In the mid-1990s, a major insurer and reinsurer estimated that between $150 billion and $250 billion were tied up in run off reserves in the US. The exact size of the US run off market – from all affected lines of business – has not been determined. However, data from US insurers’ 2016 annual statements reveals that domestic carriers hold more than $40 billion in reserves simply for direct and assumed reinsurance exposure for asbestos and environmental liabilities.  That $40 billion represents, on average, just under 6% of the total policyholders’ surplus for the same companies.

Boards owe it to their shareholders to explore all the possible ways to release the funds impacted by all types of run off liabilities. While companies continue to rely on the conventional options of run off to closure or reinsurance transfer, the range of more proactive options is increasing all the time.

Time to look further

Run off to closure is a slow process, tying up capital and management time for decades. The most common solutions could be equally flawed:

1. Sale may eliminate the balance sheet burden, but the acquisition price is unlikely to reflect anything like the value of the assets as it needs to take account of the risk of future adverse loss development and continued administrative expense and distraction. The rise in the number of run off acquirers could increase competition for available portfolios and hence raise prices. While sellers may benefit to some extent, they are still unlikely to get the full value of their assets, while buyers may be storing up problems for the future.

2. Many owners of legacy liabilities continue to opt for reinsurance transfer instead, but once again value is lost as the transfer price (i.e. the reinsurance premium) needs to be high enough to protect the buyers from adverse claims development, and therefore the amount of funds that are left to be extracted can be limited.

The alternative options

Although many insurers still prefer traditional options, it’s worth looking at regulatory alternatives that not only release capital, but also eliminate expenses and liabilities altogether.

New in 2017

Connecticut Division Statute

The opportunity
Connecticut has become the latest state to offer a solution for owners of legacy liabilities – especially those active Connecticut-domiciled insurers that have legacy risks residing within the same legal entity as their ongoing underwriting activity.

Modelled on the Pennsylvania Association Transactions Act (see below), the Connecticut Division Statute allows separation of active business from inactive portfolios ready for run off. The run off entity can be packaged up for sale or managed on a separate balance sheet. Active business can go forward without the drag of the run off portfolio.

Issues to consider
This is a relatively straightforward process, with no requirement for specific counterparty consent or judicial review. While this opens the way for sale, there is no option for a commutation plan for the newly created run off entity.

Important recent developments

1. Rhode Island Commutation
The opportunity
Allows insurers and reinsurers to accelerate the final closure of eligible business in run off.

 

What’s changed?
Implementing regulations only used to allow whole companies to be transferred to Rhode Island for commutation, but legislative amendment allows for the separation and packaging up of an eligible block of business for transfer and eventual closure through the Rhode Island commutation plan statute.

 

Issues to consider
The process suits some portfolios more than others. To win approval for transfer to Rhode Island and achieve subsequent commutation, insurers and reinsurers need to develop a clear justification, focused closely on the protection of policyholder interests. They will also need to develop effective structures for both the transfer and commutation plans, each of which must reflect the demands of the legislation and the particular characteristics of each block of business.

 

For those carriers with legacy liabilities residing on an active balance sheet, the portfolio transfer and commutation plan processes provide a transparent regulatory and court approved mechanism to demonstrate their commitment to the insurance or reinsurance protection they issued.

 

2. Pennsylvania Association Transactions Act
Potential opportunity
Separation of active business from inactive portfolios ready for run off.

 

What’s changed?
Legislative amendment allows for the direct conversion of a business organization from a foreign to a domestic entity (or vice versa), which was previously only allowed by merger or some similar action.

 

Issues to consider
The process requires board and shareholder approval, fairness and solvency opinions, along with actuarial reviews of various financial and accounting measures. Policyholders should be consulted, but the process does not require their approval.

 

3. Vermont Legacy Insurance Management Act 
Potential opportunity
Facilitates and streamlines the process for transfers of commercial insurance policies and reinsurance agreements between solvent insurance companies.

 

Issues to consider
The Vermont Statute enables a non-admitted insurer from any jurisdiction to transfer closed blocks of business to a special-purpose corporate entity domiciled in Vermont, which assumes the obligations to policyholders.  However, the process applies only to excess and surplus lines carriers and not to companies that are admitted in Vermont. By contrast, the Rhode Island Statute applies to admitted and non-admitted carriers. Moreover, the Vermont Statute does not provide the same level of transparency, review, and policyholder protection as the Rhode Island Statute and its implementing regulations.

 

Under the Vermont Statute, policyholders can choose to opt-out of the transfer process. This has the disadvantage of splitting the assets and making it more difficult to ensure that liabilities are covered by sufficient backing assets (Rhode Island has no opt-out provision). Moreover, the Vermont Statute does not provide a process for the liabilities to be crystallized and closed. This leaves the policyholders subject to the potential erosion of capital in the newly created Vermont entity.

 

4. New York Regulation 141
Potential opportunity
Allows a financially troubled New York-domiciled reinsurer to offer to pay a percentage of cedents’ losses in return for an agreement on commutation of liabilities.

 

Issues to consider
Comparable, if not, identical, offers must be made to each and every cedent. Commutation terms must also be consistent. The New York Superintendent of Insurance judges the fairness of the offers as part of its power of review, approval, and possible modification. Individual cedents can say no, rather than having to follow a majority decision, so it is important to take soundings in advance to see how many will accept, and hence whether the plan is viable.

 

Making this work

None of these options is a silver bullet. Nor is there a one size fits all solution. Moreover, all of the regulatory solutions lag – in industry acceptance  – behind the conventional option of traditional reinsurance protection in the forms of an adverse development cover or loss portfolio transfer. However, it is important to analyze and assess all options and match these against strategic aims and the nature of the run off business in question. While this requires expertise and possible third-party advice, the value gained and reclaimed could be considerable.

We would be pleased to speak or meet with you to discuss the options, how they would apply to your particular business, and the value derived from the process of analyzing and assessing your company’s options.

Andrew Rothseid

Andrew Rothseid

Principal

RunOff Re.Solve LLC
Two Bala Plaza, Suite 300
Bala Cynwyd, Pennsylvania 19004
610 660 7738 (Direct)
267 253 3529 (Mobile)
andrew.rothseid@runoffresolve.com

Who We Are

Andrew Rothseid, Principal of RunOff Re.Solve, designs and executes solutions that provide insurers, reinsurers, cedents, policyholders, and regulators with legal and financial finality from run off captive and legacy liabilities.

To find out more, please visit http://runoffresolve.com/