Living in the world of run-off

Jean-Pierre LeRoy and Julia Mazur of JLT Re enter the world of actively managed run-off and offer advice on how to out-run run-off

The reinsurance market is seeing increased activity in the run-off sector. Unlike a decade earlier, today's run-off is no longer synonymous with insolvency - many perfectly solvent reinsurers may seek to exit a class of business if it is not consistent with their business strategy. In an environment of stricter capital-adequacy requirements and an increasing influence of rating agencies, companies often view run-off as a form of capital management, enabling them to free up capital and then return it to shareholders or reinvest in the business.

For some, this increase in run-off activity will bring back memories of the 1990s, when the spate of insolvencies in the London Market led to the establishment of Equitas and spurred the development of the non-life run-off market. However, a key difference between the 1990s and what we are seeing today lies in the trend toward accelerated closure, as companies seek to minimise some of the common 'side-effects' of run-off, such as claims deterioration and escalating legal costs.

As indicated by PricewaterhouseCoopers, a leading run-off adviser, over half of insurance and reinsurance companies with discontinued business are planning an exit strategy in the next five years. Many of these companies may consider establishing a solvent scheme of arrangement.

Solvent scheme problems

Over the last few years, such schemes have evolved from a method of handling the liabilities of an insolvent company by making them into a tool for achieving finality in a solvent operation. Not everyone is enthusiastic about this rapid growth, however.

Solvent schemes present an attractive option for shareholders, but there is often a question of whether they are equally fair to policyholders and cedents.

Certain policyholders may have substantial incurred-but-not-reported (IBNR) claims, and their interests may differ from those with agreed or short-tail claims. Even if the run-off company and its advisers exercise considerable caution in constructing the solvent scheme of arrangement, cedents are still faced with a challenge to ensure that their interests are protected.

So how can an insurer protect itself against an adverse impact of a solvent scheme of arrangement (or another form of active run-off management)? Here are a few tips.

(1) Be proactive: An obvious self-protection tactic is to be proactive. Policyholder apathy is both good and bad news for solvent schemes - it can facilitate the establishment process, but the interests of all parties involved may not be taken into account fully. Despite the fact that run-off companies are required to give policyholders sufficient notice of any proposed scheme, in practice cedents are likely to find themselves working against a deadline when asked to vote on the scheme.

(2) Know your exposure: As a result of the reinsurance-market consolidation, many insurers, especially those with strict market-security requirements, find themselves in a situation of having placed their eggs in very few baskets. In such situations, effective counterparty management is critical. Knowing how much of the company's reinsurance protection depends on specific companies will help concentrate the minds of management, underwriters and claims professionals.

A good practice is to conduct a reinsurer-aggregation study following a major reinsurance renewal to establish whether a disproportionate share of the company's reinsurance is dependent upon a small number of reinsurers. This is particularly important for cedents with complex reinsurance structures.

Reinsurer aggregation analysis should take into account both reinsurance premiums and limits of cover. Premium-based aggregation is more relevant for working layers of the programme, while limit-based analysis is more appropriate for catastrophe covers.

(3) Know your reinsurers: For most insurers, the fact that their reinsurers decide to place their business into run-off should not come as a bolt from the blue. There is always advanced warning, and insurers should be looking for signs that their reinsurers may be experiencing financial difficulties or considering an exit strategy for strategic reasons.

For example, tighter claims adjustment procedures, slower claims payments and a change in the frequency of settlements should provide cedents with some food for thought. Brokers can also act as an effective barometer of reinsurer sentiment.

(4) Choose the right expert: If a reinsurer does go into run-off, hiring a debt-collection expert may prove beneficial to the cedent. Here, local knowledge can be extremely useful, and our experience indicates that a specialist located in close proximity to the run-off reinsurer can provide more timely feedback to the client, improve the communication process, and ultimately achieve a faster settlement.

(5) Time your own exit: In all run-off situations, an insurer needs to consider the options. It does not always pay to wait until the reinsurer has established a scheme of arrangement; however, for some insurers this may be the best option.

An insurer should examine its relationship with the reinsurer carefully and consider the potential benefits of an earlier exit. If the insurer-reinsurer relationship is more complex, combining both inward and outward reinsurance, it will be essential to understand the current offset position as part of the strategy for mitigating any adverse impact.

Actively managed run-off

Actively managed run-off has now become a permanent feature of the reinsurance market. With the impending introduction of the new reinsurance directive and the Solvency II regime, we are likely to see even more solvent run-off activity as reinsurers seek to deploy their capital in a more efficient manner. London, in particular, is set to become a global centre of excellence for active run-off management.

Undoubtedly, this can make the relationship between cedents and reinsurers more complex. However, the run-off industry today is arguably more professionally managed, and the issues that commonly arise in run-off situations are now better understood. Both cedents and reinsurers are in a position to develop appropriate strategies for dealing with run-off that suit their unique objectives and circumstances.

Jean-Pierre LeRoy is a partner and Julia Mazur is an associate with JLT Re.

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