Regulation changes in Australia has meant the re-examination of capital strategies by those managing run-offs, explains Peter Aroney.

Recent changes to insurance prudential standards in Australia have codified new requirements relating to the capital reduction of companies in runoff. Before a release is approved by the Australian Prudential Regulation Authority (APRA), the company is required to demonstrate a level of capital that exceeds a 99.5% probability of sufficiency (POS) in their reserving. This requirement raises some interesting issues for those managing runoffs, both in terms of capital strategies, and the measurement of actuarial reserves.

Cobalt recently achieved the 99.5% POS milestone on behalf of one of its major clients – Gordian RunOff. APRA gave approval for the release of $164m capital, representing 20% of the capital base.

Gordian was established as a series of individual businesses. The reinsurance book was very different to the corporate insurance and special financial risks portfolios. In its heyday, the company was also the largest underwriter of space business globally, and had a huge film slate insurance exposure.

The approach involved strategies such as commutation, and the judicious settlement of claims; often settling claims ahead of their natural course.

In the early days business was cancelled, which meant giving premium back to cedants, as well as purchasing reinsurance protection. Commutations were, and still are, a key “de-risking” tool – the largest individual commutation was in excess of A$90m, and others regularly exceeded A$10m.

Any future profit Gordian earns (and therefore any future reductions in risk) should lead to a further capital release. There is the chance that although risk is reduced in the accounts, the 99.5% is negatively impacted by reserve movements that could not have been anticipated.

Risk modelling is the hot issue in general insurance around the world at the moment. Generally speaking, regulators are looking to regulated entities to develop sophisticated methods of modelling their risk. It's all about the diversification of risk and being able to quantify that. It has long been a point of discussion in underwriting, but ironically, it looks as though the runoff market is in fact leading the way.