Run-off: when the stars align
Inactive business can be a major drag on the performance of re/ insurers, particularly as they navigate a course through a period of profound change in the sector. Entering such books of business into run-off represents an attractive option, with discontinued insurance liabilities across Europe exceeding ¤220 billion, according to statistics from PwC. Not that it is always a simple task, with considerable hurdles to run-off being faced by the industry in certain jurisdictions.
Finality and a desire to release tied-up capital are among the leading drivers of run-off, according to PwC’s latest review of the run-off market, entitled Unlocking value in run-off. Dan Schwarzmann, partner at PwC said that the impact of regulation, including views on Solvency II, is seen as a keen driver for restructuring activity over the next fi ve years. Indeed, in the company’s latest survey—the seventh produced by PwC—72 percent of respondents highlighted the issue compared with 43 percent in the previous survey. As a result, more businesses with run-off are looking at a variety of exit strategies.
Paul Corver of Randall & Quilter, Chairman of the Insurance & Reinsurance Legacy Association (IRLA) argued that while Solvency II has been talked up as giving rise to run-off opportunities, they will generally be restricted to the smaller and medium-sized players. As he explained, larger re/insurers in Europe and Bermuda have generally got to grips with the implications of Solvency II and rationalisedwhere necessary. It is more likely that the smaller players—those still waiting on the rules and timetable of Solvency II to grow more certain—may be tempted to release discontinued portfolios to the run-off sector as the date for implementation nears.
"Many business now have clear operational plans and a greater proportion of respondents are now classifying business as being run-off earlier in its life cycle."
Corver said that capital considerations are significant in encouraging firms to re-examine inactive books of business. He said that firms examining their run-off options are considering the implications of inactive books of business on their operating performance, capital requirements and its potential distraction of management. Corver indicated that companies need to consider whether such books are receiving the attention they need and whether they are improving or degrading with age, while also considering whether the capital supporting those liabilities could be deployed elsewhere. Evidently such considerations should form a serious part of discussions concerning run-off options.
Schwarzmann noted that the recent PwC survey on European runoff business also highlighted the ever-increasing focus on run-off business. Many businesses now have clear operational plans and a greater proportion of respondents are now classifying business as being run-off earlier in its life cycle. Furthermore, while asbestos remains the most challenging exposure [see box out], respondents also cited pharmaceutical claims, medical malpractice, motor liabilities and mis-selling exposures as providing a significant challenge.
Untangling mixed books of business is also encouraging firms to consider their run-off options. As Schwartzman explained, research carried out by PwC has found over the years that there is often significant value tied up in inactive books of business. It is necessary to have a good level of oversight in order to do so, he explained, but by being proactive in finding end solutions to discontinued business, companies can unlock considerable value.
Helping matters is the state of the run-off acquisition market, where prices are buoyant for those looking to dispose of books of business. Corver said that the interest of capital markets in finding new sources of return had enticed greater levels of capital into the space, with those selling run-off the most obvious beneficiaries. He said that a number of run-off acquirers have raised funds in the market in order to acquire more portfolios, with sellers benefiting from the number of potential bidders.
Over the last few years pricing has encouraged more firms to consider the sale of books of business rather than their exit through other processes such as schemes of arrangement, said Schwarzmann. However, he noted that the tide may be changing as PwC’s latest survey highlighted a fall in the proportion of continental European respondents willing to consider a disposal.
Finally, the changing reinsurance environment may yet play its part in encouraging closer consideration of run-off options. As Corver outlined, recent capital infusions into the market will inevitably affect reinsurers and encourage some to re-examine their capitalrequirements. If they can free up internal capital, it will put them in a stronger position to compete with the influx of new capital, he explained. While short tail lines are unlikely to be a good fit for such a move, Bermuda players’ increasingly diverse books of business are likely to contain long tail lines that may yet be a drag on capital and operational efficiency.
It seems that the prospects for further run-off activity—whether it is through mechanisms such as schemes of arrangement or through sale—is high. Acquirers and those with discontinued business will undoubtedly be watching developments with interest.
Asbestos as a driver of run-off
One of the leading risks to have faced the re/insurance industry in recent years has been the threat posed by asbestos exposures, which have led to sizable claims. For run-off acquirers however there are significant opportunities for those with the expertise to handle such business. Ruxley is one such company with a focus on US asbestos, pollution and health hazard (APH) run-off claims and has completed a number of transactions that have helped generate “substantial benefits to insurers in terms of profit and released capital”, said John Winter, chief executive of Ruxley Ventures.
European re/insurers presently carry substantial reserves to meet their US APH liabilities, according to research carried out by Ruxley, as a result of sizable claims that emerged in the 1990s. However, in the current environment many re/insurers are finding themselves over-reserved for APH. Winter explained that by transferring liabilities to a specialist such as Ruxley many re/ insurers will be able “to book a profit against the reserves that they are able to release. The capital can then be deployed to more profitable current underwriting activities, rather than supporting ancient liabilities.”
He explained that the transfer of liabilities will also help to reduce the often significant burden of “administrative, legal, actuarial, regulatory and accounting costs” associated with retaining old liabilities that are often subject to further legal action. Doing so will also allow management to concentrate on the pursuit of new and profitable business, rather than being distracted by old liabilities, explained Winter.