Download Exit Strategies: Know Your Options

Exit Strategies: Know Your Options
Darren Bailey
is a senior underwriter
at AIG Global Risk
Solutions. Based in
London, he structures
and executes nontraditional insurance
solutions for AIG’s
clients in Europe, the
Middle East and Africa.
These non-traditional
solutions include
structured insurance,
captive and corporate
liability buyouts and
solutions for new and
evolving risks.
Darren Bailey, senior underwriter at AIG,
discusses the range of exit strategies available to
captive owners.
legal agreement that, with effect from the date of the
transaction, transfers back to the fronting insurer the
liabilities that it had ceded to the reinsuring captive.
It is vital that captive owners periodically re-assess
their utilisation of their captive to ensure that it remains
a viable and useful tool in their risk management
programme. Often, maintaining an existing captive
is the right decision following a periodic analysis of
a vehicle’s usefulness and effectiveness. However,
there may be circumstances where it is appropriate to
adjust a risk management strategy which includes one
or more captives, and risk and insurance managers
should be aware of the options available to them.
Novations
Once a captive writes its first policy, the company
must remain active until all regulators, actuaries,
auditors, and most importantly, the insured(s)
are satisfied that there are no further rights,
responsibilities and obligations. If a decision is made
to close a captive, there are a number of techniques
that can be utilised to achieve this aim.
With both novations and commutations, a captive
is released from its contractual responsibilities and
will have no further liabi lities. When this has been
achieved, a captive owner can then approach a
regulator with a view to liquidating a captive and
repatriating any residual assets back to the parent
company. These types of exit strategies are growing
in popularity, particularly within the M&A arena,
as acquirers or merged entities seek to reduce the
surplus number of captives in most simple, timely
and cost effective manner.
Motivation
The decision to exit a captive vehicle could be made
for a number of reasons, including:
•Change in internal risk management philosophy
•Change in the macro, fiscal or regulatory
environment
•M&A. where company ‘A’ purchases company
‘B’, resulting in the newly formed company
having a surplus of captives, one or more of
which may need to be closed
•Disposals that change the risk profile of the
parent so that it no longer has the critical mass to
warrant using a captive
•Management of capital, as this can be tied up
for the duration of the captive’s life
•De-risking of a captive, i.e. closing out legacy
years rather than closing the whole captive
maybe be appropriate in some circumstances
Below, we review techniques that can be utilised to
exit a captive or reduce the liabilities on the balance
sheet of an ongoing captive in order to make it more
effective for future renewals.
Commutations
The majority of captives operate as reinsurers behind
fronting insurers. Consequently, the common form of
exit strategy is a commutation. A commutation is a
A novation involves a new reinsurer assuming
the obligations of a captive in respect of specific
policies. The fronting insurer will be reinsured by the
new reinsurer once the novation becomes effective.
Such arrangements require the consent of the fronting
insurer who must sign the novation agreement.
Therefore, it is critical that the fronting insurer is
satisfied with the new reinsurer and —in particular—
its security and willingness to pay claims.
Selling a captive
An alternative to a buy-out of the liabilities would be
the sale of a captive to a third-party. In this case, the
third-party would acquire the insurance liabilities
as well as any non-insurance liabilities and all
the assets. Since the fronting insurer’s approval is
required for a change in the ownership of a captive,
it is important that the captive owner and the
fronting insurer are comfortable with the acquiring
company’s strategy for running-off a captive.
Reinsurance
A captive can free up capacity by using a
commutation or novation. Reinsurance would also
work. However, this technique requires the captive
to remain in the reinsurance chain, and therefore, it
cannot be closed. While this means it is probably the
least used exit strategy, it can be useful where the
fronting insurer is not willing to offer a commutation
or sign up to a novation.
Alternative exit strategies
When considering which exit strategy is most
appropriate, a relevant consideration is whether or
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Exit Strategies: Know Your Options
not a captive writes both direct insurance and reinsurance business.
Where there is a mixture of direct and reinsurance business, a
captive may want to utilise a combination of techniques.
Additional techniques that apply under English Law are a Solvent
Scheme of Arrangement (generally for a captive writing thirdparty business) and a Part VII Transfer under the UK Financial
Services and Markets Act (Part 7). Whilst these techniques are
predominantly used for traditional insurance companies, they can
also be used for captives under certain circumstances.
Benefits of captive closure
In many cases, a review of strategy might highlight the need to
free up underwriting capacity for future renewals or to release
an element of capital and/or collateral by closing out old
underwriting years.
When captive owners and their advisers are analysing any form of
exit strategy, it can be easy to focus solely on pricing for whether
the transaction makes commercial sense. However, it is important
to consider a number of additional benefits.
•Reduced volatility and increased certainty – long-tail liabilities
by their nature may take a considerable time to be reported,
and even longer to settle. These liabilities will also be subject
to any regulatory, legal and commercial change that occurs
over that time period. Therefore, the final liability will be very
difficult to estimate. An exit strategy can alleviate this volatility
and uncertainty.
•Reduced capital – as the aggregate limits it writes increase
over time and loss reserves accumulate, a captive will need
to hold an increasing amount of capital to meet minimum
solvency requirements. Transferring some of these policies and
their associated liabilities can free up capital to support new
policies.
•Release of collateral – typically Letters of Credit secure the
reinsuring captive’s obligations to the fronting insurer. This
collateral would be released to the parent when the captive
is closed.
•Reduced costs and administration – the costs and management
time associated with running a captive can be significant. In
addition to direct management costs in running a vehicle, there
can also be significant indirect costs at a corporate level. A full
buy-out will eliminate these burdens, and a partial buy-out will
reduce them.
•Regulatory and compliance – increasing regulatory reform
prompted by directives such as Solvency II have caused
captive owners to incur more cost as a result of annual
actuarial reviews, board of director meetings, non-executive
directorships, etc.
If a captive runs off its liabilities until there are little or no
outstanding claims left, the minimal size of any transaction
would result in limited incentive for the fronting insurer or a new
reinsurer to undertake analysis and due diligence to complete an
exit strategy transaction. A captive could then find itself left with
policies that remain open as no other party is willing to take on the
unused limits for what is likely to be a small premium – essentially
meaning that a captive cannot be closed. Therefore, it is important
to consider an exit strategy at an early point in the run-off stage or
from the outset during business planning.
Some insurance companies offer solutions in support of exit
strategies. These solutions should be thoroughly planned and
involve knowledgeable professionals in every step of the process.
Planning for exit strategies requires detailed information on the
outstanding claims reserves, capital, and security held. Armed
with such information, either directly or via an intermediary, the
owner can commence negotiations with fronting and reinsurance
insurers and liaise with regulators to finalise an exit strategy.
For more information, please contact
Darren Bailey at 44.203.217.1514 or
[email protected] or visit
www.aig.com/captives.
Global Risk Solutions is a division of AIG, the marketing name for the worldwide property-casualty, life and retirement, and general insurance operations of American
International Group, Inc. For additional information please visit our website at www.aig.co.uk and the Global Risk Solutions pages at www.aig.com/globalrisksolutions.
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