RunOff Re.Solve
Andrew Rothseid of RunOff Re.Solve says a perfect storm is brewing in a global run-off market that continues to expand and evolve
How big is the current run-off market in the US? And do you expect the market to increase?
When commentators reference the ‘size’ of a run-off market, the term ‘size’ generally refers to the amount of liabilities that are in run-off. To use a phrase that has become all too popular in this US election season—it is huge.
The size of the US non-life run-off market has never been determined. It has been estimated. In the mid-1990s, a study conducted by Swiss Re estimated the size of the US run-off to be between $150 milion and $200 million.
However, with more than 400 entities in solvent run-off and a similar number in insolvency, it is difficult to put any precise number on the size of US non-life run-off. Many insolvent entities do not issue reports on their financial condition. Similarly, many captive insurers and reinsurers have liabilities in run-off and there are few, if any, captives that issue publicly available financial statements.
Complicating the analysis further is the fact that large blocks of run-off reside on the balance sheets of insurers and reinsurers that continue to write business within the same legal entity in which the run-off liabilities reside. Few, if any, active carriers will identify their total reserves in run-off.
Additionally, and by no means, finally, few, if any, estimates of non-life liabilities take into account the wave of financial guarantors that when into run-off in 2007 and 2008 with billions of dollars of per value liabilities on their books.
The perfect storm continues for insurers and reinsurers. Premium rates remain soft. Insurers’ investment returns are under pressure from a prolonged period of low interest rates. At the same time, reserves from discontinued or run-off liabilities continue to deteriorate.
Despite this volatile climate, the global run-off market continues to expand and evolve. Run-off liabilities are no longer comprised exclusively of long-tail exposures—asbestos, pollution, health hazards and workers’ compensation claims. New, varied lines of business, such as financial guarantee, have created both the opportunity for capital relief and investment by opportunistic, as well as strategic, capital providers.
In tandem with the growing diversity of liabilities in run-off, existing and emerging regulations force companies exposed to run-off business to undergo greater capital scrutiny.
Do you believe the current soft market conditions are putting pressure on captives, thereby increasing run-offs? If so, how?
Soft markets traditionally are a breeding ground for run-off. Historically, poor underwriting decisions have been made in the race to write premium. Whether the industry as a whole will follow this historic pattern is unclear. Even more opaque is whether corporate risk managers will follow this practice.
If captive liabilities are moving into run-off, it may be the result of soft market conditions or simply the increased use of captives as a risk management/capital management tool.
Generally speaking, what would make a company to put its captive into run-off?
As corporations look for ways to control the amount of capital that they spend on insurance cover, there can be a tendency to increase their appetite for risk retention. The fact that there are larger numbers of liabilities held by captives can translate into the fact that there are a larger number of captive liabilities in run-off.
Captive owners find their captive entities enter run-off for a variety of reasons not necessarily experienced by traditional insurers. Insurers and reinsurers enter run-off, or place lines of business in run-off, due to poor underwriting, poor claims management, adverse loss development, poor investment strategy, changes in the law, or adverse court decisions.
Corporate owners of captives find themselves with run-off exposures for these factors and others that are more closely related to traditional corporate activity. For instance, a merger of companies in similar businesses can result in redundant captive operations. As part of the post-merger integration process, the redundant captive may be placed into run-off.
Similarly, simple asset purchase transactions may leave the seller with the residual captive liabilities of the business sold. Following an asset-based transactions, it is likely that those liabilities will be placed into run-off.
What about the captive’s reinsurance cover? How does this complicate matters?
The real impediment for captives in run-off is the fact that the captive is, in many circumstances, the reinsurer for the fronting carrier that insures the corporate parent. As is well known, the captive reinsures the fronting carrier by paying an initial portion or retention of the risk insured by the fronting company. The captive posts collateral to secure its payment obligation and then that collateral takes the form of either (evergreen) letters of credit or funds placed in trust.
The complication occurs when the captive goes into run-off. The fronting carrier stays on the risk but, disputes can arise, depending upon the types of liabilities insured and the provisions in the captive’s reinsurance agreement with the front covering the captive’s collateral obligations.
The result can be one where the immovable force meets the immovable object. The captive or its corporate parent may have a far different view of the ultimate value of the liabilities insured from that of the fronting carrier.
The fronting carrier will want to be protected in case of adverse loss development, while the captive or its owner may want to repatriate previously trapped capital.
What makes a successful run-off?
A successful run-off is a careful balance of interests and perspectives among policyholders, insurers and regulators. Transparency, fairness and finality are the goals.
The path to effective resolution of run-off liabilities has several objectives, including honouring valid policyholder obligations, adjusting liabilities fairly and correctly, preserving assets, capital, industry rating and shareholder value, controlling and reducing expenses, and planning and achieving a path toward finality.
The timing, quality of structuring and efficient management of the run-off resolution is critical in determining the amount of value that can be released. For a captive, this can be more straightforward than for a traditional property and casualty insurer or reinsurer.
For the traditional insurer, simply commuting all known claims does not end the run-off. Hence, the unique value and attraction of the solvent scheme of arrangement (available in the UK, Bermuda or other countries based upon the commonwealth legal system), or the Rhode Island commutation plan.
Both of these processes allow the implementing insurer or reinsurer to crystalise its liabilities as of a date certain and then accelerate the closure of all known and unknown liabilities provided a majority of creditors, representing a supermajority of reserves, vote in favour of the implementing company’s plan at a meeting of creditors. Following the successful vote and court approval of the voting process, a bar date is set. All creditors that submit their claims by the bar date will receive 100 percent of the present value of their agreed claim. Following the claim agreement process and payment, the implementing company will be discharged from its insurance obligations.
For a captive in run-off, the process can be much more direct. For instance, assume that the captive operated for 20 years before it entered run-off. Assume further that during that 20-year period, the captive reinsured some reasonable number of fronting carriers, perhaps five or six. Upon entering run-off, the captive can accelerate the conclusion of its run-off process if it can commute with all of the relevant front carriers. By commuting this limited number of reinsurance relationships it will have discharged its obligations to its fronting carriers.
Consequently, the captive may be eligible for closure and any remaining capital can be repatriated to the captive owner.
