Regulatory changes and challenges for insurers 

Interviewers Opening Remarks

Many insurers have legal entity, operating and capital structures that have evolved organically over time, partly because of mergers and acquisitions and partly due to piecemeal initiatives undertaken now and then to improve tax efficiency.

Over time, these structures can become complex and unwieldy, and higher regulatory and compliance burdens, fragmented reporting and increased operating costs can result.

Complex insurance groups typically revisit and simplify or reorganize their structures only every few years or after an acquisition, divestment or other major event.

But given the unprecedented pace of regulatory change the world over and the fiscal and market turbulence facing insurers today, insurers should consider taking a hard look at their current structures now, to make sure their structures are in step with current tax and regulatory regimes and that their enterprises are well positioned for an uncertain future.

Joining me today to explore these issues are Hugh von Bergen, Tax partner with KPMG in the UK, Martin Noble, a senior manager with KPMG in Hong Kong, and Jane Portas, a KPMG partner with our UK practice.

Interviewer

To start things off, what is it that inspires insurers to structure today as opposed to changes that were made historically?

Jane

I think historically we've seen insurers traditionally restructure as a result of technical changes such as regulatory change or tax change and review their structures, perhaps, on a somewhat infrequent basis in response to those changes. And where we are in the global marketplace right now is there are so many different factors that are influencing insurers today that are having a fundamental impact both on their strategy and consequentially on their structure. And structure is increasingly becoming a competitive issue and initiatives such as Solvency II are causing insurers to really review the entirety of their structure and to consider that in the context of both regulatory agenda but the broader tax agenda and wider market issues. So that is leading insurers to really take a more holistic approach to structure than perhaps they would have done historically, really, due to the competitive aspects around structure.

Hugh

What's interesting about this is that we're seeing clients now moving away from looking at these issues from a technical perspective. So, no longer do we get asked simply to look from a tax perspective as to how groups ought to organize their structure. Very much, now, they're moving towards actually understanding what are the main business drivers in their marketplace, what are their ambitions, how do they want to shape the business, how do they want to access their clients. Tax remains an important part of it, but it is just one of the many ingredients that have to be taken into account in helping insurers look at their structures.

Martin

I think it's also important to consider the emerging markets and how they will impact the way the groups think about their organization in the future. In Asia-Pacific, for example, the industry is booming with growth rates in some countries in some insurance sectors above 20, 30 even 40 percent. This growth will change the shape and feel of insurance groups operating in the region. It is therefore important for groups to understand how their businesses might look in one, two, five, even 10 years time. To put it quite simply, the Asian part of the group is likely to change significantly both in size and from a regulatory and operational perspective. Some flexibility in the group structure, for example, might therefore be very welcome.

Interviewer

You’ve noted that the structural issues facing insurers today have considerably broadened. So, what’s driving this structural change and what are insurers seeking to achieve?

Jane

Ultimately, in the changing environment, what insurers are really seeking to achieve is to optimize the overall effectiveness of their business and ensure that their structure is really aligned to, and complimentary to, their overarching business strategy. What that really means, ultimately, is they’re trying to achieve capital efficiency, operational efficiency and effective access to market i.e. to customers in the context of the regulatory fiscal and market environment. And perhaps if I can just start by touching on the capital efficiency angle; what insurers really are trying to do here is to ensure that they have not only the most effective capital structure; capital make up across the breadth of their insurance group, but also that they have mechanisms and structures in place for managing that capital most effectively. And what that means is, in some contexts, looking at the way in which they structure their underwriting platforms, whether they structure through branches or subsidiaries and how they can minimize the amount of capital that they need to hold, to support that business in order to achieve the best returns for their investors whilst still maintaining sufficient capital to support the business.

Hugh

If we look at operational efficiency, I think the important thing is that the clients actually look at this right through from their own customer requirements right through to their own back offices. So, just thinking about their distribution mechanisms, for example, we’re finding clients increasingly are wanting to bring common processes to their distribution and so that they have a single market facing picture that they show to the market. To achieve this they often now look at putting in place distribution organizations that are common across multiple countries. These distribution organizations are then supported by common manufacturing plants were, effectively, the underwriting is done on a single platform, say, to cover the whole of Europe or to cover the whole of Asia-Pacific and this, therefore, achieves efficiency in terms of use of capital as well as efficiency in terms of the operational management of the business. We're also seeing shared service centers becoming increasingly common and they range from back-office processing, IT centers, right through to centers of excellence where higher value activities are concentrated so, typically, pricing and actuarial functions we’re seeing centered in one or two locations around the world.

Martin

It's important to remember that each country has a different accounting, customer treatment, taxation, risk and capital regulatory rule and so an optimized, or the most optimal group structure from a theoretical point of view may need some tweaking and may need some adjustments in order to balance that with local regulatory rules. I mean, clearly, growth markets such as Americas and the Asia-Pacific region are key growth areas and regions for groups as a whole and it's important, however, to understand the intricacies between the differences in the jurisdictional-based regulatory regimes across Asia and across different Americas compared to those traditionally in Europe and the US.

Interviewer

As we’ve noted, insurers today face an unprecedented degree of regulatory change, both in Europe and around the world. Could you tell us some more about the nature of some of these changes and their structural impact?

Jane

I think first of all it's important that we consider why there is all this regulatory change and much of the change that you're seeing in the market right now has really stemmed from the financial crisis. And that highlighted, really, the need on the part of regulators to really, much better, understand how risk is managed within insurance groups but also, in particular, what are the group risks that insurance operations are exposed to by virtue of being part of a group. So, one of the significant initiatives taking place in the regulatory arena right now relates to solvency regulation. In Europe we have Solvency II and arguably this is really leading the way in developing prudential regulation globally and indeed we see the International Association of Insurance Supervisors, which is a body of supervisors, who have put together a series of standards that will apply to the global marketplace relating to prudential regulation and supervision of insurers.

Hugh

From a tax perspective the impact of regulatory changes is actually somewhat more mixed. In terms of the direct impact on tax regimes around Europe, some countries have had to re-jig their tax regimes for insurance companies very significantly. So, for example, in the UK over the last two years or so there has been major consultation on changes to the tax code that applies to insurance companies. In other countries, the introduction of Solvency II has a less direct impact on the tax code because it's based on local tax rather on regulatory measurements. Even so, because of the changes that insurance companies are now undergoing as a result of Solvency II and the other drivers that we've identified, the tax law is still having to catch up with what they're wanting to do to make sure that they can restructure in an efficient way without having unfair or unpredictable tax charges and indeed, above all, that they have certainty about the tax result that they are going to achieve when they do undertake restructuring.

Martin

The difference in Asia-Pacific are that in these emerging and growth markets enhanced regulation, for example, from the International Association of Insurance Supervisors, the IAIS, which comes into force in October this year, this will spur jurisdiction to change the solvency capital requirements and adopt a wider risk management practices. However, the impact on future regulatory landscape in these regions is difficult to predict because, in a sense, and in some ways, the IAIS has no formal mandate so organizations will likely stay to varying levels of change under different timelines in each jurisdiction. From a group supervisory perspective, again, we've heard from Solvency II is having an impact on insurance groups because that is a group supervisory regime and indeed some groups in Europe have started and are restructuring as a direct result and in some cases of Solvency II.

Jane

One of the key noteworthy points is that in Europe our supervisory regime has evolved over quite a long period of time so we’ve seen a fairly gradual move towards the Solvency II style regime, in particular in the UK where we do already have a risk-based capital regime. Solvency II is a huge step change for the European insurance industry but actually it's an even bigger step change when you start to impose a Solvency II style regime in other regions such as the US and in the Asia region and part of the reason for that is because under the Solvency I regime there is, actually, a group solvency test albeit it's not risk sensitive. However, the starting point for the regulatory change in some of the other regions is, to a degree, below that that we are experiencing in the European market for Solvency II really because the regulation has evolved in Europe over a considerable period of time. Also, insurance structures in Europe have changed quite considerably in recent times over recent years as a result of regulatory and other changes that have occurred in the market and I think what we're going to see, we're seeing a fundamental restructuring going on in Europe as a result of all these changes that exist in some of the other regions outside of Europe, are representative of the type of structures that existed in Europe a few years ago and therefore the extent of structural change outside of the European region in regions such as Asia is going to be significantly greater in its impact than even that in Europe.

Martin

And I would agree with that if you take China for example, the pace of regulatory change there is in many ways much, much faster than we have seen throughout Europe as you have just described and I think the legacy group structures will have to cope with a raft of changes and in many ways, which is why I said towards the beginning, to introduce a flexible group structure because of the pace of change, because of the uncertainty of change across the Asia-Pacific and other emerging market regions, to have that flexibility in that structure, I think, is of great importance otherwise groups run the risk of having too formalized, too rigid structures which are not able to accommodate and respond in a timely fashion to future change. I think that another side point on that is we're seeing some of the emerging insurance markets; the Chinese market is growing rapidly, Indonesia is the same, the Australian market, Japanese markets are already well-established and still growing and I think as these markets increasingly look outwards to, in particular, China, the Chinese market is very much domesticated at the moment, as China and others begin to look outwards in to the world in a sense, they will in some ways have a clean slate because if they don't have much of a structure existing outside of their domestic markets at present, I think, they are in a good position to grow without the shackles of the existing legacy structures that we see elsewhere and they, perhaps, are in a good position to take on leading group structure perspective.

Interviewer

So how does all this affect the group structures of insurers? What should insurers be doing in response?

Hugh

The point about looking at structure is that it ought to be an ongoing exercise rather than just a one-off activity that one does, say, every decade. Businesses develop, regulation clearly is developing and as we've discussed in this podcast there are multiple drivers for change for insurance companies’ structures. So what they need to do is really keep their structure under continuous review to make sure they accommodate the developments in their business, their entry into new markets, growth in new regions and, indeed, accommodate changes in the regulatory environment in the countries in which they operate in as well as the tax law. So we very much advocate that this is a regular board agenda item rather than something that is undertaken by the technical specialist within the organization on an ad-hoc basis

Martin

As the insurance world emerges from the global financial crisis and in particular in the emerging market regions, Asia, the Americas, we do see continued change and uncertainty in regulatory regimes, we see a very fast paced changing regulatory regime and groups need to be aware of that and need build in flexibility to allow those sorts of changes.

Interviewer

Thank-you for your insights and for bringing some clarity to this complex topic.  Before we conclude, do you have any final thoughts on how insurers should approach any potential restructuring?

Hugh

The key thing about any approach to structuring for insurance groups is that the project should actually look at the business aims and drivers of the business. What is it actually trying to achieve and then the various specialists such as the tax professionals, the regulatory specialists, then are tasked with coming up with a structure which delivers those benefits and meets the aims of the business. It is, I think, very important that these sort of structuring activities are not driven by the technical work streams. The technical work streams are there to deliver the businesses objectives and not to make the decisions on behalf of the businesses

Jane

So, the really key thing for insurance groups right now, in particular, given the extent of change whether it be regulatory, fiscal and indeed changes in the market in the global insurance industry is really to absolutely ensure that their structure is designed so that it fully compliments their business strategy and in addition has sufficient flexibility to accommodate further change as the market evolves.

Interviewer

Thanks you Hugh von Bergen, Martin Noble and Jane Portas.

Listeners can find more details on this topic in the September 2011 edition of KPMG’s frontiers in tax publication

Our next podcast in this series is KPMG Tax partners from our member firms in the United States, Japan and the United Kingdom shedding some light on complex issues coming into play arising from tax reforms in the domestic taxation of offshore earnings of foreign operations.

Thank-you and we look forward to you joining us next time.