Reinsurance Overview
CAS
May 8, 2007
Damien Magarelli
Director
Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s.
Copyright (c) 2006 Standard & Poor’s, a subsidiary of The McGraw-Hill Companies, Inc. All rights reserved.
Agenda
 Reinsurance Ratings & Outlook
 Insurance Major Rating Factors
Reinsurance Focus
 Catastrophe Issues & Criteria
Florida’s legislative changes
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2.
Rating Distribution: Global Reinsurance Lines
July 26, 2001
July 26, 2006
46%
41%
24%
20%
19%
22%
19%
6%
AAA
4%
AA
A
BBB
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3.
Lower
Global Reinsurance Outlook Stable
2005
CreditWatch
Negative
Outlook
Negative
Outlook
Stable
Outlook
Positive
CreditWatch
Positive
2006
0%
20%
40%
60%
80%
As of 11/13 of each year; 54 interactive ratings.
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4.
100%
Global Reinsurance Outlook
Positive Factors influencing Reinsurance Outlook:
• Very strong earnings generation in 2006, expectation of good
earnings in 2007.
• The pricing peak was in 2005 and 2006 for many accounts and
product lines (terms and conditions are deteriorating).
• Increased focus on risk management and profitability.
Negative Factors influencing Reinsurance Outlook:
• High earnings and balance sheet volatility
• Commoditized market/low differentiation
• Potential increase in frequency of large catastrophe events
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5.
Insurance Major Rating Factors

Industry Risk
Potential threat of new entrants, Substitute products or services,
Regulatory risk

Competitive Position
Competitive advantage: distribution channel, underwriting, pricing power,
scale, diversification (sector and/or line of business).

Management and Corporate Strategy

Enterprise Risk Management (ERM)
Risk controls, optimization of earnings and capital

Operating Performance

Capitalization/Reinsurance

Investments and Liquidity

Financial Flexibility/Reinsurance
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6.
Reinsurance – Importance to Ratings

Reinsurance Risk is incorporated into ratings and major rating
factors, with varying degrees of importance depending on each
company’s risk profile.
Company utilizing significant reinsurance protections – may be
the overwhelming ratings factor.
Company with excess capital and minimal use of reinsurance,
may be less important.

Reinsurance Risk is incorporated in ratings on a quantitative basis
(capitalization) and on a qualitative basis as well.

Reinsurance Risk is incorporated as part of our ERM evaluation.
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7.
Reinsurance – Importance to Ratings
Quantitative Basis
Capital Model:
 Reinsurance recoverables are charged based on credit risk
and amount of recoverable (historical loss).
 The catastrophe exposure charge (1/250 net aggregate
property PML) is applied on a net basis – so, reinsurance is
applied and reduces this PML capital charge.
Side-cars, catastrophe bonds and other forms of
reinsurance may receive credit in the capital model based
on a transaction level review in each case.
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8.
Reinsurance – Importance to Ratings
Qualitative Basis
Could a company adjust its level of reinsurance utilization, would
this impact competitive position or not? (line size, capacity
offered)
 The selection of a retention involves a compromise between stability
and cost.
 A relatively low retention provides earnings stability but is expensive.
(specifically, post-event cost may be too expensive)
Due to reinsurance, does the insurance company insure large
single risks (or a large number of smaller risks) in excess of what
capital base can safely support?
 Is reinsurance purchased to protect against frequency or severity, or
both? (mitigate volatility, generate steady earnings).
Ability to access reinsurance? (financial flexibility)
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9.
Reinsurance Risk
Qualitative Basis
Why is reinsurance utilized? (reduce capital charges including
catastrophe charges).
How is reinsurance purchased? (committee approach, purchased by
segment or at a corporate level)
Does company monitor reinsurance quality? (low or non-rated
companies)
Does company monitor concentrations? (Florida, FHCF)
Does company utilize reinsurance to manage pricing cycles? Optimize
earnings? (ERM)
What is the process to monitor reinsurance quality? (ERM)
What is the process to update reinsurance program as conditions
change? (ERM)
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10.
Catastrophe - Year 2004 & 2005 in Review
 Year 2004
 Southeast hurricanes: The four hurricanes in the Southeast US during Q3 2004
caused more than $23 billion in insured damage.
 The last time 4 hurricanes hit one state (Texas) was 1886.
 Japan: The 10 typhoons in Japan caused more than $6 billion in damages during the
third and fourth quarters in 2004.
 10 typhoons in Japan in 2004, previous maximum was 6, and the average from
1950-2003 was 2.6 per year.
 Year 2005
 In 2005, insurers worldwide measured property losses (includes business interruption) of
$83 billion, in 2004 this figure measured $48 billion.
 Hurricane Katrina alone measured property losses of $45 billion.
 Year 2005 measured 27 named storms, previous record was 21 in 1933.
 Number of hurricanes in 2005 was 15, previous record was 12 in 1969.
 Year 2005 was also the highest number of category 5 hurricanes – at three.
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11.
Meteorological changes
 Climate change:
 The 1990s were the warmest decade globally since records began, with the
four warmest years all occurring since 1998. Climate change could increase
frequency and severity of extreme weather events.
 Atlantic Multi-decadal Oscillation (AMO): describes how sea surface
temperatures oscillate between warm and cold periods. Warm Sea
Surface Temperatures are strongly correlated to high tropical cyclone
activity.
 Bermuda High: An area of high pressure that forms over the Atlantic
Ocean during the summer.
 Depending on its location this in part determines the number of hurricanes
that make landfall in the US or remain over the Atlantic Ocean.
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12.
Socio-economic factors
 The severity of property catastrophe risks is increasing with population growth in
coastal areas, inflation, and higher building values.
 From 1980 to 2003 the coastal population in the US grew by 33 million, and is
projected to increase by a further 12 million by 2015.
 At the same time, household sizes are decreasing.
 Result: The number of properties at risk to extreme weather is increasing.
 In the U.S., more than 50% of the U.S. population now lives within 50 miles of a
coastline.
 Florida specifically has experienced a 70% increase in the number of state residents
from 1980 to 2001.
 During the period from 1995-2006 residential exposure in Florida increased over 90%.
 Hurricane Andrew: If Hurricane Andrew had hit Florida in 2002 rather than 1992, the
losses would have been double due to increased coastal development and rising
asset values.
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13.
Property Catastrophe Criteria Conclusion
 It is very likely that insured losses due to hurricanes will increase over
the next 15-25 years due to meteorological and socio-economic
changes.
 This higher risk will be imbedded in ratings.
 Result: Where a modeling agency provides more than one view of
expected loss on a portfolio of catastrophe risk, Standard & Poor's
will use the most conservative view.
 Currently, that equates to selecting the shorter term view of expected
loss, but it is reasonable to assume in periods of benign activity the
most conservative view would be obtained by using the longer term
perspective.
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14.
Property Catastrophe Criteria/Capital Charge
 Tax adjusted Net aggregate 1/250-year property Probable Maximum Loss
(PML) with two premium offsets.
 (New) The catastrophe capital charge will now be Tax Adjusted (US = 35%).
 First premium offset, the catastrophe related premium embedded in the property
book will be removed from the premium risk charge to avoid double count of
required capital.
 Second premium offset, the net aggregate 1/250-year PML will be reduced by
70% of the associated catastrophe Net Written Premium.
 For both Insurers and Reinsurers – this premium offset reflects the view that
premiums could be collected early in the year that would reduce a prospective PML
loss later in the same year.
 The capital charge is applied on all property (personal & commercial) exposures on a
global basis. The total portfolio PMLs are expected to be calculated for all perils (wind,
earthquake, tornado/hail and flood (non-US)), and zones combined.
 Therefore, diversification by peril and location is applied.
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15.
Legislative Changes in Florida
 In January 2007, the State of Florida (Florida) passed an insurance and
reinsurance reform bill that will significantly impact insurance and reinsurance
pricing, the capacity the insurance industry offers, and the competitive position of
many companies from 2007-2009.
 The reform bill has the objective of lowering insurance premiums in Florida, and
is expected to reduce property insurance rates by an average of 22%.
 Property reinsurance rates are also expected to decrease substantially to a level
below what private reinsurers would have charged for catastrophe reinsurance.
 The reform bill will be made effective through Florida’s two state sponsored
entities: Citizens Property Insurance Company (Citizens), and the Florida
Hurricane Catastrophe Fund (FHCF).
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16.
Legislative Changes in Florida
Modeling & Pricing
 The pricing structure expected in Florida does not apply the near-term
catalog of events and does not include assumptions for demand surge
and storm surge.
 Standard & Poor’s applies the near-term catalog of events as part of its
insurance and reinsurance catastrophe criteria and capital charges,
consistent with its criteria for ratings on sidecars and catastrophe bonds.
 If a company does not apply these assumptions, Standard & Poor’s will
adjust the data and PMLs accordingly, and increasing PMLs above 40%
would be expected.
 Standard & Poor’s also expects that assumptions for demand surge and
storm surge will be incorporated within PML figures, in some cases
increasing PMLs greater than 30% is expected.
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17.
Legislative Changes in Florida
Conclusion
 The insurance industry’s ability to price for catastrophe risk has been
significantly reduced.
 The lack of pricing power could lead to inadequate prices, substantially
reduced earnings and increased competition in other geographic
locations outside Florida and lines of businesses outside property, as
capital flows to these other locals.
 The likelihood exists for earnings and ratings to slowly deteriorate or
simply be limited at their 2006 level. Potential rating upgrades,
especially for property focused companies, has also declined
substantially.
 Prospective rate increases are not expected to be substantial, and the
lack of significant rate increases post-event may limit the flow of new
capital (including sidecars and catastrophe bonds), into the insurance
industry, and so the financial flexibility of many companies has
weakened.
Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s.
18.
Reinsurance Overview
CAS
May 8, 2007
Damien Magarelli
Director
Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s.
Copyright (c) 2006 Standard & Poor’s, a subsidiary of The McGraw-Hill Companies, Inc. All rights reserved.