While there is no clear agreement on the exact definition of run-off in the insurance context, it is generally taken to mean one of two things. This article primary discusses the first form of run-off, that being an insurer ceasing part or all of its business.
1. An insurance company will considered to be in run-off when it ceases to take onboard any new business but will continue to honor existing claims. Usually when the net balance of the company's assets and liabilities is such that the insurer does not have the ability to honor all existing policies based on their predicted loss, the company will cease to write new policies and attempt to use their existing assets to pay off any claims arising from existing clients. In such instances, those with existing claims need not worry about their insurer being in run off, as their claim will be considered superior to that of any creditor.
Another variant on this scenario is when an otherwise solvent insurer determines that it wishes to exit from a particular class of business, but wishes to continue underwriting in other classes. This could be the result of strategic considerations, lack of profitability in the to be discontinued class, or a desire to restructure and to focus on the remaining classes.
2. Run-off insurance on the other hand, is a type of insurance policy that provides liability coverage against claims made against companies that have been acquired, merged, or have ceased operations. Run-off insurance is generally purchased by the company being acquired and protects it and its officers and directors, among other things, from claims and lawsuits filed relating to the company's activity subsequent to the date of acquisition. This type of policy is also usually a claims-made policy, meaning that coverage is based on the fact the claim may be made several years after the incident that caused damage or loss, and the policy period is based upon the date the claim is presented and not the date of the occurrence subject of the claim. The length of the run-off policy or the "runoff" as it is usually referred to, is typically set for several years after the policy becomes active. The provision is typically purchased by the company being acquired.
Run-off insurance is particularly beneficial for directors and officers of a company following a change in corporate structure, as the directors and officers of a company may believe that they are no longer at risk of being held accountable for their actions made in their former capacity. It is in fact the case that even after control of a company has been transferred, the former directors and officers of the company remain exposed to allegations, legal claims and personal liability, and under the terms of their policy, the prior cover is discontinued upon a change in control of the company, making run off cover for any ensuing claims a very prudent investment.
Run-off insurance is also important to any company or individual that carries insurance on a claims-made basis, particularly professions such as physicians and attorneys. A retiring professional may feel that they no longer require liability insurance upon their exiting their profession; however, the policy period of their claims-made policies requires that they maintain such cover until at least the statute of limitations expires on any potential claims that may be asserted against them.
The UAE insurance market is growingly rapidly; gross written premiums for all insurance classes amounted to AED37 billion in 2015, a 10.2 percent increase over 2014. For the first half of 2017, gross written premiums in the UAE increased by 17 percent to AED12.2 billion compared to the AED10.5 billion from the same period in 2016. Such rapid growth can be attributed in part to an increased level of compulsory insurance, economic growth, and improved regulations.
However, the current market is overcrowded and under-penetrated. The volume of premiums is not increasing rapidly enough to provide profit for all insurance companies. Smaller insurers in particular struggle with profitability, due to their high expense base.
There has been an appetite from international insurance companies to penetrate the market by acquiring existing licenses. The demand for such transactions is ongoing as it provides an opportunity for foreign companies to acquire an existing company and take advantage of the company's knowledge of the local insurance market. It also provides an opportunity to rebrand for the benefit of both companies.
There are headwinds, however, limiting the entry of more solvency into the market. The large number of local family businesses operating within the UAE can act as deterrent for M&A's. Often times, owing to a sentimental attachment, families are reluctant to cede ownership of family run insurance companies and transfer control of their business to another investor. However, as these businesses pass from the first-generation founder to next generation shareholders they will become more receptive to merging with other companies or being acquired. Mismatched price expectations between buyers and sellers have also hindered many transactions, as have the regulatory restrictions limiting the allowable percentage of foreign ownership (25 percent, soon to increase to 49 percent).
Run-Off, a Positive
Given the above described prevailing scenario, run-off no longer needs to be viewed as only a indicia of failure; gone are the days where run-off was associated with deadly liabilities that instantly lead to the demise of a company.
We now see an increasing amount of international insurance companies with dedicated run-off practices as well as an increased number of companies willing to dispose of their liabilities. In addition, insurers have become more adept at run off procedures, reducing the associated costs and managing volatility.
Additionally, a properly structured and managed run-off can allow an insurer to mitigate the potentially crippling effects of the insolvency process set forth in the UAE Federal Law No. 6 of 2007, pertaining to how insolvent insurers should be dealt with.
Thus, there is now an increased level of appreciation of the benefits surrounding run-off in the UAE, especially as larger companies are showing a strong desire for the acquisition of insurers that may hold run-off portfolios. It is likely that we will continue to witness an increase in run-off transactions which involve portfolios or books of business that sit within a live entity rather than the share sales of standalone entities. In such instances, we can expect much of the risk to be transferred through reinsurance, or injections of capital into the primary insurers.
In summary, run-off has many benefits for both the acquired and acquiring company. The transferring company is afforded economic and legal finality as well as improved solvency and removal of immediate risk. The acquiring company benefits from an increased market presence and operational efficiency.
Premium Magazine, November 2017
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.