Run-off: a more blended approach
Touching upon the impact of those soft market conditions that have characterised the commercial sector in recent years, Andre Perez, chief executive of the Horseshoe Group, said that whilst there has been some impact from the cycle, opportunities nevertheless remain in the run-off space. Rather, the most significant concern for runoff business is the current low interest rate environment, which has led to a “lack of investment income associated with the book of business”, Perez said. Such concerns were nevertheless reflected in pricing, with sellers now needing to pay book value “or a little higher” in order to attract acquirers to buy their book(s) of business. Addressing the outlook for run-off business going forward, Charles Thresh, managing director, KPMG Advisory said that despite the low interest rate environment, there has nevertheless been an “acceleration in the number of deals being done” in recent months, with the seller community now more used to the role of, and opportunities presented by, the run-off community, he said.
Mark Allitt, senior manager, KPMG Advisory said that with the re/insurance and captive industry now “better capitalised and more experienced, run-offs will be increasingly strategic decisions”, rather than involuntary ones. Tim Riddell, corporate development—Bermuda at Randall and Quilter, agreed that decisions to enter books into runoff had become increasingly strategic, with issues such as 2011 cat events and Solvency II likely to encourage firms to consider running off those books of business viewed as unprofitable or over-diversified. Riddell said that Randall and Quilter had already recognised this as an area of opportunity, with the firm “getting in there early to discuss run-off business with potential sellers”. Perez concurred that the capital intensity of certain lines and the impending implementation of Solvency II would likely present “good opportunities” for the run-off industry. And addressing the impact of Solvency II within the captive space, Perez said that, while it is uncertain how captives will be addressing the Solvency II framework, regulatory and capitalrequirements set out by the regime “might just tip captives writing third-party business into considering run-off” as the requirements of compliance get “simply too expensive”. Allitt predicted a further uptick in captive run-off thanks to the prolonged soft market, but said that it will be “interesting to watch if this will change if there is a hardening”.
Everyone at the roundtable agreed that the pricing environment has become increasingly competitive as the industry has grown and evolved. Driving pricing has been an “appetite of competition, rather than the value of assets”, Thresh said, with some run-off acquirers pursuing business at levels a “step change away from the wider community’s price”. Riddell added that present pricing was being “driven by an oversupply of capital and strong demand from those providing that capital to execute transactions”. Nevertheless the “drivers of value are the same as ever”, according to Thresh—namely “acquiring the book at the right price, asset liability matching and making sure that cash outflow is minimised”.
An important driver of pricing has been the move into live business by certain run-off acquirers, with the proposition being that such companies are “able to offer a different type of structure to sellers”, Thresh said. Using a business model in which they build a “core of capability” that can deal with run-off business in busy periods and “offer services to third parties” during lulls in the cycle. Thresh said that such an approach is enabling firms to more aggressively compete for run-off business. Riddell agreed that there was an increasing amount of bolt-on capabilities being included in the run-off offering, with companies such as Randall and Quilter “supporting the live market”—a proposition that Riddell said would be a growth area for the industry.
"An important driver of pricing has been the move into live business by certain run-off acquirers, with the proposition being that such companies are able to offer a different type of structure to sellers."
Touching upon the potential of a mixed business model, in which run-off acquirers are active in the live market, the group agreed that there was a danger of conflict of interest, but that significant potential existed to leverage expertise in the run-off space on the live underwriting side of the business. Perez warned that if a mixed operator wasn’t careful, it might “burn most of its live relationships handling run-off”, adding that without clear differentiation, such an approach would be “too antagonistic a proposition”. Riddell agreed that there need to be “quite clear walls within such an organisation”, but said that run-off teams were nevertheless increasingly pursuing business in the live space. Riddell highlighted the collaborative turn-key approach used in the Lloyd’s market, whereby one side of the business attends to the underwriting, while the other deals with claims, accounting and administration. And it is in applying just such an approach that run-off companies can “apply their skills in the live market and survive the ebb and flow of the cycle”, Thresh said.
Solvency II: opportunity knocks
Taking a closer look at the likely impact of Solvency II on the run-off sector, Riddell said that opportunities would likely arise if re/insurers are obliged by the new regulations “to spend more time dealing with underperforming live business”. Perez added that following the QIS consultative process, many firms are “already preparing those lines they will send into run-off”, in particular those regarded as having “inadequate return to allocated capital”. Riddell said that should Solvency II prove to be a trigger for run-off, the industry can expect a pipeline of new business in the coming six months.
Looking more closely at the possible impact of Solvency II, Thresh asked whether the regulators would “allow capital extraction whilst there remains uncertainty surrounding the status of Solvency II”. He said that there may well be appetite on the seller’s side, but the “buyers may falter if the soundings they are getting from the regulator are creating uncertainty as to whether the established path of capital extraction is going to be the same going forward”. Perez then asked whether a Solvency IIcompliant domicile would be the appropriate one for acquirers. Thresh pointed to Guernsey’s decision to opt out of Solvency II and said that while a potential boon to its captive industry, it might also play well for the jurisdiction as a run-off jurisdiction, with opportunities presented by a more significant captive community. Perez commented that with the uncertainties surrounding Solvency II, it was also as yet unclear as to whether compliant firms would also need to run off their business through compliant jurisdictions. He pointed to a decision by Green Light Re to establish a subsidiary in Ireland and suggested that the move might be in order to conduct European business through Ireland, whilst attending to non-European business through its existing presence in Cayman.
Addressing the potential impact of capital requirements set out by Solvency II, Perez said that run-off acquirers had traditionally been “poorly capitalised”, with the industry regarded as “poor cousins”, using their capital-light positions to negotiate better terms when running off acquired books of business. Riddell agreed that this used to be the case in the past, but said that levels of reserving “now more closely match capital requirements”, with run-off entities now “better capitalised than they ever were”. Perez concluded by asking what impact capital requirements might have on run-off acquirers’ “ability to distribute dividends to investors”. Uncertainties regarding the final impact of Solvency II upon the run-off space look set to continue.
Addressing the risk pricing of run-off business, Thresh suggested that with reserving having been on the rise in recent years, run-off can only end up “being more profitable or solvent” for acquirers. And he suggested that with a perception among buyers that “reserve strengthening has occurred”, there would be greater willingness “to pay more for run-off”. Perez warned however that sub-books of business might not necessarily prove to have been as well reserved as first thought, with possible dangers lurking in such acquisitions. As Perez put it: “You can have your head in the fridge and your feet in the oven, and fool yourself thinking that you are comfortable”, with close attention needing to be paid to all aspects of the run-off book.
As Riddell made clear, in taking on any new book of business, it is “all about understanding the numbers, getting the right advice and testing the actuarial reports in-house”. Not being caught out was all down to “how good your due diligence is” and “how much you understand the type of business you are acquiring”, he said. Perez agreed that like any other transaction, it was essential to “leave no stone unturned”. He added that there might be issues “when investors don’t know what they are getting into” or when “egos take over a transaction—particularly in a competitive environment”, but said that suitable due diligence should stop any run-off acquirer being blindsided by possible pitfalls in a book of business.
The geography of run-off
Turning to the geographical make-up of run-off business, Perez said that the “natural domiciles for run-off are the same as for insurance— London, Europe, the US”, but agreed that there were potential “gems” elsewhere in the world—viable run-off that would attract few bidders. He warned however that in such jurisdictions, “getting comfortable with loss reserves might be troubled by the level of information”, which is traditionally more scant than in mature markets. Allitt agreed that in less well-known jurisdictions, you would be dealing with “regulators you don’t know, and legal issues and structures you don’t necessarily understand”, and said that if run-off acquirers do pursue business in such territories, it would be well worth “developing a presence in the jurisdiction”. In the case of captive run-off, Perez described the acquisition process as a “little tricky” in any jurisdiction. Much depends on finding a “willing seller”, he said, with service providers’ involvement acting as a potential brake on sale; and with some captives lacking the “sophistication to pull the trigger”, he said that “as a buyer you really need to access the ultimate owner”. And in emerging jurisdictions, this might just prove a hurdle too many.
Examining Bermuda’s strengths as run-off domicile, Perez said that the Bermuda market continues to boast “speed to market” and “a depth of experience” that helps set it apart from other jurisdictions. Allitt added that the Island boasts a “depth of knowledge”, with the run-off industry able to leverage the capabilities of the wider re/insurance and business community on the Island to make a compelling case as a run-off jurisdiction. Riddell added that Bermuda enjoys a “cluster effect”, with all the major players having a presence on the Island, and with everybody being in even closer proximity than the City of London, it is “easier to meet people higher up the tree than in London”. Riddell also highlighted the Island’s position as a bridge between the US and Europe, something that run-off acquirers can exploit from offices in Hamilton. Perez concluded by pointing to the significant role that the BMA plays in making the jurisdiction a favoured choice for run-off acquirers. He described the BMA as a “very pro-business regulator” that is both “approachable and understands the business”, and said that discussions with the BMA are “co-operative, not dogmatic”.