Irish insurers brace for change in approach to run-off supervision

Acquisition of run-off portfolios and run-off undertakings is increasing and attracting interest from specialised investment entities throughout Europe, including private equity. The anticipated changes are particularly relevant to the Irish insurance market given the number of run-off undertakings actively consolidating books of European run-off insurance business on the balance sheets of Irish-authorised undertakings – as well as the number of Irish insurance companies, or books of business underwritten by them, being acquired by run-off specialists.

EIOPA’s proposed supervisory statement for run-off undertakings, issued for consultation last year, sets out supervisory expectations for the supervision of run-off undertakings in the context of portfolio transfers; acquisitions of qualifying holdings and mergers; and ongoing supervision. It is intended to apply to undertakings both fully and partially in run-off, where that partial run-off applies to a material part of the business.

The statement is relevant to key transactions that consolidators and run-off specialists will look to undertake in future, and the principles set out in it are likely to dominate the approaches of domestic supervisory authorities, even before the final statement is issued. Consolidators and run-off specialists should therefore be referring to the draft supervisory statement now in the context of transactions and business-as-usual activities.

EIOPA is currently considering the feedback to its consultation and developing an impact statement. It will publish a final report on the consultation and submit the supervisory statement for adoption by its board of supervisors in due course.

Proposed acquisitions

The draft supervisory statement sets out several points which supervisory authorities should consider in the context of proposed acquisitions of undertakings by way of share sales or portfolio transfers of books of insurance business:

• if the transaction affects the recoverability or amount of the claims, the supervisory authority may request the acquirer to make additional commitments suitable to safeguard the interests of policyholders;
• if there are justified doubts about the financial capacity of the acquirer or its credit rating cannot be reliably assessed, the supervisory authority may ask the acquirer to provide collateral to back up the commitment (e.g. bank guarantees);
• it is important to assess whether the acquiring/accepting insurance undertaking’s product oversight and governance policy has adequate system and controls aimed at mitigating possible risks which can emerge for the acquired/accepted target market, taking into account the product characteristics of the acquired portfolio. If needed, the acquiring/accepting undertaking should have its own product oversight and governance policy adjusted and aligned with the acquired/accepted portfolio. It should also carry out the product monitoring and review as part of the product oversight and governance process for the acquired/accepted portfolio.

This last point is consistent with the current regulatory objectives of the Central Bank of Ireland, which has cited an increased focus on compliance with the product oversight and governance principles set out in the Insurance Distribution Directive.

Ongoing supervision

The draft supervisory statement is not limited to supervisory practices to be applied to large transactions requiring supervisory approval. It also sets out principles to be applied by supervisory authorities to ongoing supervision of consolidators and run-off undertakings.

The statement provides that there should be specific focus on how the undertaking is expected to remain profitable in the near future while also ensuring the compliance with Solvency II rules relating to technical provisions, solvency capital requirement and fair treatment of policyholders. It notes that life run-off undertakings might try to optimise both underwriting and investment results by investing in higher yielding (but also riskier or more illiquid) assets. Supervisory authorities should carefully monitor changes in investments and assess if the prudent person principle is still being adhered to in those circumstances.

The draft supervisory statement also specifically cites unit-linked products where risks are entirely borne by policyholders and the importance that the risk/reward profile of assets backing those products is aligned with the risk profile of the policyholders.

Private equity investment

Interestingly, the draft supervisory statement deals expressly with private equity investments.

It states: “Private equity or similar investment entities are developing a growing interest in acquiring run-off undertakings. Since their investment horizon is usually shorter than more traditional shareholders, there is a risk that capital is pulled out of the target undertaking with potential negative impact on policyholders protection. To prevent this, supervisory authorities should consider the track record of the involved private equity party and assess the possible consequences of an early withdrawal from the investment. In the case of undertakings providing financial guarantees, investors should not be privileged with regards to profit and losses in the near future to the detriment of policyholders with longer contract terms.”

The implications of this are that supervisory authorities are likely to look more closely at potential private equity buyers of insurance business for the reasons cited. In reality, though, this probably reflects the approach already taken by the Central Bank of Ireland.

The draft supervisory statement makes a number of additional points in respect of private equity which are instructive as to the likely attitude of supervisory authorities going forward, including:

• private equity investors may seek to increase their return on their investments and so supervisory authorities should not permit erosion of the undertaking’s substance and earning power, nor an erosion of policyholders returns or an increase in any undue costs charged to policyholders;
• if leverage is used to finance the acquisition, the acquirer must be able to show an ability to service the debt or refinance any remaining amount at maturity even under unfavourable circumstances;
• if outsourcing, the private equity investor must be able to show that it is able to manage and oversee the activity of third party service providers and that the use of outsourcing will not lead to new operational challenges or risks;
• legacy platforms backed by private equity are usually embedded in complex group structures which can create difficulties; and
• the time horizon and funding structures applicable to dividend and coupon payments should be carefully examined.