Chapter 4: Portfolio Transfer Flashcards
(28 cards)
What are some reasons a general insurer may want to transfer a portfolio of business?
- Reasons include the business being non-core
- Requiring disproportionate capital or management time
- Acquired incidentally during a broader acquisition
- Loss-making or expected to become unprofitable, or regulatory/legal changes making the business less attractive.
- Insolvency requiring cessation of new business may also drive such transfers.
What are the main methods for effecting a portfolio transfer?
1) Run-off to exhaustion
2) Reinsurance
3) Scheme for the transfer of insurance business (substitution),
4) Sale of the business.
What does “run-off to exhaustion” mean in the context of portfolio transfers?
Run-off to exhaustion refers to a strategy where the insurer stops writing new business or renewals in the exiting lines and continues to manage and settle existing claims until all liabilities are fully paid.
What are the disadvantages of a run-off to exhaustion strategy?
- Long time to finality especially for long-tailed business
- High costs to maintain claims functions
- Decreasing efficiency due to reducing volumes
- Ongoing requirement to meet full regulatory and capital obligations.
How does reinsurance help exit a line of business?
Reinsurance can be used to exit a line of business by reinsuring all future claims on historical business. The reinsurer may also take over claims administration under a binder agreement, effectively working as a UMA.
- Reserves are maintained by the insurer and it receives all investment income form the investments backing these reserves
- Protects the cedant form significant reserve deterioration on run-off business
Why does reinsurance not provide full risk transfer?
Reinsurance does not provide full risk transfer because the insurer remains ultimately liable for policyholder claims, even if the reinsurer defaults or becomes insolvent.
What factors affect the cost and availability of reinsurance as an exit tool?
- Estimated cost of liabilities
- Uncertainty around the estimate
- Anticipated investment returns, administration costs.
- Required capital
- Reinsurer’s financial strength, desired return on capital
- General market availability.
What makes a substitution different from reinsurance in terms of risk transfer?
Unlike reinsurance, a substitution (or scheme for the transfer of insurance business) achieves complete risk transfer by formally transferring obligations to a new insurer.
- Investment income will also be passed on to the new reinsurer
- Assets may need to be realised to pass across the value of the reserves to the accepting reinsurer (which is particularly important if there is mismatching or if tax gains / losses would be crystallised).
- Transfer may require the buy-in of reinsurers where there are existing reinsurance arrangements covering the portfolio
What regulatory framework governs substitution in South Africa?
Substitution is governed by Sections 50 and 51 of the Insurance Act and GOI 6, with the Prudential Authority’s approval required for the transaction.
What is required in an application to the Prudential Authority for a substitution?
- Full details of the proposed action
- Agreements or documents, relevant financials
- Report from the Head of Actuarial Function on the soundness of the action
- Policyholder communication plan with timelines and notices.
What are common motivations for using substitution?
- Achieve finality for the insurer
- Reduce cost and release capital through consolidation (all legacy liabilities consolidated, one regulatory reporting)
- Support mergers or acquisitions by simplifying structures or packaging business units.
When would a sale of a whole company be used as an exit strategy?
A whole-company sale is used when the insurer exits an entire portfolio and a buyer is willing to purchase the full entity, achieving complete finality for the seller.
What risks might remain even after a sale of business?
Even after a sale, the seller may retain liability for uncertain historic claims, especially those arising from events with large uncertainty like latent liability cases. Though some would be transferred, its the uncertain ones that will remain.
What are the advantages of purchasing a whole company?
Swift entry into a market for the buyer as the company already has necessary regulatory approvals and infrastructure in place, which can reduce time and effort for the buyer.
What factors affect the valuation of liabilities in portfolio transfers?
- Negotiating strength
- Whether the insurer or counterparty initiated the deal
- Risk appetite
- Length and uncertainty of claims tail
- Regulatory views, opinions of oversight bodies and reinsurers.
Besides actuaries, which other stakeholders are typically involved in portfolio transfer transactions, and what approvals might be required?
In addition to actuaries, other stakeholders involved in portfolio transfers:
* Lawyers
* Tax advisors
* Accountants
* Auditors, and other subject-matter experts.
These transactions may also require material insight and approval from the Board, the Head of Actuarial Function (HAF), Risk functions, and internal audit.
What are the potential downsides to outsourcing functions of the insurer?
Potential downsides include:
* Higher costs due to the outsource company’s profit margin
* Reduced policyholder experience and recourse
* Inconsistencies in claims procedures under the insurer’s brand
* Misaligned incentives since the insurer still bears the ultimate claim costs.
What are key areas to consider when contemplating reinsurance as an exit strategy?
- Level of risk transfer achieved (e.g., limits, caps, proportions covered)
- Ongoing liability of the insurer if the reinsurer defaults
- Cost and availability of reinsurance
- Uncertainty in liabilities, investment return assumptions, administrative costs, required capital, reinsurer strength, and required return on capital.
What are the disadvantages of using reinsurance as an exit strategy?
- Reinsurance does not achieve full risk transfer since the insurer remains ultimately liable if the reinsurer becomes insolvent.
- There may also be limitations on coverage such as lower limits, caps, or partial coverage which leave some risk with the insurer (gaps in cover).
- Reinsurance may be expensive and not readily available in the market, and the insurer may still need to include the business in regulatory reporting.
- The management of claims and admin thereof would still be the responsbility of the original insurer
Why is it important to obtain policyholder consent for a transfer?
It is important to obtain policyholder consent to ensure:
* They understand how the transfer affects them, including potential changes to cover levels, limits, excess structures, or perils covered.
* Policyholders must assess whether the new insurer continues to meet their needs, especially if the original product features caused unprofitability and may be altered.
* Interim arrangements with respect to benefits while transfer is being completed is important for the policyholders
What factors should be considered when negotiating a commutation during a portfolio transfer?
- Valuation of the ultimate liabilities
- Uncertainty surrounding that valuation
- Administrative costs or savings for both parties
- Impact of anticipated future investment return
- Any effects on outwards reinsurance arrangements.
What makes a substitution successful and what factors influence its timeline?
A successful substitution requires agreement between three parties: the policyholder, the new insurer, and the old insurer. Agreement must be reached separately for each policy. The process can be lengthy, often taking several months, and may require Competition Commission approval depending on the size of the transaction.
How are portfolio transfers used in mergers and acquisitions?
Portfolio transfers are used in M&A in several ways:
1) Prior to an acquisition, by consolidating similar portfolios into one entity for sale or separating unwanted portfolios to facilitate a sale.
2) After an acquisition, by combining subsidiaries to achieve cost savings or capital release.
3) As an alternative to buying the entire company, by acquiring only specific portfolios.
When and why might an insurer sell reinsurance assets, and what requirements apply?
An insurer may sell reinsurance assets when the recoveries are uncertain in timing or amount due to the reinsurer’s weak financial position. The reinsured may accept a lower value than expected due to this impairment. Such asset sales must comply with the Insurance Act and Prudential Standards.
