Clifford Chance

The global economy continues to face challenges arising from inflation, geopolitical tensions, and market uncertainty. This in turn has had a knock-on effect on the M&A markets more broadly. In this article, we take a closer look at how this has impacted M&A in the life insurance sector in the UK, Europe and the US and consider alternative arrangements and structures which are gaining prominence in the market.

M&A and consolidation

Life insurance M&A, despite the macroeconomic headwinds impacting M&A generally, remained reasonably active in 2022. However, there "does seem to be a downturn in 2023 and certainly we're not seeing transformational strategic deals," says Imogen Ainsworth, a London-based Clifford Chance Partner in the Financial Institutions Corporate Group which she attributes, in part, to concerns over cost and expensive transaction financing. "That said, we're still seeing activity in the legacy markets, fuelled in large part by continued private equity investment in the sector." For disposals of non-core or non-performing portfolios, she notes that these may be attractive to buyers who are able to consolidate and achieve efficiencies. Yet, execution risk is still key with operational and technological complexity, for example around separation, migration and integration, being cited as a key transaction challenge.

The picture in the US is similar with fewer auctions and fewer transformational stock deals although "the auction processes that we're involved in for the big block deals, there's fewer of them but they're getting done," says Frank Monaco, a Clifford Chance Partner based in New York. Despite the slowdown, the sale of annuities provider, American Equity Life to Brookfield shows that there's still life in the market.

Lucio Bonavitacola, a Partner at Clifford Chance in Milan points to two active areas in the Italian market, "consolidation on the one hand and bancassurance on the other hand". The trend for amalgamations over the years has continued with the acquisition of Cattolica by Generali. On the bancassurance side, there are a number of joint ventures which are being renewed or are changing partners.

Partnership arrangements

Aside from M&A and consolidation in the legacy markets, there is now an increasing trend towards private equity and asset managers investing in active underwriting business through partnership arrangements. "It's a bit of a shift from the back book to new business," says Monaco. Flow reinsurance transactions where the reinsurer takes on a portion of a cedant's new business writings have seen partnership arrangements between large private equity-backed reinsurers and ceding companies which are often highly customised. Asset management may also be split between the ceding company's affiliated asset manager and the reinsurer's asset manager.

Regulatory concerns

Regulators' views on private equity ownership of insurance companies have shifted over time. Whilst difficulties remain in Italy, including around asset management arrangements, private equity ownership is now generally accepted in the UK and US. In Bonavitacola's view, there are a number of actions private equity firms can take to gain the trust of the Italian regulator. First is to set up a robust risk management framework and second is ensuring a diversification of assets. Overseas investors need to understand that the Italian regulatory environment operates differently and "there are moving targets which are very much at the discretion of the regulator". For example, capital add-ons are decided on a discretionary basis by the EBA.

"From the UK perspective, we probably sit somewhere between the US and Europe" says James Cashier, a Clifford Chance Partner in London. The PRA is generally used to private equity ownership in the life insurance sector and is not unsupportive but there is an element of prudential supervision around change of control or portfolio transfer processes. The regulator will want to see what the private equity firm's investment horizon is, what their exit strategies are and on the asset side, what the investment strategies are, what capabilities and expertise they have and that there are robust risk management processes, business plans, capital projections and governance arrangements in place.

In the US, regulatory attention is turning to investment management agreements. According to Monaco, "Where we're seeing more activity or more concern from regulators is where a party is not acting as if they control the insurer, but in fact they actually might." The definition of control, which is the power to direct the management of policies of the insurer directly or indirectly, is very subjective. "What regulators are now focused on is does an investment management agreement effectively constitutes control? How much do you cede control to the point where the person with the discretionary authority is actually controlling the insurer and if they're doing that and they haven't gotten regulatory approval, that's a big problem."

Structuring issues

When considering how to structure a transaction, "portfolio transfers do bring the benefit of economic and legal finality for the transferor," notes Ainsworth. Whilst in the UK, portfolio transfers (known as Part VII transfers) involve a court procedure and are time, cost and resource-heavy, they allow the transferor to avoid ongoing capital and regulatory compliance requirements and once completed, free up senior management time to focus on core business. However, the ability to use this structure in the UK is limited as they can only be used for domestic transfers.

Until recently there was no portfolio transfer mechanism in the US and there remains no equivalent structure for life and annuity deals. The US market, therefore, largely relies on reinsurance. "What that means from a structuring perspective," says Monaco "is that the seller or ceding company are still liable for the policyholders until those liabilities run off." He notes that some US states now have legislation permitting the equivalent of a Part VII transfer but "it's very embryonic. So far it's only been used a couple of times in property and casualty insurance". Another mechanism used by some US states allows an insurance company to divide into two or more operating insurers. "You divide, you insolate the business you want to sell and then the purchaser purchases that legal entity, post division. Again early days," says Monaco, noting that it's not something that's been talked about in terms of life and annuity risks.

"In Italy, the portfolio transfer is a very well-trodden path", says Bonavitacola. It doesn't require sanction by a court like the UK but it does require consent from the regulator. The position is much the same across continental Europe under Solvency II. Despite the requirement for consent, Bonavitacola believes that portfolio transfers in Italy are in some ways more straightforward than reinsurance arrangements as the requirements are clear. Although reinsurance doesn't require formal approval, it is often subject to case by case assessment by the regulator.

Pension risk transfers – the future?

Looking ahead, Monaco describes the pension risk transfer (PRT) market as "the next frontier". Pension risk transfers involve defined benefit pension providers transferring their obligation to provide future benefit payments to plan participants, to life insurance companies. The PRT market is seeing an increasing number of collaborations between direct writers of pension risk transfer products and reinsurers. Private equity-backed companies are also looking to participate in the market either on a direct basis or as reinsurers. Having reinsurance locked in allows the direct writer to offer the best price when bidding on a PRT transaction.

Ainsworth agrees: "When you are executing those mega PRT deals, they almost become like an M&A transaction. You've got to gear up in that sense, looking at longer lead times for diligence, getting the commitment on reinsurance upfront so you know you have the capacity to write that business, looking at revised governance processes internally, what approvals you need, announcements etc. All those things you would expect on a larger M&A deal, we're now going to apply to large PRT transactions."

Conclusion

The life insurance M&A landscape in 2023 has shown a significant slowdown in large and transformative deals, mainly due to concerns about costs and financing. Despite this, activity continues in established markets and private equity investment, leading to the exploration of alternative structures and partnerships. Differences in regulations across regions affect how deals are structured. Looking forward, the industry is focusing more on the emerging pension risk transfer market, requiring strategic planning similar to that of major M&A deals. The future of life insurance M&A and alternatives depends on innovative adaptations to regulations, creative partnerships, and the growing potential of pension risk transfers.