Reaching a new peak

The run-off market is hitting new highs and breaking all records in 2016 as large insurers execute their post-Solvency II strategies, Arndt Gossmann, chief executive officer of DARAG, tells Monte Carlo Today.

The run-off market in Europe is undergoing a seismic shift in 2016 with both the number of deals and their size increasing exponentially, according to Arndt Gossmann, chief executive officer of specialty run-off insurer DARAG.

In total, Gossmann predicts atransaction volume of more than €4 billion ($4.4 billion) in 2016 and the first in a series of run-off deals worth more than €1 billion ($1.1 billion) as the market reaches a new peak.

He attributes this to many of the bigger insurers finally executing pre-determined strategies on how to handle closed books of business and best manage their capital now that Solvency II has finally come into effect after many years of delays.

“We always thought Solvency II would trigger a lot more run-off activity and stimulate the market but that has certainly happened for real this year. There was an increasing level of activity in 2015 but in 2016 it has gone through the roof,” Gossmann says. He says that the legacy market has seen €2.5 billion ($2.8 billion) worth of deals so far this year with an average transaction size of €200 million ($223 million).

To put this in context, in 2014 the average deal size was just €20 million ($22.3 million). During the whole of 2015, DARAG added some €299 million ($33 million) of new business to its portfolio, increasing its liabilities under management to €376 million ($419 million) from €77 million ($86 million).

Gossmann says that the increased deal size in the market is largely because Europe’s biggest insurers are suddenly entering. He believes that many of these companies had already developed highly sophisticated business plans for transferring closed books of business in areas that will offer maximum capital relief. The constant delays around Solvency II meant that they waited until the regulation was finalised and in-force before acting on these plans.

“The biggest players were prepared. They have their own internal capital models, they knew where the capital relief was possible so they started immediately. We now expect some of the medium-sized and smaller players to follow,” he says.

He adds that many smaller players also struggled with the cost and time needed to fully implement Solvency II, meaning they are now behind the curve on being prepared to consider selling closed books of business.

The dilemma for DARAG now revolves around which deals the company chooses to work on; achieving a fine balance between growth, protecting its capital base and being realistic about the management time and resources each deal requires.

“The good news for us is that all this means expansion of market opportunities,” he says. “Everyone understands this market has potential but it is now growing in real time and the deals coming through are qualified. We started getting involved in bigger deals last year but we are also very conscious that we are a mid-sized player. We will grow but in a measured and careful way.”

He emphasises that DARAG has the capital and backing available to grow substantially and attain meaningful deals. The company was bought out by its former minority shareholder, Keyhaven Capital, a London-based private equity firm, in 2014, but Gossmann stresses that any growth must be enduring.

“If we were to triple or quadruple the size of the company every year, which might be possible given the demand in the market, that is probably unsustainable and risky,” he says. “Every large deal means a significant change for us so we have to look at each transaction carefully and select exactly how and where we put our shareholders’ money.”

Run-off sidecar

There is another way of taking advantage of this burgeoning market, however. In 2015, DARAG launched R-pad (Run-off pad), the first sidecar for run-off business to be created within the EU using a protected cell company in Malta. The structure allows third party capital to access the run-off market by investing in specific portfolios without having to worry about operational issues.

Under this arrangement, the management of the portfolios, including claims handling, would be done by DARAG, which would also take a minimum 10 percent stake in each deal.

“The R-pad allows third party capital to access these risks managed by us, while we keep our costs at a healthy level,” Gossmann says.

“This could be especially useful for some of the larger deals we are seeing. The first cell within the R-pad was approved three months ago and it is being marketed to investors now. A second cell is also being created with a specific transaction in mind.”

Gossmann believes that innovation is key not only to business success, but to business survival. This means constantly enhancing existing solutions and structures, and developing new ones in order to stay in or ahead of the game.

“The R-pad is a new concept. No-one has done this before so we are doing it swiftly but with care. Once the first few cells are done, it will be easy to replicate,” he says. “We are seeing significant investor interest and we believe this will translate into more deals.”

Whether it is through theR-pad or on its own books, Gossmann forecasts a busy period ahead for the run-off market. He believes there could be between €80 and €90 billion ($89 and $100 billion) of current run-off that might qualify for a portfolio transaction and the current tide of consolidation in the insurance sector could help bring this to market.

Arndt Gossmann is the group chief executive officer of DARAG. He can be contacted at:  a.gossmann@darag.de