Squeeze starts drive to free capital

Who can avoid the doomsayers predicting the imminent demise of the global financial services industry following the credit crunch? In many markets capital is scarce, encouraging its owners to reduce risk and push for ever higher returns for such a relatively rare commodity.

The insurance industry is both a major recipient of, and a contributor to, global capital markets. As an industry, undoubtedly there will be some impact. So far, attention has centred around those with exposure to the specialist mono line players which had a key role in the financial structuring and risk transfer that took place around the asset-backed securities.

It is likely that more widespread impact will emerge over the next couple of months as we enter the insurance reporting season.

But such negative headlines should not distract from the huge strides the insurance industry has made by putting in place more sophisticated and comprehensive capital management frameworks. Two such examples in the UK are the implementation of the Prudential Source Book, and learning from the banking industry following the implementation of the Basel accords.

The benefit of this enhanced capital management capability has been the ability – and willingness – of insurers to continually look to free-up capital and move it around the business with the aim of maximising returns both in the UK and overseas.

The capacity of insurers to manage and deploy capital quickly and effectively is becoming a source of real competitive difference. In the past two years, releasing value from legacy and run-off portfolios has been one area where capital management has seen real focus and success.

The drive to release capital and de-risk balance sheets, against the backdrop of the continuing soft market, is potentially where the smart money will be as companies seek to shape up for M&A opportunities once the credit crunch eases.

Global composites sitting on large amounts of capital consumed by run-off portfolios are now developing strategies driven by capital efficiency, that encompass both current and run-off books.

No longer are ‘proactive’ collection and claims management tactics centre stage. Instead major insurers are adopting a broader, wholesale strategic approach, matching their portfolios to a range of finality solutions from disposal, portfolio transfers and major transformation programmes of the run-off business.

We are also seeing many insurers examining their legal entity structure in the UK and Europe to support new businesses and support capital repatriation and optimisation.

Fuelling this activity are the new companies seeking to acquire run-off. A larger investor pool with a varied appetite means that volatility in long-tail exposures need not be held until expiry, but rather consolidated and sold without triggering public auctions.

Heightened sensitivities in the financial markets have exposed the need for portfolio transparency and appropriate due diligence. The winners will be those companies able to accelerate the finality solutions of legal entity restructuring and M&A through robust programme management.

There appears to be little likelihood that the factors driving portfolio disposal will diminish in the next few years.

The current trends are to separate run-off businesses from current business units, and this is exemplified by the increasing readiness of European insurers to begin actively managing their run-off; to put pressure on companies to generate capital organically; and to focus on core current activity. It appears that the drivers are set fair to create a wave of run off disposals and acquisitions to free up capital.

The industry may have got the timing just right, releasing capital from its own legacy and run off portfolios. And just as external supply starts to tighten and prices rise from the financial markets.