Clifford Chance
Capitalising on opportunities in the run-off market
2 May 2019
The global run-off market is in its most active period of recent years, with increasing numbers of high-value deals in the sector. This growth trajectory appears set to continue.
Sellers are increasingly proactively managing their legacy books and this has resulted in more and larger portfolios coming to market. Solvency II, IFRS 17 and Brexit have all played a role in focusing boards’ attention on their overall strategy and assessing whether to exit certain products, markets or geographies. This has resulted in an increasing number of diverse business lines being placed into run-off.
For sellers, it is operationally costly and cumbersome to manage their run-off portfolios and such portfolios divert attention and capital from the core business. Run-off portfolios are also vulnerable to an increasingly uncertain economic and political landscape – the lowering of the Ogden discount rate in the UK last year is just one example. Boards are therefore choosing to dispose of their run-off portfolios with a view to mitigating these issues and releasing capital.
The growth in availability of run-off portfolios makes this an opportune time for buyers to acquire and consolidate such portfolios with their own. In a low interest rate environment, the acquisition of such portfolios, together with their sizeable reserves, enables buyers to access a new income stream and reap the benefits of capital diversification and economies of scale. Buyers are increasingly sophisticated and well capitalised and so are able to take on larger portfolios.
For those seeking to capitalise on the opportunities in the run-off market, there are various issues to consider. For example:
- Structuring: legal transfer of a run-off portfolio gives sellers a clean break and gives buyers freedom to consolidate the portfolio into their own. In Europe, insurance business transfer legislation (for example, the UK’s Part VII process) is well established and typically requires court and regulator approval. In the UK and Ireland the court order can transfer the business associated with the portfolio. In other jurisdictions, the process is more cumbersome as additional assignments, novations and third-party consents are often needed. Brexit is also likely to make cross-border transfers between the UK and EU more challenging. Reinsurance is a quicker way of transferring the economic risks of a run-off portfolio to a buyer and obtaining many of the benefits of disposal. However, as the seller remains the legal insurer, the seller has no finality and the buyer’s ability to maximise economies of scale is limited. Reinsurance is instead often used in conjunction with a portfolio transfer to ensure the economics are quickly transferred while awaiting legal transfer.
- Operational issues: run-off portfolios are typically managed on legacy systems, which can be difficult to integrate with the buyer’s systems. This can be a major challenge to realising the benefits of economies of scale. A transitional services agreement may also be appropriate.
- Expertise: employees with expertise in managing the run-off portfolio can be scarce and should ideally be transferred to the buyer. Incentivising such employees will be a key factor for the buyer.
- Regulatory process: regulators are taking a more favourable stance to run-off mergers and acquisitions but buyers will need to demonstrate they have the resources to pay claims, treat customers fairly and prove they do not pose operational risk.
- Due diligence: Due diligence is a vital part of the acquisition process.
Opportunities in the run-off sector are expected to continue to grow. For those able to adapt to the growing and diverse market, there are exciting times ahead.
This article first appeared in Insurance Day
