Insurance Post

Fast forwarding finality.

Business in run off has traditionally stumbled on for years, but industry insiders are optimistic that changing attitudes and new approaches are speeding up the process. As John Sanders explains, finality is increasingly seen as a realistic goal rather than a distant dream.

Finality was the theme of the annual congress of the Association of
Run-Off Companies (ARC) in London in March, with speakers keen to
highlight new ways to close old business. Companies have always wanted
finality for their run-off operations, but a variety of factors, including
fear, complexity and ignorance of available options, have often led to
inaction.


Nowadays, though, companies are less keen to bury their heads in the sand
and allow run-off to carry on for decades. The reasons are often to do
with money, either saving it or realising an asset before a reinsurer goes
bust. In addition, poor returns on investment may be encouraging some
companies to look at finality more closely.


Julian Ward, managing director of JTW Reinsurance Consultants, believes
this change in attitude is not restricted to the London market, but is
evident around the world. "There is far more willingness on the part of
Europeans and the Far East to enter disputes and arbitration litigation if
necessary. Ten years ago, Europeans and certainly people in the Far East
did not want to be seen to be taking issues through the courts."


Fear of failure


The likely fallout from the World Trade Centre disaster, coupled with the
resurgence of asbestos claims, has heightened fears of corporate failure.
Under these circumstances, says ARC treasurer and independent consultant
Philip Grant, companies are more likely to settle for a compromise now
than hang on and risk losing everything in the future. "History tells us
that the solvency of companies tends to deteriorate as time goes on.


So there is clearly a credit risk and where there is a credit risk,
companies are generally quite keen on commutation," he says.


PwC partner and insolvency specialist Dan Schwarzmann cautions that
insolvency is very disruptive and avoiding it means huge cost savings. He,
too, is in no doubt that recent corporate failures provide an incentive to
act sooner rather than later: "We're certainly seeing directors saying
much earlier than they did before that they have issues they would like to
talk about."


Although credit risk remains a key driver behind companies deciding to
consider finality options such as commutation and schemes of arrangement,
it is no longer the only one. "Once upon a time, people would only do
commutations with reinsurers or cedants who they believed were financially
impaired," says Mr Ward. "Now people are far more willing to entertain it
for commercial and other reasons."


For example, businesses and companies in run off can both damage the
reputations of ongoing, live operations and be a drag on management
resources.


In these circumstances, insolvency practitioners believe the best course
of action is to close the business quickly. Time is a crucial factor, but
by carrying out inspections, audits and fact finds, companies should also
be able to negotiate a reasonable financial settlement to put past
problems behind them.


This approach is gaining ground, and not just in the London market. The
ARC conference attracted delegates from the US and all over Europe. "I
think there is a recognition in the market place that, rather than enter
into severe global punch-ups between groups of companies, an alternative
to litigation and arbitration is to commute," says Mr Ward.


This more proactive approach coincides with the development of legal,
regulatory and other tools which make finality more achievable. Mr
Schwarzmann sees evidence that run-off managers are waking up to the
options now open to them to bring finality nearer. "More and more people
are saying here are problems, do you have a solution, rather than here are
problems and they are just problems," he says.


Serious about schemes


He points to the recent rush of solvent schemes of arrangement as evidence
that companies are taking these options seriously. Schemes have moved on
significantly in the last year, he says, adding that in the last six
months PwC has seen schemes for 12 companies hit the market. Moreover, as
well as the increase in number, some of the schemes are on a scale not
seen before, showing that they can be arranged for bigger, more complex
situations.


One reason for this is the greater flexibility PwC has built into its
solutions. It can now, for example, offer a scheme with an option to
revert to run off if problems arise. "We have done that over the last six
months and it has helped many directors say 'my board will now go forward
with a closure scheme'," says Mr Schwarzmann.


Another innovation is the use of the internet in run off. Although not
widespread yet, the example of the North Atlantic Insurance Company scheme
of arrangement suggests that e-mail and websites can be very successful in
reducing costs and improving communication with policyholders.


Mr Grant, who specialises in strategic and management consulting services
for the run-off sector, points out that progress on schemes can help to
clear other logjams. "Schemes of arrangement have their own momentum
towards finality. It is essentially a mass commutation, but with statutory
backing. I think that means people will be looking to settle these
liabilities by way of commutation," he says.


The purchase of run-off companies by entities such as Castlewood and Tawa
also helps in the quest for closure, as the purchasers have finality
firmly in their sights. "They've taken the view that by buying a company
and closing it down as quickly as they can, there's money to be made,"
explains Mr Grant. "I think we will have a new breed of shareholder who
will be very much more focused on finality and therefore more willing to
cut through the Gordian knot, go to the heart of these issues and resolve
them."


Again, speed is the key to success in this buy-to-close approach.
Companies expecting to run on for five or 10 years will have substantial
expense provisions. Achieving finality within two or three years leads to
immediate savings. "That's before you start thinking about possible
redundancies in the reserves and other possible savings," argues Mr Grant.
"That's very much the motivation for these companies. They're not buying
them to hold on to them. They're buying them to close them down."


A change in UK law on insurance-business transfers should further
facilitate the sale of businesses in run off. Under the new
court-sanctioned mechanism, it is far more likely that the reinsurance
asset will be transferred with the underlying liabilities. In the past,
insurers had to negotiate the transfer with each reinsurer. Now reinsurers
can make objections before the court, but then have to abide by the
court's decision.


Industry consolidation is another factor influencing finality, since
liabilities are becoming concentrated in fewer hands. Mr Grant argues that
this makes it easier for people to reach agreement: "London has been a
market of very disparate interests and lots of sometimes very small
companies. They tend to consolidate as time goes on in terms of management
or ownership and it becomes easier to resolve the issues."


Mr Ward acknowledges that having liabilities concentrated in fewer hands
makes a difference, but points out that bigger solutions can take more
time: "I agree that it will mean more commutations can be done. It will
simply mean the nature of those commutations is far more complex, with the
result that a smaller number are being done on a far larger scale."


Clearing a path


At the same time as new approaches to finality are being developed, some
of the old hurdles are being removed or lowered. Andrew Bandurka, a lawyer
at Holman Fenwick & Willan specialising in dispute resolution, believes
that progress is possible on two of the major logjams that stymie many
commutation opportunities. An appeal ruling on disputed aviation claims
stemming from the Iraqi invasion of Kuwait in 1991 is due within months
and a court hearing to decide key issues on the oil spill from the Exxon
Valdez is possible next year.


Mr Grant agrees that there is a greater will to resolve these old spiral
losses: "It's not happening rapidly, but there is, as time goes on, a
greater will. And with the concentration of decision-making in fewer and
more motivated hands, those issues will be resolved in due course."


In some sectors of the market, regulators have been viewed as an obstacle
to finality, although this is disputed by Paul Taylor of the UK's
Financial Services Authority. The regulator is keen to co-operate with the
market and is favourably disposed both towards schemes of arrangement and
the sale of businesses in run off, he says. The only proviso Mr Taylor
makes is that the regulator does need a comfort cushion in the form of
information to give the go-ahead.


The FSA is certainly more proactive and has more tools at its disposal
under its new regime. Observers point out that the regulator pretty much
addresses the run-off market as a separate business line. They also agree
that it has a positive attitude towards schemes of arrangement and other
measures aimed at achieving finality. "They have to be because there's a
growing amount of run off and it's a problem for everybody," comments Mr
Grant.


PwC's experience echoes this. Mr Schwarzmann says the FSA is very positive
towards what he describes as sensible solutions. He believes this applies
to regulators outside the UK as well, pointing to the recent schemes set
up involving five ING companies. "These techniques can be worked out in
other jurisdictions as well," he adds.


The structural barrier of run-off managers spinning out a project until
retirement is also becoming a thing of the past. The size of the market is
creating more career opportunities, especially for those with a successful
track record, while new incentive structures reward managers and staff for
quick completion. The culture of the job market has changed, says Mr Ward:
"In the past, there was inherent conflict of interest because finality
meant the end of that book of business and then people were back on the
job search."


Commutation protocol


Looking ahead, ARC is working on a commutation protocol aimed at breaking
the impasse on large, often long-tail claims between cedants and
retrocessionaires in the London market. If the initiative is approved, the
idea is that companies that sign up to it will, broadly speaking, commute
business at pre-set levels.


Just how the market will react to the proposal is hard to predict, says Mr
Ward. He supports the initiative and believes it could work, especially
where organisations on both sides of a relationship agree to give it a go.
"A few years ago it would have been a non-starter, whereas it's a very
reasonable question now whether the market is ready to accept something
like that," he says.


Against this general trend in favour of finality, it should be pointed out
that in some quarters interest is waning. In particular, some major US
companies have pulled back to re-assess their position on APH (asbestos,
pollution and health hazard). Their concern is that calculations for APH
reserves made a couple of years ago have been derailed by rising
claims.


For example, a new wave of US class actions on asbestos, where lawyers are
signing up anyone exposed to asbestos whether they have symptoms or not,
is causing problems. The London market and Equitas have asked for more
information in the form of the reinsurance document requirement
initiative.


"They've hit a number of roadblocks with that. This is a major difficulty
which as an industry we haven't got past yet," warns Mr Ward.


Efforts are being made to resolve this latest asbestos-related dispute,
though. Mr Grant detects a groundswell of opinion keen to address the
issue, but accepts that a solution is still some years off. Companies
looking to close in the meantime will have to commute based on a view
developed with actuarial support. "Providing there is a willingness on
both sides to take that view, then it is possible to close out a
liability," says Mr Grant.
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