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Opinion: Axa XL’s mammoth ADC – Another tick on the turnaround checklist

If there was a checklist for turning round a troubled insurance company, then Axa is working methodically through it with Axa XL.

Since the global insurance giant bought XL Group in 2018 for $15.3bn, it has been looking to demonstrate value from the acquisition.

At the time, Axa CEO Thomas Buberl said it would probably take 12 to 18 months to convince investors that buying XL Group was the right decision – but in reality, it has taken a lot longer than that, if indeed investors are yet convinced.

Since acquisition, Axa XL has failed to turn an annual underwriting profit. The business has been beset with volatility issues and consistently plagued with cat losses which exceeded budget.

Its latest result – much like the rest of the specialty/reinsurance market – has been battered by Covid losses and adds to the string of triple-figure full-year combined ratios.

Axa XL combined ratio ID 26 feb.jpg

But remediation work is underway – and Axa is following the tried-and-tested script for company turnarounds.

It changed its leadership in February last year, with Greg Hendrick departing and new CEO Scott Gunter recruited to the helm.

Two months later, it unveiled a full leadership overhaul for Axa XL, with a string of senior staff leaving the company and a number of further staff redundancies made as it moved to a regional structure for the business, to drive greater accountability.

The group has bought more reinsurance and adjusted retentions to reduce Axa XL’s volatility, and now is working hard on re-underwriting the book – a task which Buberl said was the “absolute priority” for Axa XL in a call with journalists in December.

The extent of this re-underwriting was made clear when Axa XL withdrew from its leading position in management liability and financial lines in London – a decision said to be driven by poor performance.

Axa XL revenues for the year also decreased by 1% to EUR18.5bn, highlighting the extent of the cut-backs exposure in a 2020 pricing environment which saw 17% rate increases in insurance and 7% for reinsurance.

But the stand-out piece to date of the turnaround work is a mammoth legacy transaction with Enstar, a two-layer deal providing a combined $2.55bn of protection through a hybrid of a loss reserves transfer and an adverse development cover (ADC).

In scope for the deal, announced with full-year results yesterday, is $11bn of global casualty and professional lines reserves for the 2019 underwriting years and prior.

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Axa does not provide a granular breakdown of reserve development at Axa XL, but the deal provides circumstantial evidence that Axa XL was indeed struggling with adverse development on its casualty and finpro books, as has been suggested by sources.

The size of the deal is one of the largest seen in the legacy market to date and is a clear demonstration of the ambitions and capabilities of Enstar, as it flexes its muscles in a space which was previously only really occupied by the likes of Berkshire Hathaway (which wrote the giant $20bn AIG ADC).

Coming on the back of the Aspen ADC, which also provided protection to immature accident years, it also establishes Enstar as the port of call for companies seeking this kind of solution.

The optics of this transaction are not to be ignored. In securing this deal, Axa XL has drawn a line in the sand on reserving issues and signalled a fresh start to investors.

The Enstar deal has effectively eliminated another source of volatility and management distraction at a time when pricing conditions are favourable and Axa XL has opportunity to write a substantial – and profitable – book of go-forward business.

Price increases in commerical Axa XL ID 26 Feb.jpg

Analysts have welcomed the deal, claiming it provides more certainty on reserving and negates the potential for further bad news.

Citi analyst James Shuck noted that the $11bn of in-scope reserves compares to total XL reserves of $37bn, of which total long-tail insurance reserves are $16.7bn.

The transfer of the $1.6bn of loss reserves acted as effective payment for the ADC, meaning the cost to Axa is effectively the EUR20mn of lost investment income from those transferred reserves.

“For a cost of EUR20mn of forgone investment income, Axa has transferred much of the social inflation risk in long-tail lines,” Jefferies analyst Philip Kett said.

With the ADC now in place, the key question is how much work remains before Axa XL will start bearing the fruit that was promised back in 2018.

Re-underwriting work continues, and today Axa management told journalists that Axa XL would leverage better market conditions to re-underwrite the portfolio at improved margin. The challenge here is that it is still executing this work at a time when it should be leaning into growth in a hardening market, as its peers increasingly are.

Investors will believe that it has successfully remediated when the profit line swings back into the black, and the carrier is generating consistently good results without future reserve deterioration.

Good results will also require the attraction and retention of great talent, fostering a culture of underwriting excellence, and re-establishing a strong company identity which has arguably been eroded via a series of ownership changes.

So after working through the turnaround checklist, Axa XL still has much to prove.

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