Deals landscape in the run-off legacy insurance market

Christoph Baertz
Partner, Leader Financial Services Deals, PwC Switzerland

The financial services industry is undergoing profound change and needs to upgrade its business models. Globally, we expect deal activity to pick up in 2023, but due diligence remains crucial. And what is the situation in Switzerland? Find out more in this blogpost.

Run-off books inherently pose a significant profitability challenge

Fixed costs per policy tend to increase proportionately over time as the size of the book decreases. Moreover, many policies are still managed on the basis of inefficient legacy systems, which in turn results in high administration costs per policy. To address this, insurers have the option to (1) right-size their operations as the policies run off to ensure a stable cost ratio, (2) outsource certain administrative activities to third parties that can run these businesses more efficiently (as opposed to keeping them in-house), or (3) divest or reinsure the closed book to a specialised consolidator, reinsurer or other interested party. The option to sell includes a variety of benefits, ranging from freeing up capital and reducing management’s time and effort to removing economic and legal exposure while ensuring that the policyholder is protected. This is especially the case as run-off portfolios are often sold to specialist legacy players, who have a surplus of capital as a result of being backed by private equity (PE) players. Other potential buyers of these run-off blocks include independent insurers looking to diversify their portfolio/risk exposure.

Buyers within the run-off space will seek to acquire or merge portfolios to achieve economies of scale and decrease expenses per policy, while streamlining operations and investing in new IT capabilities, digitising processes and switching to alternative, less liquid and higher-yielding investments.

Global Life and Non-Life growth in estimated run-off reserves to remain buoyant

In our recent European Life Insurance M&A and Restructuring Outlook, we highlight the significance of the European life insurance sector as being the most developed in the world, with significant legacy portfolios still expected to exist in almost all markets across Europe. Overall, we estimate that European life reserves represent approximately EUR 10 trillion. The UK insurance market remains the largest and most active in Europe, with technical provisions that have increased by GBP 389 billion (21%) to GBP 2.2 trillion over the past four years.

As for the Non-Life area, our 2022 Global Run-Off Survey estimates that the global non-life run-off reserves have increased from approximately USD 864 billion to USD 960 billion, an 11% increase compared to the 2021 survey. North America continues to dominate the global non-life run-off market with reserves of USD 464 billion, up from USD 402 billion or 15% year-on-year growth. The UK and continental Europe markets have combined reserves of USD 319 billion, up from USD 302 billion or 6% year on year. Our estimates of the reserves in other key territories, including Asia, the Middle East and South America have also increased to USD 177 billion or 11% year on year. In the last two years, 15 non-life run-off deals have been publicly disclosed in continental Europe, with estimated gross liabilities of USD 684 million transferred.

On the right path to Deal Value Creation: optimising value levers

Survey respondents highlight that data and systems integration/adequacy represent a common operational challenge when faced when working in the non-life and life run-off market. This is followed closely by data cleansing and operating model integration and transformation, reflecting the technological challenges the market is keen to address. In our article, we’ve identified and explored four key value levers to address the operational and profitability concerns around:

asset optimisation
technical liability excellence
expense base optimisation
IT & operational entanglement and separation

Conclusions

Life and non-life players can maximise opportunities to boost returns and efficiently manage investment risk by making use of the expertise of sponsors invested in the market.

Legacy acquirers are pricing legacy deals at target internal rates of return (‘IRRs’) of between 10% and 17%, with a majority in the 10% to 13% range. While we note that different market players will make vastly different assumptions when pricing deals, the expectation that most acquirers are targeting returns around the low to mid-teens is consistent with recent market history. Most importantly, despite all the private capital dry powder searching for targets, we’ve seen a real emphasis on maintaining pricing discipline.

The Deal Value Creation cycle entails understanding and acting upon specific value levers, which offer great upside potential to tackle operational and profitability challenges in the best possible way. This will ultimately play a key role in driving synergies and pricing considerations.

Overall, considering the current inflationary environment, we believe it’s unlikely that we’ll see any real slowdown in the market, and we expect the legacy or run-off market to remain buoyant.

#social#