19 August 2009

Published in: Corporate strategy, Accounting - tax

Corporate restructuring driven not just by tax

The trend in insurance for restructuring and redomestication is set to continue, but factors other than just tax play a part in this, explain Stuart Higgins and Jim Bichard.

The recently released report from the Insurance Industry Working Group, Vision for the insurance industry in 2020*, suggests that the UK government needs to take action to prevent the loss of UK business to low tax and offshore domiciles. Also known as the "Moss Report" after the working group's co-chairman and chief executive of Aviva, Andrew Moss, the report is a response in part to the trend of global insurers moving to locations such as Bermuda, Ireland, Luxemburg, Switzerland and The Netherlands.

This year UK insurers Beazley and Brit Insurance announced that they would relocate their corporate headquarters to Dublin and The Netherlands respectively, following early moves by companies such as Hiscox, Hardy Underwriting and Omega Underwriting, which all redomiciled to Bermuda. Insurers outside the UK have also moved domiciles: Bermudian insurer Ace Ltd relocated its head office to Switzerland from the Cayman Islands in 2008 and a 2007 restructuring of Swiss Re centred on legal entities in Luxembourg.

Tax has often been cited by commentators as the reason for these moves.. However, this is too simplistic a view. Although, tax has helped to determine a domicile, it has often not driven the need to restructure. However, growing uncertainty over some tax regimes is itself creating a new wave of interest in restructuring and the relocation of the group headquarters, also known as redomestication.

Regulation as a driver

Changes to the regulatory landscape have meant that insurance groups have been restructuring to optimize their capital structures. The 2007 European Reinsurance Directive which harmonized supervision across the European Union has given some reinsurers an incentive to establish a single Europe-wide carrier, allowing them to use their "passport" to write insurance business across Europe.

The move by Swiss Re to reorganize its EU operations reflects this trend to establish a single European underwriting company with branches in the local markets. Zurich Financial Services and XL Reinsurance have also restructured some of their European insurance businesses around Dublin-based entities. Some groups are also looking at merging existing subsidiaries into single carriers and generally streamlining their organizations. One of the other regulatory drivers has been Solvency II, which will create a consistent approach to prudential regulation across Europe.

Against this background, flexible capital management is key. Unlike a group consisting of incorporated subsidiaries, each maintaining its own capital, a branch structure provides an insurer or reinsurer with access to fungible capital that can be deployed to the best business opportunity. It may also allow some groups to gain diversification benefits which may mean less total capital is needed.

The uncertainty over the application and impact of Solvency II in 2012, particularly the removal of group capital support, has led some groups to move to a branch network as defensive measure. The group support provisions were based on the economic argument that as long as the group as a whole had sufficient capital, individual subsidiaries may be allowed to carry less. Branches remove uncertainty over how much capital (re)insurers may have to hold locally versus centrally after 2012.

Tax uncertainty

As governments respond to the need to raise taxes, so the taxation of multinational groups is coming into focus. The Moss Report notes that a number of high-profile UK insurers have moved, or announced their intention to move, their holding companies to a domicile that they regard as having a more favourable tax regime. It is not just the headline rate of tax that will determine whether a regime is favourable; factors such as the certainty of tax policies and the strength of the treaty networks will also be key.

Within the US there is considerable concern that tax measures could target the use of jurisdictions such as Bermuda. Many Bermudian/Cayman Island-headquartered groups with large US operations are at present considering whether redomesticating to other jurisdictions would afford them more certainty over their future tax position, even if the rate of tax they suffer will increase. The moves by ACE and United America Indemnity from the Cayman Islands to Switzerland reflect this trend.

In the UK, too, considerable interest is being paid to how overseas operations will be taxed in the future. There is concern that some overseas subsidiaries which may not at present be taxed here could be brought within the UK tax net. The taxation of overseas branches is also being brought into focus. The profits of overseas branches are currently taxed in the UK and some in the insurance industry are concerned about the competitive impact this has on UK-based reinsurance and insurance companies.

The UK can be contrasted with The Netherlands, for example, which exempts from taxation much of the overseas income generated by groups headquartered there, whether in a subsidiary or branch. Such uncertainty over the taxation of overseas profits may encourage groups to consider jurisdictions outside of, say, the UK when choosing their domicile.

The trend for restructuring and redomestication is set to continue

As Solvency II comes closer to implementation and as governments develop their taxation policies in the aftermath of the current global recession, so insurance groups will be able to gain a clearer understanding of the landscape. What is clear is that many will move to where they are best placed. Regulation and tax will help groups decide where they move to, but in reality even now issues such as the ease of changing employment, access to qualified staff with the requisite skills and expertise, quality of infrastructure and quality of life all play their part.

Stuart Higgins and Jim Bichard are partners at PricewaterhouseCoopers LLP in London

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