The life insurance industry has been affected by a number of factors over the past few years: the 2008-2009 financial crisis, increasing regulation, historically low interest rates, aging populations and tougher accounting rules. And while the future may be hard to predict, it's definitely not impossible to prepare for. There is life within the life insurance industry and like Albert Einstein said, the key is to "keep moving" and take action for the uncertain future, and exploit the emerging opportunities.
PwC is pleased to present a special edition of our Insurance Review: The Canadian life insurer – Competing for a future. This life insurance edition of the Insurance Review spotlights articles on three compelling issues in today's life insurance market:
- The current low interest rate environment continues to have a lasting effect on the insurance industry and its market, resulting in fewer long-term insurance products, lower guarantees and greater risk transfer to consumers. In Low interest rates: Life insurers' great depression, we outline our Future of Insurance analysis framework, the objective of which is to help you and your organization make the most of your competitive potential.
- There is always a tendency to focus on what peers are doing and ignore developments outside of one's own industry. But to stay competitive, your business needs to be thinking and acting at the same rate that technology and customer expectations are evolving. Key considerations for survival and success in a sector facing disruptive and rapid change are discussed in our feature piece, Life insurance 2020: Competing for a future.
- Amid the current scrutiny of reinsurance transactions, we also take an in-depth look at the need for a multinational insurer or reinsurer to appropriately plan for and implement its intra-group reinsurance. The article, Intra-group reinsurance: Considerations to preempt a transfer pricing dispute with the CRA, considers why the management of the attendant transfer pricing risk should become a company-wide responsibility, not just a function of corporate tax.
I hope you find this special edition helpful and look forward to your feedback.
National Insurance Leader
LOW INTEREST RATES - LIFE INSURERS' GREAT DEPRESSION
Long gone are the days where life insurance was mainly about managing mortality risk, when the role of life insurers was to create predictable mortality risk by pooling sufficiently large numbers of lives.
Insurers must now deal with many types of risks, including longevity, policyholder behaviour, operations, expenses, policy guarantees, and long-term investment returns.
Indeed, life insurance products, by their very nature, can be in force for decades. In pricing and reserving for these products, life insurers must make assumptions as to the level of future investment returns they will realize. Everything else being equal, higher returns drive lower premiums and reserves, and vice versa.
Until the 1970s, traditional life insurance products that provided basic death, health and disability coverage were the foundation of the Canadian life insurance business. The period of increasing interest rates during the 1970s and 1980s (Figure 1) put significant pressure on Canadian life insurers' sales and policy retention rates, as consumers were lured by the high interest rates and attractive investment products offered by other financial institutions. This led insurers to venture into non-traditional insurance and the marketing of non-participating products with interest-rate guarantees and deposit-like features, and more aggressive pricing based on projected long periods of higher investment income. Lower interest rates of the 1990s put pressure on pricing and guarantees, but profitability from large and older business priced at much lower interest rates helped soften the impact.
Then came the late 1990s and early 2000s, which arguably saw the single biggest event to hit the Canadian life insurance industry: demutualization.
It allowed insurers access to unprecedented amounts of capital, but along with it came shareholders' demand for growth and returns. Pressure for profits combined with decades of stable market growth and healthy levels of interest rates – at least relative to the 2008 crisis and the ensuing recession – led to further risk taking by life insurers, which was at times questionable. Insurers increasingly provided long-term investment guarantees and looked to relatively riskier invested assets to support those guarantees or provide higher shareholder returns.
So how will the current low interest rate environment, which is not expected to revert anytime soon, affect the life insurance industry?
The impact of low interest rates
The long-term nature of life insurance products exposes insurers to reinvestment risks including the risk of sustained low interest rates. This forces insurers to tightly manage reinvestment risks by using asset and liability management techniques such as matching the projected timing of future asset and liability cash flows, or matching the average respective duration of those cash flows.
Reinvestment risks that are not adequately managed will have an immediate unfavourable impact on an insurance company's reserve levels and capital margins (the difference between available capital and the capital required by regulators). The mismatch leads to earnings volatility and could expose the company to potential solvency issues due to sudden changes in interest rates (usually decreases).
There are few fixed income assets that generate cash flows as far into the future as many insurance products require. Therefore, most insurers remain subject to a certain level of reinvestment risk, particularly that of sustained low interest rates. Actuarial standards require conservatism in dealing with long-term reinvestment risk. This leads to increased actuarial reserve balances and regulatory required capital, and reduces available capital.
Insurers have been hit hard by the continuing low interest rate environment. It is also an issue for stakeholders, regulators, and public policy setters.
Many insurers cannot increase prices without feeling the impact on sales. Their large infrastructures and unwillingness to upset distribution channels have led them down a path of no return. Insurers cannot afford to keep prices unchanged due to low earnings and do not want to increase prices at the risk of jeopardizing sales, leading to problems related to market share, growth, and expenses.
The management of some insurers have made the tough decisions and taken action. Standard Life Canada withdrew from the individual life insurance market in 2011 after spending many years building up the savings and annuities side of its business. In December 2011, Sun Life announced that it was pulling out of the individual life insurance and variable annuity market in the United States. RBC Insurance has recently gone ahead with plans to suspend sales of some permanent life, long-term health, and disability insurance products. Other insurers have been implementing premium rate increases and had to revise their medium-to longer-term earnings plans.
Others are attempting to revive the dormant participating products. Participating products pay dividends to policyholders, which are adjusted to reflect the emerging experience of the business.
Sustained low interest rates are changing the product mix that life insurance companies are willing to sell. If this trend continues, we are looking at a major reshaping of the life insurance market:
- Exposures to long duration guarantee products such as permanent life insurance, critical illness and long-term care may disappear; product offerings are being designed with shorter terms to reduce the periods where guarantees and terms are fixed;
- Companies will be taking on less risk and will pass on risk to policyholders. By reducing guarantees or transferring investment risk, companies are contemplating the re-introduction of participating products; and
- The cost of insurance will become unaffordable to some customers; price increases are being implemented, reaching double-digit percentages in many cases
- These changes also have the potential of introducing important public policy issues:
- Long duration guarantee products do meet a genuine social need for wealth accumulation and retirement planning. The disappearance of these products would create pressure on government programs;
- Consumers arguably are less able to accept and manage life, health, and disability risks without insurance;
- Customers may be unwilling to pay the required premium and forgo protection; and
- Reduction in long-term investments (no longer needed by insurers to support long-term products) which fund domestic infrastructure and support economic growth
Regulators are also paying close attention as life insurers' capital margins which are under pressure from low interest rates. Although insurance is a long-term business, relatively shorter-term market changes can have significant financial impact on insurers. Regulators are looking into whether the underlying financial risks from long-term insurance may need to be better captured in accounting and regulatory capital models. In that regard, the future IFRS rules for insurance accounting and the Canadian regulators' new regulatory capital requirements are anticipated to be more market consistent, whereby actuarial reserves and regulatory capital calculations would reflect interest rates linked to current risk-free rates. That is a material change from the current approach of using returns on the invested assets supporting their liabilities. This change would put further pressure on life insurers' financial results.
Where do we go from here?
The current low interest rate environment will undoubtedly have a lasting effect on the insurance industry and market: fewer long-term insurance products, lower guarantees, risk transfer to consumers. Only time will tell how deep those changes will be.
As challenging as things look for life insurers, one must remember that it is a very resilient and still a very strong industry financially. They have shown their resiliency a number of times over the recent decades: competing with deposit institutions for the consumer dollars during the period of high interest rates of the mid 1970s to 1980s, which was then followed by a prolonged period of low interest rates. And more recently, they managed the impact of the decline in equity markets on segregated fund products. The fallouts from those eras were by no means easy and were hard felt by the industry and consumers. It is, however, a testament to the insurers' product pricing and their financial strength, which has been strong enough as an industry to carry on through difficult times.
With change comes opportunity. Life insurers have been opportunistic in capitalizing from environmental and economic changes as evidenced by the diversity of products now offered compared to 50 years ago, and more importantly, the history of limited life insurer failures (four since the 1970s). There may also be a silver lining in that when interest rates start climbing, the insurance industry will be in a much better position – provided lessons learned from this current environment are remembered.
Regulators and public policy setters will also need to take a hard look at unintended consequences of the transfer of risks in various forms to consumers, its potential impact on society, and make important decisions on what will be the right path to take.
The significant impact of sustained low interest rates underscores the importance of strategic decisions that insurers will need to take.
Interest rates are but one of the significant changes facing the insurance industry. The insurance market is set for transformation as its role, industry structure, and commercial realities are disrupted by major trends reshaping the global economy and competitive landscape. As smart and agile players leapfrog slower-moving competitors, many businesses will be unrecognizable and the list of market leaders could be very different by the end of the decade.
Seeing the future clearly and developing a proactive response – rather than simply reacting to events – will be a key competitive advantage in a fast-evolving market.
PwC's Future of Insurance analysis framework:
- Helps you assess these trends and how they'll impact your strategy and business model
- Considers the rise and interconnectivity of emerging markets and state-directed approaches to economic development
- Examines the impact of new technology, demographics, changing customer behaviour and mounting pressure on the world's most critical natural resources. The analysis draws on the perspectives of industry leaders and PwC's network around the world. It also brings together a huge amount of research into the forces shaping the global economy, customer expectations, and government policy
Rather than offering a one way forward, the Future of Insurance framework recognizes that whether these developments are threats or opportunities depends on the nature of your organization and where in the world you sit. The framework:
- Analyzes the key market to do an outside-in scenario planning based on the five key STEEP factors (social, technological, environmental, economic, and political) and their drivers.
- Looks at the implications for your business model to take an inside-out business analysis that will identify the impact of potential scenarios, the strategies that can be developed to prepare for those changes, and design the levers that you should use to execute your strategy.
The results will help you to target investment, identify talent requirements, and develop the necessary operational capabilities needed to make the most of your competitive potential.
LIFE INSURANCE 2020: COMPETING FOR A FUTURE
The life and pensions sector has many reasons to be upbeat about its future. A larger and longer living global population is increasing demand for retirement products. In turn, the increasing affluence of people within the high-growth markets of South America, Asia, Africa and the Middle East (SAAAME) is creating a growing need for wealth protection.
But this is also a time of massive and potentially disruptive change. As customers become accustomed to the ease, elegance and intuition of the Apple/Amazon 'experience', they want the same accessibility, transparency and responsiveness in their life insurance and pensions products. We've already seen the emergence of easy-to-access and manage products such as target date funds, which automatically adjust the asset mix to the policyholder's selected retirement age. Advances in processing capacity, customer profiling and risk analytics are now opening the way for a new generation of 'smart' policies. While being as affordable and easy to understand/compare as today's off-the-shelf products, these policies would be fully customized and able to adapt to the individual customer's changing needs. Crucially, the technological developments that are making this new generation of policies possible are also making it easier for new entrants to break into the market at relatively little cost.
There is always a tendency to focus on what peers are doing and ignore developments outside the industry orbit. But to stay in the game, your business needs to be thinking and acting at the same rate as technology and customer expectations are evolving. This is especially true at a time when start-ups and new entrants are eyeing the potential within life and pensions. We've seen in other sectors how even market-leading companies can quickly slide into obsolescence once customers see that they can get what they want cheaper and easier. Examples of this rapid decline include Kodak, which, having been America's market-leading digital camera maker as recently as 2008, is now in Chapter 11. In the intervening period, smartphones took away Kodak's market by becoming the most popular means of digital photography. In this brief period, we've also seen music stores lose out to the iTunes store and film rental shops being swept aside by on-demand downloadable films. It's therefore vital to make sure that your business is alert to emerging threats from both inside and outside the industry and that you're ahead of the curve rather than playing catch-up.
While insurance is a highly regulated industry, this shouldn't be an excuse for doing nothing. If regulatory constraints are standing in the way of developments that could benefit customers then it's your job to make supervisors aware of this and work with them to bring controls up to date. Moreover, you can't simply wait for changes in demographics and government policy to create new openings as more proactive competitors are going to get in ahead of you. You have to be nurturing the new markets, designing the smart new products and forging the partnerships needed to capitalize on these opportunities now. You will also need to think about how to create the integrity and trust within the organization that would allow you to respond to customers' evolving needs faster and more effectively than your competitors.
Many life and pensions companies are conscious of the need for fresh thinking and new strategies. Our latest global CEO survey found that insurers as a whole are just behind the technology, communications and entertainment sectors in their readiness to embrace business model innovation1 (see Figure 1). Yet a survey of life and pensions executives carried out for this report raises questions about how far and how quickly they're prepared to go to adapt to change and sustain competitive relevance.2 The uncertainty over where growth is going to come from and how life and pensions companies are going to deal with the disruptive forces they face is reflected in the generally disappointing share prices in the sector.
In this article, we examine the developments that are set to have the most decisive impact over the next five years and the main opportunities for innovation, growth and competitive differentiation. This includes how to deal with the shifting focus of growth ('two-speed' global growth), changes in customer preferences (distribution disruption and the customer revolution), sharper profiling (information advantage through 'big data') and new competitive threats (evolving business models 'big and fast'). The aim is to help life and pensions companies assess the implications of a marketplace in transformation for their particular organization.
The forces shaping change
The life and pensions sector is facing a rapidly evolving and potentially disruptive set of market dynamics:
An older population: The number of people aged over 60 will more than triple to over two billion by 2050,3 creating huge extra demand for retirement solutions.
An increasingly wealthy global population: The number of middle class people (earning more than $10 a day) will grow from 430 million in 2000 to 1.2 billion in 2030,4 with two-thirds of this growth coming from India and China, creating much more wealth to protect and more demand for life cover.
An increasingly connected global population: The number of people connected to the internet will increase from 1.8 billion today to 5 billion by 2020,5 changing how customers interact with your business and their expectations over the speed and intuition of response.
Nearly 50% of the life and pensions executives in our survey believe that the internet will not only change how customers buy insurance, but also the type of products they choose6
Surge in data traffic and development of advanced analytical techniques: The amount of data flowing around the internet will reach 1.3 billion terabytes by 2016 (from around 240 exabytes in 2010).7 Advanced analytical techniques would allow your business to turn this goldmine of digital information into a complete picture of how individual customers behave, what they expect and the risks they present.
Sensors track behaviour: Sensors are now being applied to driving and health, allowing customers to be more proactive about their safety, health and well-being and therefore providing insurers with invaluable insights about their policyholders.
Cloud transforms cost equation: Cloud computing is allowing businesses to turn fixed costs into variable costs. This could reduce expenses for your business, but also lower barriers to entry from new competitors.
Influx into the cities: Over the next 30 years, some 1.8 billion people are expected to move into cities, most of them in Asia and Africa, increasing the world's urban population to 5.6 billion8 and reshaping the marketplace for insurers and other financial services businesses.
Nearly 50% of the life and pensions executives believe that harnessing 'big data' developments will provide a key source of competitive advantage and increased market share9
Pollution: The global increase in industrialization and urbanization is fuelling further rises in pollution and the dangers to health this creates. This could lead to increased demand for your life products on the one side and the need to adjust premiums to reflect shifts in health and mortality rates on the other.
Limits of medicine: The rise reflected in pandemics such as avian flu and drug-resistant strains of diseases like tuberculosis highlights the limits of medicine in the face of mutating viruses and will heighten risks and liabilities.
Most life and pensions executives believe that pollution is increasing, with a significant proportion (one in eight) seeing it as a threat to health and well-being, though most believe it will be contained9
SAAAME grows, mature markets slow: As growth in developed markets stalls and SAAAME markets continue to expand rapidly, the focus of investment and growth within the insurance market is going to shift.
Huge potential for further growth in SAAAME markets: GDP per capita has been growing at 9% in China and at 4% in India over the past 20 years.10 Yet most SAAAME markets still have life insurance to GDP penetration of less than 3%11 and therefore considerable room to grow.
Pressure of debt burden: Sovereign debt concerns and slowing growth in developed markets are leading to instability in capital markets, which could affect both demand for your products and your position as an investor.
Cash-strapped governments withdraw welfare: State support for ageing populations in many markets is being eroded by a combination of government debt and a decline in the ratio of people working to retired ('dependency ratio'). As governments look to insurers to help fill the gap in public provision, reputation and social responsibility are going to become ever more crucial competitive differentiators, spurring smart firms to look beyond short-term 'transactional' gains at how to meet more enduring objectives in areas such as public trust, health and well-being.
Governments look to overhaul regulation: Regulatory change is going to be a way of life for the foreseeable future. It is important to look beyond compliance to understand how regulatory developments will affect your strategy, product design, costs and organizational structure.
The implications for the competitive environment
Dealing with the STEEP dynamics calls for a major rethink of strategic assumptions, routes to market and organizational models, with the ability to look outside-in on your business at the core (Figure 2 sets out the four main challenges we address in this paper):
Two-speed global growth
- Demand for retirement solutions in mature markets is increasing, but life cover sales as a proportion of GDP in a number of major developed markets including the US are declining.12 In SAAAME markets, the big rise is in life cover, with sales of retirement products growing less quickly. Your business will need to develop an agile operating model capable of dealing with the different trajectories of growth. This includes developing innovative growth strategies on the one side and meeting the need for scale and efficiency to sustain margins on the other. It will also be important to support the development of insurance markets, including investment in professional training and educating consumers about the value of life and pension cover and how it works.
- As cities grow and make up an ever increasing share of global GDP, they will become a key competitive 'battleground' for insurers. City dwellers' demand for insurance and other financial services is greater than that of their rural counterparts, especially in SAAAME markets. Indeed, some observers now see the real distinction as not between emerging and developed markets, but rather between city and rural areas.
Distribution disruption and the customer revolution
- Consumers have become accustomed to the ease, intuition and elegance of digital retail interaction and want the same experience from your business. As smartphones, iPads and other such versatile mobile devices proliferate, they also want to be able to conduct business when they want, where they want and on the channel of their choice.
- Customers want greater transparency (allowing them to compare products), flexibility (products that adapt to their changing needs) and control (the comfort of being able to change their mind if not satisfied).
- Regulatory insistence on greater transparency will make it easier to compare prices and value. Developments such as the caps on fees in India and the planned elimination of commissions for advisers in the UK are going to bring charges, and the value policyholders receive in return further into the spotlight.
- The emergence of virtual networks, multichannel interaction and direct-to-consumer life insurance is fragmenting the value chain.
- Risk-based capital regimes are raising capital demands for variable annuities and could lead to higher prices, just as many customers are once again looking for the assurance of guarantees.
Information advantage through 'big data'
- Extracting profiling data from all of the unstructured purchasing, social media and other digital trails people leave behind would allow your business to gain unprecedented insights into their health, wealth and behaviour. The technology to make this possible is already available. The challenge is how to channel the data into actionable insights and build the results into decision making, product design and the underlying culture of the business.
- Sensor technology could be used to help develop a more proactive approach to risk management and customer support by allowing your business to monitor policyholders' health in real-time and alert them to any early signs of illness. Your business would benefit from reduced liabilities and could offer lower premiums in return.
Big and fast: evolving business models
- Improved ability to sense consumer sentiment would allow your business to adjust your position in the market and provide products and services that meet customer demands in shorter timeframes. Gathering information throughout the customer lifecycle, in near real-time, would allow your business to shorten management decision cycles, speed up development cycles and ultimately better serve your customers.
- Use of cloud computing and other technology developments to harness more data and automate underwriting is opening up customized solutions at lower cost.
- Use of technology to create 'virtual outsourcing' solutions can improve service and reduce costs.
- Cheap and easy access to open source software and cloud computing allow new players to enter the market and take advantage of flexible rented computing capacity and smart new analytics to develop their businesses without the need for high start-up costs.
- A combination of more informed risk management and use of automation to lower costs would allow your business to provide policies offering secure returns at reasonable premiums under a risk-based capital regime.
INTRA-GROUP REINSURANCE - CONSIDERATIONS TO PREEMPT A TRANSFER PRICING DISPUTE WITH THE CRA
In the past, tax authorities around the world have tended not to focus on intra-group reinsurance when auditing cross-border transactions, largely due to the perceived complexity of such transactions and the lack of personnel qualified to review them (e.g. tax authorities usually don't employ actuaries). However, as tax authorities have become more sophisticated in their approach to transfer pricing and have gained some knowledge of the insurance industry, they're starting to better understand the factors that affect the pricing of these transactions. As with other cross-border related party transactions, tax authorities are now seeking to ensure that intra-group reinsurance is not used to shift profits from one jurisdiction to another.
Tax authorities outside Canada have succeeded in arguing their positions to allocate most of the profits earned by an intra-group offshore reinsurer back to their respective countries, even in structures involving indirect transactions between related entities through an unrelated company. Specifically, the UK tax authority, Her Majesty's Revenue and Customs (HMRC), successfully argued its position on non-arm's length pricing between a UK retailer that sold extended warranties at point-of-sale and its related offshore captive insurer in 2009. The retailer's customers contracted with a third party that in turn passed the risks of extended warranty contracts to the retailer's captive insurer.13 Since then, HMRC has continued to actively audit and litigate intra-group reinsurance transactions among UK multinationals.
A more recent captive insurance case ruling in the Netherlands involved a Dutch holiday and leisure resort group that sold travel cancellation insurance to its customers. The travel insurance was offered by a third-party insurer that then reinsured the risks to the Dutch group's offshore captive. The Netherlands' Hague Lower Court held that most of the profits generated by the captive's insurance activities should be allocated within the Netherlands to the Dutch group.
In Canada, ongoing CRA examinations are reviewing transactions involving indirect intra-group transactions similar to those in the UK and Dutch cases, though not necessarily the same product line. More importantly, the CRA is also examining direct reinsurance structures involving a local insurer as the producer of the business (cedant) and an offshore related entity as the bearer of risk (reinsurer). While acknowledging that each case has a different set of facts and circumstances, the questions raised by the CRA under audit and the findings of the UK and Dutch courts are converging into a set of common issues. Any Canadian insurer or reinsurer with various cross-border intra-group transfers of assets and risks should closely consider these issues as part of its transfer pricing risk management strategy. In the life and health insurance sector, these considerations become more critical given longer-tail risks and the potential absence or lack of significant claims over a time period that may be the subject of a CRA audit. These considerations are outlined on the next page.
1. Assessment of functions, risks and assets
Intra-group reinsurance will be reviewed by the CRA in the same way as any typical intercompany transaction. The CRA is expected to want to understand the functional profile of the cedant and reinsurer, including the functions performed, risks assumed and assets contributed by each. Considerations include:
- What are the activities being performed by the local insurer compared to those performed by the reinsurer in respect of the ceded business?
- Which entity is responsible for insurance activities that add value?
- Do the functional profiles support how profits from the insurance activities are allocated between the cedant and the reinsurer?
- Do the activities of the offshore reinsurer justify a profit attribution to the entity?
- Will the offshore reinsurer be able to assume insurance risks in terms of having sufficient capital and qualified employees to make decisions about assuming these risks?
2. Business rationale
It's important to document the business rationale of the intra-group reinsurance transaction. Since the term of the treaty may extend for a number of years, it becomes easier for a tax authority to use hindsight to assess the purpose of the transaction and related pricing in the absence of clear documentation on the reasons for entering into the reinsurance transaction. Business rationale becomes critical in situations where the ceded business has historically been profitable or the risks involved are relatively low, or when the majority of the profits of the written business are earned offshore.
The business rationale should be documented from both the cedant's and reinsurer's perspective. Just as important as the cedant's rationale for transferring the risk is the reinsurer's rationale for assuming the ceded risks. In the life and health insurance sector, while reinsurance (or retrocession) is a common risk management tool, taxpayers should invest time to educate the CRA on the underlying mortality or morbidity risks, the implication of catastrophic risks, and most of all why it makes sense to have selected intra-group reinsurance instead of reinsuring with a third party. The involvement of company actuaries, tax or finance personnel and business people at the time of structuring and pricing of intra-group reinsurance transactions ensures that all areas of the business that will be affected by the transaction would have been considered.
3. Substance in the offshore reinsurer
Most offshore reinsurers have a limited number of employees and often rely on third-party service companies for many reinsurance related functions. This is crucial to a tax authority's review as it lends itself to potential transfer pricing, permanent establishment as well as residency inquiries:
- Who is responsible for making risk assumption decisions for the offshore reinsurer?
- Who performs the underwriting function for the offshore reinsurer?
- If a reinsurer lacks significant negotiating power, is it appropriate to assume that the measure for determining the arm's length profit for the offshore reinsurer is a routine return on its capital?
An offshore reinsurer must perform more than administrative activities to warrant an attribution of profits in excess of compensation for administrative functions. In fact, in the UK and Dutch cases, the courts took the position that as the ceded insurance risks were negligible, the assumption of the insurance required no additional compensation for the reinsurer.
4. Refinement of transfer pricing methodologies
Transfer pricing analysis requires the selection of an appropriate transfer pricing methodology, which in turn almost always entails benchmarking either the transaction price or the profit margin of at least one of the parties. It's important to validate the transfer pricing methodology:
- Is the intra-group reinsurance pricing policy consistent with the external reinsurance pricing policy?
- What are the reasons for using intra-group reinsurance instead of external reinsurance if the objective is to transfer risk?
To support the transfer pricing of reinsurance, analysis based on a two-party perspective is becoming the norm. Such an analysis is aimed at answering why the reinsurer would accept the risk. Are the levels of profits earned consistent with the level of risks being transferred?
Further, given the higher threshold of comparability under the 2010 OECD Transfer Pricing Guidelines, companies should revisit and, if necessary, improve the comparables relied on, understanding that imperfect comparables are at risk of being disregarded by the CRA.
Given the current scrutiny of reinsurance transactions, a multinational insurer or reinsurer should appropriately plan for, and implement its intra-group reinsurance by addressing the considerations discussed above. Such considerations emphasize the reality that intra-group reinsurance exists due to the combination of company-wide capital planning, risk management and tax planning objectives. Thus, to preempt the issues that the CRA may raise under audit, the management of the attendant transfer pricing risk should become a company-wide responsibility, not just a function of corporate tax.
1 1250 CEOs from 60 countries were polled at the end of 2011 as part of PwC's 15th Annual Global CEO Survey, published on 25.01.12
2 150 life and pensions executives were asked to comment on the impact and likelihood of a series of social, technological, environmental, economic and political scenarios, as well as setting out their short-and medium-term priorities, PwC 2012
3 UN Population Division media release, 11.03.09
4 'Is the Developing World Catching Up? Global Convergence and National Rising Dispersion' by Maurizio Bussolo, Rafael E. De Hoyos and Denis Medvedev, The World Bank Development Economics Prospects Group, September 2008. Middle class is defined as people whose income levels are between the average incomes of Brazil and Italy, in purchasing power parity terms.
5 The Internet in 2020, published by Intac, 22.07.10
6 PwC life and pensions survey 2012
7 Cisco Visual Networking Index, updated estimate, 30.06.12
8 United Nations, Department of Economic and Social Affairs, Population Division, 2009 Revision
9 PwC life and pensions survey 2012
10 United Nations Population Division; World Bank World Development Indicators and PwC analysis 2012
11 Swiss Re Sigma World Insurance 2010
12 According to Swiss Re Sigma World Insurance in 2005 and 2010, life insurance premiums as a proportion of GDP in the US fell from 4.14% in 2005 to 3.5% in 2010
13 For more details on this case, refer to our article "The use of captive insurers and tax havens: Implications of a UK tax court transfer pricing case," Insurance Review, Summer 2009.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.