CAS Special Interest Seminar The Changing Insurance Market

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CAS Special Interest SeminarThe Changing
Insurance Market

• Assuming New Risk
• Moderator Barry Franklin - Aon Risk Consultants
• Panelists Mark Ames - MMC Enterprise Risk

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State of the Market Pre-9/11/01

• Prices Firming
• Property, DO, WC Some pressure on excess
  liability
• Retentions Increasing
• Property Aggregates on multi-year multi-line
  covers
• Limits Challenged
• Global Property seen as too high DO seen as
  too low
• Capacity Shrinking
• Property catastrophe Combined aggregate/ERM
  covers

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State of the Market 9/11/01-12/31/01

• Prices Skyrocket
• Initial estimates for all lines was 100,
  200,...
• Retentions Increasing Substantially
• Initial estimates for all lines was 100,
  200,...
• Limits Unavailable
• Particular issue for excess liability, aviation,
  WC, DO
• Capacity Withdrawn
• Reinsurance expectations, knee-jerk risk
  avoidance
• Concern over war/terrorism exclusions, event
  triggers

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State of the Market 1/1/02-Current

• Prices Higher, but Stabilizing
• Some lines still gt100, but many more moderate
• Retentions Higher, but Stabilizing
• Property, DO and Excess Casualty most affected
• Limits Reduced
• WC, DO, Excess Casualty
• Cautious New Capacity
• New Bermuda entrants seen as cherry picking at
  times, but providing some capacity and stability

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The Same Old Market Cycle?

• Sharp increase in rates and coverage restrictions
  follow years of declining prices
• Remember the end of cash-flow underwriting?
• Cooling economy and low interest rates reduce
  insurer investment returns
• Remember what Paul Volcker did before Andersen?
• Questions arise regarding industrys ability to
  absorb emerging (mold) and re-emerging (asbestos)
  risks.
• Remember pollution and asbestos (round I)?

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Something Completely Different?

• Concurrent contractions in all segments
• 1980s was primarily a liability crisis
• Competing sources of risk capital
• Financial services convergence in 1980s was
  Sears
• RRGs, captives, finite reinsurance and other
  relief valves already in place
• Liability Risk Retention Act passed in 1986
• Captive usage has more than quadrupled since 1982
• Companies aware of risk bearing capacity
• Fungible nature of risk more widely appreciated
• Insurance viewed as a hedging tool, not an expense

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More/Better Options

• Captives and RRGs
• Finite Reinsurance
• Contingent Equity and Contingent Debt
• Multi-line, Multi-year Aggregate Covers
• Reserve Swaps
• Multiple Trigger Risk Transfer
• Global Markets

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Companies Formed After 9/11/01

• Primus Guaranty, Ltd.
• XL Winterthur Excess Casualty Unit
• Endurance Specialty
• Davinci Re
• Axis Specialty
• White Mountains
• Hampton Re

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Other Capital Added After 9/11/01

• Glencoe Insurance, Ltd.
• IPC Holdings
• ACE
• Partner Re
• Arch Capital
• Many more.

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More/Greater Risks

• Greater SIRs and Deductibles on All Lines
• Excess of Policy Limits Exposures
• WC Statutory Limits Unavailable/Expensive
• WC Insurers Avoiding Concentrations
• Terrorism Exclusions
• Global Economy Global Risk Exposure
• KR, DO Exposures Growing

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More/Better Tools Resources

• PC Hardware Software
• Monte Carlo Simulation DFA
• Risk Mapping
• Catastrophe Models
• Benchmark Data
• Consulting Industry More Accessible

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PC Hardware/Software

• Moores Law - speed doubles in 18 months
• History shows this to be fairly accurate from a
  research develop standpoint - chip speed
  doubles every 24 months or less
• Micro-processor speed has increased by a multiple
  of over 600 since the IBM PC
• Gains in peripheral speed moves the effective
  speed cycle closer to 18 months

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State of the Art PC - 1987

• IBM PS/2 Desktop
• 80386 Processor
• 20 Megahertz
• 3.5 Floppy Drive
• 40 Megabyte HD
• Lotus 1-2-3
• MS-DOS

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State of the Art PC - 2002

• Dell Latitude C840
• Pentium 4
• 1.6 Gigahertz
• 3.5 Floppy Drive
• CD-ROM Drive
• 60 Gigabyte HD
• MS Office/Excel
• Windows XP

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DFA/Simulation Analysis

• Allows companies to fairly easily look at the
  impact of alternative risk retention, risk
  financing and risk transfer structures on..

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After-tax EPS
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After-tax ROE
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Retained Property Loss by SIR
14,000
Retained Losses
12,000
99
10,000
95
8,000
Annual Losses (000)
90
6,000
70
4,000
50
2,000
0
0.5 M
1.0 M
2.0 M
3.0 M
4.0 M
5.0 M
Per Claim SIR
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Insurance Program Risk/Return Options
0.35
0.30
Alt IV
0.25
Alt II
Alt III
0.20
Expected Annual Savings (M)
Risk-Return Tradeoffs
0.15
Current
0.10
0.05
Alt I
0.00
-0.05
0.00
0.50
1.00
1.50
2.00
2.50
3.00
Increase in 90th tile Risk (M)
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Risk Maps

• Provide a means for companies to combine
  qualitative and light quantitative information
  on various risks, and make meaningful visual
  comparisons to prioritize risks for further
  analysis/action ...

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Example of Risk Map
Natural Risks N1 Earthquake N2 Fire N3
Contingent BI
250m
Financial Risks F1 Spark Spread F2 Interest
Rate F3 Counter-Party
N1
High
S E V E R I T Y
O1
200m
F1
F2
O3
100m
Employment Risks E1 Benefits E2 Workers
Comp E3 Employers Liability
N2
L1
L1
L2
E1
50m
L1
L2
E3
L1
F1
25m
L4
E1
Operational Risks O1 Forced Outage O2
Information Security O3 Rogue Trading
10m
O2
E2
Low
L3
1m
E2
N3
Liability Risks L1 Product Liability L2 E
O L3 Auto liability L4 D O
Low
High
F R E Q U E N C Y
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Probability of
Occurrence
2
Almost
Certain
1
Likely
Moderate
3
Unlikely
Remote
Insignificant
Minor
Moderate
Major
Catastrophic
Magnitude of Impact
Critical
High
Medium
Low
Risk Identifier
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Companies Today Are Able to

• Evaluate/prioritize risks using risk maps
• Measure and model the marginal impact of
  significant risks on financial results
• Construct innovative structures to optimize risk
  retention/finance/transfer options
• Insure non-traditional risks and take advantage
  of alternatives for treating risks that have
  traditionally been insured

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Bottom Line

• Some risks are new - others just more real
• Risk transfer IS more expensive today
• The insurance pricing cycle is systemic
• Risk transfer might still be the best option
• Companies have many options available
• Dont necessarily expect the current hard
  market to follow historical patterns