Financial turmoil, catastrophe losses, and legislative change could herald the start of a time of increased activity for run-off specialists, write David Banks and David Sandham.
All the required conditions appear to be in place for an increase in activity in the run-off sector: investment losses, a dearth of capital, heavy catastrophe losses, the end phase of a long soft market, and legislative change. “My expectation is that there will be an increase in portfolios going into run-off as a result of the credit crunch and the general financial turmoil,” says Steve Goodlud, director of KPMG’s restructuring insurance solutions practice. “Companies are already looking hard at their businesses in preparation for Solvency II and now the financial turmoil has increased this.”
Cedric de Linares, CEO of AXA Liabilities Managers, believes that the crisis is affecting the entire industry. “Having started with banks, it will progressively impact insurance and reinsurance in different ways. This will affect the run-off industry, especially as the write-off of assets will obviously have, at some stage, an impact on company solvency.” He also raises the question, however, whether the financial crisis could make it difficult for buyers of run-off portfolios to raise funds.
John Dewen, CEO of JMD Specialist Insurance Services Group, agrees that the credit crunch could lead to more run-off activity. “It will create problems in respect of collections of premiums let alone reinsurance recoveries, and its detrimental effect on insurance and reinsurance cash flow is yet to be fully experienced,” he says. But despite the expectation of more activity, the run-off market is currently surprisingly quiet. The only recent large deal of note has been a $343m purchase from St Paul Fire and Marine Insurance Company, an affiliate of Travelers, by Enstar, a specialist in buying insurance and reinsurance companies in run-off.
Enstar’s subsidiary, Royston Run-Off Limited, won the bidding for Unionamerica Holdings Limited, which contains the discontinued operations of Travelers’ UK-based London Market business, which had been placed into run-off between 1992 and 2003. Royston Run-Off Limited is to finance the deal partly by borrowing $184.6m from National Australia Bank. This will provide 54%; a further 14% will come from the Flowers Fund; and 32% from cash. “This transaction is the latest deal of any size in London market run off arena,” says Goodlud. “It demonstrated there is still an appetite by both buyers and sellers. There was preliminary activity last year in parcelling this up through the Part 7 transfer mechanism by which St Paul’s prepared the portfolio for auction.” He is not aware of any other similar current auctions, but says that there are portfolios in the London market “that could be packaged up in a similar way”.
Companies wrestle with doubt over the reputational repercussions of run-off. According to Ralph Bünger of Global Re, the very term “run-off ” is problematic.
“The word run-off is something that came from the London market and still has a very bad reputation,” he says. People do not always agree about what it means. Broadly, run-off means lines of business no longer being actively underwritten.
But there is disagreement about definition; to some it may mean business that no longer generates an income, or business with parties with whom there is no future business relationship. Apparently “runoff” is a difficult word to translate into other languages.
But everyone agrees that there is a stigma attached to the term. As Dewen says: “There is a danger to reputation, if run-off is not professionally managed.”
Despite the stigma, insurers and reinsurers now would be well advised to bite the bullet and take a proactive approach to all parts of their portfolios. If something unforeseen happens, you then could be panicked into hasty decisions about run-off.
“Many of these old accounts are asleep in a dark corner of a big company and are now going to have to be woken up.
Taking a proactive approach does not necessarily mean sale. According to Dewen, a potential run-off portfolio should be analysed so that all of the available options can be evaluated against the financial and business objectives and the best solution achieved. Although accelerating finality is generally considered to be the preferred approach, Dewen believes that it is not always the best solution. He argues that there is a delicate balance between the speed of achieving finality and the subsequent impact on the balance sheet, therefore it is essential to evaluate which approach is best suited to each circumstance. “The objective is to improve solvency through a blend of collection maximisation, commutations and balance sheet restructuring,” he says.
Goodlud lists six main run-off methods (see box opposite). “Decisions about which option to take depends on considerations such as price and whether to achieve finality in the short or longer term,” he says. “Still at the top of the list is commutation - though it is often a precursor to the other ones. Commutation is the way you prepare the business for other options.”
In terms of achieving a quicker finality, options three to six are the best, he says. “Run-off to expiry is not common, although this is the method often preferred by Berkshire Hathaway, which will use the asset portfolio, make returns on investments, and deal with the liability side under a longer-term approach. The disadvantage of this method is that it does not achieve finality, but its advantage is that it makes money on the asset side.”
SOLVENCY II DEADLINE
With Solvency II looming, companies that are otherwise healthy will streamline their portfolios and ditch unprofitable lines. According to Stephen Cane, CEO of Whittington: “We are no longer just talking about companies falling down that will go into complete run-off, but individual lines of business and discontinued lines.”
Jim Moran of Randall & Quilter says: “When Solvency II comes in, companies are going to have to do something about these exposures and increase their capital, so they are going to take a hit. Many of these old accounts have been forgotten and hidden somewhere. They are all asleep in a dark corner of a big company and are now going to have to be woken up.”
The EU Solvency II Directive is due to be implemented in 2012. According to Goodlud: “If they have not already done so, time is running out for companies to meet the challenges and the opportunities that the Solvency II regime will bring.”
Some companies may leave decisions to sell too late. The closer to 2012 a decision to sell is made, the harder it will be for buyers to make a profit, and this will be reflected in the price they will be prepared to offer to the current owner. The message is clear: the time to act is now.
David Banks is Deputy Editor of Global Reinsurance.
David Sandham is Editor of Global Reinsurance.
Major M&A Run-Off transactions â€“ 2008
PURCHASER TARGET DATE PURCHASE PRICE
Enstar Unionamerica Oct 2008 $343m
Enstar Goshawk Aug 2008 Â£45.7m
Audley Gilroy Scottish Lion May 2008 Undisclosed
Enstar Guildhall Feb 2008 Â£33.4m