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State of the Reinsurance Market and Implications for Primary Insurers Southern California Casualty Actuarial Club. Bob Fox, ACAS, MAAA Managing Director, Catastrophe Actuarial Aon Benfield June 6, 2013. Agenda Slide. Section 1 State of the Reinsurance Market - PowerPoint PPT Presentation
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State of the Reinsurance Market and Implications for Primary InsurersSouthern California Casualty Actuarial Club
Bob Fox, ACAS, MAAAManaging Director, Catastrophe ActuarialAon BenfieldJune 6, 2013
2
Agenda SlideSection 1 State of the Reinsurance MarketSection 2 Implications for the Property Insurance Market
Section 1State of the Reinsurance Market
4
ERM
5
ERM
EnterpriseReinsuranceMinimization
6
Reinsurance Premiums by Line
2000 20120
5
10
15
20
25
30
35
40
45
50
CasualtyProperty
Bill
ions
Source: SNL
7Source: Aon Benfield Analytics
2012 very similar to average of 10 prior years Five years of severe weather has people asking if this is the “new normal”
$47.4b$48.4b
Global Catastrophe Losses by Year
CharlieFrances
IvanJeanne
KatrinaRita
Wilma
Ike
JoplinTuscaloosa
TohokuChristchurch
Thai Floods
Irene
8
1 Subject to change as loss estimates are further developed2 Includes losses sustained by private insurers and government-sponsored programs
2012 Top 10 Global Insured Loss Events
Drought/heatwave losses highlight the growth of Crop/Hail Insurance
9
Largest diameter: 945 miles– Previous record: 920 miles, 2010’s Hurricane Igor
Largest wave in New York Harbor: 32.5 feet– Previous record: 25.0 feet, 2011’s Hurricane Irene
Second NE event in two years for which hurricane deductibles did not apply– Deductible language variable across companies– Wind speed, hurricane category, etc.– Events do not drive tail, but generally not modeled correctly
“2/3 of all New York City homes damaged by Superstorm Sandy were outside of FEMA’s existing 100-year flood zone.”– Wall Street Journal– Estimate flood return period: 90 years
“With respect to storm surge, we think the [NOAA] SLOSH model generally performed well, and we calibrated our US storm surge expectations from that.” – Kean Driscoll, CEO, Validus Re
Super Storm Sandy – Overview
10
PCS Claims: ~ 1,152,000 Insured Loss Estimate: $18.75 billion
– Personal Lines Claims: $6.997 billion (average claim: $6,558)– Commercial Lines Claims: $9.024 billion (average claim: $44,563)– Automobile Lines Claims: $2.729 billion (average claim: $10,894)
Impact Forecasting $16 to $22 billion 80 to 90 Year Return Period
RMS $20 to $25 billion ~90 Year Return Period (NY, NJ)
AIR $16 to $22 billion ~85 Year Return Period
EQECAT $10 to $20 billion 70 to 90 Year Return Period
Super Storm Sandy – US Insurance Loss Estimates
Industry wind event return period: 5-10 years
11
Hurricane Sandy Impact on Shareholder Funds Average impact of Hurricane Sandy reported to date is 4.9%
**Alleghany SHF as of March 31, 2012 to incorporate Transatlantic acquisitionMid-points used where a range of loss was disclosedChart represents most recent disclosureSource: Individual company reports, Aon Benfield Analytics
12
ABA Historical Reinsurer Combined Ratio 2012 ABA showed improved combined ratio of 92.6% resulting from a 60% decline in total
catastrophe losses
Source: Individual company reports, Aon Benfield Analytics
-0.7% -2.4% -5.0% -4.0% -4.9% -5.0% -4.3%
27.3% 28.4% 28.7% 29.1% 29.8% 29.8% 30.0%
60.8% 60.0% 64.2% 62.6% 60.0% 60.3% 59.4%
0.9% 2.7%
6.6%1.7%
8.8%20.0%
7.5%88.3% 88.6%94.4%
89.4%93.8%
105.1%
92.6%
-10%
10%
30%
50%
70%
90%
110%
FY 2006 FY 2007 FY 2008 FY 2009 FY 2010 FY 2011 FY 2012Prior year reserve adjustment Expense ratio Attritional loss ratio Total catastrophe losses
13
Reinsurer Capital (USD Billions) by Year Year end 2012 reinsurer capital increased 11% over year end 2011 Reinsurer capital increased by USD5B throughout Q4 2012; a slower pace than earlier in the year Supply continues to exceed demand in all global regions
Source: Individual Company Reports, Aon Benfield Analytics
14
Source: Aon Benfield Securities, Inc.
Despite a decrease in Q4 2012 issuances from the prior two years, 2012 issuances reached an all time high of $6.3b based on the increased issuance activity in the first half of 2012
650 300 1,015
1,493 810
2,350 742
2,095
411
232
854
775
1,600
2,393 1,990
1,888
3,471
5,275
4,601
6,251
-
1,000
2,000
3,000
4,000
5,000
6,000
7,000
2009 2010 2011 2012
$ M
illio
nsQ1 Q2 Q3 Q4
Cat Bond Issuance by Quarter
15
1.00% 1.50% 2.00% 2.50% 3.00%2%
4%
6%
8%
10%
Expected Loss
Risk
Pre
miu
m
1.00% 1.50% 2.00% 2.50%4%
8%
12%
16%
Expected Loss
Risk
Pre
miu
m
2013 ILS Market
Source: Aon Benfield Securities' RLS Indicative Price Sheets
As of May 31, 2013
New inflows of capital continue to outstrip supply, and spreads have decreased to historic lows– US multi-peril spreads are down 35% -
45% from 2012– Non-US peril spreads are down 15% -
20% from 2015
State Farm's Merna Re IV, covering New Madrid earthquake, was issued with the lowest spread for a cat bond since 2008
Allstate’s Sanders Re, providing US multi-peril coverage on index basis, priced blew market guidance and with Sharpe ratios at new lows
Twelve property cat bonds with a total of US$ 3.49 billion limit and one health bond with US$ 0.15 billion limit have closed
US Multi-Peril Spreads
Current Trendline
■ 2009 ■ 2010
■ 2011■ 2012
40%
36%
45%
Non-US Peril Spreads
Current Trendline
■ 2009 ■ 2010
■ 2011■ 2012
18%19%
18%
16
Seeking 600 to
800bps on dive
rsifyi
ng products
as yields o
n other credit r
elated asset c
lasses
press lo
wer
Risk per unit of capital
Insurers & Reinsurers
Pensions, Life Insurers,Endowments & Family Trusts
TI
ME
Risk adjusted returnon invested assets
Convergence
Seeking 1000 to 1600bps on
decreasing leverage
Insurance and capital markets are converging – global capital is growing ($ trillions) and looking for returns in a low interest rate environment
All amidst increasing insurer capabilities, increasing insurer demands, pricing pressure on brokers, declining demand for traditional reinsurance…
Insurance and Capital Markets are Converging
17
Pension assets of 13 countries
~$30T
Global capital supply figuresHighly Preliminary
Sovereign wealth funds~$5T
Private Equity~$3T
Insurance Capital~$3.4T
Reins. Capital~$505B
Non-lifeCapital~$1.9T
Source: Swiss Re, Bain, Towers Watson, Aon Benfield Analytics
Other, unquantified large pools of capital also exist• High net worth individuals• Retail investors• Hedge funds• Mutual funds• Exchange traded funds• Trusts• Other
Non-Traditional Capital is Massive and Has Begun to Enter our Space
18
SpecialtyInsurer
PersonalLines Insurer
Multiple LinesInsurer
Lloyd’sSyndicate
EmergingMarket Insurer
Life & AnnuityInsurer
Commercial Insurer
Health Insurer
Pension Funds
Life Insurers
High Net Worth Individuals
Hedge Funds
EquityInvestors
Insurer Debt &Mezzanine Investors
RetrocessionReinsurers
SPVs, Sidecars
and Managed
Funds
Utilize appropriate
capital sources for risks assumed
SelectRisks
All NetRisks
Form relationships
Understand a very wide range
of risks
Select from those risks
suitable business
Manage cycles and events
Managing Dynamic Portfolio of Risks
Assumed
ModernGlobal
Reinsurers
Managing Dynamic CapitalAssuming Risk
Modern Global Reinsurers and the Debt Challenge
19
Increasing Supply
Decreasing Supply
Exploding Investor Capital
Record Reinsurer
Capital
Reinsurer Stock
Repurchases
Reinsurance Supply Summary
20
Reinsurance Supply and Demand
P
Q
supplydemand
P0P1
Q0 Q1
21
What About Demand?
Source: Individual Company Reports, Aon Benfield Analytics
Insurer capital increased 10% from year end 2011 to year end 2012 Growth occurred due to lower catastrophe losses and higher primary premiums
22
Increasing Demand
Decreasing Demand
Low Investment Returns
Competitive Markets
Sluggish Insurance Demand
Strong Insurer Capital
Sovereign Debt Issues
Solvency II Capital Requirements
Insurer Stock Repurchases
Reinsurance Demand Summary
23
Reinsurance Supply and Demand
P
Q
supplydemand
P0
Q0
P1
Q1
Section 2Implications for the Primary Insurance Market
25
History of Homeowners Profitability
26
History of Homeowners Profitability
27
History of Homeowners Ratemaking
20’s-60’s• 5% Profit Provision
70’s-80’s• Offset for investment income
1990’s• Rise of auto specialists• Increase in hurricane activity leads to introduction of catastrophe models
2000’s• Profit models using P/S or R/S ratios• Reinsurance cost recovery standard in almost all states
2010’s• Cost of equity capital held to support catastrophe risk
28
Traditional Profit Model
Premium $150
Required Surplus @1.5 $100
Required Return @15% $15
Investment Return $6
Underwriting Return $9
Catastrophe Surplus $100
Investment Return $5
Cat Risk Margin
Total Return $20
Total Surplus $200
Return on Surplus 10%
29
Profit Model with Cat Risk Margin
Premium $150 $150
Required Surplus @1.5 $100 $100
Required Return @15% $15 $15
Investment Return $6 $6
Underwriting Return $9 $9
Catastrophe Surplus $100 $100
Investment Return $5 $5
Cat Risk Margin $10
Total Return $20 $30
Total Surplus $200 $200
Return on Surplus 10% 15%
30
Cost of Capital
Decreasing reinsurance premiums present an
opportunity to build in cost of capital
Accepted by Most Regulators
Understand drivers
Allocate in detail
31
California Example – Cost of Capital
Gross NetRequired Catastrophe Capital* 181,933,425 88,961,820 Target GAAP ROE 12.0% 12.0%SAP/GAAP Ratio 0.9 0.9Federal Income Tax Rate 35.0% 35.0%Investment Rate of Return 3.0% 3.0%Pre-tax Underwriting Return = [(2)/(3)]/[1-(4)]-(5) 17.5% 17.5%Cost of Required Catastrophe Capital 31,861,674 15,579,724
Fictitious California-only writer Based on AM Best Stressed BCAR Model Fire Following PML estimate from RMS RiskLink 13.0 Assumes reinsurance from 10-year to 100-year PML
32
California Example – Total Cost of Catastrophes
Without Reinsurance
With Reinsurance
Average Annual Loss 9,579,770 9,579,770 Net Cost of Reinsurance - 6,385,943 Cost of Net Required Catastrophe Capital 31,861,674 15,579,724 Total 41,441,445 31,545,437 Reinsurance Savings 9,896,007
California RatemakingRecoverable in Rates 9,579,770 9,579,770 Not Recoverable in Rates 31,861,674 21,965,667
Lesson: Don’t let regulatory restrictions dictate reinsurance purchase decisions How would this exhibit look for a national insurer with the same California exposure?
33
California Example – Total Cost of Catastrophes
Without Reinsurance
With Reinsurance
Average Annual Loss 9,579,770 9,579,770 Net Cost of Reinsurance - 6,385,943 Cost of Net Required Catastrophe Capital 31,861,674 15,579,724 Total 41,441,445 31,545,437 Reinsurance Savings 9,896,007
California RatemakingRecoverable in Rates 9,579,770 9,579,770 Not Recoverable in Rates 31,861,674 21,965,667
Lesson: Don’t let regulatory restrictions dictate reinsurance purchase decisions How would this exhibit look for a national insurer with the same California exposure?
– AAL unchanged– Lower reinsurance cost (California is diversifying risk to reinsurers)– Lower capital cost (diversification benefit within company)– Most of reinsurance and capital cost recoverable in rates
34
Potential Unintended Consequences of Regulatory Restrictions
• Excessive reinsurance• Excessive rate indications• Greatest harm to insurers concentrated in state
Allow Reinsurance but not Capital Cost
• Inefficient single-state towers• Excessive rate indications• Greatest harm to multi-state insurers
Allow Reinsurance but Limit Allocation
• No savings due to reinsurance• Excessive rate indicationsAllow Capital Cost
but not Reinsurance
• Inadequate rates• Availability may be limited• Greatest harm to insurers concentrated in state
Allow Neither Reinsurance Nor
Capital Cost
35
Potential Unintended Consequences of Regulatory Restrictions
• Excessive reinsurance• Excessive rate indications• Greatest harm to insurers concentrated in state
Allow Reinsurance but not Capital Cost
• Inefficient single-state towers• Excessive rate indications• Greatest harm to multi-state insurers
Allow Reinsurance but Limit Allocation
• No savings due to reinsurance• Excessive rate indicationsAllow Capital Cost
but not Reinsurance
• Inadequate rates• Availability may be limited• Greatest harm to insurers concentrated in state
Allow Neither Reinsurance Nor
Capital Cost
36
Potential Unintended Consequences of Regulatory Restrictions
• Excessive reinsurance• Excessive rate indications• Greatest harm to insurers concentrated in state
Allow Reinsurance but not Capital Cost
• Inefficient single-state towers• Excessive rate indications• Greatest harm to multi-state insurers
Allow Reinsurance but Limit Allocation
• No savings due to reinsurance• Excessive rate indicationsAllow Capital Cost
but not Reinsurance
• Inadequate rates• Availability may be limited• Greatest harm to insurers concentrated in state
Allow Neither Reinsurance Nor
Capital Cost
37
Potential Unintended Consequences of Regulatory Restrictions
• Excessive reinsurance• Excessive rate indications• Greatest harm to insurers concentrated in state
Allow Reinsurance but not Capital Cost
• Inefficient single-state towers• Excessive rate indications• Greatest harm to multi-state insurers
Allow Reinsurance but Limit Allocation
• No savings due to reinsurance• Excessive rate indicationsAllow Capital Cost
but not Reinsurance
• Inadequate rates• Availability may be limited• Greatest harm to insurers concentrated in state
Allow Neither Reinsurance Nor
Capital Cost
38
Potential Unintended Consequences of Regulatory Restrictions
• Excessive reinsurance• Excessive rate indications• Greatest harm to insurers concentrated in state
Allow Reinsurance but not Capital Cost
• Inefficient single-state towers• Excessive rate indications• Greatest harm to multi-state insurers
Allow Reinsurance but Limit Allocation
• No savings due to reinsurance• Excessive rate indicationsAllow Capital Cost
but not Reinsurance
• Inadequate rates• Availability may be limited• Greatest harm to insurers concentrated in state
Allow Neither Reinsurance Nor
Capital Cost
39
Potential Unintended Consequences of Regulatory Restrictions
• Excessive reinsurance• Excessive rate indications• Greatest harm to insurers concentrated in state
Allow Reinsurance but not Capital Cost
• Inefficient single-state towers• Excessive rate indications• Greatest harm to multi-state insurers
Allow Reinsurance but Limit Allocation
• No savings due to reinsurance• Excessive rate indicationsAllow Capital Cost
but not Reinsurance
• Inadequate rates• Availability may be limited• Greatest harm to insurers concentrated in state
Allow Neither Reinsurance Nor
Capital Cost
40
• Excessive reinsurance• Excessive rate indications• Greatest harm to insurers concentrated in state
Allow Reinsurance but not Capital Cost
• Inefficient single-state towers• Excessive rate indications• Greatest harm to multi-state insurers
Allow Reinsurance but Limit Allocation
• No savings due to reinsurance• Excessive rate indicationsAllow Capital Cost
but not Reinsurance
• Inadequate rates• Availability may be limited• Greatest harm to insurers concentrated in state
Allow Neither Reinsurance Nor
Capital Cost
Potential Unintended Consequences of Regulatory Restrictions
41
Potential Unintended Consequences of Regulatory Restrictions
• Excessive reinsurance• Excessive rate indications• Greatest harm to insurers concentrated in state
Allow Reinsurance but not Capital Cost
• Inefficient single-state towers• Excessive rate indications• Greatest harm to multi-state insurers
Allow Reinsurance but Limit Allocation
• No savings due to reinsurance• Excessive rate indicationsAllow Capital Cost
but not Reinsurance
• Inadequate rates• Availability may be limited• Greatest harm to insurers concentrated in state
Allow Neither Reinsurance Nor
Capital Cost
42
State Summary – California
Proprietary & Confidential
DPW ($M) Mkt Sh (%)Rank California 2012Y 2012Y 5-yr 10-yr 15-yr 5-yr 10-yr 15-yr 5-yr 10-yr 15-yr 15-yr SD
1 Auto 19,431.2 100.0 (0.9) 1.6 2.4 96.5 94.6 96.4 71.5 70.0 71.9 5.1 2 Home 7,039.2 100.0 1.7 4.4 5.3 82.5 84.4 87.5 54.8 56.8 59.6 14.3
Top 5 Auto Carriers1 Farmers Insurance Group of Cos 2,718.4 14.0 (3.9) (1.8) (1.0) 97.5 96.1 96.9 69.9 69.9 71.6 4.4 2 State Farm Mutl Automobile Ins 2,687.8 13.8 1.6 1.6 1.4 101.5 96.3 99.0 77.3 73.6 76.3 8.0 3 Allstate Corp. 1,745.2 9.0 (2.9) 1.4 3.0 97.5 93.9 95.7 71.6 68.4 70.4 7.4 4 Auto Club Exchange Group 1,688.4 8.7 (1.2) 1.4 3.5 85.8 84.7 87.0 63.8 63.4 65.7 5.1 5 Mercury General Corp. 1,642.5 8.5 (3.6) 1.5 3.8 100.1 96.1 95.4 71.7 68.7 68.7 4.6
1 Farmers Insurance Group of Cos 2,718.4 14.0 (3.9) (1.8) (1.0) 97.5 96.1 96.9 69.9 69.9 71.6 4.4
Top 5 Homeowners Carriers1 State Farm Mutl Automobile Ins 1,555.3 22.1 3.5 3.8 4.9 86.4 85.7 91.1 60.0 59.5 64.0 18.8 2 Farmers Insurance Group of Cos 1,165.7 16.6 (0.2) 2.7 4.4 86.0 89.3 92.3 51.0 55.4 59.5 18.2 3 Allstate Corp. 632.2 9.0 (6.1) (0.1) 2.5 80.8 80.4 81.9 57.4 57.4 58.1 14.0 4 AAA Northern CA NV & Utah Ins 463.2 6.6 1.3 7.3 8.7 81.9 77.5 81.7 50.7 48.1 52.9 14.0 5 Liberty Mutual 388.2 5.5 5.2 5.4 4.5 81.3 83.4 88.1 49.3 52.4 57.0 16.0
2 Farmers Insurance Group of Cos 1,165.7 16.6 (0.2) 2.7 4.4 86.0 89.3 92.3 51.0 55.4 59.5 18.2
CA Catastrophe Risk Regulatory Summary Cat/Non Cat Split DemographicsCombined Ratio to Achieve 14% ROE 93.5% 15-yr PCS Loss % of Total Loss Total PopulationCatastrophe Models Projected Population Change (2012 - 2017)
Total HouseholdsReinsurance Cost Median HH Income ($)
Unemployment RateCapital Cost
CommentaryRegulatory Environment
Homeowners Filing SummaryCompany Effective Date
Days to Approve Indicated Requested Approved
Auto Club Southern California 9/30/2012 257 0.7% 0.2% 0.2%Farmers 6/16/2012 224 21.1% 6.9% 6.9%
Catastrophe Residual Market SummaryResidual Market Premium (% Statewide Property Premium)0.5Assessment Mechanism Unlimited Assessments (Plan Deficits)Recoupable No specific statutory provision, possible rate increase request250 year Industry Assessment Exposure ($M)
% of Statewide Property Premium #VALUE! Modeled AAL based on the average NT RMS v11 and NT AIR v13
Very Challenging
Cat % of HO Premium
- Industry HO and auto results have been profitable over past 15 yrs
- Despite what is perceived as a generally difficult regulatory environment
- This excludes EQ as that is written on a different line than HO
Prop 103 governs all ratemaking
Combined Ratio (%)DPW CAGR (%) Loss&LAE Ratio (%)
Models permitted only for EQ fire following and must be certified to actuarial standards (ASOP 38)
Not permitted
Not permitted (except for earthquake and medical malpractice)
37,707,477 3.4%
12,743,499 57,385
9.4%
0.0
5.0
10.0
15.0
20.0
25.0
97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
Amou
nt (
$B)
Industry - Auto
5%0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
15-yr PCS LR Modeled AALto 2012 DPW
Non-Hurricane Hurricane
0.0
2.0
4.0
6.0
8.0
97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
Amou
nt (
$B)
Industry - Homeowners
DPE Loss & LAE
PCS Cat,
10.0%
Non-Cat,
90.0%
Questions?