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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 continued > 1 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. Products are subject to underwriting guidelines, review and approval. Products may not be available in all jurisdictions. This presentation does not constitute an offer to sell any of the insurance coverages or other financial products described herein. The purpose of this presentation is to provide information only and you should not take any action in reliance on the information contained in this presentation. Whilst every effort has been taken to ensure the accuracy of the information in these pages, we make no representation and/or warranty express or implied that the information is correct, complete or up to date. Scenarios and descriptions are offered only as summaries and illustrations and these may not include all terms, conditions and exclusions of the products described herein. Please refer to the final documentation for complete terms, conditions and exclusions which may vary based on individual requirements. We do not provide legal, credit, tax, accounting or other professional advice, and you and your advisors should perform your own independent review with respect to such matters as they relate to your particular circumstances and reach your own independent conclusions regarding the benefits and risks of any proposed transaction. We will not be liable to you for any loss or damage of any kind (including, without limitation, damage for loss of business or loss of profits) arising directly or indirectly as a result of reliance on the information contained in this presentation. American International Group, Inc. (AIG) is a leading international insurance organization serving customers in more than 130 countries and jurisdictions. AIG companies serve commercial, institutional, and individual customers through one of the most extensive worldwide property-casualty networks of any insurer. In addition, AIG companies are leading providers of life insurance and retirement services in the United States. AIG Common stock is listed on the New York Stock Exchange and the Tokyo Stock Exchange. AIG Europe Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and Prudential Regulation Authority. Registered in England: Company Number 1486260. Registered Address: The AIG Building, 58 Fenchurch Street, London EC3M 4AB (EU08/14) 2