UK: Words Turn To Action As The Market Focuses On Solvency II-Driven Transactions

For several years now, there has been considerable discussion around the fact that the implementation of Solvency II would, almost inevitably, lead to a spate of corporate activity in the insurance industry. However, until recently it was more talk than action. Now, however, companies are starting to act, and there has been a marked increase in activity which can be identified as being specifically driven by Solvency II. This looks set to continue as businesses seek to optimise their risk capital position under the new regulations.

As re/insurers move closer to the start date for Solvency II, they are looking much more carefully at the composition of their portfolios – both live and in runoff – and the capital that these require. This is creating a very noticeable driver of corporate activity in the sector, including disposals, acquisitions and restructurings, as businesses look to increase their competitive advantage and maximise their capital efficiency.

Considering all the options

Companies that are considering transactions are already gearing up and project planning to implement their plans over the coming 12 months, and many are likely to act soon as the deadline for implementation of the new regime becomes closer. It is hard to see that there is much to be gained by waiting on the sidelines and those that do risk facing delays in getting the attention and support of the FSA in implementing their changes or running out of time to get their optimum structures in place.

One area which seems to be growing in prominence is the rebalancing of portfolios to benefit from diversification under the Solvency II modelling. A key question to consider is how to identify a portfolio of risks that complements the existing business, and is profitable, since any benefits gained through capital efficiency would be swiftly outweighed by adding a loss-making business. Another consideration is a clear understanding of the business mechanics of the acquisition, for example while the diversification benefits of a personal lines business acquiring a catastrophe portfolio may have a positive effect on the theoretical modelling, the management and shareholders may have little appetite for such risk in practice or any experience of how to handle the claims. As with any deal, the key success factor is acquiring the talent as well as the risks.

There is also interest amongst investment banks about whether they can offer insurers increased portfolio diversity using derivative products under the new regime. It is expected that, while these have some potential, they may not be the panacea that some of the investment community might hope for and there is likely to be some nervousness or resistance within the sector as well, driven by regulatory concerns.

Regional re-structuring

For historic reasons, some insurance groups have also maintained underwriting platforms in a number of different jurisdictions which are affected by Solvency II and to continue with all of them under the new regime will lead to capital inefficiencies. There are therefore, a number of restructurings taking place where aspects of regulatory, tax and capital regimes are being assessed to find the most efficient single platform.

Examples of this trend are numerous including Chartis, which at the end of 2011 took the first step in its legal restructuring into a single European entity headquartered in the UK; Euler Hermes, which, earlier this month, completed the streamlining of its European legal structure, merging 13 former subsidiaries into one; and Aviva, which towards the end of last year, consolidated 12 of its UK authorised general insurance companies into one entity.

Part VII transfers increasingly popular

The almost inevitable consequence of all of this activity is a marked increase in Part VII transfers – some driven by restructuring and others by diversification. Barely a week goes by without advertisements appearing in the press to alert policyholders to yet another transfer of business. Where used as a method of acquisition, the appeal of a Part VII is that it allows the buyer to take only the business they want, rather than the whole company. Although in comparison to most other sectors the insurance industry has remained relatively buoyant throughout the recession, there is still less appetite for buying entire companies compared with the desire to buy add-on portfolios. Solvency II is clearly a key driver of deals in this area and this may well continue once the new regime is in place, for example, if an insurer is looking to increase the diversification in its portfolio the prospect of liability swapping of portfolios would seem to be an area for longer term growth.

Whatever the reason for wanting to undertake a business transfer, companies which are considering a Part VII in the coming year need to move quickly. Such is the growing demand to use this process that the FSA are seeing a growing number of applications and this could well lead to delays as they seek to process them all.

Other considerations for a company considering a Part VII transfer include:

  • Having a realistic project plan and timetable, which the business is confident it can deliver. Timescales for due diligence, data cleansing and actuarial work-streams are frequently underestimated and ensuring that FSA deliverables are provided in line with the project plan is key to a smooth process.
  • Preparation is everything. In particular, the FSA and the IE will want to discuss the state of preparedness of the parties for Solvency II at an early stage.
  • The FSA will look at the proposal from the point of view of a policyholder and so will scrutinise the communication strategy for notifying affected parties to ensure this satisfies regulatory requirements – a lot of time and attention will have to be spent developing this strategy.

Looking ahead

Solvency II will continue to be a driver for corporate activity in Europe right up to its implementation and beyond. For example, some smaller firms may struggle to compete with larger, more diversified incorporated competitors under the new regime and ultimately may seek diversification benefits or economies of scale through mergers. Therefore, whatever the state of the M&A market in other sectors, for once there is one thing that seems certain in the insurance sector: as the deadline for Solvency II approaches, transactional activity driven by the new regime will continue to accelerate.

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.

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