Tore Kalmeborg: We have a very good cross-section of the market here today, and therefore perhaps a good starter question is to ask what the key factors are which have contributed to the dramatic growth of the international run-off market and whether this growth will be sustainable going forward?
Lee Brandon: I believe it will continue to grow based on a number of factors. One, we've still not seen the full extent of the pain coming out of the US casualty markets - the long tail claims. Lloyd's studies are still saying that the US P&C industry is under-reserved by billions of dollars on asbestos alone. Obviously, more recently we've seen one or two companies fail due to the hurricanes, particularly the newer start-ups. This raises another issue, which is that capital is going to be much more transitory, and will fly in and out of the market much more quickly. Also, we've yet to see the real impact of the hedge funds, and I think their focus will be much more short term. This will increase the power of the rating agencies, and I think will force companies either in whole or in part into run-off. And another area for growth is outside the established run-off markets of the UK and the US. There has been perhaps an emerging recognition of run-off issues in Europe, and beyond into other markets. So I believe that when you've got a dynamic industry like insurance you will continue to have change. And I think the run-off will certainly continue.
Tore Kalmeborg: What about the issue of capital? Take Bermuda for example, do you expect to see a lot of collapses and then re-start-ups and further collapses and so on?
Nick Bentley: You have to look at it in two ways. One is into the ongoing market, looking opportunistically to get a return based upon the loss history. I think this actually causes a problem for the ongoing market, because what the ongoing markets need is to look at the underwriting cycle. If you have a position where losses occur, and new capacity comes in for new capital, the ability of the existing market to get a return is diminished because the new capital attracts the premiums, thereby creating run-off.
The other area for new capital is into run-off itself. I've seen in recent months extensive contact being made with organisations where billions of dollars have been talked about as an investment into run-off as an industry. And I feel that they're looking for short-term returns, and I don't think you get short-term returns in run-off. I think it's over a longer period and you have to look at two sides of the balance sheet: the asset management and the return from that, and the liability management - and I'm not sure that they recognise that the two have to go in tandem.
What they're looking for is the ability to use the asset side and get a return from that, and the way I see that happening is you maximise the assets by slowing down the claims and keeping the expense low. That to me is not a good development for run-off. Run-off has to be the other side of the balance sheet, the liability management. The new capacity brings opportunities in the ongoing market for run-off, because it's going to create growth within the run-off inventory. But it also brings challenges to the market, because it's going to be putting a lot of companies who will be attractive and bringing that equity and new capital to themselves, trying to give returns which they're not able to sustain, and then the capital will just exit. So it's a double-edged sword.
Ian Marshall: I think history bears out what Nick has said. If we think back 15 or 20 years as new capital has come into the market, first of all into London in the 1980s, eventually creating this huge market which we see today. Take a smaller market, say, the Australian market in the later 1990s, the same thing happened, a lot of capital came in, there were some big expanded start-ups, and where are they today?
Mike Walker: Well we're dealing with one of them actually (laughter).
Ian Marshall: History always has a habit of repeating itself, and the Bermuda market may be following that sort of pattern - there's a lot of new capital going in and a lot of new companies, and is there enough for them all to go around? And on the second issue Nick raised, which is external capital looking at run-off as an investment per se, the thing I fear is external naiveté, looking at an easier return but not really understanding what it takes to achieve that return and, perhaps more particularly, the length of time that it takes to achieve that return. And I think whether that capital proves to be transitory is too early to say, but that's one observation I would make.
Lee Brandon: I'd agree with what Nick and Ian said. I think the other thing to add is that the new capital coming in doesn't actually address the run-off problem in its entirety, it just passes it from one balance sheet to another. That in itself isn't addressing the overall liabilities.
Mike Walker: But isn't it also the attractiveness of the scheme solution - for want of a better phrase - which is driving a lot of that capital into the run-off market, because they perceive an easy way of making money, maybe managing the cash better, maybe handling the liabilities aggressively for a couple of years, and then getting money out through a close-down through a scheme of arrangement. But I'm sure you're aware there is some push-back on that at the moment, and Martin and I are going to sit in a courtroom this afternoon where there's a hearing on a "leave to convene". So it remains to be seen whether the scheme solution continues to be as viable an option as it has been in the past.
Martin Rebisz: On that score, I'm slightly concerned about the development of fresh capital coming into the run-off market on the assumption they can make quick returns using the available accelerated mechanisms, and that development is likely to generate further push-backs. And it may end up being a self-destructive mechanism, and that's the last thing this market wants.
Another very basic observation I'd like to make is, and it's been said many times, but we continue not to learn from our mistakes.
Paul Howick: That's good news for people like me (laughter).
Martin Rebisz: It's good news for all those who are in the run-off business, but I'm puzzled. It's a very human trait, which we've seen throughout history, but you'd expect that with time, and especially now, we'd have become a little more sophisticated, but that does not appear to be the case.
Paul Taylor: I think the answer to the question is self-evident. Of course run-off is going to increase, unless the market does something about it. "Why do we have run-off at all?" is a much better question I think. It seems to me that it's about time the insurance industry addressed the concept of why they have uncertainty over the duration of their contracts - if they had certainty over the duration of their contracts and liabilities, there wouldn't be a run-off industry. But until that time, the answer to the question is self-evident - there's going to be increasing amounts of run-off, until there's nobody left! (Laughter).
Personally, I'd like to work myself out of a job, but the reality is that my portfolio of companies is increasing, and with insolvents it's in excess of 200 companies, which is far more than there are in the live market in London.
Paul Howick: Twenty years ago I suppose run-off was very much an internal thing. It was the mad aunt in the attic that no-one cared to acknowledge and it tended to be shoved into provincial offices, with people facing retirement assigned to it. But it has now emerged as an industry, and I think it's a highly sophisticated one, and money can obviously be made out of run-off. Will we now see a tendency for run-off to be kept within companies rather than books of run-off businesses being sold off to outside providers? We hear stories that many of the French companies, for example, have huge run-off liabilities which they're keeping very close to their chests, but will there come a time when they seek outside providers to take those books of business from them or will they tend to manage it internally? We've seen the development in the Scandinavian companies where for many years run-offs were handled within the live companies, and in a comparatively short space of time all books of very extensive run-off business have been sold off to outside providers. So it will be interesting to see whether the continued growth of outside providers taking books of business will continue. I suppose that has implications for capital investment as well.
Robin Erswell: But it's such a broad generic term. Run-off business per se can include discontinued lines of business or discontinued clients, aside from the run-off companies that we are only too familiar with in London.
Tore Kalmeborg: As such, every insurance contract, once it's expired, is in run-off.
Paul Taylor: We've come up with a new definition, which is that "run-off is every insurance contract between the end of the policy period and the expiration of liability". That's run-off.
Tore Kalmeborg: But I suppose when those policies sit in a live book, it's an active business for sure, but essentially it's the same question. What is the insurance company's management's view on what its core business is. Is the core business to deal with portfolios of insurance that we no longer underwrite actively?
Equitas was the first really large-scale dedicated run-off organisation and Robin, you were there almost from the beginning. Would you like to comment on the essential elements of a successful run-off strategy?
Robin Erswell: I think there are at least two key features and one is to continue to pay valid claims. The other is to secure the reinsurance asset. And I think many of the peripheral activities are linked to one or other of those two elements.
Nick Bentley: Looking at where run-off sits within the business, a successful run-off, in my view, only works if you actually ring-fence it either within an organisation or separately from the organisation and you have dedicated management and specialists running it. Having sat in ongoing organisations with the run-off department within it, the talent always goes to what the future issues are or the future pressures are. Successful run-off is a simple business, you pay claims, you collect reinsurance. Some claims you shouldn't pay and you have disputes on it, and you have some disputes with reinsurers. But you put a plan together which recognises that those are the two things you are fundamentally trying to achieve. And you have specialists who actually focus on doing those two things. Outside that I think you're distracting management from the main core function of trying to achieve those two.
I also think you ought to do an accelerated run-off. The problem most companies have is that they underestimate the cost of run-off. I haven't yet seen a company which is properly reserved for the expense of run-off.
Paul Howick: Which is where schemes of arrangement come in.
Nick Bentley: I think schemes are a different issue. Schemes are a solution, part of the toolkit to deal with and extinguish liability at the appropriate time. They're seen as a quick return for new capital to the market, and I think we're going to abuse the scheme so much that we won't have it as a tool in future, and that'll be a shame for us because we're one of the few jurisdictions which has it.
I think when you fully structure it together you want to dedicate people to that function, incentivise them and get an accelerated run-off, because it drives down the expense over the period and it also takes the volatility out of it. Find out where it's going wrong, inspect it, review it, use consultants who've got the skillsets to do it properly, and then deal with it. In the ongoing market, if you've got a problem you end up adjusting premium for the next year. Within our own organisation we have run-off entities and the ongoing market, and people talk about making sure that you don't jeopardise the ongoing relationship by the way in which you handle the run-off. Some of the more cynical ones within our organisation say, "you can't jeopardise that premium to create a 100% loss ratio or 110%". The reality of the commercial relationship with the ongoing needs a more realistic assessment as well.
Ian Marshall: One of the things which has changed is the rate of recognition of the separate management, but it's taking a long time and there are obviously cultural differences. I suspect one of the developments which gave a boost to that recognition was the establishment of Equitas, which is obviously watched around the world. And from where I observe things in different countries, some are much more advanced at separating run-off management from active management. Some markets, and we've mentioned the French, seem to prefer to keep things in-house, whereas in other markets, such as Scandinavia, there's been a change to try to move it on to other markets. But each in their own way is doing things differently now than they did 10 to 15 years ago, which of course is contributing to the increase in the run-off market, simply by recognising what's in run-off.
Steve McCann: Equitas though started off with one massive advantage that I don't think many London market companies will ever have, and that is they effectively control the slips, the policies of insurance that they were trying to handle the claims on. Equitas have always said to me they've got typically 70% of the risks there, the company market has the rest, and they're as fragmented as can be. And so Equitas have de facto control. Now, for the companies that are in run-off, they're one of two things generically. They're either so small that they can get away with murder or they're not as big as the Lloyd's market and not small enough to hide in the reeds. So where do they go?
Paul Taylor: Are you saying that Equitas's advantage was volume?
Steve McCann: Effectively.
Tore Kalmeborg: Well, to a certain degree I would agree. They have had negotiating muscle in having a huge chunk of the slips. I couldn't agree more that it's a negotiating advantage. If you're talking commutation, it's all about negotiating.
Nick Bentley: And that's been to the advantage of some of the following market, and there's been many a deal done by Equitas where company markets have been on the shirt-tail end taking advantage of it, which we won't give you any credit for, Robin... (laughter). To me there's a clear tension between a London market set-up and a run-off set-up, because they don't complement each other. The London subscription market, which has a great passion to delegate authority to a lead for claims authority is absolutely against everything which a run-off organisation wants as its strategy.
Mike Walker: And that emphasises your point about accelerating run-off; some of the barriers that we have found as insolvency practitioners dealing with large run-offs have been on the one hand data and the manner in which it's been held and on the other hand the change of dynamic between the insolvent company and the brokers. Addressing those problems are some of the biggest challenges we've faced to accelerating such a run-off.
Tore Kalmeborg: Martin, what do you think are some of the more common issues that companies fail to take into account when they make run-off strategies and plans? I'm not saying that you failed in anything in particular... (laughter).
Martin Rebisz: I'm not so sure whether in relation to run-off one should speak about common issues. Of course there are common issues, but in designing the optimal strategy for a run-off I suggest that you look at the individual run-off itself and that your point of departure is understanding what you have in hand before making final decisions as to where it should go.
Reinsurance, of course, is always an important part of decisions about where run-off should go and whether you'd want to implement a process of accelerated winding down. Without your reinsurers, you're nowhere.
Common issues such as expertise, dedication, motivation and resolution are all vital factors. Also I entirely agree with Ian on the subject of separate management. It's vital that you have expertise within the run-off operation itself, you need some of your best people in run-off, whether it's your core business or not. I think it's an unforgivable mistake to move some of your brightest people off business that you've just put into run-off and into your core business operations. Run-off isn't going anywhere and might fail on a large scale if you don't have some of your brightest people involved.
Tore Kalmeborg: That's of course very true, but
at the same time run-off is a dead-end career for most people.
Martin Rebisz: Within my company that is not a major problem, as there is so much continuity within that organisation. But one has to have a motivation policy. If you don't have this, your practice people would run out the moment you even consider run-off, or would be receiving offers from others in the market to move elsewhere.
Robin Erswell: One of the issues though is whether you make do with the staff doing that job presently, or bring in the necessary expertise to form a run-off unit within the ongoing business.
Paul Howick: This is something that's always puzzled me, the conflict - and sometimes there's some really tangible, quite emotional conflict between the live market and the run-off market - but also the extent to which the skills that are needed in the run-off market, which is I suppose essentially how best to deal with claims, are not seen as being an extension of the claims process in the live market. Insurance is about paying claims, and I've always found it difficult, as someone involved in dispute resolution, to see why there is that conflict in the industry.
Nick Bentley: People who have worked in run-off for too long can't actually cope with the ongoing market because what you're telling them is they shouldn't be writing the business, certainly at the rates they're charging (laughter). Steve and I were talking earlier about how the cynicism within run-off is sometimes just about balanced by the optimism within the ongoing market (laughter).
Tore Kalmeborg: I've also thought for a long time that a training requirement for an underwriter should actually be a year or two in run-off.
Lee Brandon: Going back to your point, Paul, it's perhaps not so much a question of technical skills. I think it's very much a mindset, and this is the big issue. Going into run-off requires a significant mental adjustment. The claims people and many others are essentially there almost as a service, an extension of marketing, and yes they need to evaluate claims and pay them properly, but it's very much part of keeping the ongoing business. So in run-off, where cash is key, you certainly want to pay claims absolutely fairly. If you didn't, the regulator would be on all our backs. But the mindset and the way you approach the run-off is the big difference.
Ian Marshall: I would see the big difference as being that in the live market you're looking at each individual claim, whereas in the run-off market you're looking at, "How does this claim fit into my strategy?" And that's one of the real skillsets, which is to try and tie the detail into the bigger picture.
Nick Bentley: I think you're right, it goes a bit further than the ongoing market. They see a claim as a change to the premium rate, as a factor within the loss ratio which they need to adjust for the next year. In run-off you see claims as a problem of where there's coverage, or where there isn't coverage, and you need to determine that.
Ian Marshall: I'm not sure the actual person adjusting the claims sees that claim as an adjustment in next year's premium rate, just looking at it as a claim, whereas in the run-off market there's a bigger picture involved and that's why it comes back to the earlier point of whether it is a problem from a career perspective that a company goes into run-off? One of the advantages in the London market is that there is such critical mass that if somebody's working in the run-off field in a company manager's own run-off and that run-off's coming to an end, someone who's very good is going to have no problem in finding a job elsewhere. One of the biggest problems we probably all face is finding enough good people.