top issues

Volume 42012

FPO

An annual report

The insurance industry in 2012

Table of contents

2012

Risk and capital management 2The impact of persistently low interest rates 2Solvency 3Strategic risk management 6

Financial reporting 9Improving market reporting 9

Strategy and execution 11M&A 11Global growth 13“Big Data” and smart analytics 16Customer-oriented operating models 18What to ask before a policy administration systems transformation 20

Regulatory compliance 22 Dodd-Frank update 22 Unclaimed property 23

Tax compliance 25SSAP 101 25FATCA 27

2 top issues

Risk and capital management

The impact of persistently low interest rates

Interest rates are at historic lows and there is every indication that they will remain there. The US Federal Reserve (the Fed) has publicly stated its commitment to an extremely low interest rate policy; in the December 13, 2011 minutes of its Federal Open Market Committee (FOMC), reiterated that economic conditions are likely to warrant exceptionally low interest rates through at least mid-2013. Accordingly, companies that assume interest rates will return to “normal” in the near future do so at their own peril.

• A large domestic VA writer stopped all new sales;

• A mid-size domestic income annuity writer announced its plans to diversify its product portfolio away from interest sensitive products;

• A large multi-national VA/EIA writer took a large write-0ff associated with unfavorable policyholder behavior;

• There were numerous company exits or repricings of products with profit streams that are especially vulnerable to low interest rates, namely secondary guarantee universal life and long-term care; and,

• Fixed annuity and universal life credited and policyholder dividend scale interest rates steadily declined.

Implications

• In 2011, life insurers started to feel meaningful effects from the low interest rate environment. If interest rates continue to stay low, then life insurers’ financial pain will be broader, deeper and more prevalent. As this environment persists, it is unlikely that any company will be immune to:

» Lower investment earnings decreasing revenues;

» Smaller margins causing DAC amortization to accelerate;

» Traditional products becoming more likely to experience loss recognition; and,

» Goodwill potentially becoming impaired as earnings decrease.

• Because companies are reinvesting their cash flows at yields below current portfolio rates, they may be motivated to overreach in their investment decisions to maintain current portfolio yields. Companies may extend duration beyond what is prudent for their liability characteristics or increase credit risk testing the limits of their risk policies. These will serve to increase regulatory and economic capital requirements, and may prove unattractive on a risk-adjusted basis.

The low level of interest rates and the period for which they have persisted are unusual but not unprecedented. Following the Great Depression, interest rates were as low as or even lower than they are today and remained so for over ten years. More recently, Japan has experienced a very low interest rate environment for the last two decades.

The Fed is committed to low rates in order to stimulate the economy, most notably to encourage a housing market recovery. Overcapacity in the manufacturing sector, high unemployment and underemployment, and the ability to move manufacturing and services to lower cost locales, are keeping a lid on inflation. And, despite concerns about the long-term health of the US economy, foreign investors still view US treasuries as a safe haven.

For years, industry observers have tried to anticipate the financial impacts of a low interest rate environment on the life insurance industry. Their predictive scenarios have foreseen declining sales, revenue, profitability and company valuations. 2011 saw validation of these forecasts. For instance:

3 Risk and capital management

• As we cite above, lower investment income will cause company revenues to decline, and any related decreases in sales will only accelerate the downward trend. In order to maintain margins, companies are likely to more aggressively seek ways to reduce expenses. However, expense reduction initiatives have been in place at many companies for some time, and it is uncertain how much more in earnings they can squeeze from this stone. At the same time, increased regulatory and compliance requirements are generating increasing headwinds for any company trying to achieve lower costs.

• The current low interest rate environment is causing companies to re-examine policyholder experience assumptions. Insurers have made experience assumptions, such as those for persistency, renewal premiums, and optional benefit elections, against the historical backdrop of a more “normal” interest rate environment. As the low interest rate environment persists, current policyholder experience is increasingly straying from what insurers have experienced in the past.

• The low interest rate environment is forcing companies to address fundamental strategic issues. The strategic response to a temporary low interest rate environment is understandably different from the response to a prolonged low interest rate environment. If companies assume the current low interest rate environment will be temporary, then a business as usual approach may serve them most effectively. If they expect low interest rates to persist indefinitely, then they should consider fundamentally redesigning their product portfolio to reflect new economic realities

Solvency

Significant shifts in insurance regulation around the globe continued throughout 2011, with substantial regulatory development underway in the US, Bermuda, Canada, Mexico, Europe, Japan and other major jurisdictions. Regulators and standard-setters were correspondingly busy, with activity in particular from the National Association of Insurance Commissioners (NAIC), the European Commission, Council and Parliament, the European Insurance and Occupational Pensions Authority (EIOPA), and the International Association of Insurance Supervisors (IAIS).

The majority of developments over 2011 were part of multi-year regulatory change initiatives, for example, Solvency II and the NAIC’s Solvency Modernization Initiative (SMI). In the US, two key themes dominated regulatory discussions: Supervisory focus on Enterprise Risk Management (ERM) and capital management, and concerted efforts to move towards a consistent approach to cross-territory supervision of insurance groups.

Approximately 75 percent of insurance industry respondents to PwC’s 15th Annual Global CEO Survey anticipate at least some further change in the way they manage risk over the next twelve months, and nearly 40 percent are planning to modify their capital structure.

75%

4 top issues

ERM and the ORSA—In November 2011, a preliminary committee of the NAIC voted to adopt a significant new addition to US insurance regulation, the US Own Risk and Solvency Assessment (ORSA). The vote was unanimous and met little opposition. After a period of intense public consultation (which contributed greatly to the swiftness of the first vote), the NAIC issued a Guidance Manual for insurers carrying out the ORSA, which contains two requirements:

• The ORSA as a process: The ORSA is an insurer’s own process for assessing its risk profile and the capital required to support its business plans in normal and stressed environments on a forward-looking basis. The NAIC views the ORSA as a core part of an ERM framework, and one of its key objectives is to encourage insurers to develop their ERM capability. The Guidance Manual requires insurers to carry out this risk and solvency assessment process on a regular basis.

• The ORSA as a regulatory filing: On an annual basis, if requested by its lead state regulator, insurers will be required to provide a regulatory filing that explains the ORSA process and results. The filing does not have a detailed prescribed format, but there are three required sections that should contain: 1) a description of the risk management (ERM) framework; 2) an assessment of risk exposures under normal and stressed conditions; and 3) capital adequacy and prospective solvency assessments.

The NAIC’s focus is now on the development of the legal mechanism to implement the ORSA requirement, which we expect to be through a new, stand-alone model act. The NAIC is committed to having the ORSA requirement in place in time to receive credit from the International Monetary Fund (IMF) during its next assessment of US insurance regulation, expected in 2014. However, implementation though a new Model Act will lengthen the process, as the act is passed into individual state legislatures.

Europe and Solvency II—The development of Solvency II continues, and those insurers and groups with operations in Europe are continuing to invest in preparing for the new regulations. However, 2011 was marked by a series of delays

in the development of the new regime, most significantly around the “Omnibus 2” directive, which will make a number of important changes to the Solvency II directive, including a change to the implementation date and the introduction of transitional arrangements.

As at the date of this publication, Solvency II is expected to be implemented on January 1, 2014, with transitional provisions extending for several years beyond this. 2013 is expected to be a preparation year, with a certain level of regulatory reporting required to demonstrate progress towards compliance at implementation.

As insurers’ Solvency II projects have progressed, attention has widened from the early focus on Pillar 1 and capital modeling to the wider risk management, governance and reporting requirements (ORSA) under Pillars 2 and 3. This has placed a greater degree of focus on those Solvency II requirements that are applicable to insurance groups, and many insurers in the US and other territories that are either headquartered in or have operations in Europe have increased their efforts to understand the impact of Solvency II on their wider groups.

In 2011, the NAIC continued its discussions with the European Union on US equivalence with Solvency II. Going into 2012, the US is considered a strong candidate for equivalence under the transitional program that we expect to be introduced by Omnibus 2. However, the NAIC has stated publically that it expects the equivalence assessment to be performed on an outcomes basis, and that it will not move US regulatory practices wholesale towards the Solvency II model.

The IAIS, ICPs and ComFrame—At its annual conference in Seoul, South Korea, in October 2011, the IAIS adopted its newly revised Insurance Core Principles (ICPs), replacing the 2003 principles. Many of the principles had been publically available for some time before their official adoption, in particular ICP 16 (Enterprise Risk Management for Solvency Purposes), which has significantly influenced the NAIC’s new US ORSA requirement.

5

The Common Framework for the Supervision of Internationally Active Insurance Groups (ComFrame) is one of the IAIS’s most significant current projects. ComFrame is designed to provide a comprehensive framework for regulators to supervise internationally active groups in a coordinated manner, and the IAIS hopes that it will be a key tool to coordinate supervision of international groups. ComFrame is closely tied to the new ICPs, including ICPs 16 and 17 (Capital Adequacy). The NAIC is a significant stakeholder in the IAIS, and, along with regulators from other major jurisdictions, is investing substantial time in supporting ComFrame. A public consultation on the framework was held in summer 2011, and we expect a second consultation will take place in the summer 2012.

The US and the NAIC’s Solvency Modernization Initiative—The most significant output of SMI discussions in 2011 was the new US ORSA requirement. During 2011, group supervision arrangements also were the subject of extensive discussion, and the NAIC adopted its Holding Company and Supervisory College Best Practices document in November 2011. 2011 also was a significant year for reinsurance, with the adoption in November of changes to the Credit for Reinsurance models, which prospectively reduced collateral posting requirements for overseas reinsurers assuming risk from US (re)insurers to nil for the highest rated reinsurers. The amendments were controversial, with several close votes at the NAIC and substantial comment from interested parties; at the present time, only a small minority of states has adopted the changes. More widespread adoption could be a lengthy process because adoption will not be a requirement for states to maintain accreditation.

Because the project’s timetable requires all SMI activities to be complete by the end of the 2012, many of the SMI working groups have significant items on their agendas this year. The corporate governance working group has one of the most significant agendas. It plans to issue a public consultation in the summer on the changes it recommends to US corporate governance requirements. In the fall, it will finalize its recommendations, which will be based on both the working group’s review of current US corporate governance requirements and its earlier white paper on corporate governance principles for use in US insurance regulation.

Wholesale revisions to RBC are now unlikely; rather than ground-up recalibration, current plans call for improve-ment to be incremental and based on empirical evidence. Adoption and implementation of a catastrophe risk charge for property/casualty companies is the highest priority item.

Implications

• Insurers need to start preparing for the new US ORSA requirement. For insurers with established and effective ERM capability, complying with the requirements is unlikely to be a challenge, although as ERM standards across the industry improve, further investment may be necessary to maintain a market-leading position. For other insurers, investment in ERM may well be necessary to present a strong message in the new filing.

• ERM and the assessment of solvency are becoming more important to both rating agencies and regulators. Formal assessment of ERM and capital modeling is becoming the norm, and many insurers are starting to invest in developing more formal capabilities. Communicating this to rating agencies is just as important and should be a focus both for insurers developing their ERM and modeling as well as for those with existing capabilities.

• Although regulation is becoming more internationally focused, and there appears to be high level agreement on key principles for solvency regime reform, full convergence of the different regimes is unlikely given territorial industry differences and individual regulator preferences. Therefore there may be scope to leverage potential competitive advantages, arbitrage opportunities, and consideration of group structures and product portfolios.

• Furthermore, as regulation becomes more internation-ally focused, groups should consider developing a more holistic strategy for regulation and supervision. Doing so can help groups avoid duplication of activities and reporting, as well as enable them to make the best use of new opportunities to streamline supervision.

Risk and capital management

6 top issues

Strategic Risk Management: Facilitating Risk-Based Decisions

Strategic risk management (SRM) is the process of identifying, assessing and economically managing potentially enterprise-threatening losses over time. In other words, it is a way to identify, track and mitigate evolving risks before they spiral out of control. Like strategy in general, SRM encompasses quantitative, qualitative and behavioural analyses and activities, and integrates them into enterprise-wide guidance and actions.

• Integration issues can complicate netting efforts. For example, during the recent financial crisis, some institutions did not know which of their divisions put on a hedge.

There are a number of ways to mitigate significant exposure concentrations, for example:

• A concentration can be managed down to a given risk appetite. For instance, in the case of a large trade credit concentration, a firm could manage it down by refusing to grant further credit until the exposure is reduced below a given threshold by a specific time. One way to facilitate this would be to negotiate a concentration reduction at a discount to the nominal value.

• An alternative is to factor off (or transfer) the concentration—in other words, selling all or a portion of the exposure to a third party.

• Product mix changes can also mitigate a concentration. For example, when products begin deteriorating due to market conditions, firms can reduce their exposure to those products by offering others.

• Hedging also can mitigate a concentration, but it should take place before—not after—spreads widen or volatility spikes. Although hedging can be costly, it frequently is a function of pricing models that, at times, can dramatically under-price risk.

Another core SRM activity is ensuring business model integrity by regularly assessing the risk of normalized strategic deviations, which is the incremental expansion of a business model over time that results in a broader risk profile than what was originally intended. This can occur when business opportunities become increasingly limited and, as a result, some executives begin to incrementally loosen or expand their product offerings or investment standards. Significantly, it is relatively easy to rationalize incremental deviations for reasons of profitability, diversification or assumed informational advantages that, in isolation, seem strategically consistent even though they are not. One consequence of this is a broader risk profile that can result in outsized losses during crises. Such losses have been a root cause of many business failures.

For far too long, risk management has been the realm of “quants” instead of strategic decision-makers.

SRM begins with the identification of significant balance sheet concentrations, such as large counterparty, sector, region, and/or product exposures. An example is a credit exposure from one client that is greater than a firm’s equity. Another example involves leverage: For example, a firm leveraged 44-to-1, like Lehman Brothers was in 2008, is at a much higher risk of failure than more conservatively capitalized firms.

Firms should assess risk concentrations on both a gross and net (or after recovery) basis, not just on a net basis because there could be net-related concentrations within overall exposures that could put a full recovery at risk during times of distress. In other words, an actual recovery during an extreme event could wind up being less than 100 cents on the dollar and therefore could exacerbate a concentrated loss. It often is difficult to accumulate gross and net exposures because:

• The scope of analysis can be very wide and involve: (1) standard balance sheet items, (2) liquidity considerations (e.g., concentrated credit lines from potentially at-risk institutions), (3) customer segments, (4) product lines, (5) regions, (6) industries/sectors, etc.;

• Systems, data and process issues can complicate the accumulation of gross exposures; and

7

SRM also entails periphery monitoring, or reviewing information that does not seem pertinent to a firm’s immediate business activities or risk profile. There are three main reasons to actively monitor the periphery:

• As history has repeatedly shown, peripheral risks develop over time and some trigger concentrated losses;

• Disruptive or business-ending events often emerge from the periphery, out of the immediate sight of strategists and executives; and

• A peripheral threat could potentially trigger a risk and lead to a chain of errors that threatens the existence of an enterprise.

Periphery monitoring should consider all pertinent information sources, not just mainstream ones. Because the periphery is inherently blurry and does not often present a clear picture, it can be easier to assess with multiple monitoring methods and techniques that take into account a diverse range of viewpoints. Differing viewpoints can provide insight into the bigger picture, as well as help an organization think creatively to connect the dots.

For example, the London Market Excess of Loss (LMX) spiral in the late 1980s and early 1990s resulted from insurance and reinsurance companies within the London market transferring risks to one another. Given this

inter-connectedness, premiums shrank at each point in the risk transfer chain, which resulted in very large exposures at disproportionately low premiums toward the end of the chain. As a result, the amount of cash changing hands in the form of claim payments and reinsurance recoveries for events such as the 1988 Piper Alpha North Sea oil rig explosion typically amounted to ten or more times the original loss as payments flowed down the insurance chain. This pattern is similar to what would happen with credit default swaps in 2007-2008.

Connecting the dots can be very difficult in real-time, in large part because—even with active monitoring—peripheral threats can be ambiguous. Ambiguous threats are potential losses that seem highly uncertain due to an unexpected (and frequently non-linear) fact pattern that does not lead to obvious conclusions. Ambiguous threats are everywhere so it can be challenging to prioritize the threats that could wind up being more strategically significant than others. One way to accomplish this is to sift through the ambiguity and identify threats that could trigger a concentrated loss and impact the business model, and then to track those threats over time using broad information sources.

Risk and capital management

By reviewing “weak signals” that are frequently present, it is often possible to identify “off-model” inflection points before risks become serious threats. Such signals frequently go unnoticed because people either do not look for them or because they discount and otherwise ignore them.

8 top issues

Implications

• An executive risk committee should regularly track risk mitigation and other SRM activities against a formalized risk appetite, which is the amount of potential loss that is deemed acceptable in executing a strategy.

• Risk tracking should cover all noteworthy SRM developments over a given timeframe via a common reporting and dashboard structure. This structure should focus on the potential impact of a variety of risks to a business model and how to economically mitigate those risks over time. To optimize this structure for decision-making purposes, risk reports should be based on integrated analyses that provide enterprise-wide findings and recommendations.

• Corporate strategy and SRM both involve some level of quantification. However, quantitative analysis should inform decision-making, not dictate it—not the least because of the inherent uncertainty in any quantification exercise.

• In strategy and SRM alike, all pertinent forms of information should factor in a decision, not just quantitative information.

Concentration Ambiguous threats Mitigation Tracking

Governance • Risk appetites

• Executive risk committee(s)

• Process controls

• Business owner Oversight/ contribution

• Concentration reduction protocols

• Product mix changes

• Hedging strategy

• Risk profile

• Exception processes

• Audits (Process & technical)

Metrics/Analyses • Gross

• Net

• Strategic discipline/ deviation

• Top concentrations

• Cross-concentrations

• Modeled loss

• Stressed loss

• Qualification (Business model impact)

• Quantification

• Scenarios & development patterns

• Key milestones

• Pricing

• Volatility

• Product specifications & tracking

• Per share impact

• Capital impact

• Liquidity impact

• Internal information

• External information

• Lessons learned

• Knowledge management

Peripheral activityMonitor the periphery to mitigate the risk of concentrated loss triggered by an ambiguous threat that was neither mitigated nor tracked.

Risk Tracking

9 Financial Reporting

• Current financial reporting for life insurers, specifically accounting for insurance liabilities, imposes significant limitations on showing how the life business operates from an economic standpoint.

• Segmental analysis often fails to reflect a meaningful view of business capital. As a result, divisional results often fail to provide a clear view of underlying operating performance and returns.

Many life insurers have difficulty conducting integrated performance analysis, simplifying external disclosures, and keeping pace with constantly shifting analyst and investor expectations. As a result, although most annual reports and investor presentations contain a great deal of data, they fail to clearly link strategy, performance, and shareholder value. While insurers have justified concerns about performance data confidentiality and information disclosure, they need to balance them with the need to provide investors and analysts the information they want.

In order to construct an effective communication strategy, is useful to consider the three fundamental metrics that are most important to the users of insurance companies’ financial statements:

• Capital—A combination of statutory requirements and a company’s internal view of how much capital it needs to manage the business and meet corporate objectives. Regulatory capital requirements dictate the minimum amount of capital a company needs to maintain. Capital requirements to meet internal objectives are more economic and risk sensitive and may take into account objectives such as maintaining a particular rating classification.

Financial Reporting

Improving Market Reporting

Most life insurers’ poor stock market performance in recent year suggests that many investors have concerns about the sector’s potential. Disappointing share price performance largely is the result of continuing economic, market and regulatory uncertainty. However, disjointed and inconsistent financial reporting—which makes it difficult for investors to judge and differentiate the strategy, performance and true strength of a business—also appears to be a significant contributing factor. Many analysts doubt that the financial reports they see accurately indicate what is actually happening within a company and are uncertain if these reports even reflect management’s perceptions of how they run their business.

These concerns are not new. For many years, industry stakeholders have expressed their desire for more credible and relevant financial reporting metrics. A recent PwC survey on market reporting1 highlights the challenges many life insurers face presenting clear, coherent and compelling messages to analysts and investors:

• Most insurers acknowledge the need for an easily understandable dashboard of different metrics, including free capital generation, analysis of US GAAP margins, and a comprehensive view of new business profitability. However only a few actually have created one.

• Capital and solvency disclosures often seem arbitrary and do not necessarily reflect how the business really operates.

• Risk disclosures tend to be boilerplate and offer very little analysis of the potential real world impact of different stresses and scenarios on the business.

Many insurers often trade as leveraged “macro plays” rather than on economic fundamentals.

1 “Seeing the Wood for the Trees”—Available at: http://www.pwc.com/gx/en/insurance/publications/seeing-the-wood-for-the-trees.jhtml

10 top issues

• Value—The long-term value that is expected to ultimately become available to shareholders. This represents retained earnings, locked in capital, and the business’s potential to realize future profits. Value can come from current in-force business (similar to the embedded value for reporting currently common in Europe) or an appraisal value metric that allows for the company’s ability to generate new business.

• Free cashflows—What are current and expected cashflows? Analysts actively look for this information when trying to assess how a company stands to fare in both the short- and long-term.

By focusing on these fundamental metrics, insurers can provide financial statement users clearer insight into their true financial condition, real and potential value, and how they manage risk and capital. Furthermore, it is important that insurers be able to show links and interactions between and among these key metrics.

The following framework can benefit insurers as they try to improve external reporting; even though the framework may seem basic, insurers need to clearly articulate to the market that they have one. That said, insurers actually may see the greatest benefits from reassessing what is most important within the business itself. At the least, taking this course of action can help insurers produce management information that is coherent, consistent, and ultimately more useful for informing business decisions.

Meeting market expectations Managing the business

• Are you confident that the market understands your strategy and what makes your business successful?

• Does external reporting reflect how your business operates?

• Does your reporting provide a clear and transparent link between and among value, cash, capital and risk?

• Have you identified and are you using the right set of metrics?

• Are the key components of what makes your business successful missing from external reporting?

• Are there significant differences between business unit and group head office metrics?

• How confident are you that the metrics you use to manage the business are integrated?

• Do you have a sufficiently clear view of how economic measures translate into cash?

• How much of the management information you produce do you use?

Risk reporting Operational environment

• Is your risk reporting sufficiently clear about how required capital constraints may affect your capital strategy and how you run your business?

• Have you identified how you will embed economic capital concepts with your wider reporting on an integrated and joined up basis?

• Do you have a clear risk strategy?

• Is measurement of risk performance against appetite embedded in your business planning cycle?

• Are the demands of producing the numbers leaving you too little time for generating useful business insights?

• Do your risk, finance and actuarial teams collaborate sufficiently?

• Are manual interventions impeding efficiency and control?

• Are reward performance measures for senior management in alignment with the new suite of measures?

11 Strategy and execution

Implications

The current, challenging business and market conditions provides insurers a catalyst for improving their market reporting. In particular:

• In a volatile market, analysts’ lack of confidence in prevailing disclosure standards can only heighten investor uncertainty. This makes it even more important to provide stakeholders clear and informative financial information.

• Companies and investors want an integrated reporting framework that is capable of explaining current developments and provides a forward looking perspective. By taking the initiative on improving reporting, insurers can satisfy analyst requests and simplify approaches to valuing the business.

• Focusing on fundamental reporting metrics is a key objective. This is the case regardless of the potential timing of any insurance contract standard, since the need is independent of any future change in accounting. Furthermore, waiting for an industry-wide solution to emerge may not match individual companies’ time horizon.

• Once they establish the right metrics, companies can jettison any superfluous measures. The resulting rationalization can help make reports briefer and more informative, reduce the finance department’s workload, and cut reporting costs.

• There is no easy or instant solution. Companies that have most successfully addressed these issues have initiated pragmatic, one- to two-year strategies to improve and refine reporting.

Strategy and execution

M&A

Despite high expectations for increased insurance M&A activity in 2011, deals remained relatively flat compared to 2010. Insurance companies continued to search for opportunities to effectively deploy their excess capital in 2011, but, as a result of continued valuation gaps in the market, many of them were unable to find willing sellers from whom to make acquisitions.

According to SNL data, there were 239 announced insurance deals (excluding managed care) in 2011, compared to 203 in 2010; total announced deal values increased to $11.9 billion from $9.0 billion in 2010. The increase in disclosed deal values was largely attributable to a few significant, announced transactions, including Alleghany Corporation’s acquisition of Transatlantic Holdings, Inc. for approximately $3.5 billion, Tokio Marine Holdings, Inc.’s acquisition of Delphi Financial Group, Inc. for $2.8 billion, Allstate Corporation’s acquisition of White Mountains Inc. and Answer Financial Inc. for $1.0 billion, Nationwide Mutual Insurance Company’s acquisition of Harleysville Mutual Insurance Company for $800 million, and QBE Insurance Group Limited’s acquisition of the Balboa insurance business for $700 million.

Only 15 percent of respondents to PwC’s 15th Annual Global CEO Survey are planning to carry out a cross-border acquisition in the coming year. Uncertainty over capital demands and valuations appears to be making many organizations reluctant to commit to anything more than limited bolt-on deals.

12 top issues

2007–2011 US Insurance Deal Activity (excluding Managed Care)

0

50

100

150

200

250

300

350

20112010200920082007

164

$22.0

135

188

139

75

$5.0

$9.0

101

203

$11.9

70

239

153

$21.2

Disclosed Non-disclosed Disclosed deal value

$0

$5

$10

$15

$20

$25

Dea

l Vol

ume

$ in

bill

ions

Source: SNL

As has been the trend in recent years, a significant amount of pre-deal activity continues to take place, but not many deals are proceeding beyond this phase. Valuation gaps resulting from differences in buyers’ and sellers’ expectations of future profitability continue to present significant challenges to agreement on pricing and structuring, and is preventing many potential buyers and sellers from consummating a deal. In addition, significant uncertainty remains about the financial impact of regulatory and tax reform, which continues to pose valuation challenges for buyers and sellers.

Furthermore, many buyers are looking to deploy excess capital in building scale and efficiencies through domestic and international expansion of their core businesses,

while exiting businesses management deems non-core. The valuation gap and a lack of willing sellers are causing many would be buyers to look to alternative uses for capital, including organic growth, loss portfolio transfers, and renewal rights transactions, as well as stock buybacks. Distressed or “forced” sellers are still driving some deal activity; however, as global capital levels and market expectations begin to recover, the source of this deal flow seems to be limited to specific regions. As market conditions began to improve in early 2011, many distressed sellers considered strategic alternatives, including IPOs, instead of deals. However, due to market volatility in the second half of the year, many of these sellers have been forced to delay or reconsider any planned IPOs.

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Implications

While insurance M&A activity may strengthen in 2012, we expect a number of issues will impact deal activity in the industry, including:

• Uncertainty surrounding legislation and US federal regulation will continue to create hesitancy in 2012. This uncertainty could have a significant impact on offshore property-casualty reinsurance strategies and offshore reinsurers. Health care reform could have a major impact on accident and health, life, and other writers of related workers compensation, long term disability, or long term care products. The impact of health care reform is far from final and we believe that Federal Insurance Office (FIO) oversight has the potential to further impact insurance operations and costs.

• Solvency II—Solvency II may increase the amount of capital European insurers and reinsurers are required to hold, which will make it more challenging for them to compete in the US market. European investors’ interest in the US M&A market appears to be on the decline, in part because of uncertainty about Solvency II’s impact on the capital they are required to hold at their foreign subsidiaries.

• Yields are likely to remain low in 2012—The interest rate environment likely will remain low throughout 2012. Because they rely on investment returns on premiums before paying claims, low yields are likely to impact pricing considerations for many insurers. Insurers are evaluating the realistic yields they can earn in the current environment and are evaluating their pricing and growth

strategies. This may lead some insurers to exit certain businesses and thereby make more properties or blocks of business available to the market.

• Significant catastrophe-related losses may result in a stabilization of or increase in market pricing— P&C rates have been softening over the last few years as a result of excess capacity and relatively low catastrophe-related losses. In 2011, the P&C industry experienced significant catastrophe-related losses as a result of various floods, hurricanes, earthquakes and tsunamis around the world. Many believe that these catastrophe losses will lead to increases in market pricing, which would make US property and casualty insurers more appealing to potential investors.

• Insurance companies have recovered from the financial crisis and are looking to put their excess capital to use. Many US and foreign insurance companies have recapitalized over the last several years and have begun to return some excess capital to shareholders through stock buybacks and (to a lesser extent) dividend increases. Insurers will be evaluating whether to continue returning their excess capital to shareholders or to put it to use by expanding their core business though M&A.

Global Growth

A number of factors are contributing to an ongoing shift from a world dominated by developed markets to a world in which the majority of growth occurs in emerging markets:

• In the developed world, the old outnumber the young. In emerging markets (except China) the working age population outnumbers the dependent population— and will continue to do so for the foreseeable future—thereby increasing productive growth;

• A rising middle class in emerging markets is fuelling greater consumer consumption, which is leading to impressive small business growth; and,

• Government infrastructure investment, population growth, new businesses, and wealth creation are driving growth in construction, land development, energy and transport sectors, all of which are creating a greater need for insurance.

Strategy and execution

Percent of insurance industry respondents to PwC’s 15th Annual Global CEO Survey “agree” or “strongly agree” that emerging markets are more important to their companies’ future than developed ones.

48%

14 top issues

More specifically, emerging-economy insurance markets have boomed by eleven percent annually over the last ten years. During this same period, insurance premiums in industrial economies experienced total growth of only 1.3 percent annually.

Despite the obvious attractions of expanding globally, insurers should consider each country’s unique profile and its own goals. Uniform approaches usually fall short, and insurers should target market opportunities that are a strategic fit with their organizations, attractive for growth, and feasible. In particular, they should weigh new investment opportunities against the complexities of conducting business that exist in many emerging markets. These include inflationary concerns, prohibitive or uncertain market-entry costs, and frequent regulatory changes, such as the allowed percentage of foreign ownership or market share.

G6 Contribution to Global Growth from 2006–2020 (%)

15.9

Japan

Canada

France

Germany

UK

US

1.9

1.9

1.5

1.3

1.1

Source: Economist Intelligence Unit, Foresight 20202

E6 Contribution to Global Growth from 2006–2020 (%)

26.7

Mexico

Indonesia

Russia

Brazil

India

China

12.2

2.4

2.3

2.3

1.4

Source: Economist Intelligence Unit, Foresight 20202

E6 vs G6 Contribution to Global Growth from 2006–2020 (%)

E647.3 %

G623.6 %

Other countries29.1 %

Source: Economist Intelligence Unit, Foresight 20202

2 Available at: http://graphics.eiu.com/files/ad_pdfs/eiuForesight2020_WP.pdf

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We have observed that globally expanding insurers struggle with the following challenges and complications in particular:

• While developing economies have been growing rapidly, factors such as the business environment can be unpredictable, thus increasing investment risk and inhibiting the ability to realize the required rate of return.

• Insurers’ approaches to emerging-market expansion often lack:

1. Insightful analysis of unquantifiable intangibles;

2. The use of scenario analysis that promotes executive agreement on strategy; and,

3. A systematic approach to analyzing global markets and a consistent way to understand the relevant risks and benefits.

In our view, the companies that are pursuing successfully expansion strategies:

• Effectively target their allocation of assets around the world in order to increase their return on investment on a global scale. This may result in decreasing investments in certain parts of the world in order to increase investments in new markets. As most industry leaders now operate on a global scale, determining where to allocate capital is more critical than ever.

• Determine the appropriate timing to move into new markets. In our view, presence alone neither guarantees success nor the ability to know when to fully commit to a market. Performing the right analysis from the outset will help insurers to place their bets in the right place at the right time. For example, more advanced markets may already be at a point where it is too expensive or logistically difficult for new entrants to successfully create a profitable business. Other, less mature markets are candidates for a timely investment that will set the stage for meaningful market share after a growth inflection point.

• Understand their target markets. Notably, in emerging markets, it is important to consider social media and mobility. Throughout Southeast Asia, for example, the

middle class typically stays connected via mobile devices instead of personal computers; in fact, Indonesia is one of the largest markets for BlackBerry phones and has the world’s second-largest Facebook population.

• Develop creative distribution messages to reach new consumers. For instance, an insurer might partner with telecom and utility companies that already have billing relationships with uninsured segments of the population. Moreover, bundling low-margin products with higher-margin products and offering a number of pricing options and distribution incentives that reward loyalty can help new market entrants remain competitive.

• Build relationships with local insurance agents and brokers. Despite the importance of technology and direct distribution, this still remains central to market penetration. Moreover, because most countries are at a different level of the distribution maturity curve, successful companies make their approach very market-specific.

Implications

• Given capital constraints and the nature of competition specific to each market, no one strategy fits all in terms of where, how, and when to expand.

• The breadth and depth of information available to analyze markets may quickly become overwhelming. Management’s key to success is making the right information actionable. By using a detailed and multi-faceted approach to planning international growth, insurers can implement a well-planned and executable strategy.

• Creative approaches to and use of technology and distribution plays a vital role in developing and maintaining market share.

• Developing and managing mutually beneficial broker relationships are critical to advancing growth, particularly in commercial lines.

Strategy and execution

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in a constantly available stream of valuable data from a variety of sources. In addition, the 50 billion or so active sensors and devices that will connect to the Internet in the near future will further supplement this interactive customer information and provide real-time behavioral information on these customers. Insurers who intelligently harness this agglomeration of information will be able to better understand their customers and prospcts, develop solutions—not push products—that address very specific customer needs, and build a foundation for a very positive customer experience. From a corporate performance standpoint, this will facilitate better pricing, optimization of marketing and contact management spend, sharper underwriting, improved retention, and better loss control.

The rise of smart analytics—Today’s advanced analytical techniques can identify meaningful patterns and highlight emerging themes by very quickly processing enormous volumes of data from “unstructured” sources such as those we describe above (e.g., web blogs and customer comments on various sites, online search words, rough notes from agent meetings, continuous real-time video, life logging) and multi-media (e.g.,video, audio, gestures, mobile, social chatter). Insurers that are on the leading edge of techology have the potential to build technological capabilities that can translate these patterns into insights and actions; for example, they can search a continuous video cam feed to identify suspicious activities and enhance and match these images (i.e., facial recognition) to a database of suspects. As this technology spreads and matures, the reliability of identification and prediction will increase and lead to greater automated generation of insights.

Beyond property and casualty, into life and health—While commercial insurers are already using electronic devices and sensors to develop risk and loss management and improve productivity, we also are seeing life and health insurers use them to monitor vital health statistics. The nanotechnology drug delivery market is expected to grow at a CAGR of 21.7 percent between 2009 and 2014, and reach almost $16 billion by 2014. By 2020, a number of biotechnologies will move to the nano scale and embed

Transforming “big data” and smart analytics into a competitive advantage

By 2013, the amount of traffic annually flowing over the internet will reach 667 exabytes and the amount of data collected in one year by connected sensors will be able to fill a stack of DVDs going one-fifth of the way to the sun! The explosion of computing power, combined with enormous storage capabilities, is enabling companies to process extremely large amounts of data and interpret them in new and exciting ways.

“Big data” is a powerful combination of (a) sophisticated technologies and devices—all of which are communicating seamlessly with each other in real-time—and (b) the use of unstructured multi-media (e.g., audio, video) data. Fully exploiting the big data trend requires “smart” predictive and simulation analytics that analyze real-time dynamic data to project the future. Properly done, this can result in a variety of high business-impact scenarios; for example, if a driver unwittingly re-routes his/her path to work through congested and accident-prone areas, then the car’s mobile tracking device will immediately alert the driver’s insurance company, which can potentially adjust the premium. In addition, the company can inform the driver of any risks he/she might be facing and suggest safer alternate routes. In this and many similar ways, big data and smart analytics are starting to help insurers improve their overall performance by facilitating greater pricing accuracy, deeper relationships with customers, and more effective and efficient loss prevention.

Rapidly evolving technology and mobility— The dramatically increasing number of Internet connected and mobile devices, as well as sensors (which are projected to number 20 billion by 2020), is already helping insurers access real-time policyholder information. Smart phones and tablets now provide consumers anytime/anywhere access to the Internet. People also are much more comfortable than they used to be sharing personal information and making transactions via any channel. All of this has resulted

devices and sensors unintrusively within bodies. Such customizable nanotechnologies have the potential to dramatically improve health outcomes through enhanced monitoring and preventative control of chronic disease. Consumers eventually will use personalized medicine to create highly-customized healthcare solutions that actively change the body’s biochemistry in response to risks and conditions that are unique to each individual. We anticipate that these medical advances will flatten the cost curve as mortality and morbidity rates dramatically improve. There are tremendous opportunities to use Big Data to seek drug interactions and lower malpractice incidents, thereby reducing litigation costs as medical product manufacturers are increasingly able to provide detailed information on drug efficacy.

Implications

While commercial insurers have always focused on loss control and risk management, other lines of insurance are starting to do so, as well. Personal and life carriers are moving away from just passively identifying and pricing risk and reactively paying claims once an event has occurred to proactively using big data and smart analytics to reduce losses and better manage risk before a claims event occurs. Notably:

• Real-time data from sensors and devices will transform the commercial insurance business model. Carriers may no longer need to compete on price—they instead may be able to assess the risk of individual customers

based on their actual behaviours. This could enable the industry to return to policyholder-specific pricing because customers will no longer be able to game the market for better entry point prices. Additionally, commercial insurance increasingly will be able to focus on providing customized, flexible products and value-added services that involve working with the clients to proactively avoid or reduce losses and manage risks.

• Access to such detailed customer information can greatly improve the efficiency and effectiveness of marketing and outreach campaigns. Insurers will be able to precisely target customer groups at the degree and intensity that yields the best results at the lowest possible cost, thereby creating an optimized marketing model.

• As technology spreads and matures, the reliability of identification and prediction will increase and lead to greater automated generation of insights and process simplification. This can improve loss and risk management, as well as productivity, but will require a re-examination of the existing operating models of a majority of insurers that are heavily process and manual intensive.

• There is a significant shortage of talent in the market that can effectively analyze and apply the lesson big data contains. Organizations that can attract and retain data analysis talent will maintain an advantage over their competitors, but in light of demand, probably will have to pay a premium for these resources.

At the June 2011 International Insurance Society (IIS) event, PwC asked attendees about their perspective on the future of data-driven decision making. 49 percent responded that they expect new sources and techniques in the use of data analytics to be a key competitive differentiator. 14 percent also indicated that they expect analytics to progress to a point where a majority of decisions are automated, which would allow insurers to shift their attention from traditional underwriting to gains in prevention and productivity.

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outreach and sophisticated technologies that gather real-time information and trigger actions that can reduce or even prevent a potential claims event from occurring.

• Altering the competitive playing field by developing a sustainable and competitive pricing advantage instead of aggressively fighting for marketshare with price wars. Some P&C players are overcoming commoditization by providing customers a highly customized and personalized package of price, product and service at an individual level. They are accomplishing this through simultaneous investments in mobile telematics that can adjust pricing in real-time based on each person’s unique behaviors, modular product platforms that can easily configure products based on customers’ needs, and an optimized customer service model that provides the minimum adequate level of support for each customer.

• Redesigning their operating models’ focus to serving customers’ needs rather just pushing products. This is probably the most dramatic change insurers have to face because it requires a transformation of leadership models, internal culture, and performance drivers.

When shifting from a product-focused to a customer-centric operating model, there are three key considerations:

º Strategy Design: Most current insurance operating models typically leverage a “divergent” thinking model that focuses on developing a portfolio of best-in-class products and then identifying the largest number of possible uses and buyers of these products.

On the other hand, a customer-centric approach requires “convergent” thinking—in other words, what combination of an insurer’s products and services will help solve client needs? Effective convergent thinking attracts customers that are both profitable and loyal.

º Structure and Organization: This requires extensive organizational change, including:

1. Shifting from product-driven profit centers to P&Ls that are organized around customer segments;

2. Developing account teams that specialize in client needs rather than teams that specialize in creating new products and;

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• In the immediate term, personal lines insurers primarily will use advances in telematics to price usage-based insurance. However, in the medium term, they will be able to use telematics to proactively control losses and manage risk, which should substantially enhance operating profitability. Over time, this competitive advantage will disappear as automotive safety features and advanced analytics become commonplace.

• Because big data enables the consumption, storage, and analysis of vast amounts of information very quickly and with a high degree of precision, there is a real opportunity for claims to leverage unstructured data (pictures, etc.) to improve claims performance, turnaround time, and customer satisfaction. Insurers are starting to combine sophisticated data mining and highly specialized subject matter expertise to uncover new correlations that help detect fraud in new ways.

• Greater availability of medical and behavioural data, along with personalized medicine, will continue to drive greater sophistication in and the automation of underwriting.

From product-focused to customer-oriented operating models

Across all sectors, carriers are dealing with diminishing margins as they fight for marketshare in the developed world’s contracting markets. At the same time, they are searching for ways to reduce their operating expenses, identify viable opportunities to expand globally, and engage with their customers in ways the latter choose. All of this amounts to a tremendous challenge for a historically inward-looking, cautious, and technologically conservative industry.

The most prescient insurers have identified at least three ways to improve their financial performance:

• Shifting emphasis from after-the-fact claims and loss management to preventative and preemptive loss mitigation and reduction. This requires a deep appreciation of customer behavior and psychology and is largely dependent on insurers’ ability to partner with individual customers and commercial clients. This partnering occurs via investments in better client

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3. Striving to address all of a client’s needs and deepen business development rather than striving to improve offerings to outpace the market. Under this approach, the highest internal incentives go to relationship managers who develop long-term relationships and act as trusted advisors to their clients.

º Success Metrics: This usually requires a major change to an insurer’s core performance drivers and metrics. In a product-focused model, the biggest driver historically has been market share by product or line of business; however, in a customer-centric model, the key drivers are client retention and lifetime value, with secondary metrics that relate to client satisfaction and depth of relationship.

As the table below shows, strategic changes are encouraging insurers to challenge how they have traditionally managed their businesses, break down internal silos, and restructure themselves in ways that are responsive to individual market needs, while still remaining internally flexible, efficient and economical. More specifically, in personal lines, insurers are trying to understand what customers want, why they switch carriers, and how to retain them. In the commercial sector, insurers are trying tailor coverage to client needs, help them control losses, and manage risks. In the life sector, insurers are trying to raise customer awareness of their products, match their needs with appropriate solutions, and make the purchase process easier and more transparent.

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Product-centric Consumer-centric

Strategy focus • Develop “best-in-class” products for customers

• Attracts more transactional, less-relationship focused customers

• Divergent thinking: How many possible uses of this product?

• Develops customized “solutions” to meet client needs

• Attracts profitable, loyal customers

• Convergent thinking: What combination of products is best for this customer?

Structure and organization

• Creates product profit centers

• Develops product teams that specialize in creating new products

• Highest reward is working on next most challenging product

• Strives to improve offerings to outpace the market

• Organized P & Ls around customer segments

• Develops account teams that specialize in client needs

• Strives to address all client needs and deepen business development

• Highest rewards to relationships managers who develop long-term relationships and act as a trusted advisor

Measures of success

• Depth and breadth of product offerings

• Revenue from most novel and innovate products

• Market share by product

• Depth of relationships with clients

• Client loyalty (retention) and lifetime value

• Client satisfaction

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Implications

Recognition of growing customer power, and the industry imperative to cater to customers’ needs instead of presenting them generic options, has had a profound impact on how insurers think about their core business models and operating structures.

• In life, annuities and retirement, the gap between the need for convergent health and wealth solutions and their availability is creating significant opportunity. Life insurers’ frame of reference—their “aperture”— is gradually shifting from a disjointed focus on product delivery to a broader solutions driven view. They now are attempting to address the full range of customers’ concerns about health, wealth, and life uncertainties, —not just financial stability.

• In addition, wealth-management provision is changing, and the point of value-capture may shift from the full-service advice model to direct-to-client within the next twenty years.

• In personal lines (and also to some extent in life), we have seen a tremendous rise in self-directed customers; many Gen Xers (born between 1965-80) and a majority of the Millennials (born after 1980) tend to do their own research and make their own insurance decisions, and require only some customer service support.

• Personal lines customers, as well as agents, are demanding greater transparency and control over pricing, service and claims. The leap in mobility and speed of service that customers demand—“anything, anytime, anywhere”—has made it imperative for personal lines insurers to invest heavily in mobile and interactive technologies for multimedia and multi-channel content dissemination, dialogue, and transactional capabilities via multiple digital platforms.

• P&C insurers in the developed world are facing a tremendous profit challenge as escalating price transparency, disintermediated direct purchase, and virtual social community-influenced purchases all lead to greater commoditization of personal lines insurance and severely squeeze margins.

• Commercial lines insurers are challenged by the growing power of distributors, who are self-organizing and demanding greater speed, responsiveness and partnership from carriers, so that they, in turn, can more efficiently manage their own diminishing margins.

• There also is greater recognition among insurers that they need to reconfigure their offerings and how they manage their risk appetites. Doing so will help them better cater to clients’ total account needs versus just one or two major lines ; if they continue their current practices, they could lose key parts of their book as customers look to simplify their own (growing) operational complexities.

• However, accomplishing all this is very much a work in progress even for industry leaders. The shift to total solutions has implications for the (re-)design of core product platforms, pricing and loss assessment approaches, all of which now need to operate at an account level, versus at a line-of-business level.

What to ask before a policy administration system (PAS) transformation

The convergence of complex market demands, antiquated legacy platforms, and an increasingly mature vendor landscape has created an environment in which carriers view policy administration system (PAS) transformation as a necessary and attainable initiative. PwC’s industry research, observations, and experience suggest that PAS transformations will continue to be a top priority for insurers—regardless of size and product mix—in 2012.

Carriers intend to achieve a dramatic change in business results by moving PAS out of the back office to a bigger and broader role in day-to-day business operations. In modern policy administration systems, customers—not policies—drive data and application flow.

Current system overhauls have reached their practical limits.

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In our experience, carriers are approaching PAS transformation from different angles, based on their unique business, technological, and competitive circumstances. However, regardless of the approach they take, organizations will build the foundation for achieving expected benefits and minimizing risks by answering six core questions before they begin an actual transformation:

1. Where Is the Source of Business Value? Effective PAS promotes organizational competitiveness. Because PAS transformation is a strategic and tactical business initiative—not an IT project—carriers should focus on what matters most: Establishing a common view of value for business and technology stakeholders, and setting benchmarks for measuring financial success. We have observed five common source of business value as a result of successful PAS implementations:

a. Differentiated customer and agent experience;

b. Speed to market in terms of product agility and regulatory improvements;

c. Expense ratio reduction and long term efficiency gains;

d. Improved information management and analytics; and,

e. Loss ratio improvements (if predictive model overhaul is part of PAS implementation).

2. What Organizational Alignment Is Required? The word “alignment” is overused, but proper organizational alignment—what it takes to achieve a common vision and line of sight for organizational stakeholders—will result in lasting PAS transformation effects. Business should sponsor the project, but joint ownership by both business and IT is necessary for a successful PAS transformation. Common line of sight means that both groups can agree on core business drivers, priority market segments, channels, and product lines.

3. How Can We Achieve Incremental Value? Business value can occur in stages throughout a PAS transformation. In fact, staged delivery is the only way carriers can achieve early benefits and keep an organization energized during a long project timetable. Companies can apply the lessons they learn along the way to future stages, and can manage in small steps the significant risks of changing PAS platforms. They should prioritize by selecting the product facing the most competitive pressure and the one that will provide the biggest “bang for the buck” from the PAS transformation. Even though targeting a high impact product first carries a risk, we suggest that a new system should be designed around its most important—rather than the safest—product

4. Can We Effectively Manage Risk? Carriers should not underestimate the operational challenges associated with replacing an existing PAS platform. Since policy administration is the core system for insurance carriers, swapping it out requires changes to nearly every business process and technical system. Changing a current policy system uncovers the skeletons in IT’s closet; to mitigate risk, carriers also should prepare to maintain both the old and new policy systems for a set period before shutting down the legacy PAS platform. First-rate project and change management, along with a staged deployment, are the keys to minimizing risk and managing complexity during PAS transformation.

5. What Is the Role of Solution Vendors? Business priorities and industry benchmarking should drive vendor selection. Too often, PAS teams will begin selecting a vendor before they adequately define their business needs. The ability for third parties to configure and customize vendor product code provides the carrier with the greatest flexibility. The PAS market has matured and currently offers a wide variety of capabilities, so buying a package is better than building a custom solution for most small- to mid-market carriers. Carriers also should consider the availability of a secondary sourcing market for a vendor solution, since carriers will be committed to the new PAS for the long haul.

Strategy and execution

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6. How Do We Mobilize for Success? The human transformation resulting from a new PAS will be as significant as the business and technical transformation. Establishing a strong PAS organization that is accountable for delivering the benefits of transformation promotes effective mobilization, and quarterly planning iterations will help the organization adapt the plan to changing market conditions.

Answering these questions is only the first step in a carrier’s competitive transformation. While a PAS transformation is an inherently complicated process, the resulting platform will reduce complexity and business risk, be more economical to run and manage on a daily basis, and simplify an organization’s ability to deliver value to users and policyholders. Quite simply, the cost of establishing a common view through superior IT execution, and pricing segmentation could prove to be the cost of staying in business.

Implications

• A modern, flexible PAS platform has become “table stakes” for any successful carrier and companies that do not adapt will risk losing market share while costs escalate.

• PAS transformations are inherently complicated and expensive; it is vital for carriers to identify what they want a transformation to achieve before they actually start implementing it.

• Because a PAS transformation will affect the entire business—not just the IT function—it is imperative to obtain buy-in for the transformation from throughout the company. In addition, many different stakeholders throughout the company will need to prepare for how a PAS transformation can affect human capital.

• The PAS market now offers a variety of off-the-shelf capabilities, and a transformation is easier to achieve now than in the past.

• An incremental approach to transformation will reduce risk and complexity, as well as enable a carrier to digest the changes to how it does business.

Regulatory compliance

Dodd-Frank update

Although the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) was enacted in July 2010, implementation of it through rule marking and other discharge of authority has been slow in coming. The act does not directly target insurers, and the authority to regulate them remains with state insurance commissioners, but it does have implications the industry should continue to monitor, particularly:

Federal Insurance Office (FIO)—Dodd-Frank created a new authority within the US Department of the Treasury, the Federal Insurance Office. Michael McRaith, a former Illinois regulator, was named FIO director in the summer of 2011. Although the FIO is not a regulator, it is responsible for informing the federal government on issues confronting the industry and is the single voice representing the US in international insurance trade agreements. The FIO director has the authority to collect, aggregate and report on data he collects in his advisory role. He also is a non-voting member of the Financial Stability Oversight Counsel (FSOC), but can recommend whether or not an insurer poses a systemic risk to the economy. Director McRaith’s early attention has been on creating a report to Congress on the efficacy of insurance regulation in the US and where it could be modernized. The report, which was still pending at the time of this publication’s release, likely will set the tone for the FIO’s long-term vision.

PAS transformation is a strategic and tactical business initiative, not an IT project.

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Systemic Risk—The FSOC has published a revised set of rules that addresses the triggering thresholds for non-bank Systemically Important Financial Institutions (SIFIs). We anticipate that the FSOC will determine which companies are SIFIs later this year. The institutions that are classified as SIFIs will face a number of challenges, notably the likelihood of increased capital requirements, the need to have a “living will,” and their subjection to Federal Reserve supervision, examination, and monitoring. For insurers, it is noteworthy that former Kentucky Insurance Commissioner and Treasury Department official Roy Woodall, the voting member of FSOC with “insurance expertise,” has publicly implied that insurance does not, in and of itself, constitute a systemic risk.

Insurance Thrift Holding Companies—Historically, some insurers have structured themselves as thrifts or savings and loan holding companies (SLHCs), and thus the Office of Thrift Supervision (OTS) previously served as their regulator. Dodd-Frank abolished the OTS and moved its functional authority to the Office of the Comptroller of the Currency (OCC) and the Federal Reserve. This may mean that insurers which are SLHCs will be subject to additional and much more comprehensive Federal reporting and examinations than in the past. In response, some insurers have sold, or announced their intentions to sell, their “banks” and abandon the SLHC structure.

Implications

• Because it will comment on the efficacy of and potential areas to modernize insurance regulation, as well as set the tone for the FIO’s long-term vision, insurers should closely monitor the status of the FIO Director McRaith’s pending report to Congress.

• Even though it is unlikely that many—or perhaps even any—of them will qualify as non-bank SIFIs, large global insurers should continue to prepare for the possibility of such a designation, particularly because it could change their capital, planning, and regulatory requirements.

• If they are not comfortable with the idea of OCC or Federal Reserve exams and reporting, insurers that are structured as SLHCs should investigate abandoning the SLHC structure.

Unclaimed Property

Public officials with authority over unclaimed property and insurance regulators have alleged that life insurers routinely check the Social Security Administration’s Death Master File (DMF) when it benefits them (i.e., to stop annuity payments or other retirement benefits), but not when it benefits the policyholder or beneficiary (i.e., when a death benefit is due under a life insurance contract.) Some industry observers, including many state governments, estimate that these practices amount to billions in unpaid benefits to policyholders or escheatments to states. Insurers dispute these allegations and argue that the legal obligation to pay under a life insurance policy exists upon a valid proof of claim, and that their various operating units are understandably not always aware of the potential claims outside of their respective silos.

However, proving that operational shortcomings have not intentionally thwarted either the payment of claims or escheatment poses a number of challenges for insurers, including:

• Life insurers are being asked to meet a regulatory standard that does not currently exist either in law or in their contract. Previously, there was no requirement for a life insurer to take affirmative steps to determine if a policy holder or annuitant has died. The insurance industry has objected to regulators’ retrospective imposition (often without notice) of this requirement.

Regulatory compliance

72 percent of insurance industry respondents to PwC’s 15th Annual Global CEO Survey said they were “extremely” or “somewhat” concerned about over-regulation and 68 percent said that changes in regulation were influencing their anticipated need to change strategy.

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• Addressing changes in policy that will harm policyholders in the long run. Some regulators have suggested that the dormancy period should begin on the date of death, not on the day a claim has been submitted. If this reform is enacted, beneficiaries will have less time to collect their benefit before it is escheated to the state.

• Mitigating reputational risks. Whether a benefit is to be paid to a beneficiary or escheated to the state, insurers point out—often to a sceptical public and lawmakers—that they do not view benefits as the company’s money.

• Reliance on incomplete and sometimes inaccurate databases. The DMF is not comprehensive, and the American Council of Life Insurers (ACLI) and some life insurers claim that it also can be inaccurate.3

• Operational challenges, particularly in large companies that have experienced rapid and/or inorganic growth. Insurers operations and IT are extremely “siloed,” which has not helped them in their efforts to counter the perception that they conduct DMF matches only when it benefits them.

• Preventing fraud. With many older policies, for which complete data on the beneficiary or policyholder has not been maintained or is inaccurate, life insurers may be required to pay a benefit to someone who is not actually the beneficiary. Conversely, outreach efforts by some insurers have not been as successful as they hoped because many beneficiaries do not know they are named on a policy (and often believe they are the target of a scam when they hear that they are).

Investigatory Trends—Life insurers are observing several trends as they work their way through the unclaimed property examination process. In general, examiners begin by requesting large volumes of data about an insurer’s operating systems, policies and procedures for life, and annuity and RAA products. They then determine the populations of policyholder data to request. Typically, the examiner will request all in-force policy data from a particular year going forward. The insurer then will review that population for missing policyholder information, such

as date of birth or social security number and provide the examiner the missing information. Once the population of each product is confirmed, the insurer will initiate a matching process which attempts to match policyholders and/or beneficiaries to the DMF (or other source) to see if anyone listed as an active policyholder has, in fact, died. This process will include variations of “fuzzy matching,”4 which attempts to match people with the DMF even if their names or Social Security numbers are inconsistent. The company then will review all potential “fuzzy matches” in an attempt to determine why a payment has not yet been made and if any undocumented matches need to be paid to a beneficiary or (if beneficiary information is not available) escheated to the state.

Implications

Life insurers have expressed their desire to be responsive to regulatory requests and maintain good working relationships with examiners. They are equally desirous of putting behind them any problems with unclaimed property and adjusting their operational units accordingly to prevent further regulatory and reputational risks. With this in mind, we recommend life insurers:

• Examine any legislative changes that could potentially disadvantage policyholders and consider working with other organizations on shared interests and/or concerns.

• Conduct their own matching process. Whether the process is based on prior settlements or another standard, it should be well documented and easy to communicate to  regulators.

• Assess their processes, policies, and procedures to ensure they are documented and as consistent as possible.

• Consider initiating a proactive campaign to reach lost beneficiaries. While this would be a significant undertaking, it would go far to underscoring a sincere commitment to upholding contracts and maintaining relationships with regulators.

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3 See: http://www.insure.com/articles/lifeinsurance/ssa-limits-death-records.html

“Fuzzy matching” is the product of a settlement between John Hancock with the State of California. The “Global Resolution Agreement” (“GRA”) outlines a matching procedure to the DMF that includes not only exact matches but also prescribes a detailed “fuzzy match” methodology which allows the company to match potential transpositions related to birthdates or social security numbers, or name changes for policy holders.

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Tax compliance

SSAP 101

On November 6, 2011, the NAIC unanimously adopted SSAP No. 101, Income Taxes, A Replacement of SSAP No.10R and SSAP No. 10. SSAP 101 contains significant changes to accounting for current and deferred federal and foreign income taxes and is effective January 1, 2012. The following summarizes some of SSAP 101’s important provisions.

Tax Contingencies—The SAP standard for loss contingencies as codified in SSAP 5R continues to apply, with some important modifications for federal and foreign income taxes only. First, the term “probable” as used in SSAP 5R is replaced with the phrase “more likely than not,” which is defined as a likelihood of more than 50 percent. Thus, insurers will have to establish a tax loss contingency if, based upon management’s best estimate, it is more likely than not (“MLTN”) that a tax position will not be sustained. Second, filers must presume that they will be examined by the relevant taxing authority and that the taxing authority will have “full knowledge of all relevant information.”

An insurer may be obligated to establish a loss contingency even though the odds of being audited or the position being identified are remote. This is consistent with the US GAAP standard. Third, if the estimated tax loss contingency is greater than 50 percent of the tax benefit originally recognized, then the tax loss contingency recorded shall be equal to 100 percent of the original tax benefit recognized. Finally, if a tax loss contingency relates to a temporary difference, then the indicated current tax liability and

offsetting gross deferred tax asset are not recognized until an “event has occurred that would cause a re-evaluation” of the probability of assessment.

Statutory Valuation Allowance—Under SSAP 101, gross DTAs are reduced by a statutory valuation allowance (“SVA”), as they were under SSAP 10R. The SVA assessment applies a MLTN standard based upon the available evidence. However, note that the SVA analysis is not bound by the three-year timeframe applicable to most companies in the admissibility test. Companies may be able to sustain the assertion that DTAs meet the MLTN standard over a period of time as long as ten or twenty years, thus avoiding the establishment of an SVA. The gross DTAs net of the statutory valuation allowance (defined as “adjusted gross DTAs”) are then subjected to the three-part admissibility test.

No Election of Expanded Admissibility Parameters—Unlike SSAP 10R’s expanded admissibility regime, SSAP 101’s admissibility regime is not elective. Similar to SSAP 10R, only the adjusted gross DTAs are considered for admissibility and the basic three-part admissibility test remains. The first and third parts of the admissibility test are identical for all filers. The second part of the admissibility test provides three levels of reversal periods and surplus limitations that are based upon thresholds discussed below.

First Part of the Admissibility Test—Carryback Taxes—All insurers will be able to consider for admissibility federal income taxes paid in prior years that can be recovered through loss carrybacks for existing temporary differences reversing within a timeframe corresponding to Internal Revenue Code (“IRC”) loss carryback provisions. For non-life companies, ordinary and capital temporary differences reversing within two and three years, respectively, of the balance sheet date can be carried back to recoup prior year taxes. For life companies, a three year period applies to both ordinary and capital items. Applicable IRC sections, for example AMT loss carryback limitations, should be considered. Carryback rules may change over time. However, paragraph 11.a. of SSAP 101 provides that three years is the maximum reversal period that can be considered for purposes of this part of the admissibility test.

Tax compliance

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For instance, if a five-year carryback provision was enacted for life and non-life companies beginning in 2012, then only three years of reversals would be considered in this part of the admissibility test.

Second Part of the Admissibility Test—Offset of Future Years’ Income—The reversal period and adjusted capital and surplus limitation that apply in the second part of the admissibility test depend upon the type of insurer and whether the insurer meets the relevant threshold from the tables provided in ¶11.b. of SSAP 101. Companies that are subject to Risk-Based Capital (“RBC”) requirements (or required to file an RBC report with the domiciliary state) will qualify for a three year reversal period and 15 percent adjusted capital and surplus limitation if ExDTA ACL RBC (Authorized Control Level RBC computed without admitted DTAs) exceeds 300 percent. If ExDTA ACL RBC falls within the 200 to 300 percent range, then a one year reversal period and 10 percent adjusted capital and surplus limitation apply. No DTA is admissible under this part of the admissibility test if ExDTA ACL RBC is less than 200 percent. Mortgage and financial guaranty companies have separate thresholds based upon ExDTA Surplus (surplus without admitted DTAs) over Policyholders and Contingency Reserves. If the reporting entity is a non-RBC filer, and is not a mortgage or financial guaranty insurer, then a third set of thresholds applies based upon the ratio of adjusted gross DTAs (the numerator) to adjusted capital and surplus (the denominator). There also is guidance on calculating RBC for interim periods. The numerator is based on current period Total Adjusted Capital (ExDTA), while the denominator uses the Authorized Control Level as filed for the most recent calendar year.

Definition of Adjusted Capital and Surplus—SSAP 10 and SSAP 10R defined adjusted capital and surplus as statutory capital and surplus from the most recently filed statement, adjusted to exclude any net DTAs, EDP equipment and operating system software, and any net positive goodwill. Thus, companies calculating admitted DTAs at year end were required to refer to the most recently filed statement (generally September 30) in calculating adjusted capital and surplus. SSAP 101 does not alter the mechanics of the calculation but does require filers to look to adjusted capital and surplus for the current period (as opposed to the most

recently filed statement). This approach also applies when calculating the adjusted capital and surplus denominator (referred to above) for non-RBC filers that are not mortgage or financial guaranty companies.

Third Part of the Admissibility Test—DTA/DTL Offset—This part of the test allows DTAs to be admitted to the extent of DTLs. The character of DTAs and DTLs must be considered when determining the ability to offset. For instance, U.S. federal tax law does not allow capital losses to offset ordinary income. Thus, capital DTAs can be admitted under the third part of the admissibility test only to the extent of capital DTLs. This part of the test also states that reversal patterns of temporary differences should be considered but that additional scheduling is not required. We expect that the Q&A, which should be published during the first quarter of 2012, will provide clarification on the need to consider reversal patterns and perform scheduling of DTAs and DTLs.

Tax Planning Strategies—The basics of a tax planning strategy are consistent with U.S. GAAP and prior statutory guidance. SSAP 101 clarifies that tax planning strategies are considered in the statutory valuation allowance assessment, as well as the calculation of admitted deferred tax assets. Added is linkage to the guidance on loss contingencies and modifications to SSAP 5R for federal and foreign income tax loss contingencies. Also, please see below for information on disclosure of tax planning strategies.

Presentation and Disclosure—Beginning in 2012, the additional surplus realized from electing expanded admissibility under SSAP 10R will no longer be presented in the balance sheet and surplus reconciliation as expanded admissibility is no longer elective. Disclosures related to the benefits from electing expanded admissibility are no longer required. The disclosure related to tax planning strategies has been expanded. In addition to disclosing the impact of tax planning strategies on adjusted gross DTAs and admitted DTAs (by percentage and character), insurers also must disclose if they have availed themselves of a tax planning strategy involving reinsurance. However, the disclosure does not require disclosure of the magnitude of the reinsurance-related tax planning strategy. Lastly, any change resulting from the adoption of SSAP 101 shall be accounted for as a change in accounting principle pursuant to SSAP 3.

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Implications

• SSAP 101 contains significant changes to accounting for current and deferred federal and foreign income taxes, including:

• Federal and foreign income tax contingencies are governed by a modified version of SSAP 5R. FIN 48 is expressly rejected, along with its two-step recognition and measurement model and most of the required disclosures (other than the “early warning” disclosure).

• The statutory valuation allowance concept continues as the initial step in determining the amount of the admitted DTA. The applicable text from FAS 109 has been added.

• Expanded admissibility is no longer elective.

• In the first part of the admissibility test, all filers will be allowed to use a reversal period that corresponds to the tax loss carryback provisions of the Internal Revenue Code (not to exceed three years).

• In the second part of the admissibility test:

» The reversal period and surplus limitation parameters (one year/ten percent or three years/15 percent) are determined based upon risk-based capital levels; companies not meeting the minimum threshold would admit nothing in this part of the admissibility test.

» Non-RBC reporting entities and financial/mortgage guaranty companies are provided special tables for determining admissibility.

» For purposes of determining test parameters, calculations of RBC or surplus thresholds will use current reporting period information.

• The third part of the admissibility test adds a requirement that the reporting entity shall consider the reversal patterns of temporary differences; however, this consideration does not require scheduling beyond that required in paragraph 7.e. [the valuation allowance test].

• Disclosure requirements have been modified, but retain the need to disclose the impact of tax planning strategies. SSAP 101 adds a required disclosure for tax planning strategies involving reinsurance.

• Lastly, although SSAP 101 has been adopted, effective January 1, 2012, there are still issues that require clarification. The NAIC’s Q&A hopefully will resolve these issues and provide examples to ease implementation. PwC will continue to apprise industry stakeholders of these and all other relevant developments as soon as we know of them.

FATCA

On February 8, 2012, the US government released regulations for the Foreign Account Tax Compliance Act (“FATCA”). The proposed regulations provide specific guidance on a number of implementation issues relevant to the insurance industry, and appear to have incorporated a number of comments from it. The proposed regulations generally do not delay most of the existing effective dates for FATCA compliance.

Simultaneously with the issuance of the proposed regulations, the governments of the United States, France, Germany, Italy, Spain, and the United Kingdom released a joint statement providing that they are exploring a common approach to FATCA implementation through foreign financial institutions disclosing their FATCA information to the tax authority in their country of residence (rather than directly to the US government). The joint statement also emphasizes the willingness of the United States to reciprocate by automatically collecting and exchanging information on accounts held in US Financial Institutions by residents of each of the respective countries.

Of particular note for insurers:

1. Insurance terminology is now included in many FATCA definitions—Because previous guidance primarily addressed banking institutions, the insurance industry faced a significant amount of uncertainty about the applicability and impact of FATCA. As hoped, the proposed regulations do provide clarity around several terms that allow the insurance industry to appropriately address FATCA’s requirements. Specifically, the proposed regulations clarify the intended party identified as an “account holder,” as well as provide additional guidance

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around the definitions of “cash value” and “insurance company,” and address circumstances in which certain insurance or annuity contracts are included or excluded from the definition of financial account.

• Account Holder—For insurance and annuity contract accounts which qualify as financial accounts (as defined below), the account holder is deemed to be the person who can access the cash value of the contract or change the beneficiary, or, if there is no such person, the account holder is the beneficiary.

• Financial Account—Insurance contracts that include an investment component—namely cash value insurance contracts and annuity contracts—are included in the definition of “financial account.” Insurance contracts without a cash value component, such as term life, disability, health, and property and casualty are excluded from the definition of financial account.

• Cash Value—A cash value insurance contract is an insurance contract that has a cash value greater than zero. Moreover, cash value is the greater of:

a. The amount that the policyholder is entitled to receive upon surrender or termination of the contract (determined without reduction for any surrender charge or policy loan); and,

b. The amount the policyholder can borrow under or with regard to the contract.

• Cash Value Exclusions—In addition to the definition of cash value, the following items are specifically excluded from the definition of cash value:

a. A refund to the policyholder of a previously paid premium under an insurance contract (other than under a life insurance or annuity contract) due to policy cancellation, decrease in risk exposure during the effective period of the insurance contract, or arising from a redetermination of the premium due to correction of posting or other similar error; or,

b. Certain policyholder dividends, provided such dividends are not termination dividends, which relate to either a term life insurance contract or an insurance contract under which the only benefit payable is providing indemnification of an economic loss incurred upon the occurrence of the event insured against, such as personal injury or a sickness benefit.

• Insurance Company—The term insurance company is defined as a company for which more than half of its business during the calendar year is issuing (or being obligated to make payments with respect to) insurance or annuity contracts or the reinsuring of such contracts.

2. Pension contracts—Certain savings accounts (including retirement, pension, and nonretirement savings accounts) that meet specific requirements are excluded from the definition of a financial account. In general, such accounts must be held by certain retirement plans or be subject to tax and regulatory requirements. Additionally, an FFI

The joint statement addresses many of the privacy law concerns that insurers and other industries have raised. However, it does not necessarily reduce the amount of information that must be gathered from a FATCA perspective. Depending on how the reciprocal provisions are drafted, US insurance companies may in some cases need to increase reporting for non-US clients.

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that is organized for the provision of retirement or pension benefits under the law of the country in which it is established or in which it operates and meets certain requirements may qualify as a deemed-compliant FFI.

3. Modification of due diligence procedures for the identification of accounts/de minimis exception— The proposed regulations reduce the administrative burden imposed by FATCA associated with reviewing records of pre-existing accounts to determine US status by:

a. At the option of the FFI, excluding from the due diligence procedures (effectively a de minis exception) individual accounts with a balance or value of $50,000 or less and certain cash value insurance and annuity contracts with a value of $250,000 or less;

b. Providing a $250,000 de minims rule for pre-existing entity accounts;

c. Extending the reliance on information collected during a “know your customer” or “anti-money laundering” process (KYC/AML);

d. Increasing the threshold for manual reviews to $1,000,000 for pre-existing individual accounts (a “high value account”);

e. Providing guidance on the scope of a “diligent review” of paper account records (e.g., paper search); and,

f. Eliminating the special rules in the prior guidance for so-called “private banking accounts” and replacing this concept with the aforementioned “high value” account concept.

The proposed regulations require that all account balances be aggregated, but only to the extent that computerized systems are able to link accounts by reference to a data element such as a client number or taxpayer identification number that would allow account balances to be aggregated. In addition, relationship managers of high value accounts are also required to aggregate all accounts that the relationship manager knows or has reason to know are directly or indirectly owned, controlled or established by the same person.

4. Grandfathered obligations—The proposed regulations modify and expand upon the guidance provided in previous notices regarding the scope of grandfathered obligations by expanding the term to include obligations outstanding on January 1, 2013. The proposed guidance also indicates that any material modification of an outstanding obligation will result in the obligation being treated as newly issued or executed as of the effective date of such modification, and thus will no longer be a grandfathered obligation.

Insurance companies with grandfathered obligations that do not qualify for the de minims exclusion will have to conduct proper due diligence procedures to identify any withholdable payments made which are subject to reporting and have the processes in place to report on such payment.

Additionally, the proposed regulations identify certain obligations (including life insurance contracts payable upon the earlier of attaining a stated age or death and term certain annuity contracts) as eligible for grandfathered status.

5. Additional categories of deemed compliant FFIs— The proposed regulations expand on previous guidance and provide additional categories of deemed compliant foreign financial institutions. This expansion is an effort to reduce the compliance burdens on entities for whom entering into an FFI agreement is not necessary to carry out the provisions of FATCA. The categories of deemed compliant FFIs are broader than those described in previous guidance, and include categories for registered deemed compliant FFIs and certified deemed compliant FFIs. The additions focus on the nature of the investors (e.g., retirement plans, participating FFIs or exempt beneficial owners), investment contribution (e.g., employer, government or employee contribution), as well as the nature of the distribution relationship (e.g., limited to local banks or distributors restricted from distribution outside of the country of residence).

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6. Guidance on procedures required to verify compliance—The proposed regulations modify the guidance provided in the previous notices by providing that the responsible officer of an FFI will be expected to periodically certify that the FFI complied with the terms of the FFI agreement, which will include (among other items) adopting written policies and procedures, and conducting periodic reviews of the FFI’s compliance with these aforementioned policies and procedures. While verification of compliance through a third-party audit is not required of FFIs, the IRS may choose to perform an audit of the FFI in instances of suspected trends of compliance failures.

Implications

Some industry observers have suggested that the proposed regulations have either delayed FATCA or that the efforts around compliance for the insurance industry have been substantially mitigated. In fact, it seems that there is still a substantial amount of work for insurance companies to do. Given that the regulations have provided details on how these rules may ultimately work, insurers should have sufficient direction to begin assessing and developing a plan to implement the requirements of FATCA into their business processes and procedures. Considerations insurers will need to address include:

• Among the concerns the proposed regulations address are the expansion of the definition related to grandfathered obligations and the clarified definitions around financial account and account holder. Although these regulations only are proposed ones, they appear to provide sufficient guidance for insurers to determine, in order to address the looming effective dates of these rules, what products are in scope, the process and system changes they will need to make, and how to develop a communication plan with customers and distribution networks.

• The definitions in the proposed regulations provide sufficient clarity on applying appropriate due diligence processes, as well as defining reporting requirements under FATCA. In addition, cash value exclusions clarify the intent of application of a refund to the policyholder of a previously paid premium under an insurance contract as out of scope for purposes of FATCA.

• FATCA excludes certain pension contracts. However, insurer must apply due diligence procedures to identify potential risk exposures.

• While the majority of insurance contracts meet the grandfathered obligation requirements we describe above, insurers still need to review and report on pre-existing accounts and/or policies identified as a US account. Unless the participating FFI elects otherwise, it is not required to document pre-existing cash value insurance or annuity contracts of individual account holders that have an aggregate value or balance of $250,000 or less.

• Computerized systems for insurance often are specific to a particular product that is not linked to the other computerized systems for other products. Therefore, it may not be possible to link all of an individual accountholder’s accounts.

• The expansion of “grandfathered obligations” provides relief to the insurance industry with regard to withholding; however insurance companies are still required to perform due diligence procedures in order to identify any withholdable payments which are subject to reporting. The proposed regulations define a material modification as it relates to debt securities. For all other obligations, a material modification is based on “all relevant facts and circumstances.” Therefore, it remains unclear how material modifications will apply to insurance contracts. For example, if one includes a change in the face amount of the policy or a change in the beneficiary, then more IRS guidance may be needed.

• “Deemed-compliant” status is an alternative to FATCA exemption that the IRS and Treasury have offered for certain institutions, including certain local FFIs and retirement plans that present a low risk of tax evasion. Although these rules may make it easier for some entities to be deemed compliant, they will not eliminate the administrative burden associated with FATCA. For example, a registered deemed-compliant FFI still will have to perform a number of administrative activities both to register as an FFI and prior to payment to an FFI. Entities seeking registered deemed-compliant status will be required to register for deemed-compliant FFI

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status, enter into an FFI agreement, complete a required certification, and potentially obtain an FFI-EIN. As a payor, entities face additional due diligence requirements (e.g., to obtain appropriate withholding certificates for additional categories of deemed-compliant FFI). Finally, a registered deemed-compliant entity still will have certain ongoing information gathering and monitoring requirements in order to certify its “deemed-compliant” status every three years.

• In the FATCA notices, the IRS discussed potentially granting exceptions from FATCA for insurance companies issuing solely property & casualty and reinsurance contracts. In the proposed regulations, there is no deemed-compliant status such companies. However, the proposed regulations include only insurance contracts that include an investment component—cash value

insurance contracts and annuity contracts are included in the definition of “financial account.” Insurance contracts without a cash value component, such as term life, disability, health, and property and casualty, and indemnity reinsurance are excluded from the definition of financial account. It seems that any property & casualty or reinsurance company with just one financial account will need to register as participating FFIs. The Treasury Department and the IRS have requested comments about whether or not there should be categories of deemed-compliant FFIs in addition to those addressed in the proposed regulations; accordingly, providing a category of deemed-compliant FFIs for entities that issue a de minis number of financial accounts (such as cash value insurance or annuity contracts) deserve consideration.

A responsible officer will be ultimately accountable for FATCA compliance. He/she will need to certify that all necessary due diligence, withholding and reporting procedures are sufficiently complete. Because many insurance companies own asset management operations for which a third-party service provider performs a number of functions (including due diligence, withholding and reporting), the responsible officer will need to certify that all of these procedures also are sufficiently complete.

Tax compliance

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Dave Rogers Principal, Actuarial and Insurance Management Solutions Tel: 1 617 530 7311 david.y.rogers@us.pwc.com

Warren Manners Director, Actuarial and Insurance Management Solutions Tel: 1 646 471 4856 warren.manners@us.pwc.com

Jeff Schlinsog Principal, Actuarial and Insurance Management Solutions Tel: 1 414 212 1715 jeffrey.s.schlinsog@us.pwc.com

Risk and capital managementLow interest rate environment

Emile Rondhout Partner, Assurance and Business Advisory Services Tel: 1 646 471 7935 e.rondhout@us.pwc.com

Brian Paton Director, Actuarial and Insurance Management Solutions Tel: 1 312 298 2268 brian.paton@us.pwc.com

Financial reportingImproving market reporting

Tom Sullivan Principal, Advisory Services Tel: 1 860 241 7209 thomas.sullivan@us.pwc.com

Henry Jupe Manager, Actuarial and Insurance Management Solutions Tel: 1 646 471-4944 henry.m.x.jupe@us.pwc.com

Paul Delbridge Partner, Actuarial and Insurance Management Solutions Tel: 1 646 471-6345 paul.p.delbridge@us.pwc.com

Joe Calandro Managing Director, Advisory Services Tel: 1 646 471 3572 joseph.calandro@us.pwc.com

Paul Delbridge Partner, Actuarial and Insurance Management Solutions Tel: 1 646 471-6345 paul.p.delbridge@us.pwc.com

Mark Purowitz Principal, Advisory Services Tel: 1 646 471 9983 mark.purowitz@us.pwc.com

Solvency

Strategic risk managment

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John Marra Partner, Advisory Services Tel: 1 646 471 5970 john.p.marra@us.pwc.com

Sam Yildirim Principal, Advisory Services Tel: 1 646 471 2169 samiye.yildirim@us.pwc.com

Mark Friedman Director, Advisory Service Tel: 1 646 471 7382 mark.x.friedman@us.pwc.com

Strategy and executionM&A

Marie Carr Principal, Advisory Services Tel: 1 312 298 6823 marie.carr@us.pwc.com

Marik Brockman Principal, Advisory Services Tel: 1 971 544 4038 stephen.m.brockman@us.pwc.com

Global growth

Anand Rao Principal, Advisory Services Tel: 1 617 530 4691 anand.s.rao@us.pwc.com

Punita Gandhi Director, Advisory Services Tel: 1 678 419 7520 punita.gandhi@us.pwc.com

Scott Busse Director, Advisory Services Tel: 1 312 298 3597 scott.busse@us.pwc.com

Big data and smart analytics

Marie Carr Principal, Advisory Services Tel: 1 312 298 6823 marie.carr@us.pwc.com

Punita Gandhi Director, Advisory Services Tel: 1 678 419 7520 punita.gandhi@us.pwc.com

Customer-oriented operating models

Imran Ilyas Principal, Advisory Services Tel: 1 312 298 6884 imran.ilyas@us.pwc.com

Josh Knipp Director, Advisory Services Tel: 1 312 298 3044 josh.knipp@us.pwc.com

Policy administration transformation

34 Top Issues

Editorial team Rich Mayock Partner, Assurance and Business Advisory Services Tel: 1 646 471 5090 richard.mayock@us.pwc.com

Eric Trowbridge Insurance Marketing Leader Tel: 1 410 296 3446 eric.trowbridge@us.pwc.com

PwC insurance practice leadership

Jim Scanlan Insurance Practice Leader Tel: 1 267 330 2110 james.j.scanlan@us.pwc.com

James Yoder Insurance Advisory Co-leader Tel: 1 312 298 3462 james.r.yoder@us.pwc.com

Paul McDonnell Insurance Advisory Co-leader Tel: 1 646 471 2072 paul.h.mcdonnell@us.pwc.com

Sue Leonard Insurance Tax Leader Tel: 1 213 830 8248 susan.leonard@us.pwc.com

FATCA Dominick Dell’Imperio Partner, Tax Services Tel: 1 646 471 2386 dominick.dellimperio@us.pwc.com

Michele Landon Director, Tax Services Tel: 1 646 471 7084 michele.landon@us.pwc.com

Steve Chapman Partner, Tax Services Tel: 1 646 471 5809 stephen.chapman@us.pwc.com

Tax complianceSSAP 101

Tom Wheeland Managing Director, Tax Services Tel: 1 314 206 8166 thomas.f.wheeland@us.pwc.com

Rob Finnegan Managing Director, Tax Services Tel: 1 312 298 3557 rob.finnegan@us.pwc.com

Regulatory complianceDodd-Frank

Tom Sullivan Principal, Advisory Services Tel: 1 860 241 7209 thomas.sullivan@us.pwc.com

Unclaimed property Bob Bazata Partner, Tax Services Tel: 1 646 471 5140 robert.j.bazata@us.pwc.com

Amy Lazzaro Manager, Advisory Services Tel: 1 860 241 7329 amy.c.lazzaro@us.pwc.com

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Of further interest

Please visit www.pwc.com/us/en/insurance

15th Annual Global CEO Survey The Future of Insurance

The Sprint for the Global Footprint: How Insurers Can Build a Profitable Growth Strategy through International Expansion

Redefining the Customer Experience: Mobile Telematics and the Future of the Insurance Industry

Fire, Ready, Aim: Don’t Miss the Point of a Policy Administration (PAS) Transformation

Getting Set for the US ORSA

© 2012 PwC. All rights reserved.“PwC” and “PwC US” refer to PricewaterhouseCoopers LLP, a Delaware limited liability partnership, which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity. This document is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. PM-12-0174

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