With insurers and reinsurers looking to take advantage of the hardening market and the ongoing effects of COVID-19 play out, the run-off market is set to see increased interest in the next 12 months
As more insurers and reinsurers are looking to take advantage of the hardening market, an increasing number of portfolios are being put up for sale.
Daniel Linden, CEO at DARAG North America, says the opportunity to “recycle capital and redeploy it towards increasingly profitable lines” is a key driver of this trend.
Despite the potential challenges presented by completing deals during the COVID-19 pandemic, PwC’s Q2 2020 report for non-life insurance run-off deals showed that executed deals have remained relatively steady.
The report revealed that overall total estimated liabilities transacting dropped from $2.1 billion in Q1 2020 to $1.3 billion in Q2 2020.
During Q2, six different consolidators transacted, bringing the total number of active market acquirers during the year to 10.
Apart from one transaction where the purchaser has not been disclosed, the report highlighted that these were all established market participants these included R&Q, Ashbrooke, Riverstone, Enstar, Fleming Re and Quest.
Given the current market environment and opportunities in the sector, PwC said it expects to see some new entrants announce deals before the end of the year.
North America has proved to be the most active in terms of volume and value of deals, continuing recent trends, however, PwC suggested that the UK, within Lloyd’s in particular, will see deal activity increase as the year progresses.
Carolyn Fahey, executive director of AIRROC, suggests that Asia Pacific will also grow as a market following some deal completions in the last two years.
Although 2020 figures ($3.4 billion) are currently behind those of 2019 ($5.4 billion) in terms of value, this year continues to be a strong transaction year and the volume of deals has outpaced the same period last year with 25 deals completed as of Q2 compared to 21 deals last year, according to the PwC report.
Affirming the increase in run-off and legacy business, Linden says he has seen a “significant increase” in activity on both the sell and buy-side of the business.
Linden explains: “We have had conversations with potential new cedants who have not historically conducted legacy transactions. New acquirers have also emerged, with the backing of investors.”
He anticipates “a lively legacy market” in the final quarter of this year and the beginning of next year.
Captive market
In the captive market, as the economy emerges from the COVID-19 pandemic and government support gradually tapers off, corporates are taking stock of their capital and operational commitments and looking to refocus their resources on their core business.
Linden explains that some firms are exploring potential sales of their captive vehicles.
Run-off strategies can be employed in the captive markets in the same way that they are in the traditional market.
In the past run-off and finality transactions have in the past been viewed as a bad thing, however, Fahey suggests that they allow companies to free up capital and adapt and grow to continue to write new lines as needed by policyholders.
She says: “Runoff is a step in the natural process of a life cycle of a company, a strategic portfolio management tool. Runoff transactions enhance the capital efficiency of the insurance industry by allowing captives to shed business that simply no longer align with initial reasons for which the captive was created.”
A company may wish to put its captive insurer into run-off for many reasons including but not limited to: duplication of captive services following merger and acquisition activity, desirable pricing in the commercial insurance market, geographical or line-of-business changes, regulatory changes that reduce the benefit to captive ownership or long term changes in group captive participants.
Matt Kunish, chief business development officer at Riverstone, explains that the run-off process starts with an initial meeting to explore the goals of the transaction, for both the seller and the buyer.
After the initial meeting, due diligence follows, entailing a full review of the seller’s financial data and claims.
Lastly, possible structures and pricing options are presented to the seller based on the findings. A few different options include the transfer of liability such as a loss portfolio transfer, adverse development cover, insurance business transfer, or the sale of the whole captive.
According to Kunish, if the solution is acceptable, legal documents are negotiated and agreed, and regulatory approval is sought if needed.
He notes that once the transaction closes, capital/collateral may be released to the captive owner and ongoing expenses are eliminated.
The future run-off market
With effects of the COVID-19 pandemic expected to continue well into 2021 and the continuation of a hard market, Linden suggests that the increased demand for legacy solutions may not last, as the effects of the pandemic on the economy fade.
In short, Linden believes that there will be a period of increased supply and demand, but “these may both taper off towards the end of this period”.
However, he does predict that more cedants will be putting portfolios out to market and expects new vendors will emerge over the next 12 months.
“We have already seen several new acquirers set up to match this increased demand; although, with a short track record and less expertise, they may struggle in an already-mature market,” Linden says.
Also weighing in, Kunish notes that the pandemic will cause companies to re-evaluate their current business models and look to more effectively structure their risk profile.
Although forming a captive as an alternative risk transfer vehicle will continue to look more attractive over the next several months, Kunish says: “Unfortunately, with the current times being so financially demanding, I also expect existing companies to close or merge with others. In these situations, run-off providers can step in and help.”
Fahey also predicts that the industry will see increased interest from captive owners and managers.
“There is potential for some new mass tort emerging risks in the industry — beyond the traditional issues of environmental and asbestos liabilities — that may serve as an impetus for ‘lasering’ out specific legacy liability reinsurance transactions.”
She adds: “For example, recent adverse litigation around Talc, food additives, ‘fracking’, and other issues may spark companies with retained liabilities housed in captives, to explore creative ways to move these liabilities to counterparties to reduce the risk of these impacting the capital base of the captive.”
In addition, AIRROC’s Fahey believes that the interest in runoff will continue to grow on a broad basis within the insurance industry as a whole.
She also highlights the increased focus from the National Association of Insurance Commissioners (NAIC) and states enacting insurance business transfer (IBT) or division laws, will open up some new transaction options for insurers.
In mid-October this year, the District Court of Oklahoma County approved the insurance business transfer (IBT) plan in the US.
Discussing the IBT, Oklahoma Insurance Commissioner Glen Mulready, said: “This is a big step forward in transforming and invigorating the run-off market. We look forward to completing additional IBT’s in the coming months.”
The plan saw all the insurance and reinsurance business underwritten by Providence Washington Insurance Company, a wholly owned subsidiary of Enstar Group, transfer to Yosemite Insurance Company, an insurance company in Oklahoma.
Fahey explains: “Once we see a few of these transfers occur within these new laws, we believe that many others will avail themselves of these new options. The laws are based on long-standing practice that has been used for decades in Europe, especially in the UK.”
