18th December 2020
This article was first published by Insurance Day.
The legacy sector is extending its scope of activity to the freeing up capital trapped in portfolios of non-core or poor performing business.
The fundamental shift in market conditions over the past 12 months has changed the face of how the industry views the issue of legacy business. Five years ago, the run-off sector was seen to be drinking at the last-chance saloon. Few had a positive view of the sector and its long-term survival; indeed, many believed it was facing extinction. However, as the market continues to harden, driven by rising losses and, in some areas, a withdrawal of capacity, firms are seeking to access capital that is trapped in books of business that are no longer live. In the past month, ILS Capital announced it has been able to release $57m of trapped reinsurance capital in a deal that is set to be replicated by many others. The estimates of just how much capital is trapped within the industry are as high as $15bn, with some saying even that figure is on the conservative side. At Davies Group, we can attest to the size of the opportunity. We have initiated the return of more than £600m to the market to date, often from unknown or unidentified premiums that have been trapped in legacy portfolios. The same can be said for loss funds, where we have been involved in the full or partial return of £150m. It is our view, having reviewed the London market, that there is likely to be a further £700m across the legacy years that is due for return and is waiting to be unlocked.
Market hardening has seen underwriters increasingly looking to find ways they can access capital, either via the sale of legacy portfolios or by more efficiently managing their legacy operations in an effort to release the value trapped within them.
Both options, while delivering considerable benefits, require a high degree of expertise and while firms may be keen to handle the process in-house, they often discover they do not have the staff and, more importantly, the staff with the necessary expertise to carry out the tasks that are required to complete the sale or undertake effective legacy management. Instead, many companies continue to devote their attentions to active years of account, leaving funds tied up in legacy business that could be far better deployed elsewhere.
In terms of premium credit control on active years, the changing dynamics of the market have created greater focus in terms of the payment of premiums.
There is now a greater emphasis on brokers to speed the movement of premiums from their clients with managing agents keen to collect premiums in a timelier fashion.
It has created new challenges for brokers, and we have found our consolidated approach, which has been operating for some time, has delivered tangible efficiencies and has been welcomed by brokers and underwriters alike.
Disposal of live portfolios
The legacy and run-off sector has now reached a point where there is every possibility it could see an end to closed years’ business. Underwriters will operate a portfolio for, say, five years and then simply dispose of the portfolio and free up the capital to be used in other areas.
The market is clearly becoming far more sophisticated about how it deploys capital and will focus not only on the loss ratio of a given portfolio but also the operational costs of managing the business.
Technology has delivered the ability for firms to better understand portfolios. We have seen a move from XML spreadsheets, which required significant investigation to create a full understanding of costs and performance, to online management, where the information can be extracted at the touch of a button.
Poorly performing portfolios require management and staff dedicated to their operation. The disposal of portfolios can often come alongside a reduction in staffing costs. As we are all aware, Lloyd’s has been increasingly prescriptive as to the performance of the risks it wishes its syndicates to underwrite. This situation has left some managing agents disheartened by the difficulties they face and challenged by the need to manage the business that is no longer acceptable within the market.
Increasing numbers of firms are talking to us about how best to free their trapped capital. We are being asked either to review the portfolio, its operating costs and the potential future performance in preparation for sale or to use our expertise to efficiently manage the portfolio on our clients’ behalf and speed up the release of trapped premiums.
As the amount of trapped capital released continues to grow, the demand for support for solutions is likely to match that growth. While it will breathe further life into the run-off sector, the complexity of the process is likely to see live underwriters increasingly look to divest portfolios faster, as market conditions adapt to the changing face of risk.
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