R600m dividend: Eskom’s insurance captive asks for fine to be reconsidered

Eskom’s wholly owned insurance captive, Escap Limited, applied to the Financial Services Tribunal (FST) for the R5-million penalty imposed by the Prudential Authority (PA) to be reconsidered.

In July 2022, the PA fined Escap R5m, of which R3m was suspended for three years, for contraventions of the Insurance Act and two of the Prudential Standards issued in terms of the Act: GOI 2 (“Governance of insurers”) and GOI 3 (“Risk management and internal controls for insurers”).

Escap’s reconsideration application related to only one of the PA’s findings: the declaration of a dividend of R600m to the shareholder, Eskom, in July 2021.

The PA’s other findings against Escap are set out at the end of this article.

In 2021, Eskom had serious liquidity problems and asked Escap to invest R600m in short-dated Eskom paper that the market was not prepared to take up. But doing so would have exposed Escap to Eskom beyond the 20% limit for exposure to a single counterparty. It instead decided to declare and pay a dividend for that amount, the FST’s decision said.

Opinion was based on unaudited quarterly figures

Before Escap’s board met to discuss Eskom’s request, the insurer’s head of actuarial function (HAF) prepared a document in June 2021 in which he expressed his opinion on the implications of a “hypothetical” R600m dividend.

The FST emphasised that the HAF’s opinion was based on Escap’s unaudited financial position at the end of March 2021, as reflected in the quarterly Quantitative Reporting Template (QRT).

The document estimated that a R600m dividend would result in a drop in the solvency cover ratio (SCR) from 1.61 (cum dividend) to 1.52 (ex-dividend).

The board’s policy was not to declare or pay a dividend if it may result in an SCR of less than 1.5. “While getting close to 1.5, a R600m dividend would thus not have breached the board’s appetite in this regard,” the HAF said.

The HAF drew attention to the fact that the calculations underpinning his results, “to some extent, rely on high-level approximations, as opposed to detailed, bottom-up calculations. This approach was necessitated due to the time constraints under which this exercise was undertaken. As such, the purpose hereof is merely to provide broadly indicative views, and the results should be interpreted accordingly.”

The assumptions were wrong

Escap’s audit committee recommended to the board that the dividend be paid; the board resolved to pay it; and payment was approved at the annual general meeting (AGM) on 16 July 2021.

But “within days” after the AGM, it emerged that the SCR had been overstated in the March quarterly QRT, the FST said.

According to the draft annual QRT, the SCR was 1.38 (cum dividend) and 1.3 (ex-dividend), not 1.61 (cum dividend) and 1.52 (ex-dividend) as in the quarterly QRT. This material overstatement, according to the PA, was mainly due to the SCR being understated by R854m, which, in turn, was mainly caused by an overly aggressive allowance for loss absorption by taxes and the underestimation of market risk.

PA’s shifting grounds

The FST’s decision describes how, during the hearing, the PA’s reasons for fining Escap shifted from those cited by the Authority in its communication to the insurer in 2021.

Based on counsel for the PA’s submission, the Authority’s reason for the fine could be boiled down to the following: “The board knew that the finalisation of the annual QRT was imminent. Further, the board knew that the annual QRT would be more accurate than the quarterly QRT. We submit that when contemplating a dividend as large as R600m, a reasonable and prudent board acting in the best interests of an insurer would be inclined to await accurate figures that it knows would become available within a matter of days. Indeed, the annual QRT reflecting the correct solvency position was made available to the board on 26 July 2021.”

This meant, counsel said, that Escap contravened section 30(1)(a) of the Insurance Act, which states that an insurer must adopt, implement, and document an effective governance framework that provides for the prudent management and oversight of its insurance business and adequately protects the interests of its policyholders.

Could the FST reconsider the decision?

The tribunal said the PA’s “shifting grounds” raised the issue of whether it could “reconsider” a decision taken on contravention X and find the applicant “guilty” of contravention Y.

The main question was: did the applicant know what the gist or substance of the respondent’s case was?

The FST said Escap’s attention had been specifically drawn to section 30 of the Insurance Act, and the finding in paragraph (f) of the PA’s letter of intent spelled out the gist of the case.

In this paragraph, the PA said that, in declaring the dividend, “the board failed in its oversight responsibility to act with independence of mind in pursuing the best interests of the insurer, policyholders and other stakeholders, as well as to take into account the long-term financial soundness of the insurer as a whole, the interests of its policyholders and other stakeholders, and the fair treatment of customers”.

The FST said an administrative process does not require the “particularity” required in, for instance, a criminal indictment. The tribunal therefore held that it was empowered to consider whether the board implemented its governance framework in a way that adequately protected the interests of policyholders.

‘Pressure of Eskom’s needs’

It appeared that the board ticked all the right boxes and that, formally, its decision was in order. But the problem was that it did not take sufficient note of the caveats raised by the HAF, the FST said.

“One cannot escape the conclusion that the interests of the shareholder trumped the interests of policyholders (Eskom was not the only one). Had it not been for the pressure of Eskom’s needs, the board, in our estimation, would have not considered the declaration of the dividend before the annual QRT report and the final audited statements were available.

“It was a rushed process – and that is not an ex post facto assessment. Everyone involved knew that they had to rush matters,” said Judge Louis Harms, who wrote the tribunal’s decision.

Therefore, the FST concluded that the jurisdictional fact for a decision relating to the dividend issue was present, and the PA was entitled to consider imposing a fine.

Not accepted industry practice

The penalty (R5m of which R3m was suspended) was objectively lenient and when compared to other penalties imposed by the PA or the FSCA, the tribunal said. This was the same penalty that the PA initially thought “fitted the other crimes” without the dividend issue, which, on balance, was the most serious of the contraventions, it said.

Escap’s counsel highlighted four reasons for reconsidering the fine, two of which were that the insurer co-operated fully with the PA and that it put measures in place to prevent a recurrence of the events.

But the FST said the PA had taken both factors into account when it imposed the fine.

The other two reasons were that it is industry practice to rely on quarterly reports for important decisions, and the board had not been “reckless” in following this “commonly accepted” approach.

The FST said there is no evidence that it is industry practice to declare dividends based on quarterly reports. Furthermore, the board did not, in fact, rely on the quarterly report but on the HAF’s report.

However, it did not take sufficient heed of his qualifications and the conclusion, which “he carefully drafted in negative terms”, namely “as far as the duties of the HAF is concerned, that there are no obvious reasons for me to advise the board against the hypothetical payment of a R600m dividend at this time”.

The board took “a calculated risk” by taking a decision based on the HAF’s report that potentially could have put policyholders at risk. The ultimate responsibility for the declaration, as the report stated, was that of the board, the tribunal said.

In its decision dated 4 April, the FST dismissed Escap’s reconsideration application.

Click here to download the tribunal’s decision.

PA’s other findings

In addition to finding that Escap’s board failed in its oversight responsibility to ensure reliable and transparent financial reporting to the PA in respect of the R600m dividend, the PA also found that:

• There were no board-approved policies and procedures relating to the appointment and dismissal of senior management and the heads of control functions.
• There was no board-approved performance and remuneration standard for senior management and the heads of control functions as required by section 8.2 of Prudential Standard GOI 2.
• The former chief executive of Escap occupied potentially conflicting roles as an executive director of Escap and holding the position of Eskom’s general manager for tax.
• The board did not have a succession plan for board members, senior management, and the heads of control functions.
• Escap did not have an organisational structure that informed the resource needs of Escap or ensured alignment to Escap’s internal control structure as an insurance company.
• There were deficiencies in the resourcing of the compliance and risk management control functions, in contravention of section 9.1 of Prudential Standard GOI 3.
• The board failed to oversee decisions relating to the take-on of new business and risk transfer as required by section 9 of Prudential Standard GOI 2.