00) UK Run-off survey Non-life insurance_2011.pdf

RESTRUCTURING

The KPMG UK Run-off survey: Non-life insurance

October 2011

kpmg.co.uk

This highly regarded and insightful study of the UK run-off market is in its ninth successful year. Based on a detailed analysis of insurance accounts, APH liabilities still dominate legacy balance sheets and look likely to continue to do so for many years. The majority of the market is now in the hands of run-off investors and consolidators who are playing a long game, and the size of the market is beginning to level out. That approach is being tested in the grip of an economic depression.

An even greater preoccupation for run-off insurers is the unabated pace of regulatory change. Solvency II is at the heart of this and ARC has continued to lobby for recognition of issues facing run-off companies. It is unsurprising that measures continue to be taken by insurers before implementation of Solvency II to access (currently) free capital through restructuring tools such as Part VII transfers and schemes of arrangement: most recent instances of the latter have involved the unravelling of complex underwriting pools. There appears to be some relief for runoff companies with proposals to exempt them from compliance if they terminate their business fully within three years of the implementation of Solvency II, whether that is 1 January 2013 or now more likely to be a year later. However, despite urgings by ARC, I am disappointed with the level of support and cohesive action among run-off companies and currently little is being offered to ease their regulatory burden once transitional exemptions fall away.

With its valuable training programme and member networking events, ARC provides a valuable resource to the whole insurance community. But as the traditional run-off sector diminishes, either through closure or merger, it will become increasingly more important for those companies with embedded run-off to support the Association and the work it undertakes. ARC continues to provide support to the sector and is again delighted to endorse this successful publication.

Paul Corver ARC Chairman

ARC (Association of Run-off Companies Limited) is the UK market body for insurance and reinsurance legacy management professionals. It is a limited company with its members as shareholders. ARC has been in existence since 1998 and has in excess of 200 members.

2011 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.

Contents Foreword 4

Key findings 5

1. UK non-life insurance market 6

1.1 Current size 8

1.2 Change in size 9

2. Company market 10

2.1 Solvent market 10

2.2 Insolvent market 25

2.3 Equitas 27

3. Lloyds of London 29

3.1 Run-off at Lloyds 29

3.2 Management of discontinued business 31

4. Future prospects for the run-off market 33

5. Conclusion 35

Chronicle of events 38


4 | THE KPMG UK RUN-OFF SURVEY: NON-LIFE INSURANCE

Foreword External forces are shaking up the insurance industry and the run-off market

According to a recent poll of insurance practitioners around the world, the greatest challenges currently facing the global insurance market are the risks posed by the burden of wholesale changes to regulation1. New rules over solvency, conduct of business and accounting soon to be implemented in Europe, USA and other major insurance markets are taking up significant amounts of insurance leaders time and utilising valuable resources, with the prospect of a greater burden of compliance going forward. Our Solvency II team across KPMG Europe LLP is increasingly providing support to insurance groups in their preparations for the implementation of Solvency II; despite the recent announcement regarding a proposed delay to its implementation, there is little respite on its impact for insurers.

Unless there are radical changes to business strategies, few companies in the UK non-life run-off market will be wholly exempt from Solvency II, notwithstanding some welcome transitional arrangements that have been proposed recently for companies in run-off. Many of the respondents to our survey point to the efforts that are continuing to be made by run-off executives with regard to Solvency II and their attempts to limit the potential adverse compliance costs on their businesses. Of course, opportunity comes with change and similar efforts by active insurers may lead to the disposal of underperforming and/or capital draining lines of business, or simply result in an overhaul of a groups organisational structure. Some of these portfolios may end up in the hands of the run-off market.

There have been some dramatic events in the insurance and reinsurance markets over the past year but it is testament to the strength of these markets that the major natural

catastrophes, combined with difficult economic, investment and regulatory conditions have not, thus far, led to any significant portfolios of business or companies being placed into run-off in the UK. It remains to be seen if this is still the case should the economic downturn persist or if the remainder of the hurricane season is as challenging as that which we have seen to date.

The UK run-off market is now very mature and liabilities are relatively stable with 2010 showing only a modest reduction in size on that for 2009. The monoline insurers, which entered run-off in 2008 in the midst of the financial crisis, introduced a new type of run-off claim. These were associated with complex financial instruments, largely comprising derivatives of mortgage assets, and these have shown little movement in claim values over the last year. There have been few new run-offs and the vast bulk of the market now resides in the hands of entities whose business approach is not to accelerate claims; or it is held by insurers which wrote compulsory employers liability insurance covering asbestos and other personal injury claims, which are difficult to accelerate. Expectations are that these claims, alongside those of the monoline insurers, which together form the bulk of the run-off market, will take many years to run-off or otherwise be dealt with.

Another major challenge to the insurance market is presented by depressed investment yields at a time of increasing costs. It appears likely that we will face a prolonged period of low interest rates which our survey respondents indicated will necessitate a review of current run-off business plans and strategies; duration, operational efficiency and release of reserves/ capital will all be subject to greater scrutiny. In some cases, these


THE KPMG UK RUN-OFF SURVEY: NON-LIFE INSURANCE | 5

conditions are posing a fundamental threat to the overall survival of the business and radical changes may be required: disposals, combining business with others to extract synergy or economies of scale and accelerated run-off are just some of the potential routes available to companies in the industry. This creates opportunities for the mergers and acquisitions sector, which despite some concerns over the availability of capital, has held up well in the current climate. The recognition of run-off expertise, particularly in London, has also led to opportunities for run-off practitioners to move into strategically significant positions at active insurance groups and to the growth of run-off centres of excellence to provide focused management of discontinued lines of business across an entire insurance group. We expect this trend to continue.

There has been a small overall decrease in the capital tied up in run-off. Proactive management of legacy business has enabled some surplus capital to be extracted through reserve releases and schemes of arrangement. KPMG has continued to support companies to extract value from their legacy business and in 2010 we advised members of the English & American pools on the successful launch of the largest pool scheme to date.

This is the ninth KPMG survey of the UK non-life insurance market, a detailed research and analysis into the nature of the business and the challenges it faces which is endorsed by ARC. We have conducted interviews with leading professionals in the market, who comment on the current issues and developments in the sector. I am extremely grateful to these executives who have kindly given up their time to contribute to this survey.

Key findings

Total liabilities of the UK non-life run-off market are estimated at 27.1 billion (2009: 29.7 billion).

Liabilities of the non-life run-off market in the UK represent approximately 13 percent of the non-life market as a whole, compared to 15 percent in 2009.

Total capital tied up in solvent UK non-life companies in run-off is approximately 3.9 billion (2009: 4.2 billion).

By the end of 2010, liabilities of UK companies whose entire non-life insurance business has been subject to a solvent scheme of arrangement totalled approximately 802 million (2009: 527 million).

A total of 251 solvent schemes of arrangement for non-life insurance companies had become effective by the end of 2010 (2009: 227).

There were seven Part VII transfers of non-life portfolios in 2010, of which six involved predominantly discontinued business2.

Economic interest in over 70 percent (2009: 65 percent) of the total solvent run-off market is now owned by six insurance groups.

Mike Walker Head of Restructurings Insurance Solutions Practice KPMG LLP (UK)

October 2011

1 Centre for the Study of Financial Innovation: Insurance Banana Skins 2011 2 Insurance business transfers under Part VII of the Financial Services and Markets Act 2000



1. UK non-life insurance market

In this section we review the size of the UK non-life run-off market.



Survey specifics

There are approximately 500 firms and Lloyds of London (Lloyds) managing agents currently authorised by the Financial Services Authority (FSA) to carry on general insurance business in the UK. Of this number, there are approximately 450 companies for which publicly held information is available. Our survey is based on an analysis of this publicly available financial information, including regulatory returns submitted to the FSA, utilising A.M.Best Bests Statement File UK and from audited statutory accounts filed at Companies House.

This information has not, however, been verified or validated in any way by KPMG LLP (UK).

A number of industry executives have provided commentary on the run-off market. The views and opinions expressed are those of the survey respondents and do not necessarily represent the views and opinions of their organisations or KPMG LLP (UK).

This survey analyses the state of the UK non-life run-off market as at the end of 2010, unless specifically described otherwise. As in our previous surveys, UK non-life business of companies established in other EU countries has not been included.

For the purposes of the survey, insurance companies classified as in runoff comprise those companies that have ceased to actively underwrite new business. Whether a company has ceased underwriting has been determined by reference to public announcements by the applicable companies or in the absence of such information, by application of a premium volume test. Due to the inherent delays in the reporting and accounting of financial transactions in non-life insurance business, and in particular reinsurance, premiums (including adjustment and reinstatement premiums) may continue to be received long after a company ceases underwriting. Nevertheless, premium income will, in general, reduce substantially shortly after a company ceases underwriting.

Conversely, run-off at Lloyds comprises liabilities of open syndicate years in respect of underwriting years from 1993 to 2008 inclusively. A syndicate year remains open until its business is fully concluded or is transferred to another syndicate or insurer. Underwriting years 2009 and 2010 are not included as open syndicate years; under Lloyds Bye Laws, a syndicates results are not finally determined until at least two years after the end of each underwriting year.

Lloyds is not an insurance company but a society of members, both corporate and individual, who underwrite in syndicates, on an annual joint venture basis.

Unless otherwise stated, liabilities are expressed gross of reinsurance.



1.1 Current size The UK non-life run-off market can be divided into four distinct components The gross liabilities of the UK non-life as shown in Table 2.

run-off market in 2010 were 27.1 billion (a nine percent reduction from 29.7 billion in 2009) representing approximately 13 percent of the non-life market as a whole, as shown in Table 1.

Table 1: Size of the UK non-life market

Total liabilities Percentage share Technical provisions Percentage share As at end of 2010

( billion) of market ( billion) of market

Active market 179.2 87% 141.4 86%

Run-off market 27.1 13% 22.8 14%

Total 206.3 100% 164.2 100% Source: A.M. Best Bests Statement File UK, KPMG LLP (UK) 2011, Lloyds

Table 2: Main components of the UK non-life run-off market

As at end of 2010 Total liabilities

( billion) Percentage share

of market Technical provisions


of market

Solvent company run-off 12.2 45% 10.3 45%

Insolvent company run-off 9.0 33% 6.6 29%

Equitas (Lloyds 1992 and prior) 4.9 18% 4.9 22%

Lloyds (1993 onwards) 1.0 4% 1.0 4%


The principal drivers of the nine percent reduction in size of the run-off market in the year to 2010 are:

The elimination of syndicate open years in the Lloyds market from 18 in 2009 to 10 in 2010 through the Reinsurance To Close (RITC) process; and

Continuation of downward management of run-off insurance liabilities.

As we have previously reported, there is a strong correlation between the size of the run-off market and the UK sterling: US dollar exchange rate because of the large proportion of liabilities that arise from claims originating from the US.

During 2010, UK sterling depreciated by three percent against the US dollar, the smallest annual change for three years. Consequently, the size of the run-off market is not distorted materially this year by exchange rate movements.



1.2 Change in size Since 2004, the traditional UK non-life run-off market has shrunk steadily apart from one exceptional year when run-off liabilities spiked in 2008 as a result of the financial crisis and its impact on specialist monoline insurers (see Figure 1).

With the exception of Lloyds the UK non-life run-off market has become very mature, consisting mainly of long tail liabilities arising from latent claim exposures.

Technical provisions for these liabilities will remain for some time as the pattern of claims presentations is a slow trickle as opposed to a flood: asbestos related claims are expected to drip feed into the market for up to 40 or 50 years; environmental cleanup takes many years; professional indemnity and D&O/E&O claims may take several years to resolve through protracted negotiations. Accelerated run-off tools are not appropriate for some of these claims especially if they are still immature or are covered by compulsory insurance. Liabilities will also remain on the books of insurers and reinsurers who elect to take a long term approach to claims handling, dealing with claims as they are presented.

Companies which have adopted a more aggressive, shorter term runoff strategy have continued to make progress. Many businesses have been closed, or will close within the next three years to take advantage of proposed transitional exemptions from Solvency II for run-off companies 4.

Has the size of the run-off market stagnated, despite the advancements made in run-off expertise and exit mechanisms? We consider the future prospects for the UK non-life run-off market later in our survey.

Figure 1: Change in size of UK non-life run-off market3

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Insolvent company run-off

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Equitas FX Rate

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UK, KPMG LLP (UK) 2011, Lloyds

3 The total liabilities for Equitas for 2003 2005 (year end 31 March 2004 2006) are discounted values taken from its audited financial statements. Thereafter, Equitas presented its results on an undiscounted basis. The undiscounted liabilities for prior years were: 2004 7.7 billion, 2005 6.4 billion, 2006 6.4 billion.

4 Omnibus II Directive



2. Company market

2.1 Solvent market The largest component of the UK non-life run-off market is solvent company run-off.

2.1.1 Change in size At the end of 2010, the solvent company run-off market had total liabilities of 12.2 billion.




of market Technical provisions


of market



Equitas (Lloyds 1992 and prior) 4.9 18% 4.9 22%

Lloyds (1993 onwards) 1.0 4% 1.0 4%


This sector accounted for 45 percent of the total liabilities of the UK non-life run-off market (2009: 45 percent). The change in the size of the solvent run-off market since 2004 is shown in Figure 2.

Figure 2: Change in the size of the solvent run-off market

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Solvent company run-off

Source: A.M. Best Bests Statement File UK, KPMG LLP (UK) 2011 2011 KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.


The solvent run-off market has reduced in size by nine percent in 2010; total liabilities have decreased by 1.2 billion.

The decrease has been driven largely by favourable prior year claims development and the continuation of downward management of run-off insurance liabilities.

The reduction would have been greater but for a large run-off entering the market in the period under review: HSBC Insurance (UK) Limited. As at the end of 2010, its total liabilities were approximately 380 million, comprising entirely motor insurance business. The company has since been sold to Syndicate Holding Corp in 2011. Two smaller run-offs have now also been included in our statistics as a result of these legacy portfolios being sold by live operations to Enstar 5.

5 In March 2010, Enstar acquired British Engine Insurance Limited, a subsidiary of RSA Insurance Plc. This company has been renamed as Knapton Insurance Limited. In May 2010, Enstar acquired a portfolio of legacy business from Mitsui Sumitomo Insurance Company Limited. The acquiring vehicle is Bosworth Run-Off Limited (50.1 percent owned by Enstar).



2.1.2 Capital At the end of 2010, total capital tied up in solvent UK non-life companies in run-off was approximately 3.9 billion (2009: 4.2 billion), excluding Lloyds vehicles and companies with run-off portfolios that are combined with other live business.

The net assets figure as calculated for regulatory solvency purposes is 2.7 billion (2009: 3.2 billion).

The overall decrease in trapped capital in 2010 is driven by multiple reasons. Companies continue to run-off liabilities proactively and in a number of cases have extracted surplus funds through the payment of dividends or capital reduction. Meanwhile, there have been a small number of new run-offs included in our analysis, in respect of business that has recently been discontinued or has otherwise become visible as a result of disposal by a live operation.

Table 4: Capital tied up in the solvent run-off market

2004 2005 2006 2007 2008 2009 2010 ( billion) ( billion) ( billion) ( billion) ( billion) ( billion) ( billion)

Capital in solvent companies 4.0 4.8 4.9 4.6 5.4 4.2 3.9 Source: A.M. Best Bests Statement File UK, KPMG LLP (UK) 2011

Efficient and innovative capital reduction strategies are incredibly important to run-off companies and their investors.

Plans to achieve capital efficiency via group restructuring in preparation for the imminent implementation of Solvency II have continued during 2011. For example there are very large internal reorganisations being proposed by Aviva, RBS Insurance and RSA groups by means of a series of Part VII transfers.

For the time being, the effects of Solvency II on capital have yet to be felt by the run-off market. This is discussed further in the Section 2.1.3: Management of discontinued business.



2.1.3 Management of discontinued business

Run-off strategy Since we started this annual survey in 2003, with the assistance of the tremendous insight from participating run-off executives we have observed a number of significant changes to the nature of the UK run-off market and companies approach to the management of their discontinued operations.

The strategies adopted by run-off companies have changed in response to market events; to changes in regulation; to the state of the worldwide economy; and from the development of run-off expertise and tools available to assist with the management and closure of legacy business.

The size of the run-off market has shown a small decline, and a number of survey respondents expect it to continue to shrink slowly in the future. It would appear that the opportunities available, in the London Market in particular, for short term rewards have been largely exploited. The long term hold appears to be the strategy of choice for the owners of the liabilities in the UK non-life run-off market. Aside from the monoline casualties of the 2007/8 financial crisis, over 70 percent of the liabilities in solvent run-off in the UK now reside with companies that appear to have adopted a longer term strategy for their run-off. These liabilities are principally held with organisations that are managing an orderly run-off of their business in house, have obtained stop loss reinsurance cover or are with



Some run-off companies may need to change their strategies if these conditions persist

Alan Quilter, R&Q

run-off acquirers whose objectives are to make greater returns over the longer term from investment income, and from savings in claims and administration costs.

The longer term strategy relies on balance sheet strength to withstand any volatility or escalation in latent claims and on future investment income being sufficient to cover run-off costs, borrowing costs on finance used for acquisitions and annual dividend expectations from investors. This strategy is coming under threat from a number of sources.

Depressed investment values and yields continue to put pressure on companies to find alternative ways to support and justify the longer term strategy. In addition, monetary policy and inflationary pressures are increasing run-off and claims costs. If this situation continues, which is a genuine possibility given the looming threat of a double-dip recession, then pressure on cost control and cash flow management will increase and, according to Alan Quilter, Chief Operating Officer of R&Q, some run-off companies may need to change their strategies if these conditions persist. John Wardrop, Partner, KPMG in the UK states these conditions have led to improved cash flow management, but there is plenty of room for companies to improve their practices still further.

Cost reduction Run-off companies continue to look for ways to reduce costs. Many of our survey respondents spoke of their review of outsourcing options for certain functions of their business. Will Bridger, Managing Director Acquisitions at Compre, says that some functions are outsourced currently in order to keep cost efficient, although this situation also has to be monitored from a risk management perspective.

Jason Richards, Managing Director - Claims, Accounting and Liability Management at Swiss Re, is one of a number of respondents seeking to reduce the administrative burden of run-off and cut claims costs in particular: Because Swiss Re has transparency on its costs, we know that run-off costs are huge. Swiss Re is trying to get the industry to improve market practice with regard to claims. Legacy claims represent the majority of all of our claims and accounting activity and a market-wide initiative would improve efficiency.

The environment for service providers is equally tough. While Bridgers comments with regard to outsourcing above may suggest a little hope for service providers, he tempers those comments somewhat: there is little net new business to be outsourced; everyone is competing for the same contracts. The owners of the significant liabilities in run-off are largely dealing with their run-off in-house and, as predicted in our previous survey, the difficult conditions for service providers to the UK run-off market has led to continued consolidation. This is considered further in the Section 2.1.4.3: Mergers and acquisitions.



The practice of run-off Within the UK, we are starting to see a necessary transformation in the practice of run-off. Klaus Endres, Head of Business Development and Acquisitions at AXA Liabilities Managers, notes that the UK has a wealth of experience and useful run-off tools but its market is mature and shrinking. The expertise gained in London is highly valued and there are opportunities in active insurance groups for consulting and specific roles for run-off practitioners. We have observed a growing acceptance of run-off on the Continent and many large groups have created the position of Head of Run-off.

In addition, a number of larger groups have already created, or are in the process of considering, a run-off centre of excellence for the management of legacy business across the group. Run-off is increasingly becoming a cost or profit centre in large groups who are keen to access the benefits that focused management of discontinued lines of business can generate. It is anticipated that many of these centres of excellence may either be located in the UK and/or will feature UK run-off practitioners in prominent positions within them.

Simon Hawkins, Head of Run-off at QBE European Operations in London, comments that his role is quite different to that of management of a pure run-off company. The initial challenge is to define what run-off means and then embed the priorities of run-off management within the organisation. He suggests that run-off will become an integrated part of how a company approaches claims and liability management generally.

The UK has a wealth of experience and useful run-off tools but its market is mature and shrinking.

Klaus Endres, AXA Liabilities Managers



Solvency II As discussed in the Foreword, the greatest challenges currently facing the global insurance market are the risks posed by the burden of changes to regulation. The UK run-off market is no different; all of our survey contributors testify to the significant resources in their firms devoted to preparing for Solvency II. Those respondents who sit within larger active underwriting groups appear to have been far less affected by all the work that is being undertaken with regard to Solvency II. Although the principle of proportionality set out in the Solvency II Directive discussed further at the end of this section should reduce the burden of full implementation on pure run-off companies/groups, it still occupies the focus of run-off executives. According to Luke Tanzer, Managing Director of RiverStone UK, it places a significant strain on resource, particularly for those smaller companies needing or wanting to obtain Internal Model approval.

For some, however, there appears to be a silver lining. Simon Hawkins says that Solvency II is driving a number of significant projects across QBE European Operations on data and management information, which has already increased the quality and availability of legacy data, thus improving decision-making for run-off portfolios. Ken Randall, Chairman and CEO of R&Q agrees, but with a note of caution: there are concerns that some of this effort may go to waste and the full benefits of Solvency II will not be realised by run-off companies. He continues, the FSA has given little guidance on how Solvency II should be applied to run-off companies and that makes it more difficult to plan ahead. We are not being given much warning.

Some elements of Solvency II are already familiar to UK companies and should, therefore, be more straightforward to implement. The quantitative analysis required under Pillar 1 for example, has been rehearsed

for a number of years through the Individual Capital Assessment process introduced by the FSA in 2004. Some respondents, however, pointed to different approaches appearing to be taken by different regulators. Klaus Endres observes that the Continental European experience generally is that, except for the largest insurance groups, the standard formula approach is encouraged by regulators, whereas in the UK, the FSA seems to prefer that firms develop bespoke internal models. However, the principle of proportionality remains open to question and is still being grappled by regulators, firms and consultants.

Philip Grant, Chairman of Ambant, believes that Pillar 2 [governance and management] is currently the neglected pillar, with most attention having been focused on the more quantitative components of Pillar 1. In our view, continuing compliance with Pillar 2 will prove to be the most enduring Solvency II challenge for UK insurers.

Pillar 3, largely relating to reporting requirements, is already driving a number of significant projects in the runoff arena. The proposed Part VII transfers for RSA and Aviva, for example, both discussed in Section 2.4.1.2 are driven by Solvency II and will address a number of Pillar 3 considerations.

A revised draft of the Omnibus II Directive with regard to transitional arrangements for insurance companies in run-off under Solvency II may be the source of some comfort going forwards. The draft currently envisages full exemption from Solvency II requirements for run-off companies that can show they plan to close within three years of the implementation of Solvency II, or five years if that process is conducted under a formal reorganisation measure or winding up. Companies that are part of a group will not be able to avail themselves of this exemption unless the entirety of the group has also ceased writing new insurance business.

Mike Walker welcomed the draft directive. The run-off sector has been lobbying for Solvency II concessions for some time, arguing that the costs of implementation are disproportionate for their businesses. There will be run-off companies that will still need to comply with Solvency II and it is also not clear what additional evidence supervisors will require to support the progress that is being made towards terminating activity. However, the new transitional arrangements will clearly be welcomed by the vast majority of the run-off sector. As a consequence of the new provisions we are also likely to see run-off entities revisiting schemes of arrangement and other finality options in an effort to benefit from the new run-off exemptions.

The full benefits of Solvency II will not be realised by run-off companies.

Ken Randall, R&Q



2.1.4 Exit solutions

While run-off executives have been focusing heavily on the challenges outlined in the previous section, exit mechanisms have continued to be used for discontinued business. These include solvent schemes, Part VII transfers and sale.

2.1.4.1 Solvent schemes

Schemes continue to be a popular mechanism for companies to achieve finality. Table 5 plots the number of solvent schemes of UK insurance businesses over time, both by entity and by pool/business portfolio, represented by the calendar year in which the schemes became effective. There have been a total of 251 solvent schemes for individual entities to the end of 2010, an increase of 24 on 2009. This is a result of the schemes for the English & American Underwriting Agency Pools (EAUA Pools), the Camomile Pool and for Minster Insurance Company Limited and its related business. When considered on a pool or portfolio basis, the 2010 year end aggregate total is 59 (2009: 56).


Table 5: Solvent schemes of UK non-life business

Number of solvent 2004 2005 2006

schemes and prior 2007 2008 2009 2010 Total

By entity 30 24 9 27 87 50 24 251

By pool/portfolio 20 7 9 10 6 4 3 59

Source: KPMG LLP (UK) 2011


There is a continuing appetite for using schemes of arrangement to achieve finality especially as a means to close complex underwriting pools. The scheme mechanism offers an attractive option for both pool participants and pool creditors to terminate their relationships en-masse. The alternative is likely to be either individual commutations between each relevant pool member and each creditor which can be very time consuming, costly and administratively burdensome to complete (even if possible), or continuation of the pool run-off, which again can involve a disproportionate administrative effort for the values involved for each party. Mike Walker

continues to see interest from pool participants for exit solutions and the experience we have now gathered from promoting the successful pool schemes for the WFUM pools, the EW Payne pools, the Trimark pools and the largest pool scheme to date for the EAUA pools, has been invaluable in being able to provide clients with practical and well thought through propositions.

Many solvent schemes have included UK business of overseas companies and the mechanism is seen as a useful tool for such companies which do not have similar provisions within their own jurisdictions.

Table 6: Changes in total assets and total liabilities following bar dates for UK companies subject to solvent schemes6

As at end of 2010 Total assets

( million) Total liabilities

( million) Net assets ( million)

Year end immediately preceding bar date 1,652 802 850

Latest audited balances following bar date 1,112 164 948

Increase/(reduction) (540) (638) 98

Increase/(reduction) (33%) (80%) 12% Source: KPMG LLP (UK) 2011

The USA has had provisions since 2002 in the State of Rhode Island for the restructuring of solvent insurers. These provisions share many similar features to UK schemes although they are more restrictive in their application. It was not until 2010, however, some eight years after the legislation came into effect, that the first US insurer, GTE Reinsurance Company, applied successfully to use the provisions. Observers will follow the implementation of the GTE scheme with interest to see whether this begins a trend followed by other US insurers.

Table 6 highlights the change in assets and liabilities of UK companies subject to solvent schemes by comparing year end results before and after the respective scheme bar dates.

Our analysis reveals that UK solvent schemes with a 2010 or prior bar date have generated an increase in net worth of approximately 98 million after the elimination of 638 million (or 80 percent) of their liabilities. On a relative basis the increase in net assets (or net worth) of these businesses following the launch of the scheme averages 12 percent (2009: 11 percent).

For the purpose of verification, the analysis of solvent schemes is restricted to accounts filed for solvent schemes of UK companies with bar dates falling on or before 31 December 2010 and excludes companies where only certain parts of the business have been subject to a scheme. Non-UK companies have been excluded from the analysis. As a result of the limitation in the scope of this analysis a number of solvent schemes have been excluded. However, the impact of all solvent schemes on the liabilities of UK companies is reflected in the overall size of run-off as at the end of 2010.


6


2.1.4.2 Part VII transfers and reinsurance

From December 2001, when the Financial Services and Markets Act 2000 took effect, to the end of 2010, there have been 96 Part VII transfers of non-life portfolios, of which 50 involved predominantly or entirely business in run-off (see Table 7).

Of the seven Part VII transfers of nonlife business in 2010, there were two external Part VII transfers of legacy business to third parties. Tenecom (part of the Berkshire Hathaway Group) acquired a run-off portfolio from Aviation & General Insurance Company and Enstar acquired a run-off portfolio from Mitsui Sumitomo Insurance Companys UK Branch.

The remaining five Part VII transfers were all used for the purpose of internal group reorganisation and maximising capital efficiencies. Of these, two portfolios held by UK insurers were transferred to UK branches of overseas group companies and as a result will no longer be regulated directly by the FSA.

Table 7: Number of Part VII transfers in the UK non-life insurance market

Dominant 2004 2005 2006 2007 portfolio and prior

2008 2009 2010

Active 11 12 7 6 5 4 1

Run-off 7 4 13 9 7 4 6

Total 18 16 20 15 12 8 7

Cumulative 18 34 54 69 81 89 96 Source: KPMG LLP (UK) 2011, Sidley Austin LLP

Part VII transfers continue to be used as a tool for the reorganisation of run-off liabilities, something which has become more and more important as the implementation of Solvency II draws nearer. Although activity in 2010 was relatively consistent with 2009, 2011 has been a very busy year. RSA, RBS Insurance and Aviva have all recently proposed to reduce substantially the number of regulated entities in their UK group structure by means of a series of Part VII transfers. This has been driven by planning for Solvency II, to achieve greater simplification of reporting and governance, to achieve significant administrative cost savings and to maximise capital efficiencies.

More internal restructuring of insurance groups by means of Part VII transfer is expected before the implementation of Solvency II. By that time, we anticipate that the total number of UK authorised non-life insurance companies will have reduced considerably.



2.1.4.3 Mergers and acquisitions Insurance companies The level of sales activity for either insurance companies in run-off or run-off portfolios was quite buoyant in 2010, although it appeared to slow in 2011. This follows a period of prolonged activity which commenced in 2008. This lack of recent sales activity should not, however, be viewed as an indicator that the run-off sector is currently inactive or that it is not restructuring or developing in line with market or regulatory developments. Indeed, as discussed above, there has been considerable internal restructuring through the use of Part VII transfers. This internal restructuring has inevitably forced these groups to look more closely at the composition of their business, and in particular their run-off business, as well as its ongoing

structure and management. It remains to be seen, however, whether this will ultimately lead to more external sales of portfolios or other restructuring, such as schemes of arrangement, to achieve finality as the groups determine whether or not maintaining such business is a disproportionate burden in terms of management and capital requirements.


Table 8: UK M&A transactions in 20107

Purchaser Target Date Purchase price Liabilities (excluding

capital and reserves)

Net assets/ (liabilities)

Enstar British Engine Insurance March 2010 28.8 million 159.5 million as at 31 December 2009

35.1 million as at 31 December 2009

R&Q La Licorne Compagnie de Reassurances

April 2010 3.2 million 8.3 million 3.7 million

Berkshire Hathaway Scottish Lion April 2010 Undisclosed 46.1 million 12.3 million

Enstar Mitsui Sumitomo Insurance Company UK

Branch run-off portfolio

May 2010 Undisclosed US$117.5 million

Compre London & Leith Insurance Company

June 2010 2.4 million 0.5 million 4.2 million

Tawa Island Capital August 2010 US$7.4 million initial consideration

US$20.6 million US$28.1 million

up to US$40.0 million deferred

consideration

Global Re Aviation & General Insurance Company

Canadian Run-off portfolio

September 2010 Undisclosed Not available Not available

Berkshire Hathaway Aviation & General Insurance Company

Run-off portfolio

December 2010 Undisclosed Approx. 0.6 million Approx. 0.6 million

Tawa Oslo Reinsurance (UK) December 2010 4.0 million 2.8 million as at 31 December 2010

5.2 million as at 31 December 2010


7 This table includes all those acquisitions that we have identified where either the purchaser or the acquired company or portfolio is UK based.

Table 9: UK M&A transactions in 20118

Purchaser Target Date Purchase price Liabilities (excluding

capital and reserves)

Net assets/ (liabilities)

Milestone Capital Partners

Investment in acquirer Compre

February 2011 Undisclosed 60.4 million 23.0 million

Swiss Re Zurich Specialties London

June 2011 Book value US$950 million

Syndicate Holding Corp.

HSBC Insurance (UK) July 2011 68.5 million 377.4 million 97.0 million



Although the number of sales transactions has been relatively low since we last reported, so far in 2011 there have been two large deals. Zurich Financial Services Group sold the bulk of its run-off company, Zurich Specialties London, to Swiss Re at book value and this included liabilities totalling some US$950 million. This follows Zurichs stated strategy to divest its non-core business and release and redeploy the associated capital (estimated to total approximately US$360 million over time). HSBC sold HSBC Insurance (UK) to Syndicate Holding Corp. Unlike many disposals of traditional run-off portfolios, HSBC Insurance (UK) is a motor insurer that went into run-off in 2009. Motor insurance has been a troubled area for many insurers in recent years and there have been several sales of live portfolios as some operators have sought to withdraw from the market. Given the continued difficulties in the motor market it would not be surprising if the HSBC transaction is the forerunner of other similar deals in this area.

Despite the relatively small number of transactions in 2011 most of the major run-off acquirers or consolidators are still active in the market and they report that they are looking at many opportunities. Nigel Rogers, CEO of RITC Syndicate Management, comments that their challenge is to find a business that meets their requirements and even then a lot of due diligence is required before a decision is made. He adds that its a case of kissing a lot of frogs before

finding the prince. Luke Tanzer agrees many of the most attractive targets have already been sold or reinsured to close and the remainder have smaller expected margins. This requires a thorough approach to due diligence and disciplined pricing of acquisitions. Most commentators believe that there are opportunities out there but target selection and pricing must be right.

Although there are still numerous parties who express interest in acquiring run-off business, there are in reality only a few players who can actually consummate a deal, especially a larger transaction requiring substantial funding. The funding challenges facing run-off acquirers are recognised by the banks which are generally taking a more cautious approach in the wake of the banking crisis. Paul Johnson, Director Insurance, Barclays Corporate reports that Barclays continues to have appetite for leveraged finance in this sector. Management must have credibility, a proven track record in generating good returns on captital, and an ability to bring equity backing to potential acquisitions.

Nevertheless, Ken Randall comments that although they have the capital to support larger acquisitions, the competition for these (amongst the serious players) is stronger. Nigel Rogers believes that there is limited competition in the market but what there is can be quite damaging. There only needs to be one person doing the wrong business to ruin it for everyone

else and some are overpaying. Will Bridger of Compre believes most opportunities will in future derive from the Continental European market and further that they will take the form of portfolios rather than companies. He adds a word of warning, however, that to be able to get work in Europe you need to be based there its a case of local people managing local business. The key is understanding the local market and culture.

The international theme is an important one as most of the larger UK run-off consolidators and providers have expanded their operations into overseas markets in recent years. They all recognise the need to expand their service offering and this has taken the form of extending the breadth of services into both the live and run-off markets as well as geographic spread. Different organisations favour different international markets, but Continental Europe, USA and the traditional offshore captive centres are currently the most popular. Few, if any, of the UK-based run-off operators have so far ventured into Asia, the Middle East, Africa or South America.

Its a case of kissing a lot of frogs before finding the prince.

Nigel Rogers, RITC Syndicate Management


8 This table includes all those acquisitions that we have identified where either the purchaser or the acquired business is UK based.


Consolidation across the European market will accelerate in the light of Solvency II.

Jason Richards, Swiss Re

On the Continent the run-off market is large but still partially immature, experience and tools are currently being developed. In the USA, the market is huge but run-off transaction tools are limited and there are barriers to entry.

Klaus Endres, AXA

Management must have credibility, a proven track record in generating good returns on captital, and an ability to bring equity backing to potential acquisitions.

Paul Johnson, Barclays

Klaus Endres identifies some of the challenges of venturing overseas by commenting that on the Continent the run-off market is large but still partially immature, experience and tools are currently being developed. In the USA, the market is huge but run-off transaction tools are limited and there are barriers to entry. Nevertheless, Jason Richards expects that consolidation across the European market will accelerate in the light of Solvency II.

The need to diversify has been a common theme among many run-off operators. Alan Quilter comments that R&Q established a strategy a few years ago to diversify the group and believes now that this positions them well for opportunities that flow from changes in the market and the underwriting cycle. Philip Grant adds that there is still over-supply in the service provider market for traditional run-off business and that their response has been to diversify into non-traditional legacy and live business areas, where margins are better and competition is less suicidal. He concludes that the answer lies in diversity and that they aim to reduce their dependence on London and look to the UK provincial market for sources of business.

As in prior years the activity that has taken place has led to a further concentration of insurers in run-off being owned by several run-off market consolidators. Virtually all the acquisitions noted in Table 8 and Table 9 were made by recognised run-off acquirers.

Based on the technical provisions at 31 December 2010, the economic interest in over 44 percent of the total UK solvent run-off is now owned by recognised market acquirers. Berkshire Hathaway is the largest with over 37% of the solvent company market including Equitas, which is currently

still the largest run-off. In addition over 70 percent (2009: 65 percent) of the total is now owned by six groups, three of which are monoline insurers which collectively represent over 15 percent (2009: 15 percent) of the market.

It is difficult to determine from the published details of sale transactions that have taken place whether the decline in prices (relative to the value of net assets acquired) identified last year has continued. This is because only limited financial details have been provided for many of the deals but the indicators are that prices achieved are continuing at a level equating to a slight discount to net asset value.

The implementation of Solvency II was anticipated to trigger a growth in the amount of M&A activity in the run-off market. As mentioned previously, however, this has not yet materialised but it has been a catalyst for internal reorganisation and it is still possible that M&A activity will increase as we get closer to Solvency II. The nearer the implementation date, the more the market is likely to move in favour of the buyer as either an increase in the supply depresses prices or advantage is taken of stressed sellers. Time will tell if this proves to be the case but this may in part depend upon the sanctions the FSA may impose on any authorised insurers who fail to comply with Solvency II.



Service providers As in prior years there has continued to be consolidation in the run-off service provider market and several deals were concluded in 2010/11.

Table 10: UK Broker and service provider transactions in 20109

Purchaser Target Date Purchase price Net assets/ (liabilities)

R&Q JMD Specialist Insurance Services January 2010 2.0 million 0.2 million

R&Q Reinsurance Solutions September 2010 US$10.0 million -

R&Q Excess & Treaty Management Corporation September 2010 $1 on a debt free basis

-

Senator Insurance Warrior Square Recoveries Services

October 2010 (0.3) million (0.1) million


Table 11: UK broker and service provider transactions in 20119

Purchaser Target Date Purchase price Net assets/ (liabilities)

Tawa Chiltington International September 2011 Undisclosed 0.8 million

Tawa/Skuld/Paraline Whittington Insurance September 2011 consortium Markets

Undisclosed 0.7 million


I dont see how some smaller businesses can survive in the current economic and regulatory environment.

Ken Randall, R&Q

Details of the acquisitions which we have identified are detailed in Table 10 and Table 11. The acquisitions have tended to broaden the range of services of acquirers. This diversification provides benefits by expanding the markets available to the service providers while also allowing cost savings through integration in areas such as systems, offices and personnel. There is also the attraction for some smaller service providers to join larger groups as this provides more security while also mitigating the increasing regulatory burden they are currently facing. Ken Randall comments that he doesnt see how some smaller businesses can survive in the current economic and regulatory environment.

Although further consolidation and diversification within the main service providers is likely to continue, there will inevitably be periods of less activity while previous acquisitions are fully integrated and the benefits of acquisitions can be realised. As in all areas of business some deals will prove to be better than others but the value that can be achieved is largely dependent upon how well the key personnel are incorporated as this is usually the major asset of any service business. The challenge is, therefore, to develop opportunities while still retaining staff morale and maintaining or improving existing client service and goodwill.


9 This table includes all those acquisitions that we have identified where either the purchaser or the acquired business is UK based.


2.2 Insolvent market In this survey, the insolvent run-off market comprises the liabilities of both failed UK insurers and the cost to the industry as a result of these failures through the Financial Services Compensation Scheme (FSCS).

2.2.1 Size The insolvent company element of the UK non-life run-off market continues to be a significant component of this sector.

The insolvent run-off market marginally decreased in size from 9.1 billion in 2009 to 9.0 billion in 2010.

The size of the insolvent market is unlikely to change significantly until the larger estates finally close or unless reserving for APH losses is significantly revalued. During 2010 one of the largest insurance insolvencies, English & American Insurance Company Limited successfully launched a cut off or

closure scheme of arrangement for the vast majority of its business.

A change will occur of course if there are significant new insolvencies, of which there were none in the year.

The largest insurance insolvencies that remain Chester Street Insurance Holdings Limited, Independent Insurance Company Limited and BAI (Run-Off) Limited all have significant exposures to direct asbestos claims arising under protected policies10. There is little prospect of these estates closing until a solution is agreed with the FSCS, which will eventually take over the runoff of protected business.


As at end of 2010 Total liabilities ( billion)

Percentage share of market

Technical provisions ( billion)

Percentage share of market



Equitas (Lloyd's 1992 and prior) 4.9 18% 4.9 22%

Lloyd's (1993 onwards) 1.0 4% 1.0 4%

Total 27.1 100% 22.8 100%

Source: A.M. Best Bests Statement File UK, KPMG LLP (UK) 2011, Lloyds

Tota

l lia

bili

ties

(

bill

ion

)

Figure 3: Change in the size of the insolvent UK non-life company run-off market 12

10 10.6 10.4 9.5 9.1 9.3 9.1 9.0

8

6

4

2

0 2004 2005 2006 2007 2008 2009 2010

Insolvent company run-off

Source: A.M. Best Bests Statement File UK, KPMG LLP (UK) 2011

10 Total liabilities of Chester Street, Independent and BAI (Run-Off) were approximately 5.6 billion at the end of 2010.



2.2.2 FSCS The insurance sub-scheme of the Financial Services Compensation Scheme (FSCS) and its predecessor under the Policyholders Protection Board (PPB) is funded (on a cash flow basis) by levies raised against active UK insurers plus recoveries from insolvent estates. The FSCS is a statutory fund for customers of authorised financial services firms from which customers may receive compensation if a firm is unable, or is likely to be unable to pay claims against it.

Levies raised and compensation payments made since 1990 in respect of non-life insurance are summarised in Table 13.

The total amount of compensation paid to protected policyholders of failed UK insurers in the year to 31 March 2011 was 61.6 million (2009: 59.8 million). The largest spend was in respect of employers liability claims against Chester Street Insurance Holdings Limited and compensation costs of this estate incurred by the FSCS in 2010/11 were 39.5 million.

In 2010/11, a levy of 43.9 million was charged to insurers compared with a levy of 66.7 million charged in 2009/10. This levy is calculated by taking into account the amount of compensation paid in the previous year plus an estimate of compensation to be paid in the following 12 months.

Table 13: Payments and levies by the FSCS and the PPB (non-life)11

Payments and levies Industry levy

( million) Compensation payments

( million)

PPB 1990-2001 341.5 418.7

FSCS 2001-2011 440.2 778.5

Total 781.7 1,197.2

Source: FSCS Annual Reports (2002-2011), PPB Annual Reports (1990-2001)

One of the largest casualties of the PPI market is Welcome Financial Services Limited, which was declared in default on 2 March 2011. To assist in its handling of claims, the FSCS arranged to use Welcomes claims-handling capabilities. KPMG advised Welcome on its restructuring which was achieved by means of a scheme of arrangement: KPMG was subsequently appointed as the Scheme Supervisor. The Welcome scheme provides for payments to the FSCS to fund compensation and the associated costs for handling PPI claims in respect of policies sold on or after 14 January 2005.

The FSCS has been more active in 2010 compared to previous years dealing with claims against non-life intermediaries, particularly compensation for mis-selling of Payment Protection Insurance (PPI). Almost all of the new claims in the General Insurance Intermediaries subclass relate to PPI. Total compensation paid in the year to 31 March 2011 was 35.8 million (2009/2010: 12.3 million).

The FSCS has forecast that claims will increase and in 2010/2011 a levy of 57.2 million was charged to the market (2009/2010: 8.0 million).

11 Analysis excludes recoveries from insolvent estates.



2.3 Equitas


Whilst we do not chart specific company details from the UK non-life run-off company market in our survey, Equitas, as the largest single component, is worth individual comment.




of market (%) Technical provisions


of market (%)




Lloyd's (1993 onwards) 1.0 4% 1.0 4%



In March 2007, Equitas entered into a transaction by which Equitas liabilities were reinsured by National Indemnity Company, a member of the Berkshire Hathaway Group. The second phase of the transaction, the Part VII transfer of the original liabilities to another Equitas special purpose vehicle, Equitas Insurance Limited, was completed in June 2009 and means that Members at Lloyds are no longer liable under English and EEA law for any future claims by policyholders on their 1992 and prior business. Resolute Management Services Limited is responsible for the management of run-off for Equitas Insurance Limited.

Figure 4 shows the reduction of the liabilities of Equitas run-off since its inception. Equitas total liabilities have reduced by 0.4 billion in the year to March 2011 to 4.9 billion (2009: 5.3 billion). The reduction in these reserves has been driven by claims payments, as well as exchange gains during the financial year: its technical provisions are largely denominated in US dollars. This trend is consistent with movements in prior years.

Resolute Management Services Limited reported revenues of 28.4 million in the year to March 2010 (2009: 33.6 million). There is a continuing downward trend in headcount: the average number of staff for the year ended 31 March 2010 was 133 (2009: 157).

Figure 4: Development of run-off at Equitas

18 1000

16 900

14 800

ion

)

12700

ber

)

bill 600

10 (nu

m

s ( 500 t

ie 8 un

ilit

400 co

ota

l lia

b 6 300

Hea

d

T

4 200

2 100

0 0 1998 1999 2000 2001 2002 2003 2004 2005 2006

Claims discount Reinsurance discount

Discounted liabilities Discounted reinsurers share of technical provisions

2007 2008 2009 2010 2011

Headcount

Undiscounted liabilities, wholly reinsured

Source: Equitas Limited accounts (1998-2011) and Resolute Management Services Limited accounts (1998-2010)



3. Lloyds of London

In existence as new Lloyds since 1993, the markets discontinued business is largely free of the APH liabilities that plague the company market.

3.1 Run-off at Lloyds The Lloyds market is currently the smallest component of the UK non-life run-off sector. Lloyds defines liabilities in run-off being those attributable to syndicate underwriting years that remain open, having not been closed via Reinsurance to Close (RITC).This survey has also consistently applied this definition in reporting run-off liabilities at Lloyds.


As at end of 2010 Total liabilities Percentage share Technical provisions Percentage share ( billion) of market ( billion) of market




Lloyd's (1993 onwards) 1.0 4% 1.0 4%


At the end of 2010, the total liabilities of Lloyds non-life insurance syndicates in run-off were 1.0 billion (2009: 1.9 billion) across 10 open syndicate years (2009: 18 open years). The gross technical provisions of Lloyds open year syndicates have decreased by 0.8 billion over the year.


Tota

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bili

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(

bill

ion

)

Tota

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mb

er o

f sy

nd

icat

e o

pen

yea

rs

Figure 5: Change in the size of the Lloyds non-life run-off market

8.0 120

7.0 100

6.0 7.2 7.5 80

5.0

5.2 19.7

4.0 60

3.0 2.9 40

2.0 2.5

20 1.0

1.9 1.0

0 0 2004 2005 2006 2007 2008 2009 2010

Lloyds liabilities Number of syndicate open years


Non-life run-off liabilities at Lloyds totalling 1.5 billion were removed during 2010 through RITC transactions involving nine syndicates and 16 years of account, leaving 0.4 billion held in open years. The balance of run-off liabilities at the end of 2010 of 0.6 billion is made up of four syndicates new to our survey, whose 2008 year of account remained open.

The RITC process, revitalised since 2006 following a relaxation of the rules on the treatment of RITC capital has proven to be a success. Most of the liabilities that comprised Lloyds runoff have been reinsured through RITC. Steve McCann, Head of Open Years at Lloyds, is pleased to report that all RITC vehicles have made money and those syndicates have been able to release profits and capital.

We have also assessed the liabilities at Lloyds that are not captured within its definition of run-off but that nevertheless related purely to inactive business. A reasonable estimate of this is the liabilities of the main RITC purchasers which have reinsured run-off liabilities.

As at 31 December 2010, there were approximately 1.5 billion (2009 1.1 billion) run-off liabilities held within active RITC acquirer syndicates, of which 1.3 billion represents gross technical provisions (2009: 1.0 billion).


Table 16: Reinsurance to close (RITC) transactions in 2010

RITC agent Former managing agent RITC transactions in 2010

Shelbourne Syndicate Services Limited Capita Managing Agency Limited Syndicate 5500 closed into Syndicate 2008

Flagstone Syndicate Management Limited (formerly Marlborough Underwriting

Limited)

Syndicate 1243 closed into Syndicate 2008

Shelbourne Syndicate Services Limited (internal RITC)


Capita Managing Agency Limited Travelers Syndicate Management Limited Syndicate 0340 closed into Syndicate 2255

RiverStone Managing Agency Limited Whittington Capital Management Limited Riverstone Managing Agency Limited

(internal RITC)

Syndicate 0376 closed into Syndicate 3500 Syndicate 3500 closed into Syndicate 3500

Novae Syndicates Limited Novae Syndicates Limited (internal RITC)

Syndicate 1007 closed into Syndicate 2007 Syndicate 1241 closed into Syndicate 2007

R&Q Managing Agency Limited R&Q Managing Agency Limited (internal RITC)


Source: Lloyds 2011


3.2 Management of discontinued business

Following reconstruction and renewal of the Lloyds market and the formation of Equitas, Lloyds effectively freed itself of exposures to traditional APH liabilities when it started business as new Lloyds in 1993. By that time insurance policy wordings in the London Market largely excluded cover for such claims, except in relation to compulsory employers liability insurance. Steve McCann has confirmed that the prohibition at Lloyds on taking on pre-1993 liabilities remains.

Consequently run-off at Lloyds has a much shorter duration compared to the company market. This reflects the strategy adopted by run-off players at Lloyds. According to Nigel Rogers, pricing [of acquisitions] is the key and our aim is to close claims quickly and early and crystallise profit. At the moment, interest rates and the investment environment remain low. While claims are still open there is

little gain to be made on holding investments longer. Close early and get your money out.

Solvency II remains a priority for Lloyds and the market is pressing ahead with plans for implementation on 1 January 2013 regardless of the proposed delay announced by the European Commission. Lloyds has issued guidance on implementation to all syndicates and Steve McCann advises that Lloyds expects 100% compliance with Solvency II by the market.

All syndicates including RITC syndicates have to meet this challenge. Extra resource and money is being spent trying to meet the Lloyds timescale, says Nigel Rogers. However, he questions the relevance of Solvency II to run-off and believes that run-off companies have little to gain from Solvency II; few of the outputs are useful.



4. Future prospects for the run-off market

There will always be run-off but the nature of run-off is changing.

The traditional run-off market (substantially comprising London Market APH liabilities) which largely emerged in the 1980s and 1990s is slowly being dealt with through a combination of schemes of arrangement, commutations and claim payments. However, there remains, as the survey reveals, a considerable value of run-off liabilities still on the books of UK insurers. Based on the current rate of erosion of these liabilities it can be expected that the run-off of these books will continue for some 20 years or more. Why is it then that, despite these recognised and now well used and understood techniques for accelerating run-off, there is still such a long tail?

Part of the answer lies in the regulatory and political environment. Certain liabilities such as those made under employers liability policies or other compulsory insurance classes cannot be accelerated. Other liabilities are held by insurers who have a strategy of maintaining the run-off over its natural life with no acceleration, in order to maximise investment returns on the matching assets. Some liabilities are held by insurers who are still not actively managing their run-off liabilities and finally there are liabilities which are tied up in insolvent estates where there are issues which may be delaying final payments to creditors. Clearly there are only certain components of this traditional run-off that are capable of acceleration, absent some change in legislation or regulatory provisions, but even these will require a change in approach or strategy from the relevant insurers. Accordingly it is likely that, notwithstanding efforts by many parties to accelerate and close down run-off portfolios, traditional run-off may continue for many years.

Traditional run-off is, however, gradually being replaced in part by new types of run-off. These tend to be shorter tail and are across various business classes and as a result have different characteristics. Current total run-off balances now include substantial reserves for monoline business as well as motor. Three or four years ago, these types of run-off would not have featured in the total run-off balances, or at least not to any material degree. The run-off industry is adapting to the changing face of run-off not only by adapting skills to deal with new types of run-off but also by diversification into other areas.

Solvency II has brought into sharp focus the need for insurers to fully manage the risks within their business and for them to apply appropriate amounts of capital to manage each of these risks. This approach means that liability management is now a central part of the risk management function of many insurers. The impact of this is that the definition of run-off is becoming much more blurred. Whereas in the past this tended to comprise mainly risks on policies which expired many years ago, nowadays many insurers include much more recent business within run-off, including in some instances non-renewed business (ie less than one year old). The impact of this can be positive as it can lead to techniques, skills and practices that have been developed in relation to traditional run-off being applied to more recent business.

This period of the UK run-off market has been neatly summarised by Graham Jackson, General Manager of IRB Brasil Resseguros S.A. in London, who suggests that the Golden Age of run-off is over. There will still be run-off of course, but with less distress.



5. Conclusion

The total size of the UK non-life run-off market decreased by approximately nine percent on the previous year and is now estimated at 27.1 billion of total gross liabilities at the end of 2010.

The UK non-life insurance market is levelling out and the bulk of it now looks set for the long haul.

Exit mechanisms continue to allow many books to be closed out early and profitably; those that remain are (or may soon be) owned by run-off acquirers seeking greater long term gains. That strategy is now under threat from two serious challenges facing the industry:

The imminent implementation of Solvency II has occupied significant management attention and corporate resources, as insurers seek to limit the burden of regulatory compliance and to maximise capital efficiency; and

Investment performance remains very low, putting pressure on run-off companies to cover their costs by making greater operational efficiencies.

Capital tied-up in (or net worth of) UK run-off companies has reduced as some companies have accessed this capital through commutation, release of reserves, schemes of arrangement or other exit solutions. Use of such tools will be critical to run-off investors going forward as they seek to extract value from run-off business.

Activity in the run-off acquisition market has been mixed. M&A is expected to increase as insurance groups refine their structures ahead of Solvency II. Unsurprisingly consolidation in the run-off services sector continues at a pace as service providers continue to adapt to the changing demands of the marketplace.



Acknowledgements We would like to thank all who contributed to the

production of this report, in particular:

Philip Grant, Ambant

Paul Corver, ARC

Klaus Endres, AXA Liabilities Managers

Paul Johnson, Barclays Corporate

Will Bridger, Compre Holdings

Graham Jackson, IRB Brasil Re

Simon Hawkins, QBE

Nigel Rogers, RITC Syndicate Management

Luke Tanzer, RiverStone UK

Alan Quilter, R&Q

Ken Randall, R&Q

Steve McCann, The Society of Lloyds

Jason Richards, Swiss Re



THE KPMG UK RTHE KPMG UK RUN-OFF SURUN-OFF SURVEYVEY: NON-LIFE INSURANCE | 37: NON-LIFE INSURANCE | 37


Chronicle of events 2010 Run-off transactions

R&Q acquires JMD Specialist Insurance Services

JAN

Asbestos working party revises UK asbestos liabilities estimates

Scottish Lion appeal overturns initial ruling

Judge rejects challenges in Scottish pleural plaque judicial review

Enstar and Allianz Global Corp & Speciality AG (UK) 100% quota share agreement

FEB

Government announces compensation for pleural plaque sufferers

Chilean earthquake

Minster scheme effective

Enstar completes acquisition of British Engine

MAR

Quinn Insurance Ltd (Ireland) ceases underwriting in the UK

R&Q acquires La Licorne

Berkshire Hathaway completes acquisition of Scottish Lion

APR

ABI announces establishment of ELTO

Iceland volcanic ash cloud

BP Deepwater Horizon oil spill

Enstar acquires Mitsui Sumitomo portfolio by Part VII transfer

DARAG acquires HVAG

MAY

FirstCity Insurance Group Limited in Administration

Compre acquires London & Leith Insurance Company

JUN

WTC respiratory suits settlement reached

Other events

2011


Run-off transactions Catalina Holdings acquires Glacier Re

Enstar purchases Clarendon Insurance from Hannover Re

JAN

Australian floods

Egypt Start of revolution

DARAG takes over the non-life portfolio of Quantum Insurance

Sompo Japan transfers UK branch to Transfercom

FEB

Government announces compensation for pleural plaque sufferers

Chilean earthquake

Libya Start of civil war

Milestone Capital Partners invests in Compre

MAR

Japan earthquake which triggers destructive tsunami

Syria Start of civil disorder

Liberty Mutual acquires parts of Irish insurer, Quinn

Goldman Sachs reinvests in Enstar, becoming the groups largest single shareholder

MAY

Tokio Marine Europe Insurance scheme becomes effective

NICO reinsures the bulk of Chartis (AIG) US asbestos liabilities

APR

Zurich Specialties agrees reinsurance by Swiss Re

Ageas transfers run-off portfolio to Swiss Re

JUN

Omnibus II directive proposes transitional exemption from Solvency II to run-off companies

Other events


Camomile Pool scheme sanctioned

JUL

Berkshire Hathaway agrees reinsurance of CNA asbestos liabilities

Scottish Lion judgement on disclosure of valuations for voting

R&Q acquires AM Associates Insurance Services

Tawa acquires Island Capital

Catalina Holdings acquires Western General Insurance

AUG

GTE Reinsurance commutation plan approved (Rhode Island)

Novae Part VII transfer scheme sanctioned

R&Q acquires RSL from Marsh

SEP

Pakistan flooding

Hurricane Igor

New Zealand earthquake (Christchurch)

Aviation & General transfers Canadian legacy portfolio to Global Re

Grafton Europe accepted transfer of legacy years liabilities from Morrison captive

EAUA Pools scheme becomes effective

OCT

QIS 5 submission deadline for solo entities

Alumina plant disaster, Hungary

Tawa announces partnership with Lincoln General in the US

NOV

USA storms and floods

Tawa purchases Oslo Reinsurance UK

Aviation & General transfers its remaining liabilities to Tenecom

DEC

Australian floods

Tunisia Start of revolution


HSBC sells HSBC Insurance (UK) to Syndicate Holding Corp

JUL AUG

Hurricane Irene

UK Riots

Highlands UK scheme sanctioned

Tawa, Skuld and Paraline consortium announces acquisition of Whittington UK

Tawa announces acquisition of Chiltington

SEP

Texas wildfires Typhoon Talas, Japan

OCT NOV DEC


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