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Managing the UW Cycle CARe Hamilton Bermuda June 2005

This article discusses the underwriting cycle, company strategies, and the role of actuaries in managing the cycle. It emphasizes the importance of underwriting discipline and the need for quantitative skills in both hard and soft markets.

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Managing the UW Cycle CARe Hamilton Bermuda June 2005

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  1. Managing the UW CycleCAReHamilton BermudaJune 2005 John Doucette

  2. Introduction • The Underwriting Cycle • Company Strategies • Actuaries and the Cycle

  3. I. The Underwriting Cycle According to Warren Buffett “Insurers sell a non-proprietary piece of paper containing a non-proprietary promise. Anyone can copy anyone else’s product. No installed base, key patents, critical real estate or natural resource position protects an insurer’s competitive position. Typically, brands do not mean much either. What counts in this business is underwriting discipline.” “There seems to be some perverse human characteristic that likes to make easy things difficult.” Source: USAIG

  4. I. The Underwriting Cycle 14% 12% 10% 8% 6% 4% 2% 0% 120% 115% 110% 105% 100% 95% 90% 118.0% 116.3% 115.9% 115.7% World Trade Center Loss Return on Average Invested Assets Combined Ratio P&C Insurance Market Combined Ratio1955 to 2004 Source: General Re

  5. II. Company Strategies • Fundamental Strategy : Long Term Book Value Growth • The ability to compound real book value per share over time is the single most important measurement tool (Total Value Creation) when comparing property/casualty (re)insurers. • Creating value over time is the sum of: • i. traditional insurance operating results • ii. capital gains and losses on the investment portfolio • iii. capital management decisions • Source: Dowling & Partners

  6. II. Company Strategies • To achieve fundamental strategy throughout a cycle • First decide on total allocation of capital to (re)insurance based on where in the cycle • Hard Capital • Equity • Debt • Dividend strategy • Soft Capital • Amount of reinsurance support • Form of reinsurance • Capital Management

  7. II. Company Strategies • To achieve fundamental strategy throughout a cycle • Then decide where to best to allocate the total amount of capital • Insurance vs. reinsurance • Class / Line: • Short tail vs. long tail vs. specialty • Various lines by adequacy • Form of coverage offered • Liability risk vs. asset risk • Fee income vs. underwriting risk

  8. II. Company Strategies • To execute that strategy, a (re)insurer needs to know • Where are we in the cycle? • What is the expected cost of goods sold? • What is an appropriate capital allocation methodology • Top down vs. bottom up • Risk capital vs. rating agency capital vs. other constraints • Based on (2) and (3), what is technical price? • Bottom line: (Re)insurers need quantitative power to understand and execute the fundamental strategy

  9. III. Actuaries and the Cycle • In hard market, need actuaries / quantitative skills for • Capital planning • Strategic business planning • Pricing lines of insurance / reinsurance treaties • Allow for translation of results for various audiences • Underwriters • Management • Shareholders • Rating agencies • Regulator • Clients • Improve transparency • In hard market, actuaries have skill sets that can provide more impact on rank ordering the opportunity set to optimize risk adjusted return (Strength)

  10. III. Actuaries and the Cycle • In softening market • Aspects as per the hard market are required and more • Lower hit ratio on transactions • More analysis of profitability by line • More analysis of reinsurance / retrocessional strategy • In soft market, actuaries have skill sets that can provide more even more value to (re)insurance company • (Strength)

  11. III. Actuaries and the Cycle • Lessons learned from CEO survey about actuaries • Too narrow and too technical • Reserve analysis only because of certification required • “Actuaries pursuing greater precision in areas of decreasing relevance.” • Need to develop general business skills • Need to enhance their value – communication / execution • Reality, or perception of that reality by key actuarial clients (senior management), that actuaries are too technical and not business savvy • (Weakness)

  12. III. Actuaries and the Cycle • First the good news for actuaries • Our industry is becoming more quantitative • Pulled by regulators • SOX • SEC • Lloyds / RBC / ICA • FSA • Pushed by competitive forces • Broader number and type of risks to be managed • More transparency required • Going forward, more demand for quantitative skills • (Opportunity)

  13. III. Actuaries and the Cycle • Now the bad news for actuaries • Quantitative skills do not mean CAS actuaries are required • Cat modelers • Technically strong underwriters • Large US insurer(s) training recent college grads (non-actuaries) to fill actuarial pricing role • Chief risk officers • Supply needed to meet quantitative demand may not filled by actuaries??? • (Threat)

  14. III. Actuaries and the Cycle Non-traditional Roles for Actuaries

  15. III. Actuaries and the Cycle Non-traditional Roles for Actuaries

  16. Conclusion The UW cycle - Non-transparency of risk / pricing - Classic supply and demand - Inevitability Company Strategy throughout the cycle - Compound real book value per share over time - Diversification only works if lines / deals create (and not destroy) book value growth Actuaries - Consider SWOT analysis - Look to CEO lessons learned - Try to proactively add value to company in different ways

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