Chapter 4: Portfolio Transfers

Question 1

Possible reasons that an insurer may seek to exit from a line of insurance (or book of business)?

[3]

Answer 1

• The business requires a disproportionate amount of senior management time and/or capital for its size
• The business was purchased as part of a larger acquisition, but was not the reason for undertaking the transaction
• The business has been, or is expected to be, loss making or not sufficiently profitable

Question 2

Strategies that can be used to exit business?

[4]

Answer 2

• Run-off the book to exhaustion
• Reinsurance
• Scheme for transfer of insurance business (substitution)
• Sale of the business

Question 3

Considerations when deciding on exit strategy to use and bases for valuing liabilities? [4]

Answer 3

• Negotiating strength of insurer
• Risk in the book (uncertainty, length of tail)
• View of the regulator
• Opinions of the reinsurer (not always)

Question 4

Explain the run-off to exhaustion approach and state 3 consequences?

Answer 4

The company ceases to write any new business or renewals in the business being exited, but continues to retain responsibility for administering and paying the claims for the historical business previously underwritten.

As a result:
- Business functions such as claims handling have to be maintained.
- Time period is dependent on the length of the tail on the business and the possibility of latent claims
- As the level of underwritten business decreases over time this strategy becomes expensive to administer (time and capital relative to size of book)
- Outsourcing certain administrative functions to specialist run-off providers can reduce these costs
- Often used as an interim solution while alternative exit strategies are considered

Question 5

How does the reinsurance approach work?

Answer 5

Under this exit strategy all future claims that may arise from historical business is reinsured.
- The insurer can allow the reinsurer to administer and settle all future claims, in which case a binder agreement will be required
- Level of risk transfer achieved depends on the specific terms of reinsurance, such as lower limits, caps at upper limits, aggregate constraints, etc.
- If the reinsurer defaults the ultimate responsibility of paying claims still lies with the insurer
- The insurer will still need to include the business in its regulatory reporting

Question 6

Factors to consider when negotiating reinsurance premium?

Answer 6

• Estimated cost of the liabilities recoveries the reinsurance
• Uncertainty around this estimated cost
• Anticipated future investment return
• Costs of ongoing administration
• Capital required to support the liabilities
• Financial strength of the reinsurer
• Required return on capital (profit loading)
• Availability of such reinsurance in the market

Question 7

How does the substitution approach work?

Answer 7

Substitution is the complete risk transfer to another insurer
- Will follow Sections 50 and 51 of the Insurance Act and GOI 6 set out the conditions for such a transfer
- A successful substitution requires an agreement to be reached between the policyholder, the new insurer and the old insurer
- Agreement needs to be reached separately for every policy that is to be substituted
- Transfers can be used to consolidate multiple insurance subsidiaries in a group structure to gain operational cost savings and releases of capital
- Also useful in packaging business units together for tailored solutions in mergers and acquisitions

Question 8

What is required before substitution can occur?

What is the content of the requirement?
[5]

Answer 8

The insurer must submit an application for approval of such transaction to the PA.

Application should include:
* Full details of the proposed action
* Copies of any agreements or other documentation
* Relevant financial statements /returns;
* Report from the HAF as to the soundness of the proposed action
* Full details of how the insurer proposes to communicate the action to policyholders
(communication plan), including timelines, communication notices and details of the
documents to be made available for inspection.

Question 9

How does the sale of business approach work?

Answer 9

It is the sale of whole companies or other assets

Selling whole companies
- This achieves complete finality for the insurer
- It is not very flexible
- On some occasions the seller will have to retain certain liabilities, such as the claims arising from a historical event with great uncertainty
- Buyers may find this strategy appealing as it affords a quick entry to a market

Selling other assets
- An example of this would be selling reinsurance assets
- This is typically done when reinsurance recoveries are uncertain. As a result, the asset is sold for much less than the
expected recovery
- Assets sold in this manner should adhere to the requirements set out in the Insurance Act and Prudential Standards