Reviews of organisational structure are now happening across the industry. In some cases, the question is whether to relocate the ultimate holding company – Bermuda has been an attractive location for many companies, but Switzerland, Ireland, Luxembourg and Holland all have strong arguments in their favour.
In other cases, companies are looking at merging existing subsidiaries into single carriers, changing their group reinsurance structure and generally streamlining their organisations – and they are not just doing it to be neat and tidy.
One of the drivers is Solvency II, which will create a consistent approach to prudential regulation across Europe and should radically change the way that the industry thinks about capital. Many players may see an increase in capital, and others a benefit, particularly where significant diversification exists. As a result, many groups are looking to take advantage of these changes to simplify their structures and maximise capital reduction opportunities.
Although the arguments in favour of reorganisation may all appear to be of the capital, cost and time-savings variety, the decision is often taken on commercial grounds: having a single, deep pool of capital backing all of the group’s entities can make each company appear stronger to customers, and excess capital can be ploughed back into the business.
Meanwhile, simplified regulatory requirements and more streamlined operations can translate into competitive advantage when other companies remain burdened by more complex arrangements.
The EU's Reinsurance Directive has also given reinsurers an incentive to establish a single Europe-wide carrier as they can use their ‘passport’ to write insurance business across Europe.
However, changing the structure of an insurance group is not easy and the pros and cons need to be weighed up carefully. A growing number of companies are reviewing their options. Some will find compelling reasons to take the plunge, while others will find good reasons to retain their existing structures – but the important thing is for companies to ask themselves the question, and try to answer it in a structured, methodical way.
Some companies have already made radical changes to their organisational structure and gained tangible commercial advantages:
One of the most attention-grabbing benefits of corporate reorganisation is capital efficiency. In part that is because markets are forming increasingly conservative expectations about capital quality and capital requirements. At a time when raising fresh capital is costly, it makes sense to use existing capital
effectively – and that is difficult with a traditional insurance group structure. Individual subsidiaries are separately regulated and have their own minimum capital requirements, locking the group’s stock of capital away.
In theory, the group may have a significant capital surplus because of the diversification benefits that exist when its separate carriers are viewed as a single portfolio of business. As a simple illustration, the risks associated with term business would partially offset those associated with annuity business, meaning that less capital overall needs to be held, or that the excess capital could be put to work elsewhere. Spread around separate companies with their own requirements, however, the diversification benefits are not as clear.
Excess capital may be held by an individual company, but it can be hard to redistribute that to another part of the group for a number of reasons: customers, investors, rating agencies and other stakeholders typically do not like to see capital decline, especially in times of economic stress.
A rationalised organisational structure can eliminate these issues at a stroke: for example, if the group has a single carrier, with branches spread across Europe, it will only be subject to a single regulatory capital requirement. Rather than holding five or six separate pots of capital, the carrier has just one capital pot and is able to benefit from diversification within its larger pool of business and the geographical spread of that business.
This seems like a pretty convincing argument in favour of restructuring, but it is clouded slightly by the possibility that insurers may be able to achieve some of the same capital benefits, thanks to Solvency II. The proposed regulation contains ‘group support’ provisions, based on the economic argument that as long as the group as a whole has sufficient capital to support its various activities, individual subsidiaries may be allowed to carry less capital.
This proposal has been one of Solvency II’s lightning rods and it may still be amended to reduce the benefits, or struck out of the rules altogether.
Some insurers may regard the uncertainty about group support as a reason to put restructuring on hold. Others will go ahead regardless, arguing that a new group structure removes the need to cross their fingers and hope that the proposals are implemented in their most beneficial form.
For some groups the aim will be to consolidate their operations across Europe; for others, the simpler option of merging insurance operations in individual territories or in a few countries will still be advantageous.
In addition to the capital benefits, a single carrier will have a single regulatory relationship to maintain with its home-country authority - which means a single set of reporting requirements, and a single set of rules.
A single operating company can also create operational benefits, as it may be easier to use centres of excellence and shared service centres. Duplicated systems, procedures and costs can be removed and the operating model reshaped in order to generate considerable administrative savings.
The tax advantages can also be attractive. It is often important where the head office is located and where the key profit generating functions (e.g. underwriting) take place. While profits earned from a single carrier’s branch network will still be taxed according to the host countries’ rates, the head office and its associated activities can be sited in a country with a favourable regime – Ireland’s 12.5%25 rate, for example, is far more attractive than the 28%25 typically paid in the UK.
Some insurers are even looking to magnify these benefits by cutting back the branch network itself, and writing some business on a services basis rather than an establishment basis – in other words, reducing the amount of bricks and mortar they have, and seeking to do more business from the head office location at a lower rate of tax.
Restructuring is not an easy thing to do, but companies should not be put off – many insurers are finding that the potential benefits outweigh the costs.
There are a number of issues that need consideration. For a start, determining the capital benefits on offer will require considerable actuarial and capital-modelling expertise. Companies that have already made good progress towards Solvency II may have the requisite capabilities in house. Others may need to enlist help from third-party service providers.
The operational efficiency argument can be undermined if a company sites its new head office in a country that lacks either the necessary infrastructure or the workforce to support its activities. Some locations may offer fantastic tax advantages and a sympathetic regulator, but be inappropriate in other respects.
While the potential financial and operational efficiencies can be quantified and used to present a compelling case for change, the success in actually achieving these savings will largely depend on how well the organisation can manage those changes. In our experience, any reorganisation depends on its ability to effectively tackle the human resources issues. The following questions will need to be addressed:
Legal and tax issues have often been a barrier to companies reorganising, but the introduction of the Merger Directive (Directive 2005/56/EC) in most EU Member States makes it easier for insurers to amend their group structure. Companies in different countries can now be merged without the need for any liquidation process and the potential tax leakages that can arise. Some recent reorganisations have made use of a single European company to help facilitate a merger.
Finally, customer relationship issues can be a barrier to change, especially for life companies. Customers of non-life insurers may not have strong feelings if their policy is switched to a company domiciled in another country, but life policies are much longer term and more complex. As a result, the vast majority of companies that have completed any serious restructuring efforts in the last five years have been non-life insurers or reinsurers. However, due to a number of factors, including the current economic climate, we are now seeing a number of life insurers also looking to restructure their business.
Weighing up the pros and cons of a major organisational overhaul is not simple. It requires knowledge of the capital efficiencies available, an assessment of different regulatory regimes and detailed knowledge about the local business environment as it relates to services and skills – all of which may need to be compared across a number of different jurisdictions.
Working out the capital requirements that a new group structure would have and the capital efficiencies that could be achieved can be key.
Companies may feel somewhat overwhelmed by all of this: the period leading up to the introduction of Solvency II will already be a challenging time, without the additional complexity of an organisational review. If approached in a step-by-step manner (see Figure 1), however, we would argue that companies can tackle both issues at once – and a number of groups have already demonstrated that it is possible to reorganise successfully while simultaneously preparing for the new regulatory framework.