Report of the Independent Expert on the proposed Scheme to transfer a block of the European International Life Insurance Business of Scottish Widows Limited to Scottish Widows Europe SA Prepared by Tim Roff FIA 14 November 2018 Contents 1 Executive Summary 1 2 Introduction 14 3 Regulatory background 21 4 Background on SWL 31 5 Background on Transferring Business 40 6 Background on SWE 43 7 Outline of the proposed Scheme 51 8 Structure of the Transfer 61 9 Associated Arrangements 66 10 Consideration of SWL’s and SWE’s risk profile and capital projections, and the impact of these on the security of policyholder benefits 79 11 The impact of the Transfer on Transferring Policyholders 89 12 The impact of the Transfer on the Non-transferring Policyholders of SWL 109 13 The Impact of the Transfer on the reinsurer of Transferring Business of SWL 115 A Summary CV for Tim Roff 116 B Extract from w ork order 117 C PRA's approach to insurance business transfers 119 D FCA’s Approach to insurance business transfers 123 E Information/Documents review ed/relied on 130 F Certification for changes to the 2015 Scheme 131 G Communication w aivers 132 H Glossary 133 Scottish Widows Independent Expert Report 14 Nov ember 2018 1 Executive Summary Introduction 1.1 Scottish Widow s Limited (SWL or Transferor) is a private limited life insurance company incorporated in England and Wales and domiciled in the United Kingdom (UK). SWL operates under the UK Companies Act 2006, is authorised by the Prudential Regulation Authority (PRA) and is regulated by both the PRA and the Financial Conduct Authority (FCA) (together the UK Regulators). The principal activity of SWL is the transaction of long-term insurance business. 1.2 Under European Union (EU) regulations, UK insurance companies can sell policies and service business w ritten in European Economic Area (EEA) countries on a Freedom of Services or Freedom of Establishment basis (commonly referred to as "EU passporting rights"). SWL has previously w ritten life insurance and pensions business, primarily in Germany, Austria and Italy under EU passporting rights. SWL is not currently actively seeking new business outside of the UK. 1.3 On 23 June 2016, the UK voted to leave the EU. On 29 March 2017, the UK government officially notified the European Council of the UK's intention to w ithdraw from the EU (Brexit). It is uncertain w hether or not UK insurance companies w ill continue to be able to service business w ritten in EEA countries outside of the UK, under EU passporting rights, after 29 March 2019. Therefore, unless suitable transitional or grandfathering arrangements betw een the UK and the EU are agreed, it is expected that it w ill become illegal for SWL to continue to service its policies w ritten in the EU from that date. 1.4 SWL has decided to establish a new w holly-ow ned subsidiary life insurance company in Luxembourg, Scottish Widow s Europe SA (SWE), w hich is expected to be authorised by the Luxembourg Insurance Supervisory Authority, Commissariat aux Assurances (CAA) by the end of January 2019. After court and regulatory approval, and once SWE has been authorised, SWL w ill transfer its existing business that w as originally w ritten in EU countries (Transferring Business) to this subsidiary. Business being transferred 1.5 I have classified the Transferring Business into tw o main groups: Transferring unitised w ith-profits business (Transferring UWP Business) – business currently invested in Guaranteed Grow th Funds (GGFs) w hich reside in SWL’s Clerical Medical (CM) w ith-profits fund (WPF) (CM WPF), w ritten primarily in Germany, Austria and Italy under EU passporting rights. This group also includes a small number of vested annuities as at 31 December 2017. It is expected that this number w ill grow over time as more policies vest Transferring unit-linked business (Transferring UL Business) – business currently invested in unit-linked (UL) funds that reside in the SWL Combined Fund, w ritten primarily in Germany, Austria and Italy under EU passporting rights. These unit-linked funds are exclusive for policies of the Transferring UL Business (Transferring UL Policies). 1.6 The table below sets out the policy count and the Best Estimate Liabilities (BEL) for the Transferring Business as at 31 December 2017. Number of BEL (investment Total BEL* Policies element only) (£m) (£m) Transferring UWP Business 61,408 1,766 1,753 Transferring UL Business 26,995 318 360 Total 88,403 2,084 2,113 All numbers in the above table are rounded to the nearest whole number. * BEL for the non-investment element is based on Luxembourg Generally Accepted Accounting Principles (GAAP) basis. © 2018 Grant Thornton UK LLP. All rights reserved. 1 Scottish Widows Independent Expert Report 14 Nov ember 2018 1.7 Immediately follow ing the transfer, the unitised w ith-profits (UWP) business w ill be reinsured back to SWL through a reinsurance agreement (the Reinsurance Agreement), w hich w ill include the associated collateral arrangements know n as funds w ithheld (FWH). To provide further security for the Transferring Business, SWL w ill enter into a floating charge agreement (the Charge Agreement) w ith SWE. The Transferring UL business w ill remain w ith SWE, but to ensure that the operations of the UL business remain unchanged, SWE w ill enter into a service agreement w ith Lloyds Bank Plc (LB) to enable them to provide support for the back office management tasks related to the Transferring UL Business (Unit Linked Service Agreement), as happens at present for SWL. 1.8 Additionally, to provide protection for SWE against any litigation claims resulting from SWL's actions prior to the transfer of business to SWE, SWL w ill enter into an indemnity agreement (the Indemnity Agreement) w ith SWE. The Charge Agreement w ill also cover the obligations of SWL under the Indemnity Agreement. 1.9 In this report, I refer to the Reinsurance Agreement (including FWH), Charge Agreement, Unit Linked Service Agreement and Indemnity Agreement together as “Associated Arrangements”. Legal process 1.10 The proposed transfer of business w ill be carried out using a legal process know n as a Part VII Transfer of insurance business (under the Financial Services and Market Act 2000 (as amended) (FSMA)). The terms of the proposed transfer are set out in a document know n as the Scheme. 1.11 It is a requirement that w hen the Scheme is submitted to the High Court of Justice of England and Wales (the High Court) for approval, it is accompanied by a report from an independent expert (Independent Expert). The High Court w ill consider the contents of the Independent Expert's report (the Report) w hen deciding w hether or not to sanction the Scheme. SWL has nominated me, Tim Roff, to act as the Independent Expert and to provide the Report in respect of the Scheme. The PRA has approved my appointment in consultation w ith the FCA. I ow e a duty to the High Court, w hich overrides any duties I ow e to SWL, the PRA and the FCA. 1.12 The Scheme w ill be submitted for sanction by the High Court under Section 111 of Part VII of FSMA. If approved, it is expected that the Scheme w ill become operative and take effect on 28 March 2019 (the Effective Date). The purpose of the Report 1.13 The Report describes the impact of the Scheme and the Associated Arrangements (together the Transfer) on the policyholders w hose policies w ill be transferred as a result of the Transfer (Transferring Policyholders) and the policyholders of SWL w hose policies w ill not transfer (Non- transferring Policyholders). In each case, I have considered the security of the benefits, benefit expectations and contractual rights of the policyholders. I have also considered how the Transfer w ill impact policyholder protection, service levels and any other factors (eg governance, tax and expenses) that might result in a material adverse effect for any group of policyholders. 1.14 I give an opinion on w hether I consider the position of any group of policyholders to be “materially adversely affected” as a result of the Transfer. The definition of w hat is “material” depends on the matter being discussed, but if a potential effect is very unlikely to happen and does not have a large impact, or if it is likely to happen but has a very small impact, I do not consider it material. 1.15 The Report also describes the impact of the Transfer on the current external reinsurers of SWL w hose treaties cover the risks associated w ith the policies of the Transferring Business (Transferring Policies). Key Dependencies 1.16 I have prepared the Report on the assumption that a number of actions take place either on or before the Effective Date. If these actions are not completed by the Effective Date, the conclusions in the Report may not be valid. I w ill revisit my conclusions based on the latest developments in my supplementary report (Supplementary Report) w hich I w ill provide to the High Court shortly before the © 2018 Grant Thornton UK LLP. All rights reserved. 2 Scottish Widows Independent Expert Report 14 Nov ember 2018 Scheme is submitted for sanction. Accordingly, I consider these actions to be key dependencies. These dependencies are: SWE receives authorisation from the CAA. Without the relevant authorisations, it w ould not be possible for the Scheme to be implemented SWE receives an initial capital injection from SWL that is sufficient to capitalise SWE at its target capital level (see paragraph 6.19), taking into account the transfer of assets under the Scheme SWE and SWL enter into the Associated Arrangements, namely the Reinsurance Agreement, Charge Agreement, Unit Linked Service Agreement and Indemnity Agreement, to be effective immediately follow ing the Effective Date.