The perfect storm of conditions that has allowed the legacy sector to boom over the past couple of years looks set to continue throughout 2018 as capital continues to flow into the market, fuelling a pipeline of deals.
The legacy sector is attracting interest from pension funds and private equity investors as well as the live insurance market. Recent tie-ups between private equity houses and (re)insurers include Apollo Global Management and Renaissance Re taking stakes in Bermudian run-off specialist Catalina Holdings; Aquiline Capital Partners and Validus teaming up to make a $500m (£360) investment in legacy manager Armour Holdings and the launch of a run-off reinsurer, Premia Holdings, which is backed by both Arch Capital and Kelso & Co.
“Conditions will continue for investors,” says Simon Barnes, chief restructuring officer at Zurich Legacy Solutions. “Investors are out there and this is also about investors from outside the insurance community. Pensions funds and PE are just looking at this as an interesting market with opportunities and that means that they are being able to provide capital to the legacy market.”
This year has also seen AIG create DSA Re to house around $37bn of its own run-off liabilities backed by $40bn of invested assets that will be managed by AIG Investments.
Although some in the legacy sector have expressed concern that this could deprive the market of a substantial block of run-off books that ordinarily would have been sold off, Barnes says that it not necessarily true. “First, it creates a huge amount of profile for the run-off industry, which is a great prop. Having created an infrastructure where they manage and they’ve got a specialist team who understand it, it could be that they actually do decide to get rid of parts of the portfolio. Because you’ve got someone focused on it and understanding it, they’re not scared of taking actions that might mean they can get rid of stuff.”
It was another massive AIG deal that set the tone for a busy 2017 in the sector, a transaction with Berkshire Hathaway that saw Berkshire agree to take on up to $20bn of AIG’S long-tail liabilities written prior to 2015.
Although the AIG-Berkshire deal stood out for its size, last year was also notable for its high frequency of transactions, with Compre alone accounting for eight, including a £300m acquisition of Generali’s asbestos, pollution and health hazard and employers’ liabilities. And 2018 has started in the same vein with Enstar’s acquisition of Novae’s £840m legacy portfolio, while R&Q completed a reinsurance to close deal on a £30m Sportscover legacy book owned by Hamilton among an ever-growing number of transactions.
PWC’s annual survey of the run-off sector showed it has now grown to $700bn globally and predicted a healthy pipeline of deals for 2018. This would make it three years in succession that have seen strong transactional activity.
Dan Schwarzmann, head of market initiatives and industries at PWC UK, says: “It is clear from our survey that the global run-off market remains extremely buoyant and there is growing recognition among re/insurers of the benefits of proactively managing legacy books.”
The accounting firm found that deals were being driven by a range of factors, including Solvency II in Europe, capital efficiency and the desire of international re/insurers to gain either full legal or economic finality for their legacy liabilities.
“For the past couple of years Solvency II has undoubtedly been a catalyst for companies to review their portfolios, says Eleni Iacovides, group chief client officer at Darag. “The more time that passes since implementation and the end of transitional measures, the more focus is put on lines that are perhaps unprofitable, or unwanted, or even just engaging in shedding past underwriting years of a line that the insurer wants to continue underwriting,
“Capital and operational optimisation are really the two key drivers for companies of all sizes. We see the number and size of deals and where they emanate from, and we see that the big insurance groups are selling off things to the legacy market.”
The process of capital optimisation driven by Solvency II allied with improvements to the capital modelling process is giving carriers a deeper understanding of how capital is being deployed across portfolios. It is also shining a light on operational efficiency, core versus non-core business and in some cases the regulatory burden that helps insurers realise that capital could be used better elsewhere sometimes.
Also, the key terms and conditions – for example, price, structure and security – now provided by legacy buyers have improved to the point where they help allay any risk and reputational concerns that sellers might have.
Barry Gale, partner - insurance restructuring at KPMG UK, explains: “As delivering on plan is becoming increasingly important for large insurance groups, removing potentially volatile legacy portfolios that may threaten the group result is also frequently cited as a reason for legacy deals.
“While these factors may be prevalent in many deals from a supply side perspective, I believe buyers have been fundamentally important in increasing the number of deals.”
The influx of capital into the legacy market is partly due to the soft market conditions in many lines of live insurance business and continued low interest rates. By contrast, investors see that the run-off market is capable of generating good returns. Those returns are also by and large dependable and predictable with a steady cashflow because they are free from the constraints of writing new business.
Legacy experts predict that the volume of deals will continue to grow due to a continued supply and demand imbalance, as well as the relatively untapped nature of some of the key markets with very significant levels of liabilities in run-off, particularly in continental Europe and the US.
“From my perspective, we have the right conditions for the volume of deals to grow very substantively, Gale comments. ”The demand side of the equation is a very healthy one. Buyers are primed to move quickly and effectively as and when new opportunities arise and new capital is lined up and waiting, given the attractive and often uncorrelated nature of the opportunity and the dearth of alternatives.”
Zurich disappointed in new #discountrate. David Nichols, Ch Claims Officer: "The failure to change the discount rate to a balanced level will only serve to increase the cost and, therefore, affordability of certain types of insurance - especially for higher risk customers." pic.twitter.com/ac1CfBzfxX— Zurich Insurance UK (@ZurichInsUK) July 15, 2019
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