SA3-12-Portfolio Transfers

Question 1

Companies can use portfolio transfers to seek to exist from either (3)

Answer 1

• single lines of business - a group of different lines of business - complete portfolios

Question 2

5 Possible reasons for companies seeking to exit from business

Answer 2

-the business no longer features in the company’s core strategy - the business requires a disproportionate amount of senior management time/Capital - the business was purchased as part of a larger acquisition, but was not the reason for the acquisition - the business has been, or is expected to be, loss making or not sufficiently profitable - the company may have become insolvent and forced by its regulator to cease writing new business - a combination of these

Question 3

Run-off to exhaustion

Answer 3

The company ceases to write any new business or renewals in the lines being exited, but continues to retain responsibility for administering and paying the claims for the historical business. - business functions (e.g. claims handling) have to be maintained - as the level of underwritten business decreases over time this strategy becomes expensive to administer - outsourcing certain administrative functions to specialist run-off providers can reduce these costs - this exist strategy is often used as an interim solution while alternative exist strategies are considered.

Question 4

Reinsurance (as an exist strategy)

Answer 4

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 (lower limits, caps at upper limits, aggregate constraints, etc.) - the insurer need to balance cost against release in reserves-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 5

If the business is reinsured, the parties will negotiate the reinsurance premium and it is likely to depend on (8)

Answer 5

• the estimated cost of the liabilities, given the precise structure of the reinsurance - the uncertainty around this estimated cost - anticipated future investment return - cost of ongoing administration - the capital required to support the liabilities - the financial strength of the reinsurer - the required return on capital (or profit loading) - the availability of such reinsurance in the market

Question 6

Sale of business: Selling whole comapnies

Answer 6

• Achieves complete finality for the insurer. - Not very flexible - On some occasions the seller will have to retain certain liabilities, such as claims arising from a historical event with great uncertainty. - Buyers may find this strategy appealing as it affords a quick entry to a market (all FSB requirements, etc. will already be in place).

Question 7

Sale of business: Selling other assets

Answer 7

• An example of this would be selling reinsurance assets - Typically done when reinsurance recoveries are uncertain. As a result, the asset is sold for much less than the expected recovery. - The short-term insurer will have to seek the Registrar’s approval before it can allow its assets to be held by another person.

Question 8

Typical considerations when deciding on methods and bases for valuing the liabilities would be (7)

Answer 8

• negotiating strength - the initiator of the deal - risk appetite - the uncertainty, length of tail, etc. - the views of regulators - recommendations of oversight persons/bodies e.g. FSB, independent experts, Lloyd’s - the opinions of reinsurers (possibly)

Question 9

Comparing: sale / portfolio transfer / reinsurance Advantages of a portfolio transfer to the transferring insurer

Answer 9

• A one-off payment will transfer the liability - The original insurer will stay operations and future products can still be sold - No further policy administration - No further capital requirement to service the portfolio

Question 10

Comparing: sale / portfolio transfer / reinsurance Disadvantages of a portfolio transfer to the transferring insurer

Answer 10

• Policyholder consent needs to be obtained - The process is time consuming & admin intensive - Approval is required from the registrar - The insurer may be left with expensive staff / overheads and one fewer portfolio to manage - The cost of the portfolio transfer could be very high - Reputational risk if the other insurer doesn’t pay claims - Assets may need to be realized at unfavourable or tax inefficient times

Question 11

Comparing: sale / portfolio transfer / reinsurance Advantages of reinsurance to the transferring insurer

Answer 11

• The insurer will still be operational and future products can be sold - Reinsurance should allow a lower level of capital to be held - Lower concentration risk - Simplest and easiest method of transferring the liabilities - Can still benefit from interest on reserves - No policyholder / regulatory consent will be required

Question 12

Comparing: sale / portfolio transfer / reinsurance Disadvantages of reinsurance to the transferring insurer

Answer 12

• The insurer will still need to run off the underlying policies - All court cases and claims will still be brought against and managed by the insurer - The insurer is liable in the case of reinsurer default - The required reinsurance products may not be available or the cost may be prohibitive - The required reinsurance capacity may not be available locally and will have to be placed in the international market. - Depending on the reinsurance, there may be gaps in cover

Question 13

Comparing: sale / portfolio transfer / reinsurance Advantages of SALE to the transferring insurer

Answer 13

• The insurer will have no further liabilities to worry about - The admin of managing the product will no longer be required - The insurer is no longer required to hold any regulatory capital

Question 14

Comparing: sale / portfolio transfer / reinsurance Disadvantages of SALE to the transferring insurer

Answer 14

• Complicated - Requires both regulatory and competition commission approval - Finding a buyer may prove difficult

Question 15

Strategies for exiting insurance business (7)

Answer 15

1. run-off to exhausation
2. reinsurance
3. commutations
4. novation
5. insurance business transfers
6. sale of the business
7. a combination of the above

Question 16

Factors influencing the choice of exit strategy

Answer 16

1. the reason for exiting
2. the availability of alternatives
3. the costs involved
4. the desired level of risk transfer the time it takes to implement the solution compared to the time available
5. the likely perception of the deal from the point of view of, in particular:
   
   1. policyholders
   2. shareholders
   3. rating agencies
   4. reinsurers
   5. regulators
6. the relative size of the business being exited
7. industry practice
8. the level of uncertainty underlying the business
9. the financial strength of the insurer
10. the extent and quality of any remaining reinsurance protection
11. the impact on cashflows and capital
12. any regulatory factors
13. tax implications.