Darryl Ashbourne and Paul Grimshare explain the findings of a recent survey of the UK life run-off market
The volume of column inches dedicated to the UK life industry in recent years has led to a very public airing of issues faced by the industry, and suggests that never before has the market been in such a state of turmoil.
Several well-respected names in the market have been forced to close to new business and large mutual life insurer has recently announced plans to demutualise in order to meet its future capital needs. With-profits business, the foundations on which UK life business developed, is under threat, such that its very survival is in question.
This unprecedented level of change has contributed to the substantial growth in the number of life insurers now in run-off, as disclosed by a recent life insurance survey produced by KPMG LLP (UK) with the Association of Run-Off Companies (ARC)1.
UK life run-off
There are approximately 415 entities authorised to carry on life assurance business in the UK, including composite insurers which write both life and non-life business, and friendly societies. Of these, approximately 10% by number account for almost 80% by value (measured by total value of long term liabilities).
The survey was based on insurers that have ceased to actively underwrite new life insurance contracts (defined as 'in run-off'). It did not include figures for life insurers that have closed identifiable parts of their business, as an analysis between the active and run-off components is not readily quantifiable. As a result, the true size of the UK life run-off market is potentially even larger than the figures presented in the survey.
The UK life run-off market has grown significantly since 2000, although the overall size of the UK life market has reduced in terms of total technical liabilities. The growth in the run-off market results largely from the increase in the number of life insurers moving into run-off in the last three years.
In value terms, the long-term liabilities of UK life insurers in run-off at the end of 2002 reached a staggering £118bn, a £46bn increase since the end of 2000. These figures are huge by any measure, and amount to more than four times the total value of the technical provisions of non-life insurers in run-off (see 'UK run-off survey', ARC/KPMG LLP (UK) 2003).
At the end of 2002, the long-term liabilities of the UK life run-off market represented over 14% of the total long-term liabilities of all UK life insurers. At the end of 2001 the equivalent figure was 8%, demonstrating that the UK life run-off market had almost doubled in its relative size.
The bulk of the increase in this period was due to the substantial withdrawal from the UK life market of two large insurance groups.
The analysis reveals that by the end of 2002, over £5.9bn of shareholders' funds2 were locked into life run-off businesses in the UK. If these funds were allowed to run-off over their natural course, the run-offs would likely exceed 25 years. Add to this the fact that the UK life run-off market incurred over £1.1bn of administrative expenditure in 2002 and it is evident that the considerable purchasing power of this market, coupled with the significant amount of corporate capital tied up, means that there needs to be a cost-effective method of administering and ultimately closing these run-offs.
Why the increase?
It is not possible to identify definitive reasons for the recent growth in the UK life run-off market, although it probably does reflect difficulties facing the life market and an unprecedented level of challenge in recent years.
Some of the principal reasons quoted by life insurers for their decision to move into run-off are:
- M&A activity - group consolidation following merger and acquisition activity;
- solvency issues - primarily due to falls in the equity markets during 2000, 2001 and 2002, low interest rates impacting policy guarantees and mis-selling costs;
- strategic decisions - for example, moving out of capital-intensive with-profits business to non-profit linked business, or the ability to gain a higher return on capital in non-UK markets; and
- margin pressures, including the impact of stakeholder pensions and the potential introduction of 'Sandler-type' products with low maximum charges.
Indeed, there are normally several factors contributing to an individual insurer's decision to move into run-off, as seen in the report of Lord Penrose into the situation of the Equitable Life Assurance Society.
Furthermore, the life market still needs to deal with considerable planned regulatory and potential legislative changes relating to a variety of perceived poor practices and market concerns including mis-selling complaints, the lack of an industry standard for realistic reserving for guarantees and the lack of transparency, in particular, regarding with-profits business.
Unlike the UK non-life run-off market, the UK life run-off market does not include a significant proportion of insolvent insurers. In fact, there is only one current example of a life insurer that has become insolvent, Oaklife Assurance Co. Although the financial problems of Equitable Life have been well publicised, it has never been declared insolvent and has now entered into a scheme of arrangement.
Unsurprisingly perhaps, a comparison of the solvency position of the UK life run-off market to the remainder of the UK life market reveals that the active market has significantly higher free asset ratio and solvency coverage. On average, the solvency coverage of companies not in run-off is approximately twice the level of those in run-off.3
A closer comparison of the differences between the UK run-off and active life markets reveals that insurers in run-off still collect substantial volumes of premium income, amounting to over £4.6bn of net earned premiums in 2002. In addition, the UK life run-off industry is not comprised of small weaker players who found they could not compete with the larger insurers, but is a mixture of insurers, including companies with substantial life funds which, until recently, were major players in the market.
Management of run-off
In the initial stages of run-off, many of the issues faced by management in the life industry are similar to those faced by the non-life run-off industry (protecting existing value by actively managing relationships with key stakeholders, restructuring functions related to new business and actively managing other hot issues). However, to maximise and realise the value embedded in a closed life book, management needs to maintain most of the customer servicing, administrative and investment management functions seen in an active life insurer as well as the claims management functions of the business.
Although not visible from the survey data, KPMG LLP (UK) has seen managers of life companies in run-off employ a number of techniques to stabilise and reduce the risk of deterioration of the insurer's financial position and protect its embedded value. These include: selling or reinsuring 'select' portfolios to realise value and capital, or to facilitate an orderly run down of the business; reducing the proportion of assets invested in equities and property; implementing active strategies to retain those policies which are profitable; and stringent cost control, often including outsourcing of major functions.
While these activities are critical in the stabilisation and active management of life businesses in run-off, they have little impact on the overall term of the run-off and (except where business is divested) do little or nothing to facilitate the early release of shareholder capital.
Acceleration of run-off
In the non-life market, insurers in run-off have often pursued an accelerated run-off strategy involving such devices as commutations, novations and schemes of arrangement. These devices have not to date been widely adopted by the life run-off market and there are probably several reasons for this.
In the UK life run-off market business is almost exclusively comprised of direct insurance of individuals and the cost of individual policy acceleration can be prohibitive compared to individual claim values, although collective strategies affecting many policyholders might still generate real value for both shareholders and individual policyholders. Furthermore, direct life policies are more actively regulated to protect policyholder interests, life policies are often subject to complex tax/pension rules that can impact early settlement actions, and future profits from life portfolios have often been used as security for borrowings.
Although it may be difficult to implement any acceleration of the run-off of a life insurer to reduce costs and uncertainty, it is not impossible.
Techniques successfully used to finalise non-life business can, if properly implemented at an appropriate time, be a suitable strategy for run-off in the life market.
The size of the UK life run-off market has grown substantially in recent years, both in absolute terms and in relation to the size of the entire UK life market. This reflects the difficulties currently facing the life market, which has experienced an unprecedented level of challenge in recent years and still needs to deal with considerable planned regulatory and potential legislative changes.
Such pressures have already led many insurers to conclude that they cannot continue to remain open to new business and become closed funds. With the life market still facing significant change there is a real chance that further major insurers may be forced to move totally or partially into run-off.
Irrespective of this, there is a clear need to find cost-effective means of administering and, at the appropriate time, accelerating and ultimately closing the run-off of existing closed life portfolios, while protecting both policyholder and shareholder interests. This will present a major challenge for the management of, and advisors to, the life run-off market for many years to come.
1 The survey is based on publicly available financial data and Financial Services Authority returns, including AM Best Statement File Life - UK and audited statutory accounts filed at Companies House. This information has not been verified or validated in anyway by KPMG LLP (UK).
2 Measured on an FSA Return basis, this includes policyholders' funds in the case of mutuals.
3 Based on current regulatory requirements - the FSA's new realistic reporting is not yet publicly available.
- Darryl Ashbourne is a Director and Paul Grimshare is a Manager in Insurance Solutions, KPMG Corporate Recovery. Email: firstname.lastname@example.org.