The P&C insurance industry is confronted with many challenges involving run-off legacy liability portfolios.  The primary concerns include capital constraints, run-off administration costs, dedicated management time, long term exposures to loss development and reinsurance credit risks, as well as negative impact on a company’s rating.  The larger insurance groups are rethinking organizational structures with a view to maximizing the efficiency of capital deployed and more effective deployment of resources. Smaller and mid-size companies generally have limited options, if any, to address their run-off situation.

Whether an entity is a small P&C company or an international insurance group, there is a continual need for effective restructuring tools for run-off portfolios to optimize capital deployment as well as to manage the run-off of liabilities.  Clearly the market is ready to consider new tools and approaches to address the challenges of run-off business with the ultimate goal being to allow transferring companies to achieve finality.

Important Considerations:

  • The US commercial run-off market is estimated to be approximately $200 billion and growing.
  • An effective run-off strategy must focus on capping or eliminating open-ended legacy liabilities.
  • Exit strategies or options must be considered in run-off programs.
  • Currently there are limited exit options available in the US.
  • Commutations, sale, reinsurance and loss portfolio transfers have been the favored run-off exit mechanisms, but these options are limited in their scope and affect.
  • Most companies have exhausted these alternatives and are now looking for more effective ways to deal with the “rump” of the run-off legacy liabilities that remain on their balance sheet.
  • The new RI run-off regulations will create an expanded review of run-off in the US and potentially bring finality to run-off liabilities

RUN-OFF TRENDS

The US P&C insurance industry continues to experience significant consolidation (i.e. acquisition of Chubb by ACE).  As a result of this consolidation and other factors, the remaining participants in the industry often have portfolios of business that are either inconsistent with their core competency or provide excessive exposure to a particular risk or segment of the market including property and casualty, asbestos, environmental, and director and officer liability exposures.

  • Senior management is frustrated by the lack of progress and limited options to address legacy liabilities.
  • Low interest rate environment has resulted in fewer LPTs and other mitigating actions.
  • US run-off market has become staid and complacent in addressing the wind down of these liabilities because of the lack of available options.
  • In recent years, the larger companies (CNA/AIG/Liberty) have entered into complex reinsurance arrangements with Berkshire Hathaway that are most note-worthy run-off transactions but these are isolated transactions and not available to the general market.
  • These non-core and discontinued policies and portfolios are often associated with potentially large exposures and lengthy time periods before resolution of the last remaining insured claims, resulting in significant uncertainty to the insurer or reinsurer covering those risks. These factors can distract management, drive up the cost of capital and surplus for the insurer or reinsurer, and negatively impact the company’s credit rating, making the disposal of the discontinued business an attractive option.
  • Large amounts of capital are deployed to support these run-off portfolios, which is viewed negatively by rating agencies and investors.

UK EXPERIENCE

The RI IBT is modeled on the UK Part VII Transfer that has been in place since 2001. In the UK, the Part VII transfer is an increasingly popular finality tool in the discontinued insurance sector with several hundred internal and external transfers accomplished to date. The transfer process is being institutionalized within the UK framework of the insurance industry as it is an extremely valuable tool for companies seeking to consolidate their portfolios or diversify.

Like the Part VII Transfer, the IBT provides a mechanism to transfer the contractual obligations of an insurer of a set of policyholders to another insurer (which may be a separate legal entity) by way of a court-approved novation. The RI IBT provides a means to bring finality to run-offs while protecting policyholders and ensuring the integrity of the regulatory process.  In practice, these transactions will take a variety of forms as the IBT evolves in the US insurance market as an important restructuring tool. We expect that, over time, the IBT will also become a widely accepted business practice in the US marketplace as it has significant strategic importance as a restructuring tool for insurance companies while also ensuring that the interests of policyholders are protected.