which compensates customers in the event

of the insolvency (or other defined default) of a financial services firm authorised by the PRA or FCA. Insurance

protection exists for private policyholders and small businesses (those with annual turnover less than £1,000,000) in

the situation when an insurer is unable to meet fully its liabilities. For general insurance business, the FSCS will pay

100% of any claim incurred before the wind-up under compulsory insurance (such as motor third party liability cover)

and 90% of the claim incurred before the wind-up for non-compulsory insurance (such as home insurance, or the non-

compulsory parts of motor insurance), without any maximum. The FSCS is funded by levies on firms authorised by the

PRA.

Financial Ombudsman Service

2.10 The Financial Ombudsman Service (“FOS”) provides private individuals (and micro enterprises2) with a free,

independent service for resolving disputes with financial companies. It is not necessary for the private individual (or

micro enterprise) to live or be based in the UK for a complaint regarding an insurance policy to be dealt with by the

FOS; it is necessary for the insurance policy concerned to be, or have been, administered from within the UK.

Risk-Based Capital Framework

2.11 At the end of 2004 the FSA introduced a risk-based capital framework (known as the ICAS framework) under which

companies are required to assess solvency under two regimes, referred to as Pillar I and Pillar II. This framework is

now supervised by the PRA.

PILLAR I

2.12 Under ICAS Pillar I, each insurer has both to meet statutory requirements based on EU Directives and to provide a

more risk-based enhanced capital requirement (“ECR”) calculation to the PRA. This includes setting up Technical

Provisions in accordance with those Directives and having sufficient available capital to meet at least the Minimum

Capital Requirement (“MCR”). Composites calculate separate ECRs and MCRs for their long-term and general

insurance businesses; those relating to general insurance business can only be met by assets outside of the long-term

funds, although capital resources arising outside the long-term funds may be allocated towards long-term business.

2.13 Details of the calculation of the MCR as it relates to general insurance are given in Appendix E but essentially it

comprises the greater of a premium measure, a claims measure, a prior year MCR measure, and a minimum amount,

currently set at €3.7 million. The ECR is the sum of an asset charge, a premium charge and a charge for technical

provisions less the claims equalisation reserve (“CER”). Insurers are not required to make publicly available their ECR

calculation and supporting documentation insofar as it relates to non-life insurance. For long-term insurance business,

insurers are required to show the ECR on Form 2 of their returns to the PRA.

2.14 The Technical Provisions required under the EU Directives as relating to general insurance business are:

The unearned premium provision (“UPR”) – the UPR is the amount set aside from premiums written before the

valuation date to cover risks incurred after that date;

The additional amount for unexpired risk (“URR”) – the URR is the amount held in excess of the UPR, to allow for

any expectation as at the valuation date that the UPR will prove to be insufficient to cover the cost of claims and

expenses incurred during the period of unexpired risk; and

_______________________________________________________________________________

2 Micro-enterprises (an EU term covering smaller businesses) can bring complaints to FOS as long as they have an annual turnover of less than €2k and fewer

than ten employees.

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The claims outstanding provision – the reserve set up in respect of the liability for all outstanding claims at the

valuation date, whether reported or not.

2.15 The UPR is typically calculated on a daily basis (but alternative methods may be acceptable where the daily basis is

not appropriate) and makes no allowance for the time value of money (i.e. discounting).

2.16 The claims outstanding provision typically comprises the case reserves plus the amount, if any, for claims incurred but

not reported (“IBNR”) at the valuation date. Case reserves are the amounts estimated on a case-by-case basis as

being required to settle reported (open) claims. The IBNR reserve is the amount estimated as being required to provide

for:

claims still to be reported to the insurer as at the valuation date which related to claim events that have occurred

before that date; and

any perceived shortfall between the projected ultimate costs and the case estimates for claims already notified,

although occasionally this provision is shown separately where it is often referred to as an “incurred but not enough

reported” (“IBNER”) reserve.

The IBNR (and IBNER) reserves would typically be evaluated using statistical techniques based on grouped data.

2.17 Under UK regulatory practices, only in particular limited circumstances may the claims outstanding provision estimate

include any allowance for the time value of money (i.e. discounting). Therefore, all other things being equal, a margin

exists in the provision to cover (at least in part) unexpectedly adverse claims development.

PILLAR II

2.18 The capital that must be held under ICAS Pillar II is an amount based upon the Individual Capital Assessment (“ICA”),

which is the company’s own assessment of its capital requirements. Pillar II is intended to provide a more realistic and

complete view (than is provided by the MCR under Pillar I) of the risks to which the company is exposed, and to provide

a framework within which the company should be managed. The separate management of the long-term and general

insurance businesses within composites necessitates these entities to prepare separate ICAs for the two business

types.

2.19 The PRA requires each insurer, when preparing its ICA, to identify the major risks it faces and, where capital is

appropriate to mitigate those risks, to quantify how much (and what type) of capital is appropriate. The PRA expects

each insurer to conduct stress tests and scenario analyses in respect of each risk. The capital requirements so

determined are then aggregated, allowing for diversification between risks where appropriate. These stress tests and

scenario analyses, together with the supporting analysis, must be documented and, along with the results, submitted

to the PRA (on request) as the ICA. The insurer is not required to publish its Pillar II capital requirement.

2.20 The PRA will review the ICA periodically and may prescribe an additional amount of capital that must be held by the

insurer in addition to the ICA. The total amount of Pillar II capital prescribed by the PRA is called Individual Capital

Guidance (“ICG”). The ICG is usually set as a percentage of the ECR, gross of CER. The ICG is not published and

details of this remain private between the insurer and the PRA.

2.21 For the ICA, an insurer will assess the amount of capital it needs to hold to remain able to meet its liabilities as they fall

due in all but extreme circumstances. The PRA has indicated that ICG will be given taking into consideration capital

resources consistent with a 99.5% confidence level that the insurer will be able to meet its liabilities over a one-year

timeframe or, if appropriate to the insurer’s business, an equivalent lower confidence level over a longer timeframe.

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FCA Conduct Principles

2.22 Within its “Journey to the FCA” document, the FCA notes that it expects firms to continue to demonstrate that they are

achieving the six consumer outcomes set out in an earlier document, published in July 2006 under the auspices of the

FSA and entitled “Treating customers fairly – towards fair outcomes for consumers” (“TCF”). The aim of this document

was to develop Principle 6 of the FSA’s Principles for Businesses (PRIN 2.1.1) which stated that each insurer “must

pay due regard to the interests of its customers and treat them fairly”. Principle 7 outlines that each insurer “must pay

due regard to the information needs of its clients, and communicate information to them in a way which is clear, fair and

not misleading” while Principle 8 states that each insurer “must manage conflicts of interest fairly, both between itself

and its customers and between a customer and another client”.

2.23 The TCF document lists six outcomes that collectively outline insurers’ regulatory obligations for the fair treatment of

customers. These are as follows:

Outcome 1: Consumers can be confident that they are dealing with insurers where the fair treatment of customers

is central to the corporate culture;

Outcome 2: Products and services marketed and sold in the retail market are designed to meet the needs of

identified consumer groups and are targeted accordingly;

Outcome 3: Consumers are provided with clear information and are kept appropriately informed before, during and

after the point of sale;

Outcome 4: Where consumers receive advice, the advice is suitable and takes account of their circumstances;

Outcome 5: Consumers are provided with products that perform as insurers have led them to expect, and the

associated service is both of an acceptable standard and as they have been led to expect; and

Outcome 6: Consumers do not face unreasonable post-sale barriers imposed by insurers to change product, switch

provider, submit a claim or make a complaint.

The Insurers (Reorganisation and Winding Up) Regulations 2004

2.24 Under UK law, the winding-up of an insurance undertaking is governed by the Insurers (Reorganisation and Winding

Up) Regulations 2004. Under these regulations, insurance claims have precedence over any claim on the insurance

undertaking with the exception of certain preferential claims (e.g. claims by employees, etc.) with respect to the whole

of the insurance undertaking’s assets. Therefore, direct policyholders rank equally and above inwards reinsurance

policyholders and all other unsecured/non preferential creditors in the event that an insurer is wound up.

Solvency II

2.25 The regulatory solvency reporting requirements for insurers and reinsurers regulated within the EU are due to undergo

a major overhaul as they will need to meet the requirements of a new solvency regime that are currently being finalised

by the European Commission. This new regime is commonly referred to as Solvency II and aims to introduce,

consistently across the EU, solvency requirements that reflect better than the existing solvency regimes the risks that

insurers and reinsurers actually face. UK insurers and reinsurers will be required to adhere to the new capital

requirements. There are similarities between the existing ICAS regime and the proposed Solvency II regime, but there

are also significant differences. For example, in contrast to the position under the current UK Pillar II requirements,

some of the results under Solvency II will be public. The formal date for implementation of these new rules is 1 January

2016, although there will be a tapering period during which insurers need not meet all of the minimum solvency capital

requirements.

2.26 Like the ICAS regime, Solvency II has been formulated using the image of pillars supporting the overall regime.

Solvency II will be based on three pillars:

Under Pillar I, quantitative requirements define a market-consistent framework for valuing the assets and liabilities

of insurers;

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Under Pillar II, insurers must meet minimum standards for their corporate governance, and also for their risk and

capital management. There is a requirement for permanent internal audit and actuarial functions. Insurers must

each regularly complete an Own Risk and Solvency Assessment (“ORSA”);

Under Pillar III, there are explicit requirements governing disclosures to supervisors and policyholders.

These pillars are different from those supporting the ICAS regime.

2.27 The Solvency Capital Requirement (“SCR”) under Solvency II is the amount of capital required to ensure continued

solvency over a 1 year timeframe with a probability of 99.5%. The SCR is calculated based on the particular risks to

which the insurer in question is exposed.

2.28 The Solvency II Minimum Capital Requirement (“MCR2”), which will be lower than the SCR, defines the trigger point for

intensive regulatory intervention. The MCR2 calculation is more formulaic and less risk sensitive than the SCR

calculation.

2.29 RSAI and Knapton have prepared some illustrative calculations to assess the likely impact of the new regime, based

on the final draft of the Solvency II rules. I have discussed, at a high level, the likely impact of the Scheme on a Solvency

II basis with the senior management of RSAI and of Knapton. Through these discussions, consideration has been

given to the likely change in financial strength under Solvency II as a result of the Scheme.

The Financial Information in the Report

2.30 The statutory balance sheet items as at 31 December 2013 are shown in Section 4. These have been published,

externally audited and approved by the respective Boards of Knapton and RSAI.

2.31 As stated above, ICAS Pillar II financial information is not published and remains private between the PRA and the

company. I have therefore reviewed this information and have commented on it in general terms, but I have not included

any ICAS Pillar II figures in the Report.

Milliman Report


3. BACKGROUND ON THE ENTITIES CONCERNED IN THE SCHEME

RSAI

BACKGROUND

3.1 RSAI is an insurance company, registered as a public limited company in England and Wales (registered number

93792) under the Companies Act 2006. It is an indirectly wholly owned subsidiary of RSAIG, which itself is registered

as a public limited company in England and Wales (registered number 2339826) under the Companies Act 2006.

RSAIG is the ultimate holding company of a multinational insurance group currently operating in 33 countries and

covering risks in over 130 countries, with the vast majority of the business being written in the UK, Scandinavia and

Canada.

3.2 RSAI is the largest insurance operation in RSAIG. It is jointly regulated by the PRA and the FCA, and is authorised to

write general insurance and reinsurance business. The active business of RSAI is written largely in the UK, but also in

Belgium, France, Germany, Hong Kong, Italy, the Netherlands, Singapore and Spain.

3.3 RSAI’s issued and fully paid share capital as at 31 December 2013 was made up of 4,511,091,326 ordinary class A

shares of 25p each and 1 ordinary class B share of US$1.

3.4 The main elements of RSAI’s business are:

3.4.1 Personal lines:

o Direct to customer via the MORE TH>N brand (including MORE TH>N Business, RSAI’s direct

commercial offering);

o Affinity schemes (e.g. Tesco Pet) where the customer relationship is "controlled" by the affinity partner;

o Broker business, primarily via brand broker panels (e.g. AA, Kwik Fit) where the customer relationship is

"owned" by the broker.

3.4.2 Commercial lines, offering traditional property/liability/motor insurance via three routes to market:

o Small Medium Enterprises via smaller brokers;

o Mid-market for larger enterprises via larger brokers; and

o Global which includes the Risk Solutions business for multi-national clients, written from the UK, Greece

and Spain placed via global brokers, the Marine portfolio which is written on an international basis via

brokers and Construction, Power & Engineering.

Commercial lines also participate in Delegated Authority arrangements where policy administration and claims

handling are delegated with reporting on a bordereau basis.

3.5 RSAI has approximately 4.1 million policyholders, and the level of data it holds on them varies by nature of the customer

relationship.

3.6 The main elements of the business are as follows (percentages in brackets are the proportions of total gross premiums

written in 2013 which total £4,222 million3):

Personal Lines Motor (11%);

Personal Lines Household (18%);

_______________________________________________________________________________

3 Based on Column 1 of Form 20A of RSAI’s Returns to the PRA as at 31 December 2013. It should be noted that the PRA returns includes figures relating to

UK subsidiaries of RSAI on a “look-through” basis

Milliman Report


Personal Lines Financial Loss (7%);

Commercial Lines Motor (16%);

Commercial Lines Property (21%);

Commercial Lines Liability (10%);

Marine (5%);

Goods-in-Transit (5%)

Accident & Health (1%); and

Inwards Treaty Reinsurance (6%).

KEY FINANCIAL INFORMATION

3.7 As at 31 December 2013 the gross outstanding claim reserves within RSAI were £5,431 million4, comprising:

Personal Lines Motor (13%);

Personal Lines Household (4%);

Commercial Lines Motor (13%);

Commercial Lines Property (12%);

Commercial Lines Liability (42%);

Marine (5%);

Goods-in-Transit (3%);

Inwards Treaty Reinsurance (5%); and

Other classes combined (3%).

In addition, RSAI held a gross provision for unearned premiums of £2,395 million5 and £80 million6 in respect of

unallocated future claims management expenses. Reinsurers’ share of claims outstanding was £1,046 million7 and

reinsurers’ share of unearned premiums was £255 million8.

3.8 I have been informed by RSAI that a provision of £6.7 million was included within its gross provisions for outstanding

claims as at 31 December 2013 for the Transferring Business. The Transferring Business therefore represented just

0.1% of RSAI’s total gross outstanding claims reserves as at 31 December 2013. As the Transferring Business is 100%

reinsured into Knapton, £6.7 million of RSAI’s total reinsurers’ share of outstanding claims (or 0.7%) was in respect of

the Transferring Business.

_______________________________________________________________________________

4 Based on Form 20A, line 1, columns 2 & 3, of RSAI’s Returns to the PRA as at 31 December 2013

5 Based on Form 20A, line 1, column 4, of RSAI’s Returns to the PRA as at 31 December 2013

6 Based on Form 22, lines 14 and 18, column 3, of RSAI’s Returns to the PRA as at 31 December 2013

7 Based on Form 13, Line 61 of RSAI’s Returns to the PRA as at 31 December 2013


Milliman Report


3.9 As at 31 December 2013, the capital resources of RSAI amounted to £2,041 million9, compared with a statutory MCR

for the business of £1,624 million10, i.e. the capital resources in excess of regulatory requirements as at 31 December

2013 were £416 million. This implied cover for the MCR (assets available to meet the MCR divided by the MCR) of

126% as at 31 December 2013.

3.10 I note that, other than as mentioned in paragraph 1.43 above, I have seen no financial information relating to RSAI that

has been updated since 31 December 2013.

3.11 Effective 28 February 2014, RSAI is rated ‘A’ (stable outlook) by Standard & Poor’s and A2 (negative outlook) by

Moody’s11.

REINSURANCE

3.12 RSAI has a comprehensive series of reinsurance programmes in place, including excess, stop loss and catastrophe

coverage. The intended effect of such reinsurance arrangements, when the other reinsurance arrangements within the

RSA Group are taken into account, is that the RSA Group should not suffer total net insurance losses beyond the RSA

Group’s risk appetite in any one year.

3.13 Reinsurance programmes cover each of RSAI’s and the RSA Group’s main business areas including UK and

international property (including catastrophe cover), construction and engineering, professional indemnity and Directors

& Officers, surety, marine, motor, casualty and personal accident.

3.14 The RSA Group purchases significant catastrophe cover, with all the RSA Group’s operations required to purchase

reinsurance within agreed local reinsurance appetite parameters. The RSA Group reviews the operations’ proposed

catastrophe purchases to check that they at least meet the RSA Group’s ‘1 in 200 year’ standard and are also consistent

with the required risk based capital. As a result, the RSA Group may decide to purchase further catastrophe coverage

at the RSA Group level. All catastrophe reinsurance is placed with reinsurers with a Standard & Poor’s credit rating of

A- or better.

3.15 The RSA Group has a number of external reinsurers providing the reinsurance protections described above. For the

financial year ended 31 December 2013, their share of gross written premiums was £701 million12 (or 17%). As at

31 December 2013, the major external reinsurers were Lloyd’s syndicates, Berkshire Hathaway, Munich Re, Swiss Re,

Pool Re, Hannover Re, HDI-Gerling and MO Reinsurance.

3.16 RSAI’s reinsurance programmes include the 100% reinsurance by Knapton of the Transferring Business.

RISKS

3.17 RSAI is exposed to a large number of risks in the course of its operations. The key risks may be classified under the

headings of insurance, market, credit, liquidity, operational, group and pension scheme risk.

3.18 The key drivers of insurance risk are inappropriate pricing methodologies leading to inadequate premiums; deterioration

of reserves; catastrophes (e.g. earthquakes); counterparty risk within the RSA Group; and the risk of increased

expenses.

3.19 Market risk arises from the RSA Group’s investment portfolios, and largely comprises changes in interest rates and a

fall in the market value of equities and properties. A decrease in the value of the assets backing the insurance contracts

could adversely affect the financial position of RSAI to the extent that a movement (in particular, a fall) in asset values

is not matched by a corresponding movement in liability values.

_______________________________________________________________________________



11 http://www.rsagroup.com/rsagroup/en/investor-relations/bond-investor-information/credit-ratings#.U_X63010y7w

12 As per RSAI’s statutory accounts for the year ended 31 December 2013

Milliman Report


3.20 Within credit risk, the pertinent risks consist of the risk of default on corporate bonds, asset backed securities, residential

and commercial mortgages, and reinsurance contracts.

3.21 Liquidity risk is the risk of RSAI being unable to:

Meet its cash outflows without recourse to contingent funding;

Implement its contingent funding plan due to excessive costs; or

Meet its cash outflows as they fall due despite having sufficiently deep and liquid resources or contingent funding.

3.22 Operational risks are the risks to which RSAI is exposed to during its day-to-day operations, mainly arising from possible

failures of control and external events.

3.23 RSAI is exposed to risks from other parts of the RSA Group. Group risk could, for example, arise from reputational

issues resulting in lower than anticipated new business volumes.

3.24 The funding position of the RSAI pension scheme(s) is sensitive to the assumptions made from time to time (including

inflation, interest rate, investment return and mortality) to determine its long-term liabilities relative to the corresponding

market value of the pension fund’s assets. In particular, the financial position of the RSAI pension fund is highly

sensitive to changes in bond yields and will also be impacted by changes in equity markets.

3.25 There are a range of actions that RSAI management can take and has taken to mitigate the risks facing the business.

For example, the RSA Group (including RSAI) uses techniques which include asset liability management strategies,

monitoring the financial strength of its reinsurers (including those to whom risks are no longer ceded), and review by

external consultants of the RSA Group’s (and hence RSAI’s) exposure to long-tail claims such as those arising from

asbestos.

CONDUCT RISK – TCF

3.26 In the UK, RSAI has set up a TCF Framework in order to ensure that fair outcomes are delivered to customers. The

key components of this framework are culture, governance, management information, customer dedication

assessments and assurances.

3.27 Staff in the UK must complete mandatory TCF training, with managers being provided with guidance on applying the

principles of TCF. Staff surveys are carried out to measure the success with which key TCF messages are being

received by staff. Staff rewards are partly based on the performance against TCF objectives.

3.28 There are processes in place to ensure that the fair treatment of customers is achieved, including regular monitoring

and rectification of any shortcomings that are identified.

3.29 The Board has overall responsibility for ensuring that TCF objectives are met. A governance structure has been

implemented to enable the objectives to be met and to embed TCF throughout the RSA Group.

EUROZONE EXPOSURES

3.30 The RSA Group's investment portfolio contains sovereign debt holdings issued by some Eurozone countries and it also

invests in certificate of deposits (“CDs”) issued by various banks including those issued by certain European banks.

Peripheral European sovereign debt13 amounts to less than 1% of the RSA Group’s portfolio and is primarily backing

the liabilities of its insurance operations in Ireland and Italy.

_______________________________________________________________________________

13 Peripheral Eurozone countries being Portugal, Ireland, Italy, Greece and Spain.

Milliman Report


Knapton

BACKGROUND

3.31 Knapton is an insurance company, registered as a private limited company in England and Wales (registered number

14644) under the Companies Act 2006. Its immediate parent company is Knapton Holdings Limited, a company

registered in England and Wales, and it is ultimately owned by Enstar Group Limited, a company domiciled in Bermuda.

It is authorised to carry out general insurance and reinsurance business. Knapton is in run-off, having voluntarily ceased

to underwrite new business in 2002.

3.32 Knapton was acquired from RSAI in 2010 at which time it was known as British Engine Insurance Limited (“BE”). BE

had primarily been a writer of engineering-related risks. It wrote its last direct policy in 1995. In 2006 the liabilities of

several other RSAI subsidiaries were transferred into BE by means of insurance business transfers under Section 105

of the FSMA. The Tower Pool liabilities that RSAI had assumed from Phoenix were also retroceded to BE in 2006.

3.33 The Enstar Group actively seeks to acquire run-off portfolios and may use Knapton as a vehicle to accept further such

portfolios in the future. It has just completed the transfer into Knapton from the Allianz Group of an additional portfolio

of business. I discuss this in more detail below.

KEY FINANCIAL INFORMATION

3.34 As at 31 December 2013 Knapton held gross claims reserves of £60.5 million, with reinsurers’ share of these reserves

booked at £9.4 million. Therefore, Knapton held net claims reserves as at 31 December 2013 of £51.2 million14. These

reserves were undiscounted. Knapton did not hold any reserve for unearned premiums or any equalisation provision.

Knapton held no reserve for unallocated loss adjustment expenses on the basis that such expenses will be paid for out

of future investment income. I note that Knapton’s investment income in the two years 2012-2013 totalled £7.4 million,

whereas the operating expenses, of which the unallocated loss adjustment expenses would only be a part, totalled £5.0

million15.

3.35 The main components of Knapton’s claim portfolio are listed below together with their respective contributions to

Knapton’s gross claims reserves as at 31 December 2013 (as per an external actuarial analysis of the portfolio on which

the held reserves are based):-

Casualty (17%)

Engineering (35%)

International Construction and Engineering (5%)

Financial Products (10%)

Tower Pool (7%)

Asbestos, Pollution and Health Hazard (“APH”) (11%)

Marine, Aviation and Transportation (“MAT”) (4%)

Property (11%)

_______________________________________________________________________________

14 Figures taken from Knapton’s Annual Report and Financial Statements for the year ended 31 December 2013

15 Figures taken from the Annual Report and Financial Statements of Knapton for the year ended 31 December 2013

Milliman Report


3.36 It should be noted that, while APH claims form a significant part of the Tower Pool liabilities (80% of the reserves as at

30 September 2013, as explained in paragraph 3.54 below), the “APH” segment shown above refers to APH claims

occurring outside of the Tower Pool. Were Tower Pool to be split in paragraph 3.35 between its component elements

then APH would comprise 17% of the gross claims reserves as at 31 December 2013.

3.37 As at 31 December 2013, the total capital resources of Knapton available to meet its regulatory capital requirements

amounted to £51.8 million16, compared with a statutory minimum capital requirement of £3.1 million17, i.e. the assets in

excess of regulatory requirements as at 31 December 2013 were £48.6 million. This implied cover for the MCR (assets

available to meet the MCR divided by the MCR) of 1,645% as at 31 December 2013.

ALLIANZ MARINE XL PORTFOLIO TRANSFER

3.38 As noted in paragraph 3.33 above, a portfolio of marine excess of loss business underwritten by the Allianz Group (the

“Allianz Marine XL Portfolio”) was recently transferred into Knapton by means of an insurance business transfer under

German law (the “Allianz Transfer”). The Allianz Marine XL Portfolio is a portfolio of marine excess of loss assumed

reinsurance contracts written by Allianz Global Corporate & Specialty SE UK branch (“AGCS”) (90%) and Allianz SE

(10%) between 2003 and 2005. AGCS also 100% reinsures Allianz SE’s 10% share. The portfolio comprises 1,928

contracts covering 189 cedants. The cedants are spread worldwide but the UK (56) and USA (31) have by far the

largest numbers per country (Bermuda has the third largest number at 10). Hurricanes Katrina and Rita account for

much of the claims activity to date. I am informed by the Enstar Group that gross reserves for the portfolio are of the

order of US$20m and that there is no remaining external reinsurance.

3.39 I have been told by Knapton that a business transfer deed was entered into by the Allianz Group and the Enstar Group

on 2 February 2010. At the same time, Fitzwilliam Insurance Limited (“Fitzwilliam”), acting in respect of its Segregated

Account Number 17, entered into a 100% quota share arrangement in respect of AGCS’s liability for the Allianz Marine

XL Portfolio. The 100% quota share has a limit equivalent to 120% of the premium paid. Fitzwilliam is a Class 3

Bermuda segregated account reinsurance company, which is a wholly owned indirect subsidiary of Enstar Group

Limited. The 100% quota share arrangement novated in favour of Knapton on completion of the Allianz Transfer.

Therefore, on a net basis, Knapton’s claims reserve has not increased as a result of the Allianz Transfer. Knapton has,

however, assumed additional credit risk relating to the reinsurance arrangement with Fitzwilliam, and is now also

exposed to the risk of losses on the business ultimately exceeding the limit of the Fitzwilliam reinsurance.

REINSURANCE

3.40 As at 31 December 2013 Knapton booked reinsurers’ share of outstanding claims of £9.4 million. I have been informed

that, during the course of 2014, more than half (by value) of the reinsurance asset has been commuted.

EUROZONE EXPOSURES

3.41 Knapton has identified the market value of its exposure to assets held in peripheral Eurozone countries as being

approximately $1 million as at 30 June 2014 (out of a total investment portfolio valued at $160 million as at that date).

These investments, held through UCITS funds, were in Spanish and Italian utility and telecommunication companies.

I am informed that Knapton has no exposure to sovereign debt in peripheral Eurozone countries.

RISKS

3.42 Knapton has identified the principal risks and uncertainties it faces and its approach to managing these risks as

follows18:

_______________________________________________________________________________

16 Based on Form 1, Line 13 of Knapton’s Returns to the PRA as at 31 December 2013

17 Based on Form 1, Line 36 of Knapton’s Returns to the PRA as at 31 December 2013

18 These are set out in Knapton’s Annual Report and Financial Statements for the year-ended 31 December 2013

Milliman Report


Strategic risk: the risk associated with being unable to implement business plans and strategies. The experience

of the management team supported by a robust risk management framework is intended to allow Knapton to

manage the run-off of the business while mitigating the impact and likelihood of associated risks.

Reserving risk: the risk that the reserves set at the start of the projection period prove to be inadequate. To help

manage this risk, Knapton uses independent, external actuaries to estimate incurred but not reported (“IBNR”)

reserves.

Claims management and commutation risk: Knapton has implemented claims handling guidelines along with

reporting and control procedures to ensure claims are handled effectively and in accordance with regulatory

requirements. These guidelines are reviewed regularly with material claims matters referred to and authorised by

management before action taken. When appropriate, Knapton negotiates with insureds to buy back policies and

with cedants to commute inwards reinsurance contracts. Such settlements, when entered into on favourable terms,

will remove the risks associated with the liabilities. Knapton says it follows a disciplined approach to commutation

and policy buyback process to minimise risk and increase the probability of a positive outcome.

Liquidity risk: this is the risk of insufficient liquid assets being accessible when needed to pay claims as they fall

due. Knapton mitigates this risk through a conservative investment policy.

Credit risk: the risk that a counterparty (e.g. a reinsurer) fails to make promised payments either wholly or partly.

Knapton places limits on its exposures to single counterparties or groups of counterparties and holds provisions

against bad or doubtful debts.

Foreign currency risk: Knapton is exposed to movements in foreign exchange rates. It does not hedge its foreign

currency risk but broadly matches its liabilities with assets by currency. This matching is done quarterly in arrears

and so it is exposed to mismatches occurring in the period. The assets matching Knapton’s shareholder funds are

held mainly in US dollars, the Enstar Group’s main currency. Knapton is therefore exposed to exchange losses

when reporting in pounds sterling.

Outsourcing risk: some business activities/services of Knapton are outsourced via service level agreements with

third parties (or other members of the Enstar Group). These are reviewed on a regular basis to ensure that they

are appropriate for the business, and while outsourced, the board of directors of Knapton remains fully accountable

for the risks inherent in the business.

3.43 Knapton is also exposed to the risk of a fall in the market value of its assets, which could adversely affect its financial

position to the extent that a fall in asset values was not matched by a corresponding movement in liability values. As

at 31 December 2013 Knapton held £84.2 million of financial investments. Around 70% of this amount was held in a

UCITS fund. This fund consists of two sub-funds of roughly equal weighting, one of which is invested in primarily high

grade global fixed income securities, predominantly North American, and the other in a “balanced fund” with the principal

allocations being emerging market debt, global equities, US large cap equities and short duration, high income fixed

income securities. The remainder of the portfolio includes direct equity and bond holdings (short duration, high grade

European corporate debt), a sub-investment grade bond fund, investments in a private equity fund and a fund invested

in debt securitisations.

CAPITAL POLICY AND RISK APPETITE

3.44 Knapton has a policy to maintain capital so that it meets its ICG at all times. Knapton seeks to release capital amounts

in excess of ICG, subject to regulatory approval.

3.45 Knapton has recognised 35 specific risks which are relevant to its business, which are monitored by management on

an on-going basis. The board of directors of Knapton annually identifies those risks that it considers to be key and sets,

in quantitative terms, the appetite (usually measured by the impact on the P&L or balance sheet). These are then

monitored and any outliers are reported to the Board quarterly.

3.46 Of these specific risks, eight are currently considered to be key, falling under the broad risk categories of strategic/group

risk, insurance risk, operational risk and market risk. For each of these risks, the level of risk tolerated is quantified into

three categories: within risk appetite (no action required), excessive but tolerable (action required) and exceeding risk

appetite (immediate action required).

Milliman Report


OTHER INTRA-GROUP RELATIONSHIPS

3.47 I have been informed by the Enstar Group that Knapton does not benefit from any parental or other intra-group

guarantees.

CONDUCT RISK – TCF

3.48 Knapton is committed to the fair treatment of customers, and to ensure that fair outcomes are delivered to customers.

As Knapton does not write new business, this is primarily achieved through its Enstar UK’s complaints handling

procedures. These are applied in accordance with UK regulatory guidelines, but are applied across all policyholders,

not just individuals and small businesses. The Knapton board receives quarterly reports of all customer complaints.

The Tower Pool

3.49 The Tower Pool ran from late 1967 to mid-1972. The original members of the pool were Phoenix, Continental Insurance

Company (“Continental” – in 2005 Continental transferred its UK business, including its Tower Pool liabilities, to KX Re)

and London and Edinburgh Insurance Company Limited (“L&E”, now a subsidiary of Aviva plc). Each member took a

one third share of all risks; however, certain members may have individually, or collectively, fronted risks on behalf of

the pool. Each member’s one third share would then be achieved through internal reinsurance arrangements between

the pool members.

3.50 Due diligence undertaken on behalf of Knapton and RSAI has concluded that most risks insured by the pool were

actually underwritten 100% by L&E, with the majority of the remainder underwritten two-thirds Continental, one-third

L&E. Very few risks have been identified where Phoenix actually appears on the underwriting stamp. Phoenix’s

exposure to the Tower Pool was therefore mainly as a reinsurer of the other two pool members.

3.51 The due diligence identified Phoenix as the direct insurer (whether on policy documentation or notes on the underwriting

file) in only nine cases. These comprised:

a) three unique policyholders (two under direct insurance policies and one under a facultative reinsurance policy)

b) five reinsurance contracts protecting Lloyd's syndicates (which are now represented by Equitas); and

c) a participation on another underwriting pool, the EW Payne Pool (Phoenix’s participation on the EW Payne Pool

was as a member of the Tower Pool (although the members of the Tower Pool were individually named), rather

than as an individual member of the EW Payne Pool, via an underlying agency agreement. The arrangement

enabled the EW Payne Pool to write various classes of reinsurance business). Through enquiries of, and

correspondence with, the manager of the EW Payne Pool (which had previously undertaken its own review of the

records of the EW Payne Pool), a further 41 policyholders have been identified.

3.52 The Tower Pool business is managed on behalf of the pool members by Downlands. Downlands is ultimately owned

by The Hartford Financial Services Group, Inc. (“Hartford”). Companies within Hartford wholly reinsure L&E’s

participation in the Tower Pool. Downlands provides quarterly reports to members of the Tower Pool, which includes

financial information pertaining to the Tower Pool and details of recent claims activity.

3.53 As at 30 September 2013 (the most recent date as at which figures have been provided by the managers of the Tower

Pool) the total outstanding case reserves of the Tower Pool were approximately $5.9 million (RSAI’s share of which

was $2.0 million). This amount is net of outwards reinsurance case reserves of approximately $245k (RSAI’s share of

which was $82k).

3.54 RSAI and Knapton have made due enquiries into the remaining records of the business written and believe that the

only business where liabilities remain outstanding relates to US casualty risks arising in respect of US direct liability

insurance and London market excess of loss liability reinsurance. The vast majority (over 99%) of the outstanding

claim amounts as at 30 September 2013 were denominated in US dollars. Of these amounts around 45% were in

respect of asbestos-related claims, 35% environmental pollution claims and 20% other claim types.

Milliman Report


4. THE PROPOSED SCHEME

4.1 Under the Scheme, the Transferring Business (i.e. the liabilities that RSAI has assumed in respect of Phoenix’s

participation in the Tower Pool between 1967 and 1972) will be transferred from RSAI to Knapton. Since the

Transferring Business is entirely reinsured by the Transferee, the only transferring assets are expected to be the benefit

of certain reinsurance contracts and other third party contracts, reinsurance recoveries, salvage and subrogation rights,

and the books and records of the Transferring Business.

4.2 Under the terms of the Business Transfer Deed (the “Deed”) between RSAI and Knapton, dated 13 March 2014,

Knapton procured a Letter of Credit (“LOC”) to be drawn down in order to meet claims payments from 1 January

onwards. The LOC amount was set at $9.5 million, as at 1 January 2012. Between that date and 30 September 2013,

RSAI’s share of payments made by the Tower Pool was approximately $0.5 million, leaving roughly $9 million remaining

in the LOC as at 30 September 2013. On completion of the Scheme RSAI will be entitled to receive $750,000, to be

drawn down from the LOC. Should the balance remaining in the LOC at as the Effective Date be less than $750,000

then Knapton will make good the shortfall, so that RSAI receives the full $750,000.

4.3 It should be noted that either RSAI or Knapton would be entitled to terminate the Deed in certain circumstances such

as the Scheme not being sanctioned. Were the Deed to be terminated then the reinsurance agreement between RSAI

and Knapton concerning the Transferring Business would cease and RSAI would be able to draw down funds from the

LOC. I discuss in Section 9 below (and also mention in Section 8 below) the likely consequences were the Scheme

not to be sanctioned and, as a result, the Deed to be terminated.

Motivation for the Scheme

4.4 As noted in Section 1 above, RSAI wholly reinsured its liability in respect of the Transferring Business with its subsidiary

company BE in 2006. In 2010 BE was sold by RSAI to the Enstar Group and was renamed Knapton. As the

Transferring Business is 100% reinsured into Knapton, RSAI’s net liability in respect of the Transferring Business is nil;

Knapton ultimately carries the economic liability for the business.

4.5 The purpose of the proposed Scheme is to align the legal liability for the Transferring Business with the economic

liability for the Transferring Business, in a way that avoids any adverse impact to policyholders and which obviates the

need for the parties to agree upon a commutation price (which would have been necessary had RSAI and Knapton

opted to effect a commutation of the reinsurance arrangement in place between them).

Effect of the Scheme on the Balance Sheets of RSAI and Knapton

4.6 Table 4.1 below shows simplified balance sheets for RSAI pre and post Scheme (based on its statutory accounts as at

31 December 2013). As can be seen, the effect of the transfer will be to reduce both the technical provisions and

reinsurers’ share of technical provisions by £6.7 million. This amount represents roughly 0.1% of gross technical

provisions and 0.7% of reinsurers’ share of technical provisions. As at 31 December 2013, RSAI held around

£0.5 million in respect of debtors relating to the Tower Pool business, and an equal and opposite amount of creditors

in respect of the reinsurance of the same. If the Scheme is sanctioned, these amounts will be removed from the balance

sheet and this is reflected in the figures shown in Table 4.1 below. As noted in paragraph 4.2 above, if the Scheme is

sanctioned, RSAI will then be able to draw down $750,000 (approximately £0.5 million) from the LOC. This is reflected

in Table 4.1 below through an increase in both investments and shareholders’ funds.

Milliman Report


Table 4.1

Simplified Balance Sheets for RSAI as at 31 December 2013

4.7 Table 4.2 below shows simplified balance sheets for Knapton pre and post Scheme (based on its statutory accounts

as at 31 December 2013). As Knapton currently 100% reinsures the Transferring Business, the liability for the

Transferring Business is already included within Knapton’s technical provisions. There should therefore be no change

to Knapton’s technical provisions as a result of the Scheme. If the Scheme is sanctioned, RSAI will be able to draw

down $750,000 from the LOC. This is reflected in Table 4.2 below as a reduction in both investments and shareholders’

funds of £0.5 million. I note that, as at 31 December 2013, Knapton booked technical provisions totalling £4.2 million in

respect of the Transferring Business. This is roughly £2.5 million less than that booked by RSAI. The reserving strength

of both RSAI and Knapton are discussed in more detail in Section 6 below, and in paragraphs 6.21 and 6.22 I discuss

the different approaches taken by RSAI and by Knapton to reserving for the Transferring Business. The figures shown

in Table 4.2 below are on the basis that Knapton maintains its current reserving strength in respect of the Transferring

Business post Scheme.

Table 4.2

Simplified Balance Sheets for Knapton as at 31 December 2013

Policyholders Affected

4.8 I have considered the effects of the Scheme on three main groups of policyholders, namely:

those policyholders of RSAI whose policies are to be transferred to Knapton;

the current policyholders of RSAI who have policies that are not being transferred; and

the current policyholders of Knapton.

4.9 I do not consider that the policyholders of any other insurance companies are affected by the Scheme.

£mPre-

Transfer

Post-

Transfer

Assets

Investments 14,268.0 14,268.5

Reinsurers' share of technical provisions 1,024.0 1,017.3

Debtors 4,198.0 4,197.5

Other Assets 905.0 905.0

20,395.0 20,388.3

Liabilities

Funds attributable to equity holders 3,922.0 3,922.5

Subordinated liabilities 492.0 492.0

Technical provisions 7,491.0 7,484.3

Creditors 8,049.0 8,048.5

Other liabilities 441.0 441.0

20,395.0 20,388.3

£mPre-

Transfer

Post-

Transfer

Assets

Investments 86.6 86.1

Reinsurers' share of technical provisions 9.4 9.4

Debtors 3.5 3.5

Other Assets 22.1 22.1

121.6 121.1

Liabilities

Shareholders' funds 55.2 54.7

Technical provisions 60.5 60.5

Creditors 5.8 5.8

Other liabilities 0.1 0.1

121.6 121.1

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Compensation and Complaints

4.10 After the implementation of the Scheme, as with all other insurance companies with an establishment in the UK,

Knapton will be required to participate in the FSCS, as it has done since its inception. The Scheme will have no impact

on the eligibility of any policyholder or group of policyholders for compensation under the FSCS.

4.11 The Scheme will have no effect on the eligibility of any policyholder or group of policyholders to bring complaints to the

UK FOS. If, as described in Section 2, they are currently able to bring complaints to the FOS, then this will remain the

case after the implementation of the Scheme. If they are currently not eligible to complain to the FOS then this will also

remain the case after the implementation of the Scheme.

Administration

4.12 The contract with Downlands for third party administration of the Tower Pool business is for two year periods and was

renewed for the period 1 July 2014 to 30 June 2016. The contract will be included within the assets being transferred

to Knapton under the Scheme and therefore, after implementation of the Scheme, the Transferring Business will

continue to be administered by Downlands. There will also be no change to the administration of either the non-

transferring business of RSAI or the existing business of Knapton.

4.13 As noted in Section 2, there is an FCA requirement that companies treat customers fairly in all their actions. These

requirements will still apply to policyholders in Knapton after the proposed transfer.

Excluded Policies

4.14 Any policies which are not capable of being transferred for legal reasons will be treated as Excluded Policies and will

be fully reinsured (from RSAI) by Knapton with effect from the Effective Date.

Capital Policy after the Scheme

4.15 Following the implementation of the Scheme, RSAI and Knapton will continue, as required by UK regulation, to maintain

capital for the entirety of their businesses to support their respective ICAs.

4.16 Capital in both RSAI and Knapton is currently maintained using a risk-based approach in line with the ICA, as set out

in Section 2, such that each company remains solvent relative to regulatory confidence levels.

4.17 The capital policy set out above will be replaced by a suitable alternative following the implementation of Solvency II.

The implementation of Solvency II is expected with effect from 1 January 2016.

Approach to Communication with Policyholders

4.18 RSAI and Knapton have set out the approach that they intend to take in communicating information about the proposed

transfer of business to the affected policyholders and other parties.

4.19 The main objectives of the communications are to:

Give affected policyholders the information that they need to understand the proposed changes;

Inform affected policyholders about the implications for them of the proposed changes;

Give affected policyholders access to further relevant information (beyond that in the communications pack);

Let affected policyholders know what steps they should take if they object to any of the proposed changes;

Maintain customers’ confidence in Knapton’s willingness and ability to continue to meet its obligations under

transferring and non-transferring policies; and

Meet legal and regulatory requirements.

4.20 In respect of the transferring policyholders, in line with the due diligence conducted on behalf of RSAI and Knapton, as

referenced in paragraph 3.51 above, RSAI intends to directly notify:-

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the two distinct policyholders which due diligence has shown were insured directly by Phoenix;

the single policyholder identified as being covered by Phoenix under a facultative reinsurance policy;

Equitas, which now represents the five syndicates that were protected under reinsurance contracts issued by

Phoenix;

41 policyholders who were insured by the Tower Pool as a whole pursuant to the EW Payne Pool arrangements

and where each Tower Pool member (including Phoenix) directly insured one third of the Tower Pool's liability; and

the two other Tower Pool members which Phoenix reinsured in respect of the majority of their liabilities under the

Tower Pool.

4.21 In addition, RSAI intends to notify directly those brokers who have been identified as relevant to the Transferring

Business and also the outwards reinsurers who reinsured the Transferring Business, to the extent that they still have

outstanding liabilities in respect of the Tower Pool.

4.22 RSAI does not intend to notify directly any of its policyholders that are not transferring under the Scheme for the

following reasons:

gross of reinsurance, the liability to be transferred by the Scheme is not material in the context of the overall

reserves of RSAI;

the gross liability is 100% reinsured and so, net of reinsurance, no liability will be transferred by the Scheme; and

the cost of mailing all current RSAI policyholders, as well the transferring policyholders, has been estimated at

£6 million.

4.23 Knapton also does not intend to notify directly its current policyholders on the basis that (i) the relevant liabilities are

already with Knapton through its reinsurance arrangement with RSAI and (ii) in light of the financial information in

Knapton’s latest audited accounts the transaction is not material in the context of Knapton as a whole.

4.24 Indirect notification is also planned via advertisements in two national newspapers and in Insurance Day, and notices

in the London, Edinburgh and Belfast Gazettes.

4.25 The letters, notices and advertisements will refer all queries to a postal address or a telephone number or a website

address, all of which will be dedicated to responding promptly to any such queries.

4.26 I comment on this proposed approach to communications with policyholders in Section 9.

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5. GENERAL CONSIDERATIONS OF THE INDEPENDENT EXPERT

Introduction

5.1 I have compiled my report in accordance with the Policy Statement and with SUP18.

5.2 Under FSMA, the concept of TCF must be applied. To help ensure that customers are treated fairly in the future it is

necessary to understand how they have been treated in the past. From the policyholders’ perspective, the acceptability

of the Scheme must be on the basis that it will not have a materially adverse effect on their benefits or fair treatment.

5.3 I need to consider the terms of the Scheme generally and how the different groups of policyholders are likely to be

affected by the Scheme and, in particular:

The effect of the Scheme on the security of the policyholders’ contractual rights, including the likelihood and

potential effects of the insolvency of the insurer; and

The likely effects of the Scheme on policyholder servicing levels (e.g. claims handling).

5.4 The main factors that determine the risks to which a policyholder is exposed are:

Size of company;

Amount of capital held, other calls on that capital and capital support currently available to the company;

Reserve strength;

Investment strategy;

Mix of business written; and

Company strategy – for example, whether it is open or closed to new business.

Security of Policyholder Benefits

5.5 As part of my role as Independent Expert for this Scheme, I need to consider the security of policyholder benefits, i.e.

the likelihood that policyholders will receive their benefits when due.

5.6 In considering and commenting upon policyholder security I shall consider the financial strength of each entity. Financial

strength is provided by the margins for prudence in the assumptions used to calculate the Technical Provisions, by the

shareholder capital and by any specific arrangements for the provision of financial support. In considering policyholder

security it is also necessary to take into account the potential variability of future experience (including claim frequency

and severity). Security is also affected by the nature and volume of future new business.

5.7 The nature of the assets that constitute each company’s capital and surplus is also relevant. The shareholder is able

to withdraw surplus shareholder assets (i.e. retained profits, but not share capital) in the form of realised profits, provided

minimum capital requirements are met. The security provided by such assets may therefore be temporary.

Treating Customers Fairly

5.8 As Independent Expert for the Scheme I need also to consider the proposals in the context of the FCA’s TCF regime

and, in particular, the impact of the proposals on the benefit expectations of policyholders.

5.9 This involves consideration of areas where discretion is involved on behalf of the relevant insurance company with

regard to charges applied to a policy and the benefits granted to the policyholder, and also to service standards applied.

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Other Considerations

5.10 Paragraph 2.34(4)(b) of the Policy Statement and paragraph 2.36 of SUP18 both require me, as Independent Expert,

to consider the likely effects of the Scheme on matters such as investment management, new business, administration,

expense levels and valuation bases insofar as they might impact on levels of service to policyholders or on the security

of policyholders’ contractual rights.

5.11 I am also required to consider the cost of the Scheme and the tax effects of the Scheme insofar as they might impact

on the security of policyholders’ contractual rights.

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6. THE IMPACT OF THE SCHEMES ON THE TRANSFERRING POLICYHOLDERS OF

RSAI

Introduction

6.1 Under the Scheme, the Transferring Business of RSAI will be transferred to Knapton.

6.2 The main issues affecting the transferring policyholders of RSAI as a result of the Scheme are likely to arise from

relative differences in:

The financial strength of Knapton after the transfer compared with that of RSAI. Financial strength is derived from:

o the strength of the reserves held;

o excess assets or capital; and

o specific financial support arrangements

The risk exposures in Knapton compared with those in RSAI

The policy servicing levels provided by Knapton after the transfer compared with those currently enjoyed by the

policyholders of RSAI.

In this Section I deal with each of these in turn.

6.3 As I have mentioned earlier in the Report, certain capital requirements are private matters between insurers and the

PRA and therefore I am not at liberty to disclose in the Report actual figures relating to those requirements, or figures

by which those amounts could be calculated. In the Report I have considered the extent to which RSAI and Knapton

each hold capital in excess of their regulatory solvency level. I refer to the ratio of the actual capital that the entity under

consideration holds to the minimum regulatory solvency capital requirement to be the “Capital Cover Ratio”. Each entity

will have different Capital Cover Ratios for the different solvency measures. Purely for comparative purposes in the

Report I have defined the following terms:

“sufficiently capitalised” refers to a Capital Cover Ratio between 100% and 119%;

“more than sufficiently capitalised” refers to a Capital Cover Ratio between 120% and 149%;

“well-capitalised” refers to a Capital Cover Ratio between 150% and 199%, and

“very well-capitalised” refers to a Capital Cover Ratio in excess of 200%.

Reserve strength of RSAI

6.4 I have been provided with details of the reserves of RSAI as at 31 December 2013, the process by which the reserves

are established and details of the internal and external actuarial reviews which have been performed.

6.5 I have not attempted to review in detail the calculations performed by the respective actuaries. Instead I have reviewed

the process by which reserves are set, the approach followed by the relevant actuaries, the key areas of reserve

uncertainty and the apparent strength of the reserves based on this review. The areas of uncertainty identified by RSAI

are:

The impact of changes to claims handling and claims systems within RSAI

Periodical payment orders (“PPOs”)

The prevailing economic conditions, and the impact of subsequent changes

Asbestos-related claims

Deafness-related claims

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Other latent / industrial claims types

The impact of the so-called “compensation culture”

Claims inflation

Individual large claims

Potential changes in the Ogden discount rate

The impact on claim costs of the recent the Court of Appeal ruling regarding Pain, Suffering and Loss of Amenities

(“PSLA”) awards

The long-term effects of the Legal Aid, Sentencing and Punishment of Offenders Act 2012 (implemented in 2013)

and other changes implemented over the last few years by the Ministry of Justice (“MoJ”)

Specific issues with specific books and claim types that are inherently difficult to predict

Changes in the rate and discount period used for long-tail liabilities (excluding PPOs)

Underwriting changes: The business has changed its underwriting philosophy considerably in recent years as well

as changing the main policy administration system

Movement in currency exchange rates

Other uncertainties

Statistical uncertainty (i.e. the limitations in the models currently employed to help estimate outstanding claim

provisions).

I have considered in more detail the treatment of those aspects where I consider the greatest risk of variance lies, for

example PPOs, deafness and asbestos.

6.6 The internal actuaries have used generally accepted actuarial methods to estimate reserve requirements (termed

“actuarial indications”). From my review of the various documents supporting the reserve calculations I am satisfied

that the methodologies, major assumptions and results as at 31 December 2013 appear reasonable.

6.7 The actuarial indications are on a best estimate basis, i.e. not deliberately biased upwards or downwards, and do not

include any margins. I interpret this measure to be on a basis higher than a 50% confidence level (as the claim

distribution is expected to be positively skewed19).

6.8 External actuarial reviews are also performed periodically for (parts of) RSAI’s legacy business. The most recent of

such reviews were undertaken as at 31 December 2013 for UK asbestos IBNR reserves (by far the largest component

of RSAI’s legacy reserves). From my review of this report I consider that the external actuaries have employed actuarial

methods in line with normal market practice to estimate IBNR reserve requirements for UK asbestos liabilities. While

noting that typically there is more uncertainty in reserve estimates for a portfolio of asbestos claims/risks than for most

other portfolios of claims/risks, I am satisfied that the methodologies, major assumptions and results as at 31 December

2013 appear reasonable.

6.9 The IBNR reserves estimated by the external actuaries (and adopted by RSAI as their corresponding actuarial

indications) have been set using a best estimate approach, i.e. they are not deliberately biased upwards or downwards,

and contain no margin for either prudence or optimism, which I consider to be on a basis higher than a 50% confidence

level (as the claim distribution is expected to be positively skewed).

_______________________________________________________________________________

19 In probability theory and statistics, skewness is a measure of the asymmetry of the probability distribution of a variable. A distribution is skewed if the majority

of values lie to one side of the mean. It is positively skewed if the majority of values lie to the left of the mean, i.e. have values lower than the mean, but that

there are a few values higher, possibly much higher, than the mean.

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6.10 RSAI’s gross reserves as at 31 December 2013 included £6.7 million (comprising £1.2 million of case reserves and

£5.5 million of IBNR) in respect of the Transferring Business. The gross reserve amounts in respect of the Transferring

Business are actually net of all outwards reinsurance other than the 100% reinsurance arrangement with Knapton.

Were the reserves to have been provided gross of all reinsurance I understand that they would have been larger, but

not significantly so. I have been informed by RSAI that it last performed a detailed internal actuarial analysis of the

Tower Pool business in 2008. The reserves held subsequently in respect of the Tower Pool business have been based

on the result of that review, with the result being continually rolled forward, other than as at the end of 2009 when the

reserves were increased beyond the level implied by the roll-forward. An external actuarial review was commissioned

based on data as at 30 September 2011. Although the results of the 30 September 2011 external review were less

than the held reserve at the time, RSAI did not make any adjustment to its held reserve. We are unaware of any similar

review having been commissioned subsequently by RSAI.

6.11 I have been provided with, and have reviewed, the external actuaries’ report on the Tower Pool business as at 30

September 2011. I am satisfied that the methodologies employed by the external actuaries were reasonable given the

liabilities concerned, which are predominantly US asbestos and pollution claims. The very long-tail nature of these

types of liabilities increases the inherent uncertainty of any projection of eventual outcome and means that a range of

best estimates in this context is likely to be particularly wide relative to other portfolios of insurance liabilities. Comparing

the results of the external actuaries’ analysis to those that could be derived from market benchmarks suggests that the

results are towards the high end of a range of reasonable best estimates.

6.12 The gross reserves booked for the Tower Pool business as at 31 December 2013 are based on the incurred claims

position as at 30 September 2013, the latest date at which claim information from the Tower Pool was available. Had

the external actuaries’ estimated reserves as at 30 September 2011 been rolled forward for payments to 30 September

2013 this would have suggested an IBNR reserve requirement of around £3.5 million. This compares to the held IBNR

reserve of £5.5 million. The incurred development of claims in the period between 30 September 2011 and

30 September 2013 was relatively modest and would not suggest any deficiency in the external actuaries’ estimates.

While repeating my earlier comment that the range of best estimates in this context is likely to be particularly wide, I

consider the gross IBNR reserve held by RSAI as at 31 December 2013 in respect of the Transferring Business to be

stronger than a best estimate. However, net of reinsurance RSAI’s provisions for the Transferring Business were nil

as the business is wholly reinsured by Knapton.

6.13 The reserves held by RSAI generally are based on the Management’s Best Estimates (“MBE”), which in turn are based

on the actuarial indications plus an allowance for the various sources of uncertainty surrounding the actuarial

indications. I thus consider the MBE to be on a basis stronger than a 50% confidence level. As at 31 December 2013,

RSAI reported Technical Provisions, net of reinsurance, of £6.5 billion20 of which the provision for claims outstanding

(before discounting and net of reinsurance) amounted to £4.4 billion21.

6.14 Notwithstanding the fact that RSAI discounts its reserves for asbestos and environmental claims, it does not similarly

reflect the time value of money in the estimation of the bulk of its claims reserves. This gives rise to an off balance

sheet asset (or margin) equivalent to the time value of money inherent in the undiscounted part of the reserves. Such

a margin increases the security of the policyholders.

Conclusion

6.15 Based on my review as described above concerning the reserves of RSAI as at 31 December 2013, the reserves

appear reasonable at present.

_______________________________________________________________________________

20 Forms 20A and 13 of RSAI's return to the PRA as at 31 December 2013

21 Form 11 of RSAI's return to the FSA as at 31 December 2013

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Reserve Strength of Knapton (pre and post Scheme)

6.16 Knapton’s claims reserves as at 31 December 2013 were based on the results of an external actuarial review

commissioned by Knapton. I have been provided with a copy of a report prepared by the external actuaries setting out

the results of their review.

6.17 I have not attempted to review in detail the calculations performed by the external actuaries. Instead I have reviewed

the process by which reserves are set, the approach followed by the external actuaries, the key areas of reserve

uncertainty and the apparent strength of the reserves based on this review.

6.18 The external actuaries divided Knapton’s claims into two groups: attritional and latent. Losses in respect of attritional

claims are estimated using standard actuarial techniques using paid and incurred development patterns by underwriting

year. Latent claims are reserved using a variety of methods which incorporate market benchmarks. Latent claims

include asbestos and pollution exposures, emanating from both within and outside of the Tower Pool. The Tower Pool

APH exposures are less significant than those emanating from elsewhere. The external actuaries’ approach to

estimating reserves for the asbestos and pollution claims of the Tower Pool business has been to apply the IBNR-to-

outstanding ratios implied by the results of its analysis of the non-Tower Pool claims to the Tower Pool outstanding

amounts. I consider the approach taken by the external actuaries to be reasonable given the exposures concerned.

Overall, the estimates made by the external actuaries, and adopted by Knapton, as at 31 December 2013 appear

reasonable.

6.19 Knapton has adopted the external actuaries’ central estimate of gross reserve requirements as its held reserve as at

31 December 2013. Knapton has also used the external actuaries’ central estimate of ceded reinsurance amounts, but

has reduced this amount for its estimate of reinsurance bad debt. The external actuaries’ central estimate is said to

represent an expected value over the range of reasonably foreseeable outcomes (such a range is stated to exclude

allowance for new latent claims or events not in the data).

6.20 I note that the external actuaries based their reserve estimates for the Transferring Business on the outstanding position

as at 31 December 2011. I am informed that no advices were received by Knapton from RSAI relating to the

Transferring Business due to negotiations between the two over a possible commutation of the reinsurance contract.

The 31 December 2011 data was therefore the most recent available at the time of the external actuaries’ review. I

note that I have not been able to reconcile fully the data underlying the analysis by the external actuaries and the

accounts as at the same date, but I do not consider the differences to be sufficient to invalidate the results of the external

actuaries’ review.

6.21 The external actuaries’ estimate of future claims in respect of the Transferring Business totals $6.9 million gross of

outwards reinsurance, and this was adopted by Knapton as at 31 December 2013 (expressed as £4.2 million within

Knapton’s Report and Accounts – see paragraph 4.7 above). I have been told that Knapton has made no allowance in

its provisions for any further outwards reinsurance recoveries by the Tower Pool. This compares to RSAI’s booked

gross provision for the Transferring Business of $11.1 million (the effective exchange rate is about £1 = $1.65).

However, as noted in paragraph 6.20 above, there is a difference in timing between the two reserve figures: Knapton’s

reserve is based on data as at 31 December 2011, whereas RSAI’s reserve is based on data as at 30 September 2013.

By subtracting payments made between 31 December 2011 and 30 September 2013 one can derive Knapton’s held

reserve as at 30 September 2013, which would be $6.4 million, i.e. $4.7 million less than RSAI’s gross provision as at

the same point.

6.22 The external actuaries’ approach to reserving for the asbestos and pollution liabilities under Knapton’s reinsurance of

the Transferring Business has been to adopt IBNR-to-outstanding ratios developed from its analysis of the asbestos

and pollution losses elsewhere on the book (which are more significant and for which more data was available). I have

reviewed the resulting reserve estimates relative to industry benchmarks and recent developments on the Tower Pool

account. I believe that, in aggregate, despite being significantly less than RSAI’s held reserve, the resulting IBNR

appears reasonable. As noted above, RSAI’s held reserve is larger than that implied by its external actuarial review,

and I have concluded that the external actuaries’ estimate was at the high end of a range of reasonable best estimates.

I therefore believe that, despite being significantly less than the gross reserve held by RSAI, Knapton’s held

reserve, as at 31 December 2013, in respect of the Transferring Business appears reasonable.

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6.23 As explained in Section 3 above, the Allianz Marine XL Portfolio has transferred into Knapton, the transfer being

completed on 9 February 2015. I have been provided with an internal memorandum setting out the reserves held by

the Enstar Group in respect of the Allianz Marine XL Portfolio as at 31 December 2013. At that time, gross reserves

totalled $20.5 million. The portfolio was written between 2003 and 2005 and covers short tailed risks that are now well

developed. The memorandum explains that there is limited potential for deterioration as the claims are close to

underlying policy limits. Based on the information provided, I consider that the held reserves of $20.5 million appear

reasonable. I understand that the Enstar Group will continue reserving for the Allianz Martine XL Portfolio on the same

basis if it is transferred to Knapton.

6.24 Post its transfer, the Allianz Marine XL Portfolio continues to be 100% reinsured (up to the limit of the reinsurance) by

Fitzwilliam; Knapton’s net best estimate liability in respect of the portfolio is therefore zero. I am satisfied that the

Allianz Transfer will not have affected the strength of the reserves maintained by Knapton.

6.25 As the Transferring Business is already reinsured by Knapton its reserves will not change as a result of the Scheme,

and therefore I have no reason to believe that the Scheme will have any effect on the reserve strength of Knapton.

Conclusion

6.26 Based on my review, as described above, I am satisfied that the reserves held by Knapton as at 31 December

2013 appear reasonable. Furthermore, I do not believe that the reserve strength of Knapton will be materially

affected either by the Scheme, or by the Allianz Transfer.

Excess Assets of RSAI

6.27 RSAI is a major UK insurer, and at the time of writing this Report has a Standard and Poor’s rating of ‘A’ (stable outlook)

and Moody’s rating of A2 (negative outlook).

6.28 As at 31 December 2013 the policyholders of RSAI enjoyed the security of capital resources (i.e. assets available to

meet regulatory capital requirements) as measured in RSAI’s 2013 PRA return of £2,041 million compared with a

statutory minimum capital requirement of £1,624 million. The Capital Cover Ratio for the MCR was therefore 126%

and the free assets equal to £416 million (i.e. capital resources less MCR).

6.29 On an Enhanced Capital Requirement (“ECR”) basis (a more risk sensitive and targeted capital requirement than the

MCR), RSAI could be considered to be sufficiently capitalised as at 31 December 2012.

6.30 RSAI is the largest insurer in the RSA Group. The RSA Group also has significant operations overseas, particularly in

Scandinavia and Canada (which are owned through subsidiaries of RSAI). Thus RSAI is exposed to the financial

destinies of these overseas operations. I understand that the RSA Group’s material operations comprise RSAI and its

insurance subsidiaries. Thus the capital strength of RSAI also needs to be gauged by comparing the overall capital of

the RSA Group to the risks being run by the RSA Group.

6.31 In line with regulatory requirements, the RSA Group has made an Individual Capital Assessment (“ICA”) of the capital

it needs to retain (at a Group level) in order to maintain its ability to meet its obligations to a level of certainty prescribed

by the PRA – the level of capital so determined is intended to ensure that the RSA Group is less than 0.5% likely to

become insolvent, allowing for one year’s new business (or the equivalent percentage over a longer new business

period) and the subsequent run-off to extinction of the liabilities.

6.32 The RSA Group is exposed to a wide range of risks; the ICA identifies the following categories of risk:

market and credit risk (including asset/liability mismatch, fluctuations in exchange rates and reinsurance default);

reserving risk (including the risks associated with exposures to asbestos and disease claims and PPOs);

underwriting risk (including exposure to the insurance cycle and insufficient pricing margins);

catastrophe risk (including exposure to windstorms, flooding and winter freezes on the property account); and

operational risk (including acts of terrorism and failure of controls).

The RSA Group operates a number of defined benefit pension schemes and there is considerable uncertainty

surrounding future liabilities. The risks associated with the pension schemes are also included in the ICA.

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6.33 The ICA is a complicated process that relies on an assessment of the risks in the business, extensive modelling and

management judgement to determine an appropriate figure. I have reviewed the RSA Group’s 2013 Capital Report

(the latest finalised report of this type available at the time of writing, but see paragraph 6.36 below), which details its

ICA as at 31 December 2012. It describes the work conducted in order to make the assessment, including a discussion

of the risks to which RSAI is subject in the course of its business.

6.34 Some of the key sensitivities to the RSA Group’s ICA are noted as being the mean loss ratio (an adverse movement of

5% would increase the ICA by more than 24%), exposure to catastrophes (a 20% increase in frequency/severity would

increase the ICA by 14%) and the diversification assumption (a 20% reduction in diversification would increase the ICA

by 13%).

6.35 I have not reviewed in detail the calculations performed by the RSA Group in producing its ICA, nor have I reviewed all

of the key assumptions used in the model. However, based on what I have reviewed, I consider the methodology and

modelling techniques used by RSAI to be in line with current market practice and broadly appropriate. The results of

the RSA Group’s ICA show that it was more than sufficiently capitalised as at 31 December 2012.

6.36 RSAI has provided me with the results of updated Group ICA model runs made as at 31 December 2013 and as at 30

June 2014. The results as at 31 December 2013 show a fall in surplus capital relative to the position as at 31 December

2012. Based on these figures, the RSA Group could be considered only sufficiently capitalised as 31 December 2013.

However, since the 2013 year-end the RSA Group has made a rights issue and undertaken other measures to

strengthen its balance sheet. The calculations performed as at 30 June 2014 take into account these actions and the

results show a significantly increased margin of capital over the ICA, such that the RSA Group could be considered to

be more than sufficiently capitalised. I have very recently received a copy of a draft of the RSA Group’s 2014 Capital

Report which explains and supports the analysis behind the ICA calculations as at 31 December 2013 and as at 30

June 2014. My initial review of the draft Capital Report has given me no cause to doubt the reasonableness of the

results produced but I intend to review it, and any subsequent versions of the Capital Report, in more detail and report

on the findings of my review in my Supplementary Report to the Court.

6.37 The Regulator provides individual capital guidance (“ICG”) to the RSA Group and RSAI. This guidance sets out the

minimum level of capital that it would expect the RSA Group and RSAI to hold based on its review of the ICA and the

risk management framework of the RSA Group/RSAI. The ICG is intended to target the same level of confidence as

described above for the ICA, but it represents the Regulator’s view rather than that of the RSA Group/RSAI.

6.38 Due to limitations on the degree of disclosure permitted by the Regulator, I am not able to provide details of the results

of these exercises in this Report. However, I confirm that I have taken them into account in reaching my conclusions.

6.39 The RSA Group’s 2013 Capital Report also details its Solvency Capital Requirement under Solvency II. The RSA

Group intends to use an internal model to assess its capital requirements under Solvency II and the 2013 Capital Report

shows the results of the calculation on this basis. Based on the modelling undertaken as at 31 December 2012, the

RSA Group could be considered more than sufficiently capitalised relative to its Solvency II capital requirements. I

have not reviewed the adequacy of the internal model. I note that the Solvency Capital Requirement estimated using

the internal model is materially less than that which would be suggested using a standard formula approach.

6.40 If the Scheme is sanctioned, RSAI (and the wider RSA Group) will no longer be exposed to the risks associated with

the Transferring Business. However, as the Transferring Business is currently 100% reinsured, and represents a very

small fraction of RSAI’s overall gross liabilities, these risks are minimal in relation to the other risks facing RSAI. The

effect of the Scheme on the capital requirements of RSAI will therefore also be minimal. The principal change will be

a reduction in credit risk associated with the reinsurance with Knapton. As the reinsurance asset associated with the

Transferring Business comprises just 0.7% of RSAI’s overall reinsurance asset, the reduction in the credit risk will be

very small. I therefore consider that the excess assets of RSAI with be virtually unchanged as a result of the Scheme.

Conclusion

6.41 Overall, based on my review as described above concerning the excess assets of RSAI as at 31 December 2013

(and as at 31 December 2012), I believe the policyholders of RSAI, including those who will transfer under the

Scheme, currently benefit from the strength provided by a more than sufficiently capitalised company.

Milliman Report


Excess assets of Knapton

6.42 As at 31 December 2013 the policyholders of Knapton enjoyed the security of capital resources (i.e. assets available

to meet regulatory capital requirements) as measured in Knapton’s Return to the PRA as at 31 December 2013 of £51.8

million compared with a statutory minimum capital requirement of £3.1 million. The Capital Cover Ratio for the MCR

was 1,659% and the free assets equal to £46.5 million (i.e. capital resources less MCR). The MCR is based on a set

formula, which is based on premiums written and claims paid. Where portfolios have been built-up through business

transfers and where claim payments to date are small compared with the outstanding claims liability, the MCR can

appear small relative to other measures of capital requirements.

6.43 On an ECR basis, which is also formula driven but which allows for a broader range of risks, Knapton could be

considered to be very well-capitalised as at 31 December 2013.

6.44 Knapton has also undertaken an ICA of its capital requirements as at 31 December 2013. At the time of writing this

Report, a report detailing the work carried out to produce the ICA was not available However, Knapton has provided

me with the results of its ICA and I have discussed the methodology and assumptions used in the ICA with Knapton’s

actuary.

6.45 The key components of Knapton’s ICA are the charges for reserve and market risk. Credit risk and operational risk are

also considered, but the charges for these risk classes are less significant.

6.46 Knapton calibrates its ICA modelling to 97.5th percentile outcomes, consistent with the PRA’s requirements under the

ICAS regime for insurers in run-off. The ICAS regime for insurers in run-off has been set up to be the equivalent of that

for ongoing insurers, but is intended to reflect the different risk profile created by run-off insurers having no future new

business streams. As a run-off insurer with liabilities with a mean term exceeding 5 years, Knapton must ensure its

overall likelihood of failure does not exceed 2½%. While having subtly different targets, the ICAs for insurers in run-off,

such as Knapton, and “live” insurers, such as RSAI, should be comparable.

6.47 In assessing its reserve risk charge Knapton assesses the uncertainty associated with each major line of business. It

commissioned external actuaries to assess the coefficient of variation of reserve amounts associated with each line of

business, and the 97.5th percentile outcome of each. The overall reserve risk charge has been determined by combining

the 97.5th percentile outcomes for each line of business, allowing for diversification between the lines using a correlation

matrix, which has been assessed by external actuaries.

6.48 The market risk charge is calculated in accordance with the Solvency II standard formula approach, as is the operational

risk charge. The major risk charges are combined using the correlation coefficients within the standard formula

correlation matrix, with the exception that operational risk is assumed to be 50% (rather than 100%) correlated with the

other risk components.

6.49 I have not reviewed the calculations performed by Knapton’s actuaries in assessing its ICA in detail, but the approach

and methodologies used appear to be reasonable and in line with market practice for a company in run-off and of

Knapton’s size.

6.50 The results of the ICA as at 31 December 2013 suggest that Knapton is well-capitalised.

6.51 I am informed that Knapton received ICG from the PRA earlier in 2014, which included specific adjustments to Knapton’s

ICA methodology. While these adjustments are not reflected in Knapton’s ICA as at 31 December 2013, Knapton has

separately calculated the effect of applying these adjustments. After diversification, these adjustments result in a capital

requirement around 12.5% higher than the ICA. Nevertheless, relative to the excess assets of Knapton, it continues to

suggest Knapton is a well-capitalised company.

Milliman Report


6.52 Knapton intends to use the standard formula to calculate its SCR when Solvency II is introduced, and it has calculated

its SCR on this basis using financial data as at 31 December 2013. Its SCR is similar to its ICA, which is to be expected

given that the standard formula approach has been used for a number of elements of the ICA. The main differences

are a slightly lower reserve risk charge and a higher credit risk charge in the Solvency II SCR compared with the ICA.

The amount of own funds using Solvency II principles is slightly less than shareholders’ funds in Knapton’s GAAP

balance sheet. This relates to differences in the valuation of technical provisions under Solvency II. Overall, the Capital

Cover Ratio using the standard formula SCR approach is slightly less than the ICA, but nevertheless indicates that

Knapton is a well-capitalised company.

6.53 As discussed above, the Allianz Marine XL Portfolio has been transferred into Knapton, the transfer being completed

on 9 February 2015. In order to assess the effect of this portfolio on its business, Knapton has also prepared ICA and

standard formula SCR calculations, as at 31 December 2013, on the basis that this business had already been

transferred into Knapton as at that date. Knapton has shared with me the results of these calculations.

6.54 As the Allianz Marine XL Portfolio continues to be 100% reinsured (up to the limit of the reinsurance) by Fitzwilliam, the

principal net effect of the Allianz Transfer on Knapton has been an increase in its credit risk due to the reinsurance with

Fitzwilliam. However, its impact on the credit risk in the standard formula calculation will be minimal as the reinsurance

will be collateralised through a funds-withheld arrangement and as a result does not attract a significant loading. In its

ICA calculation, Knapton has not made allowance for the funds-withheld arrangement in calculating the credit risk

charge, meaning that the credit-risk element of its ICA is significantly increased as a result of accounting for the Allianz

Transfer, although the impact of this is diluted by diversification benefits. Nevertheless, accounting for the Allianz

Transfer does not change the conclusion, on any of the ICA, standard formula SCR, or ICG bases, that Knapton is a

well-capitalised company.

6.55 If the Scheme is sanctioned, the only change to Knapton’s balance sheet will result from the draw-down of $750,000

from the LOC, as described in paragraph 4.2 above. This will lead to a slight reduction in the excess assets of Knapton

of approximately £0.5 million, or around 1% of the excess assets of Knapton as at 31 December 2013. A reduction in

excess assets of this magnitude will not materially alter the Capital Cover Ratios of Knapton, as described above, and

I believe will not represent a material reduction in the security afforded to the policyholders of Knapton.

Conclusion

6.56 Based on my review of the excess assets of Knapton as at 31 December 2013, as described above, I believe

that Knapton is a well-capitalised company and will continue to be so whether or not the Scheme is sanctioned.

Relative financial strength of transferring policyholders pre and post Scheme

6.57 I have concluded above, based on my review of excess assets held relative to various capital requirements, that RSAI

was, as at 31 December 2013, a sufficiently capitalised company, and that Knapton was a well-capitalised company,

i.e. Knapton had, on the measures considered, a greater degree of excess assets relative to its capital requirements (I

define what I mean by “sufficiently capitalised” and “well capitalised” in paragraph 6.3 above). This would suggest that,

in terms of excess assets and the security that they afford policyholders, the policyholders of the Transferring Business

would benefit from the Scheme being sanctioned. It should be borne in mind, however, that while the excess assets in

RSAI are, in relative terms, less than those in Knapton, in absolute terms the amount of excess assets is far greater in

RSAI, and policyholders of RSAI also benefit from being part of a larger and more diversified insurance company,

compared to Knapton. These different aspects are not wholly quantifiable and hence are not directly comparable with

one another. However, taking them all into account, I conclude that, on an ongoing basis, the transferring policyholders

will not be materially affected by differences in the financial strength between RSAI and Knapton.

Milliman Report


6.58 Pre Scheme, were Knapton to become insolvent, the policyholders of the Transferring Business would continue to have

their claims paid by RSAI. Furthermore, given the small size of the Transferring Business relative to RSAI’s entire

portfolio, a default on its reinsurance contract by Knapton would be very unlikely to have a significant financial effect on

RSAI. Post Scheme, were Knapton to become insolvent, the policyholders of the Transferring Business would not have

any recourse to RSAI. Moreover, in accessing the remaining assets of Knapton in the event of its insolvency, the

holders of Transferring Business that was in the form of reinsurance of other Tower Pool members (these being the

majority of the Transferring Business policyholders, there being only two policies within the Transferring Business that

have been identified as being direct by the due diligence exercise that I refer to in paragraph 3.50 above) would rank

behind direct policyholders of Knapton. This would appear to be a disadvantage of the Scheme from the point of view

of the policyholders of the Transferring Business, at least those whose policies were for reinsurance. However, given

the level of excess assets within each company, the insolvency of Knapton would presently appear to be a remote

possibility, and one that would not be materially affected by the Scheme. I also note that Knapton’s current business

contains material amounts of reinsurance which, in the event of Knapton becoming insolvent post Transfer, would rank

alongside the policyholders of the Transferring Business that related to reinsurance, and behind the policyholders of

the two direct policies within the Transferring Business.

6.59 I am therefore satisfied that the policyholders of the Transferring Business will not be materially adversely

affected due to relative differences in the financial strength of Knapton post Scheme to those of RSAI pre

Scheme.

Changes in risk exposures

6.60 If the Scheme is sanctioned, the policyholders of the Transferring Business will no longer be exposed to the risk

exposures of RSAI, but will be exposed to those of Knapton. While these policyholders are already indirectly exposed,

to some extent, to the risk exposures of Knapton through its reinsurance of the Transferring Business, the reinsurance

asset held with Knapton is not significant relative to RSAI’s assets as a whole, and therefore a failure of Knapton would

be very unlikely to have a significant effect on RSAI or on its ability to pay meet the liability payments in respect of the

Transferring Business.

6.61 There are significant differences between the risk exposures in Knapton relative to those in RSAI, in particular relating

to the types of business written. Knapton is a relatively small insurer in run-off whose remaining liabilities include a

significant amount of engineering-related exposures, although it does have exposures similar to those of the

Transferring Business, including US APH-related claims. On the other hand, RSAI is a large on-going insurer writing

large amounts of new business, including UK personal and commercial lines. Within this, RSAI does have a large and

uncertain legacy portfolio, although its principal risks relate to UK asbestos and other exposures, as opposed to the

mainly US exposures in the Transferring Business.

6.62 The policyholders of RSAI that will transfer under the Scheme will lose the benefit afforded by being part of a large and

diverse insurance company. However, given the financial strength of Knapton, as discussed above, I do not consider

that the Scheme will materially adversely affect the policyholders of the Transferring Business.

Conclusion

6.63 I am satisfied that, although the proposed Scheme will lead to a change to the risk exposures of the

Transferring Business, this will not have a materially adverse impact on the security of policyholder benefits.

Policy servicing

6.64 There will be no change to the policy administration arrangements of the Transferring Business as a result of the

Scheme. The business of the Tower Pool (of which the Transferring Business is a part) is currently administered by

Downlands and this will not change as a result of the Scheme.

6.65 I therefore have no reason to believe that there will be any change to policy servicing standards resulting from the

Scheme.

Conclusion

6.66 I believe that the proposed Scheme is unlikely to have a materially adverse impact on the standards of policy

servicing experienced by the transferring policyholders of the RSAI compared to their current position.

Milliman Report


Conclusion for the policyholders of RSAI transferring under the Scheme

6.67 I am satisfied that the proposed Scheme does not affect in a materially adverse way either the security or the

policy servicing levels of the policyholders of RSAI transferring under the proposed Scheme.

Milliman Report


7. THE IMPACT OF THE SCHEME ON THE POLICYHOLDERS OF RSAI WHO WILL

REMAIN IN PLACE AFTER THE TRANSFER

7.1 As the Transferring Business is currently a very small part of RSAI’s portfolio, and is already 100% reinsured into

Knapton, the non-transferring policyholders will be, to all intents and purposes, unaffected by the Scheme.

7.2 Currently, if Knapton were to fail (a scenario which appears to be remote based on Knapton’s current excess assets,

as described in Section 6 above), the gross liabilities of the Transferring Business would fall back on RSAI. Given the

size of the Transferring Business, this is unlikely to affect materially the other policyholders of RSAI. If the Scheme

were sanctioned this risk would be removed, and therefore the non-transferring policyholders would benefit from the

Scheme in this way. Similarly, were RSAI to be wound-up (a possibility which also appears to be remote based on

RSAI’s current assets, as described in Section 6 above), the non-transferring policyholders of RSAI would be marginally

better off had the Scheme been sanctioned as there would be fewer policies over which to share the remaining assets

of RSAI.

7.3 As noted above in paragraph 4.14, it is possible that, after the Effective Date, there might remain in RSAI some policies

of the Tower Pool business that could not be transferred under the Scheme. The gross liability for these will remain

with RSAI but, although the existing reinsurance arrangement will cease on the Effective Date, the Scheme provides

for them to be 100% reinsured by Knapton. In this respect the situation of the holders of Excluded Policies would be

identical to that prior to the Effective Date. There would also be no changes to the policy servicing or administration of

the Excluded Policies.

Conclusion for the policyholders RSAI not transferring under the scheme

7.4 I am satisfied that the non-transferring policyholders of RSAI will not be adversely affected by the Scheme.

Milliman Report


8. THE IMPACT OF THE SCHEME ON THE CURRENT KNAPTON POLICYHOLDERS

8.1 Under the Scheme, the policyholders within RSAI whom Knapton currently reinsures will become policyholders of

Knapton. The Scheme does not provide for any transfer of assets from or to Knapton, other than the outwards

reinsurance contracts that relate to the Transferring Business, although, if the Scheme is sanctioned, RSAI will be

entitled to draw-down $750,000 from the LOC which will represent a slight reduction in the excess assets of Knapton.

As the liabilities of the Transferring Business are already reinsured into Knapton, there will be no change to the reserves

or risk exposures in Knapton as a result of the Scheme. No other changes in policy servicing or administration will

result from the Scheme. I concluded in Section 6 above that the policyholders of Knapton currently enjoy a degree of

financial security in terms of reserve strength and excess assets as afforded by a well-capitalised company, and will

continue to do so if the Scheme is sanctioned, notwithstanding the slight reduction in excess assets that will result from

the draw-down from the LOC. As explained further in Section 9 below, if the Scheme is not sanctioned, the reinsurance

agreement between RSAI and Knapton concerning the Transferring Business will cease and RSAI will be able to draw

down funds from the LOC. As these funds are likely to be greater than the value of reserves held by the business, the

non-sanctioning of the Scheme will result in a reduction in the excess assets of Knapton in any case.

8.2 I note that, in an insolvency situation, direct policyholders rank ahead of reinsurance policyholders in recovering unpaid

liabilities. Therefore, in the event of an insolvency of Knapton, currently the direct policyholders of Knapton would rank

ahead of the reinsured Transferring Business, as well as other reinsurance business written by Knapton. However,

were the Scheme sanctioned, the direct policyholders of the Transferring Business would become direct policyholders

of Knapton and would therefore rank alongside existing direct Knapton policyholders. In this way, the current direct

policyholders of Knapton may be disadvantaged as a result of the transfer. However, as noted in paragraphs 3.50

- 3.51 above, the vast majority of policies written by the Tower Pool were underwritten by the members of the Tower

Pool other than RSAI (previously Phoenix), with RSAI typically being a reinsurer of the other pool members. Therefore,

Knapton would have just two additional direct policyholders as a result of the Scheme, and in any case the gross

reserves of Knapton relating to the Transferring Business represent only around 7% of the total gross reserves of

Knapton as at 31 December 2013. Furthermore, the likelihood of an insolvency of Knapton, based on my assessment

as described in Section 6 above, would appear to be remote.

Conclusion for the Knapton policyholders

8.3 For the reasons discussed above, I am satisfied that the Scheme will not have a materially adverse effect on

the security of existing Knapton policyholders. Further, the service levels provided to the policyholders of

Knapton will not be adversely affected by the Scheme.

Milliman Report


9. OTHER CONSIDERATIONS

The Likely Effects of the Scheme upon Reinsurers of the Transferring Business

9.1 The outstanding outwards reinsurance in respect of the Transferring Business is relatively minor. As explained in

paragraph 3.53, as at 30 September 2013, the outwards reinsurance case reserves relating to this business totalled

just $82k. In its reserves for this business Knapton assumes no outwards reinsurance IBNR and we understand that

RSAI also makes no allowance for outwards reinsurance IBNR, other than that relating to the 100% reinsurance

provided by Knapton. Nevertheless, in accordance with both paragraph 2.30(12) of the Policy Statement and paragraph

2.33 of SUP18, I have considered the likely effects of the Scheme on the reinsurers whose reinsurance contracts are

to be transferred by the Scheme from RSAI to Knapton.

9.2 As noted in paragraph 1.8 above, the run-off of RSAI’s business is currently handled by Downlands. This will remain

the case post the Effective Date of the Scheme. I have no reason to expect any change in the standards of claims

handling or management. Therefore, the magnitude and timing of recoveries claimed against reinsurance contracts

relating to the business to be transferred by the Scheme from RSAI to Knapton will be unaffected by the Scheme.

9.3 Similarly, all matters between RSAI and the reinsurers whose reinsurance contracts are to be transferred by the Scheme

from RSAI to Knapton are currently dealt with by Downlands. This will remain the case post the Effective Date of the

Scheme.

Conclusion for the reinsurers of the Transferring Business whose contracts of reinsurance are to be transferred by the Scheme

9.4 For the reasons discussed above, I am satisfied that the Scheme will not have a materially adverse effect on

the reinsurers of RSAI whose contracts of reinsurance are to be transferred by the Scheme.

The Approach to Communication with Policyholders

9.5 Regulations made under the FSMA require a communication regarding the proposed transfer to be sent to every

policyholder of the parties to the Scheme (“the Parties”). However, consideration may be given to the practicality and

costs of sending notices against the likely benefits for policyholders of receiving such communications. In order to

comply with both paragraph 2.53 of the Policy Statement and paragraph 2.46G of SUP18, the companies would be

expected to notify the policyholders, or interested persons, at least six weeks before the date of the Court hearing at

which the application to sanction the Scheme will be heard.

9.6 The Parties’ approach to communicating the Scheme to affected policyholders is outlined in Section 4 above.

9.7 I have reviewed draft copies of the proposed notices and letters, including the draft summary of the Scheme and of the

Report. I am not an expert in such communications. However, I consider the draft notices and letters to be clear and

concise, and to contain all of the information that I would expect them to contain.

9.8 I am satisfied that the proposed approach to communication with policyholders in respect of the Scheme is both

proportionate and reasonable.

Service Standards

9.9 Administrative services for the Transferring Business, as for all of the Tower Pool business, are currently undertaken

by Downlands. I have been informed that the contract with Downlands has recently been renewed for a further 2 year

term and that this contract will transfer to Knapton if the Scheme is sanctioned.

9.10 The claims service standards for the business of Knapton (generally) are required to meet TCF criteria. These

arrangements will continue following the implementation of the Scheme.

9.11 The Scheme will have no effect on the service standards experienced by existing Knapton and non-transferring RSAI

policyholders.

9.12 Therefore, I am satisfied that there should be no changes to the service standards for transferring and non-transferring

policyholders as a result of the Scheme.

Milliman Report


Assets and Liabilities of RSAI and Knapton

9.13 Since the Transferring Business is entirely reinsured by the Transferee, the only transferring assets are expected to be

the benefit of certain reinsurance contracts and other third party contracts, reinsurance recoveries, salvage and

subrogation rights and the books and records of the Transferring Business.

9.14 The Court has the power to order (and the Scheme provides for) the transfer of the relevant outwards reinsurance

contracts of RSAI to Knapton. On the basis that the relevant outwards reinsurance contracts of RSAI are transferred

as part of the Scheme, the net (of reinsurance) position of Knapton should not be adversely impacted as a result of the

Scheme. Even were they not to be fully transferred, on the basis that Knapton currently makes no allowance for any

future recoveries against the outwards reinsurance protecting the Transferring Business the net (of reinsurance)

position of Knapton should still not be adversely impacted as a result of the Scheme.

Operational Plans and Changes in Assets and Liabilities up to the Effective Date

9.15 The balance sheets I have reviewed for RSAI and Knapton show amounts as at 31 December 2013. I have chosen

this date because it is the latest date for which audited financial information is available.

9.16 I expect that the current activities of Knapton and RSAI have continued, and will continue, between 31 December 2013

and the Effective Date (and, as appropriate, after the Effective Date). RSAI has continued, and will continue, to write

new business, and has continued, and will continue, to settle claims and reassess reserves in the light of experience.

I do not consider that any material additional risk to any group of affected policyholders will emerge as a result of the

continuation of normal business.

9.17 Similarly, Knapton has continued to settle claims and reassess reserves in the light of experience. The Enstar Group

continues to consider other portfolios of run-off business to take on and may use Knapton as a vehicle for taking on

such portfolios if it is deemed appropriate. I have given details above of one such portfolio, the Allianz Marine XL

Portfolio, which has recently transferred to Knapton, and I have discussed the effect of that transfer on the financial

strength of Knapton in Section 6 above. I am not aware of any additional proposed transfers into Knapton.

9.18 I believe that it is unlikely that any events occurring between 31 December 2013 and the Effective Date would affect

any conclusion that I have reached based on my review as at 31 December 2013.

9.19 A short time before the final Court hearing, I will consider the extent to which actual changes in assets and liabilities

have been in line with expectations (relative to the position as at 31 December 2013) and hence whether there have

been any changes (including those associated with current economic conditions) that would affect my overall opinion,

and, if necessary, I will report on these separately.

What would happen were the Scheme not to proceed?

9.20 Should the Scheme not proceed, according to the Deed the reinsurance agreement between RSAI and Knapton relating

to the Tower Pool business would be cancelled. On the cancellation of the reinsurance agreement, the LOC would

terminate, with between $0 and $1 million being released to Knapton (depending on the reasons for the Scheme not

proceeding, and particularly whether either party were deemed responsible for the Scheme not proceeding) and the

remaining balance of the LOC being paid to RSAI.

9.21 As noted in paragraph 4.2 above, roughly $9 million remained in the LOC as at 30 September 2013. RSAI’s held gross

reserves as at 31 December 2013 (which were based on figures as at 30 September 2013) totalled $11.1 million in

respect of the Transferring Business, while Knapton’s held reserves for the same business, when rolled-forward for

payments to 30 September 2013, totalled $6.4 million.

9.22 Therefore, if the Scheme were not sanctioned, the amount of money Knapton will have to pay to RSAI will exceed its

held reserves in respect of the Transferring Business by between $1.6 million and $2.6 million, depending on the

circumstances, and therefore the excess assets of Knapton will reduce by this amount. I note that this amount exceeds

the $0.75 million that would be due to RSAI were the Scheme sanctioned.

Milliman Report


9.23 The position is rather different for RSAI. As RSAI is holding provisions, gross of the Knapton reinsurance arrangement,

in respect of the Transferring Business that are higher than those held by Knapton, if the Scheme is not sanctioned, for

whatever reason, then the amount that RSAI will receive from the LOC will be less than its held reserves in respect of

the Transferring Business (although, as discussed in paragraph 6.12 above, the gross reserves held by RSAI as at 31

December 2013 in respect of the Transferring Business appear to be greater than a best estimate). Therefore, in the

short term, policyholders of RSAI would suffer a small reduction in excess assets if the Scheme were not sanctioned.

This may or may not be permanent – as more of the outstanding liabilities under the Transferring Business were paid,

it would be reasonable to expect that RSAI would revise its estimate of its gross provisions for the business which

would, if its current provisions prove to be overstated, reverse (at least in part) this reduction. In any case, the effect

on the shareholders’ funds of RSAI, whether the Scheme is sanctioned or not, would be very small in relative terms (in

paragraph 6.28 above I note that RSAI’s 2013 PRA return showed capital resources of over £2 billion), and would not

have a material effect on the security of RSAI policyholders, including those of the Transferring Business.

Solvency II

9.24 As described in Section 2, the regulatory solvency reporting requirements for EU insurers and reinsurers are due to

undergo a major overhaul. I am informed that both RSAI and Knapton are progressing with their respective preparations

for Solvency II. As noted above, RSAI is intending to adopt the internal model approach when assessing its SCR,

whereas Knapton is intending to use the standard formula, and both have already made estimates of their capital

requirements under these bases. These calculations indicate that both companies are expected to meet their solvency

capital requirements, based on the latest information at the time of calculation.

Conclusion

9.25 I am satisfied that, as the Scheme does not alter the overall risk in Knapton, it will not impact Knapton’s

approach to meeting and complying with Solvency II requirements. In addition, based on recent standard

formula calculations, Knapton will have sufficient capital resources to meet its SCR. In my view, the

introduction of Solvency II will not impact in a materially adverse way the security and policy serving levels of

any group of policyholders affected by the Scheme.

Tax

9.26 I am informed that the Scheme is not expected to have tax implications that would affect any policyholders impacted

by the transfer under the Scheme.

Costs of the Scheme

9.27 The external costs of the Scheme (estimated to be about £300,000, based on the Scheme and planned communication

with policyholders outlined above) will be met by RSAI and Enstar in equal proportions. While these costs are not

insubstantial, they are one-off in nature and not material in the context of the surplus capital as at 31 December 2013

of either organisation.

Milliman Report


10. CONCLUSIONS

10.1 In summary, in my opinion, provided the proposed Scheme operates as intended, and I have no grounds for believing

that it will not do so:

The security of benefits to policyholders of RSAI and Knapton will not be materially adversely affected by the

implementation of the Scheme on the Effective Date; and

The Scheme will have no impact on service standards (operated in accordance with TCF criteria) experienced by

the policyholders of RSAI and Knapton.

10.2 In reaching this opinion I have applied the following principles (as set out in the Transformations TAS):

I have considered which parties might be affected by the Scheme and in what way. I have documented my findings.

Although I have not performed my own modelling, rather I have relied on the results of models developed and

operated within RSAI and Knapton, I have reviewed documentation describing the models, describing and justifying

the assumptions underlying those models, and explaining the derivation of the data underlying the models and

assumptions, in particular explaining how its accuracy, completeness and relevance has been verified.

To the best of my knowledge there are no beneficiaries for whom the impact of the Scheme has not been

considered.

I have considered how the Scheme might lead to any changes in the material risks to the benefits of the different

interested parties.

I have considered the impact on the actuarial information provided to me of RSAI and Knapton having adopted

alternative plausible assumptions, for example in the scenario and sensitivity tests within the ICA calculation.

Derek Newton / 5 May 2015

Fellow of the Institute and Faculty of Actuaries

Milliman Report


APPENDIX A DEFINITIONS

Allianz Group The group of companies ultimately owned by Allianz SE, a company incorporated in Germany.

Correlation Correlation (in the context of the Report) is a number that describes the statistical relationship between

two variables (e.g. equity prices and interest rates).

Enhanced

Capital

Requirement

(“ECR”)

A more risk sensitive capital requirement (than the MCR) for UK insurers as measured by the PRA.

Enstar Group The group of companies ultimately owned by Enstar Group Limited, a company incorporated in Bermuda.

Equalisation

Reserve

An equalisation reserve is a reserve built-up (generally from profitable years) as a cushion against periods

with worse than average claims experience.

PRA Returns Accounts, balance sheets, abstracts and statements relating to the business of an insurance company

required under PRA rules to be submitted periodically to the PRA. Prior to May 2013, companies were

required to submit this information to the FSA.

Individual

Capital

Assessment

(“ICA”)

An insurance company’s own assessment of the capital it needs for regulatory purposes in order to mitigate

appropriately the risks to which it is exposed and that could otherwise cause it to be unable to meet its

liabilities as they fall due.

Individual

Capital

Guidance

(“ICG”)

The PRA’s assessment of the minimum level of capital that it would expect an insurance company to hold

based on its view of the insurance company’s ICA and risk management framework.

Minimum

Capital

Requirement

(“MCR”)

Required minimum level of capital under Solvency I rules. See Appendix D for further details.

Reinsurance An arrangement with another insurer whereby risks are shared (or passed on).

Solvency I The system for establishing minimum capital requirements for EU insurers under relevant EU Directives

presently in-force.

Technical

Provisions

Liabilities determined for regulatory purposes. In particular, the provisions for the ultimate costs of settling

all claims arising from events which have occurred up to the balance sheet date, including provision for

claims incurred but not yet reported, less any amounts paid in respect of these claims; plus the provisions

for future claims arising on unexpired periods of risk.

Milliman Report


APPENDIX B CV FOR DEREK NEWTON

B.1. Derek Newton is a principal and actuarial consultant in Milliman's London office. He is co-leader of Milliman's UK

General Insurance practice. He joined the firm in 2003.

B.2. Derek started his actuarial career in 1983. Since 1994 he has worked exclusively within General Insurance, where he

has experience with reserving, mergers and acquisitions (M&A) activity, portfolio transfers, Solvency II, the underwriting

process, management reporting, designing and evaluating non-traditional risk transfer mechanisms, capital modelling

and evaluation, and the design and construction of model office software. His experience includes:

Providing a full actuarial reserving service to several Lloyd's syndicates. These syndicates were multi-line

insurance providers, writing direct and reinsurance covers, covering short-term and long-term, marine and non-

marine, property and casualty risks. The service included providing statements of actuarial opinion for Lloyd's and

for the relevant US insurance departments, and assisting with the preparation of internal capital assessments, in

accordance with the relevant solvency requirements

Providing independent assessments of the unpaid claims liabilities of several UK motor insurers, both on a regular

and a one-off basis

Leading a review of the reserving processes, procedures and practices for a major UK insurer, covering both

commercial and personal lines

Leading assignments to review the underwriting effectiveness of several insurance operations, both commercial

and personal lines

Leading teams reviewing reserves for major divisions of global reinsurers

Providing expert-witness support to lawyers involved in legal action concerning insurance companies both in the

UK and elsewhere

Developing a stochastic model to help a motor insurer evaluate the benefits of a multi-year funding layer as a

replacement for more conventional layers of reinsurance cover

Leading the development of an innovative strategic planning tool for a UK insurer

Leading the review of reserves of various Europe insurers as part of due diligence assignments

Providing advice and support to UK insurers preparing for Solvency II.

B.3. Of particular relevance in this context, Derek acted as the independent expert in the Part VII transfer of the general

insurance business of RL(CIS) limited to CIS General Insurance Ltd, a transfer which was sanctioned earlier this year.

In addition, Derek has been involved (mostly as peer reviewer to the Independent Expert) in the following transfers

(some of which were cross border).

the business of various UK-regulated subsidiaries of RSAIG to a smaller number of UK-regulated subsidiaries of

RSAIG. The transfers were approved by the Court on 12 December 2011

the business of PA(GI) Limited to RSAI and to Marine Insurance Company. The transfers were approved by the

Court on 12 December 2011

the Irish branch business of RSAI to EGI. The transfer was approved by the Court on 18 December 2008

business of Euler Hermes Guarantee plc to Euler Hermes UK plc in 2010

business of Euler Hermes UK plc to Euler Hermes Belgium in 2011

certain business of the Italian branch of Sompo Japan Insurance Company of Europe Limited to Berkshire

Hathaway International Insurance Limited. The transfer was effective 31 March 2013

Milliman Report


the business of Chevanstell Limited to R&Q Insurance (Malta) Limited. The transfer was effective 31 December

2013

the European branch business of Mitsui Sumitomo Insurance Company (Europe) Limited to MSIG Insurance

Europe AG. The transfer was effective 31 December 2013.

B.4. Before joining Milliman, Derek was:

A director of Heath Lambert's ART division (2002-2003)

A partner within Ernst & Young's UK property & casualty consulting practice (1998-2001)

In a variety of roles within Prudential plc (1983-1998), culminating in finance director and actuary for Prudential's

UK general insurance operation.

B.5. Derek was awarded Fellowship of the Institute of Actuaries in 1988 and of the Society of Actuaries in Ireland in 2004.

He has been a member of the General Insurance Board of the Institute & Faculty of Actuaries since 2002 and chaired

the Board 2005-2007. He also served on the Council of the Institute of Actuaries between 2005 and 2010. He has

chaired various actuarial working parties and authored or co-authored several papers. Until earlier this year he chaired

the profession's General Insurance Reserving Oversight Committee. In 2013 Derek received a special award from the

profession to mark his Outstanding Contribution to General Insurance Research.

Milliman Report


APPENDIX C TERMS OF REFERENCE

C.1. The Independent Expert’s Report will consider the terms of the Scheme generally and the effect which the Scheme will

have on the holders of insurance policies issued by RSAI and by Knapton (“the Companies”).

C.2. The Independent Expert’s review and Report will address generally the way in which each of RSAI and Knapton has

conducted its insurance business, taking into account the particular circumstances of each class of business to be

transferred. In summary the review and Report will consider the merits of the Scheme from the perspective of each of

the groups of policyholders affected by the Scheme and deemed to require separate consideration. This will involve

any policyholders remaining in RSAI, policyholders being transferred and the existing policyholders of Knapton.

C.3. The Independent Expert will carry out the work necessary to enable him to form an opinion on the Scheme. This is

likely to include, amongst other things, all or part of the following:

C.3.1. Production and provision of a data request detailing the information Milliman requires from the Companies in

order to provide services under the Scheme.

C.3.2. Support to the Companies’ dialogue with the Regulator and provision of information required by that dialogue

including:

information about the Independent Expert, Milliman and its clients in order that the Regulator may assess

whether it is appropriate for Milliman to carry out this work; and

information to enable the Regulator to assess whether the proposed Independent Expert is suitably

qualified for the role.

C.3.3. Agreement of the scope of Milliman’s work with the PRA, including the provision of the documented agreed

scope.

C.3.4. For each of the Companies, an analysis (where necessary) of the:

liabilities being transferred (including reserves for incurred but not reported claims, unearned premium

reserves and any additional reserve for unexpired risks), including the likely scope for deteriorations in the

technical reserves (i.e. the likelihood and extent to which reserves may prove inadequate);

assets in respect of outwards reinsurance;

bad debt provision in relation to outwards reinsurance;

allocation of reinsurance protection to different groups of policyholders, if appropriate;

other assets and liabilities to be transferred;

current profitability; and

exposure to catastrophic losses.

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C.3.5. Comparison of the solvency positions of the Companies, including consideration of any intra group reinsurance

contracts and/or guarantees that may be provided, with the aim of comparing the current solvency position

with the anticipated solvency position immediately after the Scheme is implemented and after other planned

material corporate changes that the Companies have advised to the Independent Expert are completed. The

consideration of the solvency position of these companies is expected to be carried out by comparing available

capital against regulatory minimum capital based on Solvency I, ICA and the proposed Solvency II (as

presently understood) regulations, and taking into account the qualitative and quantitative aspects of these

solvency regimes (using, but not limited to, the Companies’ internal models for ICA and Solvency II purposes)

produced by the Companies (as necessary).

C.3.6. Analysis of publically available information on the financial strength of each of the Companies, where available,

including rating agency reports, analysts’ reports annual report and accounts and financial statements.

C.3.7. Analysis of the effect of the Scheme on non-financial aspects, including existing policyholder service levels

and agreements, for the policyholders remaining in RSAI (if any), policyholders being transferred and the

policyholders of Knapton.

C.3.8. Discussion with the Companies regarding the initial findings in respect of the Scheme, which may involve the

provision by Milliman of exhibits documenting various findings from its work including where appropriate, but

not limited to, work carried out in items C.3.4 to C.3.7above.

C.3.9. Discussion with the Regulator as required, in line with the discussions with the Companies in C.3.8 above.

C.3.10. Production of the Report, for submission to the Court.

C.3.11. Production or approval of a summary of the Independent Expert Report that forms part of the Scheme

summary for inclusion within letters to policyholders.

C.3.12. Production of the Independent Expert Update Report, for submission to the Court.

C.3.13. If required attendance at Court hearings.

C.4. Milliman will liaise with the Companies and their professional advisors where necessary, in order to complete its work

under the Scheme. The Independent Expert will request from the Companies the information required by the

Independent Expert which is necessary to complete his work.

C.5. The scope of Milliman’s services and any deliverables will be limited solely to the services and deliverables set out in

this agreement. Milliman will make no representation in respect of, and will not consider any other aspect of, the

Companies’ operations.

These terms of reference were reviewed by the PRA when it approved the appointment of Derek Newton as Independent Expert

in respect of the Scheme.

Milliman Report


APPENDIX D KEY SOURCES OF DATA

D.1. In writing the Report, I relied upon the accuracy of certain documents provided by Knapton. These included, but were

not limited to the following:

Legal documents

Draft Scheme document

Draft Witness Statements

A copy of the reinsurance agreement between RSAI and Knapton concerning the Transferring Business.

Financial returns and performance

PRA Returns for RSAI and Knapton for the year-ended 31 December 2013

Financial Statements for RSAI and Knapton for the 2013 year

Management accounts of Knapton as at end of Q1 and Q2 2014

Solvency / Capital information

The RSA Group’s 2013 Capital Report, as at 31 December 2012

A draft of the RSA Group’s 2014 Capital Report, as at 31 December 2013

Half-year ICA model results update slide for the RSA Group, as at 30 June 2014

Spreadsheet summarising the results of Knapton’s ICA, standard formula SCR calculation and ICG as at 31

December 2013 and 31 December 2012

Knapton’s ECR return as at 31 December 2013

A report prepared by external actuarial consultants on the reserve risk assumptions used in Knapton’s ICA as at

31 December 2013

A document detailing Knapton’s risk appetite monitoring

Knapton’s risk management dash board dated Q2 2014

Reserving

“UK Reserve Assessment” actuarial reports for RSAI as at year-end 2013 and 2013 (based on data as at the end

of the previous September)

A roll forward document showing the development in reserves to the end of June 2014 for RSAI

External actuarial report, as at 30 September 2011, commissioned by RSAI in respect of the Transferring Business

External actuarial reports concerning the UK asbestos reserves of RSAI as at 31 December 2013

External actuarial reports on the reserves of Knapton as at 31 December 2013 and 31 December 2012

An internal Enstar Group memo, dated 16 January 2014, concerning the reserves of the Allianz Marine XL Portfolio

as at 31 December 2013

An internal Enstar Group memo, dated 14 January 2014, concerning the bad debt provisions of Knapton as at 31

December 2013

Outwards reinsurance

A spreadsheet listing Knapton’s outwards reinsurers, reserves and bad debt provisions as at 31 December 2013

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A document setting out Knapton’s outwards reinsurance programmes

Treating Customers Fairly

A document, dated July 2013, setting out Knapton’s UK complaints handling procedures.

D.2. Information relating to the items listed above was also gathered during discussions with staff of RSAI.

Milliman Report


APPENDIX E MINIMUM CAPITAL REQUIREMENT FOR GENERAL INSURANCE

BUSINESS AS AT THE 2013 YEAR-END

E.1. In the UK, the process of setting minimum solvency margins changed with effect from 2005. However, UK general

insurers remain subject to statutory requirements based on EU Directives and, for the time being, provide their risk-

based enhanced capital requirement (“ECR”) calculation to the FSA in private. In addition, all UK general insurers are

required to make individual capital assessments (“ICAs”) of their own capital needs which will be used by the FSA when

giving individual capital guidance (“ICG”).

E.2. The minimum capital requirement (“MCR”), based on EU Directives, is calculated as the greater of:

a premium measure

a claims measure

a prior year MCR measure

a minimum amount, currently set at €3.7 million.

E.3. The premium measure (A) is based on gross adjusted premiums (P) as follows:

If P ≤ €61.3 million then A1 = P x 18%, A2 = 0

If P > €61.3 million then A1 = €11.034 million, A2 = (P - €61.3 million) × 16%

A = A1 + A2

E.4. The claims measure (B) for other than health insurance is based on gross adjusted incurred claims (C) as follows:

If C ≤ €42.9 million then B1 = C × 26%, B2 = 0

If C > €42.9 million then B1 = €11.154 million, B2 = (C - €42.9 million) × 23%

B = B1 + B2

E.5. A credit for reinsurance factor (r) is then determined as the ratio of net incurred claims over the 3 year period (to the

valuation date) to gross incurred claims ratio over the same 3 year period. If r < 0.5 then r is set to 0.5.

E.6. The prior year MCR measure (M) is based on the MCR as at the prior financial year-end and changes in outstanding

claims:

Where net outstanding claims are greater than zero as at the end of the current and previous financial years then

M = Prior year MCR × min(1, net outstanding claims as at the end of the current financial year divided by the net

outstanding claims as at the end of the previous financial year);

Where net outstanding claims are zero as at the end of the current and previous financial years then

M = Prior year MCR × min(1, gross outstanding claims as at the end of the current financial year divided by the

gross outstanding claims as at the end of the previous financial year);

Where gross outstanding claims are zero as at the end of the current and previous financial year then

M = MCR as at the end of the previous financial year.

E.7. Minimum solvency margin = max {max (A,B) × r, M, €3.7million}

E.8. For the purposes of this calculation, inwards reinsurance business is treated as insurance business.

E.9. The currency amounts within this calculation are subject to periodic revision.

Documents

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