Legacy out--investors in
As more insurers transfer legacy business to specialised insurers and financial investors look to run-off as a new investment, Arndt Gossmann, CEO of DARAG explains why the sector is booming.
DARAG raised €60 million earlier in the year. Why is this?
Since 2009 we have completed 12 transactions, assuming €200 million of inactive liabilities, which happened faster and was more than we initially expected. At the same time, we began this year with a solid pipeline of potential transactions—therefore we needed to bring forward the increase of capital that we had originally scheduled for 2014/15.
For our clients—insurers that limber up their liability structure transferring legacy— reputation is as important as the terms of the transaction. We handle this concern as we offer relief into a solid balance sheet of a fully regulated and fully licensed insurer in Germany. On a voluntary basis, we commit to a solvency level of 196 percent. Our clients should and can expect that we have the capital to hand whenever we conclude a transaction.
Has the money been used yet?
We have signed three smaller transactions so far and we expect three more to come this year. In total we have the ambitious target to increase our liabilities under management by €100 million, which is a lot, but not enough to ‘use’ a total capital base of more than €80 million.
Since DARAG announced the capital increase, two competitors have followed: Catalina and R&Q. Are they only following your exam- ple or is run-off now an attractive investment proposition?
The capital measures happened within two months and I expected others to follow. The sequence is coincidental, the timing is not. For me it is no surprise that most run-off consolidators witness a significant shift in demand for finality. Don’t forget the continental European legacy volume is immense and the interest from insurers is not as discreet as it was before.
Why is run-off attractive for investors and beneficial for insurers?
An investment in equity that backs legacy business offers a stable and long-term return profile. Margins are released over time and the volatility of run-off may be high, but it is very predictable. The most appealing attraction, however, is the correlation of an investment in non-live run-off with any other asset classes: zero. Hence, runoff investments are outperforming from the moment they are at market interest.
The benefit for insurers is a release of complexity and a release of capital. Independent from the live date of Solvency II, there is no argument that can justify allocated capital to closed business instead of using it for active business or returning it to the shareholders. So, whenever the risk premium of a run-off transaction is a fair remuneration for the release of capital, it makes perfect sense to externalise the legacy.
Have you seen an increase in companies wanting to transfer their inactive business?
We see a strong level of interest across Europe. The dedicated run-off units in larger and midsized groups monitor and manage dead liabilities “Whenever the risk premium of a run-off transaction is a fair remuneration for the release of capital, it makes perfect sense to externalise the legacy.” and are state of the art; the findings from these groups are further fortified by the CFO. It is clear that the dedicated capital efficiency teams, whose mission it is to find and solve any inappropriate use of capital, have started their mission.
Is this being driven by Solvency II?
The insurance industry is not driven by Solvency II. Solvency II is a regulatory framework. If a framework would drive an industry the industry is dead. It is however fair to say that Solvency II stimulates the industry—and the transfer of run-off is only one of many efficient strategies.
A survey by the Institute of Insurance Economics at the University of St Gallen concludes that overall, Swiss insurers are ahead in the management of run-off portfolios compared to insurers in EU countries. The explanation is simple: In Switzerland the equivalent of Solvency II, the Swiss Solvency Test, is already implemented.