Europe: The run-off opportunity

The run-off market is growing quickly, driven by an increase in insurers closing books of business following the financial crisis and the impact of Solvency II. Many insurers are no longer willing to tie up capital by letting run-off business quietly wither away.

What was once a taboo subject is now a board-level issue for many insurers across Europe. Fortunately the options for dealing with run-off are also increasing, with auctions of run-off business now common and a growth in the number of managers offering specialist run-off services.

As run-off describes the process an insurance company follows when it has a block of business from which it wishes to exit, no renewal premium is being received.

However, liabilities remain that must still be dealt with and managed appropriately. The decision to put a book of business into run-off can be taken for a wide combination of reasons, one of the most popular ones being that the portfolio in question is underperforming and the insurer wishes to concentrate its capital and expertise elsewhere.

This decision needs to be weighed carefully and the advantages of doing so can include increasing the efficient use of capital and reduced capital requirements; cutting costs and generating value by managing the remaining portfolio in the most efficient manner. There can also be downsides, which can include retaining the right staff, managing the insurer's brand and reputation, and ensuring that policyholder service is maintained to the satisfaction of regulators.

The run-off market is estimated to have $550bn in non-life reserves, of which approximately 45% are non-US – predominately in the European Union. It is estimated that the growth in these reserves is approximately 8% per year and is driven by a number of factors. These include discontinuations as a result of the recent financial crisis and the troubles in the Eurozone and more sophisticated value and risk-based portfolio management techniques that lead to quicker discontinuations for non-strategic lines of business.

Drivers in growth
Other drivers of the growth include Solvency II, as regulatory requirements lead to stricter capital requirements as well as increases in long-tail liabilities, and the fact that insurers are choosing to put business lines into run-off earlier in their life cycle. New growth will also come from emerging markets that will have the potential to generate run-off business and that perennial favourite: large claims events and natural catastrophes that will create new run-off business as carriers exit less profitable territories and classes of business.

The growth trend is driving demand for run-off management services as owners seek the most cost-effective way to manage down their portfolios and the previously taboo subject of run-off is now a board level issue for many insurers across Europe.

The options for carriers seeking resolution are many and varied. They could simply sell the entire portfolio or alternatively reorganise the business they wish to exit through portfolio transfers, commutations and reinsurances in order to create a single legal entity containing all the business the group wishes to sell. The sale of a large portfolio usually follows the normal merger and acquisition processes.

The sale is likely to be subject to an auction process and some sellers, that have developed run-off capability in-house, may seek to retain either the claims management or the asset management processes for themselves once the business has been sold. However, the overwhelming tendency is for sellers to seek finality, meaning that little or no contractual protection – by way of warranties and indemnities – is offered over the level of reserves, the reinsurance assets or the accuracy of actuarial information.

Sale can offer finality
The advantages of a sale are that it can achieve finality, it will follow a competitive auction sale process, thereby ensuring the best price, and it is notably quicker than a portfolio transfer or a scheme. However, sellers should not forget that they may be exposed to residual liability from warranty and indemnity claims.

Any sale will be subject to the relevant jurisdiction's rules on changes of control. In the UK, this means an application to the Financial Conduct Authority for approval of the new controllers (broadly, anyone with a direct or indirect 10% interest in the company) and of the new approved persons. Similar consents are required in other jurisdictions, although a change of control of a reinsurer often only requires notification rather than consent.

In the Lloyd's market, transactions may be structured such that in addition to taking on the management of the run-off of a syndicate, the purchaser also acquires one or more of the underlying capital providers (corporate members) to the syndicate in order to realise any anticipated or created surplus. Lloyd's consent to the change of control of the capital provider would be required. Reinsurance techniques may be used to protect a minimum level of surplus or assets for the purchaser.

If a carrier decides that it does not want to spend the management time involved in actively managing its run-off, there are now many specialist run-off managers who will take on the administration on their behalf. As this is a form of outsourcing, the arrangements need to comply with the relevant regulatory rules on material outsourcings.

However, the advantages of engaging a specialist run-off manager include freeing up of management time and may allow the redeployment of staff. A run-off manager may take a firmer approach to claims handling and pursuit of reinsurance recoveries, and this may have an impact on the carrier's reputation and brand.

The UK has a more developed market in run-off service providers than many other jurisdictions. This could be as a result of cultural perception of run-off, as well as the higher influence of the employee bodies in Continental Europe and the application of VAT on outsourcing services. However, perception of run-off has changed massively in recent years, in large part due to the work of bodies such as the Insurance and Reinsurance Legacy Association.

There are now more options than ever for an insurer or reinsurer looking to exit a particular line of business, or even its whole business. Some require a significant investment in time and resources, but achieve a finality within a timeframe that is not possible through a simple run-off. The most appropriate course of action will vary from insurer to insurer and from jurisdiction to jurisdiction, but almost all companies should be considering the most efficient deployment of their capital, the management time involved in running discontinued businesses and the effects of the discontinued business on its rating as a high priority.