Despite the maturing legacy and run-off market in the UK, the market continues to grow rapidly – a trend we are set to see remain. Hardening rates are forcing underwriters to assess which classes of business they continue to write, and insurers continue to look for opportunities to divest unwanted legacy portfolios. We are seeing several new acquirers interested in investing capital in this market and indeed the number and size of run-off portfolios for sale is increasing. This is partly due to the combination of insurers’ increased appetite to benefit from the capital relief triggered by off-loading old liabilities and attractive pricing.
Whilst the UK run-off market is developed, this is not the case in all regions. In many jurisdictions, it remains a relatively untested concept and the lack of legislation and regulation remains a barrier to the growth of those markets.
The supervisory challenges arise due to the specific risk profiles of different run-off undertakings and the fact that in Europe and the UK, the Solvency II framework doesn’t specifically distinguish between different types of run-off situations. Various regulators and supervisory bodies including EIOPA do, however, recognise the benefits that the run-off business model can bring to the market, namely making it possible to use capital to support more profitable business, enabling cost reduction or orderly exit from the market.
Accordingly, EIOPA published a consultation paper on a supervisory statement regarding the supervision of run-off undertakings. The supervisory statement covers the authorisation of acquisitions of run-off undertakings or portfolios, the ongoing supervision of run-off undertakings as well as prudential and conduct of business issues. We discuss below some of the main points from the consultation paper and also look at the latest developments in the UK.
Requirements when an insurer decides to go into run-off
As the decision to become a run-off insurer is material information, it should be reflected in the insurer’s Solvency and Financial Condition Report. Insurers that decide to become run-off undertakings are required to notify their supervisory authority of this decision by submitting, among other things, a description of their strategy to manage the remaining business, financial projections, material reinsurance and outsourcing arrangements and the impact on the remaining staff and existing policyholders.
In the case of cross-border run-off, there are additional requirements. Home and host state supervisory authorities are expected to co-operate and exchange any information which could affect policyholders’ rights. Specific areas of potential risk include partial knowledge of the products and market trends and reduced ability of customers to submit claims.
Acquisition of a run-off undertaking or a transfer of a run-off portfolio
Potential acquirers are also encouraged to have an early dialogue with the supervisory authority before submission of the formal notification of the acquisition of a run-off undertaking or portfolio. The acquirer should provide the supervisory authority with the same information as when an entity takes the decision to go into run-off, together with an external actuarial report assessing the adequacy of technical provisions related to the portfolio transfer. The financial projections should cover the same period as the duration of the insurance liabilities.
Supervisors are encouraged to undertake a detailed assessment of all the above documentation to check for potential risks. Regulators will be required to measure the financial soundness of the acquirer, the impact on the policyholders, and will need to understand in detail the business model of the acquirer, as well as the changes that the acquisition will bring to its risk appetite and governance.
The key in any transfer is ensuring the protection of policyholders. EIOPA makes it clear that this should be one of the main objectives of the regulators’ assessment and that it should not be impaired by the transaction. For the acquirer this may mean the need to post collateral if the transaction affects the recoverability or number of claims. EIOPA notes that one important assessment is to verify whether the risk profile of the acquirer, after including the new portfolio/undertaking, is in line with its risk appetite and does not go beyond the risk tolerance and its risk bearing capacity.
Ongoing product oversight and governance processes will also need to be reviewed and assessed. For long-term products, throughout the lifetime of the acquired portfolio the acquirer needs to have the ability to take remedial measures if, for example, it emerges that a certain product’s main features (e.g. risk coverage or guarantees being materially impacted) cause detriment to policyholders.
Private equity acquirers
When private equity investors acquire or invest in run-off insurers, they generally tend to increase investor returns by changing the asset allocation of the insurer, making operational changes or by changing the methodology and underlying assumptions for both the valuation of technical provisions and of capital requirements.
One point to emerge from the consultation paper is a focus on the involvement of private equity, or similar investment entities, in the process. EIOPA notes that since their investment horizon is usually shorter than more traditional shareholders, there is a risk that capital is pulled out of the target undertaking with potential negative impact on policyholders’ protection. To prevent this, supervisory authorities are expected to now also consider the track record of the private equity investor and assess the possible consequences of an early withdrawal from the investment.
Regulators are encouraged to take steps to monitor private equity participation to ensure that policyholders are protected against any potential negative impact. The proposals add an additional layer of guidance which may run the risk of deterring private equity investment.
The business model review isn’t only considered by regulators as part of the preliminary decision to go into run-off, or at the outset for an acquirer. It is an on-going consideration. There is an increased focus on how the run-off insurer is expected to stay profitable in the near future and on compliance with Solvency II. EIOPA notes that the focus of a non-life run-off undertaking will be on the claims provisions, by handling the claims in a more ‘efficient and effective’ way to increase the technical profit – but that efficiency, however, should not lead to the unfair treatment of policyholders. Life run-off undertakings might however try to optimise both underwriting and investments results, by investing in higher yielding (but also riskier or more illiquid) assets.
Investment strategy also needs to be assessed by regulators. Run-off insurers tend to either take on a higher risk / return mix of assets, or transfer their assets to another undertaking to invest in higher risks. The investment strategy will need to be monitored and regulators must ensure that the “prudent personal principle” is complied with – ultimately that any new acquirers are able to manage the insurance business that they have taken on.
Conduct of business supervision
Specific conduct of business risks can arise in the case of run-off activities and it is necessary to safeguard policyholder interests.
For life business and medium and long-term commitments in run-off, EIOPA notes that supervisory authorities should assess whether the accepting insurance undertaking has a customer centric business model, including to ensure that customers belonging to the run-off portfolio will be treated fairly throughout the lifecycle of the run-off products.
Run-off insurers are urged to be as transparent as possible with policyholders and to give them timely information about the impact of the transactions to their insurance policies. Supervisory authorities are also advised to assess how complaints handling requirements will be complied with and whether the acquirer will ensure customers are treated fairly in the complaints handling process
The European proposals to a large extent mirror the approach already taken by regulators in the UK. The FCA, the PRA and the Bank of England have a key aim of strengthening the resilience of financial institutions and financial market infrastructures and to protect the wider financial sector and UK economy from the impact of operational disruptions. When looking at a potential run-off transferee, carrying out complete due diligence on the financial resilience of that transferee has never been more critical.
From an insurance business transfer perspective, there are further challenges when looking at who a suitable run-off portfolio transferee might be. The PRA recently launched a consultation on proposed updates to its approach to insurance business transfers. In this consultation, the PRA notes that schemes involving transferees in run-off may in certain circumstances pose risks to its statutory objectives. Therefore, the PRA is making two proposals to mitigate this risk.
The first proposal is that for schemes that trigger particular criteria (where the scheme involves non-life business in run-off with technical provisions of over £100 million, and where the scheme will increase the transferee’s technical provisions by 10% or more), the PRA will utilise its powers under section 166 of the Financial Services and Markets Act (FSMA) to assess the operational readiness of the transferee. The PRA proposes to do this in all cases that meet the criteria unless it is able to satisfy itself of the transferee’s operational readiness by other means.
The second proposal is that where the transferee is in run-off (or is in the business of acquiring books of business in run-off), it should be able to demonstrate that it has considered both its existing risks and risks it is acquiring over the ultimate time horizon, until the risks taken on are fully run-off.
These proposals add an extra hurdle for transferees and the potential for a section 166 review will only serve to make an already lengthy Part VII transfer timetable considerably longer. Whilst the run-off market continues to grow and whilst there is significant interest from new acquirers, there is a very real question around the impact that this new requirement would have. There is some comfort though – the PRA anticipates that this will only be triggered rarely – it notes that of the 43 sanctioned insurance business transfers since 2019, only one would have triggered a section 166 assessment.
The regulatory focus on run-off markets in the UK and the EU shows no signs of abating and firms should be aware of the regulatory direction of travel. The outcome of these consultations will no doubt affect the run-off process and impact the pool of entities to whom run-off business can be transferred.