“Legacy deals might be quite attractive to some of them as a way of unlocking that cash.”
Paul Corver, R&Q

How has business been in recent months, during the COVID-19 era?

In spring 2020 when COVID-19 first hit there was huge disruption in the markets, which in turn had a big impact on insurers’ capital and asset bases. That led to many companies needing to bolster their balance sheets, and one way to achieve that is to dispose of the economic risk around legacy liabilities in order to free up capital.

For captives it is also a way of freeing up the collateral they are required to hold in favour of front companies. R&Q has never been busier than in the last 12 months as companies and captives have sought to bolster their balance sheets.

That awareness of what the legacy sector can offer has continued through into 2021 and we continue to see interest from across the board in Europe, from commercial re/insurers and from captives. Most of this has been from institutions looking for a little extra protection around their portfolios of liabilities, rather than for disposals, although those outright purchases have also been completed.

Is the hardening market having much of an impact on business with captives?

The hardening market creates a real challenge for risk managers and for companies generally having to pay higher premiums and it certainly seem to be leading to an increase in captive insurance startups, and to captives wanting to write new lines of business.

Some companies in this latter group may not want to pump more capital into the captive to finance this new business, and legacy is another way to finance it if the parent does not have a huge amount of spare cash available.

Undertaking an effective legacy solution is a good way to recycle and redeploy that capital, disposing of old portfolios in order to free up capital to write new business. What is the benefit of maintaining capital to support old liabilities when it could be used to lessen the impact of hardening rates?

Assuming we will see a gradual easing of lockdowns in 2021, what does that mean for business?

As we come out of lockdown we will see the extent of the financial hit that companies have taken from COVID-19, whether that is the long-term impact on passenger numbers for airlines, demand for hotel rooms for tourists, or other sectors. Some companies will face very challenging circumstances, and some of them might have captives that are sitting on a pile of cash, albeit locked in capital or collateral. Legacy deals might be quite attractive to some of them as a way of unlocking that cash, allowing it to be distributed to the parent.

We have all seen the distress in the retail sector in particular, and some of the big chains that are struggling have captives, so that is something to watch. R&Q’s first experience in the captive insurance sector was a legacy deal with Woolworths’ captive in Guernsey back in 2009, and there could be more situations like that to come.

It isn’t clear how many institutions will be in that kind of trouble, but even for companies that do not face outright bankruptcy it is a good time to be looking to optimise their capital and financing positions.

The legacy sector as a whole works hard to educate people that legacy is not only suitable for distressed situations but is about providing capital relief and finality and helping healthy companies use their capital more efficiently. In 2020 we completed deals with companies such as Allianz SE and with various Lloyd’s syndicates, which are not distressed institutions, and should show captives that legacy is something they can consider even if they are not facing obvious uncertainty.

We could also be approaching a phase in the economic cycle where there is increased corporate M&A activity. Some companies have prospered during the COVID-19 pandemic and are relatively cash rich, while others may be desperately short of cash, even if the outlook for their business is relatively good once the economy starts to normalise.

That could lead to takeovers and mergers which could result in a new structure with surplus captives that require rationalisation. Similarly, companies may be left with liabilities in their captive arising from a disposed operational division. These are all examples where we have provided legacy solutions to the captive insurance sector.

Are there any regulatory developments in Europe that will impact your business?

Regulatory developments could also be a source of new business for the legacy sector. It has been widely reported that France had threatened there will be no state bailouts for companies that have subsidiaries in offshore, low tax jurisdictions, and there is likely to be a lot more of that kind of rhetoric going forward from other countries too.

While most captives are not set up for the purposes of avoiding tax, there is a reputational component to this that may lead some to decide to bring their captives onshore into the EU, or to wherever the parent company is based. Legacy could play a part in that, taking on any liabilities from offshore captives that companies did not want to retain and bring into a potentially higher capital regulatory regime.

Is Europe catching up with the US, in terms of the amount of legacy business being done?

There is certainly better understanding in Europe than there used to be about what the legacy sector can do, and how legacy deals can help insurers and captives use their capital more efficiently.

Part of the difference between the US and Europe comes down to a question of culture. In Continental Europe there is more of a mindset that an insurer has written a policy and should stand by it, for better or worse, whereas in the US and UK they were historically more open to the legacy solution as a wider benefit to all stakeholders.

Language has always been more of a challenge in Europe too. Most business is conducted in English so that isn’t a problem, but when it comes to detailed due diligence you are more likely to find yourself analysing contracts and claim files in different languages. That adds an extra layer of complexity, compared to the US and UK which have previously been the much bigger legacy markets.

There has also traditionally been a greater demand for legacy in the US. There is significant exposure to lines such as workers’ compensation, which have long tails and are therefore ripe for legacy deals. There are also asbestos exposures, and the UK market in particular wrote considerable volumes of US casualty which is now impacted by these claims.

In Europe there has traditionally been more state support for these kinds of exposures, which meant there was less demand for legacy, but the European market is certainly opening up.

Paradoxically, while the US market has always been more active for legacy, Europe actually has better tools for managing legacy transactions. The Part VII transfer concept in the UK, which is a way of moving insurance policies from one company to another, is based on an EU-wide directive, and is now increasingly being copied in the US—Oklahoma has most recently led efforts to apply that principle in the US.

It is however more challenging for the US: while it is one country, it comprises 50 different states, each of them being a distinct regulatory jurisdiction. In Europe, on the other hand, 30 countries make up the European Economic Area, but these countries have a greater degree of regulatory harmonisation under Solvency II and other EU-wide directives.

Paul Corver is group head of M&A at Randall & Quilter Investment Holdings. He can be contacted at: paul.corver@rqih.com

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