Andrew Ward examines the continued growth of run-off in Continental Europe and asks what effects Solvency II will have on the industry?
Over the past year there has been increased interest in, and scrutiny of, discontinued insurance business within Continental Europe. Why is run-off in Europe now under the spotlight? What are the reasons for this increasing awareness and what does the future hold for run-off in Europe?
The size and characteristics of the European run-off market has historically not been well publicised. Continental Europe has seen relatively few high-profile standalone run-offs, with legacy liabilities more traditionally managed alongside live business.
In the first survey of European discontinued business released in February 2007, PricewaterhouseCoopers (PwC), in conjunction with the Association of Run-off Companies (ARC) estimated that run-off liabilities in Europe exceeded ?204bn. With some ?57bn of these liabilities attributable to the London Market, it is clear that Continental Europe is a very significant market (see figure 1).
While it is convenient to talk about a Continental European run-off market, a single pan-European market does not exist. The run-off liabilities need to be viewed in the context of the individual territories, taking into account regulatory and cultural differences. It is generally accepted that Continental Europe as a whole has not been as proactive as London in dealing with run-off, but it must be appreciated that approaches and attitudes to run-off differ across all of the European states. They range from the relatively advanced countries to the rapidly emerging areas as well as the embryonic countries.
The lack of high-profile standalone run-offs across the Continent is more understandable when considering the types of business generally written in Europe. It is typical for European companies to write a spread of risks including domestic and international business. With the exception perhaps of companies like Alea and Global Re, it has been rare for European companies with international reinsurance exposures to enter run-off. While those types of run-off exposures exist – often emanating from the reinsurance of London Market risks in the 1970s and 1980s and where European entities experimented in underwriting pools – it is often masked by the ongoing domestic business. Broadly speaking, risks underwritten by Continental European insurers tend to be shorter tail than has been the case in the London Market.
European insurers are becoming more attuned to the idea that opportunities do exist to create value for their organisations by focusing greater attention on their discontinued reinsurance portfolios. This has developed in recent years through exposure to market gatherings such as the Cavell Commutation Rendez-Vous held in Norwich, UK, where a culture of proactive commutation discussion has fostered a greater interest in gaining finality for reinsurance relationships.
Continental Europe now boasts its own commutation event, the Rendez-Vous held in Cologne in December each year with participants from all over Europe. Similarly, in the past 12 months, events have been held in France by the French run-off association SEGS (Syndicat Européen de Gestion de Sinistres) and a Nordic run-off event hosted by Wasa. Both had the aim of promoting debate and discussion about key run-off issues.
The desire to achieve finality for reinsurance run-off has not been confined to single counterparty relationships and individual commutations. There have now been 31 “sufficient connection” UK solvent schemes of arrangement that already have or are in the process of providing finality for whole books of European business. The principle of “sufficient connection” is not set out in a prescribed set of rules and regulations, but may be evidenced by a number of means including:
• The existence of UK creditors;
• The existence of UK assets;
• Business having been written through a UK business presence such as a branch; and/or
“Risks underwritten by Continental European insurers tend to be shorter tail than has been the case in the London Market
• Business having been accepted from UK brokers.
As the “sufficient connection” concept becomes more familiar to European owners of reinsurance run-off portfolios, it is likely that more of these schemes will be proposed (see figure 2).
Part VII heaven
It is clear from the extent of commutation and UK “sufficient connection” scheme activity that Continental Europe is beginning to adopt some the tools and techniques utilised by the London Market in proactively approaching run-off and seeking finality for discontinued operations. One further area where there has been significant activity in the UK over the past five years is insurance business transfers facilitated by Part VII of the Financial Services and Markets Act 2000. The UK has seen numerous examples of Part VII transfers being utilised to restructure portfolios, consolidate run-off books of business and pave the way for finality mechanisms such as a sale of business or solvent schemes of arrangement.
To date, the extent of insurance business transfers in Continental Europe has been less widespread. The Third Non-Life Directive was implemented in 1994 and facilitated the transfer of insurance and reinsurance books of business around the European Economic Area. Activity has been limited to date but the forthcoming Reinsurance Directive, required to be implemented by December 2007, will allow pure reinsurers to benefit from transfers of business.
Traditionally, reinsurers have been more proactive in dealing with run-off liabilities. The implementation of the Reinsurance Directive is expected to herald much greater transfer activity as organisations seek to consolidate run-off, create run-off centres of excellence and transfer appropriate books of business to the UK. One reason for this is to utilise the solvent scheme of arrangement approach where “sufficient connection” to the UK does not exist.
Underpinning the current situation is the European Commission’s forthcoming implementation of Solvency II in 2012 which will represent a fundamental shift from the existing simple quantitative approach of monitoring solvency, to a much more sophisticated holistic approach.
Solvency II will seek to map the regulatory and capital requirements of each company against its individual risk profile and embed that profile into the risk management and internal control functions of the organisation. This will encourage, if not force, many companies to develop and implement new policies, strategies and processes within their businesses. Solvency II will provide a significant incentive to companies prepared to restructure operations to deal efficiently with capital-intensive or volatile lines of business, which are likely to include existing and future discontinued lines of business.
One of the key practical implications of Solvency II is likely to be evidenced by a desire for companies to develop and implement a clear strategic plan to manage their discontinued operations more efficiently. Streamlining operations to release and recycle capital will provide forward thinking organisations with a significant competitive advantage.
Not least with the implementation of Solvency II, the European discontinued insurance business landscape is going to change considerably over the next ten years as greater focus is given to addressing existing legacy liabilities and establishing a European blueprint for dealing with future run-off business. Initiatives to address the challenges of Central European run-off are already gaining momentum and will continue as additional stakeholders appreciate the value and opportunities provided by the proactive management of discontinued business.
Andrew Ward is a partner at PricewaterhouseCoopers.