Prudential’s threat to jump ship is real. The UK insurer has admitted that new European Union reforms were forcing it to re-examine its London headquarters. Playing the relocation card is a standard threat for companies faced with unhelpful rules. But even though the other benefits of moving are negligible, the risk to Pru is genuine.
Planned Solvency II rules, which will force European insurers to use more sophisticated risk models to work out their capital requirements, could deal Pru a double blow. First, EU-domiciled insurers will have to apply Solvency II to non-EU operations where Brussels decides the local regulations are not up to scratch. For Pru, that could increase the amount of capital it has to hold against the fixed annuity book of Jackson National Life, its U.S. subsidiary, by over two and a half times, according to Morgan Stanley and Oliver Wyman. That would put it at a huge disadvantage to local rivals.
Meanwhile, the European Parliament, which is debating the detail of Solvency II, last month revealed it might scrap the so-called “matching premium”. This provision would allow UK insurers, which have huge fixed annuity books, to discount their liabilities at a roughly comparable rate to the assets that support them. If the clause is dropped, Pru and others might have to hold at least 50 percent more capital against their fixed annuities.
Pru does not break out the precise level of capital it holds against its fixed annuity books, which are about 30 billion pounds in the UK and 11 billion pounds in the US. But insurers are supposed to hold a minimum of 4 percent capital against guaranteed business in the UK. Assume that’s what Pru does across the entire company, and in theory it would need to find 1.4 billion pounds of extra capital.
Moving to Hong Kong wouldn’t allow Pru to escape Solvency II entirely: its UK business would still have to obey the rules. And Hong Kong is not necessarily a light-touch haven: it and many other jurisdictions are pondering risk-based capital reforms, though not as unwieldy as Solvency II.
Meanwhile, tax rates aren’t much of a factor. True, Hong Kong’s corporate tax rate is still 6 percentage points lower than the probable UK rate in 2014. But since 2009 the UK government has allowed UK-domiciled companies with foreign subsidiaries to enjoy the full benefit of lower foreign tax rates.
Moving also entails a lot of bother. Three-quarters of shareholders would have to okay a new Hong Kong holding company. The cost of administration, rebranding, and relocating top staff could be at least 20 million pounds, according to one consultant. Then there would be a debate over whether Pru should move its primary listing – potentially forcing index-tracking funds to sell their shares.
Pru’s Asian operations are growing quickly and should be the biggest source of surplus capital by 2015. If Solvency II proves punitive, it would make strategic sense to depart for its main growth market. The most likely outcome is that the rules are watered down, and Pru keeps its UK domicile for the short to medium term. But it will see no downside in focusing politicians’ minds in the meantime.