Managing the UW Cycle
CARe
Hamilton Bermuda
June 2005
John Doucette
Introduction
I.
The Underwriting Cycle
II.
Company Strategies
III. Actuaries and the Cycle
I. The Underwriting Cycle
According to Warren Buffett
“Insurers sell a non-proprietary piece of
paper containing a non-proprietary
promise. Anyone can copy anyone else’s
product. No installed base, key patents,
critical real estate or natural resource
position protects an insurer’s competitive
position. Typically, brands do not mean
much either. What counts in this business
is underwriting discipline.”
“There seems to be some perverse human
characteristic that likes to make easy things difficult.”
Source: USAIG
I. The Underwriting Cycle
P&C Insurance Market Combined Ratio
1955 to 2004
120%
118.0%
116.3%
14%
115.9%
115.7%
12%
115%
10%
110%
8%
105%
6%
100%
4%
95%
2%
90%
0%
1955
1960
1965
Combined Ratio
1970
1975
1980
1985
Return on Average Invested Assets
1990
1995
2000
2004
World Trade Center Loss
Source: General Re
II. Company Strategies
Fundamental Strategy : Long Term Book Value Growth
•
The ability to compound real book value per share over time is
the single most important measurement tool (Total Value
Creation) when comparing property/casualty (re)insurers.
•
Creating value over time is the sum of:
i. traditional insurance operating results
ii. capital gains and losses on the investment portfolio
iii. capital management decisions
Source: Dowling & Partners
II. Company Strategies
To achieve fundamental strategy throughout a cycle
•
First decide on total allocation of capital to (re)insurance based
on where in the cycle
•
Hard Capital
•
Equity
•
Debt
•
Dividend strategy
•
Soft Capital
•
Amount of reinsurance support
•
Form of reinsurance
•
Capital Management
II. Company Strategies
To achieve fundamental strategy throughout a cycle
•
Then decide where to best to allocate the total amount of capital
•
Insurance vs. reinsurance
•
Class / Line:
•
Short tail vs. long tail vs. specialty
•
Various lines by adequacy
•
Form of coverage offered
•
Liability risk vs. asset risk
•
Fee income vs. underwriting risk
II. Company Strategies
To execute that strategy, a (re)insurer needs to know
1.
Where are we in the cycle?
2.
What is the expected cost of goods sold?
3.
What is an appropriate capital allocation methodology
•
Top down vs. bottom up
•
Risk capital vs. rating agency capital vs. other constraints
4.
Based on (2) and (3), what is technical price?
Bottom line: (Re)insurers need quantitative power to understand and execute
the fundamental strategy
III. Actuaries and the Cycle
In hard market, need actuaries / quantitative skills for
•
•
•
•
•
Capital planning
Strategic business planning
Pricing lines of insurance / reinsurance treaties
Allow for translation of results for various audiences
•
Underwriters
•
Management
•
Shareholders
•
Rating agencies
•
Regulator
•
Clients
Improve transparency
In hard market, actuaries have skill sets that can provide more impact on
rank ordering the opportunity set to optimize risk adjusted return
(Strength)
III. Actuaries and the Cycle
In softening market
•
Aspects as per the hard market are required and more
•
Lower hit ratio on transactions
•
More analysis of profitability by line
•
More analysis of reinsurance / retrocessional strategy
In soft market, actuaries have skill sets that can provide more even more
value to (re)insurance company
(Strength)
III. Actuaries and the Cycle
Lessons learned from CEO survey about actuaries
•
Too narrow and too technical
•
Reserve analysis only because of certification required
•
“Actuaries pursuing greater precision in areas of decreasing
relevance.”
•
Need to develop general business skills
•
Need to enhance their value – communication / execution
Reality, or perception of that reality by key actuarial clients (senior
management), that actuaries are too technical and not business savvy
(Weakness)
III. Actuaries and the Cycle
First the good news for actuaries
•
Our industry is becoming more quantitative
•
Pulled by regulators
•
SOX
•
SEC
•
Lloyds / RBC / ICA
•
FSA
•
Pushed by competitive forces
•
Broader number and type of risks to be managed
•
More transparency required
Going forward, more demand for quantitative skills
(Opportunity)
III. Actuaries and the Cycle
Now the bad news for actuaries
•
Quantitative skills do not mean CAS actuaries are required
•
Cat modelers
•
Technically strong underwriters
•
Large US insurer(s) training recent college grads (non-actuaries)
to fill actuarial pricing role
•
Chief risk officers
Supply needed to meet quantitative demand may not filled by actuaries???
(Threat)
III. Actuaries and the Cycle
Non-traditional Roles for Actuaries
Non-Traditional
Roles
6%
Traditional
Actuarial Roles
94%
III. Actuaries and the Cycle
Non-traditional Roles for Actuaries
Finance/
Investment
7%
Risk
Management
22%
Underwriting
15%
President
/ CEO
50%
Conclusion
The UW cycle
- Non-transparency of risk / pricing
- Classic supply and demand
- Inevitability
Company Strategy throughout the cycle
- Compound real book value per share over time
- Diversification only works if lines / deals create
(and not destroy) book value growth
Actuaries
- Consider SWOT analysis
- Look to CEO lessons learned
- Try to proactively add value to company in different ways