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Developments in the World Insurance and Reinsurance Markets David Forcey, Aon Limited

Developments in the World Insurance and Reinsurance Markets David Forcey, Aon Limited Topdanmark Seminar, 29th May 2002. In theory risk is spread or “atomised” through reinsurance. DIRECT MARKETS WHOLESALE SURPLUS LINE. INSURANCE BUYER. MULTIPLE POLICIES. FACULTATIVE REINSURANCE.

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Developments in the World Insurance and Reinsurance Markets David Forcey, Aon Limited

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  1. Developments in the World Insurance and Reinsurance Markets David Forcey, Aon Limited Topdanmark Seminar, 29th May 2002

  2. In theory risk is spread or “atomised” through reinsurance DIRECT MARKETS WHOLESALE SURPLUS LINE INSURANCE BUYER MULTIPLE POLICIES FACULTATIVE REINSURANCE TREATY REINSURANCE BEARING CAPITAL ULTIMATE RISK ASSURED

  3. … but in practice it has a habit of aggregating again DIRECT MARKETS WHOLESALE SURPLUS LINE INSURANCE BUYER MULTIPLE POLICIES FACULTATIVE REINSURANCE TREATY REINSURANCE PROFESSIONAL REINSURERS ASSURED ABC Re

  4. Insurance pricing tends to go through cycles Top of the cycle Top of the cycle Marked depletion in policyholder surplus for 3 or 4 consecutive years. Often positive runoff slows down as well runs dry. Insurers and reinsurers ROEs bottom out. Pressure from shareholders intensifies. Insurers strive to implement rate increases. Some reinsurers pull out of certain lines or retire from business. Often when the P&C cycle is on the upswing, the overall economy is on the downswing. Competition for market share intensifies, rates are cut, and U/W results weaken. More reliance on investment income. Rate adequacy achieved Rate adequacy achieved Growth in non-traditional markets as buyers of insurance & reinsurance seek alternatives. Strong industry returns tempt some companies to loosen U/W standards in a quest to grow market share. Start of soft market. Some companies in some markets fail, others retire from certain lines or go out of business. More industry restructurings and lay offs. Organic growth is very difficult. More M&As. Retro market begins to harden, followed by reinsurance market. Bottom of the cycle Sensing the upswing, some insurers attempt to lock in cheap reinsurance with multiyear agreements. Source: Swiss Reinsurance Company, Canada

  5. Outline of remarks • Market conditions • Pre-WTC • “Retreat from risk” • Post-WTC • Capital movement • The new world of risk and regulation • Market outlook

  6. Market conditions - pre WTC

  7. Since hard market of 93/94 reinsurance pricing has been falling ... Northridge Andrew 87J Piper Alpha 90A Source: Paragon

  8. ... whilst catastrophe losses continue to increase ... Losses from major natural catastrophes Source: Munich Re

  9. Major losses (pre WTC) Estimated Year Insured Loss ($m) 1999 Ford Motor/Rouge Steel 650 Sydney Hail 1,000 Oklahoma Storms 1,536 Hurricane Floyd 2,441 Taiwan Earthquake 1,000 European Storm (Martin) 2,482 European Storm (Anatol) 1,551 European Storm (Lothar) 5,998 2000 UK Storms and Flooding 747 2001 Earthquake in Seattle region 500-800 Petrobas 36 semi-submersible oil rig, explosion and fire 500 Hail, wind, tornadoes, flooding in Texas and adjacent states 1,700 Tropical Storm Allison 2,500

  10. ..result is poor profitability(e.g. US Property/Casualty Industry)

  11. But then stockmarket started falling late 2000 ...

  12. Re/insurance company results - before WTC • So market was hit by combination of • Continuing poor underwriting results • and low interest rates and investment returns • … and something finally had to give … so we had • Insurance company failures (Australian retro, Reliance, Independent) • Withdrawals from selected classes • Rates - hardening • Coverage - narrowing • Retentions - increasing • Capacity - reducing

  13. “Retreat from risk”

  14. Capital and volatility Comparative returns on equity for 5-years 1994-98 Min Ave Max Range • Property/casualty 5% 14% 23% 18% • Diversified financial 15% 18% 20% 5% (financials services with large p/c) • Commercial banks 16% 16% 17% 1% • Fortune 500 13% 14% 14% 1% Source: A. M. Best’s Review, January 2000 • Is industry over-capitalised and/or earning too low a return?

  15. Capital and volatility • Corporations under constant pressure to delivershareholder value • Stockmarkets want • growth, every quarter • and do not want volatility • The shareholder versus the policyholder - conflict or conundrum? • Shareholders (of all types) do not want volatility • but, Policyholders want to transfer volatility

  16. “Retreat from risk” - Structural change, not just cyclical • CGNU has withdrawn from global risks market • sold non-life businesses in US, Germany, South Africa and Lloyd’s operations • growing bancassurance joint venture with Royal Bank of Scotland and targeting life businesses in Europe • proposed name change to Aviva • ACE intends to diversify • from 2/3 property/casualty and 1/3 accident & health • to 1/3 property/casualty, 1/3 accident & health, and 1/3 personal lines • Citigroup has spun off 21% of Travelers Property & Casualty - wants higher earnings and less risk

  17. “Retreat from risk” - reinsurance examples • Zurich has spun off Zurich Re as Converium • Generali Global stopped writing non-life commercial treaty r/i • CNA quits reinsurance outside US • Gerling Group for sale • St. Paul to spin-off reinsurance operations as Platinum • Rumours about GE spinning-off ERC Frankona, Axa Re, Chubb, Hartford, etc. “This is a trend which will continue in the next few years. What a lot of publicly-held companies have determined is that their shareholders will not reward them for volatility of earnings.” “The volatility on the property/casualty side side for property catastrophe, the restatement of earnings that seems to come to occur for prior year results for liabilities like asbestos and now mould. This is something troublesome for investors post-Enron.”Don Watson, Standard & Poor’s

  18. But the grass is not always greener ... • CGNU Chief admits stakeholder pensions have shrunk margins • CGNU has become the largest provider of low-cost stakeholder pensions, with 20% of the market, but total new business sales in the UK fell from £2.2bn to £2bn • “Richard Harvey (CGNU CEO) told investors that he was cutting their dividend in order to generate profitable growth. Well it hasn’t been that profitable and there has not been that much growth.” • Munich Re, Swiss Re, etc. tried to develop third-party asset management as core business stream, but ”Asset management is weighed down by volatile equity markets and business so far does not meet our expectations” Rolf Hueppi, now ex-Chairman & CEO, Zurich Financial Services

  19. Market conditions - post WTC

  20. … and then WTC disaster 11th September 2001 • Estimated losses by line US$ billion • Commercial property 10 to 12 • Business interruption 3.5 to 7 • Liability 5 to 20 • Aviation 3 to 6 • Workers compensation 3 to 5 • Life, accidental death & disability 4.5 to 6 • Other 1 to 2 Total 30 to 58 Source: Tillinghast Towers-Perrin

  21. … which was followed by ... • Explosion at AZF petrochemical plant, Toulouse, France • Enron - causing investment losses to insurers as well as claims under credit, surety and D&O covers • Liability losses • from the past increasing - AM Best estimates US property/casualty insurers’ reserves for asbestos and environmental losses are underfunded by $57 billion or almost 50% • and the present - average cost of D&O settlements has tripled to $25 million and no abatement in frequency of cases [SSB 26 April 2002] • … and potential new major claims arisinge.g. IPO “laddering” on Wall Street, mould in Texas • Investment hitse.g. corporate bond default rate 8.57% in 2001

  22. Overview of market developments since WTC Disaster • WTC claims settlement issues - one or two losses? • Exacerbated “retreat from risk” trends • Fear of “systemic risk” - role of Government as re/insurer of last resort? • Exclusions - war, terrorism and sabotage - many different & diverse wordings • Flight to quality • Clients generally opting, where possible, to take higher deductibles rather than pay increased premiums

  23. Overview of market developments since WTC Disaster • Hard to get fronting for global programmes • Insurers withdrawing from volatile, complex risks and multi-line & multi-year programmes • “Back to basics” underwriting, with • Narrowing forms • Tighter terms & conditions • Recalculation of EMLs/PMLs upwards • Increasing retentions • Some reduction in capacity / line sizes • … and higher premiums!

  24. Capital movements

  25. Aioi / Fortress Re Alleghany exited reinsurance AMP exits property/casualty Arig Re closed to new business Bavarian Re - merged into Swiss Re CNA Re ceased reinsurance ex-US Copenhagen Re - suspended Cox Insurance - discontinued r/i Delphi / Oracle - liquidation DPM - now into Faraday Folksam International Fremont to exit workers comp Generali - exits commercial treaty Hartford Fire - casualty and risk HIH Insurance Independent ING Re / Reliastar Newmarket Nissan / Fortress Overseas Partners into run-off PAULA to cease u/w RSA / Royal Re closed Sampo Industrial NV ABB / Sirius / Scandinavian Re St Paul Re - out of most classes Taisei - insolvency WR Berkley withdraws from ART & treaty reinsurance Capital movements - some withdrawals

  26. Capital movements - new capital post WTC (i) • ACE Raised $1.2bn in equity offering • AIG Formation of Allied World Ass; contributed $291m of $1.5bn capital • AIG International Lease Finance subsidiary filed shelf to sell up to $4bn debt • AIG Issued $1.52bn of zero-coupon convertible senior debenture due 2031 • Aon Formation of Endurance Specialty Inc. initially capitalised with $1.2bn • Arch Capital $763m invested in Arch Re • Ceres Group Filed registration to sell 14m shares to raise c$46m • Chubb Formation of Allied World Ass; contributed $291m of $1.5bn capital • Chubb Sold $600m of debt • Everest Re Filed registration to sell $575m common shares • Fairfax Sold 1.25m shares, raising $157m • Goldman Sachs Formation of Allied World contributed $291m of $1.5bn capitalisation

  27. Capital movements - new capital post WTC (ii) • Goshawk To raise £100m to set up new reinsurance subsidiary in Bermuda • Hannover Re Plans to sell 2.9m shares to raise $173m • Hartford Sold $500m of trust preferred and $400m of common stock • IPC Holdings Filed registration to sell 15.2m shares to raise up to $510.8m • Lloyd’s Capacity increased from £11bn to £12.3bn for 2002 • Markel Plans to offer 1.3m shares • Munich Re To inject more than $1bn into American Re • PartnerRe Raised $387.7m in securities • Philadelphia Filed registration to sell 3m shares to raise c$100m • PMA Capital Filed registration to sell up to 8.5m shares, expected to raise $139m • Progressive Filed registration to sell up to $500m of debt • QBE Insurance Raised $337m of equity

  28. Capital movements - new capital post WTC (iii) • Renaissance Re Sold 6n shares, raising $150m • Renaissance Re Raised $233m of equity • Renaissance Re Announced formation of DaVinci Re with State Farm • RSA Looking to release more capital by selling life and funds mgt ops • SCOR Capital raising exercise • St Paul Co's Filed shelf registration to sell up to $575m in trust preferred securities • Swiss Re Raised $2.87bn through rights issue • Wellington To set up a non-Lloyd’s insurance subsidiary capitalised to £400m • White Mountain Filed shelf registration to sell up to $1bn of debt • White Mountain Capitalised new Bermuda-based company with $1bn • WR Berkley Sold 3.3m shares raising $178m • XL Capital Sold 8m shares to raise $819m

  29. Summary of major new Bermuda companies • Axis Specialty $1.5 bn MMC Capital • Allied World $1 bn AIG, Credit Suisse, Goldman Sachs • Arch Re $1 bn Warburg / Helman & Jordan • DaVinci Re $0.4 bn State Farm, Renaissance Re • Endurance Re $1.2 bn Aon / Zurich • Montpelier Re $1 bn White Mountain / Benfield Greig • Olympus Re $0.5 bn Leucadia/Gilbert Global/Gill & Roeser

  30. Developments at Lloyd’s • Loss of £3.1 bn ($4.5 bn) for 2001 (inc. $2.9 bn for WTC) • Largest capacity ever for 2002 at £12.2 bn ($17.75 bn) • US Trust Funds • $5 billion deposited in cash for WTC claims • Trust Funds now total $11 billion • Chairman’s Strategy Group reform proposals • Single franchise board • To adopt annual GAAP accounting • AM Best has confirmed A- rating

  31. Capital movements in 2001 • Around $25 billion of new or additional capital entered insurance industry during 2001 • But something like $100 billion exited industry, due to • Incurred losses • Reserve strengthening • Investment losses • Withdrawals - involuntary and voluntary • Poor 2001 results • Combined ratios: US reinsurers 142% European reinsurers 129% [Swiss Re first loss since 1868] Lloyd’s 140%

  32. Market outlook

  33. Hard market - not good news yet for all carriers • Royal & SunAlliance still faces more clouds than sunshine • R&SA hit by £37 million rise in flood claims • Falling investment returns wiped out a £20 million increase in new premiums [FT 10 May 2002] • CNA Financial profit falls on Underwriting, Investment [Reuters 9 May 2002] • Kemper’s AM Best financial strength rating cut from A to A- mainly due to adverse loss reserve development, principally in asbestos reserves [May 2002] • Munich Re paying a high price for its American adventure [Insurance Day 30 April 2002]

  34. Hard market - not good news yet for all carriers • Rising costs force State Farm to act • Citing steadily rising costs, particularly form toxic mould claims, State Farm Insurance said to would stop issuing new homeowner’s policies in California “for the foreseeable future” • “Our policyholder protection fund has gone from $605m to $425m in two years. Our losses are going up steadily” [Insurance Day 1 May 2002] • Australia was on the brink of a healthcare crisis last night after the collapse of its biggest medical indemnity insurer, United Medical Protection, which insures more than half Australia’s doctors, including more than 90% of those in New South Wales [FT 30 April 2002] • US plc ratings still negative despite hard market[Moody’s Investors Service May 2002]

  35. Re/insurance and RoE • Bermudian’s RoE struggle • New crop of Bermuda-reinsurance companies will struggle to meet the ambitious RoE (Return on Equity) targets set by their investors • The group of property reinsurers set up in the early to mid-1990s with RoE targets of 20% have only managed to hit that level in one year since 1994 [Insurance Day 1 May 2002] • Alternative RoE (Replacement of Executive!) • Rolf Hueppi, now ex-Chairman & CEO, Zurich Financial Services • Jean-Marie Nessi replaced as CEO at Axa Corporate Solutions by Phillipe Donnet • Norbert Strohschen resigned as chairman of the executive board of Gerling Global Re and succeeded by Bjorn Jansli • William Adamson replaced as CEO of CNA Re by Debra McClenahan • Edward J Noonan replaced as president and CEO of American Re by John P Phelan

  36. The new world of risk and regulation • Post-Enron desire for “transparency” • AIG • Shares in the world’s largest insurance company down by 35% since their high in late 2000, and by 15% this year alone • The company’s audit committee opinion on the fairness of AIG’s financial statements is so “ambiguous, elusive, equivocal, hedged, and oblique” as to be “virtually meaningless” David Schiff, reported in The Economist, 11 May 2002 • If the audit committee is not prepared to lay itself on the line, little wonder that investors in AIG are not either [The Economist] • Bermudan insurers offer hedge funds tax breaks but the US tax man is not pleased - lack of a corporate income tax boost insurers’profit margin by 25% [FT 30 April 2002]

  37. The new world of risk and regulation • Asset / liability matching • Banks generally know pretty exactly what their liabilities are, but not what their assets are worth. Insurers have the opposite problem; their assets are relatively easy to measure, but they only have a sketchy idea of what their liabilities will be • The International Accounting Standards Board has proposed that insurance companies should be required to report a current value for their liabilities, provoking a storm of protest by US, Japanese and German life assurers • Existing standards in US and elsewhere completely ignores the effect of sweeping interest rate movements [FT April 2002] • example: “Munich Re’s losses in 2001 from its investments were over twice the $2 billion it lost on terrorism” [The Economist 9 February 2002]

  38. The new world of risk and regulation • Insurers must upgrade means of assessing risk, says report. Key findings: • The existing solvency rules are based on simple fixed ratios that provide for safety margins that do not adequately reflect the full range of risks to which insurers are exposed • A number of implicit capital requirements are imposed through the prudential valuation of assets and liabilities that make it difficult to assess the true financial position and compare the financial strength of companies located in different EU states • The high degree of subjectivity involved means that some companies setting technical provisions on a very prudent basis may unnecessarily appears weaker than companies with a less prudent approach [FT 2 May 2002, KPMG report for European Commission]

  39. The new world of risk and regulation • Key limitations of premium-based approach to solvency • Not factored into the calculation • Asset risk • Reserve risk • Catastrophe risk • Risk profile on underwriting book • Credit risk (e.g. reinsurance recoveries) • and reported shareholders’ funds (surplus) can be poor proxy for available risk capital [AM Best article in Insurance Times, 9 May 2002] • example: Analyst claims that changing probability of sufficiency on its loss reserves from 85% to 82% enabled QBE to declare net loss of A$25m rather than net loss of A$123m [The Australian 17 April 2002]

  40. The new world of risk and regulation • Asset risk is increasing • Stockmarket volatility - the days when blue-chip shares rose and fell by small amounts, giving investors time to respond, are over • For much of the past two years, shares in at least 10% of the FTSE 100 companies have moved by 5% or more on every trading day [The Sunday Times 10 March 2002] • Insurers use derivatives more • Research from the FSA shows that the role of insurers on the global credit derivatives market is growing, as the financial services industry tries to diversify its risks or increase its returns • Insurers were estimated to have 20% to 25% of the $1,000bn to $1,025bn credit derivatives market [Insurance Times 9 May 2002]

  41. The new world of risk and regulation • FSA orders insurers to increase capital reserves and moves to tighten policing [FT 10 May 2002] • The FSA said it would adopt a “risk-based” approach to insurance company solvency from 2004 • This will bring insurers into line with banks, which are already subject to higher capital adequacy adequacy standards • The regulator wants to crack down on insurance after the collapse of Equitable Life and Independent Insurance • The watchdog will allow insurers to take part in determining how much capital they should keep against their risks, but a firm may be required to hold additional capital for specific systems and controls related concerns

  42. The investment outlook • Stockmarket • Alan Greenspan December 1996 “irrational exurberance”- Dow at 6437 • Further caution October 1997 - Dow around 8000 • Dow since hit high of 11908 in Jan 2000 - but now still at 9800 • Bond market • Government bonds - most OECD governments in surplus in recent years • Decline in availability of government bonds; growth in corporate bonds • US number of credit downgrades 5 times number of credit upgrades; ratio is 20.5 in Europe in 1Q 2002 • Corporate bond defaults reached record high of $34 billion in 1st quarter 2002

  43. Government borrowing Worldwide 2001 total bonds in issue $33,000bn

  44. Market conditions - coverage issues • Named perils • Some leading reinsurers sought to restrict cover to named perils only, but have since become flexible and reverted to traditional all risks basis • Terrorism • Original hard line from reinsurers - terrorism excluded • Position now softening somewhat • written back for Household business • Nuclear/Biological./Chemical contamination resulting from terrorism excluded completely • Aviation - Trioka extended for third (and final?) time to 31 May 2002 • Cyber liability

  45. Terrorism coverages in the UK • Property • Pool Re created in 1993 as a mutual pool • Now has 182 UK insurance companies and 28 Lloyd’s syndicates • Only covers fire and explosion • Public Liability • Exclusion for all policies attaching on or after 1st April • Motor bodily injury • Restricted to Road Traffic Act only for all policies attaching on or after 1st April • Motor third party property damage • TPPD cover given to legal minimum of £250,000

  46. 1 January 2002 treaty renewals • UK pricing • Property cat - 50% plus increases • Property risk XL - 20% to 25% increases with restrictions on target risks • PA - renewals at multiples of prior cost (effectively no retro market) • Casualty - up to 20% increases with restrictions on target risks • Motor - 50% to 70% increases

  47. 1 January 2002 treaty renewals • European pricing • Property cat - generally 50% increases, except • Italy +35% to 50% • Germany +15% • Switzerland +25% to 35% • France +10% (big increases last year following Lothar) • Property risk XL - 20% increases with restrictions on target risks • Casualty - generally 30% increases with exclusions on terrorism (except Employers Liability where required by law), cyber and toxic mold

  48. 1 January 2002 treaty renewals • US pricing • Property cat - generally up to 20% increases, limited by new capital and capacity in Bermuda • Property risk XL - 5% to 10% increases • Terrorism intended to be excluded, but wordings to be agreed • Casualty XL - 20% to 25% increases, partly due to lower interest rates with exclusions on terrorism and toxic mold (but wording to be agreed) • Japan 1.4.2002 • Property Cat Programme - increase average 20%

  49. Effects on UK & European clients • Capital departures and reallocations have significantly changed the balance of supply and demand for insurance capacity • Supply has shrunk below levels of demand levels that are largely unchanged • It’s a sellers’ market • Competition has switched sides • insurers no longer compete or speculate for your business • you are competing for theirs

  50. Effects on UK & European Markets • Premium rates have hardened (risen) substantially • Higher deductibles have been imposed • Indemnity limits and scope of cover are being reduced • Far more scrutiny of individual exposures (info required) • Mandatory risk improvements • Premium payment warranties are being imposed

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