The market for non-life run-off is contracting, says the latest KPMG survey. Steve Goodlud explores future prospects in a hostile financial climate
The sixth KPMG Run-off Survey: Non-Life Insurance reveals that the size of the market in the UK at the end of 2007 was £28.3bn, 13% down on the previous year and 25% smaller than two years before. By the end of 2008, the situation may be very different again as insurance companies absorb the impact of the storms buffeting the financial markets this year.
The principal driver of the decrease in the size of the market is the change at Lloyd's of London, where liabilities in open year syndicates - which Lloyd's defines as its run-off business - have fallen by £4.6bn or more than 60% since the end of 2005. This change has come about through significant use of reinsurance-to-close transactions by investors in run-off targeting the Lloyd's market. In truth, those run-off liabilities, or a component thereof, remain at Lloyd's, housed in new RITC syndicates although they now fall outside Lloyd's definition of run-off.
The picture at Lloyd's is replicated to a lesser degree in the company market, where increasing numbers of investors seeking opportunities in the non-correlated risks of the run-off sector are encountering a shrinking market. These were the principle findings of the KPMG survey published this week. Recent events in 2008, however, suggest the environment may change dramatically.
The credit crisis, which began in 2007, struck in earnest in 2008. In the banking sector, there was the nationalisation of Northern Rock in February and the takeover of Bear Stearns by JP Morgan in March.
In a shocking September, more banks succumbed to the financial crisis: Merrill Lynch was taken over by Bank of America, Halifax Bank of Scotland is poised to be taken over by Lloyds TSB, Bradford and Bingley and Glitnir Bank were nationalised and Fortis Bank was partially nationalised. Among the biggest casualties were the bankruptcy of Lehman Brothers and the conservatorship of Freddie Mac and Fannie Mae.
This contagion was not restricted to the banking sector: AIG, one of the world's largest insurance groups came close to collapse, and was rescued by the US Federal Reserve. The US government is now seeking to provide hundreds of billions of dollars to prop up its ailing financial services industry by the end of 2008.
These are unprecedented times for the current generation of decision-makers. As far as the insurance run-off community is concerned, a proven track record of managing legacy business effectively may be the skills needed by insurers in this troubling period.
Insurance groups in Europe are already focusing on their business and capital structures in preparation for Solvency II, which is due to be implemented by European regulators in 2012. This work has already included internal reorganisation and divestment of non-core business or legacy portfolios. Run-off specialists are alive to the opportunities that Solvency II may bring to them in the UK and continental Europe.
However, the events of September 2008 have given this reorganisation and restructuring activity a greater priority, and the regulation of the financial services sector going forward will place greater emphasis on capital management. Over the coming months and years insurers are expected to critically review their business strategies and risk appetite, which will determine the level of capital required to support the business. The pressures insurers now face mean they have to ensure their capital structure balances strategy with operational tax and regulatory drivers as efficiently as possible.
According to the survey, at the end of 2007 approximately £4.6bn of capital was tied up in solvent UK non-life companies in run-off, excluding Lloyd's vehicles and companies with run-off portfolios that are mixed with live business. Accessing this capital using the various means available, including sale, scheme of arrangement or insurance business transfer (Part VII transfer), may be a greater imperative for shareholders looking to make better use of it.
Insurance brokers may need to undertake similar analysis and there have already been moves by Aon and Marsh to outsource their back-office functions to Xchanging and Capita, respectively. The broking market and service providers generally may see greater consolidation as part of the drive towards capital efficiency and profitability. In a significant market development in August 2008, Benfield agreed to a purchase offer from Aon valued at £844m.
The snapshot of the UK non-life run-off market at the end of 2007 presented in the KPMG survey may look different by the end of 2008, and it may alter the trend of a shrinking run-off market. The credit crisis has impacted significantly on the asset side of insurers' balance sheets through their investment portfolios and, for some, the fall-out may hit the liability side as well. The final impact of the credit crisis may not be known for some time and navigating through this period will be a major challenge for the market.
- Steve Goodlud is a director in the restructuring insurance solutions practice of KPMG.
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