Cash Pooling at Insurance Companies

Cash Pooling at Insurance Companies

The cash management trend of pooling and centralizing excess cash has been a focus area for most treasury departments over the past decade. The are many benefits to this approach, including gaining a centralized visibility of cash, an improved utilization of funds and the optimization of bank account structures. With this centralization, the aim is to ensure the best utilization of the organization’s cash, typically either paying off credit lines or by making short- or medium-term investments at better rates.

Setting up a cash pool is not an easy project and the treasurer will need to decide on what the optimal structure of a cash pool for their organization is. Some questions to consider at this stage include:

  • What legal entity is best suited to be the cash pool owner?
  • Should one or multiple currencies be catered for?
  • Zero balancing or notional pooling? Should cash be physically pooled daily, or do you only want to apply the interest optimization?
  • How to setup interest rates that are compliant to the transfer pricing guidelines of the OECD?

The biggest challenge of the cash pool design is a balancing act of an operational and strategically sound solution while complying with the relevant international and local regulations.

Banks and restrictions

Insurance companies need to consider their cash pooling options carefully. One of the most debated topics here is the treatment of notional cash pooling. The enforcement of the Capital Requirements Directive (CRD IV) posed restrictions on the netting of loans and deposits. However, it should be recognized that banks act differently on these restrictions. In practice we see that banks, for example, set a restriction on the maximum debit position a client can have in a notional pool. Another often seen mitigating action demanded by the bank is the requirement to physically settle the debit and credit position in a notional pool at the end of a reporting period and re-credit the position the first business day of the next period. Next to CRD IV, the BEPS regulations of the OECD with respect to pooling agreements stipulates the need to ensure agreed interest rates and pool benefits are divided between the participants on an arm’s length basis. In addition to this, the pricing documentation needs to be well taken care of. The regulatory developments create some additional complexity for insurance companies when setting up a (notional) pooling structure to effectively manage cash.

Single sweep currency

For a notional cash pool there are no fund transfers involved, hence there are no intercompany balances and interest to deal with. Subsequently, daily accounting activities are not required in comparison to a zero balancing structure. We observe zero balancing structures to be organized as a single currency sweep compared to multiple currency sweeping. Possibly due to the cost effectiveness, the ultimate accuracy and risk increase to manage this. Additionally, in some countries, withholding tax regulations need to be applied. In that instance, any cross-border sweeps result in intercompany balances and imply interest to be paid. This might impact the decision on whether to have a zero balancing or notional pooling structure in place.

Solvency

Next to the cash pool considerations, Solvency II also affects the cash management function. Solvency II describes that cash is not recognized as a risk-free asset anymore due to the capital treatments of liquidity instruments. Therefore, insurance companies should evaluate the optimal mix of cash and liquidity instruments for their liquidity management strategy while considering the Solvency Capital Requirement (SCR). This will move insurance companies to a cash management structure where cash can easily be managed and invested in a variety of short-term liquidity instruments. To effectuate such a lean and mean cash management approach, a reliable cash flow forecast is vital. A real-time view on cash balances and expected cash flows will become the new standard for treasury organizations, to ensure all obligations can be paid when due.

Country-specific regulations

Besides the above-mentioned regulatory impact on the cash management function of European insurance companies, some countries have additional specific regulations in place. In Switzerland, for example, insurance companies should deal with the tied assets regulation (see box) imposed upon by the Swiss Financial Market Supervisory Authority (FINMA). The restrictions and rules when investing in tied assets are set out in FINMA Circular 2016/5. One important aspect of this refers to how the assets are managed. It should always be clearly distinguished which assets belong to the tied asset group, e.g. through earmarking. This adds significant complexity to the cash management function – particularly to the cash pool structure. If invested tied assets need to be easily liquidized, diversification of investments should be achieved without risking the value of the asset. Furthermore, treasurers should consider that tied assets are not allowed to be encumbered or netted with other assets.

Tied Assets
To ensure the insured parties’ claims will be met before any other creditors, a Swiss insurance company needs to allocate a portion of their assets (based on actuarial principles) as tied assets. These represent the liabilities towards the insured parties.

Achieving the best cash management structure for your business

An effective cash management structure is highly dependent on the organizational structure of the company. Factors to consider include the number and location of legal entities, required bank accounts, different currencies, for example. The decision on how to structure the cash pool comes down to the costs and benefits of the different options. Does it make sense to setup a notional or hybrid cash pool structure or is a cash concentration structure more effective? Should all entities be included, or does it make sense to exclude certain entities due to specific regulations, such as the tied assets example? As regulations increase and continue to evolve, there is no simple answer. The best approach is to carefully evaluate all of the costs and benefits of the different structures.

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