Reinsurance Matters

1. Reinsurance Matters Steve Adams Senior Vice President Houston Marine Insurance Seminar September 23rd 2003

2. White-Haired The White Knuckle Ride

3. Agenda • Reinsurance matters • Where we’ve been • Where we are now • Where we might be going • Why reinsurance matters

4. Reinsurance according to Kiln • "What is reinsurance? Insuring insurers is a short and as good a description as any. That is to say, it is: • the business of insuring an insurance company or underwriter against suffering too great a loss from their insurance operations; and • allowing an insurance company or Underwriter to lay off or pass on part of their liability to another Insurer on a given insurance which they have accepted."

5. Pre-Spiral days The age of innocence The Spiral The $2bn boys Post Piper Alpha Fundamental problem ignored 1993 to 1997 Halcyon Days 1998 to 2000 Plumbing the depths 2001 The year to end all years Where we’ve been

6. Pre-Spiral DaysThe age of innocence • The eighties • Lowering retentions • Benign period for losses • More cover • …..and more cover • ….and more cover • The first clue - 87J • Piper Alpha 6th July 1988

7. The SpiralThe $2bn Boys • Original loss $1.4bn • Spiral loss by 1992 was $14bn • They stopped counting

8. Insurer XL Direct XL on XL (1st Tier) XL on XL (2nd Tier) XL on XL (3rd Tier) XL on XL (3rd Tier) XL on XL (3rd Tier)

9. The SpiralThe $2bn Boys • Each company buys as follows: • ABC Ins Co - $95,000 xs $5,000 from DEF Ins Co • DEF Ins Co - $85,000 xs $5,000 from GHI Ins Co • GHI Ins Co - $95,000 xs $5,000 from ABC Ins Co

10. The SpiralThe $2bn Boys • ABC Ins Co - $5,000 loss (retained) • DEF Ins Co - nil • GHI Ins Co - nil

11. The SpiralThe $2bn Boys • ABC Ins Co - $10,000 loss ($5,000 retained, $5,000 reinsured with DEF) • DEF Ins Co - $5,000 loss (retained) • GHI Ins Co - nil

12. The SpiralThe $2bn Boys • ABC Ins Co - $15,000 loss ($5,000 retained, $10,000 reinsured with DEF) • DEF Ins Co - $10,000 loss ($5,000 retained, $5,000 reinsured with GHI) • GHI Ins Co - $5,000 loss (retained)

13. The SpiralThe $2bn Boys • ABC Ins Co - $20,000 loss ($5,000 retained, $15,000 reinsured with DEF) • DEF Ins Co - $15,000 loss ($5,000 retained, $10,000 reinsured with GHI) • GHI Ins Co - $10,000 loss ($5,000 retained, $5,000 reinsured with ABC)

14. The SpiralThe $2bn Boys • ABC Ins Co - $25,000 loss ($5,000 retained, $20,000 reinsured with DEF) • DEF Ins Co - $20,000 loss ($5,000 retained, $15,000 reinsured with GHI) • GHI Ins Co - $15,000 loss ($5,000 retained, $10,000 reinsured with ABC)

15. The SpiralThe $2bn Boys • ABC Ins Co - $30,000 loss ($5,000 retained, $25,000 reinsured with DEF) • DEF Ins Co - $25,000 loss ($5,000 retained, $20,000 reinsured with GHI) • GHI Ins Co - $20,000 loss ($5,000 retained, $15,000 reinsured with ABC)

16. The SpiralThe $2bn Boys • ABC Ins Co - $35,000 loss ($5,000 retained, $30,000 reinsured with DEF) • DEF Ins Co - $30,000 loss ($5,000 retained, $25,000 reinsured with GHI) • GHI Ins Co - $25,000 loss ($5,000 retained, $20,000 reinsured with ABC)

17. The SpiralThe $2bn Boys • ABC Ins Co - $40,000 loss ($5,000 retained, $35,000 reinsured with DEF) • DEF Ins Co - $35,000 loss ($5,000 retained, $30,000 reinsured with GHI) • GHI Ins Co - $30,000 loss ($5,000 retained, $25,000 reinsured with ABC)

18. The SpiralThe $2bn Boys • ABC Ins Co - $45,000 loss ($5,000 retained, $40,000 reinsured with DEF) • DEF Ins Co - $40,000 loss ($5,000 retained, $35,000 reinsured with GHI) • GHI Ins Co - $35,000 loss ($5,000 retained, $30,000 reinsured with ABC)

19. The $2bn Boys The SpiralThe $2bn Boys • ABC Ins Co - $100,000 loss ($5,000 retained, $95,000 reinsured with DEF) • DEF Ins Co - $95,000 loss ($10,000 retained, $85,000 reinsured with GHI) • GHI Ins Co - $85,000 loss ($5,000 retained, $80,000 reinsured with ABC) Original loss: $20,000 Spiral loss: $280,000

20. Post Piper AlphaThe fundamental problem ignored • Prices were tripled • Retentions raised • Losses • Hugo • Phillips Petroleum • Exxon Valdez • 90A • The fundamental problem wasn’t addressed

21. 1993 to 1997Halcyon Days • The penny dropped • Prices went through the roof • Specifics to maximum line • Generals

22. 1998 to 2000Plumbing the depths • International business • Packaging layers • Lower retentions • Composite business • Political Risk • Onshore Energy • Aviation War • Property

23. 2001The year to end all years

24. Coverage issues Less for more Original risk pricing Not as good as expected Marine reinsurance Factors to flatten the cycle Underwriters and brokers The friendly enemy Security The fabled “flight to quality!” Technical pricing Modelling marine business Where we are now

25. General principle More money, higher retentions and exclude everything that gave the market losses Coverage PREC REC Aviation War Composite Terrorism Arguments for: A risk not an event Tighter security It is rated for Arguments against: Most property classes exclude it Potential aggregation of cruise ships Olympics Miami Coverage issuesLess for more

26. Original risk pricingNot as good as expected • Hull • Market levelling • Market Franchise Board • Cargo • As before • Energy • Reductions • Expenses • Reinsurance costs Source: Lloyd’s

27. Original risk pricingNot as good as expected Source: Lloyd’s Source: Lloyd’s

28. ROE requirements With low investment returns, reinsurers need low 90's combined ratios to generate 10% ROE Swiss Re Report Capital Gained $26bn in 2001 Gained $19bn in 2002 Since 2000 the market has lost $200bn of capital Non-marine management In the past, the marine market has always given them evidence of how dumb they can be Coverage and retention “Wetter” book with reinsured retaining an interest in his results Marine reinsuranceFactors to flatten the cycle

29. Underwriters and brokersThe friendly enemy • The sad truth • Man for man, in my view, brokers are • More innovative • More proactive and • Underwriters tend to be reactive • Still the way for London to prosper • Face to face • Brokers can no longer afford to wipe out a market • Close to losing critical mass

30. SecurityThe fabled “flight to quality!” • Standard & Poors / Bests • The ultimate powers • Downgrade clauses negate security concerns • We should have resisted these • A premium for superior security • Not yet • Hardly anybody has caught the flight yet

31. Technical rate v Computer-generated rate Experience Model Simple burning cost calculation with “extras” Exposure Model A snapshot in time Risk profiles to take our share of exposed premium Cat loading Dangers Different models Underwriter’s judgement Soon, the “technical price” will be the price The property market Above and below the line Benefits Discipline Consistency of approach Transparency Technical pricingModelling marine business

32. Technical pricingModelling marine business Censored Censored Censored

33. The future • Somebody will eventually catch the “flight to quality” • Brokers will continue to drive the business • Reducing client base • Technical underwriting will become mandatory • If the marine market is not careful it could end up as a specialist section of a property account

34. Why reinsurance matters • The tail, has always, and will continue to wag the dog • Reinsurers provide the direct market with the capacity to do their business • It provides balance in the proper control and management of a marine account • Reinsurance has the characteristics necessary to provide an excellent ROE