How schemes of arrangement can help reshape rights and obligations in life and pensions contracts

How schemes of arrangement can help reshape rights and obligations in life and pensions contracts

Many firms in the UK life and pensions sector are considering action to bring their legacy products in line with current law and regulation, and to deliver better and fairer outcomes for their customers.

Some of those actions require a reshaping of the rights and obligations of the firm and its customers under their policy or contract, which is likely to require the consent of customers to the changes. A scheme of arrangement is a mechanism which enables changes to be made where there has been a vote of affected customers, with the proposals sanctioned by the court.

If the requisite voting majorities are achieved and the court sanctions the scheme of arrangement, it becomes automatically binding on all in-scope customers. A scheme of arrangement is therefore a very effective mechanism to gain collective consent of customers if the voting thresholds and court sanction can be achieved.

Scheme of arrangement requirements

A scheme of arrangement is a compromise or arrangement between a company and its creditors – in this case its customers – under Part 26 of the 2006 Companies Act. A scheme can only be used where there is “give and take” between the company and its customers – typically the compromise will involve customers giving up a right under a contract in exchange for a financial or other benefit. The process involves an application to court asking it to convene a meeting of in scope customers to approve the scheme.

Detailed communications are issued to in-scope customers who are asked to vote on the scheme at a meeting. In order to proceed, the scheme must be approved by a majority in number representing 75% in value of customers voting on the scheme. If the requisite majority approves the scheme, the company returns to court to request the court to sanction the scheme. If the court sanctions the scheme, it becomes binding on all in-scope customers, irrespective of whether they voted in favour of the scheme or if they voted at all. It is a robust legal mechanism with detailed communications, credibility and transparency.

When a scheme is used

A firm can technically propose any compromise that it wishes between it and its customers, provided there is “give and take”. We have set out below some examples of where a scheme might be used as part of the toolkit for legacy simplification.

With-profits compromise

A with-profits compromise could involve a conversion to unit-linked in exchange for a one-off uplift or could accelerate the distribution of the estate of a with-profits fund to achieve fairer outcomes and avoid the impact of a tontine. With-profits business continues to be of decreasing importance to many firms, as it is mainly legacy business in run off. With-profits conversion or compromise might be performed alongside fund consolidation of legacy ring-fenced funds to achieve diversification benefit. The nature of with-profits funds makes them challenging to manage, including from a risk capital perspective.

GARs compromise

The Guaranteed Annuity Rates (GARs) compromise offers a one-off uplift in exchange for the guarantee associated with annuity purchase options. The guarantees are particularly onerous in periods of low interest rates. Despite providing a valuable benefit, customers are less likely to annuitise following ‘Freedom & Choice’, and the presence of GARs can create practical barriers to pension transfers.

Administrative upgrades and other changes

When customer consent is required for administrative changes, whether alongside another compromise or arrangement or on a standalone basis, it would be worthwhile to consider whether a scheme of arrangement can be deployed. This will require an analysis of whether there is a valid compromise or arrangement which would make it a scheme of arrangement for the purposes of Part 26 of the Companies Act.

Fairness considerations

Typically, a firm proposing a scheme of arrangement will engage an independent actuary to report to the court and customers on the fairness of a proposed scheme of arrangement. Reports are produced both at the time of the initial convening hearing where the judge is asked to convene the customer meeting, and prior to the subsequent hearing to sanction the scheme.

Timing and process considerations

A scheme of arrangement is a significant project to undertake requiring detailed communications, independent actuarial reporting and court hearings. It typically takes 12-18 months to implement. However, a scheme has significant benefits in achieving legal certainty with regard to the changes made as part of simplification.