The race to run-off

The latest delay to the implementation of Solvency II— which may now not come into force until January 2016— has prompted mixed views from insurers and reinsurers.Some say they are ready for the regulation, and just want to get on with it.

Others, it seems, welcome the extra time they now have to get their houses in order. And one thing many are grappling with is how new capital requirements could force changes to their business models, with some predicting a fl urry in run-off activity as a result.

The proposed requirements will be far more prescriptive in the amount of capital insurers must hold against different types of risks. Some believe this will force re/insurers to reassess their strategic priorities—potentially placing non-core business into run-off—while also selling discontinued books of businesses to specialist third parties.

Although it is diffi cult to blame Solvency II entirely, the European runoff market does seem to have grown in recent years, as has the proliferation of specialist run-off companies that buy such books of business.

A recent flurry

A number of recent deals are typical of this growth. For example, Compre Holdings, a provider of consulting and managed services to the insurance industry, says it has sought growth in German-speaking Europe for several years. Its acquisition of run-off business, Aurora Versicherungs AG, is the company’s fourth transaction in Europe in the past 12 months.

Aurora, which was acquired by Swiss Re in 2007 and has a portfolio of largely motor liability claims, had shareholders’ funds of Sfr 11.4 million (€9.2 million) at the end of December 2011.

According to William Bridger, managing director at Compre, the type of business being put into run-off is changing. He does not attribute recent activity to Solvency II but, rather, a greater focus by international companies.

“Old legacy portfolios of discontinued reinsurance portfolios and lines of business that companies have withdrawn from several years ago and are no longer core. International business has had a greater focus,” he says.

But growth in this sector is clearly expected by these companies which are seeing investors agree with them. In April 2013, Darag Deutsche Versicherungs-und Rückversicherungs-AG, the run-off insurer, raised €60 million of new capital to fi nance new acquisitions ahead of an expected increase in deal flow.

The capital injection came from Keyhaven Capital Partners in London and increased Darag’s capital base to a total of €83 million.

“We are currently evaluating 10 portfolios of about €219 million technical liabilities and expect to close about six deals this year,” said Arndt Gossmann, CEO of Darag.

“It should be treated as an opportunity to look again at old outstanding liabilities, and with the sufficient time now available, consider a transfer and the profit that could be generated” John Winter

Darag made its first acquisition of 2013 in May, acquiring Hamburgbased Hanseatica Rückversicherungs-AG, including its entire run-off portfolio.

Hanseatica, the single shareholder of which is the Portuguese-based group José de Mello, has not written any new business since 2004. The run-off portfolio of Hanseatica includes third-party liability insurance, motor, marine and aviation insurance, engineering insurance and fire insurance.

“We are excited about the opportunity to take over Hanseatica,” says Gossmann. “It is the first deal following our capital raise in April 2013, proving us right that run-off business in Europe is experiencing rapid growth.”

A welcome delay

The delay to Solvency II, it seems, represents welcome breathing space for many insurers and reinsurers yet to make firm decisions on how to deal with legacy business and run-off portfolios.

Andrew Ward, partner at PricewaterhouseCoopers in the department that specialises in solutions for discontinued insurance business, agrees that more insurers and reinsurers will be placing books of business into run-off ahead of the Solvency II deadline.

“It’s defi nitely on the agenda. We have seen large organisations starting to have a think about books of business: either stuff that is already in run-off or new things that they are considering putting into run-off,” he says. “The general feeling still holds true and I believe that there will be an increase nearer the time.”

Ward believes Solvency II will force companies to act based on what they view as their strategic priorities in the future.

“Some people who have run-off in their portfolios may not yet have focused on it and may be beginning to realise that now is the time,” says Ward. “There is more activity and more people thinking about exit options and consequently the possibility of run-off, which may not have been on the agenda. There will be some instances where it’s moved up in people’s schedule.”

Others agree that an uptick in activity around run-off is likely. John Winter, CEO of Ruxley Ventures, an insurance investment boutique which specialises in US-based asbestos pollution and health hazard (APH) liabilities, believes recent delays to Solvency II will give companies the chance to act.

“While many in the insurance industry will be concerned at yet another delay in the implementation of Solvency II, particularly as most of them have already completed much of the necessary and expensive preparations, it should be treated as an opportunity to look again at old outstanding liabilities, and with the sufficient time now available, consider a transfer and the profit that could be generated,” says Winter.

This view echoes the findings of several reports and surveys issued in recent months. PwC’s report Unlocking the value in run-off suggested that an increase in exit activity was likely. “Indeed, we have had more conversations over the past year with providers of new capital looking to acquire run-off business than for some time,” said PWC partner Dan Schwarzmann in that report.

The PWC survey revealed that ‘finality’ was now the most popular answer given by European respondents when asked about their strategic plans around run-off, replacing ‘capital release’ as the most cited reason.

“A greater appreciation of the potential impact of Solvency II may explain the increased desire for finality,” the report said. “Respondents perhaps recognise that long-term run-off is not an economic option for some books of business. However, while finality is high on the radar for runoff businesses, the number of exits may have been limited by businesses postponing major decisions in these times of economic uncertainty.”

“For pure run-off operations and other potentially affected entities such as captives, the delay may provide welcome breathing space to determine their Solvency II approach as feedback to date suggests that many of these entities have not been fully engaged in the process,” said Schwarzmann. “This may be due in some part to a general lack of clarity in the proposed Directive.”

The regulatory framework, which is designed to impose risk management and capital requirement standards across the EU, has been in progress for over a decade and aims to ensure that insurers better match their risks with their assets. Overall costs for UK companies alone are estimated at £3 billion (€3.5 billion).

“Some people who have run-off in their portfolios may not yet have focused on it and may be beginning to realise that now is the time” Andrew Ward

Portfolio transfers

Under Solvency II, it is widely understood, insurers will be rewarded for greater diversification. As such, many insurers have responded by moving into new lines of business.

But others businesses—especially those in run-off—have also been taking advantage of a legal procedure known as a portfolio transfer, or a Part VII transfer as it is known in the UK, that allows insurance groups to consolidate several subsidiaries to form either a single business, or a smaller number of more diversified businesses.

If considered by the regulator as separate entities, these companies would have attracted larger capital charges under the new rules.

This move towards a simplification of corporate structures through portfolio transfers, which can allow an insurance group to reduce the number of regulators it has to deal with under Solvency II, has proved popular with insurers throughout the European Economic Area (EEA).

Aside from their Solvency II applications, portfolio transfers have a range of other uses. Jonathon Colson, programme manager for Solvency II at RSA, believes that portfolio transfers will remain useful in the future, highlighting RSA’s use of them when dealing with run-off business.

“If we sell portfolios of run-off business to a company, or a number of companies, then we wouldn’t want to sell the business as well as the portfolios. Part VII allows you to transfer the portfolio, without selling the whole business. There will be a lot of this going on in the future.”

Darag’s Gossmann notes that using a portfolio transfer allows the ceding company finality in the transaction.

“The key benefit of a portfolio transfer is that it enables the ceding insurer to have a full and final exit,” he says. “This is because, by the approval of the portfolio transfer, or the Part VII transfer in the UK, all liabilities are transferred on a final basis, without the possibility of any recurrence on the ceding insurer, to a new balance sheet.

“If a company used retrospective reinsurance, it would increase the risk on the reinsurance side, and leave the acquirer in the position of a normal reinsurer. Therefore Solvency II will favour the use of portfolio transfer in those instances,” he says.