Capital Considerations of Insurers with
Catastrophe Exposure
October 22, 1998
Jeanne H. Dunleavy
Senior Vice President
Risk Management
Catastrophes

Natural Disasters

Y2K

Tobacco Liability

Asbestos & Environmental

Man-made Catastrophes
2
Discussion Outline

Best’s Rating Philosophy

Catastrophe Exposure Trends

Financial & Strategic Evaluation

Catastrophe Management Strategies
3
A.M. Best’s Rating Evaluation —
Key Components
Financial
Strength
Operating
Performance
Market
Profile
Best’s Rating
4
Best’s Rating Philosophy —
Catastrophe Risk

Extensive PML analysis

Cat modeling standardization issues

Secure insurers must survive reasonable PMLs


Gross PML leverage
 < 100% for superior insurers
Concern over opportunistic players in cat-prone areas
5
Compiling Information —
Best’s Supplemental Rating Questionnaire

Gross & net PML


50-, 100-, 250- & 500-year return periods
Catastrophe models
Modeler & version
 Key assumptions


Liquidity profile

Historical experience
6
Gross Catastrophe Leverage By Severity
Total Sample (60)
60%
40%
50%
47%
50%
36%
35%
26%
30%
20%
15%
10%
0%
75+ (Excessive)
0-30% (Moderate)
1994
Source: A.M. Best Co.
1995
1996
(Gross PML/Surplus%)
7
Net Catastrophe Leverage By Severity
Total Sample (60)
80%
70%
60%
74%
69%
55%
50%
40%
30%
22%
20%
5%
10%
2%
0%
0-15% (Moderate)
46%+ (Excessive)
1994
1995
1996
Source: A.M. Best Co.
(Net PML/Surplus %)
8
Catastrophe Reinsurance Dependence
Total Sample (60)
65%
70%
66%
60%
50%
40%
30%
25%
16%
20%
20%
19%
10%
0%
0-30% (Moderate)
Source: A.M. Best Co.
91%+ (Excessive)
1994 1995 1996
(Ceded PML/Gross PML %)
9
A.M. Best’s Financial Evaluation —
Catastrophe Risk

Capitalization

Liquidity

Profitability

Financial Flexibility
10
Cat Risk Financial Evaluation —
Capitalization

Best’s Capital Adequacy Model (BCAR)
 Net after tax PML - higher of:
 Hurricane 100-year return period
 Earthquake 250-year return period
11
Cat Risk Financial Evaluation — Liquidity


Liquid assets
Liquidity stress test
 Pro forma 120 basis point rise in
interest rates
 Bond securities with unrealized
losses
12
Cat Risk Financial Evaluation —
Profitability

Earnings volatility/earnings drag
 Frequency as well as severity
 Costly reinsurance coverage
13
Cat Risk Financial Evaluation —Flexibility

Reinsurance utilization

Access to capital markets

Debt capacity

Parental resources
14
Catastrophe Risk — Financial Evaluation
Capitalization
Liquidity
Profitability
Financial
Flexibility
Sensitivity Analysis
Gross & Net PML Leverage
Liquid Asset Profile
Cash Flow Stress Test
Earnings Volatility & Drag
Access to Capital
Reinsurance Usage
Debt Capacity
Parental Support
15
Catastrophe Risk — Strategic Evaluation
Risk Retention
Strategies
Parental
Commitment
Risk Appetite
Surplus / Solvency
Earnings Volatility
Cash Flow
Investor View
Best’s Rating
Exposure Caps
Exposure Elimination
Loss Mitigation
Reinsure/Risk Financing
Regulatory Constraints
Strategic Fit
Goals & Objectives
Corrective Timelines
16
Emerging Catastrophe Management
Strategies

Risk retention/containment

Risk mitigation

Risk transfer

Risk financing
17
Risk Containment — Example: Allstate
Issues
Excessive Florida cat exposure
Difficult regulatory environment
Solution
Create separately capitalized Florida
subsidiary to segregate exposures and
demonstrate need for increased rates
18
Risk Mitigation — Examples: Nationwide,
Farmers, State Farm
Issues
Nationwide Increased cat losses
Farmers
State Farm
Substantial CA EQ exposure
Linking CA law for HO & EQ
Tighten U/W criteria
Prem discounts for enforced bldg codes
Solutions
Nationwide Limited/non-renewal business
Farmers
State Farm
Implemented new mini-policy pre-CEA
Promote rating bldg codes’ effectiveness
19
Risk Mitigation — Example: Farmers
Issues
Farmers
Substantial CA EQ exposure
Linking CA law for HO & EQ
Solutions
Farmers
Implemented new mini-policy pre-CEA
20
Risk Transfer — Example: USAA
Issues
High cost of reinsurance
Access to capital markets/add. capital
Solutions
Non-affiliated, special purpose reinsurer
Issued reinsurance contract/cat-linked
bonds tied to East Coast hurricane losses
($500 mil XS $1 bil layer)
21
Risk Transfer — Example: RLI/Centre Re Contingent Equity
Issues
Large commercial property cat exposure
Augment traditional program with costeffective alternative
Access capacity in capital markets &
avoid market risk of issuing securities
after major event
Solutions
Catastrophe Put Option
Pre-negotiated sale of $50 mil convertible
preferred securities to Centre Re if losses
exceed RLI’s cat reinsurance protection
22
Cat Management Strategies —
Non-Traditional
Reinsurance
Catastrophe linked bonds
USAA, Swiss Re
Winterthur
Debt
Contingent surplus notes
Arkwright, Nationwide
Standby line of credit
Nationwide, State
Farm, Florida JUA
Catastrophe equity puts
RLI/Centre Re
Catastrophe options
Travelers
Equity
Investment
23
Summary

Elevated losses

Catastrophe models

Favorable trends

Best’s Ratings
24
Effectively managing catastrophe risk is one of the
major challenges for insurance companies
A.M. Best is focused on preventing
and detecting insurer insolvency
E.W. Blanch plays a vital role in providing sound
advice and innovative risk transfer and risk
financing products
25
Catastrophe Risk Management

Using Technology
As A Pricing Tool
 To Understand Layering, Loss Costs,
and Probabilities
 To Create Practical Solutions
 Integrate with Overall Financial
Performance

26
E. W. Blanch
Company
27
Overview of
E.W. Blanch holdings, Inc.
E.W. Blanch Mission Statement
To make an identifiable and measurable
contribution to the success of our clients
through innovative concepts and
unparalleled service.
29
How We Deliver Solutions
EWB Holdings, Inc.
EWB Co.
(N. America)
Swire Blanch
(International)
Relationship
Executives Linda Johnson
Scott Fest
Risk Transfer
Services
Analytical
Services
Primary
Servcices
Post-loss
Mitigation
Services
30
EWB Holdings Financial Highlights: As of
12/97
REVENUES:
$167M (53% Increase From 1996)
GROWTH:
Over 25% Compounded (Last 5 Years)
EPS:
$2.03
ASSETS:
$920M
OWNERSHIP:
Publicly owned (NYSE = EWB)
Approximately 25% Employee Ownership
MARKET
CAPITALIZATION: $446M
31
Global Network
CINCINNATI
HOBOKEN
BOSTON
BEIJING
LONDON
CHICAGO
NEW YORK
HUDDERSFIELD
COPENHAGEN
MINNEAPOLIS
SHANGHAI
DENVER
PHILADELPHIA
HONG KONG
WILMINGTON
SAN FRANCISCO
ATLANTA
MIAMI
HO CHI MINH CITY
LOS ANGELES
SARASOTA
DALLAS
MEXICO CITY
SAN ANTONIO
RIO de JANIERO
HANOI
SINGAPORE
ASUNCION
BUENOS AIRES
SYDNEY
E. W. Blanch Co.
Primary Distribution
Swire Blanch
Over 1,100 employees worldwide
32
Historical Revenues
$200
$180
$160
$140
$120
$100
$80
$60
$40
$20
$0
$167.0
$109.0
$80.7
$94.9
$64.6
1993
1994
1995
1996
1997
33
Sample Client List
Insurers / Reinsurers
Acceptance Insurance Company
Allstate Insurance Group
Alfa Insurance Corp.
Amica Mutual Insurance
CIGNA Insurance Company
CNA Group
Frontier Insurance Company
Guidant Insurance Group
Liberty Mutual Insurance Company
Orion Insurance
Reliance Insurance Company
Renaissance Reinsurance, Ltd.
St. Paul Cos.
State Farm Insurance Company
W. R. Berkley Corporation
Catastrophe Management:
American Family Mutual Insurance Co.
Gryphon Insurance Group
Hartford Insurance Company
Governmental:
California Earthquake Authority (CEA)
Florida Hurricane Catastrophe Fund (FHCF)
Florida Windstorm Underwriting Association
(FWUA)
Illinois Department of Insurance (Pine Top)
Texas Wind Pool
Business Solutions:
Fireman’s Fund Insurance Company
Orion Capital Companies
Wausau Insurance Companies
34
What Specific Services Are Available
Insurance
Services
Reinsurance
Distribution
Customer
Risk
Management
Business
Solutions
35