The sale of a company in run-off is an attractive way to release the parent or shareholders from their liabilities. There are, however, a number of issues from the buyer's and seller's perspective. Stephanie Mocatta considers those issues and also looks at the differences in approach needed for US companies as opposed to UK domiciled companies.
Run-off is fundamentally dull. Very few companies wish to take an active interest in their run-off liabilities: the parent company or shareholders either have live, trading insurance operations which attract their best staff and greatest talent or they have withdrawn completely from the insurance market.The options for a company in run-off are limited and most do not release the parent or shareholders from their ultimate liabilities. Options include:• Continuing to manage the run-off in house - this gets rid of neither the management issues nor the liability;
• Outsource to a run-off manager - management issues are transferred, but liability remains;
• Purchase of some form of reinsurance cover, possibly including a transfer of assets - the run-off is transferred, however ultimate liability remains with the parent or shareholders in the event of exhaustion of the reinsurance;
• Programme of commutations - this can be either in house, or outsourced; it is a good route for reducing liabilities, but is unlikely to deal with all liabilities;• Solvent scheme of arrangement - effectively a court managed process to agree a compromise with creditors, binding on all creditors once accepted through the voting process. This will get rid of liabilities but will take anywhere from 12 - 36 months.
The sale of the entire company is thus an attractive way to release the parent or shareholders from their liabilities. There are, however, a number of issues from both the buyer's and seller's perspective. This article considers those issues and also looks at the differences in approach needed for US companies as opposed to UK domiciled companies.
Whittington Limited has bought one insurance company in run-off in the UK and is looking to buy two others, one based in the US and one based in the UK. This article reflects our experience to date, but does not profess to cover all the legal issues, rather it covers the practical problems faced in the purchase of insurance companies.
What is a realistic price and how do you agree it?
The cynics of Lime Street will always say that any company in run-off is worth £1, and that orderly run-off is rapidly followed by insolvency. With this in mind how can you reach an equitable price?
There is little point (with apologies to my actuarial friends) in using actuarial reports to value a company, the ranges of possible results will be wide and a different actuary's view is likely to produce a different price.
The answer is that this is a commercial transaction and not an insurance transaction. The price will be a combination of:
• The amount of cash the purchaser has available and the source of that cash. Where venture capital companies supply cash the rates of return they expect are generally higher.
• The expected return and over what period of time. There may be a final dividend expected at the close of the business in run-off, but if this is estimated to be more than seven years hence then the net present value will be close to zero.
• The real perception among the shareholders or parent company as to the value, including the cost of commitment of management resources and the potential issues with rating agencies of owning a book in run-off as opposed to the book net asset value.
• Whether the seller is prepared to accept a final dividend over time.
One method that may be useful in trying to agree the price of a company is to transfer the management of the run-off to the potential purchaser for an allotted period of time. By transferring the run-off to the potential purchaser you will achieve several things: the purchaser will gain a greater understanding of the book of business and is thus less likely to factor in a “risk” premium for unknown issues; the due diligence and thus cost of purchase should be significantly reduced; any staff issues can be properly addressed over time thus reducing the possibility of any claims for unfair dismissal; there should be a significantly reduced need for any warranties on sale.
In the UK the purchase of an insurance or reinsurance company in run-off will require the approval of the Financial Services Authority (the FSA).The FSA will look at all aspects of the proposed transfer including:
• Is the purchaser fit and proper?
• Who are the new directors and are they acceptable as individuals?
• What is the purchase price (and thus the expected returns of the purchaser)?
• What are the plans for the future run-off of the company?
Most importantly the FSA will look at the position of the policyholders and will only approve the transfer if the sale is not detrimental to policyholders in any way. Indeed the FSA would prefer transactions where there is a positive benefit to policyholders. There is particular concern where the policyholders are individuals, rather than a reinsurance book, the view being that insurance companies are big boys who understand the world of run-off, commutations and schemes, whereas the direct insured does not.
Part of the process for achieving regulatory approval is to file future business plans with the FSA. If these show a pro-active approach to the run-off that adds value then the FSA are more likely to grant approval. This is particularly the case of a company in run-off where the parent has refused categorically to provide any future cash injection. The only way to strengthen the balance sheet is either by reducing liabilities with commutation (but bearing in mind the need to protect direct policyholders) or by reducing the long term run-off costs (either by a programme of commutations or a scheme of arrangement).
The FSA may prefer a company with a disinterested parent to be transferred to a company operating in the run-off market that requires other transactions also to be approved by the FSA. The authority will then have more influence over the new owners and has the ultimate sanction of refusal to authorise future transactions.
The question of what is warranted in a sale and for how long is problematic. A seller wants as few warranties as possible, preferably none, as warranties defeat the object of the sale. The buyer wants as much protection as possible.
What is important is to remember there is an agreement when signing the warranties as to the maximum amount that can be recovered and this usually reflects the purchase price in this sort of transaction. If the transaction price is £1 then there is little point in trying to secure complex warranties. There may be the need for tax indemnities even taking into account a limited purchase price.
Differences in buying a US company
As I have said, Whittington has purchased an insurance company in run-off in the UK and is looking to purchase another domiciled in the US. The following is a brief examination of the major differences between purchase in the UK or the US. Again, this is a purely practical review based on our experiences to date.
Cost / timing / travel
Attempting to purchase a company in the US has a number of implications. The cost of the purchase is likely to increase: you will almost certainly need lawyers in both the UK and US; due diligence is likely to be in the US and thus there are associated costs of either transporting your due diligence team to the States or sub-contracting the work to a local firm.
While we are all used to dealing with the States on business it should not be overlooked that the length of time taken to purchase a company in the US will be longer than the UK. This is purely on a practical level - the difference in time zone and the issues of transporting hard copy data.
With the increase in cost and time commitment in purchasing US companies in run-off it is important to balance the cost of purchase against the potential for future profit. As with all purchases it is useful to try to get an exclusive right to purchase (if only for a limited period of time) or a contribution to the cost of purchase to be offset against final price.
The law in the UK to protect staff on transfer of a contract or a company is generally well understood (Transfer of Undertakings Protection of Employment Act - TUPE). There is an expectation that staff will move with the purchase and any necessary redundancies will be built into the price. Under TUPE there are set procedures and therefore the potential purchaser has the ability to limit his downside. The unfair dismissal cap was raised from £12,500 to £50,000 in late 1999, but it is still capped.
In the US, however, the laws vary state by state. It is essential to have expert legal advice to protect against the possibility of unfair dismissal proceedings. The value of any such claims in the US is potentially significantly larger than in the UK, even with the increased cap.
In the UK any insolvency of an insurance company in run-off falls under the jurisdiction of the FSA where, as with the application process, the rules are well documented.
In the US the jurisdiction varies state by state. The general rules are similar across the States but will be driven by the insurance commissioner. The insurance commissioner can be a political appointment and thus there is less consistency across the States.
If the acquisition target is domiciled in one state but was registered in other states, for instance to write surplus lines business, then regulatory returns may need to be filed in a number of states. It is necessary to factor this into the potential future cost of run-off.
UK versus US
It is important to recognise the differences in legislation and regulation, even when the underlying insurance business is the same. It may be trite, but the US is a foreign country.
The best company from a buyer's viewpoint is a reinsurance company with no direct policyholders, one which is marginally solvent, where the parent has categorically stated there will be no cash injection, and where the buyer can demonstrate to the regulatory authorities how they will add value to the run-off process. If you have a company for sale that fits the bill please give me a call!
Stephanie Mocatta is a director of Whittington Limited and also a director of Crombie Insurance Company (UK) Ltd. Whittington provides services and solutions to the insurance industry including the provision of solvent schemes of arrangement and the purchase of insurance companies in run-off.Ms Mocatta began her career with CT Bowring Reinsurance as a North American placing broker. She moved to English & American in 1989 as a reinsurance underwriter and joined Whittington in 1995.