The decision to cease writing a particular sort of business generally leaves an insurer with a portfolio of liabilities it must service until they have run off its balance sheet.
In order to improve efficiency (capital, regulatory or operational efficiency) there is a need to handle all the discontinued business in a proactive way. As the challenges facing the industry increase it is not recommendable to ignore the issue of run-off business. Insurers and reinsurers have to focus on innovative solutions to extract value from their run-off business in order to position themselves ahead of their competitors.
Why to handle discontinued business in a proactive way
Although underwriting has ceased, new claims can continue to be reported many years after the policy period. Even known claims can take many years to settle. Thus a run-off can take an extremely long time to be truly completed. In such a situation of uncertainty management time and cost continue to increase. Successful run-off strategies reduce costs, maximise profits and manage effectively the resources of an insurance company. A proactive handling of discontinued business releases resources including management time and unsatisfactory investment returns.
One of the main concerns of some insurers is that acknowledging and dealing with run-off may adversely affect ongoing relationships. But these concerns about the client relationship have not been the experience of those insurance companies, which have already taken significant steps towards pro-actively dealing with their run-off business. This was the result of a study about discontinued insurance business in Continental Europe.
What has to be done in a run-off
Companies have various options for manag-ing their discontinued business liabilities. The exit strategy chosen will often depend on the objectives of the shareholders. There are seven main available exit options and a shareholder should consider carefully each option against its objectives:
- Passive/Traditional Run-off: Run-off to “natural” expiry
- Proactive/Fast-Track Run-off: The proactive run-off means defining clear strategic objectives and implementing a strict plan for achieving a fast-track exit.
- Commutation: The termination of all obligations between the parties to a reinsurance agreement, normally accompanied by a final cash settlement.
- Scheme of Arrangement: Arrangement between a company and its creditors or any class of them for the discharge of a company´s liabilities on a consistent basis.
- Portfolio transfer: A procedure for transferring unearned premiums and liability for outstanding losses to a reinsurer who runs them off, but maintains a limit on the amount of coverage it provides.
- Retrospective reinsurance: The retrospective reinsurance provides protection not for future risk periods but for periods that have already expired.
- Sale of run-off policies
Each company seeking to exit the market will need to explore and consider each option in detail. In particular each can have different tax consequences, which may alter the merits of the solution.