For decades, legacy business, or “run-off”, has been regarded by many as the re/insurance industry’s dirty little secret.
The legacy market has long been a success in some parts of the world, notably the UK and some aspects of Europe where the divestment or transfer of underperforming or closed books of business to specialists who have the knowledge and capability to dedicate time and resources to bringing finality to the risks contained within those portfolios has been seen as a productive practice.
In Europe, there has traditionally been something of a reluctance to get too involved with the run-off market, instead leaving old books of business in the background.
This reluctance has historically stemmed from a fear of wanting to acknowledge books or portfolios of insurance business, or in some cases entire companies, that went awry. At the same time, there have been concerns over how customers would feel if they found their old policies were being transferred out.
But the introduction of Solvency II in the European Union at the beginning of last year has brought those books of legacy business into sharp focus.
“Solvency II has continued to drive a focus on capital efficiency and effective management, leading more continental European re/insurers to re-classify business as run-off,” Nick Watford, a partner at PwC, noted in the accountancy firm’s Unlocking Value in Run-off report last year.
“Capital concerns, alongside re/insurers’ desire to reduce volatility arising from prior year loss deterioration, remain at the heart of the legacy market across Europe,” Watford explained.
Evidence of these concerns can be seen in the sheer number of run-off deals that have taken place in Europe over the last 18 months.
Compre’s acquisitions of the Ridgwell Fox & Partners (RFP) pool legacy reinsurance business held by both QBE and Allianz IARD, as well as the purchase of the UK branch of AG Insurance, Darag’s deal for Ergo Assicurazioni from Ergo Italia and Catalina’s purchase of the legacy AGF Insurance business are just some examples of the deals that have been done.
Further evidence of the heightened level of activity in the run-off market can be seen in Compre’s busy beginning to 2017, with the business having made three legacy portfolio acquisitions by the time of going to press. The firm’s most recent deal saw Compre pick up the RFP pool legacy reinsurance business of Wüstenrot & Württembergische (W&W) for an undisclosed sum. The W&W deal is the 24th portfolio acquisition Compre has completed to date, while the company has also procured a further 10 companies that are in run-off.
“We believe that legacy is evolving and developing in continental Europe while being a mature market in the UK,” Will Bridger, managing director of acquisitions at Compre, told Reactions.
“As insurers and reinsurers get increasingly comfortable that finality is really achieved for prior year liabilities and that the focus on core, new business will deliver better returns then over time we will see more deals of larger value in continental Europe,” he added.
While continental European re/insurers are gradually becoming more accustomed to the concept of the commercial run-off market and turning to it to offload unwanted books of business, interest in the legacy sector from the more mature market within the UK is once again growing.
“Despite recent experience, legacy is forecast to increase over the medium term in the UK and in the past year we have seen some strategic decisions to withdraw from business lines such as motor,” the PwC report noted, adding: “UK re/insurers continue to lead the way in managing legacy business. They have been keen to supply the consolidator market with opportunities to acquire long tail legacy liabilities as they implement transactions to dispose of non-core books that produce potentially very significant capital benefits. The last 12 months have seen a marked increase in transactions and restructuring and this trend shows no signs of abating.”
There have been a series of deals undertaken within the UK employers’ liability sector, Compre’s Bridger explained, and these have been driven by capital, cost and the desire for finality from a very long tail liability.
But, as Bridger noted, once this employers’ liability focus is over, the key question is where does the legacy market move on from there?
While Europe has seen some significant deals over the last 18 months, the US market has seen various transactions of a far greater scale.
Enstar’s decision to write a 50% reinsurance deal on a $2.2bn book of legacy US reinsurance business belonging to Allianz hit the headlines early last year, while The Hartford paid Berkshire Hathaway subsidiary National Indemnity Company $650m for a $1.5bn adverse development coverage. That agreement provides The Hartford with $1.5 billion of aggregate excess of loss reinsurance protection against certain asbestos and environmental liability exposures that, as of December 31, 2016, held net loss reserves of $1.7bn.
But that was dwarfed by the $34bn deal AIG struck with Berkshire Hathaway’s National Indemnity Company (NICO) in January. Under the terms of that deal, NICO will assume 80% of the net losses and net allocated loss adjustment expenses on the reserves in excess of the first $25bn for AIG’s accident years leading up to and including the 2015 year of account. NICO’s exposure is capped at $20bn.
The introduction of Solvency II and equivalent regimes elsewhere in the world in countries such as Switzerland and Bermuda have led to an increased focus on legacy books of re/insurance business, while in the US, new Own Risk Solvency Assessment (ORSA) rules means companies there have also been taking a closer look at whether they should offload capital demanding operations.
And interestingly, one answer to the question of “where does the legacy market move on?” may be on other side of the North Atlantic where a series of regulatory moves seem set to ignite something of a frenzy of activity in the run-off market.
Back in 2015, the New England state of Rhode Island introduced new rules which pave the way for insurers to transfer some or all of their commercial run-off liabilities to either a newly formed or redomesticated reinsurer through what will be a department-approved and court-sanctioned process of novation.
Entitled Insurance Regulation 68, the new legislation is akin to the rules that allow Part VII transfers to take place in the UK. These new rules are expected to lead to a rampant increase in the amount of run-off activity that takes place within the US as it will allow US insurers to sell their legacy books of business to specialists in the run-off space.
In the latest iteration of the annual EY and AIRROC produced Re/insurance Run-off Survey, called In Search of Finality, many respondents felt that the new Rhode Island rules were “the single most important development in the run-off market over the next three to five years”.
“In light of the fact that the key objective of most run-off plans is finality and that finality is also the key driver for run-off restructuring, many companies appear to be considering these new regulations as a means to finality,” EY and AIRROC explained in the report.
Pro Global Insurance Solutions, which late last year agreed to be acquired by private equity firm Acuity, has already taken steps for its US operation to file an application to establish a new domestic insurance company within Rhode Island to accept the inward transfer of legacy portfolios.
Called ProTucket, Pro hopes this Rhode Island-based operation will be able to complete its first transaction under the state’s new run-off laws by September of this year.
Vermont already has legislation similar to that which has been passed in Rhode Island, albeit with one significant caveat. In Vermont, the policyholders within the book of business have to approve the transfer to the new company, even if both firms are comparable in size and all of the customers receive the same service.
As such, undertaking any transactions under this Vermont legislation is very difficult apart from those involving very small-scale books. Consequently, the law has not yet been used.
The new regulations in Rhode Island remove that restriction, and as a result there is considerable hope and expectation that the path is now clear for significant growth in the US run-off market.
And, if Vermont’s step into the run-off space is a success, Pro predicts that other states may follow its lead, with Delaware a likely candidate.
Pro may not be the only firm making inroads into the US run-off space though, with Bridger noting that Compre was keeping a close eye developments in Rhode Island as it considers whether to set up its own US outfit to take advantage of the new rules.
“Legal finality has only been possible in the US when a company has been sold and not through portfolio transfers,” explained Bridger. “Rhode Island Reg 68 delivers that legal finality under a court approved process. This could open the doors for a wholesale restructuring of the US insurance sector which is well needed. As the Rhode Island process develops Compre will keep a close eye on these developments and respond accordingly.”