An eye on the exit
Run-off originated in the insurance and reinsurance sectors as a means to distinguish contracts that are cancelled on a cutoff basis, where the reinsurer is not liable for losses taking place after the date of termination, from cancellation on an ongoing or a run-off basis, where the reinsurer remains liable for losses until conclusion of all activity on the contract.
“Current players in the legacy business are creative and strategic in determining which methods will best benefit their business strategy.”
Over the past two or more decades, the term “run-off” has been expanded to refer not only to the run-off of a particular contract, but also to entire books of business, to the insurance or reinsurance company itself and to the entire sector of the market in which such business is administered. It is also referred to as legacy business.
The definition of run-off or legacy is as individual as the companies involved in this sector of the industry. Insurance and reinsurance companies put a block of business or an entire company into run-off for varying reasons. The results from particular lines may be unprofitable, the company might have changed its business strategy or it needs to focus more on chosen core business lines.
An insurer might want to exit a line of business with poor returns to seek a better return on investment. Capital deployment is another reason that run-off is a good option for companies, allowing the insurer to direct its focus to more promising business areas. Run-off in these situations is in essence strategic portfolio management.
The 2019 PwC Global Run-off Survey estimates that the size of the global run-off market is $791 billion, with $364 billion of those liabilities in North America. That is a sizable part of the insurance industry.
Why do captives need exit solutions?
Companies and captive managers can consider exiting an entire captive, or carving out specific liabilities, for the same reasons that an insurer or reinsurer might. Large amounts of liabilities can be “trapped” in captives. The reason for the creation of the captive may no longer be core to business or it may have become redundant after a merger. Run-off liability can be the result of age, inheritance, cessation of writing certain lines of business or just liability capitation after a certain period of time.
Of the over 6,100 single parent captives in existence globally, it is estimated that as many as 20 percent of them may be currently dormant. That is, they are not writing any current risks and ongoing processing costs are being incurred to maintain the current licenses and regulatory status. Often, captive owners are not aware of the potential legacy solutions that may exist to allow for an orderly wind-up of the captive and the return of invested capital.
There are also emerging risks that may suggest a lasering transaction to transfer the risks from the captive entity to a new counterparty, such as a loss portfolio transfer, for the captive owner to potentially transfer the risk to a new counterparty with a differing risk tolerance. Those emerging liabilities that have the potential for the horizontal stacking of limits from mass tort-type claims are the core focus of such transactions.
A captive owner generally doesn’t set up a captive with the expectation that liability would have an extended tail, and the benefits of transferring these liabilities can far outweigh retaining it. A run-off transaction will provide the captive owner the opportunity to achieve legal and/or financial finality to the captive.
Some motivations for divesting risk from aged liabilities include capital optimisation, dividend payments, tax motivations, and posting of collateral.
How do I exit?
Once a captive manager or owner decides to consider closing a full captive or part of one, there are providers who are expert in the run-off space who can assist.
There are generally three options for the transfer of liability: loss portfolio transfer (reinsurance); sale of whole captive (acquisition); or to carve off and transfer blocks of liability by underwriter year, line of business or block of claims. These portfolios of liability can be transferred from any domicile in the world and are readily accepted and approved by captive insurance regulators.
There are a number of key elements to actively managing run-off. It requires the support and commitment of management and a dedicated team of experts that know run-off and devote the time to doing it right. Engagement with the captive owner or manager is a necessary part of the process.
How can run-off providers and managers assist captives?
The run-off provider will assume the captive’s liabilities either partially or completely within regulated entities that they have to assume with risk. Run-off providers typically have expertise in claim administration. A portfolio strategy should be defined to include a projected roadmap to finality, key performance indicators, and a strong process to manage the run-off.
Run-off specialists have experience with the various tasks related to run-off, such as commutations, litigation management, APH (asbestos, pollution and health hazard), accounting, data, and audits. These are a key part of the management process.
Current players in the legacy business are creative and strategic in determining which methods will best benefit their business strategy, making the legacy sector a very entrepreneurial and sophisticated facet of the big-picture financial services industry.
The Association of Insurance and Reinsurance Run-Off Companies (AIRROC) is the market body which brings them all together. AIRROC is the only US-based non-profit association focusing on the legacy sector of the insurance and reinsurance industries. Many of AIRROC’s members have expertise with captives.
Carolyn Fahey is an executive director of the Association of Insurance and Reinsurance Run-Off Companies. She can be contacted at: carolyn@airroc.org
