Recently Overseas Partners (OPL) announced it was going to "stop writing new reinsurance business in Bermuda, find a buyer for OPUS Re, and begin running off its reinsurance reserves."

Its decision is based on the "desire of many of their shareholders to have greater liquidity for their investment in OPL. The capital requirements for OPL's business have constrained its ability to offer regular redemption of shares to its shareholders for several years."

Within days of OPL's announcement, Scandinavian Re announced it was going to cease underwriting. The circumstances surrounding Scandinavian Re's announcement are a little different from OPL's because its decision was made when its parent company, Sirius International Insurance Company and their ultimate parent company, ABB, a Zurich, Switzerland based energy and manufacturing giant, decided to "review the strategic fit of all its businesses". Therefore, it can be inferred from the press release that ABB is no longer committed to putting more money into their insurance arm forcing Scandinavian Re to stop underwriting.

Many of us rooting for insurers on the Island felt a chill run down our spines. The downturn in the Bermuda insurance market had already begun, way before imagined - the first quarter for the year was not even over yet.

Once the reality of what was happening sunk in and I had the time to sit back and reflect, I thought maybe runoff is not as bad as bankruptcy. Maybe these insurers are making the honourable decision to return the investment to their shareholders rather than running the company into bankruptcy.

What is run-off? And is it such a bad thing?

A run-off company is still an active company and as such is still a registered company under the Insurance Act of Bermuda. Ideally once the decision has been made to put the company into runoff, the company should write a letter to the Registrar of Companies to advise that it would like a condition attached to its license stating it has now gone into run off. This letter should also acknowledge that the company will no longer be accepting new business.

Because the company is still an active company in the eyes of the regulatory authorities in Bermuda, it must still comply with the statutory requirements. Depending on the class of insurance, the Runoff Company must still meet the required premium, minimum capital and surplus and the loss reserve tests combined. In addition the 75 percent liquidity rule (which means assets must be greater than 75 percent of the liabilities) must be maintained if the company wants to remain as an active company.

Run-off is when a company makes a decision to stop accepting new or renewal business in a particular class of business or for the entire company. The decision is made because of poor underwriting results, consolidations, mergers and acquisitions, expense reduction, and to segregate good from bad business and to concentrate on underwriting profitable business. Once the decision has been made to go into runoff, the hard work for the company begins because now the company must decide how they are going to manage the runoff. In addition, the Runoff Company must find ways to keep its staff motivated so the runoff can be handled effectively and efficiently.

Due to the nature of the insurance business, an insurance company can not just return capital to its investors. The Runoff Company must first set up reserves to pay for the insured but not reported losses, ie those losses that occur during the policy period but do not develop until much later. It must also continue control expenses so that it has enough money to pay those who are retained to handle the runoff - accountants, claims professionals, legal counsel, information technology personnel and any other expenses incurred to run off the book of business.

Insurance has been described as the "gift that keeps on giving", i.e. long after the premium has been paid on a policy, the policy has expired and the investment income has been used up, insurers are still left to handle claims. This description aptly applies to a company that makes the decision to go into runoff.

Insurance is very unique because when companies such as retailers decide to close the door to their business, they can do so without worrying that past customers will come back to ask them for money. Insurers on the other hand must make provisions for "all the skeletons which are left hanging in their closets.".

Run-offs can take many years to complete, if there ever is a completion. The completion date is often the most difficult date to establish because of the "gift that keeps on giving" characteristic of insurance.

The most notable and largest ever runoff facility created is Equitas. Equitas was formed as a specialty runoff reinsurer with $20billion in premium on September 3, 1996 in London. Equitas was formed after an extensive review of the old liabilities (losses) on the books of Lloyds revealed that the underwriting results for late 1980s and early 1990s were disastrous. Realising the disastrous earlier underwriting results could have a negative impact on the future profits and viability of Lloyds, a decision was made to create the vehicle, Equitas, to assume all of Lloyd's 1992 and prior liabilities and assets to separate these terrible underwriting results from future underwriting years. Therefore, the formation of Equitas allowed Lloyds to start anew as if it was a new company without the old liabilities to plague its future underwriting results.

Next week we will look at some of the reasons why reinsurers make the decision to go into runoff.

Cathy Duffy is a Chartered Property Casualty Underwriter (CPCU) and is now a freelance writer. She is a former executive of Zurich Global Energy and has 15 years experience in the insurance industry. She writes on insurance issues in the Royal Gazette every Monday. Feedback crduffycwbda.bm.