Run-off principle
Active management of “inactive business”
Run-off is in principle recognised in the underwriting provisions of all insurance companies. Independent market experts estimate the Run-off volume in Europe at over EUR 200 billion. A recent survey among insurers shows a Run-off volume in German-speaking countries alone of EUR 115 billion (direct and reinsurers; property-casualty insurance only). Thus, balance sheet provisions for inactive business have risen by 72% over the past three years. Procative management of Run-off is indispensable.
Insurers are increasingly dedicating more attention to Run-off: according to the survey, EUR 45 billion in provisions relating to Run-off-business is either actively managed or under observation. This represents a rise of 181% compared to 2007.
Run-off and Solvency II
Run-off has gained enormously in importance over the past three years. In the meantime, around 30% of loss reserves are no longer offset by premium revenue. Almost one third of all underwriting provisions thus relate to business that insurance companies are no longer actively underwriting. Studies between 1996 and 2007 show a constant ratio of around 20%. The majority of Run-off-portfolios are typically relates to longtail business. In this segment, the occurrence and settlement of claims can draw out over several years.
With the introduction of Solvency II at the beginning of 2013, insurers will be required to back loss reserves with equity. The problem: the more prolonged and volatile the loss potential, the higher the equity backing requirement. Consequently, inactive business will require more equity than active business. A rise in the volume of Run-off therefore goes hand in hand with a significantly higher equity requirement. Equity that is tied up for years.
Reasons for Run-off
The reasons for the occurrence of Run-off or ceasing to underwrite new business are varied: business development in certain segments is no longer profitable, critical claims experience, concentration on core business, ceased underwriting in foreign jurisdictions – or market consolidation that brings about a reorganisation before or after acquisitions and mergers. Resulting discontinued business has to be recognised in the insurer’s balance sheet with underwriting provisions.
New requirements vs. classical instruments
The development of the economic and regulatory framework is posing new challenges for the insurance sector:
Low interest rates and the development of the stock markets go hand in hand with more volatile net profits due to adoption of IFRS and increased interest from rating agencies. From 2013, Solvency II will require dedicated equity backing on both sides of the balance sheet.
Insurance underwriters are countering these requirements by actively looking to shorten run-off. However, classical instruments to shorten the Run-off phase are often inadequate. Insurers are limited in their ability to relieve their balance sheet burden. Securitisation requires high volumes and the right market environment and commutations as a Run-off-tool are restricted to reinsurers.
DARAG offers an effective solution: we are specialised in taking over and professionally processing loss reserves and transferring Run-off to our own balance sheet. Like this, insurers can reduce or even totally eliminate their Run-off-volume.