R&Q has been a leader in the legacy space for over 25 years. To mark more than a quarter of a century in the business, Re-Insurance sat down with the group’s head of legacy M&A Paul Corver to understand what has changed in the market over that time.
What tools should a successful legacy acquirer have at its disposal?
PC: The bread and butter of our trade is the ability to acquire books of legacy business outright, whether they are from insurers, reinsurers or captive carriers. Firstly, that requires a strong balance sheet. But the secret is finding the right combination of mechanisms to suit the portfolio that’s being transferred. For example, for a book of Lloyd’s business, the run-off carrier needs a syndicate in order to undertake a reinsurance to close transaction – or RITC. Whereas in the company market they have more options including a loss portfolio transfer (LPT), novation and an amalgamation or merger. In Europe, a Part VII transfer is also an option – and one that we’re hoping will soon be replicated in the US.
What has driven the apparent uptick in legacy sales that we have seen in the past two years?
PC: The increased deal activity has been driven by a combination of factors, not least a greater focus on the cost of capital in the face of of depressed investment returns. That dynamic twinned with the prolonged soft market has thrown the spotlight onto underperforming lines of business, which are no longer sustainable in a world of razor-thin underwriting margins. At the same time, the legacy sector’s focus on expert claims management has been highlighted by a number of recent mega deals, which has driven a lot of inbound calls.
What effect is Brexit expected to have on the legacy sector?
PC: The short answer is that it’s complicated and there are a lot of unknowns. We are expecting an uptick in the number of deals as EU carriers look to dispose of underperforming or non-core books of business in the UK. And that flow is likely to go the other way for UK insurers that do not do write enough business on the Continent to warrant setting up an EU-domiciled subsidiary. For insurers in that position, we see a place for our Maltese platform, recently renamed as Accredited Insurance (Europe) Ltd, which can continue to write the EU business and the carrier can then reinsure that on its own balance sheet in the UK. That way, they can continue to maintain their business flow.
While it’s too early to say exactly what will happen to legacy books after the divorce, the EU regulators have offered some guidance suggesting that they expect to see UK business currently written in the EU to be repatriated. However, the existing transfer mechanisms do not provide for the movement of any associated reinsurance assets, which could have significant financial implications. Meanwhile, books of EU legacy business that are currently housed onshore in the UK may have to transfer to branches or subsidiaries on the Continent, where they fall under the supervision of European regulators. To do that, carriers would have to go through the rigmarole of securing a Part VII transfer, which needs UK court approval and hinges on getting a green light from the country’s regulator.
However, there is still a question mark over whether the Financial Conduct Authority and the Prudential Regulation Authority have the resources to deal with the deluge of Part VII’s that are expected in the case of a hard Brexit. And we are still waiting to find out whether any transfers will be allowed at all under those circumstances.
Is Solvency II continuing to have an impact on the legacy sector?
PC: We continue to see companies becoming more conscious of the capital that is required to support legacy business. And within those firms, there is a growing awareness that the capital could be recycled to support active underwriting if they choose to dispose of the legacy books.
Meanwhile, the increased reporting burden included in the new legislation has highlighted the amount of time management spend distracted by books that are no longer core to the company. And that too has driven an uptick in the number of calls I’ve received over the last 12 months.
How is the market evolving – particularly in Europe and the US?
PC: Continental Europe has generally been slower to address legacy when compared to the UK. However that is probably because the UK was forced to face a glut of run offs in the 1990s, which led to the development of a burgeoning legacy market with a wealth of legal tools at its disposal. European deal flow is, however, increasing and that is evidenced by the number of opportunities that we are seeing through R&Q Malta.
In the US too, we are starting to see more states developing legislation that would allow for transfers of business. It’s still early days but if the regulations prove a success they will allow companies to consolidate portfolios and achieve capital and governance efficiencies – similar to those that can be achieved through a Part VII.
Oklahoma is the latest to develop a facility of this kind but it follows a trend that was started – in earnest – by regulators in Rhode Island. It is inevitable that these developments will transform the landscape of US legacy.
Are captives still a focus for R&Q? If so, how is the market evolving in that space?
PC: Captives and other self insured vehicles are still very much a key focus area for us, as you can see from recent deals we’ve completed. Utilising our rated carriers in US and Malta, as well as our Bermuda cell structure, gives us a vast tool box to provide solutions for captive managers.
We are licenced for all classes across the EU and we are in a similar position across all 50 states. That allows us to transact on the major non-life classes that we see in the captive space by providing retrospective capacity and removing the liabilities from the original carrier.
What is the R&Q message to owners of discontinued business?
PC: All owners should be aware of their discontinued business and the impact it has on capital and governance efficiency as well as the amount of management time wasted focusing on run-off books. Whether they decide to proactively manage in-house, outsource or dispose should be regularly reviewed.