We expect it to increase, however, to define how big it is, is a lot harder in the US. When considering the UK and Europe, which is where you seem to get much more information, it appears simpler.
How big is the current run-off market in the US? And do you expect the market to increase?
Stephanie Mocatta: We expect it to increase, however, to define how big it is, is a lot harder in the US. When considering the UK and Europe, which is where you seem to get much more information, it appears simpler.
For example, if you look at the PWC 2016 survey, it revealed that the UK and Europe reported approximately €250 billion of liabilities in run-off.
The problem with the US is the reporting isn’t quite the same and accumulating the data isn’t so easy.
There are companies that we would have considered that should be in run-off, under the UK or EU legislation, but in the US that same firm will continue trading.
To give an overview of market size, there are around 2,500 property casualty companies in the US, with a lot of those being very small.
The top five account for around 85 percent of the total premium in the US, so there’s an enormous number of small property and casualty companies.
There are approximately 6,000 captives and risk retention groups (RRGs), depending on how you count captives in each state. It’s an enormous market space for us.
Thomas Hodson: Yes, on the property casualty side, I’m not sure we could handle too many more opportunities, we’re very busy.
We’re getting a lot of opportunities from US regulators.
They would rather get us involved in a project, or recommend us to a company whose financials are of concern to see if we can provide a solution to prevent the company from deterioration.
How does SOBC Sandell fit into the run-off process?
Hodson: Regulators don’t like insolvencies, and we can be a helpful resource.
We like to get involved with distressed insurance entities, so they can be in run-off or they can be marginally solvent, or they can have a bunch of difficult claims, or they can have real trouble with their reinsurance collections.
In that way, we can be a resource for regulators and company owners looking for solutions to difficult issues.
But the sooner we can get involved, while there’s still some flexibility over claims handling and there’s still some cash to pay the claims because a lot of the captives we see are illiquid, the better.
In some situations, the captive has used the front company and had to put up collateral, which means they’re stuck because they’re insolvent on a cash basis, where all their cash is tied up in their collateral, and they’ve got no money to do anything, so they can’t settle any claims, can’t pay operating costs, and can’t do anything to make their lives better.
We see between 50 and 100 opportunities a year. Some of those we know within a couple of hours if we can help, but some are already insolvent—they’re too far gone.
What circumstances would cause a company to put its captive insurer into run-off?
Hodson: There was one we got involved with back in June. We told the owners and the regulators that we needed to move quickly. Cash was moving out the door at a fast pace.
Unfortunately, there was a lot of heel dragging, and ultimately we couldn’t save the company.
The captive market in the US is 35 to 40 years old, with a handful of domiciles that have been in the business for many years.
There are a number of captives and risk retention groups in those more mature domiciles that have reached a natural end of life. We can provide a solution to those captives and RRG’s looking to close down.
In Vermont, for example, there are about 1,100 licensed captives, and perhaps 40 percent of those captives are inactive and could be at the end of usefulness to their owners—they present a great opportunity for us.
On the property and casualty side, it’s often companies in financial distress or with difficult claims, but it could also be a change of business philosophy—it could be something they want to change.
For example, one of the transactions we closed in December represents another opportunity we often see.
It was a risk retention group that wasn’t distressed, it was financially healthy, but the traditional insurance market became a better option for the members, and the group was looking to close.
Often, captives are formed when coverage is unavailable or too expensive for business owners. Captives and risk retention groups can provide a better option than the traditional market.
We’re in the middle of a soft market. There’s plenty of capacity so prices are coming down, and they want to sell.
Mocatta: If a captive or risk retention group have someone in charge, who understands their business and know what the price should be for that insurance, then if the external market in that instance are quoting it cheaper, they should be asking if the external underwriters are wrong, but that’s a wider question about soft markets.
There are also captives and RRGs that have held on to what they have because they know that it’s not going to be a soft market forever, but it’s got to change at some point.
The soft market and the hard market affect our business as they make things move around. If everything was always the same and moderately priced, logically and correctly priced, we wouldn’t have a business.
But in hard markets, people set up captives and also look to merge them. A trend we see in the US is a lot of manufacturing companies setting up around seven or eight captives from mergers and acquisitions, when they only need one or maybe two.
Hodson: In Connecticut, for example, we have a company that is one of the largest employer in the state, and they have numerous captives acquired through merger, and they didn’t need five captives. The company approached us about buying one or two of their captives—the deal is not done, but may be in the future.
Do you deal with each transaction differently? For example, do you treat a captive at the end of its life cycle differently to one that has financial troubles?
Mocatta: Our philosophy is we run those companies properly, but less expensively. There’s a lot of basic stuff we do when we take something on. As an example, if the company is through with live trading, nobody cares about where the premiums are coming in from when you’re in run-off, there’s no more premium—so you can stop reporting on that.
We do a lot of streamlining. As part of the process, we take a step back and think carefully about what it is we have to do. How can we do it, how can we make it more efficient and question: are there things there that we simply don’t need to be doing anymore?
When we acquire these companies, we have an individual business plan for each company. We have to include this as part of the submission to the regulator(s). This provides the blueprint for what we do for the next two to three years going forward.
If the business is genuinely struggling, in order to keep it solvent, you have to do a number of things: check there are no problems with the front company, it could be that there are two or three large claims out there that are life-threatening to the company, and before anything else can be done, you have to go and settle those claims to get some stability.
In January last year, we acquired an illiquid captive domiciled in Montana called PIA, in this situation we had to provide liquidity so it could actually operate. After 18 months we hope to successfully stabilised that company so we can re-extract our cash. If it’s in trouble, you have to get it out of trouble. We take it as a pragmatic approach.
The earlier we can get hold of anything, the bigger the difference SOBC can make. The more room we have to maneuver, the better it is for everyone involved.
Hodson: We view ourselves as problem solvers: for regulators who may have a problem on their hands, or captive owners, or boards of directors on the traditional side, who have difficult issues.
We’ve got very patient capital, which provides opportunities for us to be different. Some captives, risk retention groups just want out. We’ll pay them, they’ll wash their hands and move on, but then with others, there can still be value, but it may not be released for years to come.
Often, in discussing a potential acquisition, the negotiations come down to who’s right on the incurred but not reported loss reserves (IBNR).
A captive owner may think the IBNR is sufficient, but we’ll take a look at the claims, and our view is that the IBNR should be significantly higher.
This issue can be a hurdle to getting to a price and getting the deal done. With our partners, we can take a longer view and offer the owner an earn out, whereby we pay a bit upfront and if the owner is right and the IBNR upon acquisition is where it should be, we’ll share the upside with the owner—we provide opportunity and a solution.
How long does the process take from when you receive the opportunity to completion?
Mocatta: There’s a lot of decision making first about whether or not the owners actually want a solution. Once you get down to it, when there’s a genuine seller, or genuine buyer, there’s about a month of negotiation.
Then there’s a regulatory filing where we sign the sale and purchase agreement, and once that’s complete, it’s down to the regulators. Some are fast, some are slow, some take weeks, and some take months—it really depends.
Hodson: On the traditional side, the regulatory process tends to take longer.
On the captive side, good regulators tend to move fast because the business is simpler. There are fewer policy holders.
Mocatta: The fastest we’ve ever got regulatory approval was 10 days, and the slowest was approximately a year. We plan two or three months for regulatory approval.
You expect questions on their side, and any transaction needs a willing buyer and a willing seller. Sellers tend to be more willing when the claims manager retires!
Do you have any acquisitions in the pipeline for this year?
Mocatta: In 2018, we would like to do another four or five transactions, six or seven would be even better—that includes disposal, as well as acquisitions.
However, we’ll have to look at around 100 opportunities to reach that figure.
It’s a skill to be able to identify if a project is worth looking at any further.
If we’ve got a fault, we probably look in too much detail at too many opportunities until we know it’s for us or not.
