How the Covid-19 Pandemic and Technological Innovations affect the insurance and M&A Market. As we are all aware, the last year was challenging for almost all industries, including the insurance companies, which were inevitably affected by both COVID-19 pandemic and technological innovations, and now must face the forthcoming risks and challenges.
THE IMPACT ON THE INSURANCE MARKET
Digitalization and Cyber Security. The trend on the insurance market, triggered by the COVID-19 pandemic and technological innovations, is definitely digitalization, which has proven to be a key strategic step, but also an increased need for security from cyber risks and/or termination/delay in doing business. Namely, the need for the acceleration of the digitalization and the larger use of virtual operations has reached insurance companies, which need to implement the transformation plans in the following year, on which implementation they would spend three to five years under the normal circumstances. Having that in mind, the need for innovations and digitalization was definitely necessary for the insurance companies, however great reliance on technology caused an increased exposure to cyber-attacks and interference in the ordinary course of business. Therefore, cyber security will certainly be on the list of priorities of the insurance companies in the following period and increased investments are to be expected in that segment. Additionally, the imposed digitalization, as a consequence of the COVID-19 pandemic, affected, on the one hand, the employees, for which undisturbed work from home environment needed to be ensured, and on the other hand corporate governance, which had to be organized through online meetings of the corporate bodies, using digital signatures etc. in order to continue with regular business activities.
In technology investments, transitioning to the cloud, data security improvements and data processing analytics can be highlighted as priorities, all with the goal of growth and improvement in the further course of business. Namely, cyber security and data protection are in focus, not only due to increased regulatory pressure, but also due to the increased volume of data from various sources, which may be a useful source of information to the insurance companies, and which information could not be analyzed until now due to technological limitations or unprofitability. In that way, the processes may be accelerated and user experience improved.
The risk of long distant contracts and FOS. With regards to the clients of the insurance companies, they were enabled to conclude insurance contracts at a distance electronically, but here it is worth mentioning that the contracts concluded at distance may be unilaterally terminated more simply then regularly, i.e. the contract may be terminated by the policyholder without stating the reason for termination, mostly within 14 days from the conclusion (with certain exceptions). The consequence of unilateral termination is the need to return the received premium, which may aggravate planning and contribute to the insecurity of the insurance companies business. Aside from entering into contracts at distance, another risk for the business of the local insurers is the so-called Freedom of Services (FOS), i.e. direct provision of services by the insurers from other EU member states, which carry on business on the territory of the Republic of Croatia without organizational forms. Providing of such insurance services, opens additional questions regarding conditions, applicable law and the protection of the rights of policyholders and insured persons. Such questions inevitably arise, even though we strive towards harmonization and the insurance company intending to provide services in another EU member state on the basis of FOS, has the obligation to notify the competent supervisory authority of that member state of its intention, along with the description of the nature of the risk and obligations it offers to cover.
Slowdown, however with new opportunities. The result of the breakout of the COVID-19 pandemic is the general economic slowdown, which certainly affected the insurance market. This is because the economic slowdown leads to higher levels of unemployment, lower income and thus the decrease of demand, which in turn may result in the decrease of premiums in life and non-life insurance segments. However, the change of habits and opinions of the clients simultaneously creates new opportunities for the insurance companies, since the clients are becoming more aware of the need to protect their health and be insured from risks, which may be a potential for growth of the related products of the insurance companies. This may particularly be a consequence in the life insurance sector, where growth is possible, and which is traditionally less represented in the countries of Central Europe, compared to the countries of Western Europe. Additionally, as the stability of the services and customer satisfaction are crucial in these turbulent and unpredictable times, insurance companies adopted solutions to provide support to the users of their services by allowing flexible payments or prolongation of policies.
Higher non-pecuniary damages. In the first half of the previous year, the insurance companies in Croatia also had to deal with the change of Orientation criteria and amounts for determining the amount of fair financial compensation for non-pecuniary damages by the Supreme Court of the Republic of Croatia. This change increased the accepted amounts for 50%, which does not benefit the insurance companies and creates the need for new reservations. Although the increase of the amount of compensation for non-pecuniary damages undoubtedly benefits the injured parties, the question who will ultimately bear the cost of payment of increased amounts of compensation remains open. This is due to the fact that the increase of the compensation will cause significant costs for the insurers, who are expected to increase premiums in the future, in order to annul the negative consequences of payment of increased amounts of compensation for non-pecuniary damages as much as possible.
THE IMPACT ON M&A
In relation to the M&A activities, which are still intense in the region, there is a relatively large number of the insurance companies which have not changed ownership in the recent years, although for some time now, future transactions are expected in order to stimulate the consolidation of the market and as such influence the fragmented insurance sector in the region. By the number of the transactions, the Vienna Insurance Group is the most active buyer in the region of Central Europe, followed by, in relation to the number of transactions, Canadian Fairfax Financial Holdings, Generali, Uniqa Insurance Group and Euroins Insurance Group.
How has the COVID-19 pandemic impacted M&A activity? Mergers and acquisitions proceedings of the insurance companies have been very complex even before, especially due to the regulatory requirements, however, the COVID-19 pandemic certainly had an impact on:
- the scope of due diligence procedures, which needs to be adjusted so that it includes additional segments, considering the impact of the COVID-19 pandemic:
- from state grants and subsidies,
- to the impact of the COVID-19 pandemic on contractual relations and whether individual contracts contain adequate provisions on force majeure and/or rebus sic stantibus clause, i.e. changed circumstances clause,
- the effect on the financial agreements and consequences and conditions of receiving a COVID-19 loan or other form of borrowing,
- employees and their rights and obligations,
- corporate governance and whether there is a framework for on-line functioning,
- liquidity and the effect on the initiation of insolvency and/or pre-insolvency proceedings,
- GDPR and the accumulation of more data on employees regarding their health and travels,
- the effect on litigations and their prolongation,
- insurance policies covering the risks caused by the COVID-19 pandemic etc.
- as well as on the transaction documentation, threw, for example:
- the inclusion of additional representations and warranties, which would confirm the status of the risks discovered in the process of the due diligence, at the closing of the transaction,
- the widening of the scope and more precise defining of the MAC clause and the conditions for its triggering, which essentially corresponds to the concept of changed circumstances in continental legal systems, to which the Croatian legal system belongs to,
- the mechanisms for the change of the purchase price,
- the conditions for termination of the sale and purchase agreement and its consequences,
- taking the separate insurance policies for the entire transaction (R&W); and
- the virtual process of negotiations which has largely replaced the physical negotiations.
Challenges of virtual negotiations. The virtual environment for negotiations, but also organizing virtual data rooms in moments when large gatherings are prohibited, as well as conducting the due diligence process itself in the context of organization and work from home, may be challenging and it usually results in the prolongation of the M&A process in all segments. More time is also needed for the fulfillment of standard formal preconditions for the closing of the transaction, due to the limitations on the side of transaction participants and given circumstances.
Caution required regarding the M&A activities. When deciding on the entry into the future M&A’s, it is certainly worth considering the increased need for the control of expenses, which pushes the insurance companies to resort to deadline prolongation or postponing investments planned before the COVID-19 pandemic, all in order to preserve the funds for high priority projects of adjustments to the current situation. Additionally, we note that the regulatory changes that might affect the M&A’s in the insurance market and the decision making, are the introduction of IFRS17 accounting standards and Solvency II regime, which jointly contribute to the better understanding of the financial standing and advantages and disadvantages in the sector.
Taking into consideration the complexity of the M&A process, it is important to hire expert advisors, who will carefully determine and clarify, from a legal, tax and financial standpoint, all key aspects which might result from such transactions, either with regards to the position of the buyer or the seller, and help with this complex process and closing of the transaction.
By Matea Gospic Plazina, Partner, Krehic & Partners in cooperation with Deloitte Legal