Industry consolidation, calls for federal oversight, and unexpected savings incentives in the Bush budget may signal significant changes ahead for the life sector.

By Jennifer C. Rankin

Change is in the air. So what else is new? After all, the life insurance industry has coped with everything from convergence to globalization, a go-go market to a stocks freefall, and executive greed to big layoffs during the past decade. What’s different now?

In a word, lots. Surprising M&A announcements from large, well-established companies. Stunning—dare we say shocking—proposals from President Bush for new savings programs, and behind-the-scenes maneuvers by both proponents and opponents of federal oversight.

Let’s start with industry consolidation, which was arguably the No. 1 news topic of 2003 and still is four months into the new year.

Merger and acquisition activity picked up in 2003 after several relatively quiet years and analysts believe there will be even more M&A transactions in the year ahead. According to Thomson Financial, the value of M&A deals worldwide grew 131 percent in 2003 compared to 2002 with virtually all of the growth coming in the U.S. markets. Activity soared in the country’s life/health sector, up 545 percent in 2003 compared to 2002.

What’s driving the recent wave of consolidation? According to a recent Standard & Poor’s commentary, a major factor is the improving economy. Rising interest rates benefit spread businesses such as insurance. Healthier stock markets help equity-based products such as variable life and annuities and 401(k)s. Decreasing credit defaults protect corporate balance sheets. All of these factors contribute to a company’s valuation and, hence, its attractiveness as a potential acquisition.

Which companies fit the buyer profile? Kevin Ahern, director in Standard & Poor’s insurance sector, names Manulife, Prudential, BankOne, AXA, RGA, Great-West, and AIG as good examples of large companies well positioned for growth. Many of them have already purchased other insurance units or companies as part of an acquisition strategy. Their shared traits include diversified operations, a capacity for taking on additional risk, and enhanced financial flexibility because of improved stock valuations.

The seller profile, conversely, is typically characterized by small to mid-sized companies that lack financial flexibility and have seen their income decline because of investment losses sustained during the long bear market. A concentration in one line of business can put them at a competitive disadvantage.

Another driver is demutualization. The mutual form of ownership that historically dominated the life industry tended to discourage consolidation, because it limited insurance companies to cash acquisitions. Therefore, widespread demutualization was a prerequisite before industry consolidation could really take off. Many companies have demutualized during the past decade in anticipation of M&A activity. Prime examples are Manulife, John Hancock and MONY. The conversion from mutual to public stock ownership, however, is a double-edged sword. While it has given insurers the ability to use stock to purchase competitors, it also turns acquirers into acquisition targets.

Merge Ahead

The most talked about deal is Manulife Financial’s acquisition of John Hancock in a stock-for-stock, tax-free transaction that will give Manulife a market capitalization of about US$ 24 billion, making it comparable in size to MetLife and larger than Prudential Financial.

"We see this as a unique strategic opportunity," says Manulife’s Dominic D’Alessandro, who will serve as chairman and CEO of the combined company, "to combine two exceptionally strong companies into a single, integrated, global market leader whose scale and capital base will drive even greater growth and shareholder value. The benefits of this transaction are many, strengthening our position in each of our core businesses. The merger also enables us to create the largest life insurance company in Canada and the second-largest in North America." The companies announced the deal in September 2003 and, in February, John Hancock shareholders gave their approval.

Analysts expect the acquisition to close by mid-year. When it does, Manulife Financial will be the largest life insurer in Canada, the second-largest in North America and No. 5 in the world.

If that wasn’t excitement enough, the same month brought an announcement from AXA Financial that it would acquire The MONY Group, a financial services leader that provides protection, accumulation and retail brokerage products through advisory and wholesale distribution channels. Like Manulife, AXA is betting that scale will enable it to succeed in an increasingly competitive market place.

With US$ 458 billion in assets under management, AXA Financial is the U.S. arm of French powerhouse AXA Group and owns The Equitable Life Assurance Society of the U.S., AXA Advisors, LLC, Alliance Capital Management, OP, Sanford C. Bernstein & Co., and wholesale distribution company AXA Distributors, LLC. The global AXA Group is a worldwide leader in financial protection and wealth management.

Facing shareholder opposition to the deal, MONY announced in late February that it would delay until May 18 a shareholder vote on the merger. Opponents believe AXA Financial’s US$ 31 per share bid is too low and that the deal gives MONY executives a financial windfall at shareholders’ expense.

Another big surprise was GE’s decision to spin off its life and mortgage insurance operations in an initial public offering (IPO) of a new company it has named Genworth Financial. The conglomerate filed a registration statement with the U.S. Securities and Exchange Commission in January and hopes to complete the IPO in the first half of the year. GE plans to retain 70 percent ownership of the new company and to sell about 30 percent of it in the IPO. GE will reduce its ownership stake over the next three years as Genworth transitions to being a fully independent company.

If all goes as planned, Genworth Financial will have 5,640 employees, US$ 28.6 billion in assets, headquarters in Richmond, Va., and offices in 19 countries outside the United States, according to published reports. It will sell mortgage insurance and investment products as well as individual life insurance, long-term care insurance, retirement savings products, and group life and health products.

Why would a company so well respected by consumers for product design and knowledgeable direct marketing representatives choose to exit the business? Since taking the reins from Jack Welch, Chairman and CEO Jeff Immelt has said repeatedly that he intended to reduce the company’s exposure to the insurance business after taking a US$ 1.4 billion charge in 2002. He intends to reduce GE’s insurance business from 40 to 15 percent of its overall financial services assets, which now total US$ 500 billion. This is a real loss for consumers and potential big win for rivals interested in acquiring a well-managed block of business once the carve-out settles into the market place.

Another major industry carve-out is Fortis NV’s divestment of Assurant, its U.S. insurance arm, which has operated as a standalone entity for more than a decade. Fortis is a Dutch-Belgian financial services giant. Assurant sells health insurance, funeral-related insurance, benefits insurance, and other products.

Assurant stock made its debut on the New York Stock Exchange in February as this year’s first billion-dollar IPO. Assurant will not receive any proceeds from the offering and Fortis will retain a 45 percent stake in the company after the IPO. Fortis CEO Anton van Rossum says the IPO’s proceeds will be used to develop and expand Fortis’s core operations.

What purpose do these carve-outs serve? According to Wall Street Journal analysts, carve-outs are one of the easiest ways for a company to pay off debt or to build other businesses. They also help companies with capital management. How? Monetizing assets enables a company to redeploy capital to faster-growing or more profitable businesses and to generally improve its balance sheet.

Also exiting the life sector is CNA Financial Corporation, the insurance arm of conglomerate Loewes Corporation and the 4th-largest commercial writer in the United States.

In January, CNA sold its group life and accident, short- and long-term disability, and certain specialty businesses, excluding group long-term care, to Hartford Financial Services Group for some US$ 500 million. One of the nation’s largest financial services companies, The Hartford is a leading provider of investment products, life insurance and group benefits, auto and homeowners products, and business property/casualty insurance.

In February, CNA sold its individual life insurance business to Swiss Reinsurance Company’s Life & Health America, Inc. for about US$ 690 million. The sale included term, universal and permanent life insurance policies and individual annuity products, but excluded the individual long-term care and structured settlement businesses. Swiss Re also bought CNA’s Nashville, Tenn.-based insurance servicing and administration operation.

According to Stephen W. Lilienthal, chairman and CEO, the sales will enable CNA to focus solely on its core business—property/casualty insurance—and move forward on the new capital plan he announced to the media this past November.

The acquisition also bolsters The Hartford’s strategy to increase the scale of its group life and disability operations and to expand its distribution capability. "The Hartford will continue to pursue strategic acquisitions to add to our current operations," says Ramani Ayer, chairman and CEO. "We’re always on the lookout, and when we find transactions that make economic sense and bolster earnings, we will seize the opportunity."

When will the merger mania slow down? Perhaps not for quite a while. According to Bernstein Research, the life industry still has lots of room for consolidation. The industry’s top 10 companies control about one-third of industry assets. In the commercial banking industry, the top 10 companies control two-thirds of the assets; in the securities brokerage industry, the top 10 companies control 99 percent of the assets.

Speed Limit

If the challenge of acquiring or being acquired isn’t enough for industry executives, they can always worry about regulation. Calls for an optional federal charter have heated up, and federal oversight is an issue that simply will not go away, much to the chagrin of smaller insurers, state insurance commissioners, and state governments.

The states have regulated insurance for 150 years. Under state regulation, most insurance writers must register in each and every state in which they want to do business. This is expensive and time-consuming for companies that want to do business nationally.

Major life insurers continue to push—thus far, unsuccessfully—for an optional federal charter to simplify nationwide filing of products and licensing.

What’s new in the debate is that proponents of a state regulation have gotten feisty in recent months, launching a public relations campaign on Capitol Hill and working hard to speed up the passage of model bills that address insurance company concerns.

Why all the activity? The National Association of Insurance Commissioners (NAIC) is increasingly worried about the likelihood of Congress introducing a bill this year that advocates some form of federal oversight. In a National Underwriter interview, NAIC President Ernst Csiszar, South Carolina Director, said, "The urgency is immediate and to wait until the original 2008 timetable in the NAIC’s statement of intent is not realistic. The market moves too fast. The message is to get going."

The NAIC statement of intent to which Csiszar refers sets a goal of at least 30 states or states representing 60 percent of the premium volume, enacting the compact legislation by year-end 2008. One of his big goals for 2004 is to establish standards for an interstate compact for life insurance products. The goal of the compact is uniformity, which is necessary to streamline—read that, speed up—state regulation. In short, the best defense is offense. To that end, the NAIC recently launched the Alliance for Sound State Uniform Regulatory Efficiency (ASSURE) program, an organization that promotes the benefits of state-based regulation.

In the past, leading life insurers have relied on the American Council of Life Insurers (ACLI) to press their case. Like their opponents, they have become increasingly proactive in recent months, speaking out publicly on the federal oversight issue. In fact, several companies—including Principal Financial, Aegon, Mass Mutual and Lincoln National—released statements to the media in late 2003 and early 2004 outlining their support for an optional federal charter.

Speed-to-market is the pivotal issue. In a December 2003 interview with the Des Moines Register, Merle Pederson, group vice president of government relations, Principal Financial, said, "Our 401(k) plan looks and feels just like Wells Fargo’s or Fidelity’s. Yet, Wells Fargo and Fidelity can move faster because they do not have that extra layer of oversight by the 50 states."

Another issue is agent licensing, which has become a major burden for producers who increasingly do business in multiple jurisdictions. The relentless scrutiny of life insurance tax issues in Congress and at Treasury, too often based on misinformation, is another challenge, according to a February e-briefing from Insurance News Net. "The recent firestorm over corporate-owned life insurance may never have happened had there been a federal insurance department that could have provided assurances that any alleged abuses were based on a legal landscape that no longer exists. And a federal insurance department may have been able to persuade Congress that variable annuities should receive the same treatment on dividend taxation as other investment products."

Various trade groups are clarifying their positions in the debate, as well. The board of the National Association of Insurance and Financial Advisors (NAIFA) is taking lots of heat for aligning itself with backers of an optional federal charter. In a January press release, Randy R. Kilgore, NAIFA’s president, said, "While NAIFA stands by its support of state regulation, the changing dynamics of the financial services industry in the 21st century compels us to be open-minded to all promising options to improve the regulation of the industry." NAIFA supports the establishment of a federal producer’s license, the creation of an office for an insurance advocate within the federal government, and a single point of filing for insurance products.

The ACLI immediately applauded NAIFA for strengthening its position on insurance regulatory reform. "This marks a very important step in the march toward a better regulatory structure for consumers, agents and companies," said ACLI President and CEO Frank Keating. "Exclusive state regulation of an industry as large and diverse as ours is an anomaly. In this era where companies compete not only against each other, but against banks and securities firms and international financial firms, the state-based system does not work for everyone. That said, both the ACLI and NAIFA expect the state to maintain a very significant role in insurance regulation. Companies and agents can and will choose to remain state regulated."

Insurance regulatory reform, then, will be a top industry issue this year. According to the Insurance Chronicle, the debate appears to be settling on a choice between two options as to the federal government’s role in regulating the industry: the establishment of a federal level of insurance regulation with an optional federal charter for insurers operating on a national basis, or the establishment of federal guidelines by Congress that would be enforced at the state level.

New Directions?

Another surprising twist in the life insurance sector is President Bush’s involvement in tax-friendly savings vehicles. The nation’s staunchest proponent of Republican values, the President is obviously pro-business. But he has some very specific ideas about giving Americans tax breaks—ideas that strike at the heart of the life insurance, annuity, and pension industries. Consequently, industry executives and lobbyists have spent much time on Capitol Hill to protect their turf.

In 2001, the Bush administration repealed estate taxes and the President has signaled his intention to lobby for permanent repeal. The administration also pushed through tax cuts on dividends and capital gains. And the President is trying to sell, for a second time, the special tax-free savings accounts that legislators rejected in his proposed 2003 budget.

In February, the U.S. Treasury Department announced that President Bush has included four new savings programs in his 2005 budget. The programs would create lifetime savings accounts (LSAs), retirement savings accounts (RSAs), employer retirement savings accounts (ERSAs), and individual development accounts (IDAs).

The President wants to simplify the existing web of tax-preferred savings accounts for retirement, health care, and education. According to the Treasury, the plan makes saving simple for everyone and for every purpose. Under the plan, existing tax-favored accounts—including IRAs, education savings accounts, and 401(k)s—would be replaced by Bush’s proposed accounts:

--Lifetime savings accounts. An all-purpose savings account for augmenting retirement, health care, education and emergency needs. Each taxpayer could contribute up to US$ 5,000 per year in after-tax dollars. Contributions would be taxed, but gains would not. Investors could withdraw the money at any time for any purpose without paying taxes.

-- Retirement savings accounts. Dedicated solely to retirement savings. Each taxpayer could contribute up to US$ 5,000 per year under contribution and distribution requirements that are similar to those for Roth IRAs. Withdrawals taken after age 58 would be tax-free.

-- Employer retirement savings accounts. Only employers could contribute to these accounts, which follow existing rules for 401(k) plans, subject to certain simplification of the rules, with employees able to defer up to US$ 13,000 annually in wages, with the amount increasing to US$ 15,000 in 2006. Contributions would be tax deductible and withdrawals at retirement would be taxed as ordinary income. Conversions from existing IRAs and defined contribution plans to the new savings accounts are outlined in the budget proposal. Defined benefit plans are unaffected. According to the National Underwriter, the Bush proposal calls for ERSAs to replace 401(k), SIMPLE, 403(b) and 457 plans. Most of the proposed changes would simplify the accounts for their sponsors.

-- Individual development accounts. These are aimed at low-income and moderate-income taxpayers. The government would provide up to US$ 500 in dollar-for-dollar matching contributions for the poorest individuals.

No existing tax-sheltered accounts would be cut, though most would be ineligible for new contributions. State 529 college savings plans and health savings accounts (HSAs) would be unaffected.

Support is building for the Bush proposal. In a statement supporting these expanded savings opportunities, Gordon Bernhardt, CFP, CPA, and chairman of the Financial Planning Association’s tax subcommittee, said, "It is estimated that 70 million Americans do not currently have an individual retirement account or a 401(k) plan. This proposal holds the promise of simplicity and universality. It would provide all Americans with increased opportunities to save and invest."

The American Society of Pension Actuaries (ASPA) also has come out in support of the Bush savings initiatives, saying they will result in greater retirement plan coverage and, consequently, greater retirement savings for working Americans. The ASPA lobbied hard to ensure that the new proposals would expand workers’ savings options while still maintaining the necessary incentives for small business owners to provide employer-sponsored retirement plans to workers. Its work with the Bush administration helped to reduce LSA and RSA contribution limits from US$ 7,500 to 5,000 and to retain important nondiscrimination testing flexibility, which the ASPA believes are critical factors in promoting new small business retirement plans.

In general, the life industry opposes these plans. For starters, the lack of restrictions on LSAs means many savers would place their money in LSAs first. In an interview with Insurance News Net’s Thomas A. Fogarty, Principal Financial CEO Barry Griswell said, "[These plans] would turn the life insurance industry on its head."

All of these moves have the potential to siphon money from insurance products and usurp the traditional role of the insurance company. Retirement products—among them, annuities, 401(k)s, defined benefit pension plans, and IRAs—have long been the bailiwick of insurance companies. Even life insurance, the primary function of which is to protect families from economic catastrophe when a wage earner dies, enables policyholders to save for heirs and for unexpected expenses. All of these products have enjoyed tax advantages for years—advantages that made them more appealing to consumers than less tax-friendly investments.

Life insurers are tired of being passed over when tax cuts are handed out. Estate tax repeal has hurt insurance sales. Tax cuts on dividends and capital gains were not extended to variable annuities. And, if Congress authorizes LSAs and RSAs, the life industry will take yet another hit. These tax issues have contributed in a big way to the federal oversight debate.

The ACLI, while commending the President’s emphasis on savings, is especially concerned about LSAs, which it emphatically opposes. In an Insurance Chronicle analysis, ACLI president Frank Keating said, "The LSA effectively is a consumption account and I think all of us know we consume enough, thank you. And they will shortchange retirement savings and lifetime savings, the 30-year savings." Keating believes Congress should incentivize insurance products by not only allowing tax-free inside build up, but also tax-free withdrawals. He believes Congress should support further tax incentives for long-term payout products, such as lifetime annuity payout accounts (LAP), which the industry continues to propose. And he supports mandatory private savings, which many other countries have.

There are obstacles in the Bush administration’s way. Analysts say growing concern about the country’s budget deficit, a short congressional year due to the presidential election in the Fall, and the lack of outside support could derail momentum for the savings plans.

The life industry, then, is at a major crossroads this year. Resource expects significant acquisition activity, significant movement on federal oversight, and significant progress on tax-friendly products that will threaten the industry’s competitive position. As always, we will keep you posted as events unfold.