Legacy attracts new investors
The legacy sector offers expanding investment opportunities as more companies prepare to sell off non-core or non-performing portfolios while investors look for new outlets. Barbara Hadley reports
This could well herald a boom time for the legacy market; an increase in sellers, favourable regulatory climate and capital looking for somewhere to go. According to a Swiss Re Sigma report in 2015, acquisitions of property and casualty business placed in run-off have increased steadily since the financial crisis, particularly between 2011 and 2013. In particular, the Sigma report points to the UK being a core market for legacy acquisitions ‘given its favourable legal and regulatory climate’, for example schemes of arrangement and Part VII transfer mechanisms, but with the UK non-life run-off sector reaching maturity, ‘legacy acquirers are reportedly looking to expand in the US and Continental Europe, where the size of run-off portfolios are significant.’
The report suggests that the majority of the traditional run-off market acquirers ‘have a foothold in one or both of these markets.’ It adds that ‘surveys persistently suggest that more efficient capital management remains the most influential driver of run-off restructuring activities.’ A recent PricewaterhouseCoopers’ survey meanwhile stresses that regulation is also a key driver.
For Steve Gowland, CEO of specialist legacy acquirer Ashbrooke, the attraction and growth of the legacy market for acquirers going forward comes down to three sources: ‘(1) the increased flow of transactions that the dislocation provided by Solvency II is delivering; (2) the continuing low interest rate/ inflation environment, specifically in Europe; and (3) our expectation that future transactions will be increasingly driven by corporate finance/restructuring solutions rather than insurance/ claims management driven solutions.’
Whilst traditionally share purchases are more straightforward, ‘Solvency II is going to throw up some significant new capital requirement hurdles for acquirers in order to gain regulatory approval. This will have a significant impact on existing market participants’ operating and financial return models,’ says Gowland. ‘As a consequence we expect a large number of transactions to be portfolio transfers from live underwriting businesses or existing run-off companies to facilitate capital efficiency or a solvent liquidation exercise.’
In addition, he adds, ‘we expect a number of smaller scale, secondary buy-out opportunities from historic and existing run-off acquirers. This will represent investments that have been managed down in scale since the original purchase and now are below the size and return profile of the parent group. These transactions may come as portfolio transfers as a cleaning-up or solvent liquidation event for the run-off entity.’
He notes that, although Solvency II presents many operational challenges, ‘the transaction opportunities it is creating, in conjunction with its application across the EU, will actually level the playing field and make the regulatory and compliance issues that face acquirers more consistent and less complex.’
So with the legacy acquisition market on an upward trend it is now clearly on a wide range of investors’ radar. As PricewaterhouseCoopers points out (see p5, Yearbook & Directory): ‘We are currently experiencing a real boom in the type and number of investors who are interested in run-off books,’ citing private equity firms and pension funds in particular. Good examples are private equity firms CBPE Capital LLP, who acquired a majority stake in run-off specialist Compre last year, and Keyhaven Capital who bought into DARAG in 2014.
The Sigma report also draws attention to the how the range of potential acquirers and investors is expanding in the insurance M&A sector as a whole, which could be reflected in future legacy market investment.
Gowland firmly believes that any future competition in the legacy market will be driven by new capital: ‘We expect this additional competition, both sustained and for specific, one-off situations, to come from: (1) existing re/insurance market participants undertaking a “live to legacy” play as a consequence of the need for capital efficiency and risk diversification in a Solvency II world; and (2) cash rich investors (eg. sovereign wealth funds, hedge funds etc.) driven out of bond holdings due to interest rate increases, specifically holders of US dollar denominated debt, chasing attractive investment opportunities.
‘The challenge for this new capital, however, will be finding the right management team with the appropriate experience and a business plan that offers something different. Otherwise increased competition, driven by capital only, will push up prices.’
In the medium to longer term, insurance linked securities (ILS) are a potential source of financing instrument in the legacy sector. The ILS market itself is growing rapidly; a study by the Institute of Insurance Economics at the University of St Gallen in June 2015 indicated that the ILS market could double within the next five years, from its current estimate of $44.7 billion to $87.3 billion by 2019.
‘The reason lies within the expansion of the investor base: pension funds and hedge funds alike appreciate the uncorrelated returns and relatively high yields … the average ILS portfolio amounts to $1.7 billion … respondents plan to increase their portfolios by over 9.5 per cent in the near future to an average of almost $1.9 billion,’ says the study. It notes that, although so far run-off business has not been considered for securitisation, this could be about to change.
Arndt Gossmann, CEO of DARAG, agrees: ‘We see an emerging potential in the securitisation even of special risks like run-off. Especially long tail run-off offers reduced volatility in a long term, non-correlated investment. So far, there are only a few experts among the sponsors who are familiar with the possibilities of all securitisation structures like microsecuritisation. Nonetheless, the demand on the investors’ side is increasing.’
Since the UK Government is anxious to make the UK a centre for ILS business, to the extent of tabling an amendment to the Bank of England and Financial Services Bill giving the Treasury the power to facilitate and regulate ILS business, this could well turn out to be a key source of capital for the legacy market.
Meanwhile Gowland warns against any move towards attracting inappropriate capital: ‘The relative ease or difficulty in raising capital is in understanding that an individual (or a class of) institutions’ pricing and risk appetite changes over time. Therefore, a significant competitive advantage for Ashbrooke is in understanding capital markets and factoring this into our transaction structures and pricing up-front, and not trying to raise money at historic prices from inappropriate sources.’
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Inside the Yearbook & Directory 2016:
Flexibility rules in the new normal
A new regulatory climate in the wake of the financial crisis means the legacy insurance market faces new challenges – but also new opportunities. Alan Augustin and Andrew Ward of PricewaterhouseCoopers analyse the new legacy landscape
Run-off after Solvency II
What next now Solvency II has arrived? Arndt Gossmann of DARAG reflects on the major opportunities ahead for legacy practitioners in Continental Europe
Legacy attracts new investors
There is a steadily growing interest in legacy business, spawning more buyers backed by a wider range of financing. Barbara Hadley reports
Secrets of a successful liquidation
The final winding up of the Legion Insurance Company last year represents a major run-off triumph say Gregg Frederick and Mike Palmer
The Insurance Act 2015 and the run-off market
All insurance and reinsurance contracts entered into from August this year will be subject to the Insurance Act 2015. David Kendall of Cooley (UK) LLP looks at the impact and implications for the legacy sector
Transfers bring new options for US market
Kevin Gill and Luann Petrellis reflect on how the Rhode Island Insurance Business Transfer initiative could emulate the success of the UK’s Part VII process
A-Z of service providers
Index of service providers
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