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CAS Spring Reinsurance Seminar “ New Capital: Same Strategies? ”

CAS Spring Reinsurance Seminar “ New Capital: Same Strategies? ” David Cash – Chief Actuary, Endurance Specialty. June 7, 2004. The Classes of 1985, 1993 and 2001. Annual Real Net Written Premium Growth. 1993-94. 2001-04. 1985-87. Class of 1985 : ACE XL. Class of 1993 :

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CAS Spring Reinsurance Seminar “ New Capital: Same Strategies? ”

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  1. CAS Spring Reinsurance Seminar “New Capital: Same Strategies?” David Cash – Chief Actuary, Endurance Specialty June 7, 2004

  2. The Classes of 1985, 1993 and 2001 Annual Real Net Written Premium Growth 1993-94 2001-04 1985-87 Class of 1985: ACE XL Class of 1993: Cat Ltd. Global Re IPC Re Mid-Ocean Re Partner Re Renaissance Re Tempest Re Class of 2001: Arch AXIS AWAC Endurance Montpelier Note: Shaded areas denote hard market periods. Real NWP is adjusted for inflation. Source: A.M. Best, Insurance Information Institute.

  3. The Three Hard Markets • 1985: The Liability / Regulatory – Hard Market The US insurance and reinsurance markets were hit by a combination of the following: • Dramatic change in the legal environment in the US • The initial emergence of Asbestos and Pollution • Dramatic reduction in interest rates • Only limited access to capital markets • 1993: The Hurricane Andrew – Hard Market In 1992 Hurricane Andrew caused $20 billion of insured losses – the largest insurance event ever experienced by a factor of three [Typhoon Mireille 1991]. • 2001: The WTC – Hard Market The world insurance and reinsurance markets were hit by a combination of the following factors: • WTC losses $ 50 billion • Re-emergence of Asbestos $ 55 billion • 1997 – 2001 Soft Market • Equity Market Losses > $150 billion - combined

  4. The 1985 Hard Market • Sources of Capital Capital was largely drawn from clients and from within the industry – as follows: • ACE: Approximately $500 million raised from a group of client companies, along with some capital provided by third parties • XL: Approximately $500 million raised from a group of client companies, along with some capital provided by third parties • Financial Reins.: Development of financial / finite reinsurance to provide capital relief without the need for imported capital • Underwriting Strategies The new companies were formed to be mono-line underwriters operating in a narrow market [Fortune 500 companies] focused exclusively on casualty business. • Impact on the Market The start up companies benefited greatly from the hard markets and showed very significant returns on capital. At the same time, their impact on the insurance market was relatively modest. After 3 – 5 years ACE and XL had accumulated sufficient capital to be forced into exploring expansion strategies.

  5. The 1993 Hard Market • Sources of Capital Capital was largely drawn from a combination of industry incumbents and private equity investors. Key differences with 1985 were as follows: • Speed: Capital raising quick – approximately 12 months • Industry Sponsors: Significant industry participation in the formation of these companies: ACE, AIG, Aon, Centre, CNA, Gen Re, XL… • Private Equity: First significant involvement of investment banks and private equity in the formation of these companies. • Exit Strategies: Because of the involvement of financial investors from the outset, the companies were always considered to be “in play” • Underwriting Strategies As was the case in 1985, these new companies were formed to be mono-line Property Catastrophe reinsurance underwriters. • Impact on the Market The start up companies had a significant impact on the catastrophe market place, but a relatively limited impact on the broader re / insurance markets.

  6. The 2001 Hard Market – The Opportunity • Sources of Dislocation The period from 1997 through 2001 brought together multiple damaging events for the industry: • WTC: $50 billion in losses spread through the Accident/Life, Aviation, Property, Workers Compensation insurance and reinsurance markets • 97 – 01 Soft Market: $100 billion of potential losses spread through out the global insurance and reinsurance markets. The casualty lines of business being most obviously affected. • Asbestos: $55 billion of exposure to older commercial lines underwriters • Equity Markets: $50 billion of investment losses – disproportionately concentrated with the European companies. Significant exposure to the underwriters of D & O / E & O business. • Reinsurance Credit: Following on from the above, users of reinsurance have a further exposure to unrecoverable reinsurance balances. In short, it is easier to list those areas of the business that did not suffer during the period from 1997 – 2001, than it is to list those that did…

  7. The 2001 Hard Market – The Capital • Obtaining Capital Once again, there were some key differences as to how capital was raised in 2001: • Speed: Capital raising was quicker – approximately 3 months start to finish. Almost all of the significant participants in the process had made the trip to Bermuda once before. • Private Equity: The capital raising process became a sprint to put together a credible business plan, strategic investors and an investment bank. This group then raced to capture investments from the leading private equity firms. • 144A Private Deals: One management team raised its money without the aid of sponsoring companies or investors – a first for the Bermuda companies. • Assumed Exit: Almost all of the business plans put forward in 2001 contemplated an IPO and subsequent secondary stock offerings as the liquidity event for investors. • Result 4 out of 5 members of the “Class of 01” were public by mid 2003 – versus 3 out of 7 from the “Class of 93”.

  8. The 2001 Hard Market – The Opposition Asset Coverage / Tot. Liabilities (excl. Equity/Real Estate) 600% 492% 500 400 300 259% 227% 196% 180% 169% 200 157% 145% 136% 116% 113% 107% 106% 104% 100% 96% 92% 91% 83% 78% 100 0 Axis Arch PXRe Allianz SCOR IPC Re Ace Ltd Ren Re MontRe Swiss Re GE Global Munich Re PartnerRe XL Capital Allied Wrld Everest Re Endurance Converium OdysseyRe HannoverRe Asset Coverage / Total Liabilities [excl. Real Estate and Equity] Note: Asset Coverage= Reinsurance recoverables + prepaid reinsurance premiums + cash and investments [excl. real estate and equity] + funds held under reinsurance treaties + accounts receivables. Total Liabilities = gross life and non-life loss reserves + funds held under reinsurance treaties + reinsurance payables + other accounts payable/other accrued liabilities + net deferred tax liabilities + total financial leverage [Debt]. Source: Dowling & Partners – Based on June 30, 2003 data

  9. The 2001 Hard Market – The Challenge 1,500+ Employees Arch 860 Axis 308 AWAC 117 Endurance 245 Montpelier 49 As of March 31,2004 4 Countries 20+ Lines of Business Accident Aviation Casualty Treaty Clash Directors and Officers Energy Errors and Omissions Fidelity / Surety International Treaty Marine Medical Malpractice Program Business Property Ind. Risk Property Catastrophe Property Treaty Terror Umbrella War Risk WC Catastrophe Workers Compensation … $18 Billion of Premium Arch $ 5.723 Billion Axis $ 4.426 AWAC $ 2.996 Endurance $ 3.121 Montpelier $ 1.751 Gross Written Premium 2002 + 2003 Combined

  10. The 2001 Hard Market – The Strategies • Areas of Strategic Importance Given the size and breadth of the market dislocation, the Class of 01 faced multiple strategic decisions in the first two years of operations: • Underwriting: Property versus Casualty versus Specialty, Insurance versus Reinsurance, US Market versus International Market. • Operations: Operating companies, operating locations, staffing, infrastructure and expense management. • Technology: The Class of 93 demonstrated that using technology in a distinctive manner could create lasting shareholder value. • Acquisitions: Acquisitions of businesses, balance sheets and underwriting teams. • Investors: The need for an early valuation by the public equity markets combined with the need for an orderly transition of ownership by the public markets made this a critical discipline. The following slides set out some of the basic issues associated with the above items.

  11. Underwriting – “Underwriters, Pick Your Markets…”

  12. Operations – “What’s a work permit ?” I. T. I. P. O S. E. C. N. A. I. C. F. S. A. S. O. A.M.B. and S&P + = An Operational Headache

  13. Technology – “The Good, the Bad and the Ugly…”

  14. Acquisition Strategy – “Make me an offer, any offer…” + 200+ Acquisition Opportunities in 30 months + =

  15. Capital – “Haven’t I answered this question already ?” • Value derived from Capital Management Capital management is a distinct discipline and one that has the potential to significantly enhance or diminish shareholder value. Raising the initial capital is the easy part – it’s managing the capital that is the hard part: • Go to Bermuda: The other easy part, all the capital goes to the same place. • I. P. O.: This represents the first step on a 4 – 5 year journey culminating in a fully public shareholder base. For most companies, this work was done at the end of 2002 – in the middle of renewal season. • Debt Issuance: A necessary part of right sizing the capital base – requires additional due diligence meetings with up to 20 banks. • Rating Agencies: Constant, unrelenting interaction… • Public Ownership: No more hassles with Private Equity, now it is just the analysts, the shareholders, the accountants and the regulators you have to deal with. • Excess Capital: The big test for all market participants – will companies give the money back, rather than burn it up in the next soft market…

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