Run-off market to attract more ILS & third-party capital: DARAG

There is an expectation that alternative or third-party capital and ILS investors will increase their appetite for participating in insurance and reinsurance run-off or legacy transactions, according to Arndt Gossmann, CEO of run-off specialist DARAG.

Gossman forecasts another busy year in 2016 for the insurance and reinsurance run-off market, with deal sizes expected to grow as larger re/insurance players look to use run-off transactions as a way to remove their legacy risks from the balance-sheet and release capital.

“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 euro,” Gossman explained.

DARAG has noted that the start of Solvency II has resulted in an increased interest in run-off transactions, saying that “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.”

Gossman continued; “The big international insurers continue to optimize their capital management under Solvency II. We expect to see the first in a streak of single run-off transactions worth 1 billion euro in 2016.”

Deal sizes are expected to increase as in order to prove an effective and efficient transaction a certain size is needed for the larger re/insurers.

“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,” Gossman explained.

Market forces also make run-off transactions attractive, as pressure results in a growing desire for scale increasing the level of merger & acquisition (M&A) activity which often can stimulate the need for run-off transactions.

“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 favor even greater consolidation. 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,” Gossman said.

All of this points to an increasing amount of run-off activity, which means more large books of insurance business available for investors of differing types to access. Increasingly investors from the ILS market and other alternative capital sources are looking to run-off as a viable way to take on the risk returns of a legacy book or portfolio.

There are also a number of initiatives looking at ways to make it even easier for ILS or third-party investors to access the returns of legacy insurance business, an area DARAG itself has been actively working in.

“In the current low-yield environment, alternative capital will increasingly search for investment opportunities in insurance risks, looking for adequate vehicles to do so,” Gossman expects.

He notes that the returns from insurance risk are “more stable and reliable in terms of yield” and as a result also attracting private equity investors.

With ILS investors looking for ways to grow their participation in insurance and reinsurance markets, while other investors such as private equity are looking for ways to access the returns from re/insurance but while minimising the corporate risks, run-off portfolios can make very attractive opportunities.

Gossman commented; “The insurance industry will seek innovative solutions to transfer risks and optimize 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 turn-key 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.”

Dynamic growth is expected for the run-off market, as “best practices for dealing with legacy books are now emerging and that most mid-sized and smaller companies are still only at the beginning of developing their run-off strategy,” DARAG explains.

With third-party or ILS investors expected to increasingly provide the capital to back run-off or legacy transactions, the volume of insurance and reinsurance risk finding its way to the capital markets looks set to grow even further.