Post COVID-19 landscape of insurance tax: Deals outlook

Read the introduction to this series

With M&A activity being key to many recovery plans, the insurance sector in particular has become an attractive target for investment. Appetite for deals is high, especially in the non-life run off and life insurance consolidation space, and insurance groups need to be prepared to defend their own value as well as explore opportunities available. This could be the ideal time to explore whether focusing on InsurTechs and new entrants could help address the gaps in services and products that the pandemic exposed.

Regardless of what is motivating the activity, there are some key tax areas to pay attention to in order to maximise the value of the deal.

Key tax areas of value in deals

Capital management

Investors and senior stakeholders should continue to focus on the tax efficient use of capital within a group. Capital inefficient lines of business are obvious candidates for sale, or may be ceased entirely. This is a huge opportunity for tax teams to add significant value by reviewing existing capital structures and proactively managing associated tax exposures.

In addition to the traditional use of reinsurance, alternative sources of capital such as hybrid debt instruments may be attractive. The ability of such debt instruments to qualify as regulatory capital while generating tax deductible interest expense increases capital efficiency. However the tax treatment of these instruments is complex and has undergone recent change - care should be taken to ensure that they deliver capital benefits while avoiding tax inefficiencies.

Tax teams should also look for capital optimisation, e.g. reducing solvency capital requirements by using the loss absorbing capacity of deferred tax ('LACDT'), something that is now subject to specific PRA approval for standard formula firms. While the opportunity may depend on regulatory approval, insurers have historically been relatively conservative in testing the availability of LACDT, and this may present an upside opportunity post acquisition.

Value preservation: tax attributes

Ensuring that tax attributes, e.g. historical losses and tax credits, remain available following a deal is important. The loss rules are considerably more complex since the 2017 reforms. For example, the new “major change in scale” test and the extension of the “major change in nature or conduct of trade” test may increase the risk of forfeiting use of carried forward losses following a change in ownership. This, coupled with the potential for further change in response to COVID-19, makes thorough diligence of tax attributes a critical deal issue. With losses potentially increasing following COVID-19 disruption, how such attributes are used in the future will be key to modelling the expected tax profile of target businesses.

Where groups are the target of M&A activity, they should be reviewing existing group attributes to ensure they can be defended robustly in valuation conversations with potential acquirers.

Looking ahead: supporting long term strategy

There are further opportunities post acquisition. Exploring more effective approaches to tax grouping, VAT recovery, and the insurance value chain, can all provide cash flow benefits. The rise of InsurTech and digitalisation is also creating chances to use data more strategically, e.g. in potential R&D expenditure credit claims, which are particularly attractive in managing ETR.

Tax teams can demonstrate the value they bring to deals through proactively identifying and quantifying such opportunities - driving their ongoing involvement within the deal cycle.

Key takeaways

Tax has a valuable role across all aspects of deals, from the protection of value on a potential disposal to enhancing cash value by identifying post deal opportunities. Engaging proactively with the opportunity, making sure that tax considerations are on the agenda, will ensure a tax efficient and robust investment case for investors ranging from existing corporates to newly financed entrants.