The likes of Legal & General and Aviva (formerly Norwich Union) face the
prospect of having to tap shareholders for billions of pounds as they
grapple with creaking capital positions, the threat of new regulation from
Brussels and Westminster, and falling demand for their products. The sector
is also in the midst of a wave of consolidation as the former zombie fund
raider, Clive Cowdery, eyes up potential targets after snaring Friends
Provident last month. These are indeed interesting times for insurers in the
The Association of British Insurers (ABI), the body that represents the
industry, fired the first salvo last week in its battle with European
regulators, who are looking to implement a new regime for insurers across
the continent. Where the banks had to grapple with Basel 2, insurers get the
snappily-titled Solvency 2 Directive, which is due to come into force in
The measures being laid down by Brussels are likely to mean insurers will have
to radically increase the amount of capital they put aside for rainy days,
of which they have had no shortage of late.
In a letter to the Chancellor, Alistair Darling, ABI’s outgoing chief
executive, Stephen Haddrill, said his members might have to raise £50bn to
comply with Solvency 2, while pensioners face the prospect of their annuity
payouts falling by a fifth if the plans are implemented.
The share prices of insurance firms with the greatest exposure to
capital-intensive products fell heavily on the back of the ABI’s claims,
with Aviva tumbling by 4 per cent and Legal & General plunging by more
than 7 per cent. L&G’s chief executive, Tim Breedon, has described the
rule changes as “a betrayal of savers”.
The extent of the negative sentiment surrounding insurers last week was
probably overdone. The chances of European regulators implementing Solvency
2 in its proposed guise are small, according to many insurance industry
“We doubt Solvency 2 will be implemented as currently envisaged,”
says Marcus Barnard, insurance analyst at Oriel Securities. “Even if it
is, we doubt the impact will require £50bn of additional capital as
reported. However, sorting out this proposed regulation will take time, so
it is unclear for how long this story will run, and there is unlikely to be
a quick resolution.”
There are certainly plenty of imponderables facing the life companies in the
run up to Solvency 2’s implementation. For starters, UK insurers could up
sticks and re-domicile in offshore locations such as the Isle of Man and the
Channel Islands to avoid the solvency rules. In such jurisdictions, annuity
investment returns aren’t taxed. Prudential has already floated the idea of
moving its headquarters abroad to avoid tax on foreign profits. Solvency 2
is bound to make others think of a move. Notionally changing the address of
your head office or a subsidiary is not all that difficult, especially if it
saves millions of pounds for the firm.
Another way British insurers could sidestep European regulations would be for
them to ditch existing annuity liabilities by offloading them to re-insurers
outside the EU, such as Swiss Re, which European regulators don’t oversee. “Swiss
Re isn’t governed by EU Solvency rules and could write annuity reinsurance
treaties, but I’m not sure how this would be treated, whether the capital
requirements would ‘look through’ to the re-insurers’ capital and require
the ceding UK company to hold more capital,” says Barnard.
One less-practical suggestion mooted last week was that insurers send their
policyholders free fags, booze and pork pies, and hope the resulting rise in
mortality rates reduces their liabilities sooner. Perhaps not.
Playing on the future uncertainty that will envelope the sector are the hedge
funds. Crispin Odey, a hedge fund manager who won big by short-selling the
banking sector before its demise, placed a hefty bet just last week that the
price of Legal & General will fall. Earlier in the year, Lansdowne
Partners, a London-based hedge fund, pocketed more than £13m after taking a
short position in Aviva, which subsequently plunged in value amid concerns
about its capital strength. Hedge fund managers often get their bets wrong,
of course, and a takeover offer for L&G would leave Odey nursing heavy
losses. Given the consolidation fever gripping the sector, with Cowdery’s
Resolution vehicle eyeing up the likes of L&G, Odey could take a bath on
his latest bet.
Cowdery, the former salesman who left school without an A-level to his name,
scooped more than £15m selling his company two years ago. He raised £600m on
the London Stock Exchange in December to create a fund to buy up ailing life
insurance companies and last month bought Friends Provident in a cash and
paper deal worth £1.86bn. It was a deal that he told friends had to happen
sooner rather than later.
When Aviva shares plummeted to 160p, the prospect of Cowdery buying the
company wasn’t perhaps as fanciful as it once might have sounded. But with
Aviva’s stock rallying to more than 400p, he probably has other names on his
Top of the list is probably Clerical Medical, which is owned by the Lloyds
Banking Group. In the spring, Lloyds hired the investment bank, Deutsche, to
review all of insurance assets, including Clerical and Scottish Widows.
Though Lloyds has remained tight-lipped about the findings of the review,
which is believed to be ongoing, sales look likely.
Rumours have circulated that Lloyds could spin off Scottish Widows through an
initial public offering, although that seems rather fanciful. Any sale of
Clerical Medical would be completed at a considerable discount to embedded
value, the tool used to measure insurance companies. Lloyds is currently
allowed to value its insurance assets as capital for its wider banking book,
so any sale would reduce the bank’s core tier one capital ratio, a key
measure of a bank’s strength. Beside Lloyds, Legal & General would look
to be a candidate for Cowdery’s vehicle.
L&G’s chief executive, Tim Breedon, has gone through a rollercoaster ride
since taking over at the helm of the firm in 2007. On his arrival, he handed
back £1bn to shareholders as markets boomed. But as the cycle turned, that
move looks to have been a woeful miscalculation. A botched explanation of
the company’s capital strength at the start of the year sent L&G’s
shares into free fall. Certainly, Breedon is under pressure.
A rights issue remains likely at L&G but intervention from Resolution
could dramatically change the course of events in the coming months.
Beside L&G, speculation persists that Prudential could split itself into
two businesses: the UK and Asian operations. Hermes, an activist investor,
wrote to Prudential’s chairman in 2007 calling for a break-up of the group
to unlock hidden value. Whether the same amount of value can be mined now is
questionable, with an increasing number of analysts suggesting that the UK
business is a helpful counterweight to fund the altogether racier
developments of Pru in Asia.
On top of all this, insurers are having to grapple with the introduction of
the retail distribution review, a radical overhauling of the way companies
distribute their products to individuals that comes into force in 2012.
“Not that long ago, there were about 200 life companies operating in the
UK,” says Paul Bradshaw, the former head of insurance at Abbey and now
non-executive chairman at Nucleus, a provider of services to the financial
adviser community. “Now there are about 10 meaningful names left. The
economics of running life businesses often just don’t add up.”
In the next two years, the number of players left could shrink further.
RSA’s quiet man at the top: Haste brings unhurried success
City investors often bemoan the quality of management in the insurance sector
but it’s hard to find anyone with a bad word to say about Andy Haste, the
chief executive of the general insurer RSA. That his reputation remains so
strong is all the more remarkable given that the former banker asked
shareholders for nearly £1bn in a 2003 rights issue, and plans to tap them
for another £600m this autumn.
He has presided over a dramatic improvement in the fortunes of a company that
was on its knees when he took over. Mr Haste successfully sold the company’s
draining American business early in his tenure. As one investor in the
company put it: “We gave him a list of things to sort on his arrival
and he’s ticked every box. The only thing now is where the growth comes from?”
By looking to raise £600m from investors for Mr Haste clearly thinks that
growth will come through chunky acquisitions. Previously, RSA has said it
only had eyes for small, bolt-on buys but the rapidly changing landscape has
altered opinion at the top.
Perhaps RSA’s biggest challenge will be to keep hold of the press-shy Mr
Haste, who has been linked to some of the most prestigious jobs in
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