Pressure to cut costs and innovate, alongside an increasingly robust regulatory environment, has squeezed the UK insurance industry in recent years. How are in-house teams faring in an ultra-competitive market?
The UK insurance market is the third largest in the world, according to the Association of British Insurers, yet it is struggling to make money. Despite taking a battering, the industry has weathered the global financial crisis far better than its counterparts in other financial services and, while it has successfully avoided many of the high-profile difficulties that have undone retail banks in recent years, the retail insurance industry now finds itself in a new era of challenges.
Charlotte Heiss, head of group legal at RSA Insurance Group, sums the situation up: ‘There has been a huge amount of legislation and comment coming our way thick and fast in the industry as a whole. We have to be really responsive and proactive. But when the whole modus operandi of the business is assessing and quantifying risk, it probably makes us more risk adverse as an industry than banking has been and my view is that has probably helped us weather the storm better.’
‘It is quite a tough market for insurers to make the profits they want to make,’ says John Salmon, head of the financial services sector group at Pinsent Masons. ‘There is a lot of focus on two things: one is cost and how to reduce it, while on the other hand they all want to be the most innovative and the most customer friendly. At the same time, they are concerned about risk management because there is new regulation all the time. It is a difficult balance.’
But any generalisations should be viewed with caution in an industry as diverse as insurance. It is inevitable that some parts of the business will be more economically significant at any one time and there are clear signs of growing confidence in some areas.
‘One example is the willingness of general insurers to make investments in, say, infrastructure projects and “shadow-banking” in the private commercial sector,’ says DWF corporate insurance partner Jeremy Irving. ‘Another is the increase in interest and investment, by private equity and others, in insurance intermediation businesses, with new managing general agents being formed and sold, often for high-price multiples.’
The general insurance market has provided a strong ground for M&A activity in recent years, with the most recent high-profile deal being Aviva’s takeover of life insurance, investments and pensions provider Friends Life in a £5.6bn deal announced last December. The deal created the UK’s largest insurance, savings and asset management firm, and gifted lead advisory roles to Magic Circle trio Linklaters, Allen & Overy and Clifford Chance.
It is still too early to tell what impact regulation – particularly the EU insurance regulatory regime Solvency II – will have on future insurance M&A activity in Europe. However, as a general rule, the US market is more volatile than its European equivalent, mostly due to greater susceptibility to natural catastrophes and different laws around ‘bad-faith behaviour’ leading to higher levels of legal compensation exposure. According to data from PwC, insurance M&A activity in the US increased significantly in 2014. There were 352 announced deals with a total announced deal value of $13.5bn, up from 252 announced deals with a total announced deal value of $11.3bn in 2013.
According to Chris Newby, EMEA general counsel (GC) at AIG, while European insurance consolidation has increased, this has been more evident among brokers than primary advisers. ‘For insurers it is still “watch this space” as regards the impact of Solvency II,’ he says. ‘There was a lot of talk a couple of years ago that it would make a lot of carriers uneconomical and there would be consolidation. I haven’t seen a volume of transactions driven by Solvency II. For insurance brokers, consolidation has increased. Whether we see consolidation in the insurance carrier market I’m not sure.’
But there is a consensus on the impact regulatory bodies have had on risk management within the industry. Both Solvency II, which goes to the heart of how risk is assessed, analysed and reported on, as well as the Jackson Reforms, which have had a significant impact on claimant operations, have put in-house legal teams increasingly at the forefront when it comes to advising the business. And although regulation in the financial services industry has been commonplace since the Financial Services and Markets Act 2000, there is no doubt that post-Lehman, insurers are paying more attention to regulatory exposure.
This seachange has been most obvious regarding conduct towards consumers. Both the Financial Conduct Authority (FCA), which ensures that insurers have the integrity of the insurance market and the fair treatment of consumers at the heart of their operations, and the Prudential Regulation Authority (PRA), which requires that insurers operate on a ‘safe and sound’ basis, are extremely active. The FCA and PRA’s Senior Managers Regime, aimed at driving particular responsibility and accountability at the top of financial services, has shaken up risk management and governance as it requires senior executives and non-executives to sign off on documents for regulators, giving the GC as an adviser greater authority.
According to Simon Konsta, head of insurance at Clydes, the fact that boards have to operate in a risk-mitigated environment is a fundamental change: ‘Demonstrating that your organisation is on top of its regulatory obligations is absolutely fundamental for any board member. And that is why boards have brought the GC functions and the compliance functions closer to the strategic and executive heart of their businesses – governance, to inform decision making and a form of protection.’
However, for Esther Felton, QBE’s GC for Europe, this more prescriptive regulatory environment does not have to be necessarily negative. ‘It is all too often that we hear talk about regulatory risk and burden. Supporting the business developing products and acting within an ever-evolving regulatory framework is the opportunity that comes with working in a regulated environment. You need to look at the positives.’
Getting off the sidelines – insurers enter the law game via new models
Innovation is critical in the insurance industry, but as well as developing new technologies and efficiencies, some are now choosing to enter the legal services market directly through an alternative business structure (ABS). RSA Insurance Group was the most recent insurer to be granted an ABS licence from the Solicitors Regulation Authority (SRA) in March this year after teaming up with Parabis to form RSA Law. Other insurers to go down the ABS route recently include German giant Allianz, which set up a personal injury legal services division called ALP Law in partnership with catastrophic injury specialist Serious Law, and Direct Line, which set up DLG Legal Services, also in conjunction with Parabis.
Two years previously, the SRA granted Admiral, Ageas and RAC ABS licences to extend their services beyond insurance and provide legal services for customers making no-fault personal injury claims. For law firms such as Bristol-based Lyons Davidson, which joined forces with Admiral, such arrangements made sense following the ban on referral fees for personal injury work as part of the Jackson Reforms.
However, despite what appears to be a clear push by insurers into legal services, some are doubtful over how far this development can go. Chris Newby, AIG EMEA’s legal head, says: ‘At the moment, I see it as being suited to individual insurers and not being across the piece, but you can never tell. Sometimes these things are cyclical and in some areas, depending on the business model, it can work, but I don’t see a trend at the moment that every insurer will be looking or thinking about that.’
Nevertheless, with an ABS licence likely to introduce cost savings and give insurers more control of legal work, their external counsel are watching developments very closely. ‘Since ABSs have been permitted, insurers have been looking at how they can use those vehicles as a means of gaining control, insourcing work and perhaps to deploy them over time to areas that have traditionally been more the preserve of external lawyers,’ says Simon Konsta, head of insurance at Clyde & Co.
‘It is not an easy balance. As an external adviser, we pay very close attention to it because it is unclear at the moment how far and in which direction the market will develop.’
Technology is king
At its heart, retail general insurance is a consumer industry and the race to be the most consumer-friendly business, together with the pressure to drive down costs, has driven increased interest in technology in recent years.
Says Newby: ‘Insurers are definitely currently investing heavily in technology. If you look at the buying habits of the consumer, more and more of it is through the web-based/iPhone/tablet-style piece. You have to look at how you utilise technology to sell to and service your customers.’
The legal team at AIG is advising the business more on the use of social media and different technologies than ever before and now has experts in that area, as well as in data protection. In addition, it has this year launched a business travel assistance app for its clients.
However, for Salmon, the fast-paced world of digital technology can also be risky for in-house teams to navigate, as they often have to react rapidly to unprecedented legal demands. ‘There are issues there that no-one has looked at before and in-house teams are having to deal with this very quickly and effectively, and make risk-based decisions,’ he says. ‘No-one is going to thank them for holding the process up and no-one is going to thank them if there is a problem further down the line.’
In addition, insurers’ race to promote digital channels and self-service options to consumers is hampered by integration with their outdated legacy systems. Replacing these systems can be expensive and risk-laden, however insurers are currently limited in the digital space as a result, particularly when it comes to capturing data. ‘It takes a brave CEO to decide to replace the legacy system,’ adds Salmon.
On the claims side specifically, the challenge is around using automated systems that increase efficiency and help drive down the costs of high-volume work. For example, Legal Business 100 law firm Keoghs was shortlisted for Legal Technology Team of the Year at the recent 2015 Legal Business Awards, notably for developing IT products to service insurance clients, such as its Advanced Data Analytics system, which identifies fraud in clients’ insurance claims and Tracker, its own bespoke case management system.
Suzanne Liversidge, an insurance litigation partner at Kennedys, says the Jackson Reforms have driven the use of technology in the industry. Kennedys has pioneered the use of automated counter-fraud tool ‘Ki’ and litigation tool ‘KLAiM’ for use with in-house teams, and an additional online dispute resolution tool is currently in the early stages of development.
‘Ki is a counter-fraud intelligence tool which helps organisations collect and understand their fraud data and risk within their business. It allows firms to instantly detect and validate fraud risk. We then work with clients to prevent the fraud claim taking place,’ says Liversidge.
Conversely, KLAiM is a tool that enables in-house claims teams in retail organisations to handle low-value litigation without the need to instruct a lawyer. Adds Liversidge: ‘We developed [KLAiM] to help clients manage the early stages of litigation, no lawyer necessary. From receipt of a claim through to settlement, it takes you through the early stages of low-value personal injury litigation where primary liability is not in dispute. It auto populates content and generates court documentation without the usual cost. It helps our clients to make better informed decisions and reduce their legal spend – something all businesses are looking to reduce these days.’
UK insurance industry – in figures
- The UK insurance industry is the largest in Europe and the third largest in the world. It generates 24% of total EU premium income.
- In 2011 it contributed £25bn to UK GDP, more than a fifth of the total gross value added for the financial services industry.
- There are 911 authorised general insurance companies in the UK, and 387 life insurance companies.
- Approximately 315,000 people are employed by the UK insurance industry, of which 118,100 are directly employed by insurance companies and 196,300 are employed in auxiliary services.
- The industry contributed nearly £12bn in taxes to the UK government in 2014.
Source: The Association of British Insurers (ABI) 2014 report
More bang, less buck
It comes as no surprise that external advisers have been pushed to develop automated systems for their clients – insurers have been traditionally highly demanding towards their law firms, driving the more-for-less agenda much more than their counterparts in other industries. Certainly, the large insurers are well known for sweating their assets and this perhaps is a major contributory factor in why the majority of law firms with a major focus on the volume insurance sector – with one or two notable exceptions – generally operate on tighter margins than firms known as corporate or banking giants, typically below 25%.
As Konsta says: ‘Insurers have been pretty tough and very successful in leveraging their legal services buying power. Certainly from a City perspective, this has led to a significant gap emerging between pricing on the provision of legal service to insurers on the claims front and litigation rates in other global sectors. You have seen significant commoditisation, low rates, fixed-fee work and discount other formulas at play. The challenge for the industry is to make sure they achieve the right balance between cost and quality in the medium to long term.’
And in-house teams themselves are not immune to this push towards efficiency. Following a period of expansion in headcount over the last ten years, generally numbers are now either stagnating or shrinking. ‘As regards the size of legal teams, there is no one-size-fits-all answer on this,’ says Salmon. ‘Clients of an equivalent size, doing broadly similar things, can have legal departments that are completely different in terms of headcount. But over the last two years, about 70% of our clients have reduced the size of their legal departments.’
The team at RSA, which has 40 lawyers globally across legal, compliance and company secretarial, is noted by one insurance GC as having a ‘fairly large team’, along with AXA, Aviva and AIG, while ACE Group, QBE Insurance and the Travelers Companies are singled out as being on the smaller side of the scale.
Derek Walsh, RSA’s group GC and company secretary, is highly recommended as ‘understanding the industry’. ‘He has been in it for a long time so he gets it. He is not a lawyer acting for the insurance industry, he is a person who uses the law in his job in insurance,’ says one peer.
Other standout individuals include Margaret Coltman, group GC and company secretary at Prudential, as well as QBE GC Esther Felton, while in-house teams at Travelers, Cigna and Willis Group Holdings are cited as effective teams.
The UK insurance team at French multinational investment group AXA, led by group GC Edward Davis, is in particular praised by private practice. Says one partner: ‘They have had a big focus on cost management as a company over the last three years, and they are looking at legal, and trying to be proactive and innovative.’
The 150-strong team at Aviva, led by group GC Kirsty Cooper and GC Monica Risam, also comes highly recommended. ‘Aviva is really interesting – its legal department is enormous,’ says one insurance lawyer. ‘It has got 30-40 in-house property lawyers in Norwich – very old-fashioned and very unusual, but just because it is old fashioned and unusual doesn’t mean it’s not a good idea.’
‘We are trying to keep the team at what we call an optimum level,’ says Kirsty Cooper, Aviva’s group GC and company secretary. ‘It is finding that sweet spot. With legal it is not about headcount it is about overall costs and making sure you have sufficient people to do the work and you are managing your outsourcing effectively. I’ve been through periods where the fashion has been to outsource everything and then other times where it has been bigger in-house teams. The key is finding that happy medium. We have a relatively large team worldwide but given the size of our business it is not huge and also we manage to keep costs fairly tight in terms of outsourcing and external spend. For me the trend within Aviva would be for the team not to grow much more, if at all.’
When it comes to instructing law firms, it is hard to identify any common trend across the sector, with some teams preferring to outsource large and significant matters such as litigation, corporate transactions and IT projects to external counsel, whereas others will try to use law firms for more of the high-volume, routine work to allow their in-house lawyers to focus on the strategic matters with some help from private practice.
RSA typically calls in external counsel when it comes to significant mandates, such as corporate transactions or its 2014 rights issue, where the in-house team was supported by Slaughter and May and Paul, Weiss, Rifkind, Wharton & Garrison. With RSA having recently secured its own alternative business structure licence for legal services (see box, ‘Getting off the sidelines’), more of the insurer’s claims work can be retained internally by the separate claims department.
Heiss comments: ‘We send out less than we used to and that is probably true elsewhere. First, in-house teams are getting better and, secondly, if people take a long hard look at costs, it’s got to be optimum to have bright people internally, who are capable of doing the majority of work that comes into the team and only using external advisers when you really have to.’ LB
kathryn.mccann@legalease.co.uk