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Guy Carpenter Fo[RE]sight Podcast
Episode 07: Legacy Transactions
00:00:03:15 - 00:00:41:23
Eric Stenson
I'm Eric Stenson from Guy Carpenter. Welcome to this episode of Fo[RE]sight: A Guy Carpenter Podcast Series, bringing you unmatched insights on trending challenges and our solutions, delivered by Guy Carpenter—experts on the vanguard of thought leadership within the reinsurance industry. Today, Guy Carpenter’s Ed Hochberg, Head of Global Risk Solutions, and Ronnie Carroll, Managing Director, Global Risk Solutions, discuss various types of legacy transactions, how they help insurers strengthen their capital positions, and how legacy transactions are useful even for insurers that are confident in the reserve establishment.
00:00:41:26 - 00:00:59:03
Eric Stenson
Guy Carpenter's Global Risk Solutions Team has the technical expertise to deliver unique, structured solutions and the sophistication to optimize their value to your enterprise. Please welcome Ed and Ronnie as they share their insights into the world of legacy transactions.
00:00:59:05 - 00:01:27:08
Ronnie Carroll
Thank you, Eric. Ed and I are very pleased to be here today to talk about legacy transactions. We plan to offer our listeners insights on what legacy transactions are; why would a company be interested in them; how a legacy transaction can help a carrier improve its capital position; and why companies who are confident in the reserves can still benefit from a legacy transaction when they redeploy capital to future underwriting activities.
00:01:27:10 - 00:01:42:01
Ed Hochberg
Thanks, Ronnie. We’ll be covering a lot more, including rating agency and regulatory credit, the role in helping M&A deals, claims administration versus capital-oriented transactions, as well as new entrants.
00:01:42:04 - 00:01:50:18
Eric Stenson
Well, we have read a lot in the trade press about legacy transactions. What are these transactions and why should a company be interested in them?
00:01:50:21 - 00:02:03:26
Ed Hochberg
Fundamentally, these transactions are retroactive or retrospective in nature. That is, they cover past insurable events. And therefore, they really transfer reserving risk as opposed to prospective underwriting risk.
00:02:03:28 - 00:02:34:20
Ronnie Carroll
You can further split these transactions into some major categories: full legal transfer, such as a reinsurance to close at Lloyd's; a part seven transfer, or a full innovation of underlying policies; versus reinsurance, such as lost portfolio transfers or LPTs, an adverse development covers or ADCS, with the key distinction being whether the coverage attaches at dollar one, in the case of an LPT, or excess of a retention, in the case of an ADC.
00:02:34:22 - 00:02:43:14
Ed Hochberg
There are many reasons that an insurer would want to enter into a legacy transaction. But the key element underpinning nearly all cases is capital.
00:02:43:17 - 00:03:00:03
Ronnie Carroll
Yes, a carrier might do a deal to exit a business financially, operationally and in some cases legally. They might enter into a legacy transaction as part of a larger M&A transaction. But typically, the objective is to improve capital position in one form or another.
00:03:00:06 - 00:03:07:20
Eric Stenson
You say that capital is an overarching theme, but how does the legacy transaction help a carrier with its capital position?
00:03:07:22 - 00:03:33:13
Ed Hochberg
If you’re in the insurance business, then you have capital tied up by business you've underwritten in the past. This is always something that was known intuitively—a carrier runs the risk of adverse loss-reserve development. Over the last 15 to 20 years, though, both the regulatory and rating agency capital models have evolved to the point where you could pretty much quantify exactly how much capital is being consumed by prior year liabilities.
00:03:33:16 - 00:03:41:17
Ronnie Carroll
And in fact, if you look back through time, what's been the number one reason for a carrier going insolvent or having serious financial difficulties?
00:03:41:19 - 00:03:43:26
Ed Hochberg
Adverse loss-reserve development.
00:03:43:28 - 00:04:01:00
Ronnie Carroll
Which is why rating agencies and regulators make carriers hold capital against their loss-reserve provisions. Depending on the line of business and the capital regime, the amount of on diversified capital required can range from 30% to 50% or more of the carried loss reserves.
00:04:01:03 - 00:04:11:12
Ed Hochberg
So a well-designed legacy transaction can have an immediate impact on a company's required capital and could often be done at an attractive cost of such capital.
00:04:11:15 - 00:04:18:11
Eric Stenson
Well, specifically, how do rating agencies give credit for legacy transactions? How about regulators?
00:04:18:13 - 00:04:35:14
Ed Hochberg
The major rating agencies have become well-versed in legacy transactions. They have prescriptive formulas for how to reflect them in their capital adequacy models. Again, because of that, we can come very, very close to estimating the exact capital relief in a rating agency capital model.
00:04:35:17 - 00:04:56:19
Ronnie Carroll
For regulators, it very much depends on the primary regulatory regime for the carrier. And then, when you get into the Solvency 2 types of regimes, it also depends on whether or not the company utilizes a standard formula or an internal model. It's pretty easy to estimate the capital relief on a standard formula, but it can be a bit more difficult with an internal model.
00:04:56:21 - 00:05:03:10
Eric Stenson
Do you get the question often: “If I'm not concerned about my reserves, why would I consider a legacy transaction?”
00:05:03:12 - 00:05:05:16
Ronnie Carroll
Yeah, we get that a lot.
00:05:05:19 - 00:05:33:17
Ed Hochberg
Yeah, that's one of the biggest misconceptions. I'm confident in my reserves, so there's no value in a legacy transaction. Now look, it's a natural question to ask. If someone doesn't perceive a lot of risk of adverse loss-reserve development, it certainly can be counterintuitive to think that a legacy transaction can be accretive. But the thing is, even if reserves are considered adequate or even redundant, under rating agency and regulatory capital regimes, those reserves still consume capital.
00:05:33:19 - 00:05:43:06
Ed Hochberg
So a legacy transaction could still improve a company's capital position, enable the company to redeploy that capital from its back pocket to future underwriting activities.
00:05:43:09 - 00:05:47:18
Ronnie Carroll
In fact, if reserves are in good shape, it makes the transaction much easier.
00:05:47:20 - 00:06:03:01
Ed Hochberg
Sure. The most common hurdle in any deal is overcoming the so-called bid-ask spread between what the respective counterparties think the reserves are worth. So, if the reserves are in good shape, that often narrows the gap and makes the transaction that much easier.
00:06:03:03 - 00:06:12:00
Eric Stenson
So, are you saying that if reserves are potentially volatile, it's difficult to do a deal? That would also seem kind of counterintuitive.
00:06:12:03 - 00:06:28:06
Ronnie Carroll
Yeah, that would be counterintuitive. No, that's not what we're saying. But it's certainly easier if reserves are perceived as adequate and not that volatile. On the other hand, we get paid to find solutions in all sorts of situations. That includes instances where there's a lot of potential volatility.
00:06:28:08 - 00:06:40:05
Ed Hochberg
Right. Every solution is different, and every situation is different. The deals that we have done definitely run the gamut in terms of how much real volatility exists in the underlying reserves.
00:06:40:07 - 00:06:48:02
Eric Stenson
You mentioned M&A or mergers and acquisitions before. How do legacy transactions help M&A deals?
00:06:48:04 - 00:06:56:01
Ed Hochberg
Well, when you buy another company, you buy its balance sheet, which generally includes liabilities for just about everything that it's ever written.
00:06:56:04 - 00:07:07:01
Ronnie Carroll
It is usually one of the major valuation sticking points. The valuation of the liabilities, and/or the perceived impact of the potential volatility of the estimates.
00:07:07:03 - 00:07:12:28
Ed Hochberg
Right, so if you could take that element out of the equation, an M&A deal can go that much more smoothly.
00:07:13:01 - 00:07:25:01
Ronnie Carroll
Yeah. So, all things being equal, a buyer should be willing to pay more with that uncertainty off the table. Done well, the uplift in potential purchase price more than exceeds the net cost of any legacy transaction.
00:07:25:04 - 00:07:32:23
Ed Hochberg
Some of the major transactions that our group has undertaken over the past few years has involved creating certainty for the buyer in an acquisition.
00:07:32:25 - 00:07:41:12
Ronnie Carroll
In these deals, the combination of reduced uncertainty as well as reducing required capital really helped these transactions in getting over the line.
00:07:41:15 - 00:07:46:05
Eric Stenson
What can you say about the counterparties for legacy transactions?
00:07:46:08 - 00:08:01:20
Ed Hochberg
Broadly speaking, you can break the market down into professional reinsurers, for lack of a better term. Those would include the likes of Swiss Re, Munich, Re, Hanover, etc., and then legacy acquirers, such as NSTAR, Riverstone, etc.
00:08:01:23 - 00:08:20:14
Ronnie Carroll
It used to be that the reinsurers focused on the reinsurance transactions where the ceding enterprise held on to claims administration. The legacy acquirers would then focus more on disposition types of transactions where claim servicing is transferred. Those lines have definitely become more blurred in the past few years.
00:08:20:16 - 00:08:43:02
Ed Hochberg
Yeah, what we really saw, is that the professional reinsurers are quite full up on long-term liabilities from their prospective books, and so they really seem to take a step back from retroactive coverages. Legacy acquirers, on the other hand, then stepped into the breach. They started considering deals that didn't require the transfer of claims administration and more capital-oriented transactions.
00:08:43:04 - 00:08:46:11
Ed Hochberg
So that's still really the current state of play.
00:08:46:13 - 00:08:51:12
Eric Stenson
Is it fair to say that some of the legacy players have wobbled in recent years?
00:08:51:14 - 00:09:02:03
Ronnie Carroll
Sure, you will have seen some of that in the trade press. The thing is, that this is a market with different players who take different types of risks. So, some will do well, and some may not.
00:09:02:05 - 00:09:04:15
Ed Hochberg
Yeah, I think that's to be expected.
00:09:04:17 - 00:09:14:21
Ronnie Carroll
Importantly for cedents, the obligations are nearly always collateralized. So that affords them a fair amount of protection against credit risk, even in the worst-case scenario.
00:09:14:24 - 00:09:19:19
Eric Stenson
And there have been new entrants in the space over the last few years, right?
00:09:19:21 - 00:09:29:29
Ed Hochberg
Capital has definitely flowed into the space, both for new entrants as well as for existing participants. And that's good because legacy business is clearly a capital-intensive one.
00:09:30:01 - 00:09:40:25
Ronnie Carroll
But I wouldn't say it's over capitalized at all. The fact is that there have been some players who have left the space over the last few years, and that has clearly been offset by new capital devoted to legacy.
00:09:40:28 - 00:09:51:00
Ed Hochberg
Clearly, you don't have the hallmarks of too much capital. We definitely don't see players acting irresponsibly. Mostly, I'd say the market is pretty orderly.
00:09:51:02 - 00:09:56:15
Eric Stenson
What about the trend toward very large transactions? Is that likely to persist?
00:09:56:17 - 00:10:07:24
Ronnie Carroll
There have been some headline transactions of a very, very large couple in excess of $1,000,000,000 of ceded reserves. But I'm not sure whether a few transactions is indicative of a trend.
00:10:07:26 - 00:10:27:27
Ed Hochberg
No, I'm not sure either. Look, there can be value to a transferrer, of getting large blocks of reserves off their books in one fell swoop. Now, on the other hand, the size and complexity of these types of transactions means that you really limit the market to a couple of players that have the capacity to do deals of that size.
00:10:27:29 - 00:10:41:15
Ronnie Carroll
Yeah, for that reason, we mostly see deals in the 200 million to $500 million sort of range. That's the sweet spot, I think. Big enough to get even the bigger players interested, but not so big that you limit the market.
00:10:41:17 - 00:10:47:00
Eric Stenson
When would a company want to transfer claim servicing? And when would they probably not?
00:10:47:03 - 00:10:57:07
Ronnie Carroll
As ever, it's going to come down to the key objectives of the transaction. Clearly, if it's an exit or legal finality, it's going to make sense to transfer the claim servicing.
00:10:57:09 - 00:11:18:17
Ed Hochberg
Yeah, beyond that, it comes down to the balance of cost-benefit in a particular transaction. Generally, legacy consolidators prefer to have claims servicing. They have extensive claims servicing operations and any savings they perceive can influence their views of the relative attractiveness of a deal, meaning better execution for the transfer.
00:11:18:20 - 00:11:33:05
Ronnie Carroll
On the other hand, there are many situations where transferring servicing obligations doesn't make sense. This will often be the case or subject portfolios where the transferer is still actively writing the business so it isn't comfortable transferring the servicing.
00:11:33:08 - 00:11:37:25
Eric Stenson
What should a company think about if it's considering a legacy transaction?
00:11:37:28 - 00:11:44:20
Ed Hochberg
Well, every deal and every transaction is different. You know, we often get the question, “how much does an LPT cost?”
00:11:44:23 - 00:11:49:02
Ronnie Carroll
Right, that's probably second only to, “how long does it take to do an LPT?”
00:11:49:04 - 00:12:00:07
Ed Hochberg
Of course. But the fact is, that cost is a very difficult question to answer, because every specific situation is so different, and most transactions are very tailored.
00:12:00:09 - 00:12:07:07
Ronnie Carroll
And, quite often, the perceived cost is a function of the extent to which the markets buy into the cedent’s last reserve picks.
00:12:07:10 - 00:12:20:28
Ed Hochberg
And once we get through that, the headline cost will be influenced by things like whether or not the transaction is profit sharing, whether or not the claim servicing is transferred, funds transferred versus funds withheld, among other things.
00:12:21:01 - 00:12:23:22
Ronnie Carroll
And… how long does it take?
00:12:23:24 - 00:12:44:05
Ed Hochberg
Well, a legacy transaction is really a hybrid of reinsurance and M&A. So, it generally takes longer than a more usual reinsurance deal. I don't know, what do we usually say: something like a median time of six months? But, many times it's a function of how quickly and efficiently the transferring carrier can address data and due diligence questions.
00:12:44:07 - 00:12:57:02
Ronnie Carroll
We always recommend appointing a project manager, particularly one who knows where and how to get the appropriate data to answer market questions. It can be much harder when the process competes too much with somebody's day job.
00:12:57:04 - 00:13:17:09
Ed Hochberg
Absolutely right. The other thing that can make things run more smoothly is very close management of the contracting phase. Hiring the right law firm, but then managing that law firm in such a way that they're fully versed in what the client believes is important and what isn't. That can just save a lot of time and drama in getting a deal closed.
00:13:17:11 - 00:13:46:25
Ronnie Carroll
Well, Ed, we've covered a lot of ground. We've talked about how there are many reasons that an insurer would want to enter into a legacy transaction. But the key element underpinning nearly all cases is capital. A carrier might do a deal to exit a business financially, operationally and in some cases legally. They might enter into a legacy transaction as part of a larger M&A transaction, but typically, the objective is to improve capital position in one form or another to create profitable growth.
00:13:46:27 - 00:14:13:04
Ed Hochberg
A key takeaway for our listeners is that a well-designed legacy transaction can have an immediate impact on a company's required capital, and it could often be done at an attractive cost of such capital. Guy Carpenter has extensive experience in helping companies understand and manage the complexities of reserved risk and its capital implications. We work with clients to create tailored solutions that match insurers’ capital and risk levels for maximum efficiency.
00:14:13:06 - 00:14:43:05
Ed Hochberg
These solutions offer greater certainty in financial results, capital efficiency, and therefore greater opportunities for profitable growth. Our experienced team has collectively executed on transactions covering in excess of $25 billion of reserves over the past several years, in every major jurisdiction. With vast actuarial accounting, financial underwriting and market experience, the team delivers results to insurers large and small around the world.
00:14:43:07 - 00:15:11:04
Eric Stenson
I am Eric Stenson and thank you to Guy Carpenter’s Ed Hochberg and Ronnie Carroll for sharing their insights on legacy transactions, how they help insurers improve their capital position, and how companies benefit from legacy transactions when they look to redeploy capital to underwriting activities. Anyone wanting to learn more, or who would like to engage with the Guy Carpenter expert directly should visit Guy Carp dot com and click on “Explore Solutions.”
00:15:11:07 - 00:22:01:11
Eric Stenson
Please look for the next episodes in our series as we address additional themes connected with the reinsurance environment. And thank you to our audience for sharing this time with us and listening to Fo[RE]sight: A Guy Carpenter Podcast Series.
Episode 07: Legacy Transactions
00:00:03:15 - 00:00:41:23
Eric Stenson
I'm Eric Stenson from Guy Carpenter. Welcome to this episode of Fo[RE]sight: A Guy Carpenter Podcast Series, bringing you unmatched insights on trending challenges and our solutions, delivered by Guy Carpenter—experts on the vanguard of thought leadership within the reinsurance industry. Today, Guy Carpenter’s Ed Hochberg, Head of Global Risk Solutions, and Ronnie Carroll, Managing Director, Global Risk Solutions, discuss various types of legacy transactions, how they help insurers strengthen their capital positions, and how legacy transactions are useful even for insurers that are confident in the reserve establishment.
00:00:41:26 - 00:00:59:03
Eric Stenson
Guy Carpenter's Global Risk Solutions Team has the technical expertise to deliver unique, structured solutions and the sophistication to optimize their value to your enterprise. Please welcome Ed and Ronnie as they share their insights into the world of legacy transactions.
00:00:59:05 - 00:01:27:08
Ronnie Carroll
Thank you, Eric. Ed and I are very pleased to be here today to talk about legacy transactions. We plan to offer our listeners insights on what legacy transactions are; why would a company be interested in them; how a legacy transaction can help a carrier improve its capital position; and why companies who are confident in the reserves can still benefit from a legacy transaction when they redeploy capital to future underwriting activities.
00:01:27:10 - 00:01:42:01
Ed Hochberg
Thanks, Ronnie. We’ll be covering a lot more, including rating agency and regulatory credit, the role in helping M&A deals, claims administration versus capital-oriented transactions, as well as new entrants.
00:01:42:04 - 00:01:50:18
Eric Stenson
Well, we have read a lot in the trade press about legacy transactions. What are these transactions and why should a company be interested in them?
00:01:50:21 - 00:02:03:26
Ed Hochberg
Fundamentally, these transactions are retroactive or retrospective in nature. That is, they cover past insurable events. And therefore, they really transfer reserving risk as opposed to prospective underwriting risk.
00:02:03:28 - 00:02:34:20
Ronnie Carroll
You can further split these transactions into some major categories: full legal transfer, such as a reinsurance to close at Lloyd's; a part seven transfer, or a full innovation of underlying policies; versus reinsurance, such as lost portfolio transfers or LPTs, an adverse development covers or ADCS, with the key distinction being whether the coverage attaches at dollar one, in the case of an LPT, or excess of a retention, in the case of an ADC.
00:02:34:22 - 00:02:43:14
Ed Hochberg
There are many reasons that an insurer would want to enter into a legacy transaction. But the key element underpinning nearly all cases is capital.
00:02:43:17 - 00:03:00:03
Ronnie Carroll
Yes, a carrier might do a deal to exit a business financially, operationally and in some cases legally. They might enter into a legacy transaction as part of a larger M&A transaction. But typically, the objective is to improve capital position in one form or another.
00:03:00:06 - 00:03:07:20
Eric Stenson
You say that capital is an overarching theme, but how does the legacy transaction help a carrier with its capital position?
00:03:07:22 - 00:03:33:13
Ed Hochberg
If you’re in the insurance business, then you have capital tied up by business you've underwritten in the past. This is always something that was known intuitively—a carrier runs the risk of adverse loss-reserve development. Over the last 15 to 20 years, though, both the regulatory and rating agency capital models have evolved to the point where you could pretty much quantify exactly how much capital is being consumed by prior year liabilities.
00:03:33:16 - 00:03:41:17
Ronnie Carroll
And in fact, if you look back through time, what's been the number one reason for a carrier going insolvent or having serious financial difficulties?
00:03:41:19 - 00:03:43:26
Ed Hochberg
Adverse loss-reserve development.
00:03:43:28 - 00:04:01:00
Ronnie Carroll
Which is why rating agencies and regulators make carriers hold capital against their loss-reserve provisions. Depending on the line of business and the capital regime, the amount of on diversified capital required can range from 30% to 50% or more of the carried loss reserves.
00:04:01:03 - 00:04:11:12
Ed Hochberg
So a well-designed legacy transaction can have an immediate impact on a company's required capital and could often be done at an attractive cost of such capital.
00:04:11:15 - 00:04:18:11
Eric Stenson
Well, specifically, how do rating agencies give credit for legacy transactions? How about regulators?
00:04:18:13 - 00:04:35:14
Ed Hochberg
The major rating agencies have become well-versed in legacy transactions. They have prescriptive formulas for how to reflect them in their capital adequacy models. Again, because of that, we can come very, very close to estimating the exact capital relief in a rating agency capital model.
00:04:35:17 - 00:04:56:19
Ronnie Carroll
For regulators, it very much depends on the primary regulatory regime for the carrier. And then, when you get into the Solvency 2 types of regimes, it also depends on whether or not the company utilizes a standard formula or an internal model. It's pretty easy to estimate the capital relief on a standard formula, but it can be a bit more difficult with an internal model.
00:04:56:21 - 00:05:03:10
Eric Stenson
Do you get the question often: “If I'm not concerned about my reserves, why would I consider a legacy transaction?”
00:05:03:12 - 00:05:05:16
Ronnie Carroll
Yeah, we get that a lot.
00:05:05:19 - 00:05:33:17
Ed Hochberg
Yeah, that's one of the biggest misconceptions. I'm confident in my reserves, so there's no value in a legacy transaction. Now look, it's a natural question to ask. If someone doesn't perceive a lot of risk of adverse loss-reserve development, it certainly can be counterintuitive to think that a legacy transaction can be accretive. But the thing is, even if reserves are considered adequate or even redundant, under rating agency and regulatory capital regimes, those reserves still consume capital.
00:05:33:19 - 00:05:43:06
Ed Hochberg
So a legacy transaction could still improve a company's capital position, enable the company to redeploy that capital from its back pocket to future underwriting activities.
00:05:43:09 - 00:05:47:18
Ronnie Carroll
In fact, if reserves are in good shape, it makes the transaction much easier.
00:05:47:20 - 00:06:03:01
Ed Hochberg
Sure. The most common hurdle in any deal is overcoming the so-called bid-ask spread between what the respective counterparties think the reserves are worth. So, if the reserves are in good shape, that often narrows the gap and makes the transaction that much easier.
00:06:03:03 - 00:06:12:00
Eric Stenson
So, are you saying that if reserves are potentially volatile, it's difficult to do a deal? That would also seem kind of counterintuitive.
00:06:12:03 - 00:06:28:06
Ronnie Carroll
Yeah, that would be counterintuitive. No, that's not what we're saying. But it's certainly easier if reserves are perceived as adequate and not that volatile. On the other hand, we get paid to find solutions in all sorts of situations. That includes instances where there's a lot of potential volatility.
00:06:28:08 - 00:06:40:05
Ed Hochberg
Right. Every solution is different, and every situation is different. The deals that we have done definitely run the gamut in terms of how much real volatility exists in the underlying reserves.
00:06:40:07 - 00:06:48:02
Eric Stenson
You mentioned M&A or mergers and acquisitions before. How do legacy transactions help M&A deals?
00:06:48:04 - 00:06:56:01
Ed Hochberg
Well, when you buy another company, you buy its balance sheet, which generally includes liabilities for just about everything that it's ever written.
00:06:56:04 - 00:07:07:01
Ronnie Carroll
It is usually one of the major valuation sticking points. The valuation of the liabilities, and/or the perceived impact of the potential volatility of the estimates.
00:07:07:03 - 00:07:12:28
Ed Hochberg
Right, so if you could take that element out of the equation, an M&A deal can go that much more smoothly.
00:07:13:01 - 00:07:25:01
Ronnie Carroll
Yeah. So, all things being equal, a buyer should be willing to pay more with that uncertainty off the table. Done well, the uplift in potential purchase price more than exceeds the net cost of any legacy transaction.
00:07:25:04 - 00:07:32:23
Ed Hochberg
Some of the major transactions that our group has undertaken over the past few years has involved creating certainty for the buyer in an acquisition.
00:07:32:25 - 00:07:41:12
Ronnie Carroll
In these deals, the combination of reduced uncertainty as well as reducing required capital really helped these transactions in getting over the line.
00:07:41:15 - 00:07:46:05
Eric Stenson
What can you say about the counterparties for legacy transactions?
00:07:46:08 - 00:08:01:20
Ed Hochberg
Broadly speaking, you can break the market down into professional reinsurers, for lack of a better term. Those would include the likes of Swiss Re, Munich, Re, Hanover, etc., and then legacy acquirers, such as NSTAR, Riverstone, etc.
00:08:01:23 - 00:08:20:14
Ronnie Carroll
It used to be that the reinsurers focused on the reinsurance transactions where the ceding enterprise held on to claims administration. The legacy acquirers would then focus more on disposition types of transactions where claim servicing is transferred. Those lines have definitely become more blurred in the past few years.
00:08:20:16 - 00:08:43:02
Ed Hochberg
Yeah, what we really saw, is that the professional reinsurers are quite full up on long-term liabilities from their prospective books, and so they really seem to take a step back from retroactive coverages. Legacy acquirers, on the other hand, then stepped into the breach. They started considering deals that didn't require the transfer of claims administration and more capital-oriented transactions.
00:08:43:04 - 00:08:46:11
Ed Hochberg
So that's still really the current state of play.
00:08:46:13 - 00:08:51:12
Eric Stenson
Is it fair to say that some of the legacy players have wobbled in recent years?
00:08:51:14 - 00:09:02:03
Ronnie Carroll
Sure, you will have seen some of that in the trade press. The thing is, that this is a market with different players who take different types of risks. So, some will do well, and some may not.
00:09:02:05 - 00:09:04:15
Ed Hochberg
Yeah, I think that's to be expected.
00:09:04:17 - 00:09:14:21
Ronnie Carroll
Importantly for cedents, the obligations are nearly always collateralized. So that affords them a fair amount of protection against credit risk, even in the worst-case scenario.
00:09:14:24 - 00:09:19:19
Eric Stenson
And there have been new entrants in the space over the last few years, right?
00:09:19:21 - 00:09:29:29
Ed Hochberg
Capital has definitely flowed into the space, both for new entrants as well as for existing participants. And that's good because legacy business is clearly a capital-intensive one.
00:09:30:01 - 00:09:40:25
Ronnie Carroll
But I wouldn't say it's over capitalized at all. The fact is that there have been some players who have left the space over the last few years, and that has clearly been offset by new capital devoted to legacy.
00:09:40:28 - 00:09:51:00
Ed Hochberg
Clearly, you don't have the hallmarks of too much capital. We definitely don't see players acting irresponsibly. Mostly, I'd say the market is pretty orderly.
00:09:51:02 - 00:09:56:15
Eric Stenson
What about the trend toward very large transactions? Is that likely to persist?
00:09:56:17 - 00:10:07:24
Ronnie Carroll
There have been some headline transactions of a very, very large couple in excess of $1,000,000,000 of ceded reserves. But I'm not sure whether a few transactions is indicative of a trend.
00:10:07:26 - 00:10:27:27
Ed Hochberg
No, I'm not sure either. Look, there can be value to a transferrer, of getting large blocks of reserves off their books in one fell swoop. Now, on the other hand, the size and complexity of these types of transactions means that you really limit the market to a couple of players that have the capacity to do deals of that size.
00:10:27:29 - 00:10:41:15
Ronnie Carroll
Yeah, for that reason, we mostly see deals in the 200 million to $500 million sort of range. That's the sweet spot, I think. Big enough to get even the bigger players interested, but not so big that you limit the market.
00:10:41:17 - 00:10:47:00
Eric Stenson
When would a company want to transfer claim servicing? And when would they probably not?
00:10:47:03 - 00:10:57:07
Ronnie Carroll
As ever, it's going to come down to the key objectives of the transaction. Clearly, if it's an exit or legal finality, it's going to make sense to transfer the claim servicing.
00:10:57:09 - 00:11:18:17
Ed Hochberg
Yeah, beyond that, it comes down to the balance of cost-benefit in a particular transaction. Generally, legacy consolidators prefer to have claims servicing. They have extensive claims servicing operations and any savings they perceive can influence their views of the relative attractiveness of a deal, meaning better execution for the transfer.
00:11:18:20 - 00:11:33:05
Ronnie Carroll
On the other hand, there are many situations where transferring servicing obligations doesn't make sense. This will often be the case or subject portfolios where the transferer is still actively writing the business so it isn't comfortable transferring the servicing.
00:11:33:08 - 00:11:37:25
Eric Stenson
What should a company think about if it's considering a legacy transaction?
00:11:37:28 - 00:11:44:20
Ed Hochberg
Well, every deal and every transaction is different. You know, we often get the question, “how much does an LPT cost?”
00:11:44:23 - 00:11:49:02
Ronnie Carroll
Right, that's probably second only to, “how long does it take to do an LPT?”
00:11:49:04 - 00:12:00:07
Ed Hochberg
Of course. But the fact is, that cost is a very difficult question to answer, because every specific situation is so different, and most transactions are very tailored.
00:12:00:09 - 00:12:07:07
Ronnie Carroll
And, quite often, the perceived cost is a function of the extent to which the markets buy into the cedent’s last reserve picks.
00:12:07:10 - 00:12:20:28
Ed Hochberg
And once we get through that, the headline cost will be influenced by things like whether or not the transaction is profit sharing, whether or not the claim servicing is transferred, funds transferred versus funds withheld, among other things.
00:12:21:01 - 00:12:23:22
Ronnie Carroll
And… how long does it take?
00:12:23:24 - 00:12:44:05
Ed Hochberg
Well, a legacy transaction is really a hybrid of reinsurance and M&A. So, it generally takes longer than a more usual reinsurance deal. I don't know, what do we usually say: something like a median time of six months? But, many times it's a function of how quickly and efficiently the transferring carrier can address data and due diligence questions.
00:12:44:07 - 00:12:57:02
Ronnie Carroll
We always recommend appointing a project manager, particularly one who knows where and how to get the appropriate data to answer market questions. It can be much harder when the process competes too much with somebody's day job.
00:12:57:04 - 00:13:17:09
Ed Hochberg
Absolutely right. The other thing that can make things run more smoothly is very close management of the contracting phase. Hiring the right law firm, but then managing that law firm in such a way that they're fully versed in what the client believes is important and what isn't. That can just save a lot of time and drama in getting a deal closed.
00:13:17:11 - 00:13:46:25
Ronnie Carroll
Well, Ed, we've covered a lot of ground. We've talked about how there are many reasons that an insurer would want to enter into a legacy transaction. But the key element underpinning nearly all cases is capital. A carrier might do a deal to exit a business financially, operationally and in some cases legally. They might enter into a legacy transaction as part of a larger M&A transaction, but typically, the objective is to improve capital position in one form or another to create profitable growth.
00:13:46:27 - 00:14:13:04
Ed Hochberg
A key takeaway for our listeners is that a well-designed legacy transaction can have an immediate impact on a company's required capital, and it could often be done at an attractive cost of such capital. Guy Carpenter has extensive experience in helping companies understand and manage the complexities of reserved risk and its capital implications. We work with clients to create tailored solutions that match insurers’ capital and risk levels for maximum efficiency.
00:14:13:06 - 00:14:43:05
Ed Hochberg
These solutions offer greater certainty in financial results, capital efficiency, and therefore greater opportunities for profitable growth. Our experienced team has collectively executed on transactions covering in excess of $25 billion of reserves over the past several years, in every major jurisdiction. With vast actuarial accounting, financial underwriting and market experience, the team delivers results to insurers large and small around the world.
00:14:43:07 - 00:15:11:04
Eric Stenson
I am Eric Stenson and thank you to Guy Carpenter’s Ed Hochberg and Ronnie Carroll for sharing their insights on legacy transactions, how they help insurers improve their capital position, and how companies benefit from legacy transactions when they look to redeploy capital to underwriting activities. Anyone wanting to learn more, or who would like to engage with the Guy Carpenter expert directly should visit Guy Carp dot com and click on “Explore Solutions.”
00:15:11:07 - 00:22:01:11
Eric Stenson
Please look for the next episodes in our series as we address additional themes connected with the reinsurance environment. And thank you to our audience for sharing this time with us and listening to Fo[RE]sight: A Guy Carpenter Podcast Series.
