Ready, set, run-off

SO FAR, the European insurance industry has managed to remain relatively unscathed from the financial crisis. But the continuing economic gloom is expected to lead to some major exits and failures, and insurers will need to extract value from legacy businesses and save costs where they can.

In its recently published third annual survey of discontinued insurance business in Europe, PricewaterhouseCoopers warns insurers that they should have strategic plans in place in order to optimise capital and unlock value in run-off.

Dan Schwarzmann, partner at PWC, says: “The global insurance sector has already witnessed some significant turbulence and, while we have yet to witness any major exits or failures in the European insurance industry, the market is already being challenged through decreasing investment returns, restricted credit lines and increases in fraudulent claim activity.

“Key themes arising out of this year’s survey include concerns surrounding the current financial crisis and its impact on the insurance industry, along with a growing acknowledgement of the need to have a strategic plan for dealing with discontinued business.”

The trick to a successful run-off is to manage it properly and, if possible, bring finality to discontinued business by getting rid of potential claims liabilities. With this in mind, here are 10 strategies recommended by PWC for making money from run-off:

Be proactive in managing claims

This means having regular reserve reviews and actuarial assessments of future claims. This should be carried out in a stand-alone section of your business. According to PWC, insurers that continue to manage run-off alongside live business risk losing value and competitive advantage. In PWC’s survey, nearly 70% of respondents says they now manage their run-off as a separate business unit. And more than 86% have a specific strategy for dealing with run-off.

Get the right skills

Managing discontinued insurance business requires the ability to manage complex long-tail claims and the ability to develop a strategic plan for the run-off. In the past, lack of run-off skills has been a problem. But PWC says the UK and Continental European run-off markets have developed dramatically over the past decade. Run-off service providers are particularly prevalent in the UK but are also gaining prominence across Europe, for example in Germany and Scandinavia.

Identify where future claims will be

Fifty-six per cent of those who responded to PWC’s survey believe that the major claims exposures in the next five years will come from the USA, while 23% say major exposures will come from the London market. Nineteen per cent believe the majority of claims will spring from Continental Europe. But Continental European and UK respondents hold different views on this – while 61% of the former believe the US will lead the major claims exposures, only 44% of UK participants agree.

Identify what the major claims will be

Thirty per cent of PWC survey respondents believe that climate-related claims such as floods and hurricanes will be the main type of claim over the next five years. Meanwhile, 28% believe the financial crisis will cause the biggest spike, while 19% predict asbestos will be the dominant claim type. Sixteen per cent list directors’ and officers’ claims.

Do not get distracted

While current market issues will be a distraction, legacy claims are likely to remain a major area of claims activity. For example, asbestos remains one of the biggest threats in long-tail liabilities, and the worst is to come. Speaking at the Association of Run-Off Companies (ARC) Congress that recently took place in London, Nigel Morson, formerly of RSA, said the issue of asbestos claims “is not under control” and warned that figures on possible future claims were “immensely uncertain”. PWC says insurers need to consider appropriate exit strategies on such legacy issues. This will help ensure these exposures are eliminated and resources can be made available to handle new claims.

Identify natural life of run-off

Pinpoint as best you can how long your run-off business will take to reach natural expiry. The longer it takes, the greater the potential of future claims. However, PWC expects that as insurers increasingly adopt alternative exit methods such as those outlined below, run-off will reach natural expiry much sooner. Fifty-two per cent of those surveyed estimate that it will take more than 10 years to run off their business in the natural course. This is an improvement, down from 70% last year.

Come to mutual agreement

A commutation is a mutual agreement to terminate claims obligations in return for a final cash settlement. In order to reduce run-off tail, consider a commutation exit strategy. According to the PWC survey, 58% of respondents believe that a strategic commutation programme will be the most popular exit strategy during 2009. This is likely because insurers have a need for cash, and might have concerns about their reinsurers’ financial security because of the current economic climate. The downside of this strategy is that it is time-consuming and liability closure is only done on a piecemeal basis.

Set a date

Solvent schemes allow estimated claims liabilities to be settled at a set date, meaning that excess capital can be released and used elsewhere in the business. The process is available under the UK Companies Act and involves a court-driven procedure which allows an organisation to start a wholesale commutation programme with all or part of its book of business.

Transfer your book

This involves moving all or part of a company’s insurance book from one insurer to another. Businesses can be transferred within the same country or to another European Economic Area (EEA) territory, and either to another member of a group or to an external company. Transfers need regulatory approval and policyholders may need to be notified. Advertising and court approval may also be required, depending on territory rules.

Sell to an external company

Transfer of liabilities from an insurer to an external company provides finality for the selling insurer to an extent, but some liabilities may still be retained through financial guarantees, indemnities and warranties. Sale activity in the discontinued sector is continuing, but the level of activity is expected to drop because of lack of capital resulting from the financial crisis.