Solvency II will have a greater impact on run-off in Europe than the credit crunch. Those are the predictions, discovers Liz Booth. The new regulations will force companies to think more strategically and to consider exit solutions for their dead wood.

Books of business fall into run-off in one of two ways. Either it is in distress, leaving the owners with no choice, or it is part of a company strategy and so is a totally controlled decision. In the past, distressed run-off appeared by far the most common. In the last decade things have changed and discontinued business has become the norm. The key question for the future is whether this is likely to change and how, in Europe in particular, this might happen.

The run-off market across Europe is worth around ?202bn as it stands, with figures from PricewaterhouseCoopers LLP (PWC) showing continental European numbers up year-on-year, while UK figures have fallen back slightly.

Subprime victims unlikely

A report from Standard & Poor’s came out in May with the prediction that US subprime asset mark-to-market losses and the broader disruption in capital markets will “have limited implications for Europe’s insurers”. Credit analyst Simon Marshall says, “To date, the insurance operations of groups headquartered in Europe have disclosed $7bn mark-to-market losses associated with subprime losses, but we continue to believe that the broader disruption in capital markets has had a relatively minor impact on individual industry participants.”

Although acknowledging a major catastrophic event could change this picture for the worse, the report also says that Solvency II promises to be much more significant for the European insurance industry than any other influence. “The results from QIS 3 indicate to us that Solvency II would force more than 25% of Europe’s insurers to face major strategic decisions,” Marshall explains. “They may need to reduce scale, reduce risk, raise capital, employ more risk mitigation, merge with other insurers, be acquired, or close to new business.”

So S&P, at least, tends to agree that discontinued rather than distressed business will be the order of the day for European run-off. Its views are echoed by Ken Randall, chairman and chief executive of Randall & Quilter, who rejects suggestions that the run-off market is in decline as he unveils a 68% increase in operating profit to £8.7m ($17m) and asserts the group now has a “more active pipeline of potential business” than in the past.

Instead he suggests “the twin challenges” of falling premium rates and rising claims frequency will create more opportunities. “Investors in the non-life insurance industry will, increasingly, need to shed their discontinued portfolios in order to focus capital into their core business.”

A report from PWC, published in February, is also suggesting busy times ahead for the run-off sector. “The year 2008 is already shaping up to be a year of change in the European discontinued insurance markets,” it predicts. The introduction of new regulation across Europe, Solvency II in particular, will drive an increased focus on run-off and the exploration of various exit options across Europe.

Solvency II solutions

Dan Schwarzmann, partner in the solutions for discontinued insurance business team at PWC, also believes that Solvency II is likely to have a huge impact. He is talking to clients who are considering the most efficient ways in which to work their capital and are looking for exit solutions to help with that. “Solvency II is on many companies’ radar already and there is a push to do things with their business. And there are solutions around now which didn’t exist before.”

Transparency and openness is mentioned by most sector players. They agree that, in the past, many European companies have organised run-off internally, often alongside live business. All agree Solvency II will bring change but the difference comes in terms of how far along the road companies have travelled. Thomas Willkowei, at Global Re, believes the first steps are being taken in some countries as the Reinsurance Directive is implemented – last year in Germany, for example, and in April in Italy.

“Our belief,” says Willkowei, “is that the capital requirements will become the crucial aspect of a company strategy. It is a change in attitude, as companies will start to question how much capital each element of the business requires. Part of the portfolio may go to a third party to clean the balance sheet.” For niche players, the future under Solvency II is likely to be even more challenging, according to his colleague Jörg Stapf, who adds that the capital requirements will be that much more stringent.

Charlotte Boij, CEO of Wasa Run-off, sees plenty of activity in this area already with some companies looking to sell some of their niche business – or even the entire company – to a more diversified group. But both she and Stapf also agree that it is not just reinsurers and insurers who have to worry about their size – several of the run-off companies too will be subject to the Solvency II requirements. Boij sees this as an opportunity for the more successful service providers to buy up some of the smaller operators.

The difficulty with Solvency II, however, is that no one yet knows exactly what requirements will be included in the final legislation. Boij quotes a recent chat from a leading figure in Brussels who discussed the stiffer requirements for niche players. The over-riding impression was that the Commission wants to work closely with industry and not disadvantage any particular group – although so far no changes are in the pipeline.

Cultural challenges

Juliette Stevens, a partner at Clyde & Co LLP, agrees there is plenty of time for further changes in the regulations. She has questions about the impact of Solvency II on business that is already in run-off – whether internally organised or by a third-party service provider. She sees plenty of opportunities for reshuffling of that business.

Having to clearly identify run-off business on the balance sheet may prove culturally difficult in some cases, believes Stevens, who feels some companies may choose to dispose of those parts of their business for that reason. There is also a question of how each regulator interprets the new rules and she believes there will be cases of forum shopping as companies look to transfer business to another state where the regulatory regime “is more sympathetic”.

It may also be that companies from outside of Europe look to bring run-off business to Europe to take advantage of the solutions available here, she adds. Francoise Gelot, managing director of Optimum Risk Research (International) Ltd, believes Solvency II could be good for the UK because sector “experts expect some more business to come their way”. But so far, she claims, few European companies see it as a priority and there is plenty more education to be done.

Gelot is watching the subprime crisis carefully and believes it will impact the market. She also wonders what new risks may develop – a pharmaceutical claim, more asbestos, claims from banking or even a natural catastrophe on the scale of China’s earthquake, but inside Europe. There may be different solutions in place by then too.

Liz Booth is a freelance journalist.

Survey findings

* Nearly two thirds of the businesses (63%) agreed dealing with run-off business is now a priority for senior management.
* One of the key factors driving this increased attention to run-off is the introduction of new regulation across Europe, with 60% of respondents believing Solvency II will drive an increased focus on run-off business and the exploration of various exit options across Europe.
* Unsurprisingly, therefore, 80% of respondents are expecting the implementation of the new Reinsurance Directive to result in European cross-border transfers over the next five years.
* The overall size of the discontinued insurance market has fallen slightly from ?204bn to ?202bn in the last 12 months. The increase across Continental European run-off has been countered by a decrease in the UK market.
* According to respondents, the key challenges facing Continental European insurers and reinsurers in relation to their run-off business include tied-up capital (63%), volatility (59%) and operational costs (56%).
* More than 70% of respondents estimated that it will take more than ten years to run-off their business in the natural course.
* The availability of certain tools for dealing with run-off, such as solvent schemes of arrangement, is not widely appreciated with only 20% of those surveyed were aware that 31 solvent schemes of arrangement have been implemented to date for Continental European insurers.