19 June 2013

Risk.net: Restructuring gathers pace as insurers look to improve capital efficiency

In recent months major insurance groups have been selling off business units or undertaking transactions to de-risk blocks of business. And the restructuring is not just taking the form of asset sales. Some firms are also turning to financial reinsurance to monetise portfolios and de-risk at the same time. This surge of activity has prompted market observers to suggest that a trend dating back to the financial crisis is accelerating in response to the dual pressures of low interest rates and upcoming regulatory requirements. Large groups are looking to evolve and become leaner and more focused on their core business strengths.

The situation with European groups is more nuanced, as on the continent some companies do write US-style products and have greater experience in dealing with interest rate and spread risk. Nevertheless, the global insurance market may be witnessing a slow-motion flight from the US by a number of European firms. The likes of Aviva and Axa may just be the tip of the iceberg.

Liberating underperforming capital in order to shore up reserves is a prudent move for insurers to make in the current climate. Shareholders need evidence that firms are taking the necessary steps to prepare for a long period in the interest rate doldrums and that management teams are maximising their efforts to squeeze profit from core business areas.

Cutting off non-core operations, therefore, offers a clear signal to investors that an insurer’s board is on the case, says Bernhard Kotanko, insurance partner at consultancy Oliver Wyman in London. “Insurers want to do something that is completely normal in other industries – divesting non-core or overly risky businesses. It’s happening in small steps. We’ve seen some companies withdrawing from macro-economic risk markets and retreat from areas that do not suit their business structure”, Kotanko says.

Restructuring is also being encouraged by increased regulatory interest in insurance group structures, such as from Europe’s Solvency II Directive and the International Association of Insurance Supervisors’ (IAIS) ComFrame project. Europe’s drive to harmonise insurance supervision, and the IAIS’s work to encourage a similar process to take hold globally, is fashioning a more benign environment for consolidations and divestments to take place, some suggest.

“The current regulatory push towards a more economically-based framework for insurers very much encourages companies to do sensible things. You have a much better alignment between economic reality and the regulatory regime in Solvency II, for example,” says Gavin Palmer, London-based insurance partner at KPMG.

Regulatory reform is also shining a brighter spotlight on insurers’ capital levels, prompting companies to look at ways to improve their capital efficiency. This, argues Philippe Guijarro, UK-based insurance partner at PwC, has been the real stimulus behind recent divestments. “There has been a significant amount of time and money invested in the risk and capital management of insurance companies. During the past year a lot of that has been put to good effect with companies using the insight they have gained to consider improvements to the future management of their business”, Guijarro says.

For insurance companies seeking to divest and restructure, there are also less tangible risks that need to be assessed. Because insurers have been slow to embrace the culture of restructuring that has swept other industries, there is a risk that divestments can be interpreted as a sign of weakness and early movers thus have to gauge what impact a sell-off will have on their reputation, not to mention their stock price if publicly listed.

PwC’s Guijarro outlines some ways these risks can be mitigated. “There are arrangements that can be made whereby the insurer can retain the servicing of the portfolio, with only the liability resting on a third-party’s balance sheet”, he says. “Also an insurer can put in place some form of capital protection, so in the event that a counterparty is not able to honour its obligations there can be a recourse back to the insurer. This provides an opportunity to divide up the servicing of the portfolio from the financing of that business, while addressing any potential brand or reputational concerns”, he adds.

So will the industry witness, as some predict, a quickening of divestments and restructurings from insurers? Certainly, if current pressures fail to find a suitable outlet, says Kotanko. Yet there may be a pause before the next spate of sales, he suggests. “Assuming market conditions remain as they are – low interest rates combined with low growth – and regulatory pressures from Solvency II remain, in continental Europe it will take some time until we see any really big moves, I’d say three years or so”, he predicts.

Yet evolution is a process that takes a long time, and even longer before it yields tangible benefits. Ultimately the most successful firms in the years to come may well be those that showed the greatest patience in adapting to the new wilderness.

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