Legacy and run-off solutions can offer many benefits to captives, but more education is needed in the sector around the sophistication of these techniques and their uses, says Paul Corver of Randall & Quilter Investment Holdings.
There remains a widespread lack of awareness in the captives industry of the benefits of legacy solutions and the sophistication of the tools available to provide captives with solutions. But captives that do leverage these solutions can enjoy real benefits—and captive managers also have the potential to benefit.
That is the view of Paul Corver, group head of legacy M&A at Randall & Quilter Investment Holdings (R&Q), a specialist in this field. He says that while the strategic role of legacy solutions is being increasingly leveraged by the mainstream insurance sector to streamline portfolios and secure additional capital relief, a process of education is still needed in the captives sector.
“Legacy solutions are now well-used strategic tools in the commercial property/casualty market,” Corver says. “The misperception of these tools being only for distressed and dormant vehicles has completely changed in the main insurance markets. Companies are using legacy solutions in very sophisticated ways to achieve better capital efficiency and to manage the unexpected deterioration of reserves.
“Yet these same tools are not being used as widely by captives or other self-insurance vehicles. We do see some deals but there is definitely a need for more awareness of the possibilities among brokers and captive managers.
“We believe this could become the next growth area for the captives space and there is an opportunity for some of the service providers to take a strong lead in this space.”
R&Q has worked with AstraZeneca, Unilever, Virgin Atlantic, and Northern Foods, among other household names. The larger the company, potentially the larger the captive, therefore there may be greater opportunity to gain efficiencies by trimming out dead wood.
“Legacy solutions can be a very forward-looking service. It can protect the health of your company and in a competitive market a leaner and fitter business has a clear advantage,” Corver says.
“It is a question of cleaning things up and getting rid of the dead wood in organisations. Run-off should be a strategic part of every captive manager’s toolkit.”
A growing appetite
That said, Corver says, there is a clear growing interest in captives using the legacy market as the scale, complexity, and sophistication of captives increases and owners look to seek more efficient capital management.
He says that captives, cells, risk retention groups (RRGs) and other forms of self-insurance vehicles can effectively be split into two buckets: those which are actively underwriting and those deemed in run-off.
In actively underwriting captives, there will be historic liabilities which require capital, and if these can be exited through novation, transfer, commutation, or reinsurance, then surplus capital or collateral held to support those liabilities could be recycled to support new underwriting or distributed to the parent.
There are increasingly sophisticated ways of achieving these outcomes. The types of legacy transactions have expanded in recent years from traditional loss portfolio transfer (LPT) reinsurance agreements and acquisitions of run-off captive insurance companies, to providing complex solutions or finality to corporates and public entities within self-insurance programmes (large deductible programmes, captives, RRGs, and self-insurance funds).
To facilitate this wide range of transactions, R&Q has built a platform to facilitate deals in the traditional run-off space and unique transactions with corporate self-insurance programmes. This has allowed it to develop solutions for counterparties to exit legacy insurance liabilities, enabling entities to (i) free up working capital trapped as collateral held as part of its insurance programme; (ii) eliminate insurance tail risk; and (iii) diminish or remove administrative and regulatory burdens.
Corver argues that changes in regulatory environments and organisations’ business lifecycles pave the way for risk managers and executives to reconsider historical insurance programmes. Self-insurance programmes fitting into an organisation’s business objectives at inception may over time become less beneficial or even an impediment to a company’s current and future goals.
A lack of awareness
Corver says there are many reasons captives do not leverage these solutions as much as they might. A big factor is the fact that the captive owners are not insurance professionals—and thus not exposed to the wider trends and knowledge in the commercial insurance industry globally. “These companies will be experts in what they do—it could be retail, construction, healthcare—but they do not have specific expertise in the insurance sector,” he says.
In addition to this, he notes, the majority of companies forming captives never consider future exit options. As an organisation’s business evolves and changes in management, strategic goals, and approach to risk management change, it is not always easy to change the role of the captive to fit in with these goals.
One of the biggest catalysts for run off, he says, is non-insurance industry-related merger and acquisition (M&A) activity, which can lead to duplicate insurance programmes, duplicate captive structures, or different risk management philosophies. Executives and risk managers alike seek ways to capture synergies contemplated as part of the M&A process. Consolidating insurance programmes, freeing up excess collateral, or eliminating existing self-insurance structures (ie, captives) can assist in achieving these synergies.
Another catalyst has been the implementation of Solvency II and other risk-based capital models around the world. These have led companies to assess what capital is required and identify whether they are getting the best return on that capital. Captives may carry liabilities that are of little ongoing interest, they may relate to disposed business units or discontinued operations. What benefits does the captive achieve by continuing to carry those liabilities which are effectively trapping capital?
Many captives will have to post collateral to give the fronting company protection on its credit risk. These collateral obligations are often considerably in excess of the held reserves, again trapping capital. Legacy solutions can provide an efficient way of freeing up this capital.
Corver says that when R&Q assumes liabilities from a captive they take on the obligation to provide collateral. This can realise a sizeable source of free cash for the captive.
A further key area for the captive to understand is whether it is comfortable with the possibility for deterioration in the held reserves. Certain lines of business, such as employers’ liability and workers’ compensation, have a long tail of claim exposure which can cause nasty surprises especially in changing regulatory environments that may favour claimants. He stresses that there is little benefit to a captive to continue holding these potentially volatile reserves.
Paul Corver is the group head of legacy M&A at Randall & Quilter Investment Holdings (R&Q). He can be contacted at: firstname.lastname@example.org
A full toolbox
Across all sectors, R&Q has closed more than 60 transactions since 2012. These transactions include captive acquisitions, traditional LPTs, novations, facultative reinsurance, assumption agreements, and deductible reimbursement policies. Included in that number are successfully completed run-off transactions with large US and European corporates as well as large insurance groups.
R&Q works with captives and their managers to ensure that the transaction undertaken provides the best benefit to the captive and its needs and motivations. While reinsurance gives economic relief the contractual obligations remain with the captive, a transfer or novation of the policies would move those obligations to the acquiring party.
R&Q uses a wide array of solutions. For captives that are no longer underwriting, the cleanest exit is a share purchase where R&Q takes over the company lock, stock and barrel. This clearly gives the seller complete finality.
More recently, and particularly in the US, R&Q has seen the use of 100 percent reinsurance or assumption increase in popularity. Accredited Surety and Casualty Company (ASCC) is the R&Q Group’s A- (VIII) AM Best-rated US carrier which is admitted in all 50 states with near full penetration of licences. ASCC has taken on a range of liabilities from medical malpractice to commercial auto to workers’ compensation from group captives, RRGs, on balance sheet deductibles and self-insurance funds.
In the EU, Accredited Insurance (Europe) is AM Best A- rated, domiciled in Malta and licensed for all 18 non-life classes with freedom of service across much of Europe. It is used to assume compulsory line liabilities from EU captives looking to reduce Solvency II obligations.
Randall & Quilter Investment Holdings, Legacy, Run-off, Captive, Eductaion, Insurance, Reinsurance, Paul Corver, North America