Maik Wandres: I agree. I do not see anything wrong with it. I would almost call it “capital recycling” because that will certainly be an issue and come to people’s attention under Solvency II by 2010. In the UK, the individual capital adequacy standards have had a big impact in boardrooms over the last couple of years. A more holistic view has been taken on the solvency capital required as opposed to the more formula-based approach used previously. I think that run-offs in Continental Europe are often dealt with as an accountancy function and cross subsidised within the organisation. Once you allocate capital to different lines of business, at least you get a feel and understanding of what impact that has. It does not mean you take an aggressive approach to reducing liabilities, but one can then make a conscious decision about what the right way forward ought to be. We see different markets with different developments. Germany, Switzerland, Scandinavia, and France to some degree, have developed significantly and are prepared to agree to compromise by way of commutation. A commutation is not a bad thing because it only happens if both parties are in agreement.
David Vaughan: I’m interested in what happens when we decide that run-off is a mature industry. I always thought a mature industry is when an ongoing player realises it might not necessarily have the skills. We now have the tools in the UK, such as Part VIIs, to get it out of an existing company into another. However, the big question at the moment is whether that hits the brand. Quite a few companies are worried that they have dealt with this business and are meant to stay right until the bitter end with those claims. Or are they wondering whether it is more efficient to move it? As soon as people realise it is acceptable and people will be treated fairly, then you will be talking about a mature market.
Tom Riddell: That is a separate issue for lawyers, is it not? What holds them back is their franchise name because they may regard a transfer out of Lloyd’s as something that will damage their image because then they are not honouring their commitment to stay there until the end.
Peter HARTLEY: We have managed to take a syndicate out of Lloyd’s. In fact, we are about the only managing agency to do that, but there is very much the reputational issue because we have syndicates to whom we try to broach that as a suitable subject, which have never written a direct policy of pure reinsurance. I think there is, shall we say, a new look to Lloyd’s. We are becoming far more electronic, and they will become more pragmatic, because everyone I represent is supported by the new Central Fund.
Ian McKenna: I would take issue with David in terms of whether we are in a mature market. I believe fundamentally we are a very mature market. We have mechanisms under English law that are not only established but developing: the courts, the regulators, everyone is doing their utmost to ensure that London remains the centrepiece of the global run-off industry, rightly or wrongly. The mechanisms are there and being used.
Peter Hughes: When you started talking about whether it is a mature market, I was trying to write down what the characteristics of a mature market might be. I have written down three words: transparency, liquidity, and efficiency. I would question whether the run-off market is yet in a position where it is has the level of liquidity you would want. Certainly, the tools are growing and coming into the market, so perhaps liquidity is improving, yet I would question whether the insurance industry as a whole is that efficient.
Nick Stimpson: David touched on this earlier, but it does seem to me that the market can be deemed to be mature when it aligns with the large markets. The run-off area will almost be deemed acceptable then, which I think is beginning to happen. It also seems that Solvency II is another major step in terms of the capital requirements that are going to be demanded for certain lines of business, and that will introduce a thought process into the large market that they are not familiar with. I am not decrying their ability, but they simply do not have the tools around them to work with the modelling requirements that are likely to be expected in Solvency II. To that extent, I think they will look to the run-off market for those solutions and to work in partnership with them. I think there will be a big turning point for the run-off market when we reach that stage.
Lee Brandon: There is a school of thought that Solvency II will have a fundamental impact on the way insurance groups are structured. The suggestion is that historically insurance groups have had a myriad of subsidiaries which they have tended to starve of capital to one degree or another and then have upstreamed dividends to the holding company. Solvency II may make that much less attractive, and if that is the case, then there is less reason to have lots of subsidiaries.
Peter Hartley: I think that is what Royal & SunAlliance is currently doing. They have shunted virtually everything off into the British engine by way of passing a transfer, except for the Guildhall. There are two units there which are pure run-off. And now they are coming back and getting themselves into a position where they can go forward under Solvency II. They have recognised the problems they had, albeit it took them 20 years to get there.
Maik Wandres: I think reducing the complexity was one of the most important aspects of run-off anyway, even prior to Solvency II. In many groups you find a huge amount of complexity, as was the case for GLOBAL Re. Once ownerships or shareholdings are sorted out within the organisation, what happens next is that you sell entities, or you sort out the retrocession within the group. These are all things that have to be dealt with anyway.
Rhydian Williams: What are the characteristics of an efficient run-off organisation? Does it have to be a separate entity or can it be managed within an ongoing operation? What do we need to see in place for an efficient run-off?
Maik Wandres: Segregation of the run-off entity is crucial. If you let the ongoing underwriters manage the run-off, it does not make it very transparent and there is a risk of cross subsidy, particularly in the long tail lines of business. Once you have segregated it, you can follow it through and make more informed decisions.
Beth Rees: The FSA has identified a number of risk factors and considerations and we want the market to look at these when putting together its run-off strategy. If those are in place and considered then you are likely to have a successful outcome to the process. Amongst those considerations would be adequacy reserves, good governance structures, but most of it is about having good people who know what they are doing, specifically in the claims arena and also in the actuarial arena.
Rhydian Williams: Nevertheless, we are talking about an environment where there is foresight and planning, and to use the old adage “those who fail to plan, plan to fail”. That is interesting – get it all packaged up and look at it as a unique entity to try to manage it. What sort of skillsets are needed for an efficient run-off operation?
Lee Brandon: Firstly, it is the mindset. I agree it has to be segregated, but it does not necessarily have to be put into a legal entity, although obviously if you do that, it gives another potential exit solution. It does need to be segregated internally and the right skillsets applied. The right skillsets have to be both an understanding of the issues and high technical competence. You need the buy-in from the stakeholders in an organisation so that you can develop a clear strategy and have the technical competence to be able to execute that strategy. One of the areas where London has evolved is that if you are going into an exit you have to take into account and come to agreement with all the counterparties.
David Vaughan: I wonder whether we have skirted around a sensitive problem because we keep saying “cross subsidy”, and I have heard “claims”, but the question is about what run-off is meant to be doing. Run-off is basically claims; it is not new underwriting. It is settling on the merits. With an ongoing organisation, I suspect most of the systems and mindset is to protect the future and they will trade a claim cross-subsidy. That is slightly a brand issue, depending on whether these are current clients or not, and that issue affects many of the companies. Most of the deals or movements we are seeing on run-off tend to be companies that are suffering financial difficulties or going through a period of restructuring because they are underperforming, and so they have to do something for the shareholders.
Tom Riddell: Quite. It is because a well performing company is not hurting enough because of the cross subsidy issue. I would say that it is not just claims management run-off, it is exposure management as well, and data is very important for that. You need proper systems and proper data, which live companies do not necessarily have. They do not necessarily even know who their policyholders are.
Beth Rees: Can I just pick up on David’s point? We expect all firms to treat their customers fairly! [Laughter]
Peter Hughes: It is a difficult dynamic, is it not? In a traditional insurance company there is a dynamic between the needs of the policyholder and the desires of the shareholder. The policyholders have a reasonably strong hand, although not great, in that they are supplying ongoing business to that company. But when you have an organisation in run-off the policyholder’s hand is much weaker.
David Vaughan: What we tend to see with companies in run-off is that basically people have a problem about their career path and as Beth says, they are quite important people and they are your biggest asset. Unless they have a career, they are working themselves out of a job. The run-off market needs to create careers and not just be one-off segments and then that is it. I believe one of the future trends will be some consolidation in the market because the units are far too small. Many of the original units are characterised by owners who are approaching retirement, so there needs to be some thought about the situation for the future.
Tom Riddell: That is why the outsourcing model works. A person can work for PRO or CMGL with confidence that it is winning portfolios and client work, so they are not working themselves out of a job. They are proving to the client that they do a good job so they get another one. Whereas if they are just within what is otherwise a successful, life insurance company, and they only do run-off, and they are put there because there is perceived to be a problem, when they have resolved that problem perhaps they feel they are going to be out of a job.
Maik Wandres: I think you have to make it clear to your staff that crucially what the job is all about is reducing liabilities and preserving capital, thus maintaining solvency. Once you have put the message of the business plan out and you have detailed exactly what you intend to do, people can then see you are making progress and can show the success. When it comes to the end of the run-off you can do one of two things. You can take the passive approach and outsource your own book to somebody else. Or, as GLOBAL Re and others have done, you can set up your own service operation and focus on the unique value proposition within the organisation and provide your services to other parties in the market.
Ian McKenna: That is very interesting. Our chairman was asking earlier about what you need for a successful run-off, but I guess the difficulty is that there is no one standard answer. It really depends on the shape of the run-off that you are looking at.
Rhydian Williams: Which brings up another point. There have not been that many insurance failures in the recent past. Is that a sign of better regulation, or is it a sign that we are managing this in a slightly different way?
Sean McDermott: I think the regulation is working, but I also think the rating agencies are having a tremendous impact, particularly when you look at what happened after the hurricanes in 2005. You had companies going into run-off which had very substantial amounts of capital. The rating had such an impact, with people building that into contracts and everything, so that if companies get downgraded the business is automatically terminated. That in itself raises a risk from an insolvency perspective, but it also means that companies are going into run-off much further away from the insolvency line, and that means there are going to be fewer failures.
Tom Riddell: You mean failure in the sense of a formal insolvency. There have been many failures though. Every syndicate that calls on the new Central Fund is a failure.
David Vaughan: The market is quite sophisticated now. In the old days, commutations were rare at below what people perceived the value was. They would put people into liquidation. I think people realised there were different ways to skin a cat. Now they look at what the best rate of return is. With any company with a large number of direct policyholders, because of the pay-out rankings in an insolvency, you will get different results, but with reinsurance I think people are fairly pragmatic and knowledgeable and they can gauge what they want.
Peter Hughes: Surely the jury is still out to a degree? We are just coming off the back of a very hard market with very hard pricing. The question is to what extent the market will soften and how long for. Certainly, there are more drivers in place to stop insurance companies and reinsurance companies from maintaining a soft market for too long. But we wait and see, do we not? Historically, they have managed to sustain a soft market for rather a long time, and if they do that, there will be failures because some people manage it better than others.
Lee Brandon: The whole structure of the market has changed in London. In the past, you had a myriad of players, under-capitalised, with reinsurance as a substitute for capital, with big pooling arrangements, and often they were incidental to the core business. It was a sexy thing to be involved in London. The London brokers did a great job of keeping us employed in the future. These are the issues that we have been dealing with. In the future, there will be fewer, financially-stronger entities. Sean made a very valid point about what the rating agencies can do with strongly-capitalised companies – and perhaps also poorly-managed companies that get into these sorts of issues. I think the number of pure insolvencies is likely to be very few.
Peter Hughes: I get the sense that shareholders are much more aware of what they have got themselves into nowadays. Historically, there was a lot of almost naïve investing in reinsurance without really knowing what the market was about. I think investors really have to get a handle on what the risks are and what the market is like now.
Rhydian Williams: A question that occurs to me
is how many of the different companies that you guys are running off, or those that have been run-off, closed down prematurely and perhaps did not need to close down and cease writing? Perhaps the results were somewhat better than the shareholders thought they were at the time.
Mark Simpson: There is still this tag of failure if it is just efficient use of capital, and when you put sophisticated capital behind it they may say, “I can make a better return over there”. Regulation is another catalyst that is increasing awareness. Obviously, there is value to be made, so you can say, “Shut that client down. I can manage it efficiently and effectively and generate some money, but I can generate more over here.” It is more sophistication and more choice.
Rhydian Williams: Is there more intelligent capital or just more capital? It is probably a bit of both.
Mark Simpson: There is more capital in the economy generally, so that is an issue. And whilst there is still some unintelligent capital, the majority is more sophisticated in almost every area.
Tom Riddell: Do capital providers outside see that there is an opportunity to make money in the market and want to get on a bandwagon? Is that the case or is it far more sophisticated and well targeted? Are they doing that simply because they know they can dive in and then get out because the facility exists for schemes and so on?
Rhydian Williams: Sidecars are a great example of that, because here you have intelligent capital coming in when they see the market as being hard, to provide additional capacity and make some money. Then, having succeeded with the sidecar, they say, “The market is softening, so we do not need that any longer and we will get out.” That is not failure.
Peter Hughes: Other than sidecars, which I would agree with you is a very neat way of dealing with that issue, what is the option for someone to get their capital back? It’s to go into run-off and the liability trap. Could the insurance industry learn from banking that maybe there should be some tools to package portfolios up so that it can be passed on and then the capital released back to the shareholders more efficiently? Maybe that is something that will happen as part of the next phase with Part VIIs.
Rhydian Williams: Are tools such as the Part VIIs and the schemes being well used, or, as some American policyholders would say, are they being abused? What is the reputational impact of capital coming in, getting its profit and then packaging the problem up and getting rid of it? What is the impact on the policyholders? Ultimately, will the reputational issues be more damaging to the market than beneficial?
Lee Brandon: To have an efficient market you need to have liquidity. I still think you have a lot of capacity that enters today and still thinks it can exit far more quickly than it can in reality, despite all the tools. And the regulators, quite rightly, are concerned about this. Where you have had the schemes so far, it has been for long trapped capital. I think schemes have been largely successful, some being better than others. It is an evolutionary process. If it is booming in the sense that London is leading the way and being innovative and doing things that the rest of the world is not doing, then clearly you will learn from the process. Nevertheless, not every scheme is perfect. I still believe there is a future for properly prepared, professionally-managed schemes where there is proper consultation and agreement with the other parties. It will be one of the tools the London market can use, and other jurisdictions can potentially benefit from. Maik, your organisation will perhaps be looking to bring German liabilities to London to use the mechanisms here?
Maik Wandres: My German colleagues are working on the solvent scheme of a London market portfolio which has been managed by our Cologne operation. I believe it is still an excellent solution. As we previously said, commutation and solvent schemes contribute to fewer insolvencies. Creditors’ concerns have to be taken seriously and communication has to be widened. There is an evolution in regards to the learning curve. London is far more advanced along that learning curve. Once the Reinsurance Directive comes into effect later this year, I am convinced there will be a lot of interest throughout Europe for sending portfolios over to London for subsequent schemes. The question is how that will be effected. I believe that both BAIC [British Aviation Insurance Company] and WFUM [Willis Faber Underwriting Management] are two big schemes that recently gave significant guidance to scheme companies on how to do this properly.
Ian McKenna: There is no doubt we are in a totally different landscape since July 2005 in the light of the BAIC judgement. There is greater fairness and transparency. I know Tom and KPMG were at the forefront, prior to BAIC, of saying that effectively these schemes are in danger of becoming a commoditised product.