Emerging risk environment poses legacy challenge for insurers

6th August 2021

This article was first published in Insurance Day.

Stressed classes such as marine – traditionally used as a risk diversification play – can be replaced by emerging risk lines, which not only offer diversification but also better returns

Away from the challenges created by the pandemic underwriters are considering how best to make use of the opportunities. Those opportunities come in the shape of a market correction which is likely to continue to see premiums harden with terms and conditions tightening as losses and lessons are learned from the events of the past two years.

The rising rates in current classes have come hand-in-hand with new risk opportunities. In addition, the rapid move to remote working and the implementation of ever more technology has shifted the risk landscape dramatically and created new demands and with it further opportunities.

There has been a significant rise in the demand for emerging coverages, especially cyber, and it comes at a time when risk values have increased, as has market understanding of the threats and the steps needed to mitigate them. Other emerging risks are seeking capacity and at a time when capacity is under pressure the laws of supply and demand are tipping in favour of the underwriters. It has, however, left many with some tough decisions to make.

The deployment of capital has long been a tough ask for insurance groups, with the need for diversification of risk all too often meaning that CUOs and CFOs have taken the decision to operate in stressed classes, such as marine, where profits are hard to come by, simply to ensure that their risks are adequately diluted across their portfolios.

Changing times

Times have changed, however, and those classes which have traditionally been used as a diversification play are now challenged by emerging risks, which not only offer diversification but will also deliver the potential for significant returns. There are also moves by some to reduce participation in classes where climate change has an impact, either in terms of extreme weather risks or the operational and environmental, social and governance risks which come with some coverages that are deemed to be harmful to the climate. Simply put, the market, given the regulatory pressures, is no longer prepared to throw good capital after bad risks in an environment that provides the opportunity not to do so.

This has created a legacy issue for many underwriters as old books of business are discontinued. As such a solution and an orderly and cost effective run-off has to be found. Increasingly, the choice comes down to whether to keep the run-off operations in-house or to use the growing outsourced sector.

The temptation to retain the legacy operation in-house remains significant. Those who choose to keep matters in-house are putting in place the systems which allow the management of the books to be securely ringfenced away from “live” operations and all aspects of the firm, including the financial reporting functions. For many others, the way to deliver clear distance between the legacy and live books is to outsource those books which they are keen to place into run-off.

Run-off benefits

There are advantages to this approach, with the ability of underwriting management to simply deliver finality on the book, place a clear and certain figure on the balance sheet and concentrate their staff on the live risks. Where they outsource, they are looking for the most cost-effective way it can be achieved, whether it be claims, delegated authority or reinsurance.

Interestingly we are also increasingly seeing firms looking to potentially subsidise the legacy process by having a renewed focus on premium collection and loss fund recovery, with hundreds of millions of dollars unclaimed across the London market alone. Firms want to really understand their true financial position and look to reduce their exposures through a professional solution that can manage the whole process.

The ever more complex regulatory landscape and the impact of Brexit have further clouded the legacy run-off process and while many underwriters would like to have complete control of the run-off there is a growing need for specific run-off expertise. This is increasingly seeing firms seeking out specific skills sets that they are unlikely to have in-house should they wish to retain the books until they are finally closed.

What sets today’s market apart is the choice that underwriters now enjoy. The options in terms of diversification of risks are wider than ever before; however, with such choices the decisions become harder as the traditional classes are forced to compete with new risks and the sizable potential returns and are tempered only by the lack of claims data, which is making these emerging risks more of a step into the unknown.

Whatever the reason, underwriters no longer see legacy as a sign of failure, rather simply a financial decision which has been made possible by the greater flexibility across the market to deliver genuine run-off efficiency and with it substantial benefits to the bottom line.

For more information on insurer and market services, please contact Rob Dewen on robert.dewen@davies-group.com

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