The Commerce Commission said yes to IAG, but no to Vero - Jenée Tibshraney asks its chairman why

Dr Mark Berry

2014: New Zealand’s largest general insurer, IAG, seeks clearance from the Commerce Commission to buy Lumley and increase its share of the general insurance market by around 9%; no dramas.

2017: New Zealand’s second largest general insurer, Vero, seeks clearance to buy Tower, and increase its share of the general insurance market by around 5%; the competition watchdog isn’t happy.

Why?

Interest.co.nz’s Jen​ée Tibshraeny asks Commerce Commission Chairman Mark Berry to explain his decision.

How was the Commerce Commission’s thinking around Vero’s application different to its thinking around IAG’s?

Berry: “Our analytical framework is the same. It’s just we’re looking at a different factual matrix here…

“At the time we looked at the Lumley acquisition that was essentially a ‘four to three’ in the market. There were four significant players if you were to count Lumley. And so when we gave approval to that, we were satisfied that with the remaining three (IAG, Vero and Tower) left in the market, the state of competition wouldn’t be materially affected…

“This case is one where we are essentially looking at three significant players reducing to two… and that’s getting to a level of concentration that was particularly of concern to us…

“Look what happened to mobile phone rates when 2degrees entered the market… I know it’s a completely different market, but there’s a lot to be said about concerns when you reach that point on concentration from three to two.”

“Bear in mind also that Lumley was quite a small player in the personal insurance lines… The Lumley case had a much wider range - particularly into commercial markets - for insurance.”

Can you provide specifics around what portion of the personal home, car and contents insurance market Vero has control over, and how this may have changed if it bought Tower?

Berry: “This is information which has had confidentiality attached to it, so that I can’t reveal the numbers unfortunately.

“There are various numbers being used in the marketplace and some of those are understated…

“Tower has a significant presence in the personal space insurance market - enough for its departure from the competitive part of the market to be of concern to us.”

Berry also points out that since the Lumley acquisition, South African insurer Youi has joined the market, and the Commission has collected more data on smaller insurers like FMG and MAS.

“What we have through this evidence is that it’s a market where expansion is very difficult, so those small players are truly very small and don’t appear to be having much of an impact.”

How much of a bearing did the existence of another possible buyer have on the Commission’s decision? (Canadian giant Fairfax Financial Holdings in February entered into a Scheme Implementation Agreement with Tower, whereby it planned to buy all of Tower’s shares for $1.17 each. Yet this proposal was quashed after Vero put $1.40 per share on the table).

Berry: “It is one factor we look at in terms of trying to work out what would Tower look like without the merger.

“For us the critical thing was, we’ve done the analysis against a scenario where you’re looking at Tower remaining independent. Tower’s got its own plans to continue to be a competitor and to enhance that level of competition.

“And there’s also noise around potential third party buyers.”

Can you confirm whether there are others, in addition to Fairfax, interested in buying Tower?

Berry: “That’s something that we just can’t opine on by us having declined clearance today.

“Who knows who may come out of the woodwork in terms of expressing interest in buying Tower. That’s something that will be revealed in the evidence going forward.”

How convinced is the Commerce Commission that Tower will be able to remain competitive in the market if it is bought out? The insurer is still struggling in the wake of the 2010/11 Canterbury earthquakes.  

Berry: “We haven’t had to opine on the viability of Tower. That wasn’t something that was part of our mandate.”

As the insurance industry’s prudential supervisor, the Reserve Bank has oversight of Tower’s solvency.

“We proceeded on the basis of the evidence we saw to assume that Tower would continue to compete in the market and we were satisfied that was likely.”

The Commerce Commission, in the Letter of Issues it sent Vero to clarify parts of its application, said Tower could be “significantly more competitive” if it goes ahead with plans to ring-fence its problematic quake-related business, raise more capital and invest in new IT platforms. Why do you believe Tower would be “significantly” more competitive?

Berry: “The critical thing is to look at is our reasons [for making our decision], and unfortunately they’re not available today. We’re targeting to release them early next week…

“Tower has articulated new competitive goals for the future. We’d expect that they’re going to focus seriously on following through on those.”

If you look at this Vero/Tower decision, coupled with the Commission’s decision to decline the Fairfax/NZME merger, it may appear you are taking a more heavy-handed approach towards regulating the market. Has the Commission had a change of heart?

Berry: “[We look at] each case on its own particular merits.

“We have a legal framework and there’s nothing new in our analytical approach to mergers.

“It simply just happens that in the last year or so we’ve had a number of the most high profile and difficult mergers to consider. It’s just the way the cases have come through the door that has ended up with this new pattern of some being declined.”

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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23 Comments

ComCom believes Tower will remain a viable competitor but in the same breath admits it did no study to validate this belief, apparently basing its views on Towers intentions to 'focus seriously on competitive goals for the future'. Whatever that means.

It's astonishing that risks to the taxpayer (of a bailout) were treated as 'not part of our mandate'. Unless there is another suitor circling and Berry is aware of this.

I am with you on this one Middleman, completely. In my opinion it seems to be the chair of Tower is a very effective lobbyist in govt circles & the interests of Tower eventually prevailed over the interests of the NZ tax payer. Going back to that scramble for what appeared to be an emergency $50 mill from the BNZ, to barely squeak in with the RBNZ it is obvious, one would think Tower is bereft of cash flow. Like you I cannnot see Tower surviving much longer.With Suncorp holding 20% in Tower, Fairfax must surely have seen themselves as stymied and it would be ditto for any other similar contender. If Suncorp fight this through the courts, and the contention that their share purchases were illicit or whatever, by the time all that is sorted out, afraid to say, Tower will have run out of options & solvency. Actually it's rather ironic. As with the Peak Re reinsurance Tower have found themselves on the wrong side of a process that is attritional, just like so many, and so many again, of their own EQ claimants.

Wow, really odd that ComCom can't (or won't) take Tower's fragile financial position into consideration. The strong third competitor argument only works if they're still here after the next big disaster - they're still struggling to survive the last one.
Looks for all the world like a tacit endorsement of the Fairfax bid - but of course ComCom couldn't possibly comment.....

Not so odd. The bids of prospective purchasers can be construed as evidence of viability, by ComCom. While they are no such thing (acquirers will buy a distressed business for a variety of reasons) this construct would be a defence for the commission should Tower remain independent and run into trouble.

I'm not a Tower shareholder but ComCom's strongly interventionist approach on this and Sky TV's merger proposals, is causing me to rethink some of my investment strategies. Moats and barriers to entry used to be a positive.

I can't imagine for a moment that the Commerce Commission did not signal to the Reserve Bank of NZ that this hospital pass was coming. With all the current headwinds blowing against the accumulated baggage of the earthquake claims, Tower has Buckley's chance of making it on their own.

With both regulators knowing the parlous state of Tower, and RBNZ very unlikely to approve the artifice that's the run-off company, there must be an acquirer in the background. I would not be surprised to learn that Canada's Fairfax have played the long game to perfection and, in the process, Suncorp has stumbled into the anti-trust quicksand.

Embarrassment all round, including the Tower Board.

Not sure what the ratio would be but Suncorp bought their shares at an average that would be over $1.30. So all of that, with shares now at $0.90 & possibly going lower, equates to around a 30% loss. Can't imagine Suncorp tamely packing that in. So they will fight and while they fight that 20% shareholding they have will be more than awkward for Tower as it exists now or the prospect of any new or old suitor, which one assumes includes Fairfax as they announced they had given up, and to my mind that in itself, confirms all the foregoing.

One fly in that ointment is time not being on Tower's side. A capital raise, spinning off the EQ claims ( a claims run off company may be interested in buying them but that would cost a premium to current claim reserves), the recent SI floods that will likely be under Towers reinsurance deductible so a bottom line cost and the investment in computer systems being discussed, are all time and capital consuming headwinds.

It's time we raised the bar about these amalgamations. In any industry.
This country is plagued with monopolies and cartels. Their path to success is via control of the market rather than efficiency or adding value. Read any brokers reports and the recommendations are centered on market control and dominance.
Time for change.

But, but, but that is exactly what capitalism is supposed to do, don't you know?

Yes PocketAces. And ComCom is there to tame the out of control beast. In our interest.

If the worst comes to the worst and Tower goes under, somebody else will buy the business. Just as longs as it is not one of the other two and is somebody else that is strong, we should preserve some competition.
I still see the CC's allowing IAG to accumulate 66% of the home, contents and car market as a large failure or possibly something more sinister. I would have thought that the minimum conditions to preserve healthy competition would be
1 no less than three strong competitors
2 no one competitor with any more than 50% of the market

I like your confidence and hope you are correct about another player entering the NZ market. A bit ominous though that Munich Reinsurance is tonight making noises about the high NZ disaster exposure and expressing concerns that reinsurance capacity for NZ may be in doubt.

At some point, you have to assume they won't be prepared to take on the risk.

If I were in the insurance business I would be far more discerning in how I priced the risks that I was assuming. I.e. far more care in categorising the risks that a house faced and pricing accordingly.
- Is it in an area that can be flooded
- Is it close to the coast, low lying
- Is it in an earthquake prone area and if so what is the geotech of the site, how is the property constructed
- Is it in a high crime area
- Is it in a large city because if there is a large natural disaster there the impact on my company will be a lot harder to swallow

I know that insurance companies do this to some extent but they do not seem anywhere discerning enough to me. An honest version of the Youi model is an example of what I mean.
If my competitors are not prepared to charge enough for the high risks then they are welcome to the business.

The Munich Re comments make complete sense. The reinsurance premiums from NZ are very low relative to the risk that these global players are exposed to. A major loss in NZ like the Canterbury EQ is the equivalent of 20 plus years of reinsurance premiums. Then it's followed by another significant event 5 years later with another 2 years premiums gone. When you see losses from a small country like NZ that get into the top 10 of global disasters and then measure that risk with the rate of payback from premiums you do wonder why reinsurers bother about a small country like New Zealand. Probably the answer is they don't but most of our insurers are regional or global insurers and NZ comes as part of the deal. We should be thankful that our insurers are owned by Aust/US companies and buy reinsurance in total and NZ is just part of this. If not then Reinsurers would have closed the door and turned the lights out years ago.

Those are really good points thank you. And indeed interesting comments from Munich Re.

You might be interested in the comments IAG's Chief Risk Officer made in an interview I did with him in December. He said premiums were going to start hardening, and people who live in higher risk places such as Wellington were going to start paying much higher premiums, rather than being subsidised by policyholders in other parts of the country. 

I guess the difficulty is pricing risk. Who would've thought Canterbury would be the city to be hit by massive earthquakes?

Jene'e, correct me if I am wrong but did you not conduct another interview with a senior IAG executive who I believe was all in favour of Vero purchasing Tower and gave quite a few reasons for this? And if I remember rightly, some of these made sense. If so, could you provide a link. Tks.

Not that I can recall sorry Pharos

?

The principal reason disaster perils premiums have not gone through the roof is low interest rates combined with a benign period of global natural disasters that has both lulled investors into a false sense of security and provided excellent comparative returns. Thus RI has continued to attract plentiful capital. If either of those scenarios change there could be some impact on pricing and supply of reinsurance capital but until that happens I suspect Munich Re's comments will remain just sabre rattling.

NZ is a 'non recovery' market. It is too small for reinsurers to get back what they have paid for major events, as they are able to in places like the east coast of USA. On the other hand our earthquakes are long cycle events (or used to be !) and Australasia offers reinsurers the geographic risk spread balance they require. In addition the Aussie programs are among the biggest in the world and have recovery potential so reinsurers cannot afford to ignore them. NZ's strongest leverage is coat tailing on these Aussie programs, which is why stand alone small insurers like Tower find it harder to be competitive, especially in market cycles where the cost of RI capital is higher and supply constrained. EQC's cap increase will however assist them to an extent.

IAG's Karl Armstrong was jawboning the market with his December comments. Wellington has always paid higher EQ premium rates. EQ rates shot up after the Canty sequence but when he spoke they were in a softening cycle, since stabilised somewhat. But yes, he is right that insurers are now more focussed on allocating the true cost of reinsurance to those areas with higher disaster risk and also on the alternative and less discussed exposure management method of restricting cover by way of policy sub limits and exclusions.

So it's a policy of first in first served.

Seems fair, all wannabe monopolies start making those acquisitions now. Knowing that your competition can't buy market share if you get in first. Then use your larger percentage of market share to run the competition into the ground so they go bankrupt. Acquire the left overs from the liquidators when there's no other buyer remaining, and the CC won't interfere.

Score 100% market share. You win you are now a monopoly.

Is it really wise to aim to become a monopoly or even a duopoly. With all the best will in the world, you will become complacent, screw the market and loose a lot of client loyalty and eventually get disrupted at some point down the track by somebody who is prepared to come into the market be smarter and compete meaningfully for your disgruntled customers. Fine in the short term but you could loose the business long term.

it can be milked pretty bad. Look at the way Telecom dragged out the advantages it had as monopoly incumbent . Deny defend confuse ....
The long term is only a series of short terms