One by one, reinsurers are restructuring and relocating their European insurance headquarters. Mark Batten and Jim Bichard investigate the drivers behind this mass migration.
The changes made by a number of leading reinsurers are a response to the changing regulatory and tax landscape in Europe, and the EU?Reinsurance Directive in particular. The Reinsurance Directive resulted in, amongst other things, reinsurers being subject to supervision in relation to reinsurance business conducted within or from Europe. Under the directive, a reinsurer must now have an established European company to benefit from the freedom of services aspect of the regulation.
The traditional reinsurance group structure that served companies well for many years was to have a European-based holding company with incorporated entities wherever they wrote their reinsurance business. The restructuring moves made by Swiss Re and other reinsurers (see box on page 38) reflect the trend to establish a single European headquartered underwriting company with branches in those jurisdictions where they intend to carry on business.
There are several good reasons for reinsurers to change to this type of structure, mostly related to the Reinsurance Directive but also to the anticipated implementation of Solvency II. The two regulatory developments are linked. Solvency II, like the Reinsurance Directive, is intended to integrate the European insurance markets under one consistent regime.
Against this background, capturing diversification benefits, improving liquidity and making capital management more flexible are among the motivations for reinsurers to restructure their operations. Flexible capital management is key. Unlike a group consisting of incorporated subsidiary companies, each with its own capital, a branch structure provides a reinsurer with access to fungible capital that can be deployed to any business opportunity within that structure.
Freedom of services in European reinsurance means that when a European Economic Area (EEA) based reinsurer is considering possible expansion into new European markets, it can do that without having to incorporate a company (or indeed a branch) at the outset. The simplified structure allows a reinsurer to reduce its compliance costs and to remove management layers. At the same time, it may reduce regulatory capital requirements and improve liquidity, as cash is held in one entity.
The uncertainty that surrounds Solvency II is itself one motivating factor for reinsurers to restructure. If a reinsurance group stays as a network of incorporated entities, it is still not entirely clear how much capital that reinsurer will have to hold locally and/or centrally under Solvency II regulations.
Other reinsurers may rationalise their move in a more positive light. After all, Solvency II should allow a pan-European reinsurance group to operate more seamlessly than if it were a collection of individually incorporated businesses. And it should enable reinsurers to benefit from risk diversification.
Risks in restructuring
There are risks associated with changing existing structures. After all, reinsurance groups originally put those structures into place for good reason. Reinsurance groups wanted their companies to have different legal entities to insulate them: it put firewalls between different businesses and operations.
It follows that if a reinsurer goes down a restructured branch office route it will place all its underwriting into one entity – with the consequential risk of getting some bad underwriting in the mix. So, contagion risk does exist with the branch office model. This emphasises the need for universal good risk management and governance to ensure that risks – especially catastrophe exposures – are well managed with the necessary controls in place.
There are also cultural risks related to breaking down existing structures. Senior managers like to have control of their operation and to have autonomy. In a branch structure, their operations have to be more transparent by necessity, with their activities open to scrutiny. Capital allocation for example, is likely to become a more transparent and active process; branches will have to justify and bid for their capital allocation every year.
Relocation brings with it other, more practical considerations, employment law rules for example, as well as migration of accounting systems and consolidation of IT platforms. Access to the appropriate skills and labour is an important factor.
Relocation needs careful research and planning as there are risks as well as opportunities attached to choosing a domicile. Restructuring may well produce tax efficiencies, but that only applies if the reinsurer is clear about from where its profits are derived. Properly allocating profits is essential to ensure that tax is not overpaid. Migrating to the desired structure is unlikely to be straightforward and is likely to need careful planning and consultation.
Tax regimes can change. Ireland and to a lesser extent Luxembourg, have become relocation hotspots due to their favourable tax regimes. Proposed changes to tax rules elsewhere in Europe may add further to their appeal as the European domicile of choice for global reinsurance companies.
Reinsurers will continue to restructure in advance of Solvency II. As demonstrated by the moves already made by Swiss Re, Partner Re and XL, this is to take advantage of the relative benefits offered by the Reinsurance Directive and existing solvency regulations. They won’t necessarily wait for Solvency II: there are real benefits to do it now, but they will keep one eye on how Solvency II plays out.
One of the aims of Solvency II is to bring standard supervision that is consistently applied. In theory, that ought to create a level playing field across Europe for jurisdictions. But in reality, countries will continue to compete among themselves post Solvency II – on the basis of tax, ease of employment, access to skills and expertise.
Luxembourg has made itself into an attractive jurisdiction with favourable double tax treaties with other countries and low-key, pragmatic regulation, which may lead to direct tax benefits. The rules relating to the admissibility of assets in calculating solvency in Ireland and Luxembourg are also less onerous than in the UK. Other countries may take similar steps to enhance their appeal ahead of Solvency II.
Tax will be used to differentiate jurisdictions and will influence the choice of domicile. Tax isn’t necessarily the most important criteria in choosing a domicile but it is worth noting that the corporation tax differential between the UK and Ireland is 15.5% and this is a significant difference for many insurance and reinsurance companies.
If it does go ahead as planned, Solvency II could give impetus to mergers and acquisitions among reinsurers. Consolidation in the sector could in turn add momentum to the restructuring wave among large reinsurance corporations. Although it is worth noting that Basel II did not provoke as much consolidation among banks as initially expected. But it did make them focus harder on capital management.
In this respect, the emergence of insurance special purpose vehicles (or sidecars) to provide risk financing, and how different jurisdictions treat them, will further influence restructuring decisions. One aspect is clear. While Bermuda has been the undisputed world champion for re-domiciliation over the past decade, the next few years will usher in some new European contenders.
Mark Batten is a partner and Jim Bichard is a director at PricewaterhouseCoopers LLP.
Swiss Re is reorganising its legal entity structure in the European Union by forming two companies based in Luxembourg that will serve as risk carriers for its European reinsurance and primary insurance business respectively.
Swiss Re made the decision to alter its legal structure in light of the upcoming implementation of the European reinsurance directive. It believes the new structure will result in more efficient capital management, administration and reporting.
The new companies will be based in Luxembourg but will operate via branches in the rest of the EU. Swiss Re aims to have the new structure in place by mid-2009, and started with the conversion of the first locations this year.
Bermuda-based PartnerRe announced last year that its wholly-owned subsidiary Partner Reinsurance Europe Ltd, based in Dublin, would be the principal reinsurance carrier for PartnerReâ€™s business underwritten through branches in France, Ireland, Switzerland and Canada.
Partner Re established its Dublin-based subsidiary soon after the European Reinsurance Directive came into force. By setting up Partner Re Europe, the group will be able to operate in all EU member states under a single regulatory framework, it said.
ACE completed its move to Dublin last year. ACE European Markets Insurance Ltd and ACE European Markets Reinsurance Ltd now trade under the business name of ACE Bermuda International (ABI). ACE said the restructuring would allow it to align the company more strategically with its parent company, ACE Bermuda. ACEâ€ˆhas also recently redomiciled its holding company from the Cayman Islands to Switzerland.
Capital was ahead of the curve. It announced two years ago that it had received approval for a new fully licensed European reinsurance company. XL Re Europe Ltd, based in Dublin, is now the Bermuda groupâ€™s European reinsurance platform.