Time to reconsider reinsurance

The arguments against using reinsurance as a run-off exit strategy are well known. Critics quite rightly point out that reinsurance does not provide complete finality. They also argue that it can be expensive. Some insurance consultants go so far as to describe it as esoteric, adding that few potential clients even consider it as an option.

Supporters, on the other hand, respond that reinsurance is sometimes the only solution available in certain situations and jurisdictions. And the ace up their sleeve is Berkshire Hathaway's use of reinsurance when buying Equitas - by far the biggest run-off deal to date. As for the cost of reinsurance, if it really was that exorbitant, then of course no deals would ever be done.

Only recently, London based runoff buyer Ruxley used a reinsurance contract to complete its acquisition of the London branch of Generali's Swiss subsidiary, Generali Assurances Generale (GAG). When constructing such a deal, Ruxley has to consider two levels of financial reserves. The first is the commercial level it needs to make a profit. The second is the much higher level it needs to satisfy UK regulator the Financial Services Authority (FSA), since Ruxley itself does not have a credit rating.

On this occasion, to bridge the gap between these two figures and cut its finance costs, Ruxley bought reinsurance cover from Bermuda based and A rated reinsurer XL Re. 'Effectively we rented XL's rating. So that put us in an equivalent position to a Berkshire Hathaway or any other large reinsurer,' explains Ruxley chief executive John Winter.

Significantly both for reinsurers and the run-off market Winter reckons that the purchase of GAG has broken new ground. He believes it is the first time anyone has used reinsurance in this way to provide regulatory capital on a run-off deal. What is certain is that London based runoff specialists are looking increasingly to reinsurers to help them finance deals.

Mark Adams, a partner at accountancy firm Deloitte, says this is particularly the case when small London market entities buy significant portfolios. The driver is the FSA which demands a very high degree of security in the acquiring vehicle. 'So, rather than putting capital on the balance sheet, the parties involved use reinsurance contracts. We've seen a number of the well known international reinsurers providing reinsurance contracts of that nature to facilitate a run-off purchase,' says Adams.

Reinsurers too are taking a fresh look at legacy and run-off opportunities. January saw the launch in Bermuda of St George Re with a specific brief to insure and reinsure legacy asbestos risk. The company is working with both policyholders and insurers. In addition to its own capital, St George Re has a strategic capacity arrangement with Berkshire Hathaway, a key player in this market with extensive experience of asbestos through Equitas.

"There are opportunities for reinsurance in this area. It's a product we're seriously considering using again"
John Winter, Ruxley

Winter believes that innovations like these as much as any other factor are likely to decide the future role of reinsurance in the run-off market. 'Any innovation using reinsurance or whatever form of financing is welcome. So, I think in principle yes, there are opportunities for reinsurance in this area. It's a product we're seriously considering using again.'

Typical situations

A leading reinsurer already in the market is Munich Re, whose Customised Portfolio Solutions (CPS) unit has a team of 15 which has notched up around 20 deals in recent years. The factors driving those deals often differ, but generally boil down in the end to insurers wanting to use their capital more efficiently, says CPS head Karin Barkholt.

Munich Re is often called in during mergers or disposals of specific books of business. In those cases, a new buyer - or an old buyer - may use reinsurance to protect its reserves or its business against adverse developments. 'That is the most typical situation where our products are of benefit and where we are approached most frequently,' says Barkholt.

In other instances, insurers will look at the use of reinsurance to enable them to exit particular books of business which are tying up a lot of capital. Another important source of business for Munich Re is the consolidation and relocation of captive companies in the corporate markets.

In terms of current and future prospects, Barkholt reports an increase in enquiries in connection with the planned introduction of Solvency II. Until this new regulatory regime is rolled out in its final form, predicting its impact is hard, she says. However, she adds that: 'I'm convinced that this will make a huge difference, because transparency will increase and people will have to focus on their core business and activities and capital efficiency.'

Wide market

However reinsurance is used in run-off, Barkholt believes that it is rarely in head to head competition with schemes of arrangement or Part VII transfers. 'This particular market segment is so wide. There is so much potential out there that all of those mechanisms should be used and can be used. Some situations are either or, but sometimes I can envisage situations where you start with one feature and then extend to include others.' An example could be a Part VII transfer which the new owners later decide to scheme, only to discover that certain parts are not suitable and therefore opt for reinsurance instead.

Paul Corver, claims director at London-based consultancy KMS Insurance Management, agrees that reinsurance can sometimes be used with other exit strategies. 'We've looked at reinsurance for a couple of potential clients. It is something that can be tacked on and work alongside perhaps a scheme of arrangement where the majority of a book of business can be exited and the balance can be protected by some sort of reinsurance arrangement.'

In other situations, reinsurance is the only option or offers advantages over schemes of arrangement and transfers. Schemes are not feasible in every situation, and sometimes even when they are in theory would be difficult to achieve in practice. Similarly, Part VII transfers may run into problems, if for example they have significant policyholder constituents from outside the European Economic Area.