Garry Nelson, of runoff manager Devonshire Group, examines the realities for U.S. companies facing runoff and current options…

SOLVENT INSURERS AND REINSURERS – CAUGHT BETWEEN
A ROCK AND A HARD PLACE

As the 21st century unfolds, solvent (re)insurers with significant run-off portfolios are increasingly finding themselves “between a rock and a hard place.” On one side are the many challenges inherent in run-off operations – conflicts with the demands of ongoing operations, difficulties in staff motivation and retention, mounting administrative costs, supporting a runoff infrastructure, legacy systems headaches, regulatory compliance and internal control issues, and the very real challenge of managing day-to-day operations. On the other side, management faces a veritable mountain of yet-unknown claims that can explode into huge liabilities. As time marches on, more claimants are recognized and reserves pale in the face of emerging losses and ever increasing actuarial IBNR estimates. The “mountain” seems to grow ever more menacing as even the most conservative projections prove too lean. In addition to new claims for previously unheard of causes such as “fear of harm,” lawsuits escalate and the insurance industry’s nemesis—asbestos claims—unfold in exponential proportions. Although run-off business is supposed to eventually do just that—run off to zero—the rate at which the book declines, the cost of run-off operations, and the specter of an endless tail of liabilities make many executives feel that they’ll never climb out of this dangerous terrain.

Selling a company with significant unknown exposure is often difficult and very often not financially feasible.

The various forms of finite risk reinsurance are currently the subject of much regulatory investigation and debate. Low interest rates make these transactions less attractive at the present time.

Solvent schemes of arrangement, popular in the UK, have experienced some problems with US policyholders and the English courts, beginning with BAIC wherein the court did not approve the scheme. This may eventually be sorted out through better practices and scheme design and, in some cases, may seem like a good strategy. But will they work in the U. S.?

Even the word “scheme” gives a negative impression. In the post-Enron environment faced by all corporations, and especially the insurance industry, the very term, “scheme” makes corporate executives pause.

Such schemes will have to be significantly reworked if they are to be accepted in the U.S. The public clearly understands that when companies are insolvent that they can’t pay claims. A state regulatory agency takes over, and creditors and claimants receive something less than what they are due. Less palatable is the notion that solvent companies which have plenty of capital for ongoing operations can engage in a ”scheme” that allows them to cut off future liabilities in one fell swoop. Although most in the industry would agree that it simply makes sense that liabilities should not be allowed to accrue “forever,” it is highly unlikely the public, which already has difficulty understanding our industry, let alone all the sophisticated concepts and terminology that goes with it, would agree that it is “fair” to claimants to cut off future claims.

In 2002, Rhode Island passed legislation allowing “Voluntary Restructuring of Solvent Insurers.” Four years later, no company has yet been willing to change its domicile and undertake this plan. Other initiatives are being taken, by consultants and service providers, with widely varied opinions. Critical issues such as the state guarantee funds and reinsurance recoveries will need to be addressed.

While these various proposed schemes are reviewed and analyzed by the industry and regulators, they are not currently available or palatable to U.S. insurers and reinsurers faced with runoff. For the foreseeable future, it seems that the traditional forms of runoff are here to stay.

So, what’s the beleaguered company in runoff to do? When faced with a huge mountain, day by day… step by step…chipping away will eventually reduce the mountain down to manageable size. Perhaps it should take a page out of an experienced miner’s book. A better way is to devise the right plan, hire the best engineers you can find, get the right equipment, and disintegrate large chunks of rock as quickly and methodically as you can. The whole point of runoff is to extinguish liabilities expeditiously. Since claims, unlike wine, do not improve with age, passive runoff is simply not viable in most cases. The best plans focus on early extinguishment—destroying the mountain before new changing conditions can cause new peaks to form and, of most importance, before the company runs out of money.

So, what’s the best plan? It’s a cold reality that many companies are faced with discontinued business that needs to be run off. But there is “runoff” and “smart runoff.” Smart runoff should emerge from a reasoned approach having regard to a company’s unique circumstances. It should contain the following elements:

A defined strategy to extinguish any liabilities as early as possible . Determine what is in the company’s best interest: financially and operationally continue with operations or outsource them to a specialty firm? Despite cash flow strategies that may stretch out claims payments, the exponential growth of unreported and underreported claims in most books makes the status quo option inherently unwise. There is no point in standing around the mountain, watching it grow. Grab the biggest pick you can find and start chipping away!

Realistically evaluate your resources . It is vital to evaluate existing staff and determine if they are able to handle discontinued operations effectively. The key question is whether the company and its staff have the acumen to carry out a very different strategy…getting out of business. Many companies have successfully made this transition with existing operations while others have not. The important thing is to objectively evaluate the resources available within the company and those available from runoff specialists.

The right people with the right skill sets to execute the plan effectively . Although some companies still try to commingle run-off operations with ongoing business, most industry experts would agree that the two just don’t mix. Effective run-off operations require a different and unique skill set and a different strategy.

A daily “mission” geared toward moving the mountain and extinguishing the liabilities. Companies often outsource such operations for these reasons and to take advantage of the economies of scale and expertise of run-off experts, reserving in-house talent for moving the company forward in other areas. Expertise comes with handling such issues on a regular basis and on a much greater scale. It requires proven negotiating expertise, technical skill, professional standards, inspection and audit skills, familiarity with the regulatory framework, and administrative effectiveness. Most important are individuals who are excited about the prospect of destroying the mountain and who excel in moving contracts to an early commutation or policy buyback.

While it may be tempting to choose a run-off provider based on the best price, this has some risk. Run-off operations can be outsourced, but the management that wants to feel at ease would do well to ensure that it finds the most competent, reputable, and effective run-off administrator it can. This is a critical decision for senior management as well. The management time consumed by run-off operations can be tremendous.

The right equipment, controls, and reporting. While it’s fine to outsource run-off operations, it still behooves (re)insurers to make sure their claims administrator has the systems capability to handle huge databases of information; effective internal controls and the business ethics to safeguard the company’s assets and reputation; and the accounting and management talent to analyze data, apprise the company of emerging trends in both its own business and the external factors, and report valuable, useful information to support sound decisions, in a meaningful way.

Effective day-to-day administration, leading to real results. Like the miner chipping away at the mountain, the effective claims administrator has to show up every day, and slowly but surely, contract by contract, identify, quantify, and commute “chunks” of liabilities, audit and inspect as warranted, and administer and pay individual claims and instigate recoveries. A good administrator should be able to reduce liabilities significantly, year by year, showing real progress toward destroying “the mountain.” Companies that are not getting these results would do well to begin asking questions.

Today’s (re)insurers may well be “between a rock and a hard place,” but they don’t have to be there forever. With realistic evaluation of financial and operational resources, the right plan, good professional guidance, and effective equipment, controls and administration, they will soon see real results and breathe easier as they move toward their goal – a “smart” and effective runoff.