A run-off does not have to represent lack of progress or bad management. It is the management of claims disconnected from new policies. The majority of these are commitments corresponding to old underwriting years, with insureds or ceding companies that are no longer clients and that have become inactive or are in liquidation.
Commercial pressure is no longer effective to drive claims management, and the phenomenon of accumulation over the years and distance from useful information makes clear-sighted management of these affairs rather delicate.
From the 1960s to the 1980s, many European companies were led to understand that they would rapidly find an extra source of business by taking out North American risks, in more or less homeopathic doses. But for some companies, over the years this has resulted in the addition of certain significant commitments, due particularly to considerable deterioration in exposure.
What, at the outset, should have been profitable low-risk extra business initiating them in the charms of international affairs, has for some companies become a considerable financial burden.
These claims from the 1960s to the 1980s, and even from the 1950s, essentially concern risks which develop very slowly, such as those of asbestos or pollution. Not only are many companies averse to keeping these commitments in their files for many years, but they also have to consider tomorrow's coverage of new claims that arise from these old years and involve risks which are more or less unknown today.
For many years, companies did not particularly look for transparency in a field where they were afraid of being reproached for negligence or superficial policy underwriting. Today they no longer conceal their commitments; mostly, it must be admitted, because the supervisory authorities or the rating agencies require increasingly detailed reports on the evolution of claims and their level of reserves.
Besides this old North American business, the regular development of civil liability risks in Europe has gradually led European companies to accumulate old commitments. It is thus natural that some insurers or reinsurers are now hoping to alleviate their positions.
Today, the total value of non-life run-off business represents a commitment of about $350bn (£248bn), about 20% of insurance companies' commitments and more than 24% for the reinsurance sector – it is easy to see what is at stake for any related projects.
It is interesting to note that independent run-off entities, or those that are members of an insurance or reinsurance group and manage this run-off business, will develop a strategy finally resulting in the interest of insureds and reinsureds alike. These entities will want to make claims decisions more quickly than in the past and will secure a return on assets without taking any excessive technical risk, thanks to the competence of their technical teams.
However, various traps should not be under-estimated, particularly those laid by company teams that do not necessarily wish to see greater transparency, quicker liquidation or mergers with specialised units. The best way of overcoming this resistance is by making sure that internal restructuring becomes a real company project, clearly showing the objectives of profitability and results and proposing profit-sharing schemes for teams responsible for putting them into effect.
Another difficulty is that insureds and, above all, reinsureds are entitled to have their say in this process and can oppose restructurings, transfers or policy buy-backs.
The pros and cons
Liquidations, commutations or transfers of books of business can have a positive or negative impact on the balance sheet of the company, depending on whether the level of reserves is higher or lower than the purchase price. These projects may also have a significant effect on the company's treasury, as they often incur considerable disbursements. These aspects have immediate consequences on the company's accounts, while the advantages resulting from simplifying the organisation or saving on management costs become visible only later.
There are several reasons for launching a run-off process. These are based on the pursuit of better business efficiency and organisation, which lead insurance or reinsurance groups to bring a certain order and visibility to the management of these old files, files which are considered “exotic” as they are inherited from absorbed companies or simply too old for others. Others are “orphans”, which for many years have not warranted management's attention.
Often, the run-off process in a group starts with an internal re-organisation aimed at grouping, by means of portfolio transfers between subsidiaries, the handling and liquidation of those old commitments to one company, which will be specialised in the run-off process.
Occasionally, without leading to actual transfers of portfolios which have to be notified and approved by insureds or reinsureds, the steps taken consist of coordinating claim handling within a group to avoid contradictory decisions taken on each claim by different subsidiaries.
Complications start with the insurer or reinsurer who, while willing to transfer all or part of his old business, often has trouble preparing complete, consistent and presentable files, including justifiable explanatory figures.
The second major obstacle is to assess the future level of claims deterioration and the rate of payout. In other words, to justify the amount of additional reserves retained and to succeed in selling this to the other party. Sometimes, this business is under-reserved and it may even happen that claims declared a very long time ago by insureds or reinsureds cannot be accounted for.
In most cases, these insurances or reinsurances have an international component but are poorly documented, even though the contractual context is particularly complex. Furthermore, these claims require specialised staff, experienced in managing long-term business and in negotiating commutations or policy buy-backs. While these projects are multiplying, there is an actual risk of a shortage of experienced competent teams.
Projects implemented within a group for pure internal restructuring purposes must be set apart from projects whose principal effect is to remove old commitments from the group's balance sheet. Among the numerous questions to be answered in the course of preparing the contract to establish the portfolio transfer, the following should be particularly taken into account:
The successful run-off
In this respect, a run-off process covers areas and factors which have to be taken into account judiciously so that the decisions of a company to get rid of old business or, on the contrary, develop a new activity in this area may be successful.
Besides the definition of a strategy vis-à-vis, the run-off and the accurate calculation of the price to pay or be paid, the analysis of old contractual documentation, the meticulous drafting of the transfer agreements and the preparation of related formalities are the key factors for the success of these projects.