The previous year turned out to be a busy period for the European insurance sector. Gearing up for Solvency II, which finally came into effect on January 1, 2016, increasing competitive pressure and a growing tide of M&A activities are three of the many challenges that have kept the industry on its toes.
Run-off transactions become best practice for discontinued business, as market conditions might favour even greater consolidatoin
Solvency II, in particular, has put the topic of legacy books on the front burner of strategic decision-making for insurers across Europe, now that discontinued business has to be backed by equity capital, too.
The run-off industry has seen tremendous growth since 2009, when Darag started as the first continental European insurance and reinsurance run-off specialist. Best practices for dealing with legacy books are now emerging while most mid-sized and smaller companies are still only at the beginning of developing their run-off strategy.
What do we predict for this year? We see six trends.
1. The run on run-off continues
In 2016, the market is bound to reach a new peak. This year, we expect the total volume of run-off deals to reach an all-time high of €4 billion. Driven by Solvency II, the volume of run-off transactions has already grown by a factor of eight, to a total of €1.7 billion from 2013 to 2014. In 2015, dynamic growth continued, especially in terms of transaction volume, fuelled by the increase in discontinued business held by European insurers.
According to a PwC study on run-off which was published in 2015, legacy books have grown by over 20 per cent since 2008, to a total of €247 billion. Rather than tailing off after Solvency II coming into effect, the level of activity in this market continues to rise, as run-off transactions offer a flexible and quick way for capital release.
2. The first €1 billion deal, and then some…
The big international insurers continue to optimise their capital management under Solvency II. We expect to see the first in a streak of single run-off transactions worth €1 billion in 2016. Run-off transactions have indeed proven to be an effective tool for releasing capital. In order to have an impact on the balance sheet of global players, however, the volume of those deals has already become bigger and will continue to grow.
3. Growing market – and growing accustomed
The challenges faced in 2015 will stay with us in 2016 as well: fragmented markets, low interest rates, stagnated premium incomes. In this environment, run-off transactions become best practice for discontinued business, as market conditions might favour even greater consolidation.
As insurers seek to stabilise return on equity, they will keep on turning to their legacy books when it comes to quick capital release. We estimate that about €80-90 billion of current run-off might qualify for a portfolio transaction or a share deal.
Since 2015, run-off is increasingly viewed as a rather natural element of large M&A transactions, and the industry will continue to do so, given that international corporations restructure not only single portfolios but also entire business regions and entities, so as to improve their competitiveness.
4. Growing appetite of third-party investors
In the current low-yield environment, alternative capital will increasingly search for investment opportunities in insurance risks, looking for adequate vehicles to do so.
Already, the inflow of capital from private equity funds into insurance risks is significant, as such risks are uncorrelated to the ups and downs of the global economy that affect more traditional asset classes like stocks, bonds or private equity investments, thus making them an ideal diversification tool for many types of portfolios.
At the same time, insurance risks offer attractive returns, which are at par with quality stocks, yet more stable and reliable in terms of yield. Institutional investors plan to double their engagement in Insurance Linked Securities (ILS) over the next five years, from $44.7 billion to $87.3 billion, as confirmed by the findings of a study conducted by the Institute of Insurance Economics at the University of St Gallen in 2015.
5. Insurance industry innovation
The insurance industry will seek innovative solutions to transfer risks and optimise capital structures. Run-off solutions and offerings, such as the Run-off pad (R-pad), the EU-based platform created by Darag in 2015, is a new turnkey solution for both cedants and investors. The former can fast-track the disposal of their run-off portfolios, while the latter can fast-track their investment in run-off portfolios in an efficient and easy manner.
6. Reassurance in insurance
Along with market consolidation comes the focus on specific values. Trust will dominate as a precondition for any business undertaking in 2016. In a demanding market environment, success is closely related to the notion of trust. The positive development of run-off business in the last years was made possible not only because of the proper regulatory framework, but also due to the professional and reliable handling of risks and claims by run-off specialists.
www.darag.eu
Arndt Gossmann is the CEO of Darag, a specialist run-off insurer.