2023 is expected to be a bumper year for deals in the run-off/legacy market. Barney Dixon speaks to the experts to find out why
In 2023, run-off insurance will remain a crucial component of risk management for companies. Organisations will continue to take advantage of the hard market and recycle capital to open new, profitable and efficient lines of business and, with the threat of economic hardship looming, this shows no signs of slowing. Run-off insurance is cover for businesses that have been acquired, merged, or have ceased operations.
The coverage provides protection for claims that arise after a company has stopped writing or renewing policies.
Paul Corver, group head of legacy M&A at R&Q, notes the hardening of the insurance and reinsurance markets in the last year, which he says has “caused companies to focus even more on the efficient use of capital. Releasing capital supporting legacy years or portfolios could provide the funding to increase underwriting appetite or, in the case of a captive, to perhaps increase retention or write new classes. Capital supporting legacy liabilities is unproductive capital as it is not being used to its full advantage.”
According to PwC’s 2022 review of non-life insurance run-off deals, 2022 was an active year in the market, with 48 transactions publicly announced across North America, Europe, and the UK and Ireland. Robbie Kerr, senior manager at PwC, says: “We have seen large deals being completed and North America has once again dominated geographically by deal volume, accounting for more than 50 per cent of all transactions.” While these numbers are low compared to the previous two years, 2022 saw many significant, lucrative deals announced. PwC’s Global Insurance Run-off Survey 2022 estimates the value of non-life run-off liabilities globally to be approximately US$960 billion, an 11 per cent increase year-on-year on 2021.
Eric Haller, CEO of Fleming Re, says the growth is being fuelled by “insurers divesting non-core business lines, regulatory and rating agency pressures, and counterparties seeking innovative ways to optimise their capital base. This has also drawn the attention of new investors looking to capitalise on this opportunity.”
He adds: “The combination of these factors has increased competition, especially for larger transactions. We believe the sector will experience a change in the overall paradigm and counterparties will explore ongoing relationships versus being counterparties to a one-off transaction. It is becoming increasingly important for run-off providers to demonstrate the key differentiators of their solutions and not simply bidding the lowest price.”
Significant deals in 2022 included Enstar’s US$3 billion deal with Aspen and multiple deals at Lloyd’s.
According to Kerr, this trend towards larger deals will continue, with a number of substantial transactions set to be announced in Q1 2023. He adds, “our conversations with market participants indicate that a number of players will be announcing deals that they have recently been concluding.”
Legacy’s legacy
Caroyln Fahey, executive director at AIRROC, says that the run-off market is seeing “an increased level of interest and opportunities of all sizes.” These range from very large loss portfolio transfers to smaller captive transactions and more companies considering insurance business transfers or divisions, according to Fahey.
“There are many options in the legacy ‘toolkit’ for companies that want to pursue a legacy transaction to fit any type of solution they are seeking,” she adds.
Riverstone’s chief business development officer, Matt Kunish, builds on this, stating that run-off “continues to be a strategic focus for companies broadly.”
Kunish says there are a number of well-capitalised buyers giving this space credibility and, while the US has seen fewer transactions, the size of the deals are significant.
He concludes: “We expect run-off will continue to see consistent growth in 2023 and beyond. I anticipate both the quantity of deals and the size of transactions will increase in the coming years as more companies see the benefits, both operational and financially, of doing these types of transactions.”
Corver notes that recognition of what the legacy transaction market can deliver has “increased significantly” and “big name insurers” are happy to trade in the sector, which he says was “once just associated with failure or distress.”
He explains: “The legacy community has increasingly demonstrated over the last 30 years that the transactional tools available can enhance the ongoing operation of a live underwriter or captive.”
Cover adds that the large number of deals in 2022 demonstrate the “maturity and scale” of the sector.
Mature books
With growth comes wider lines of business, and while general liability and workers’ compensation are prime areas for run-off, larger transactions have brought more classes into the fold.
According to the PwC survey, general liability, property casualty and workers compensation will continue to generate the most activity, but Fahey notes there is an interest in “younger” portfolios as insurance companies exit unprofitable lines.
She adds that there are more deals from corporate liabilities. Fahey explains: “Non-insurance entities are looking to the legacy sector to take their long-tail exposures, such as asbestos and environmental, that can be a drag on financial performance. These corporate liability deals are an area to watch.”
Haller echoes this and adds that there is demand for “tougher lines of business,” such as construction defects and A&E.
Corver remarks on the “much wider variety of classes” in the market, including commercial motor, medical malpractice, professional liability, and even cyber-and gig economy-related risks.
He adds: “Legacy portfolios used to be mature books of policies issued at least 10 to 15 years ago. Now there are frequent books coming to market that include 2021 and prior, and often contain some unexpired risk.”
Inflationary disturbance
The past few years have been tumultuous for all businesses, first with the COVID-19 pandemic, which shut down economies around the world, and now with rising inflation and a looming recession. Largely, run-off and the insurance industry as a whole has not been negatively impacted by these pressures, though the industry has suffered similar pressures to other areas of the economy.
Fahey argues that the run-off sector has “thrived”, while other industries stalled due to these environmental factors. She says it is “proof of the resiliency of the run-off sector and how we can provide solutions even in the most turbulent times.”
“I like to say when you have seen one legacy transaction you have seen one legacy transaction. The market offers options for all appetites of sizes and types of transactions,” she adds.
Corver adds that turbulence in the financial markets “invariably leads to an uptick in legacy activity,” but notes that when it comes to inflation, social inflation is a concern.
He explains: “The two inflationary areas of concern for the insurance market generally are economic inflation and social inflation. The former has less of an impact on legacy liabilities as they tend to be long tail with pay-out patterns that ride through the peaks and troughs of inflation.
“It is much more of a concern on short-tail lines, for example where property damage from windstorm or flood needs repair and prices for construction materials have significantly increased. Longer-tail bodily injury or workers compensation-type claims are impacted more by care costs, which tend to be less volatile over the longer period of treatment.”
He continues: “Social inflation is more of a concern, especially for books of US liability that might have been assumed by a legacy acquirer and which were significantly under-priced or had muted policy terms when originally underwritten during the last soft market cycle. Jury awards in the US continue to astound and the general social inflation trend is impacting many lines of recently written business for live and legacy carriers.”
This is reflected in PwC’s 2022 run-off review, which notes that the general uncertain economic environment, and protracted high period of inflation, influenced deal volume.
The report says that, while supply into the market from sellers and brokers has been plentiful, acquirers have “retained their pricing discipline.”
It continues: “This underwriting caution and ensuring that the deal is the ‘right deal’ through detailed due diligence has likely contributed to some transactions remaining on the shelf.”
Haller notes that inflationary pressures are “not all negative,” arguing that while inflation will cause the cost of liabilities to increase and the value of investments to decrease.
In addition, capital pressures “increase demand for run-off transactions due to regulatory and rating agency pressures.”
He adds: “Run-off is an efficient way to quickly optimise capital without equity dilution or increase leverage through debt. We expect the inflationary pressures to be one of the contributing factors to increasing transaction flow in the near future.”
“Depending on individual strategies, run-off carriers may successfully navigate inflationary claims pressures and mitigate unrealised losses on their own books, which in turn will allow them to provide capital solutions to counterparties. Run-off providers that are able to deploy new capital into the market will have a significant advantage.”
Capital momentum
Going into 2023, abound with inflationary pressures and a further hardening market, companies looking to recycle capital and remove historic liabilities will continue to choose run-off.
Corver argues that the benefits of pursuing a legacy solution are stronger in 2023 than in prior years. He says: “With the hard market, especially for reinsurance terms, and a retraction by insurers on certain risks, we see the uptick in captive formations but also the addition of new perils and classes written by captives. This requires capital that could be attained by removing historic liabilities. This may be preferable than the captive parent having to inject further funds themselves.”
He concludes: “Utilisation of the legacy sector has become an acceptable element of running an efficient insurance operation. Laying off the risk of historic liabilities is effectively no different to acquiring reinsurance to limit the risk taken on prospective underwriting. Both are there to provide capital efficiency and greater economic certainty.”
Haller explains that Fleming Re is looking to develop “long-term strategic partner relationships with our counterparties. This will facilitate efficiencies in pricing, execution of transactions and management of liabilities. Most importantly, our capital solutions will provide a mechanism to optimise our partners’ capital structure on an ongoing basis.”
He adds: “In the current market, the recycling of capital will allow our partners to take advantage of the hardening market. In other words, both companies will be able to recognise economic benefits from a run-off transaction, unlike historical experiences. This mutually beneficial scenario is our primary focus.”
Fahey says run-off is an “integral part of the insurance cycle and companies and captives are looking at the creative and flexible solutions that run-off provides as ways to better manage their portfolios. At AIRROC, we predict that momentum is going to continue well into the future. The future is bright for legacy!”
