Run-off: Gazing into the crystal ball
Arndt Gossmann, the former grojup CEO of run-off specialist DARAG, made the following predicitons at the end of 2016. He said these forecasts were framed by the regulatory, political, societal and economic trends facing the industry with change the only certainty for the sector.
Prediction 1: The run-off boom
“For this year, once again, we foresee a new peak,” Gossmann said. “We expect the total volume of non-life run-off deals to reach €8 billion within 2017 and to see the first €1billion run-off transaction that comes from the mid-market. This increase in deals is not surprising given that Europe’s biggest insurers are entering the run-off market all at once.
“Many of these companies had already put in place their strategies and plans for transferring closed books of business in areas that will offer maximum capital relief, yet waited until the Solvency II regulation was finalised and in force before going forward with them.
“The mid-market is bound to follow. All this creates an explosive market of opportunities. However, most run-off is driven by Solvency II requirements. It will take a bit more time until it is widely acknowledged as an efficient capital management strategy. Still, we are getting there,” he concludes.
Prediction 2: Europe is taking off
“We are seeing a significant increase in run-off opportunities and transactions coming from Europe,” Gossmann said. “More re/insurers are classifying business as run-off, mid-sized players are discovering the appeal of capital management/run-off and legacy management is increasingly being viewed as an ongoing strategic initiative rather than an ad hoc emergency measure.
“According to the latest run-off study conducted by PwC in 2016, this year has seen a stabilisation in terms of European market size, at €247 billion. I anticipate that Continental Europe will be the one riding the legacy wave the most this year and having established a first mover advantage will provide a lead-in.”
Prediction 3: There will be more, they will be more diverse and price-aggressive
“Given the rapid growth of the legacy market, particularly in the past two years, and that new run-off liabilities are constantly emerging, we are expecting new conditions to arise. Aggressive pricing will be an entrance point. In 2016 we did see some pricing which did not make any sense,” Gossmann said.
“We expect this to continue in 2017 but our strategy has always been to focus on quality rather than price. We believe that it will be proven experience, structuring expertise, sophisticated claims handling, the ability to see the ‘bigger picture’ from an insurer’s perspective and experienced and talented people that will ultimately drive the selection of a run-off partner in the future.”
Prediction 4: The (new) consumer: key, front and centre
“‘The market—from individual policyholders and small or medium-sized companies to large corporations—expects insurance companies not only to come up with new, more topical products that fit lifestyle needs, but also to adopt a personalised and differentiated value proposition and approach,” Gossmann said.
"Efficient legacy management strategies enhance focus and untie resources and capital. This can have a direct positive impact on the company's operations, capital allocation and reputation." Arndt Gossmann
“As Millennials enter the playing field, the insurance marketplace is becoming increasingly fragmented, with an ageing population at one end of the spectrum and a hard-to-attract, engage and retain younger generation at the other.
“One thing is certain: client reach, engagement and loyalty have levelled up. To what extent does this relate to legacy business? Well, to a rather significant one. Efficient legacy management strategies enhance focus and untie resources and capital. This can have a direct positive impact on the company’s operations, capital allocation and reputation.”
Prediction 5: Insurance industry disruption
“Technology is disrupting all areas of the insurance enterprise, from social and mobile to cloud and big data, as the demand for immediate access and use of information grows. The interconnectivity between insurance technology and consumers’ lives is on the rise,” Gossmann said.
“The harmonisation and globalisation of the insurance market, regulatory requirements, and geopolitical and economic conditions all influence and shape future strategies. Run-off is and should be viewed as an innovation enabler that unlocks capital, time and internal resources by providing a fast and efficient solution for discontinued business.
“More and more enterprises will be harnessing legacy and capital management solutions to spur innovation within their company.”
Prediction 6: Alternative capital is here to stay
“Alternative capital has permeated all aspects of the re/insurance business and run-off has become increasingly appealing to third-party investors. Run-off investments offer uncorrelated returns with low volatility—a sought-after strategy today. This current investment trend correlates positively with the run-off industry’s constant need for capital,” Gossmann said.
“The average transaction size has jumped from €20 million in 2014, to €200 million in 2016, while some single deals amount to up to €1 billion. Obviously, third-party capital is necessary for bigger and smaller players alike if they are to meet market demand, diversify their capital base and offer attractive and sound pricing.
“In 2016 we saw structured solutions involving multiple players. Our approach has been to employ and channel alternative capital within our own structures, such as DARAG’s Protected Cell Company (PCC)/R-pad.”
GROWTH TIPPED FOR THE US
At the end of 2016, US body the Association of Insurance and Reinsurance Runoff Companies (AIRROC) in association with EY published a paper called: EY/AIRROC re/insurance survey: in search of finality.
The paper, which surveyed run-off experts and AIRROC members, contained some interesting findings and made some predictions for the future. It concluded that the US insurance and reinsurance run-off market is poised for greater change and more activity than it has seen in many years, thanks to increasing urgency among carriers to achieve finality and new restructuring and exit options.
It noted that Rhode Island’s IBT regulation is expected to drive much change, especially as carriers try to navigate the considerable challenges associated with adverse loss experience and asbestos claims.
“There is a growing sense of clarity that run-off portfolios must be managed more proactively and efficiently (largely by dedicated teams and divisions), and growing consensus about the best approaches. The run-off business will continue to be an interesting space to watch in the coming years,” the report said.
It also noted that most respondents indicated that cyber and CTE, or head trauma, claims are most likely to create the next major exposure. Drones, obesity and cellphone use were indicated as less likely to start the next major claim exposure.
FURTHER GROWTH FOR EUROPE
A survey by PwC last year, released to coincide with the Monte Carlo Reinsurance Rendez-Vous, predicted an increasingly busy time for the European run-off market. Some 77 percent of respondents to PwC’s 10th annual Survey of Discontinued Insurance Business in Europe said they expect to engage in exit or restructuring activity by 2019.
The report predicted that sales of legacy liabilities to specialist run-off acquirers and group restructurings through business transfers will be the key tools to unlocking value for owners of run-off business.
The past 12 months have been extremely busy for the European run-off market and PwC expects activity to continue at least at its current pace.
Some 81 percent of respondents to the survey predicted that Europe will see more than 10 disposals of legacy business portfolios over the next two years, while over a fifth of respondents (21 percent) predicted more than 30 such disposals, with more than two-thirds (68 percent) estimating the most commonly disposed portfolio of liabilities will be between €11 million and €100 million.
The report concluded that releasing capital is the number one objective of companies’ strategic run-off plans. It also noted that board engagement is seen as the main challenge facing Continental European re/insurers with run-off business, with respondents revealing a dip since last year.
“Europe’s run-off market has had an exceptionally busy year and the transaction environment continues to thrive. Board level engagement on legacy business is still a challenge for Continental European insurers in particular, but the volume of deals we have seen in the UK and to some extent on the Continent shows that legacy is in the spotlight for many re/insurers.
“Solvency II has really focused attention on the most effective use of capital and is increasingly generating opportunities for acquirers of run-off. Insurers with legacy business are beginning to make decisions around the capital benefits associated with disposing of discontinued books.
“We expect to see this trend continue for some time as Solvency II becomes embedded within middle tier and more niche re/insurers,” the report said.