State of the Reinsurance Market and
Implications for Primary Insurers
Southern California Casualty Actuarial Club
Bob Fox, ACAS, MAAA
Managing Director, Catastrophe Actuarial
Aon Benfield
June 6, 2013
Agenda Slide
Section 1
Section 2
State of the Reinsurance Market
Implications for the Property Insurance Market
1
Section 1
State of the Reinsurance Market
ERM
3
ERM
Enterprise
Reinsurance
Minimization
4
Reinsurance Premiums by Line
50
45
40
Billions
35
30
Casualty
Property
25
20
15
10
5
0
2000
2012
Source: SNL
5
Global Catastrophe Losses by Year
Irene
Joplin
Tuscaloosa
Katrina
Rita
Wilma
Thai Floods
Charlie
Frances
Ivan
Jeanne
Tohoku
Christchurch
Ike
 2012 very similar to average of 10 prior years
 Five years of severe weather has people asking if this is the “new normal”
Source: Aon Benfield Analytics
6
$48.4b
$47.4b
2012 Top 10 Global Insured Loss Events
1
2
Subject to change as loss estimates are further developed
Includes losses sustained by private insurers and government-sponsored programs
 Drought/heatwave losses highlight the growth of Crop/Hail Insurance
7
Super Storm Sandy – Overview
 Largest diameter: 945 miles
– Previous record: 920 miles, 2010’s Hurricane Igor
 Largest wave in New York Harbor: 32.5 feet
– Previous record: 25.0 feet, 2011’s Hurricane Irene
 Second NE event in two years for which hurricane deductibles
did not apply
– Deductible language variable across companies
– Wind speed, hurricane category, etc.
– Events do not drive tail, but generally not modeled correctly
 “2/3 of all New York City homes damaged by Superstorm Sandy
were outside of FEMA’s existing 100-year flood zone.”
– Wall Street Journal
– Estimate flood return period: 90 years
 “With respect to storm surge, we think the [NOAA] SLOSH
model generally performed well, and we calibrated our US
storm surge expectations from that.”
– Kean Driscoll, CEO, Validus Re
8
Super Storm Sandy – US Insurance Loss Estimates
PCS
 Claims: ~ 1,152,000
 Insured Loss Estimate: $18.75 billion
– Personal Lines Claims: $6.997 billion (average claim: $6,558)
– Commercial Lines Claims: $9.024 billion (average claim: $44,563)
– Automobile Lines Claims: $2.729 billion (average claim: $10,894)
Impact Forecasting
 $16 to $22 billion
 80 to 90 Year Return Period
AIR
 $16 to $22 billion
 ~85 Year Return Period
RMS
 $20 to $25 billion
 ~90 Year Return Period (NY, NJ)
EQECAT
 $10 to $20 billion
 70 to 90 Year Return Period
Industry wind event return period: 5-10 years
9
Hurricane Sandy Impact on Shareholder Funds
 Average impact of Hurricane Sandy reported to date is 4.9%
**Alleghany SHF as of March 31, 2012 to incorporate Transatlantic acquisition
Mid-points used where a range of loss was disclosed
Chart represents most recent disclosure
Source: Individual company reports, Aon Benfield Analytics
10
ABA Historical Reinsurer Combined Ratio
 2012 ABA showed improved combined ratio of 92.6% resulting from a 60% decline in total
catastrophe losses
105.1%
110%
94.4%
90%
88.3%
88.6%
6.6%
93.8%
89.4%
20.0%
8.8%
92.6%
7.5%
1.7%
0.9%
2.7%
60.8%
60.0%
64.2%
62.6%
60.0%
60.3%
59.4%
27.3%
28.4%
28.7%
29.1%
29.8%
29.8%
30.0%
-0.7%
-2.4%
-5.0%
-4.0%
-4.9%
-5.0%
-4.3%
70%
50%
30%
10%
-10%
FY 2006
FY 2007
FY 2008
FY 2009
FY 2010
FY 2011
FY 2012
Prior year reserve adjustment Expense ratio Attritional loss ratio Total catastrophe losses
Source: Individual company reports, Aon Benfield Analytics
11
Reinsurer Capital (USD Billions) by Year
 Year end 2012 reinsurer capital increased 11% over year end 2011
 Reinsurer capital increased by USD5B throughout Q4 2012; a slower pace than earlier in the year
 Supply continues to exceed demand in all global regions
Source: Individual Company Reports, Aon Benfield Analytics
12
Cat Bond Issuance by Quarter
 Despite a decrease in Q4 2012 issuances from the prior two years, 2012 issuances reached an all
time high of $6.3b based on the increased issuance activity in the first half of 2012
Q1
Q2
Q3
Q4
7,000
6,251
6,000
5,275
$ Millions
5,000
4,000
2,393
3,471
3,000
1,600
775
1,990
232
2,095
854
2,000
411
1,000
1,888
4,601
2,350
742
810
650
2009
1,493
1,015
300
2010
2012
2011
Source: Aon Benfield Securities, Inc.
13
2013 ILS Market
As of May 31, 2013
US Multi-Peril Spreads
 New inflows of capital continue to outstrip
supply, and spreads have decreased to
historic lows
– Non-US peril spreads are down 15% 20% from 2015
Risk Premium
– US multi-peril spreads are down 35% 45% from 2012
16%
40%
8%
4%
1.00%
1.50%
2.00%
Expected Loss
2.50%
3.00%
10%
8%
6%
19%
18%
■ 2012
■ 2011
■ 2010
■ 2009
4%
18%
2%
1.00%
Source: Aon Benfield Securities' RLS Indicative Price Sheets
■ 2012
■ 2011
■ 2010
■ 2009
Non-US Peril Spreads
Risk Premium
 Twelve property cat bonds with a total of
US$ 3.49 billion limit and one health bond
with US$ 0.15 billion limit have closed
36%
45%
 State Farm's Merna Re IV, covering New
Madrid earthquake, was issued with the
lowest spread for a cat bond since 2008
 Allstate’s Sanders Re, providing US multiperil coverage on index basis, priced blew
market guidance and with Sharpe ratios at
new lows
12%
1.50%
2.00%
Expected Loss
14
2.50%
3.00%
Insurance and Capital Markets are Converging
Insurance and capital markets are converging – global capital is growing ($ trillions) and looking
for returns in a low interest rate environment
Risk per unit
of capital
T
I
Insurers &
M
Reinsurers
E
Risk adjusted return
on invested assets
Pensions, Life Insurers,
Endowments & Family Trusts
Convergence
All amidst increasing insurer capabilities, increasing insurer demands, pricing pressure on
brokers, declining demand for traditional reinsurance…
15
Non-Traditional Capital is Massive and Has Begun to Enter our Space
Global capital supply figures
Highly Preliminary
Private
Equity
~$3T
Other, unquantified large
pools of capital also exist
• High net worth individuals
• Retail investors
• Hedge funds
• Mutual funds
• Exchange traded funds
• Trusts
• Other
Sovereign wealth
funds
~$5T
Insurance
Capital
~$3.4T
Pension assets of 13
countries
~$30T
Non-life
Capital
~$1.9T
Reins.
Capital
~$505B
Source: Swiss Re, Bain, Towers
Watson, Aon Benfield Analytics
16
Modern Global Reinsurers and the Debt Challenge
Assuming Risk
Managing Dynamic Capital
Commercial
Insurer
Specialty
Insurer
Personal
Lines Insurer
Multiple Lines
Insurer
Pension Funds
Understand a
very wide range
of risks
Lloyd’s
Syndicate
Select from
those risks
suitable
business
Emerging
Market Insurer
Manage cycles
and events
Life & Annuity
Insurer
Select
Risks
Form
relationships
Modern
Global
Reinsurers
SPVs,
Sidecars
and
Managed
Funds
Life Insurers
High Net Worth
Individuals
Hedge Funds
Utilize
appropriate
capital sources
for risks
assumed
Insurer Debt &
Mezzanine Investors
Retrocession
Reinsurers
Managing Dynamic
Portfolio of Risks
Assumed
All Net
Risks
Equity
Investors
Health Insurer
17
Reinsurance Supply Summary
Increasing
Supply
Decreasing
Supply
18
Reinsurance Supply and Demand
P
P0
P1
Q0
Q
Q1
19
What About Demand?
 Insurer capital increased 10% from year end 2011 to year end 2012
 Growth occurred due to lower catastrophe losses and higher primary premiums
Source: Individual Company Reports, Aon Benfield Analytics
20
Reinsurance Demand Summary
Increasing
Demand
Decreasing
Demand
21
Reinsurance Supply and Demand
P
P0
P1
Q
Q1Q0
22
Section 2
Implications for the Primary Insurance Market
History of Homeowners Profitability
24
History of Homeowners Profitability
25
History of Homeowners Ratemaking
20’s-60’s
• 5% Profit Provision
70’s-80’s
• Offset for investment income
1990’s
• Rise of auto specialists
• Increase in hurricane activity leads to introduction of catastrophe models
2000’s
• Profit models using P/S or R/S ratios
• Reinsurance cost recovery standard in almost all states
2010’s
• Cost of equity capital held to support catastrophe risk
26
Traditional Profit Model
Premium
$150
Required Surplus @1.5
$100
Required Return @15%
$15
Investment Return
$6
Underwriting Return
$9
Catastrophe Surplus
$100
Investment Return
$5
Cat Risk Margin
Total Return
$20
Total Surplus
$200
Return on Surplus
10%
27
Profit Model with Cat Risk Margin
Premium
$150
$150
Required Surplus @1.5
$100
$100
Required Return @15%
$15
$15
Investment Return
$6
$6
Underwriting Return
$9
$9
Catastrophe Surplus
$100
$100
$5
$5
Investment Return
Cat Risk Margin
$10
Total Return
$20
$30
Total Surplus
$200
$200
Return on Surplus
10%
15%
28
Cost of Capital
Accepted by Most Regulators
Decreasing reinsurance
premiums present an
opportunity to build in cost of
capital
Understand drivers
Allocate in detail
29
California Example – Cost of Capital
Gross
Required Catastrophe Capital*
Target GAAP ROE
Net
181,933,425
12.0%
12.0%
0.9
0.9
Federal Income Tax Rate
35.0%
35.0%
Investment Rate of Return
3.0%
3.0%
17.5%
17.5%
31,861,674
15,579,724
SAP/GAAP Ratio
Pre-tax Underwriting Return = [(2)/(3)]/[1-(4)]-(5)
Cost of Required Catastrophe Capital




88,961,820
Fictitious California-only writer
Based on AM Best Stressed BCAR Model
Fire Following PML estimate from RMS RiskLink 13.0
Assumes reinsurance from 10-year to 100-year PML
30
California Example – Total Cost of Catastrophes
Without
Reinsurance
Average Annual Loss
Net Cost of Reinsurance
Cost of Net Required Catastrophe Capital
Total
With
Reinsurance
9,579,770
31,861,674
41,441,445
9,579,770
6,385,943
15,579,724
31,545,437
9,896,007
9,579,770
31,861,674
9,579,770
21,965,667
Reinsurance Savings
California Ratemaking
Recoverable in Rates
Not Recoverable in Rates
 Lesson: Don’t let regulatory restrictions dictate reinsurance purchase decisions
 How would this exhibit look for a national insurer with the same California exposure?
31
California Example – Total Cost of Catastrophes
Without
Reinsurance
Average Annual Loss
Net Cost of Reinsurance
Cost of Net Required Catastrophe Capital
Total
With
Reinsurance
9,579,770
31,861,674
41,441,445
9,579,770
6,385,943
15,579,724
31,545,437
9,896,007
9,579,770
31,861,674
9,579,770
21,965,667
Reinsurance Savings
California Ratemaking
Recoverable in Rates
Not Recoverable in Rates
 Lesson: Don’t let regulatory restrictions dictate reinsurance purchase decisions
 How would this exhibit look for a national insurer with the same California exposure?
– AAL unchanged
– Lower reinsurance cost (California is diversifying risk to reinsurers)
– Lower capital cost (diversification benefit within company)
– Most of reinsurance and capital cost recoverable in rates
32
Potential Unintended Consequences of Regulatory Restrictions
Allow Reinsurance
but not Capital Cost
Allow Reinsurance
but Limit Allocation
Allow Capital Cost but
not Reinsurance
Allow Neither
Reinsurance Nor
Capital Cost
• Excessive reinsurance
• Excessive rate indications
• Greatest harm to insurers concentrated in state
• Inefficient single-state towers
• Excessive rate indications
• Greatest harm to multi-state insurers
• No savings due to reinsurance
• Excessive rate indications
• Inadequate rates
• Availability may be limited
• Greatest harm to insurers concentrated in state
33
Potential Unintended Consequences of Regulatory Restrictions
Allow Reinsurance
but not Capital Cost
Allow Reinsurance
but Limit Allocation
Allow Capital Cost but
not Reinsurance
Allow Neither
Reinsurance Nor
Capital Cost
• Excessive reinsurance
• Excessive rate indications
• Greatest harm to insurers concentrated in state
• Inefficient single-state towers
• Excessive rate indications
• Greatest harm to multi-state insurers
• No savings due to reinsurance
• Excessive rate indications
• Inadequate rates
• Availability may be limited
• Greatest harm to insurers concentrated in state
34
Potential Unintended Consequences of Regulatory Restrictions
Allow Reinsurance
but not Capital Cost
Allow Reinsurance
but Limit Allocation
Allow Capital Cost but
not Reinsurance
Allow Neither
Reinsurance Nor
Capital Cost
• Excessive reinsurance
• Excessive rate indications
• Greatest harm to insurers concentrated in state
• Inefficient single-state towers
• Excessive rate indications
• Greatest harm to multi-state insurers
• No savings due to reinsurance
• Excessive rate indications
• Inadequate rates
• Availability may be limited
• Greatest harm to insurers concentrated in state
35
Potential Unintended Consequences of Regulatory Restrictions
Allow Reinsurance
but not Capital Cost
Allow Reinsurance
but Limit Allocation
Allow Capital Cost but
not Reinsurance
Allow Neither
Reinsurance Nor
Capital Cost
• Excessive reinsurance
• Excessive rate indications
• Greatest harm to insurers concentrated in state
• Inefficient single-state towers
• Excessive rate indications
• Greatest harm to multi-state insurers
• No savings due to reinsurance
• Excessive rate indications
• Inadequate rates
• Availability may be limited
• Greatest harm to insurers concentrated in state
36
Potential Unintended Consequences of Regulatory Restrictions
Allow Reinsurance
but not Capital Cost
Allow Reinsurance
but Limit Allocation
Allow Capital Cost but
not Reinsurance
Allow Neither
Reinsurance Nor
Capital Cost
• Excessive reinsurance
• Excessive rate indications
• Greatest harm to insurers concentrated in state
• Inefficient single-state towers
• Excessive rate indications
• Greatest harm to multi-state insurers
• No savings due to reinsurance
• Excessive rate indications
• Inadequate rates
• Availability may be limited
• Greatest harm to insurers concentrated in state
37
Potential Unintended Consequences of Regulatory Restrictions
Allow Reinsurance
but not Capital Cost
Allow Reinsurance
but Limit Allocation
Allow Capital Cost but
not Reinsurance
Allow Neither
Reinsurance Nor
Capital Cost
• Excessive reinsurance
• Excessive rate indications
• Greatest harm to insurers concentrated in state
• Inefficient single-state towers
• Excessive rate indications
• Greatest harm to multi-state insurers
• No savings due to reinsurance
• Excessive rate indications
• Inadequate rates
• Availability may be limited
• Greatest harm to insurers concentrated in state
38
Potential Unintended Consequences of Regulatory Restrictions
Allow Reinsurance
but not Capital Cost
Allow Reinsurance
but Limit Allocation
Allow Capital Cost but
not Reinsurance
Allow Neither
Reinsurance Nor
Capital Cost
• Excessive reinsurance
• Excessive rate indications
• Greatest harm to insurers concentrated in state
• Inefficient single-state towers
• Excessive rate indications
• Greatest harm to multi-state insurers
• No savings due to reinsurance
• Excessive rate indications
• Inadequate rates
• Availability may be limited
• Greatest harm to insurers concentrated in state
39
Potential Unintended Consequences of Regulatory Restrictions
Allow Reinsurance
but not Capital Cost
Allow Reinsurance
but Limit Allocation
Allow Capital Cost but
not Reinsurance
Allow Neither
Reinsurance Nor
Capital Cost
• Excessive reinsurance
• Excessive rate indications
• Greatest harm to insurers concentrated in state
• Inefficient single-state towers
• Excessive rate indications
• Greatest harm to multi-state insurers
• No savings due to reinsurance
• Excessive rate indications
• Inadequate rates
• Availability may be limited
• Greatest harm to insurers concentrated in state
40
State Summary – California
Auto
Home
Mkt Sh (%)
2012Y
5-yr
DPW CAGR (%)
10-yr
15-yr
Combined Ratio (%)
5-yr
10-yr
15-yr
5-yr
Loss&LAE Ratio (%)
10-yr
15-yr 15-yr SD
19,431.2
7,039.2
100.0
100.0
(0.9)
1.7
1.6
4.4
2.4
5.3
96.5
82.5
94.6
84.4
96.4
87.5
71.5
54.8
70.0
56.8
71.9
59.6
5.1
14.3
1
2
3
4
5
Top 5 Auto Carriers
Farmers Insurance Group of Cos
State Farm Mutl Automobile Ins
Allstate Corp.
Auto Club Exchange Group
Mercury General Corp.
2,718.4
2,687.8
1,745.2
1,688.4
1,642.5
14.0
13.8
9.0
8.7
8.5
(3.9)
1.6
(2.9)
(1.2)
(3.6)
(1.8)
1.6
1.4
1.4
1.5
(1.0)
1.4
3.0
3.5
3.8
97.5
101.5
97.5
85.8
100.1
96.1
96.3
93.9
84.7
96.1
96.9
99.0
95.7
87.0
95.4
69.9
77.3
71.6
63.8
71.7
69.9
73.6
68.4
63.4
68.7
71.6
76.3
70.4
65.7
68.7
4.4
8.0
7.4
5.1
4.6
1
Farmers Insurance Group of Cos
2,718.4
14.0
(3.9)
(1.8)
(1.0)
97.5
96.1
96.9
69.9
69.9
71.6
4.4
1
2
3
4
5
Top 5 Homeowners Carriers
State Farm Mutl Automobile Ins
Farmers Insurance Group of Cos
Allstate Corp.
AAA Northern CA NV & Utah Ins
Liberty Mutual
1,555.3
1,165.7
632.2
463.2
388.2
22.1
16.6
9.0
6.6
5.5
3.5
(0.2)
(6.1)
1.3
5.2
3.8
2.7
(0.1)
7.3
5.4
4.9
4.4
2.5
8.7
4.5
86.4
86.0
80.8
81.9
81.3
85.7
89.3
80.4
77.5
83.4
91.1
92.3
81.9
81.7
88.1
60.0
51.0
57.4
50.7
49.3
59.5
55.4
57.4
48.1
52.4
64.0
59.5
58.1
52.9
57.0
18.8
18.2
14.0
14.0
16.0
2
Farmers Insurance Group of Cos
1,165.7
16.6
(0.2)
2.7
4.4
86.0
89.3
92.3
51.0
55.4
59.5
18.2
Industry - Auto
25.0
20.0
Amount ($B)
1
2
DPW ($M)
2012Y
15.0
10.0
5.0
0.0
97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
Industry - Homeowners
8.0
Amount ($B)
Rank California
6.0
4.0
2.0
0.0
97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
DPE
Loss & LAE
CA Catastrophe Risk Regulatory Summary
Cat/Non Cat Split
Demographics
Combined Ratio to Achieve 14% ROE
Catastrophe Models
15-yr PCS Loss % of Total Loss
Total Population
Projected Population Change (2012 - 2017)
Total Households
Median HH Income ($)
Unemployment Rate
Reinsurance Cost
Capital Cost
93.5%
Models permitted only for EQ fire following and must be
certified to actuarial standards (ASOP 38)
Not permitted (except for earthquake and medical
malpractice)
PCS
Cat,
10.0%
37,707,477
3.4%
12,743,499
57,385
9.4%
Not permitted
Commentary
Regulatory Environment
Very Challenging
NonCat,
90.0%
Prop 103 governs all ratemaking
Homeowners Filing Summary
Company
Auto Club Southern California
Farmers
Cat % of HO Premium
Effective Date
9/30/2012
6/16/2012
Days to
A ppro ve
257
224
70.0%
Indicated
Requested
A ppro ved
0.7%
21.1%
0.2%
6.9%
0.2%
6.9%
- Despite what is perceived as a generally
difficult regulatory environment
60.0%
50.0%
40.0%
30.0%
20.0%
Catastrophe Residual Market Summary
0.5
Residual Market Premium (%Statewide Property Premium)
Assessment Mechanism
Unlimited Assessments (Plan Deficits)
Recoupable
No specific statutory provision, possible rate increase request
250 year Industry Assessment Exposure ($M)
% of Statewide Property Premium
#VALUE!
Proprietary & Confidential
- Industry HO and auto results have been
profitable over past 15 yrs
10.0%
0.0%
5%
- This excludes EQ as that is written on a
different line than HO
15-yr PCS LR Modeled AAL
to 2012 DPW
Non-Hurricane
Hurricane
Modeled AAL based on t he average NT RMS v11and NT AIR v13
41
Questions?