A captive embrace

In general, the legacy solutions offering is quite durable through all points of the economic cycle, although there is no denying that cases of economic distress and market dislocation present a unique opportunity for a company such as R&Q.

The global COVID-19 pandemic has been no exception, as engaging in a run-off transaction to dispose of legacy liabilities is a proactive step that management can take to shore up their balance sheet. This is certainly the case for captives that are tying up cash in the form of excess collateral. Freeing up that cash to bolster operations has always been a motivation for captives, but the value of this has clearly been on display over the past year.

Regarding individual sectors, we have been seeing a greater volume of opportunities from the healthcare sector, from both hospital-owned captives and risk retention groups. These transactions have ranged from simple run-off scenarios involving inactive self-insurance structures, to bankruptcy-induced processes, to merger- and acquisition-related activity of hospitals or healthcare systems requiring disposal of the targets’ legacy insurance liabilities.

We have also seen an uptick in public entities seeking run-off solutions, ranging from legacy general liability to workers’ compensation liabilities. While some of these entities have had COVID-19 moratoriums imposed, activity is starting to pick up. The rationale for public entities to seek a legacy solution can be broad and very different from private entities.

An intriguing aspect with public entities is that some operate a ‘pay-as-you-go’ model, meaning that collateral and capital may not be as large a consideration. However, the liability is indeed real, and we have been seeing strong risk management and cost-control efforts from these organisations with legacy solutions being incorporated to facilitate these goals.

According to PwC’s most recent Global Insurance Run-off Survey, the estimate of non-life run-off liabilities rose to $860 billion in 2021, up from $730 billion in 2018. Meanwhile, 72 percent of surveyed re/insurers, brokers, service providers and other stakeholders in the non-life legacy insurance market believe that the global legacy market is in its emerging or growth stage.

This growth opportunity has attracted new interest from carriers and capital providers to offer legacy solutions. While captives would appear to be the natural beneficiaries of this, it remains to be seen how responsive these new entrants will be to the captive insurance market. Solutions for smaller captives, with less than $50 million of reserves, may not appeal to certain players whose primary focus is the pursuit of large loss portfolio transfers for several hundred million dollars with traditional property and casualty companies.

Additionally, few carriers outside R&Q have the pre-established infrastructure and supported organisational experience required to execute on these deals. While they may be able to accommodate a captive through a reinsurance transaction, they may have less appetite for solutions that provide full legal finality via a novation or acquisition.

The most important factor is the experience that the provider brings. A proven track record not only speeds up the process for the captive’s owners, but greatly reduces the execution risks of a transaction. Given the time and effort put into these deals, faltering after weeks of work because of some unforeseen issue with a regulator or fronting carrier can be wasteful and frustrating.

Additionally, it helps to have a partner who has the appropriate breadth of product to tailor the right legacy solution that meets the captive owner’s needs when a simple sale of the captive or reinsurance is not enough.

Within the captive insurance sector, R&Q continues to offer full legal finality for captives’ liabilities via novation agreements or outright acquisition. A combination of recent enhancements to R&Q’s due diligence process and our low execution risk has enabled a more user-friendly service for both the intermediaries and the captive client.

Highlighting the sophistication and growing knowledge of legacy solutions within the space, the captive became the primary vehicle through which client companies were able to achieve finality on their legacy liabilities. For example, one transaction that was closed last year had the client consolidating all their retained workers’ comp and general ledger liabilities across multiple legal entities into their captive, which created a single counterparty for R&Q.

Additionally, R&Q’s ability to utilise its fully admitted and rated US carrier, ASC, continues to appeal to companies with US-based captives. Captives and other self-insured vehicles are increasingly enquiring about how to restructure their business to remove volatility risk and recycle or distribute capital.

The primary motivations—and this has been borne out by our own experience at R&Q and by the most recent survey from PwC—include releasing capital/collateral, disposing of non-core businesses, managing volatility, cleaning up a balance sheet for sale, and reducing operating costs.

We are consistently finding a lack of recognition of the true cost of unallocated loss adjustment expenses (ULAE), the gravity of which materialises only when the captive enters run-off. We are increasingly finding that once our clients understand the true cost of ULAE, there is little challenge in rationalising an exit solution.

This is because ULAE is not traditionally recognised as a liability on the balance sheet or reserve estimates; rather, it is included as the current year estimate, and not the present value of all future outlays.

In addition, we have seen that ULAE costs are less variable and even fixed at a certain point for many captives going into run-off, eventually growing larger as a component of the reserves. When weighing the present value of the future costs over the course of the run-off period (in other words, recognising the true economic cost of the ULAE liability), it is often the case that an exit solution creates savings.

Where we can uncover such opportunities, transactions become ‘no-brainers’ as we are able to deliver a win-win scenario to both parties.

The key advice is for the captive to be fully informed of the options available. We often see a captive (or its representative) come to us with a proposal which we do not believe is the right solution. A key part of the transaction is having open dialogue with the counterparty to understand what they want to achieve and then delivering the best solution to accomplish that.

R&Q can do that as we have a very broad platform to provide solutions including AM Best A- rated carriers in the US and Europe alongside consolidator vehicles in Bermuda, Cayman, Guernsey, the Isle of Man and Vermont.

R&Q is not the only legacy acquirer operating in the captives space, but we have probably been doing it for the longest time and have the broadest capabilities. Key questions therefore are (i) have you done this before? (ii) are you known to the regulator? (iii) how will you handle the claims? and, of course, (iv) how much will it cost me?