CAS Spring Reinsurance Seminar
“New Capital: Same Strategies?”
David Cash – Chief Actuary, Endurance Specialty
June 7, 2004
2
The Classes of 1985, 1993 and 2001
Note: Shaded areas denote hard market periods. Real NWP is adjusted for inflation.Source: A.M. Best, Insurance Information Institute.
-10%
-5%
0%
5%
10%
15%
20%
25%
19
80
19
81
19
82
19
83
19
84
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
E
20
04
E
1985-87
1993-94
2001-04
Annual Real Net Written Premium Growth
Class of 1985:
ACE
XL
Class of 1993:
Cat Ltd.
Global Re
IPC Re
Mid-Ocean Re
Partner Re
Renaissance Re
Tempest Re
Class of 2001:
Arch
AXIS
AWAC
Endurance
Montpelier
3
The Three Hard Markets
1985: The Liability / Regulatory – Hard Market
The US insurance and reinsurance markets were hit by a combination of the following:1. Dramatic change in the legal environment in the US2. The initial emergence of Asbestos and Pollution3. Dramatic reduction in interest rates4. Only limited access to capital markets
1993: The Hurricane Andrew – Hard Market
In 1992 Hurricane Andrew caused $20 billion of insured losses – the largest insurance event ever experienced by a factor of three [Typhoon Mireille 1991].
2001: The WTC – Hard Market
The world insurance and reinsurance markets were hit by a combination of the following factors:1. WTC losses $ 50 billion2. Re-emergence of Asbestos$ 55 billion3. 1997 – 2001 Soft Market4. Equity Market Losses
> $150 billion - combined
4
The 1985 Hard Market
Sources of CapitalCapital was largely drawn from clients and from within the industry – as follows:1. ACE: Approximately $500 million raised from a group of client
companies, along with some capital provided by third parties
2. XL: Approximately $500 million raised from a group of client companies, along with some capital provided by third parties
3. Financial Reins.: Development of financial / finite reinsurance to provide capital relief without the need for imported capital
Underwriting StrategiesThe new companies were formed to be mono-line underwriters operating in a narrow market [Fortune 500 companies] focused exclusively on casualty business.
Impact on the MarketThe start up companies benefited greatly from the hard markets and showed very significant returns on capital. At the same time, their impact on the insurance market was relatively modest. After 3 – 5 years ACE and XL had accumulated sufficient capital to be forced into exploring expansion strategies.
5
The 1993 Hard Market
Sources of Capital
Capital was largely drawn from a combination of industry incumbents and private equity investors. Key differences with 1985 were as follows:1. Speed: Capital raising quick – approximately 12 months
2. Industry Sponsors: Significant industry participation in the formation of these companies: ACE, AIG, Aon, Centre, CNA, Gen Re, XL…
3. Private Equity: First significant involvement of investment banks and private equity in the formation of these companies.
4. Exit Strategies: Because of the involvement of financial investors from the outset, the companies were always considered to be “in play”
Underwriting Strategies
As was the case in 1985, these new companies were formed to be mono-line Property Catastrophe reinsurance underwriters.
Impact on the Market
The start up companies had a significant impact on the catastrophe market place, but a relatively limited impact on the broader re / insurance markets.
6
The 2001 Hard Market – The Opportunity
Sources of DislocationThe period from 1997 through 2001 brought together multiple damaging events for the industry:
1. WTC: $50 billion in losses spread through the Accident/Life, Aviation, Property, Workers Compensation insurance and reinsurance markets
2. 97 – 01 Soft Market: $100 billion of potential losses spread through out the global insurance and reinsurance markets. The casualty lines of business being most obviously affected.
3. Asbestos: $55 billion of exposure to older commercial lines underwriters
4. Equity Markets: $50 billion of investment losses – disproportionately concentrated with the European companies. Significant exposure to the underwriters of D & O / E & O business.
5. Reinsurance Credit: Following on from the above, users of reinsurance have a further exposure to unrecoverable reinsurance balances.
In short, it is easier to list those areas of the business that did not suffer during the period from 1997 – 2001, than it is to list those that did…
7
The 2001 Hard Market – The Capital
Obtaining Capital
Once again, there were some key differences as to how capital was raised in 2001:1. Speed: Capital raising was quicker – approximately 3
months start to finish. Almost all of the significant participants in the process had made the trip to Bermuda once before.
2. Private Equity: The capital raising process became a sprint to put together a credible business plan, strategic investors and an investment bank. This group then raced to capture investments from the leading private equity firms.
3. 144A Private Deals: One management team raised its money without the aid of sponsoring companies or investors – a first for the Bermuda companies.
4. Assumed Exit: Almost all of the business plans put forward in 2001 contemplated an IPO and subsequent secondary stock offerings as the liquidity event for investors.
Result
4 out of 5 members of the “Class of 01” were public by mid 2003 – versus 3 out of 7 from the “Class of 93”.
8
The 2001 Hard Market – The Opposition
Asset Coverage / Total Liabilities [excl. Real Estate and Equity]
Note: Asset Coverage = Reinsurance recoverables + prepaid reinsurance premiums + cash and investments
[excl. real estate and equity] + funds held under reinsurance treaties + accounts receivables.
Total Liabilities = gross life and non-life loss reserves + funds held under reinsurance treaties +
reinsurance payables + other accounts payable/other accrued liabilities + net deferred tax liabilities +
total financial leverage [Debt].
Source: Dowling & Partners – Based on June 30, 2003 data
Asset Coverage / Tot. Liabilities (excl. Equity/Real Estate)
492%
259%227%
196% 180% 169% 157% 145% 136%116% 113% 107% 106% 104% 100% 96% 92% 91% 83% 78%
0
100
200
300
400
500
600%
IPC Re
MontRe
AxisAllied W
rld
Endurance
PXRe
Ren Re
ArchEverest Re
OdysseyRe
PartnerRe
Ace Ltd
XL Capital
GE Global
Converium
HannoverRe
SCOR
Swiss Re
Munich Re
Allianz
9
The 2001 Hard Market – The Challenge
20+ Lines of Business
AccidentAviationCasualty TreatyClashDirectors and OfficersEnergyErrors and OmissionsFidelity / SuretyInternational TreatyMarineMedical MalpracticeProgram BusinessProperty Ind. RiskProperty CatastropheProperty TreatyTerrorUmbrellaWar RiskWC CatastropheWorkers Compensation…
1,500+ Employees
Arch 860
Axis 308
AWAC 117
Endurance 245
Montpelier 49
As of March 31,2004
4 Countries
$18 Billion of Premium
Arch $ 5.723 Billion
Axis $ 4.426
AWAC $ 2.996
Endurance $ 3.121
Montpelier $ 1.751
Gross Written Premium 2002 + 2003 Combined
10
The 2001 Hard Market – The Strategies
Areas of Strategic Importance
Given the size and breadth of the market dislocation, the Class of 01 faced multiple strategic decisions in the first two years of operations:
1. Underwriting: Property versus Casualty versus Specialty, Insurance versus Reinsurance, US Market versus International Market.
2. Operations: Operating companies, operating locations, staffing, infrastructure and expense management.
3. Technology: The Class of 93 demonstrated that using technology in a distinctive manner could create lasting shareholder value.
4. Acquisitions: Acquisitions of businesses, balance sheets and underwriting teams.
5. Investors: The need for an early valuation by the public equity markets combined with the need for an orderly transition of ownership by the public markets made this a critical discipline.
The following slides set out some of the basic issues associated with the above items.
11
Underwriting – “Underwriters, Pick Your Markets…”
Specialty / Syndication Markets
Large limit [$100+ million] volatilebusiness
Expected returns of + 25% Specialist underwriting skills Includes: Aviation, Energy, Fortune
500 Liability, Fortune 500 Property,Hospital Professional Liability,Property Catastrophe, Marine…
Distribution 5 - 10 global brokers Requires material investment in
infrastructure and technology Located primarily in Bermuda, London
and NY Largest Market: Bermuda
Auction Markets
Medium limit [$10 million] stablebusiness
Expected returns of + 10% Includes: Working layer reinsurance
and middle market wholesaledinsurance…
Distribution spread across 10 - 30wholesale brokers
Low barriers to entry, business canonly tolerate a modest investment ininfrastructure and technology
Located primarily in the US Largest market US domestic
reinsurers and middle market insurers
Retail / Distribution Markets
Low limit, High transaction volume Expected returns of 15+% Requires broad geographic footprint,
specialist production skills andunderwriting/administration systems
Includes: Middle / Retail marketcommercial and personal insurance
Distribution 1,000+ middle market andretail brokers
Requires material investment ininfrastructure and technology
Located in the US, UK and potentiallyEurope.
Largest market large US CommercialInsurers
Solutions / Acquisitions Markets
Large limit [$100+ million], complexbusiness
Expected returns of 15+% Includes: Acquisitions, structured/
financial re/insurance… Typically on a direct, or near direct
basis, includes financial intermediaries Moderate barriers to entry, requires
staff with significant transactionexperience
No particular center of gravity,possibly NY
Largest market US insurance andreinsurance markets
Capital Markets
Source of original funding, andintended recipient of any excesscapital generated by companies.
Capital
Flows
Reinsurance
Flows
Phase 1: Initial inflow ofcapital into the industry.
Phase 2:Build out ofsubsidiaryplatforms.
Phase 3: Begin toreinsure difficult tooriginate business.
Phase 4: Investin those lines ofbusiness requiringmore time, effortand infrastructureto originate.
Phase 5:IMPORTANT,remember toreturn excesscapital.
Insurance Markets Capital Markets
12
20+ Lines of Business
AccidentAviationCasualty TreatyClashDirectors and OfficersEnergyErrors and OmissionsFidelity / SuretyInternational TreatyMarineMedical MalpracticeProgram BusinessProperty Ind. RiskProperty CatastropheProperty TreatyTerrorUmbrellaWar RiskWC CatastropheWorkers Compensation…
1,500+ Employees
Arch 860
Axis 308
AWAC 117
Endurance 245
Montpelier 49
As of March 31,2004
4 Countries
$18 Billion of Premium
Arch $ 5.723 Billion
Axis $ 4.426
AWAC $ 2.996
Endurance $ 3.121
Montpelier $ 1.751
Gross Written Premium 2002 + 2003 Combined
Operations – “What’s a work permit ?”
I. T.
I. P. O
S. E. C.
N. A. I. C.
F. S. A.
S. O.
A.M.B. and S&P
+
= An Operational Headache
13
Technology – “The Good, the Bad and the Ugly…”
3. Third Party Data 4. Underwriting and Financial Data1 & 2 Underwriting Workstation
A
naly
st
Data from
Client
UnderwritingSystem
PricingSystem
FormalAnalysis
U
/W
Data from
Client
DataMart
DataMart
DataMart
Reporting Data Mart
DataMart
Data from
Client
Data from
ClientAcc
ount
T A
Interface
FinancialSystem
Insurance System
Data Created by U/ Wand Pricing Process
DataMart
DataMart
Financial / Production Data
DataMart
Third Party Data used inDecision Process
Flow of Information back to U/ W and Pricing Flow of Information back to Finance and TA’s
14
Acquisition Strategy – “Make me an offer, any offer…”
+
200+ Acquisition Opportunities in 30 months
=+
0
1,000
2,000
3,000
4,000
5,000
6,000
01-Jan-97 09-Jan-99 16-Jan-01
Valu
ati
on
NASDAQ Composite
March 2000
Sept. 11 Tragedy
A.M. Bests - Upgrades versus Downgrades
91 80 77 7657
5977
148 151188
250
200
150
100
50
0
50
100
150
1999
2000
2001
2002
2003
<-
Dow
ngra
des
|
U
pgra
des
->
Upgrades
Downgrades
Asset Coverage / Total Liabilities [excl. Real Estate and Equity]
Asset Coverage / Tot. Liabilities (excl. Equity/Real Estate)
492%
259%227%
196% 180% 169% 157% 145% 136%116% 113% 107% 106% 104% 100% 96% 92% 91% 83% 78%
0
100
200
300
400
500
600%
IPC Re
MontRe
AxisAllied W
rld
Endurance
PXRe
Ren Re
ArchEverest Re
OdysseyRe
PartnerRe
Ace Ltd
XL Capital
GE Global
Converium
HannoverRe
SCOR
Swiss Re
Munich Re
Allianz
Asset Coverage / Tot. Liabilities (excl. Equity/Real Estate)
492%
259%227%
196% 180% 169% 157% 145% 136%116% 113% 107% 106% 104% 100% 96% 92% 91% 83% 78%
0
100
200
300
400
500
600%
IPC Re
MontRe
AxisAllied W
rld
Endurance
PXRe
Ren Re
ArchEverest Re
OdysseyRe
PartnerRe
Ace Ltd
XL Capital
GE Global
Converium
HannoverRe
SCOR
Swiss Re
Munich Re
Allianz
15
Capital – “Haven’t I answered this question already ?”
Value derived from Capital ManagementCapital management is a distinct discipline and one that has the potential to significantly enhance or diminish shareholder value. Raising the initial capital is the easy part – it’s managing the capital that is the hard part:
1. Go to Bermuda: The other easy part, all the capital goes to the same place.
2. I. P. O.: This represents the first step on a 4 – 5 year journey culminating in a fully public shareholder base. For most companies, this work was done at the end of 2002 – in the middle of renewal season.
3. Debt Issuance: A necessary part of right sizing the capital base – requires additional due diligence meetings with up to 20 banks.
4. Rating Agencies: Constant, unrelenting interaction…
5. Public Ownership: No more hassles with Private Equity, now it is just the analysts, the shareholders, the accountants and the regulators you have to deal with.
6. Excess Capital: The big test for all market participants – will companies give the money back, rather than burn it up in the next soft market…