General Insurance Fundamentals Basics

7/22/2019 General Insurance Fundamentals Basics

1/46

GENERAL INSURANCE

March 2011


2/46

AGENDA

Part 1 Understanding insurance basics

Part 2 Industry thematics

Part 4 IAGs businesses

Part 5 Capital management

2


3/46

PART 1UNDERSTANDING INSURANCE BASICS


4/46

WHAT AN INSURER DOES

The advantage of obtaining insurance is that it allows the pooling of r isksan re uces e pro a y o one par y ear ng e en re cos o a oss

Insurance policies originated in 17th century London coffee houses whichbecame the place for sharing information on agreements of pooled risksbetween merchants, ultimately leading to the formation of Lloyds ofLondon

In the aftermath of The Great Fire of London, Nicholas Barbon an Englishphysician opened The Fire Office to insure Londons brick homes, andesta s e nsurance po c es as we now t em to ay

Today, an insurance contract is a contract in which one party (the insurer)accepts significant insurance risk from another party (the policyholder) byagreeing to compensate the policyholder if a specified uncertain futureevent (the insured event) adversely affects the policy holder. (AASB 4)

4


5/46


erences o assurance an o er nanc a pro uc s

Insurance pools the risk of uncertain future events. This is different

to assurance models which pool the risk of events which will

The actual cost of providing the general insurance product is not

The product being sold only has intangible attributes such as

The product is often a grudge purchase and a need rather than a

5


6/46


SIMPLIFIED CONCEPT RISK OF A LARGE AND INFREQUENT LOSS

Every year 1 in every 1,000houses suffers a fire at acost of $100,000.

An individual risks having to finance

$100,000 if it is their turn for the1:1000 loss.

A group of 1,000 householderspooling together pay only $100each to rebuild the house eachyear. Even after 10 years the

individual has only paid $1,000 to

6

, .


7/46


SIMPLIFIED CONCEPT RISK OF SMALL FREQUENT LOSSES

Every year 100 in every1 000 houses suffers a

burglary at a cost of $1,000.

An individual risks having to finance

$1,000 if it is their turn for the 1:10loss.

A group of 1,000 householderspooling together pay $100 each to

reimburse the cost of oods stolen.Over 10 years the individual has

paid $1,000.

7


8/46


reported within 12 months

Settlement can take 3-4 years

settled within 12 months

Less complexity in

managing claims Higher risk in predicting final

Less risk in predicting finalsettlement

Generally based around

medical and legal outcomes

property

8


9/46


PERSONAL LINES COMMERCIAL

Private Motor Home, Contents Personal Effects

Fleet Motor Fire, Explosion Burglary, TheftSHORT

oa Caravan / Trailer Health Travel

oo s n rans Construction Personal Accident / Travel Credit

Transport Accident Consumer Credit

Political Risks Kidnap & Ransom

Com ulsor Workers Com ensation Third Party (statutory) Home Liability

(statutory)

Public & Products Liability

Product Recall

LONGTAIL

D & O Liability Defamation Environmental

9


10/46


An insurer manages the pooling of risks to optimise the result (underwriting

SOCIO

profit) not all risk attributes in the pool are the same:

Individual Risk Area Inflation Hail

Driver abili ty

Driver age

Gender

Average income

Level of un-employment

Exchange rates

Cost of parts

Fuel prices

Earthquake

ca pro e

Moral risk

eve oemployment

Type of car

Type of finance

10


11/46

KEY STAKEHOLDERS IN INSURANCE TRANSACTIONS

Customers/ Employees1st PartyClaimants

Distributors

INSURERGovernment

Third PartyClaimants

ClaimsAgents

11


12/46

PART 2INDUSTRY THEMATICS


13/46

INDUSTRY THEMATICS

Global Insurance market (US$4,060bn) Global GI market (US$1,667bn)

-Life ChinaUSA

Other

28%

41%59% 2%Australia

2%Japan

6%

Netherlands

4% France GermanySource: Sw iss Re Sigma No3/2008. Data as at December 2007.

Notes: Includes non-life health premiums 5% 7%

Source: Sw iss Re Sigma No3/2008. Data as at December 2007.

13


14/46

INDUSTRY THEMATICS

Source: APRA Industry Statistics, June 2010

14


15/46

INDUSTRY THEMATICS

Over the last decade there has been a trend of privatisation, demutualisation and consolidation.

NRMA, SGIO, SGIC, CGU, Swann, RACV (JV),

State, Circle, NZI

IAG

Allianz, MMI, Switzerland, Federation, FAI, CIC,HIH Personal Lines

Allianz

Royal, Sun All iance, Promina/Vero,Phoenix,AAMI, RAC (WA), APIA

Promina (RSA)

Suncorp

Suncorp, AMP, GIO, AGC, RAQ (JV), TGIO Suncorp

QBE, Australian Eagle, MLC, UAP (port),Mercantile Mutual (jv),ITT Hartford (port),Kemper, CE Heath, HIH (Commercial & Travel), QBE

15

Carlingford, Nat Ins Co of NZ, Colonial Mutual,

Trade Indemnity


16/46

INDUSTRY THEMATICS

Price Increases Price Increases

The Insurance Market Cycle

The Insurance Market Cycle

Underwriting ProfitsUnderwriting Profits Peak

Capacity Increases Loss Ratio Improves

Rates Deteriorate

Loss Ratio Begins to Rise /Capacity Leaves

a es on nue o a

Major Underwrit ing Losses

16

Source: Ord Minnett / Deloitte Touche


17/46

LARGEST GLOBAL INSURANCE LOSSES 1970 - 2008

Rank Event Insured Loss $bn * Year

.

2 Hurricane Andrew 24.6 1992

3 WTC Terrorist Attack 22.8 2001

, ort r ge art qua e .5 Hurricane Ike 20 2008

6 Hurricane Ivan 14.6 20047 Hurricane Wilma 13.8 2005

8 Hurricane Rita 11.1 2005

.10 Japan, Typhoone Mireille 8.9 1991

* Indexed to 2008

17

Source: Swiss Re Sigma No 2/ 2009. All figures quoted in USD.


18/46

AUSTRALIAS MAJOR INSURANCE LOSSES

$4.3bn

$3.7bn

$3.3bn

$2.1bn$2.0bn*

. n . n$1.3bn

$1.1bn $1.1bn $1.1bn $1bn

$732m $707m $662m$579m $540m $518m*

18 Source: Insurance Council of Australia (2007 Repeated Cost - $million)


19/46

PART 3KEY DRIVERS IN AN INSURERSFINANCIALS


20/46

HOW DOES AN INSURER MAKE MONEY ?

Premiums Investment IncomeREVENUE +

Claimants Govt. Taxes & Reinsurers Salaries &LESS

Levies

associated

admin expenses

EXPENSES

20

s r u on o are o ers

(return on their investment)

PROFIT


21/46

IAG 1H11 PROFIT & LOSS

1H10

A$m

2H10

A$m

1H11

A$m

Gross writ ten premium 3,863 3,919 3,936

Gross earned premium 3,872 3,749 3,938

Reinsurance expense (229) (327) (228)

Net earned premium 3,643 3,422 3,710

Net claims expense (2,335) (2,737) (2,359)

Commission expense (341) (317) (336)

Underwriting expense (689) (707) (694)

Underwrit ing profit /(loss) 278 (339) 321

Investment income on technical reserves 210 344 149

Insurance profit 488 5 470

Net corporate expense 8 (4) -

Interest (43) (45) (44)

Profit/(loss) from fee based business/share of associates 11 (1) 17Investment income on shareholders' funds 91 5 147

Profit/(loss) before income tax and amortisation 555 (40) 590

Income tax expense (156) (56) (223)

Profit/(loss) after income tax (before amortisat ion) 399 (96) 367

Non-controlling interests (58) (41) (44)

Profit/(loss) attr ibutable to IAG shareholders (before amortisation) 341 (137) 323

Amortisation and impairment (12) (101) (162)

Profit/(loss) attr ibutable to IAG shareholders 329 (238) 161

Insurance Ratios

Loss ratio 64.1% 80.0% 63.6%

Immunised loss ratio 65.0% 78.0% 66.4%

Expense ratio 28.3% 30.0% 27.8%

Commission ratio 9.4% 9.3% 9.1%

21

. . .

Administration ratio 18.9% 20.7% 18.7%

Combined ratio 92.4% 110.0% 91.4%Immunised combined ratio 93.3% 108.0% 94.2%

Insurance margin 13.4% 0.1% 12.7%


22/46

KEY DRIVERS - HOW INSURANCE WORKS

Gross Written Premium (GWP)

the payment of their insurance policies.

Gross Earned Premium (GEP)Premiums =

When we calculate our results for the year(financial) we only include the portion of policies up

.

Net Earned Premium (NEP)

premium minus reinsurance costs.

22


23/46


=-NEPNet

Claims Underwriting- Underwriting

Is the total amount This is the gross amount

Expense

These are costs This is the profit/losswe received from

customers aftermaking adjustmentsfor unearned

paid out during the year,

as well as an estimate ofhow much we need to payon future claims which

associated with

researching risk anddetermining appropriatepremiums, administering

we make from our

insurance businessbefore we considerrelated investment

premium andreinsurance costs

have been incurred(whether reported or not).It also includes the cost of

processing claims. We

policy information,marketing, distribution,etc.

income

deduct from this grossamount any recoveries(reinsurance, salvage,third parties, etc, which

23

arise from the gross claim.


24/46


Underwriting

Investment

Income from Insurancero Technical

Reserves

ro

This is theprofit/loss we

Policy Holder Funds,this is the income

Our insurance profit isdetermined by addingnet earned remium to

insurancebusiness before

investments that weremade using funds

the investment returnfrom our technical

related investmentincome

customers paying theirpremiums

subtracting claims andunderwriting expenses

24


25/46


Insurance NetTax andInvestment

-Profit Profit/Losscosts*

Shareholders

Fund

Our insurance profit isdetermined by addingnet earned premium

This is the incomereceived frominvestments made

This is the netresult after allowingfor income taxes

* Other costsinclude interest,amortisation, etc

o e nves menreturn from ourtechnical reserves

and subtractin

us ng s are o ersfunds. Theseinvestments are

usuall more

an e s are oprofit owing tominority

shareholders/ unit

which is specificto a company.

claims andunderwritingexpenses.

aggressive thanthose made usingtechnical Reserves.

holders within theGroup.

25


26/46


(NEP)

+

Loss Ratio

The ratio of underwriting expenses to net earnedpremium

=

Expense Ratio

Our claims and underwriting expenses measured a apercentage of our net earned premiumCombined Ratio

+

Investment income

on technical reserve

The pre tax profit margin of the general insurance

=

Insurance Mar in

26


27/46

KEY DRIVERS

More conservative

Policyholders Funds

(Technical nves men

approach 100%Fixed Interest

eservesProvisions made forunearned premiums

ou s an ng c a ms

Capital

More assertive,

includes

Funds)investment in

equities

27


28/46

CAPITAL

INVESTMENT ASSETALLOCATION $11.8B

GROUP FIXED INTEREST &CASH $10.3B

3%

13%

Fixed Interestand Cash

Growth

39%

3%

"AAA"

"AA"

" "

87%

55%

< "A"

87% of total portfolio in fixed interest and cash

row asse s ave r sen o o s are o ers un s

Credit quality remains high 94% of fixed interest and cash rated AA or better

28


29/46

KEY DRIVERS1H11 FINANCIAL MEASURES

5.1%

6.0%4,000 13.4%12.7%

14.0%

16.0%

500

600

3,863

3,9193,936

2.6%

3.2%

1.0%

2.0%

3.0%

4.0%

5.0%

3,800

3,900

488

5

470

0.1%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

100

200

300

400

-3,700

1H10 2H10 1H11

Reported GWP (A$m) Underlying GWP Growth (%)

-0

1H10 2H10 1H11

Ins urance Pro fit (A $m) Insurance Marg in (%)

400 20.00

329

(238)

161

(200)

(100)

0

100

200

19.65

(1.16)

17.35

8.50

4.50

9.00

0.00

5.00

10.00

15.00

1H10 2H10 1H11

(300)

1H10 2H10 1H11

Net Profit Af ter Tax (A$m)

(5.00)

Cas h E PS (c ent s) D PS (c ent s)

18% 2.00

2.40

17.0% 16.0%

2%

4%

6%

8%

10%

12%

14%

16%

2.03 1.92 1.81

0.40

0.80

1.20

1.60

29

(1.0%)

-2%

0%

1H10 2H10 1H11

Cash ROE (%)

0.00

1H10 2H10 1H11

MCR (mult ip le) Long term benchmark (1.45 - 1.50)


30/46

KEY DRIVERS

Long tail has more volatility, longer duration and higher capital

vs.

Long tail business has significantly longer Short tail business has average claims

Long tail Short tail

returns to offset the higher loss ratios:,

investment return has less of an impact onthe insurance margin earned:

$126

$1048%

8%

Pr

Pr

Prem

iuPr

emium

+emium

m+inv

emium

inv

30Yr 1 TotalYr 1 Yr 2 Yr 3 Total


31/46

KEY DRIVERS IN AN INSURERS FINANCIALS

Quality & Stability of Earnings

Claims management

Liability & risk management

sse managemen

Balance sheet management Stability of earnings

Competitive Returns on Invested Capital

31


32/46

PART 4IAGS BUSINESSES


33/46

IAGS CORPORATE STRATEGY

A portfolio of high performing, customer-focused diverse operations

for our stakeholders and creates shareholder value

OURTARGETS

Top quartile TSR

ROE > 1.5x WACC Improve our performance in

Australia and New Zealand

OURSTRATEGIC

Pursue selective internationalgrowth options Asia and othernarrow specialist opportunities

Deliver superior performance by

PRIORITIES Driving operational performanceand execution

STRATEGY

actively managing our portfolioand driving operationalperformance and execution

33


34/46

OUR BUSINESS MODEL AND BRANDS

DIRECTINSURANCE

INTERMEDIATEDINSURANCE

DIRECTINSURANCE

DIRECT INSURANCE INTERMEDIATEDINSURANCE

ONLINEINSURANCE

3

4

2

TRALIA

ZEALAND

ASIA

KINGDOM

5

AU



NEW

UN

ITE

1

OTHER

ACTIVE PORTFOLIO MANAGEMENT & GOVERNANCE (CORPORATE OFFICE)

34

.2. RACV has a 30% interest in The Buzz3. 49% ownership of AmG Insurance, which is part of AmAssurance

4. 98% voting rights in Safety Insurance, based in Thailand5. 26% ownership of SBI General Insurance Company, a joint venture wi th the State Bank of India


35/46

IAGS HISTORY

National Roads and Motorists Association (NRMA) starts providing motor1925 .

NRMA Insurance begins underwri ting home insurance.1969

NRMA Insurance expands interstate, launching in Victoria.

NRMA Insurance launches in Queensland.

1994

1995

NRMA Insurance acquires MLC Building Society.

1997

.NRMA Insurance acquires SGIO (including SGIC).

.NRMA Insurance acquires an interest in Chinas CAA.

NRMA Insurance Grou Limited lists on the ASX.2000

35


36/46

IAGS HISTORY

NRMA Insurance acquires State Insurance in NZ.NRMA Insurance acquires the in-force policies and renewal r ights to the HIH

2001

Australian workers compensation businesses.NRMA Insurance sells its Building Society.

NRMA Insurance puts its inwards reinsurance portfol io into run off.

NRMA Insurance changes its name to Insurance Australia Group (IAG).2002

2003 from Aviva.IAG acquires Zurich Insurances NSW workers compensation business.IAG sells i ts health insurance underwrit ing and claims operation.

ncreases s n eres n na s o .

IAG sells i ts f inancial services business, ClearView.

2004

.

IAGs NZ business acquires specialist underwriters National Auto Club and ClipperClub Marine.

2005

36

IAG acquires Royal & SunAlliances general insurance business in Thailand.

IAG acquires a 30% interest in Malaysias AmAssurance.


37/46

IAGS HISTORY

ncreases s n eres n a e y nsurance n a an o a mos .

IAGs NZ business acquires a 51% stake in mechanical warranty insurancecompany DriveRight.

,branded Alba Group.

IAGs NZ business increases its interest in Mike Henry Travel Insurance to 100%.

.

IAG acquires Equity Insurance Group in the UK.2007

IAGs UK business acquires specialist insurance broker Barnett & Barnett.

IAG enters negotiations to form Indian general insurance joint venture with the

State Bank of India.

2008

Following a strategic review, IAG revises its corporate strategy. As a result IAGscales back its UK operations by divesting some of its UK mass marketunderwriting and distribution businesses.

37


38/46

IAGS GWP MIX: 1H11

GWP BY REGION GWP BY CHANNEL

Australia

New Zealand

Direct

Broker/agent

38

UK

Asia

Affinity


39/46

PART 5CAPITAL MANAGEMENT

AND PRICING


40/46

INSURANCE BASICS

Outcomes of risks from individual policies are unknown whenunderwritten

However, when many similar risks are underwritten, expected results ofo a por o o ecome more pre c a e

Claims processes are driven by:

requency or pro a y o a c a m even occurr ng; an

Severity (or size) of a claim if it occurs

High frequency / low severity (eg motor and health) outcomes easy topredict reliably

Low frequency / high severity (eg earthquake and hail) outcomes hard topredict reliably

40


41/46

THE NEED FOR CAPITAL

Capital plays a central role in the provision of insurance:

Provides security to policyholders that claims will be paid

Provides support in face of adverse unexpected outcomes frominsurance activit ies, investment performance and operations

ac a es grow

Can be defined as = Total Assets Total Liabili ties

41


42/46

MINIMUM CAPITAL REQUIREMENTS

Tier 1 (Share capital, retained earnings, eligible hybrid debt and

excess technical provisions less intangible assets and goodwill) and Tier 2 (Subordinated debt, non tier 1 eligible hybrid debt and other)

Insurance risk charge, plus Investment risk charge, plus

Maximum event retention

Capital multiple = capital available/ MCR

42

Capital multiple must always > 1.0 to stay in business


43/46

IAGS MINIMUM CAPTIAL REQUIREMENTS

1H10

A$m

2H10

A$m

1H11

A$m

Tier 1 ca ital

Paid-up ordinary shares 5,353 5,353 5,353

Non-controlling interests 154 170 147

Treasury shares (34) (31) (35)

Hybrid equity

1

496 475 496

Retained earnings (362) (775) (692)

Excess technical provisions (net of tax) 482 522 454

Less: deductions2 (2,789) (2,513) (2,326)

Total Tier 1 capital 3,263 3,167 3,306

Tier 2 capital

Hybrid equity in excess of Tier 1 limit1 404 425 404

Subordinated debt3 537 536 465

Other 4 12 9

Total Tier 2 capital 945 973 878

Capital base 4,208 4,140 4,184

Minimum Capital Requ irement (MCR):

Insurance risk 1,242 1,344 1,315

Investment risk 693 790 850

Catastrophe concentration risk 135 20 150

Total MCR 2,070 2,154 2,315

MCR multiple 2.03 1.92 1.81

1Hybrid equity includes Reset Exchangeable Securities and Reset Preference Shares. These

securities are classified under APRAs prudential standards as Innovative Tier 1 and are eligible to be

43

.

securities in excess of this limit is included in Tier 2 capital.

2Includes goodwill and intangibles, net deferred tax assets, capitalised software, deferred reinsurance

expense and expected dividends.3The amount of subordinated debt eligib le to be included in Tier 2 capital excludes capitalised

transaction costs and discount on issue, and for foreign currency denominated debt, the liability is

translated at the current exchange rate excluding any related cross-currency swaps.


44/46

THE ROLE OF PRICING

Meet expected claims

Meet operational expenses

Be competitive in market for risk

44

THE RIGHT WAY!


45/46

THE RIGHT WAY!

Premium comprised of

Claims administration expenses

Acquisition & maintenance expenses (incl.Commission)

Taxes, levies, duties

Profit Margin

s rem um

Expected No. of claims x Expected AverageClaim Size

45

Inflated and discounted


46/46

46

Documents

General Insurance Fundamentals Basics