Laissez-faire leaves bad taste

19:26, May 13 2014

Some businesses are gluttons. They may have eaten up almost all their smaller competitors, but still can't help sticking their stubby sausage fingers into the petit-fours.

It's bad for them of course. They become sluggish, sclerotic, unfit and uncompetitive. But it's worse for us, because they impose their deadweight cost on everyone else as they sit there stuffing their faces with other people's money.

The all-consuming habits of these corporate Absorbaloffs are the reason we have a Commerce Commission, the government's gym-instructor-general, to whip them into shape.

However, Chalkie reckons the commission lacks the gutbusting sadism required for the job.

Its latest decision to allow the already bloated insurer IAG to chow down on little competitor Lumley reveals its slacker tendencies.

IAG is part of the big listed Australian group of the same name and it trades in New Zealand through several brand names, including State, AMI and NZI.


Lumley is also part of an Australian group owned by listed conglomerate Wesfarmers, and its acquisition is part of IAG's purchase of the Australian group from Wesfarmers.

Their relative size in New Zealand can be seen in the following numbers: IAG NZ's gross premium last year was $1.9 billion; Lumley NZ's was $435 million.

Explaining the commission's decision to allow the takeover, chairman Mark Berry said: "By their nature all mergers create a larger company with a greater market share. However, that does not mean that a substantial lessening of competition in the market naturally follows.."

The key word is "substantial". It basically means if a deal doesn't move the dial it's good to go.

The trouble with that is it allows a dominant player to scoff the minnows one by one, safe in the knowledge that each individual deal isn't big enough to be blocked by the commission. The end result is the quenching of competition and the clogging of markets into cosy duopolies or even virtual monopolies.

The complacency of our competition law in supporting this behaviour is sickening.

It's the second time in recent years that IAG has acquired a chunk of market share with the commission's approval. In February 2012 it received clearance to buy the business of Christchurch-based insurer AMI, minus the nasty earthquake liabilities which the Government kindly took over.

The $380m purchase boosted IAG's share of the market from 31 to 40 per cent, IAG chief executive Jacki Johnson said at the time.

When the Commerce Commission cleared the deal it said existing competitors Vero, Lumley and Tower "would be able to constrain any ability of the merged entity to raise prices or decrease quality".

Now Lumley has been taken out.

Unfortunately the commission report on AMI blanked out all the key details of market share that explain its reasoning, but there are some estimates in a submission from rival Suncorp on the Lumley deal.

Australia-based Suncorp, owner of Vero, reckoned the Lumley acquisition would take IAG's share of personal lines insurance - home, contents and car cover - from 50 to 60 per cent.

The commission, meanwhile, described Lumley's share of those markets as "a small presence" and said that "three main insurance providers (IAG, Vero, Tower) will continue to operate".

Granted, we can't take Suncorp's estimate as gospel but Chalkie is stunned that the commission can be so relaxed.

Tower's last annual report put its general insurance gross premium at $279m and estimated its market share at just 4.7 per cent. Its ability to act as a competitive constraint on a rival with well over 50 per cent of the market is surely not great.

That leaves Vero as the only competitor of scale in a market that's starting to look very like a cosy duopoly.

If IAG had been denied clearance to buy Lumley NZ, Chalkie reckons it would have made no difference to its much bigger Australian deal, while Wesfarmers would still have found ready buyers for the NZ unit in Vero, Tower, or a new entrant.

Since Lumley sells its insurance through intermediaries such as brokers and Westpac bank, the branding of its products is not an issue.

The purchase of Lumley NZ by anyone other than IAG would have been better for competition and better for the country.

But perhaps IAG needs a leg-up because it seems to have a remarkably poor performance record. Chalkie checked its accounts going back to 2006 and found just three profitable years. Over the eight-year period, its cumulative results added up to a loss of $649m, including a tax benefit of $241m.

The Christchurch earthquakes were devastating, sure, but it looks like IAG was limping along even without them.

Or was it?

As Christchurch accountant Cameron Preston and Chalkie's colleague Rob Stock have noted, IAG's overall group accounts show its New Zealand segment did not make a loss in the same period. On the contrary, they show a cumulative pre-tax profit from 2006 to 2013 of A$587m (NZ$638m).

So if the New Zealand business really is profitable, why do the New Zealand accounts show such losses?

The finger of suspicion has fallen on reinsurance premiums, which are a significant cost. In the June 2013 year, IAG NZ paid reinsurance premiums of $403m, about 21 per cent of its gross premium income. The percentage was much higher than normal - the eight-year average is more like 13 per cent - probably because of the higher-risk perception arising from the earthquakes.

Most of the premium, about $395m, appears to have been paid to a related party in Singapore called IAG Re. The payment reflects the IAG group's practice of reinsuring its risk through a "captive" reinsurer.

"This operation acts as the reinsurer for the group by being the main buyer of the group's outwards reinsurance programme," the New Zealand company's accounts say.

Most of the New Zealand firm's reinsurance goes through the related party, but some is bought from outside the group.

The odd thing about the reinsurance programme is that it appears to be a profit centre - rather than acting as a conduit for group purchasing power, IAG Re seems to take in more premium than it pays out to third-party reinsurers. In 2012, for example, its gross premium appears to have exceeded outward reinsurance cost by S$161m (NZ$149m). In 2011 the difference was S$145m.

Chalkie reckons the process could involve some sort of tax minimisation strategy - Singapore is known as a low-tax regime, while another of IAG's reinsurance outfits is based in the Malaysian tax haven of Labuan.

Rather than stand around watching the corporates gobble and go, Chalkie suggests it's time for some stomach stapling. Our economic health is at stake.