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How long can the legacy moment last?

The legacy sector has seen surging deal volumes of late, but the major inflows of capital into the space look set to choke off returns, with the live market’s depressed returns a cautionary tale for run-off acquirers.

Zurich’s latest proposed disposal – a £1.6bn ($2.24bn) UK employers’ liability portfolio – continues the deal momentum which has gathered pace in the legacy market in the last 18 months.

Since the end of June 2017, the running tally compiled by The Insurance Insider of known large legacy deals at various stages stands at 23.

During this period, Lloyd’s has also seen a revival of its reinsurance-to-close market, with Barbican the latest carrier understood to be mulling the idea of a transaction, and others known to be lining up behind it.

The resurgence in companies seeking legacy solutions for old portfolios has been met by the arrival of significant amounts of new capital, with external interest in the space running at an all-time high.

This has come via private equity buy-ins, partnerships with live carriers and third-party capital structures.

Buy-out firms Stone Point, Apollo and Aquiline have all made significant investments in legacy carriers, with a number of private equity firms understood to be in talks with Darag about a buy-in.

RenaissanceRe’s minority investment in Catalina, revealed by this publication in January, is the most recent example of the live market seeking exposure to legacy. But Arch, Validus, Axa and Allianz have all sought exposure to the space via joint ventures, investments, the creation of their own run-off vehicles or assumed reinsurance.

As a result, the already-competitive bidding wars for legacy deals have reached a new intensity in recent months.

Generali’s EUR300mn ($367mn) legacy sale last year was said to have been extremely competitive from the outset, with as many as 28 parties initially registering their interest in the book – some of those being small unestablished consultancies backed by private equity money.

Instances of gazumping and 11th-hour bids have also become more commonplace. Quest, with money already committed to its new Bermudian run-off platform, swooped in to secure Sovag’s EUR170mn legacy book in the final stages with an offer which was said to have outpriced the other final bidders by a wide margin.

This raises the question of how long new capital will be drawn into the space as margins narrow.

The drivers promoting the supply side of the equation – the channelling of old liabilities to the run-off market – currently show no signs of going into reverse.

Regulation including Solvency II disincentivises reserving risk and investment yields on those books remain at minimal levels. At the same time, the live market is becoming more nervous about the adequacy of its reserving position, as the better-priced years recede and the “cheating” phase of the reserving cycle arrives.

Meanwhile, the sentiment around looking for a legacy solution and the perception of the run-off players themselves has shifted.

Exploring a legacy deal is no longer considered an admission of failure and can instead be portrayed as a capital management tool for insurers looking to hand off liabilities.

And legacy acquirers, derided in the past by some as companies that make profits by avoiding claims, are increasingly seen as more effective claims managers with greater operational efficiency than the live market, as well as higher-return asset managers.

A succession of global insurers have demonstrated faith in the role of the legacy market in managing old liabilities, with Zurich, QBE and Allianz all setting about addressing their back books in earnest.

(Re)insurers are also being forced to scrutinise every aspect of their businesses more carefully as their earnings power is squeezed and are now actively examining ways to free up capital where it represents a drag on return on equity.

And there is clearly scope for businesses that have run into challenges to throw up major legacy deals, further boosting supply. It is widely expected that after the AmTrust take-private closes it will look to secure a wide-ranging legacy deal, with private equity house Stone Point likely to facilitate a transaction with its long-time partner Enstar.

Up-for-sale Aspen is also likely to dispose of major legacy liabilities from at least its US insurance business in the coming months, probably regardless of the way in which its sale process plays out.

Capital will not come into the legacy space to meet the supply of deals regardless of the return profile of the deals, but the broader low-yield environment is drawing financial investors in and cash-rich live players are seeking diversified and countercyclical revenue streams.

Well-executed legacy deals for run-off acquirers of scale are still believed to be offering investors double-digit returns, which measures up well against broader financial markets and the live insurance market.

But this does not reflect the totality of the legacy space, and seasoned observers in the market are privately arguing that some of the deals being done now will be not just low-return but loss-making when all is said and done.

They also argue that the returns available to established players with operational scale and diversification – like Enstar, Catalina and Riverstone – may not be replicable for newer entrants, or other players looking to step up a tier.

Dynamics in the legacy sector are distinct from those in the live market, but there is a mounting sense that over-capitalisation and the increasing number of bidders are materially impacting conditions, and levering down returns.

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