It can be an effective part of managing a portfolio

The run-off sector may boom as more insurance portfolios cease writing new business.

A number of factors suggest an increase. First, the recession will affect the profitability of some portfolios. Demand will fall as customers cut costs and choose not to renew policies. Claims also tend to increase during a recession, putting downward pressure on margins.

Profitability has also been hit by last year’s natural catastrophe losses of more than $20bn (£14bn) and losses on investment portfolios. Insurers that pursued anything but the most cautious of investment strategies last year have suffered badly.

The tough financial climate may mean some insurers whose capital base has been eroded by claims and investment losses may struggle to raise additional capital, forcing them to put the business into run-off.

In addition, the hardening of the reinsurance market is making it more costly for primary insurers to transfer risk through reinsurance – an alternative way to address capital shortages.

A further, unconnected factor relates to Solvency II, the forthcoming European risk-based solvency regime. Solvency II will impose new capital requirements on insurers to reduce the risk that they are unable to meet claims. Insurers preparing for the new rules will be looking carefully at where their capital is employed. One solution, again, may be to put certain capital-intensive lines into run-off.

Last year’s $343m purchase of a book of run-off business from St Paul Fire and Marine Insurance Company by Enstar, a specialist in buying insurance and reinsurance companies in run-off, shows that large deals can be done in the current climate. More than half the acquisition price came from bank debt.

It is vital that insurers take a proactive approach to managing their portfolios during the recession. They should consider using run-off as part of prudent and active management of their business.

One issue that could hold companies back is that run-off can have the whiff of failure about it – although putting a portfolio into run-off does not necessarily mean the insurer is insolvent.

It is also complex. The different methods include run-off to expiry; accelerated run-off through commutation; using reinsurance to provide economic finality; a scheme of arrangement; the sale of the equity in the business; and a Part 7 transfer (selling a book of business to another insurer). The chosen option depends on the circumstances; experts say the choice depends on whether achieving finality is the short or long-term objective.

As the recession takes its toll on the industry, insurers and reinsurers must look at a realistic and tough-minded approach to managing their portfolios. Run-off should be considered as part of this process.

Key points

• Higher claims, investment losses and Solvency II will put pressure on insurance companies to consider run-off

• The difficulty of raising new capital and the hardening reinsurance market make run-off even more necessary

• Many do not find run-off an attractive topic, and it is complex, but they should make the effort to understand it now