Reinsurance Overview
May 20, 2008
Damien Magarelli
Director
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Copyright (c) 2008 Standard & Poor’s, a subsidiary of The McGraw-Hill Companies, Inc. All rights reserved.
Agenda
 Reinsurance Major Rating Factors
Reinsurance – Importance to Ratings
 Reinsurance Sector Ratings & Outlook
Pricing trends
Q1 2008 results
 Catastrophe Issues & Criteria
2.
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Reinsurance Major Rating Factors

Industry Risk
Potential threat of new entrants (low barriers to entry), 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
3.

Operating Performance

Capitalization/Reinsurance

Investments and Liquidity

Financial Flexibility/Reinsurance
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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.
4.

Reinsurance Risk is incorporated in ratings on a quantitative basis
(capitalization) and on a qualitative basis as well.

Reinsurance Risk and Controls are incorporated as part of our ERM
review.
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Reinsurance – Importance to Ratings
Quantitative Basis
Capital Model:
 Reinsurance recoverables are charged based on credit risk
and amount of recoverable (historical loss).
 The natural catastrophe exposure charge (1/250 net aggregate
property PML) is applied on a net basis – so, reinsurance is
applied and reduces the gross PML to a net capital charge.
Side-cars, catastrophe bonds, ILS and other forms of
reinsurance may receive credit in the capital model based
on a transaction level review in each case.
5.
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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
the 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)
6.
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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? (TRIA, 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 the reinsurance program as conditions
change? (ERM)
7.
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Ratings Profile: Global Reinsurance
Ratings Profile At June 30: 2001 v 2004 v 2007
60%
53%
50%
46%
40%
38%
30%
26%
23%
24%
22%
21%
20%
10%
18%
7%
18%
5%
2%
0%
0%
0%
AAA
AA
A
2001
8.
BBB
2004
2007
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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.
9.
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100%
Global Reinsurance Outlook
Global Reinsurance Sector Outlook is Stable.
Stable outlook = We expect an equal number of
reinsurer ratings downgrades and upgrades in 2008.
Positive Factors influencing outlook:
• Continued strong, though declining, underlying earnings,
• Improving ERM credentials,
• Strong, and improving, capitalization, and
• Strong financial flexibility.
10.
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Global Reinsurance Outlook
Negative Factors influencing outlook:
• Effectiveness of ERM is yet to be tested by market
conditions,
• Declining price adequacy,
• Continued low barriers to entry, and
• Potential increase in the frequency and severity of natural
catastrophes.
11.
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Global Reinsurance - Pricing
• January 2008 renewals:
– Reinsurance pricing continued to deteriorate globally, although
pricing for most lines of business, across most geographies, is
still adequate.
 Implicit in the assumption that current prices remain "adequate" is
the expectation that loss costs are unlikely to rise suddenly.
 However, there is growing evidence that the favorable trends in
claims frequency that the industry has enjoyed in recent years have
leveled off. It is realistic to assume that claims frequency could rise
over the medium term.
– Many segments appear to have reached the point at which
further price reductions would signal the transition from a
softening market into a soft market.
12.
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Global Reinsurance - Pricing
• In regards to the Reinsurance Sector Stable Outlook
– Further widespread declining prices would likely cause us to
reassess our position.
 The average price reduction, on a risk-adjusted basis, seems to be
around 5%, although the variation around the mean is substantial.
– Standard & Poor's does not consider improved underwriting
discipline to be an optional extra for reinsurers. In our view, it is a
necessity if the sector intends to protect its ratings.
– If further deterioration in pricing occurs during the second
half of 2008 and into 2009, we will be assigning negative
outlooks to some companies.
13.
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Global Reinsurance – Other Issues
• The January 2008 renewal season has shown that primary
companies are still retaining more of their underlying risks.
– Many insurance companies are retaining more risk at lower layers, and
purchasing more severity reinsurance, but in general this is reducing the
amount primary companies spend on reinsurance.
• Terms and conditions remain firm
– One of the positive aspects of the feedback received to date is that most
of the negotiations with primary companies appears to have centered
around price only.
14.
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Global Reinsurance – Earnings & Q1 2008
• In 2007, some companies reported very strong results, producing ROE's well
in excess of 20% and combined ratios well below 90%; however, the majority
of reinsurers had combined ratios in the 90-95% range and ROEs in the 1015% range.
Q1 2008
– US Reinsurance premiums usually showing the largest decline for many
companies due to increasingly competitive conditions (significant range).
– Combined ratios for some companies increasing from low 80s in 2007 to
high 80s/low 90s – with some casualty accident year figures in Q1 near
a 100% combined ratio.
– ROEs that were previously above 15% in 2007, now slightly below 15%
(annualized Q1 2008).
15.
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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.
16.
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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%.
17.
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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.
18.
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Property Catastrophe Criteria/Capital Charge
 Tax adjusted Net aggregate 1/250-year property Probable Maximum Loss
(PML) with two premium offsets.
 The catastrophe capital charge is 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.
19.
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Property Catastrophe:
• Why a 1/250-year PML?
– The capital charge needs to capture historical volatility.
1. Hurricane Katrina based on the various vendor models measured between a 1/20 and
1/30 year event for the US, but this scenario increases to a 1/250 year event or 1/500 year
event for certain states (Louisiana, Mississippi) specifically.
•
For the US only, a 1/250 year occurrence is possible simply with a hurricane hitting
Miami – according to some of the vendor models.
2. Insurance and reinsurance companies considered Hurricane Katrina (or in some cases the
2005 hurricane season in aggregate) to be a 1/100 year event.
3. Canada (Ontario) experienced its largest catastrophe/storm event at roughly a $400
million insured loss in 2005. Insurance Bureau of Canada reports this event to be a 1/100
year event.
4. Insurance and reinsurance companies considered the Southeast hurricanes in 2004 to be a
1/20-1/50 year event in aggregate.
5. According to vendor models, the 10 typhoons in 2004 that hit Japan are considered
roughly a 1/120-year return period in aggregate. Also, the SMR catastrophe risk standard
in Japan for EQ is Great Kanto (7.9 magnitude in 1923) at the 1/250-year level.
20.
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Property Catastrophe:
• Why a 1/250-year PML (Continued)?
1. Recognizing that models are not perfect, and the potential for increasing
frequency and severity - the capital charge also needs to capture prospective
volatility.
•
US insured losses due to natural catastrophes are doubling every 10 years.
•
The severity of property catastrophe risks is increasing with population growth in coastal
areas, inflation, and higher building values.
– 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.
– 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.
21.
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Reinsurance Overview
May 20, 2008
Damien Magarelli
Director
Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s.
Copyright (c) 2008 Standard & Poor’s, a subsidiary of The McGraw-Hill Companies, Inc. All rights reserved.