Robin McCoy explains where value can be identified in run-off businesses
There is a view in some parts of the insurance community that run-off is a somewhat passive activity on the fringes of the market, but this view is badly founded in two key respects. Allowing capital providers to exit lines of business which are either unprofitable or non-core provides important liquidity to the insurance world and allows businesses to restructure, redeploying both capital and management resources. That the activity itself is merely one of administration ignores the techniques that the run-off manager is able to use to both create and perhaps more importantly extract value from companies which are no longer accepting new business.In the vast majority of run-offs there are five key 'building blocks':- underwriting exposures;
- claims liabilities;
- reinsurance (and other) assets;
- liquidity; and
- effectiveness and efficiency of administration and management information.For a successful run-off, each of these interrelated elements must be managed together within the context of a run-off plan that starts from the ultimate objective of an exit and the associated realisation of asset value, and sets out the key tasks and milestones in achieving finality.The method of exit will depend on the particular circumstances of a company.Solvent schemes of arrangement have received a lot of press recently, particularly with the state of Rhode Island amending its insurance legislation to permit such schemes in a similar way to the UK. Whilst the Randall Group is finalising one scheme (Moorgate) and starting another (Ludgate), we do not believe that schemes are the only solution and would look to consider capital restructuring and reinsurance solutions in certain situations.I do not propose to revisit the pros and cons of the various options, but rather to concentrate on the issue of increasing the underlying value of run-off companies.
An age old questionThe age of a run-off will dictate the importance of managing 'live exposures', as will the nature of the portfolio. A property reinsurance book could naturally expire within twelve months of cessation of underwriting, as the majority of policies are likely to be twelve-month in nature. At the other end of the spectrum, the inclusion in the book of such classes as energy, construction or satellite launch, or the delegation of underwriting authority to managing general agents (MGAs) and coverholders can mean exposures lasting many years after underwriting has ceased.Regardless of the exit route, live exposures will increase the time required to exit and reduce the return of capital by attracting risk premium in the exit tool. The removal of exposure by cancellation, policy buyback, line replacement or reinsurance must be considered in the context of the underlying profitability of the book, the owners' attitude to risk and the existence of reinsurance to mitigate claims.From a financial perspective, the claims liability is likely to be the most significant item both in terms of absolute size and volatility. Key issues in reducing ultimate claims cost and volatility include:- 'firm but fair' claims procedures that recognise contractual obligations but do not run the risk of bad faith actions and reciprocal treatment from reinsurers by simply ignoring the payment of claims;- staff of adequate skill and experience - in the run-off arena, the claims manager becomes king (or as likely queen!);- tight monitoring of the costs of lawyers, and other professional advisors to minimise claims leakage. The instance of cases where legal costs have dwarfed indemnity costs is staggering, even ignoring asbestos and environmental claims;- detailed analysis of the book to identify areas of volatility and those in which the claims team can make an active difference; and- active pursuit of commutation opportunities within a formal strategy to reduce volatility and litigation - goals equally applicable to reinsurance.In most run-offs, the size of reinsurance asset is likely to be significant, depending on the level of gearing. The value of this asset will be maximised by:- procedures to ensure billings are timely, complete and accurate. Over the years I have encountered many accounts where more time is spent calculating and issuing billings than is spent chasing the debt itself. One solution is the automation of the reinsurance process, while another is a concentration on major value collections only - witness the time-consuming and low value syndicate reinsurance programmes placed into 'cold storage' by Equitas;- review of claims settled by the previous management to ensure maximum billings have been issued. This can result from a simple failure to collect through poor management or, as is often the case, a lack of awareness of the entire reinsurance programme, particularly in respect of facultative placements which may have been bought by individual class underwriters or by the broker for the whole slip;- ensuring that the reinsurance impact of claims are understood, when claims are being negotiated;- where inwards business is being commuted it is essential that the agreement of reinsurers (particularly non-proportional) is obtained in advance or suitable deal structures are used to ensure that reinsurers contribute to their share of the settlement, in the absence of any all - embracing legal requirement to do so;- every account has its quirks - it is essential to retain or transfer expert knowledge at the earliest opportunity. Proper documentation of resumes, schematics and complete sets of cover notes and wordings will minimise the possible loss of contemporary knowledge of a programme;- effective collection of cash to maximise cash flow (and hence investment return) and reduce credit risk from failed reinsurers;- distinguish between credit control (broker facing) and debt recovery (direct contact with reinsurers) to identify recalcitrant reinsurers;- be relentless in pursuing those reinsurers not meeting their obligations through litigation, arbitration or mediation; and- explore opportunities to offset reinsurance debt with inwards exposures.This will require full 'principal-to-principal' record-keeping where underwriting pools are involved.
Vital liquidityLiquidity is a consequence of the results of the claims and reinsurance strategies, but its importance cannot be understated. Lack of proper cash management and cash flow forecasting will constrain the other objectives of the run-off and, while the managers of a business are rightly focused on the net asset value of a business, a lack of cash or near cash to settle claims and other debts as they fall due will threaten the liquidity of the company and make the prospect of any return to the owners of the business remote.Controlling the costs of a run-off is important, but given the low percentage of claims costs and reinsurance recoveries that these represent, the focus needs to be on effectiveness rather than absolute cost. Put simply, if higher quality and therefore higher cost allows an earlier exit and consequent higher asset value, it represents the best value for money. Key aspects of effective run-off management include:- effort and money concentrated on the key tasks identified in the run-off plan. In some cases this will require an increase in resource, particularly in the early days;- establishment and monitoring of service level agreements whether the services are provided in-house or, as is increasingly common, outsourced;- real-time management information, capable of being 'cut' in many ways;- consideration (including financial payback period) of replacing legacy IT systems;- full principal-to-principal accounting;- a cost benefit review of the withdrawal from centralised settlement and claims bureaux, particularly in the London market;- consideration of the replacement of poorly performing reinsurance brokers with specialists earning purely contingent fees; and- a review of the quality and completeness of inherited records, particularly in the area of reinsurance.Little of this is likely to be news, and the majority of the techniques are as applicable to the live underwriter as to those in run-off. The main difference is that the lack of new income for a run-off carrier means efforts must be redoubled to ensure that costs do not exceed investment income and that claims can be settled within existing reserves. In a successful run-off, both policyholders and capital providers can win.Robin McCoy is CEO of Randall & Quilter Services, London.