WHO’S LAUGHING NOW? Novae chief Matthew Fosh on motivating a successful team
LLOYD’S E-MESSAGING Can the market be convinced of the new initiative’s value?
EXTREME US HURRICANES Time to prepare – this season could be record-breaking
G LOBAL RE I NSU RANCE.COM
On the inside Uncovered: the systemic corruption – as well as the reinsurance opportunities – in Russia
The sky is the limit? Says who?
Into the future means into the unknown. Many dream of braving the voyage. But it takes knowledge to get there in one piece. Knowledge is the fuel that propels an idea — like gravity pulls a satellite — forward. At Munich Re, it’s the fuel that drives us to think the unthinkable, to make the undoable doable. To ﬁnd out more about how to navigate the future with conﬁdence, visit our website at www.munichre.com NOT IF, BUT HOW
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Cover image: Ron Borresen
Digitalising reinsurers’ products and business practices is hideously complex
Technology and reinsurance have been uneasy bedfellows. Dozens of initiatives that seemed promising at the time have fallen by the wayside from lack of support. Some might argue this is because insurers, reinsurers and brokers are essentially luddites set in their ways and determined to maintain the status quo at any cost. Those determined to drag reinsurance into the digital age eagerly point to stock exchanges, most of which eschewed the old trading floors for slick electronic execution decades ago. Remember how excited some people got when Richard Ward – credited with bringing electronic trading to the International Petroleum Exchange – took the helm at Lloyd’s? But this comparison is unfair. There are several reasons why a market such as Lloyd’s could never go the same way as an exchange. A share is a share regardless of who is buying or selling. Insurance and reinsurance contracts tend to be as individual as the companies they cover. Reinsurers have failed to embrace electronic solutions as neatly as
other areas of financial services not because they are technophobes, but because the process of digitalising their products and business practices is hideously complex. While technology can often save time and money, it can also do the opposite, particularly where negotiation is involved. How many times has it struck you that 40 emails between you and a colleague could easily have been covered in a five-minute chat? Stock exchanges might be able to teach insurers something though. Not all of them have ditched their trading floors – the New York Stock Exchange’s is still going strong, especially for more difficult trades. The difference is that instead of finalising trades in paper form, the floor brokers use hand-held electronic devices. Proof, if it were needed, that technology-enabled face-to-face negotiation does work. Ben Dyson Assistant editor Global Reinsurance GLOBAL REINSURANCE JUNE/JULY 2011 1
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June/July Lloyd’s e-messaging initiative, page 14
G LOBAL RE I NSU RANCE.COM
Matthew Fosh, page 18
US hurricanes, page 30
stick with you through the tough times Extreme US storm activity; the surge in
popularity for catastrophe bonds; life after Bin Laden’s death
14 News agenda
Brit Insurance’s Reinhard Seitz on the reinsurers that
Claims 30 Winds of change
The Lloyd’s Exchange – can it work?
2011 has already been painful but, with an
extreme US hurricane season expected, you ain’t seen nothing yet
People & Opinion
16 Carl Beardmore
32 City of changes
18 People power 44 Diary
People want alternatives to the big guys
Seven industry experts gathered to
discuss the London market, from competitiveness to contingent
Matthew Fosh on Novae’s transformation
commissions and its aversion to technology
Monty is gleeful as Red Ken turns the air blue
Special Report 21 Calculated risks
Key developments in fi nancial modelling
Editor-in-chief Ellen Bennett Tel +44 (0)20 7618 3494 Email email@example.com
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41 Conflicting signals
Managing director Tim Whitehouse Group production manager Tricia McBride Senior production controller Gareth Kime Digital content manager Michael Sharp Head of events Debbie Kidman
corruption, can Russia lose its reputation as the Wild East?
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2 JUNE/JULY 2011 GLOBAL REINSURANCE
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News Digest Joplin, Missouri: Deadliest tornado in USA for 60 y M&A
SCOR IN TRANSAMERICA RE MORTALITY RISK DEAL French reinsurer SCOR and Aegon have entered into an agreement under which SCOR will acquire the mortality risk reinsurance business of Transamerica Re, reported Global Reinsurance. As Transamerica Re is part of Aegon, but not as a legal entity, the acquisition includes a series of retrocession agreements from Aegon to SCOR Global Life US entities. SCOR SE’s chairman and chief executive, Denis Kessler, said: “This transaction relates only to biometric risks, and is fully consistent with SCOR’s strategy and risk appetite. The rebalancing of the life reinsurance book between the USA, Asia and Europe, while enlarging the group’s footprint and significantly expanding our global franchise, will also provide additional stability to the group.” SCOR will also purchase from Aegon one Irish legal entity, which underwrites Transamerica Re business. Aegon will transfer to SCOR $1.8bn of liabilities and corresponding assets in cash and/or securities. (goo.gl/7DXAj) A ABOUT GOO.GL: Type the goo.gl address into your web browser to access our recommended articles from globalreinsurance.com and its sister titles
Capital LANCASHIRE’S SIDECAR The capital backing Bermudabased (re)insurer Lancashire’s new sidecar could extend its capital backing beyond the current maximum of $250m if market conditions are sufficiently attractive, reported Global Reinsurance. Lancashire announced the formation of the new fully collateralised sidecar, Accordion Reinsurance, in late May. It reinsures the worldwide property retrocession business of Lancashire Insurance Company Ltd on a quota-share basis. (goo.gl/S1bhA)
VALIDUS LAUNCHES ALPHACAT RE SIDECAR Bermuda-based (re)insurance Validus has launched a new sidecar reinsurer called AlphaCat Re 2011, reported Global Reinsurance. Validus has teamed up with other investors to capitalise the new vehicle with $180m. AlphaCat Re will provide fully collateralised reinsurance and retrocession on an ultimate net loss, index-based and premium protection basis. AlphaCat Re will start writing until 31 December 2012, but this period may be extended under certain circumstances. Validus Underwriting Services will underwrite on behalf of AlphaCat Re, for which it will be paid an originating commission plus a profit commission based on the results for the 2011 and 2012 underwriting years. (goo.gl/lUpEz)
US TREASURY SELLS TO WIND DOWN AIG The US Treasury has agreed to sell part of its stake in American International Group (AIG), as it winds down ownership of the global insurer, reported the BBC. The government plans to sell 200 million AIG shares at $29 each, a total of $5.8bn. It stands to make as much as $7.1bn, if Wall Street banks buy. After the share sale, the government’s ownership stake will fall to 77% from 92%. “Today’s announcement represents an important milestone,” Treasury Secretary Tim Geithner said in a statement. “The decision to provide this assistance was exceptionally difficult, but it’s clear today that it was essential to stopping a fi nancial panic and helping to save American jobs.” During the fi nancial crisis of 2008, the government’s bail-out of AIG totalled $180bn.
PHOTO: MIKE MAPLE/LANDOV
MUNICH RE IN US MISSION German reinsurer Munich Re may be searching for US acquisition targets, reported Global Reinsurance. Chief executive Torsten Jeworrek told Financial Times Deutschland that Munich Re is disproportionally represented in the USA and is seeking insurers who insure industry or niche markets. Jeworrek also named Latin America and Asia as ideal markets for acquisition. He did not name any specific targets. (goo.gl/CfBpC)
4 JUNE/JULY 2011 GLOBAL REINSURANCE
News Digest 0 years
TORNADO COULD COST UP TO $7BN The single deadliest tornado to hit the USA in 60 years will cost insurers $4bn to $7bn, according to initial loss estimates from cat modelling firm AIR Worldwide. The tornado, with winds up to 198mph, struck Joplin, Missouri on 22 May, killing at least 132 people and injuring 750. Cat modelling firm EQECAT said that only midway through the 2011 tornado season, aggregate losses have reached an “extreme level”.
Claims DOUBLE QUAKE IN SPAIN Two moderate earthquakes struck southeast Spain in less than two hours on 13 May, shaking the popular tourist region of Murcia and killing eight, Post reported. According to the United States Geological Survey, the first earthquake, measuring a magnitude of 4.5, struck at 5.05pm local time and was followed by a magnitude 5.1 mainshock at 6.47pm. The British Geological Survey reported a magnitude of 5.2. Both events had shallow focal depths, which exacerbated the damage.
RECORD US TORNADO BLITZ The US has been hit by a record number of tornadoes following a series of storms across the Southern states that killed more than 200 people, reported Global Reinsurance. The National Oceanic and Atmospheric Association (NOAA) said in a statement more than 150 reports of tornadoes were received on Wednesday, with the majority across northern Mississippi and Alabama. Other reports from National Weather Service Storm Prediction Center suggest more than 160 twisters crashed through the Southern states right up to the Northern states. Widespread destruction, loss of life, and substantial injuries have been reported from numerous strong to violent long-lived tornadoes. (goo.gl/92KU3) LLOYD’S BRACED FOR CAPITAL CATASTROPHE Lloyd’s chief executive Richard Ward has warned insurers that rates need to rise “significantly” because the next big natural catastrophe will hit the industry’s capital, not only earnings, reported Insurance Times. Ward said the Lloyd’s market’s “lucky streak” in avoiding Atlantic hurricane claims could come to an end. Speaking shortly after Lloyd’s announced claims in the region of £2.4bn from natural catastrophes in the first quarter, Ward warned that these claims already exceed total losses for the whole of 2010, adding: “The next big catastrophe could well be a capital event.” (goo.gl/zSrEa)
View from Insurance Times: On the turn? ‘Being big doesn’t always mean you’re the first to innovate’ Carl Beardmore, BMS
>>> see People & Opinion, page 18 TROPICAL STORM WARNING FROM MET OFFICE The UK Met Office has bucked the trend of other forecasters predicting a “quieter” Atlantic hurricane season, reported Global Reinsurance. Meteorologists predict 13 tropical storms between June and November, one more than US-based National Weather Service. The Met Office reported 19 tropical storms in the whole of 2010. Matt Huddleston, principal consultant on climate change at the Met Office said: “North Atlantic tropical storms affect all of us through fluctuating oil, food and insurance markets. Seasonal and multi-year forecasts are the focus for key research at the Met Office and its predictions are increasingly accurate.” (goo.gl/yfFfa)
Going up? The increase of average insured claims per decade has risen dramatically DATA: ALLIANZ
$45bn $40bn $35bn $30bn $25bn $20bn $15bn $10bn
Current market conditions are remarkably similar to the late noughties, when the market turned. Are we about to see a return of the hard market? Brokers and insurers, disappointed by several years of rates scraping the bottom of the barrel, have almost given up asking this question. But Zurich commercial broker manager Dave Smith, who has over 20 years’ experience with the insurer, has spotted a trend. The last time the market turned was in the late 1990s. Back then, combined operating ratios (CORs) across the market were between 110% and 120%. These days, without reserve releases the commercial market is operating at between 110% and 115%. What’s more, Smith says, rate increases for fleet are beginning to stick: in the first quarter, premiums went up by 7%. In the 1990s, the first rate increases to stick were in fleet, before the hard market returned. However, there are big differences. The early noughties saw three massive events that helped push up premiums: September 11 2001, the dotcom crash and the demise of the independent. The recent Japan disaster may trigger rate rises, but that is likely to be confined to loss-affected reinsurance catastrophe. Smith also notes that there was less capacity in the 1990s. Today’s high levels of capacity, which create intense competition, are helping to keep prices down. So, is the hard market about to return? There are certainly signs – such as rising motor rates – that it could go that way, but there needs to be a catalyst. The wait-and-see game still has some way to go. For more news and views from the general insurance industry, visit:
$5bn 0 1970-79
GLOBAL REINSURANCE JUNE/JULY 2011 5
News Digest Breaking the banks: Repeat of Mississippi flood Results A DELUGE OF CLAIMS Insurers are facing big claims after the swollen Mississippi River broke its banks in late May, reaching a crest just shy of the forecasted 48 feet at the Memphis TN gauge after weeks of rising to historic levels. It was three miles wide at some points in early June (roughly three times wider than normal). According to Munich Re figures, similar floods in 1993 cost the industry $1.27bn, which wind engineers AIR estimated would amount to $2.6bn after exposure growth and inflation. >>> see News Analysis, page 8
‘When I walked in here, this was a troubled, unhappy place. One way of beating that was with humour’ Matthew Fosh, Novae
>>> see Profile, page 18
WILLIS RE HIRES TEAM FOR MOVE INTO LIFE Reinsurance broker Willis Re has announced that it will start broking life business, reported Global Reinsurance. It has hired life reinsurance and risk management experts Rick Hodgdon, Mike Kaster and Brian Holland to lead a new life solutions group, which it says will provide the market with advice on risk mitigation and fi nancial leverage. The new unit will initially focus on North America. Willis said it established the new unit in response to the growing capital needs of the life insurance and annuity industries. (goo.gl/Ta7uK )
KEELING QUITS AFTER GUY CARPENTER RESHUFFLE Henry Keeling, chief executive of reinsurance broker Guy Carpenter’s international operations, will leave the company on 30 June, reported Global Reinsurance. It is not yet clear who will replace Keeling or what he plans to do next. Guy Carpenter declined to comment. Keeling’s decision follows a management reshuffle at the top of Guy Carpenter. Former chief executive Peter Zaffino has become president and chief executive of insurance broker Marsh, one of Guy Carpenter’s stablemates in the Marsh & McLennan group of companies. Alex Moczarski, previously head of Marsh’s international divisions, has replaced Zaffino as Guy Carpenter’s new chief executive. Keeling joined Guy Carpenter in August 2009, having previously served as chief operating officer of Bermudan insurance group XL and chief executive of XL Re’s international operations. (goo.gl/0xqcB)
XL’S ESTEVES LEAVES INSURANCE BEHIND Insurance company XL Group PLC (XL) said it will start searching for a new chief fi nancial officer as Irene Esteves plans to depart after a transition period, reported theWall Street Journal. A release from XL said Esteves is leaving to “pursue an opportunity with a Fortune 150 company outside the insurance industry.” The Wall Street Journal had earlier reported that Time Warner Cable Inc was close to appointing Esteves as its financial chief. “Simply put, this was an offer I couldn’t pass up,” Esteves said about her new opportunity in the release from XL Monday. Chief executive Mike McGavick said that Esteves made many contributions to the company and that he is looking forward to a smooth transition. “We’ve always recognised that hiring the highest calibre executives comes with some risk, and to us this simply illustrates just how talented our team is,” he said.
PHOTO: MIKE BROWN/LANDOV/PRESS ASSOCIATION IMAGES
MUNICH RE EXPECTS TO ABSORB Q1 LOSSES German reinsurance giant Munich Re expects to record a full-year profit, despite posting a €948m loss in the fi rst quarter of 2011, reported Global Reinsurance. “Such major losses are possible in our business,” said chief fi nancial officer Jörg Schneider. “Thanks to our solid capitalisation, we are able to absorb them.” Munich Re’s reinsurance sector was hit particularly hard by Q1 natural catastrophe losses, reporting a €683m loss, compared with a €424m profit in 2010. The combined operating ratio for Q1 was 159.4%, up from 109.2% in 2010. The reinsurer said 69 percentage points was due to catastrophe losses, including €1.5bn from Japan alone. Torsten Jeworrek, Munich Re’s reinsurance chief executive, said: “Events like those in Japan demonstrate the role and significance of professional reinsurers.” (goo.gl/J7TZp)
6 JUNE/JULY 2011 GLOBAL REINSURANCE
Reinsurers AUSTRALASIAN DISASTERS LEAD TO RATES HIKE Reinsurance rates have increased by more than 30% in New Zealand and Australia, where natural disasters caused huge losses earlier this year, according to a Flagstone Re executive. But Guy Swayne, Flagstone’s Bermuda-based chief underwriting officer, international, added that the industry was not seeing the across-the-board, substantial increases of the sort that followed Hurricane Katrina in 2005, reported Royal Gazette. “We are seeing an increase in rates on the international property catastrophe business,” Swayne said.
FOTHERGILL TO HEAD BERKLEY RE UK W.R. Berkley Corp. has formed Berkley Re UK Ltd – a Londonbased company with the principal focus of underwriting property and casualty treaty reinsurance, subject to regulatory approval, reported PropertyCasualty360.com. Berkley Re UK is expected to open for business in the fourth quarter of 2011 and will complement the activities of Berkley Re America, Berkley Re Asia and Berkley Re Australia. Richard Fothergill will be named president of Berkley Re UK. He has more than 25 years of experience in the P&C reinsurance industry and previously served as head of international casualty treaty business for a major reinsurer. Elaine Perry will be appointed senior liability underwriter. She has more than 20 years experience in reinsurance and insurance, most recently as senior casualty treaty underwriter for a major reinsurer.
MORNING AFTER ERGO’S PROSTITUTE PARTY Munich Re’s primary insurance division rewarded top-performing agents with prostitutes at a party in Budapest, Hungary, according to a report by German newspaper Handelsblatt. Senior executives at Ergo, Germany’s second-largest primary insurer, arranged a party to reward highly performing agents in summer 2007 and invited around 20 prostitutes. The party, for 100 guests, was held at the Gellert Spa in Budapest, reported Global Reinsurance. The executives responsible for organising the party are no longer with the company. According to Handelsblatt, the women wore colour-coded armbands: red for hostesses, yellow indicating they were available for sexual favours, and white signifying those reserved for top agents and executives. Ergo’s spokesman Alexander Becker said the company has taken measures to prevent similar incidents and has not ruled out further action. “We are in the process of digging deeper into these allegations. If we find things that would necessitate further action – if our existing rules were not sufficient to prevent something we would like to prevent – we will introduce more measures,” said Becker. (goo.gl/pcCau) BRIT LANDS IN SYDNEY Brit Insurance has opened a new Lloyd’s service company in Sydney, Australia, reported Insurance Times. Brit opened a representative office in Sydney in March 2010 and will now be able to transact property treaty reinsurance business from Australia and New Zealand from 1 July 2011. It will write business on behalf of Brit Syndicate 2987. The underwriting team will be led by Mike Davidson, who has headed the Sydney office since it opened in 2010. Davidson said: “We know from talking to brokers that they really value having access to locally empowered underwriters who understand local conditions. With all Australasian property treaty reinsurance business now being handled by myself and Stuart Anderson, brokers will have a clear, simple channel.” (goo.gl/KFr4f )
View from Strategic RISK: Japan calling Tokyo Electric Power Co (Tepco), the Japanese power company, is involved in a heated debate over the damages it is liable to pay for the nuclear accident at the Fukushima Daiichi power plant. The Japanese government has already ordered Tepco to pay the 48,000 families who live within 30km of the plant approximately 12,000 each. This will be the start of a huge compensation bill. These events are expected to cause an increase in insurance premiums for Japanese utilities, which could affect the world insurance market. Tepco has 38,000 employees and total assets of approximately €160bn, but even a business of this size cannot afford such losses. Tepco is too integral to Japan’s electrical infrastructure to fail, so the Japanese government will have to intervene. Tepco has presented a formal written request for financial help to the government. Since the earthquake, many of the key infrastructure problems in Japan have been caused by disruptions in the power grid and the consequences on the business supply chain. As a direct result of events at the Fukushima plant, operations at the Hamaoka nuclear power station in central Japan will be suspended. Businesses, investors and bankers now want to recoup some losses through utilities like Tepco. The severe damage to infrastructure, especially the Fukushima accident, has impeded economic activity, leaving utility and insurance companies with a huge amount of liabilities. The estimated overall economic losses for the Japanese earthquake are between $200bn and $300bn. The current debate is over who will pay the final bill. For more news and views from the risk management industry, visit:
GLOBAL REINSURANCE JUNE/JULY 2011 7
News Analysis US losses
Stormy weather As reinsurers pick up the pieces after being battered by a record-breaking tornado season, Lauren Gow assesses who has been left most exposed
Every spring, the USA braces itself for a wave of tornadoes and severe storm activity. But this year, the sheer brute force and unusual nature of the storms has left even the most experienced storm watchers stunned. Between 22 April and 28 April, the second deadliest tornado outbreak in US history struck the Midwest and southern USA, causing about $5.5bn of insured damage losses and killing at least 350 people. Exactly one month later on 22 May, Joplin, Missouri, was hit by the single deadliest tornado since records began in 1950, which left 132 people dead, 156 missing and 750 others injured. The Joplin storm came during a week of wild weather across 20 US states, which risk-modelling specialist AIR Worldwide estimates cost the industry between $4bn and $7bn. AIR principal scientist Tim Doggett says: “It is becoming quickly apparent that 2011 will surpass 2008 in terms of insured losses from severe thunderstorm activity. Indeed, the two major outbreaks of this year – the first in late April, the second in late May – are the costliest on record.” While tornado outbreaks themselves are not unique, he adds, the aggregation of the events is surprising, increasing insured losses and fatalities. But what really sets tornado outbreaks in the past decade, apart from their most deadly predecessor in 1925, is how the changing layout of the US landscape has dramatically intensified risk for insurers. “Twenty years ago, there may have been activity but there were no houses in the area, just farm land,” says BMS senior vice-president Stefano Nicolini. “A tornado would come through and only destroy crops. Now a lot of these locations are high-density housing and commercial developments, which means we do have some very significant losses.”
Flooding forethought While windstorms were waging war across the Midwest, water levels in the Mississippi River rose to 14.6m in some parts as a result of heavy rainfall from the intense tornado activity. But unlike the tornado activity, US insurers will largely avoid direct claims thanks to government forward-planning. The US government uses the National Flood Insurance Program, which offers residential cover for up to $250,000 and commercial cover for $500,000. This largely acts as an initial barrier to claims, with insurers offering extra coverage where needed.
AM Best assistant vice-president Jeff Mango believes this high level of intervention is good news for flood insurers. “The government is more heavily involved in floods than in the tornado season, so there is potentially much less of an impact on the industry.” Mango believes the government’s mitigation has minimised losses. “The US Army Corp opened spillways on the Mississippi in less populated areas upstream to avoid much more catastrophic consequences downstream. It helped with the water spread, but it still flooded a lot of acreage and a lot of residential areas.” The US storm activity couldn’t have come at a worse time for reinsurers, which have been slammed by fi rst-quarter catastrophe losses. “It’s defi nitely not good for the reinsurers. It is generating more losses and even more headaches for them,” Nicolini says.
Diversification factor The level of diversification in portfolios could prove to be a key factor in how tornado claims are dealt with by the industry. “Depending on how and where an insurer’s book of business is distributed, how dispersed and diversified they are, we may fi nd some people will be particularly hard hit,” Doggett says. “This is due to the number of events that occurred, claims to be paid and the fact that the activity is highly clustered.” But Larsen argues that reinsurers may not be hit significantly by claims due to portfolio diversification. “The losses will be distributed over an enormous geographical area and an enormous number of companies. The typical mixture of types of losses includes one or two regional companies that will hit their reinsurance. Some insurance companies will get a pinpoint hit at the heart of their company.” He adds: “The bulk of the losses will go to the larger insurers that are geographically diverse. Usually the losses will not hit the reinsurance industry because the insurers are so large – it’s the law of big numbers.” Larsen believes that despite the scale of the losses, the industry will take advantage of the timing in a hardening market. “Going forward, I would say that many insurers are feeling comfortable, especially when exploring different types of policy covers. They might consider using more models and analytics to support their new product offerings,” he says. After a harrowing fi rst quarter for catastrophe losses, reinsurers must have been hoping for a lull from US storms. But as the tornado season closes, the hurricane season opens, so they could be forgiven for thinking the worst is yet to come. GR
8 JUNE/JULY 2011 GLOBAL REINSURANCE
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News Analysis Catastrophe bonds
High stakes A series of natural disasters has prompted a surge in popularity for catastrophe bonds. But, as global weather patterns get increasingly unpredictable, investors are demanding higher returns on their outlay. Mark Leftly reports
points on 28 February, and went through to 840 on 31 May. There’s As the Arizona wildfi re entered its 10th day, 480 square miles of a certain need for investors to raise liquidity, owing to losses in the earth already scorched and 3,500 residents forced to flee their Australian floods and the earthquakes.” homes, insurers realised they had missed a trick. No catastrophe As such, life insurers and reinsurers – who would have typically bond had ever been dedicated to the possibility of a freak wildfi re invested in cat bonds – have had to keep hold of their money in order causing such destruction. to cover their own losses. Such withdrawals from the market have In the wake of the fi restorm, which hit the south-western US state affected secondary trading of bonds. in early June, this is likely to change. Insurers and other fi nancial This means the values at which traders sell on investments have sponsors are preparing to issue $4bn more cat bonds by the end of been hit. The trading value of the Mariah Re bond, which protects 2011, taking the total for the year to $6bn. American Family Mutual Insurance against US thunderstorms, for Cat bonds are a high-risk alternative to traditional reinsurance. instance, is said to have fallen 8% as a result of a particularly violent The issuer sets up a bond for hugely destructive but improbable series of tornadoes that decreased demand to invest in the security. events. Investors are handsomely rewarded, in the knowledge that if a disaster causes great damage, New players the terms of the bond could One US-based insurancebe triggered and they could Q1 2011 non-life cat bond market issuance linked securities adviser lose their money. Sponsor Issuer/tranche Issue Term Amount Risk argues that despite six These triggers can include date (years) ($M) Munich Re Queen Street II 22/03/11 3 $100m US HU / Euro wind consecutive quarters an issuer’s actual losses Chubb East Lane Re IV – A 07/03/11 3 $225m US HU / Quake / T-storm / Winter storm of catastrophic events, being a specified percentage Chubb East Lane Re IV – B 07/03/11 4 $250m US HU / Quake / T-storm / Winter storm dating back to the Chilean greater than the value of the Hartford Foundation Re III 18/02/11 4 $135m US HU earthquake in February bond, which is when they are Swiss Re Successor X IV - E3 18/02/11 3 $160m US HU / CA quake last year, he still expects entitled to use that money Swiss Re Successor X IV - AL3 18/02/11 3 $145m US HU / CA quake spreads to reduce. It was to cover the claims of their Total $1.015bn thought that reinsurance policyholders. Source: WCMA Transaction Database rates would increase Following the earthquakes wildly and that the spread in Japan and New Zealand required on cat bonds would follow suit. and the wildfi re, and in anticipation of a particularly stormy “Post-Japan, a lot of forecasts were predicated on reinsurance rates hurricane season in the USA, interest in setting up cat bonds is on jumping 20, 30, 40%,” the adviser explains. “We haven’t seen this. the increase. It has been mid to high single-digits. Spread widening got ahead of John Seo, managing principal at specialist hedge fund Fermat itself, and I see those spreads coming back in.” Capital Management, says that it is “inevitable” that there will be Paul Schultz, president at Aon Benfield Securities, points out that a greater variety of cat bonds – both in geography and type – in the investors know the risks when they buy cat bonds and so any losses in wake of these extraordinary natural disasters. their trading values should be temporary. “From time-to-time there “Some cat bonds have a little bit of wildfi re,” he says, “but I wouldn’t will be losses,” says Schultz. be surprised to see more dedicated to that in the future. Also, there “But there is more and more interest from investors, because will be more non-US cat bonds.” though cat bonds have their risks, they do reduce the volatility of their overall portfolio [as investors have a greater variety of securities].” Costly move Cat bonds were already on the rise before the Japanese disaster in What is encouraging, he adds, is that new types of investors are March. Research by GC Securities showed that new cat bond issuance entering the market. Whereas in the past a lot of investors were reached $1bn in the fi rst quarter this year – more than three times the hedge funds, who typically looked for short-term returns and level of the same period in 2010. therefore did a runner when a catastrophe hit, pension funds are These events have increased the need to issue the bonds, but now pouring in money. investors are also demanding greater returns – or wider spread – in A pension fund takes a much longer-term view, meaning that its exchange for taking on increased risks. For example, the $300m investment managers will accept a few major losses if, as expected, Muteki bond, issued by Munich Re on behalf of the Zenkyoren cat bonds make them money over a 20 or 30-year period. co-operative in Japan, was triggered by the country’s 11 March “I’m pretty optimistic that this type of investor is a good investor,” earthquake. smiles Schultz. John DeCaro, founding principal at Chicago-based investment Hopefully, these “good investors” will note that a cat bond is only manager Elementum Advisors, says that the spread has increased likely to be triggered by a one-in-50 or even 70 year event, meaning that more than 25% in recent months. “Spreads were roughly at 670 basis this will become one of the most attractive securities available. GR 10 JUNE/JULY 2011 GLOBAL REINSURANCE
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News Analysis Terrorism
What now for al-Qaeda? The death of Osama Bin Laden has left a power vacuum in the jihadi organisation and uncertainty among insurers. Will the organisation regroup under a new head, will the risk of attacks reduce or will a new threat emerge from elsewhere? Lauren Gow reports
When a worm’s head or tail is cut off, it immediately begins to regenerate a replacement. Equally, the 2 May death of Osama Bin Laden in Pakistan is unlikely to stop terrorism in its tracks – al-Qaeda is probably already in the process of picking a new leader. Ten years after the 11 September attacks in the USA, the world’s most wanted man was found and killed by American special forces. The ramifications of his death remain to be seen. But experts believe the group will regenerate and regroup under a new head, which means that the risk for insurers remains potent. Exclusive Analysis global risk forecaster Anna Murison says, however, that replacing Bin Laden could be a problem for the group. “There was nobody like Bin Laden, in the way that he commanded a lot of affection,” she says. “He was almost a legendary character and people really loved him within the jihadi movement.” Bin Laden’s deputy, Ayman al-Zawahiri, who is being touted as a possible replacement, is not as popular as his former boss. “There is a lot of criticism of him on websites used by al-Qaeda,” says Murison. “There is not the same degree of trust and loyalty as there has been in the past.” It seems, though, that even before Bin Laden’s death, the terrorist network’s power was waning. “Al-Qaeda in Pakistan had been struggling to carry out attacks in the West,” Murison says. “They had been trying to attack transport links and were looking to attack train systems in the USA.” She adds: “In the short term, I foresee risk levels going down.” RMS catastrophist Gordon Woo, however, warns against complacency. He says that, despite al-Qaeda struggling to carry out attacks recently, the threat of revenge remains imminent. “In broad terms,” he says, “there is an apprehension that there may be some type of reprisal action.” But he sees this threat weakening in the future. “In the medium to long term, everyone is hopeful that the momentum behind al-Qaeda will disappear, as will the threat posed by it.”
No room for luck The death of Bin Laden confi rms the inextricable link between terrorism insurers and the international government intelligence units, such as the UK’s MI5 and the US Central Intelligence Agency (CIA).
Woo says the insurance industry has largely remained loss-free in recent times, owing to the work of these organisations. “Reflecting on the types of attacks that have occurred over the past few years, the only plots that have succeeded have involved a small number of operatives and have not really been that damaging,” he says. “The plots that might have caused significant insurance loss have been stopped.” Luck had no part to play in the death of the al-Qaeda leader, says Woo, nor does it have a role in stopping planned attacks. “The discovery of Bin Laden was not luck,” he says. “It did not depend on a tip-off or someone just bumping into him on the street. It was a systematic process that carefully unravelled his social network. This method is common to many of the plots that have been stopped over the past few years.” Premiums for terrorism-related insurance have reduced in the years following the 11 September attacks, as a result of increased global awareness of terrorism effectively cutting incidents. Woo says: “Terrorism insurers are actually at an advantage compared with others such as catastrophe insurers, who have no control over what may happen. “Terrorism insurers are not insuring against the motivations of the terrorists themselves. They are actually insuring against the failure of the security apparatus, which is essentially a failure of MI5 or CIA offices to stop the plots before they reach their targets.”
Fresh ambitions Murison claims that the next big threat on the horizon for insurers emanates from Africa’s shores. “Of more concern than al-Qaeda in Pakistan are the regional affi liates based in Yemen and Somalia,” she says. “For example, just across the border from Yemen is Saudi Arabia, with many attractive targets in the form of energy facilities. It has been difficult to attack in recent years, but it is still a big aspiration.” “I think the Yemeni group is particularly ambitious,” she continues. “However, their problem is that they don’t have a large component of foreign fighters. They haven’t become an attractive training destination for Western jihad supporters, in the same way that Pakistan did.” Going forward, insurers should remain vigilant when underwriting terrorism-related risks. “There will be individuals resolving to launch terrorism acts. But for insurers, losses from this act are likely to be very modest,” says Woo. GR
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A growi Lloyd’s of London’s best-known technology initiative is arguably still the failed Kinnect electronic trading system. Lloyd’s pulled funding on the project in 2006, having spent £70m on it. Since that setback, the market has been making valiant efforts to erase this seemingly indelible blot on its copy book and create a successful electronic trading initiative. A cornerstone of its efforts is the Exchange, formerly known as the Lloyd’s Exchange. But, while the market sees the Exchange as a step in the right direction, it is failing to realise its full potential. More damning still for the London market as a whole is that this cannot be blamed on the technology. Rather, unpreparedness and in some cases stubbornness of market practitioners is preventing true success. The system underwent its fi rst pilot between 1 October and 31 December 2010, which covered electronic transmission of endorsements – documents instructing a change to an insurance policy – and their supporting messages for primary marine hull, cargo, war and liability business. The London Market Group (LMG) – which represents the Exchange’s stakeholders – produced a report that included a fairly damning indictment of the pilot’s shortcomings. The technology and processes got the thumbs up from both underwriters and brokers, with 89% saying the processes were up to scratch and 85% positive on the technology. But only 35% felt that the pilot process provided benefit to their business. The report also found that the market still needs some convincing of
The London market’s electronic messaging system completed a pilot run last year and is now set to expand, reports Ben Dyson. Investment is required to gain full benefits, but will market participants lay out the cash?
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wing endorsement the Exchange’s value. A mere 15% of participants agreed that the pilot process had won over the hearts and minds of brokers and underwriters.
Not all bad news … Despite this, it would be a mistake to denounce the Exchange or the marine pilot as a failure. Figures provided by the Lloyd’s Market Association (LMA) say that, up to May 2011, 325,000 messages had been transacted on the system, compared with just 12,000 up to June 2010. The LMA said that volumes had not dropped following the pilot’s completion, indicating that the market has continued to fi nd electronic endorsements useful. However, it declined to provide a monthly breakdown of volumes to verify this. It is difficult to get a true picture of the project’s heath from the numbers provided. Nevertheless, the results were sufficiently good for the Exchange’s four backers to commit to rolling out e-endorsements for more business lines. It will add property, professional indemnity and specie in July, with all other lines scheduled to be online by April 2012.
… but could do better The LMG survey results show something is not quite working, however. Being able to send and receive electronic endorsements is one thing, but the real benefit comes when those electronic messages can automatically flow through to broking and underwriting systems. Without this link, participants might as well be emailing one another. One source says: “There are only a few companies that are fully integrated to the Exchange. Its primary purpose is to make the distribution and collection of data between brokers and underwriters more efficient. In other words, if data is sent electronically, it should be possible to re-use that data electronically. If you don’t integrate your systems, you can’t re-use the data.” LMA head of market processes Rob Gillies says the organisation had not recorded how many of the participants in the pilot were fully
The ins and outs of the exchange Since the failed Kinnect project, Lloyd’s and the wider London market have abandoned trying to impose electronic trading on the market. The focus is now firmly on supporting traditional face-to-face negotiation with electronic processes, such as transmitting data and documentation. In keeping with this thinking, the Exchange is designed to enable brokers and underwriters in Lloyd’s and the wider London market to exchange Acordstandard messages. Initially a Lloyd’s-only initiative, the Exchange is now run by a separate company, The Message Exchange Ltd (TMEL). It is jointly owned by the International Underwriting Association, the Lloyd’s Market Association, The London & International Insurance Brokers’ Association and Lloyd’s itself. The London Market Group, representing the joint interests of the four Exchange stakeholders, hailed the pilot as a success. In addition, all 49 Lloyd’s managing agents, 28 IUA members, and 25 brokers, representing 80% of the business placed in Lloyd’s, are now connected to the Exchange.
‘Frankly it could be better than it is. Turnaround times from underwriters are not always what they are stacked up to be’ Mark Kinsella, RFIB
integrated, but adds: “As we progress with this initiative, it will be an interesting measure of progress and success to review the level of integration that takes place within fi rms.” He says the number of fully integrated participants was probably a minority, but adds that this was not a negative, given that it was a pilot. “Understandably, many fi rms went in at an entry level to enable them to participate, and deferred decisions about increased spend and increased organisational change until the situation was clearer.”
Waiting games The position described by Gillies is creating a Catch-22: companies want to
see benefits before investing, but will not get the full benefits until they invest. “At the moment, everybody is waiting for everybody else to invest,” says the source. In addition, it is tricky to produce a cost-benefit analysis, in part because there is no record of how many endorsements are in the market. “There is no central point to draw that data from,” Gillies says. Further stunting e-endorsements’ usefulness is the fact that they are currently only suitable for the simplest kind: so-called ‘silent endorsements’, where there is no negotiation required between broker and underwriter. Where negotiation is needed, having to insert the digital messages into the face-to-face process adds another layer of complexity. Meanwhile, one of the stated benefits of the pilot was improved turnaround times. According to Ernst & Young, the quickest recorded time was 15 seconds. However, the fi rm also noted frustration that some simple endorsements, which would have been dealt with in a few hours using traditional methods, took more than 48 hours. “Frankly it could be better than it is,” says Lloyd’s broker RFIB’s head of information technology Mark Kinsella. “Turnaround times from underwriters are not always what they are stacked up to be.” Though the drawbacks frustrated some, they have spurred others to make changes. Pilot participant Markel International recognises the need to link the electronic messages to its underwriting systems. “In due course we want the electronic message to go to the underwriter and then, on approval, flow straight into our underwriting systems. That is when we really get the value of being able to trade electronically,” operations director Hugh Maltby says. Whatever the drawbacks of the Exchange, it is clear that the market does not have another Kinnect on its hands. Although the LMG report found that only 35% of the participants felt the pilot benefited their business, 89% said the pilot would provide benefit with modifications. File this one under ‘has potential’. GR GLOBAL REINSURANCE JUNE/JULY 2011 15
People & Opinion For exclusive opinion and insight from Global Reinsurance and its sister publications, visit
CATEGORISING CATASTROPHE With cats seemingly on the rise, risk managers must understand such scenarios and the cover they require strategicrisk.co.uk
IT SPOTLIGHTS LONDON MARKET: MARKET VIEWS Will recent catastrophes force a rates rise? insurancetimes.co.uk
In my view Size isn’t everything Being a big broker isn’t all it’s cracked up to be, argues Carl Beardmore – and there appears to be a genuine appetite in the market to find an alternative There is a real need and appetite for an alternative to the big three brokers – Willis Re, Aon Benfield and Guy Carpenter. The independents that once represented a different offering have been absorbed into the big enterprises and that has left a chasm. The market is keen to see someone fi lling the space at one time occupied by the likes of Blanch and Benfield. It wants the independent option that has the drive, ambition and dynamics to bring truly client-centric service and solutions.
But an independent broker of the right structure would have the ability to take a longer-term perspective, allowing it to focus on delighting the client and using that as the pathway to sustainable performance. Size doesn’t always mean you’re the fi rst to innovate. The advantage of not being as bulky is that you are nimble and can react quickly to market conditions. It is much easier to mould a smaller number of people than it is of a staff of thousands.
This is also often the case in areas such as IT, where new technology and systems can be deployed to add benefit to clients. BMS’s use of the iPad in the fi rst fully electronic placement in Lloyd’s has demonstrated the speed at which businesses of our size can implement new technology. From initial idea to implementation, the project only took about nine months because we had no distractions to push us off course. While we might not have the fi nancial resources of the big three,
There is a propensity only to respect large revenue accounts, making other clients feel second class When talking to clients, I constantly hear about their desire to deal with organisations that are committed to delivering the best products and solutions and continuous improvement. Yet the larger organisations, particularly those with external ownership, are under a lot of pressure to focus on enhancing profitability year on year, which can often be at the expense of focusing on and providing excellent client service. In addition, there is a propensity only to respect large revenue accounts, making all other clients feel second class. 16 JUNE/JULY 2011 GLOBAL REINSURANCE
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People & Opinion GULF RISES TO NEW CHALLENGES Risk awareness is becoming more sophisticated in GCC countries to keep pace with the region’s new needs strategicrisk.co.uk
we were able to move ahead faster than them on this initiative.
Response to Bribery Act The much-debated Bribery Act will be introduced in July and I am sure all brokers, be they large, medium or small, are working hard to operate within its confi nes. It is inevitable that a mid-size broker will fi nd this a little easier to control because they have fewer transactions and do not have a cast of thousands to police. But in an industry where trust and integrity are a given, I believe everyone will be working hard to ensure they conform with the act. One of the big players recently drew more attention to itself with the introduction of extra commissions on London market placements, which has raised a furore in the market. But the big guys are in a similar position to the rest of us – we are all constantly looking to improve our market share and grow our profitability. In a mature market, where it is increasingly difficult to grow profitability, one of the last options available for larger operators is to go into the distribution chain and take additional margin out of it. I understand what they are trying to do, using their influence in the distribution chain to obtain a greater proportion of the cash flow. For me, it is not about ethics or whether is it right or wrong; it is part of a wider strategic dilemma over how to continue to grow business. As the biggest in the market, these companies must constantly defend their position and this is one way they can exert their influence. Time will tell whether it will work for them or not, but in my experience no one likes to be pressurised or pushed into a corner. If another option is made available to the people being put under pressure, they are likely to take it up. Which brings me full circle, back to the reason why people want an alternative, why they want another option. They want something that offers them a valid alternative to the big guys, and that puts some muchneeded competition back into the market. GR Carl Beardmore is chief executive of (re)insurance broker BMS
Weblog It’s hard to deny that sex sells, in light of our most popular web story. Munich Re’s retail arm Ergo hit the headlines for all the wrong reasons in May after details of a sordid company-funded orgy in 2007 were leaked to the press. The Eyes Wide Shut-themed bash for 100 of the insurer’s top performers and 20 prostitutes at a Budapest hotel spa kept reinsurers clicking. The long-running staffsnatching war between broker giants JLT and Aon continued to tantalise the industry this month, following Aon Benfield UK executive Alastair Speare-Cole’s decision to jump ship to become JLT Re’s chief executive. Still on people moves, it seems reinsurers love a good mystery. Guy Carp chief executive of international Henry Keeling’s decision to leave the company without explanation was our third most popular story.
Keeling’s decision followed a management reshuffle at the top of Guy Carpenter after chief Peter Zaffi no quit to become president and chief executive at Marsh and Alex Moczarski was appointed as Zaffi no’s replacement. The fourth most popular story was a warning to underwriters from the Lloyd’s Market Association not to fall foul of the Bribery Act or FSA when responding to London market broker pressure to meet commission increases. And fi nally, taking heed of the scout’s code to always be prepared, reinsurers responded to meteorologists’ predictions of an “above average” hurricane season. The season kicked off on 1 June, so many market makers will be hoping the weathermen are wrong. To contribute to the website, email Lauren Gow at firstname.lastname@example.org
Online top five 1. MUNICH RE’S ERGO REWARDED PERFORMANCE WITH PROSTITUTES Party included 100 sellers 2. JLT AND AON POACHING WAR Speare-Cole joins JLT Re 3. HENRY KEELING TO LEAVE GUY CARPENTER Keeling move follows Zaffino’s departure 4. LMA WARNS ON BROKER REMUNERATION Commission rises resisted 5. PREPARE FOR AN ‘ABOVE AVERAGE’ HURRICANE SEASON Between 12 and 18 named storms predicted
Up the ladder How did you get to where you are today? A combination of ‘outside looking in’ jobs, such as insurance investment banker, consultant, and ‘inside looking out’ jobs such as life insurance company president. How has the industry changed? It’s more professionally managed, has dramatically better management information systems, more focus on capital management, a more global outlook, and is more beholden to regulators and rating agencies. What are the key challenges ahead? Fending off regulatory attempts to view insurers’ risks and capital requirements like that of banks and investment firms; dealing with a slower-growth global economy; and earning decent returns from low-interest-rate portfolios. What are the biggest opportunities? Emerging markets such as Asia, Latin America and Eastern Europe.
What’s been your biggest mistake? Not developing a facility with foreign languages, as most Europeans and Asians have done. What are you most proud of? Spending 40 years in global insurance with a reputation for integrity among industry leaders. What comes to mind when you think of friends or contemporaries in the market? A dedicated group of men and women who are sincerely interested not just in selling policies and paying claims when losses occur, but striving to mitigate and eliminate risk from an increasingly risky world – a great service to our society. What do you do to relax? Recline my seat, lower my tray table and read from my Kindle as soon as the pilot says so. Michael Morrissey is president and chief executive of the International Insurance Society
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PHOTO: GREG FUNNELL
Matthew Fosh faced many challenges when he joined Novae as chief executive but, as he tells Ben Dyson, the company’s success is down to the qualities of its staff “People laughed at me,” says Matthew Fosh when he recalls taking the top job at Lloyd’s (re)insurer Novae back in November 2002. “They said: ‘This capital markets guy hasn’t a clue what he’s letting himself in for.’” Fosh had chosen to join at a time when mention of the company’s name, then SVB Syndicates, would elicit a derisory snort from Lloyd’s contemporaries. SVB had got itself into hot water writing US liability reinsurance in the late 1990s – a course of action that resulted in heavy losses and repeated reserve strengthening for many companies and even failure for an unfortunate few. “SVB was written off by many people,” Fosh says. Not only had Fosh taken on a challenge in tackling US liability business that had bettered some seasoned insurance professionals, he did so with no prior insurance knowledge. His background is derivatives trading: he joined Novae from inter-dealer broker ICAP, which had bought Fosh’s own trading firm – Seagray Fosh Futures – in 2000. Little wonder that his peers did not fancy his chances. They might be laughing on the other sides of their faces now. Under Fosh, Novae has not only survived, it has completely transformed itself. The series of changes – which were completed at the end of 2010 and the beginning of 2011 with the closing of Novae’s two run-off syndicates and the folding of its separate UK legal entity into its Lloyd’s syndicate – has put the company’s past almost completely behind it and provided a source for future growth. In particular, the fi rm’s fledgling Swiss reinsurance operation, Novae Re, which was set up in August 2009, is likely to be one of the main engines for growth at Novae. The new unit wrote £103m ($167.7m) of gross premium in 2010, its fi rst year of operation, against a target of £90m-£100m. This accounted for 17.5% of Novae’s total 2010 GWP of
£587.7m and played a big role in the 53% GWP growth over 2009 levels. The unit is budgeted to write around £175m in 2011, and, with rates looking likely to harden in Novae Re’s core market of international property-catastrophe reinsurance, it is well positioned to deliver this. Novae is also now profitable. For the full 2010 year, Novae made a profit before tax of £35.1m, compared with only £4.2m in 2009. While the company is viewed as a takeover target by many analysts because of its low stock market valuation, it is clearly keeping a keen eye out for opportunities to sit in the driving
‘Yes, I have the privilege of being chief executive, but the rest of the team are absolutely embedded in the senior management structure of this business’ seat. On 31 May Novae announced that it was performing due diligence on fellow Lloyd’s fi rm Omega.
Smile, it might never happen Morale was low when Fosh arrived, and he had to tackle it fast. He did this with humour. On the back of Fosh’s office door hangs a plaque that reads: ‘The floggings will continue until morale improves’, which he says “sums up my management style to a tee”. “My Dad gave me that,” he says of the plaque. “When I walked in here, this was a troubled, miserable, grey and unhappy place. One way of beating that was with humour.”
But Fosh hasn’t lost sight of the fact that there is a serious job to be done. On top of a fi ling cabinet is another plaque with a more traditional message: ‘Good manners is good business’. While results so far seem to show Fosh has struck the right balance with his management style, there is clearly still much to be done. Despite putting Novae on an even keel and returning a £32.9m of capital to shareholders following the closure of the non-Lloyd’s unit, the company’s stock market valuation still lags behind its book value. Novae’s share price at the time of going to press was 372p, against 2010 year-end net tangible assets per share of 449.7p. As well as being disappointing for shareholders, the low valuation stunts Novae’s expansion options and marks out the company itself as a takeover target. Following the sale of close rival and one-time merger prospect Chaucer to US insurance group Hanover, Novae has become analysts’ favourite to be taken over next. And although the greater push into property reinsurance is providing diversification and growth, it also brings its own problems, as the company’s estimated $60m-$80m catastrophe losses to date underscore.
The black hole problem The journey to the more comfortable position Novae now occupies has not been smooth. Having stopped the deterioration of the casualty business in 2006 – which Fosh describes as the “black hole problem” – the company decided to start growing in a bid to improve its reputation. But despite management’s insistence that the problem was under control, shareholders would only sanction a capital raising away from the latent books of run-off liability business and thus outside the existing Lloyd’s operation. Novae Insurance Company Ltd (NICL) was born and, according to Fosh, required at least £100m of capital to secure it an A rating. However, the UK SME liability business that was to become the new company’s staple diet was soft and has GLOBAL REINSURANCE JUNE/JULY 2011 19
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Profile Predator or prey? Following the sale of Lloyd’s insurer Chaucer to German insurance group Hanover, Novae is now top of many analysts’ lists to be the next listed Lloyd’s firm to be taken over. However, while acknowledging that the decision ultimately rests with Novae’s shareholders, Fosh is determined that Novae will not go cheaply, if it goes at all. “I have not worked here eight years with my colleagues, for 12 hours a day, to fix something that someone said was unfixable just to give it to someone else for one times book value ,” he says. “If someone wants to come in and pay my shareholders a substantial premium for the patience they have shown for eight years in building this business, then I’m sure they’d want a conversation.” Novae declined to comment further on its due diligence of . However, speaking to Global Reinsurance the week before the Omega announcement, Fosh contended that the existing mid-tier Lloyd’s insurers are too small. “These businesses are sub-scale,” he said. He argued that 10 years ago many of the big names in Lloyd’s were the same size but that some firms pulled away from the pack, leaving the mid tier wanting. “What you have seen in the past five years is a separation of the bulge-bracket of Amlin, Catlin, Hiscox and Lancashire from the next tier of Novae, Omega, Hardy, Chaucer and Canopius,” Fosh said. “That tier needs to be five times the size.” The listed companies in particular need to be bigger to make them more appealing to stock market investors, Fosh argued. “Scale matters in this business,” he said. “Yes, you can be a skilful niche underwriter of certain individual classes but that doesn’t lend itself well to the public market nor the advantages the public markets bring you, such as access to capital and M&A ability.” While the Omega announcement seems to be positioning Novae as predator rather than prey, some feel that because of Novae’s low stock market valuation, Omega is one of the few firms it could buy. “My sense is that Novae management wants to do something, and you can’t sit around waiting to be bid for,” Collins Stewart analyst Ben Cohen says. “I guess they would look at this as one of the few deals that might be doable for them in terms of size and relative ratings, because Omega’s rating is also depressed, with the idea presumably to create a larger, more liquid combined entity.”
remained so since, prompting Novae’s then chief underwriting officer, Peter Matson, to turn his nose up at the business – a decision Fosh still praises Matson for today. While Matson’s decision likely saved Novae a further beating at the hands of underpriced liability insurance, it also meant that NICL had plenty of capital but little to do with it. This proved a drag on Novae’s return on equity, in turn hitting its stock market valuation. “We had exchanged a black hole problem for a surplus capital problem,” Fosh says. “A third of our capital simply wasn’t being deployed at all, so it was no surprise we had a return on revenue one-third less than our peers.” And so the tough decision was taken to abandon the UK insurance
division, combine its business with the syndicate and free up the capital tied up in the business.
Consistency’s key Fosh argues that the missing ingredient that will put Novae alongside the likes of Hiscox and Amlin, whose shares trade at an – admittedly modest – premium to net tangible asset value, is consistent results. “We have to demonstrate the ability to deliver a combined ratio consistently in the low 90s year on year,” he says. “I have every confidence we will do that. The reason we haven’t done it to date has not been anything to do with the classes we have had. It has been to do with the classes we haven’t had.” What Novae was lacking was property-catastrophe reinsurance business. Its answer to this problem was Novae Re, established a year before a clutch of its peers, notably Amlin, Catlin and Canopius, decided that the next must-have for budding Lloyd’s operations was a Swiss office. The company is managed by a group of senior continental European underwriters under former Endurance executive Gunther Saacke, who serves as Novae Re’s chief executive and chief underwriting officer. The senior team at Novae Re also includes deputy chief underwriting officer Willi Schuerch, former chief catastrophe underwriter at PartnerRe and one-time Swiss Re executive, and head of engineering Johannes Goebel, who previously worked for Allianz Global Corporate & Specialty and Allianz Global Risks. The entire team is now 25 strong, with 20 in Zurich and five in London. According to Fosh, the senior team had left their respective companies and teamed up between 2007 and 2008 with a view to set up their own reinsurer. However, they were foiled by the fi nancial crisis, which made it difficult for them to raise funds. Not wishing to be out of the market for too long, the team found a home within Novae as its new dedicated reinsurance unit.
Enter Novae Re Fosh likens the hiring of the Novae Re team to making a premium-free acquisition of a ready-made reinsurer. He believes the team’s previous experience helps set Novae Re apart from the other Swiss operation of Lloyd’s (re)insurers. “Look at their track records,” he says. “Karl Schneider [Novae Re’s head of agriculture] is a global authority in agriculture. Willi Schuerch is internationally known in propertycatastrophe. These are 50-somethings,
not 32-year-old wannabes. These are established, credible, experienced, wellknown underwriters.” Fosh believes the team’s standing has also allowed the reinsurance division to hit its premium targets despite generally soft conditions during 2010. “People ask me: ‘How can you be growing business in a soft market?’,” says Fosh. “I’m not asking these guys to plant the flag in Zurich and steal lots of business from everybody else at a cheaper price. I’m asking them to effectively bring their franchise as underwriters to Novae. This is business they have been writing for 20 to 30 years and typically leading.” The senior reinsurance team’s business plan before joining Novae was to be writing $600m of business by year two. Within Novae, they will only be writing a fraction of this in their second year. It could be assumed that a larger, better capitalised rival with need for a ready-made Swiss reinsurance division would be able to steal the team from under Novae’s nose. However, Fosh is insistent that the team knew what they were letting themselves in for and are happy with what they have achieved – although it is not what they had originally planned. He also contends that his management approach, which he describes in simple terms as “choose good people and back them” makes their sudden departure unlikely. “It is down to good management, good integration, incentivising them properly and making them feel embedded at a senior level in the strategy of the business as a whole,” he says. “Yes, I have the privilege of being chief executive of this business but they are absolutely embedded in the senior management structure of this business.” While it is hitting premium targets, the reinsurance business still has some way to go before it is contributing to Novae’s overall profitability. Fosh admits the unit has yet to turn a profit. And it could struggle to do so this year as a result of catastrophe losses. While it could be argued Novae Re chose a bad time to set up, Fosh says: “These businesses take a year or two to properly bed down and to build up to critical mass. If we’d had a stonking hard market in January 2010, we’d have missed it.” While Novae clearly still has a lot to prove, and it remains a takeover target, it is certainly no laughing stock now. GR FIND OUT MORE ONLINE: NOVAE CHIEF: LLOYD’S FIRMS NEED TO MERGE To read this feature, and for more on Novae, go to globalreinsurance.com or goo.gl/ahjRc
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The last big push Do internal Solvency II models create more problems than they solve?
24: DFA goes global
Dynamic fi nancial analysis is fi nding favour in new territories
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25: Model management
How will recent major updates to cat models affect the industry?
27: The magic number
The three factors that property casualty modellers need to consider
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Special Report: Financial Modelling In the run-up tp Solvency II, many companies are seeking to develop their own internal models to avoid the problems of the standard formula. But this approach is likely to hold troubles of its own. Helen Yates reports
The last big pu Europe and the rest of the world are gearing up for Solvency II, as the 18-month countdown begins. The directive, which will come into effect on 1 January 2013, is set to trigger a major change in how risk is measured and managed. While this will herald a new era in analytics and modelling, areas of uncertainty and controversy remain. This will, of course, affect companies in Europe. But it could also have wider implications, as the new regulatory regime is looking more and more likely to be rolled out to other major insurance jurisdictions as they seek equivalence. It’s a great time for actuaries and risk professionals, and a tough time for all (re)insurers – particularly small to mid-sized companies, which will be required to invest a lot of time and money in the process, potentially only to see their capital requirements rise substantially. With the deadline fast approaching, we examine the pitfalls that lie in wait for (re)insurers navigating the last leg of this journey.
Ups and downs For an industry that has had mixed success in embracing the tenets of enterprise risk management (ERM) and risk-based capital modelling, Solvency II is proving to be a significant driver. “It’s been going on for 20 years now and things have become a lot more technical,” says BMS Group executive vice-president and chief actuary David Spiegler. “People are focusing on stochastic modelling and distributions of losses. But with Solvency II pushing things forward, it has gone into a whole new generation of analytical requirements that companies are going to be required to use in managing their business.” However, those businesses preparing internal models for approval still have numerous hurdles to overcome, not least whether the regulators themselves
‘I’m wary of the regulators’ abilities to oversee the process fairly and consistently’ David Spiegler BMS Group
will be resourced enough to cope with multiple model assessments. “I’m a little wary of every company developing their own internal model, and of the regulators’ abilities to oversee the process fairly and consistently,” says Spiegler. “One of the nice things about catastrophe models is that, although they have their own issues, everyone is using the same models – so you can compare the relative merits of companies or portfolios. “But when everyone is developing their own model, it seems like it’s going to be awfully difficult for regulators to police this process.” He does not think there is much risk of over-regulation, simply because of the pressures the task at hand will place on regulators. “In a world where you didn’t have to worry about resource issues, over-regulation could be a concern,” he says. “But Solvency II could create such a burden on regulators, including having to evaluate every company’s individual model and oversee this process, that I don’t see how they’ll have the resources to over-regulate.”
Breaking the mould It is mainly the large, more diversified, organisations that are looking to develop their own internal capital models for the new regime. Smaller, monoline writers lack the resources, so are more likely to use the standard formula – a one-size-fits-all approach to risk-based capital modelling.
The main problem is that many feel that capital requirements under the standard formula will be too high. After substantial lobbying by industry bodies, these were recalibrated ahead of the latest impact study (QIS5). The results, which came out on 11 March, revealed lower solvency capital requirements (SCR) than had been feared. “I would say it’s not as disastrous as people were expecting,” says AM Best Europe general manager Vasilis Katsipis. “It started with the original technical specifications and these got a strong reaction from the industry, but then they started getting more flexible.” However, the fi ndings did show that most insurers would need to hold more capital – in some cases, a lot more. While European (re)insurers are, on the whole, strongly capitalised – holding $395bn of capital in excess of their solvency capital requirement – several may fall short of the requirements. Furthermore, many remain dissatisfied with the standard formula. In particular there is worry over how small insurers and captives will be treated and the defi nition of contract boundaries. Meanwhile, a concern for international carriers is that non-European catastrophe risk is not adequately accounted for under the standard formula. Following the release of the QIS5 results, representatives of the European insurance industry – including European insurance and reinsurance federation the Comité Européen des Assurances (CEA), the Pan European Insurance Forum, CFO Forum and the CRO Forum – wrote a strongly worded letter to the European commissioner for the internal market and services, Michel Barnier, highlighting their concerns with Solvency II. They also wrote to the Financial Times’ letter page, saying: “It is absolutely imperative that changes are made to the overly conservative approach being adopted in several areas.”
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Special Report: Financial Modelling Modelling experts: a finite resource
push The letter stated that, while QIS5 demonstrated the health of the European insurance industry, it confi rmed that some areas of the implementing measures needed correction. These include a more balanced calibration of certain requirements, the tackling of procyclicality and volatility in the Solvency II framework and the need to address unnecessary complexity. “There are still elements in there that need clarification or need to be adopted – and there are also elements that seem to be unrealistically cumbersome and absorb too much capital,” says Katsipis.
A matter of timing For its part, the regulatory body European Insurance and Occupational Pensions Authority (EIOPA) is performing additional work to improve the calibrations. Nevertheless, given the expected capital burdens under the standard formula, it is understandable that many insurance industry players with the necessary resources are opting to go the internal model route. But this is a tough exercise, and those who have left it too late will not be guaranteed internal model approval, warns Katsipis. “For companies that have not applied for pre-approval, the boat has probably sailed because there is no guarantee that they will get their capital model for 1 January 2013.” The release of the Omnibus II directive – which sets out the transitional measures in adopting Solvency II – has done little to ease pressure over this issue. There has been little clarity on whether transitional measures might be adopted and, if they are, whether this will buy more time for companies seeking internal model approval. Experts think it is a dangerous game to lose momentum in an effort to wait and see if Solvency II will be staggered in some way. “On the one hand, Omnibus II may mean a softer
Preparations for Solvency II are creating a boom for all kinds of risk specialist. Forty-four percent of risk professionals expect their teams to grow over the next 12 months, according to research from the Institute of Risk Management and Kinsey Allen International. It also found that a senior risk professional now dedicates almost 50% of their working day to Solvency II compared to 20% just 18 months ago. While it is an exciting time for people in the risk world, there are practical challenges. The demand for skills and lack of suitable candidates is pushing salaries up in the sector, as insurers, consultants and regulators staff up and do all they can to hold on to existing talent. The skills requested by organisations have necessarily become more analytical, with financial risk expertise, capital modelling, prudential regulation, financial modelling, strong mathematical modelling and quantitative analysis all featuring strongly on job forms. “The demand they’ve got for headcount has increased but the supply hasn’t increased. You will get businesses who will sometimes have to
landing for the whole industry on Solvency II capital requirements, and in the long run that is good for the industry,” says Katsipis. “However, the timing for adopting Omnibus II is the fi rst quarter of 2012, which is relatively late and therefore a lot of companies will feel that they are in uncertain and unchartered waters.” For companies lagging behind, there is a real risk that they could be required to use the standard formula, meaning that their regulatory capital requirements could go up. Katsipis says: “If they haven’t gone through the pre-approval process before the implementation of Solvency II then, yes, companies that have not started will most likely fall into the standard formula. “Companies that have started, but not applied for the pre-approval, will begin to fi nd it difficult if not impossible to have an internal model to be used for regulatory purpose in 2013.” The longer companies leave it, the more expensive the process will become, he adds: “The resourcing issues are quite well publicised – there are limited resources, and insurers, consultants and regulators are fighting for the same type of resources. “I would expect companies that start their capital model now to have higher costs than if they had started earlier, because they will have to do the same amount of work in a more limited timeframe, which typically brings additional cost.” While the cost of compliance and uncertainty is an issue, Katsipis thinks too much time has been spent looking
wait six months for a position to be filled, so that’s one of the first frustrations,” says Kinsey Allen International senior consultant Loraine Silvester. “To fill those gaps you have interims who have modelling skills and understand the insurance business,” she continues. “Their day rates are being increased dramatically and you have to retain their knowledge, because Solvency II isn’t going to be implemented until the beginning of 2013. So if they’re being attracted by companies who are screening for that skillset you’re in a very competitive market and it’s creating a bubble.” It’s a great time to be an actuary, thinks BMS Group’s David Spiegler, who anticipates that his team with be double its size within a year both due to BMS’s expanding business in the USA, as demand grows from clients with business in Europe, and as the USA gears up for Solvency II equivalence. “It is a great thing for actuaries – we’ll see how it works for insurance companies, but it is definitely going to create a huge analytical resource demand for all insurance and reinsurance companies.”
at the capital implications of Solvency II and not enough on Pillar II. “The more exciting part of Solvency II is probably the second pillar with the own risk and solvency assessment (ORSA),” he says. “I know a lot of effort, brain power and cost has been expended on capital models in Pillar I, but when all is said and done even companies that do not have an internal capital model will have a standard formula. That standard formula is going to be more accurate in describing their capital requirements than the current Solvency I standard.” “But the big sea change,” he says, “is around ERM and how you take that model and make it part of your overall practice.” Katsipis thinks Solvency II through ORSA and the standard formula will force ERM into the lower echelons of the insurance industry in a way that has not been achieved before and that arguably could not have been achieved without the regulatory framework. “Before Solvency II there were certain companies globally that were thinking in these terms, but these tended to be the larger (re)insurers that probably already had their own capital model and ERM framework,” says Katsipis. “If you look further down at small-to-mediumsized companies, I don’t think these had well-developed ERM or the appetite to do so.” GR
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Special Report: Financial Modelling Ultimate Risk Solutions chief executive Alex Bushel talks about the value of dynamic financial analysis software in mapping future business strategies
DFA goes global Insurers and reinsurers worldwide are integrating dynamic fi nancial analysis (DFA) into the process of making strategic decisions. DFA models have long been accepted by the industry in the UK, Europe and the USA. Today, we’re seeing companies in Russia, the Middle East and Asia adopting fi nancial risk modelling. In the global economy, decision makers recognise the need to identify and quantify all the risks they face when making critical decisions. Two major developments influenced the recent growth of DFA models. Over the last few years, rating agencies began to evaluate companies on the quality of their enterprise risk management (ERM)programmes and, for those doing business in the EU, preparing to comply with Solvency II became a high priority. The value of DFA software is now recognised by regulators around the world. By the end of 2012, Solvency II will require insurers to maintain capital based on fi nancial risk models. In the USA, ERM programmes fueled by fi nancial risk software are being considered in fi nancial stability ratings. Standard & Poor’s and AM Best are expecting companies to show they have an ERM programme that includes a DFA model to quantify risk. But the wide acceptance of modelling technology to identify and quantify risks is based not only on rating agency pressure and regulatory compliance. Since the framework for ERM was published by the Casualty Actuarial Society in 2003, insurance industry chief executives have learned to depend on fi nancial risk models to avoid the pit falls of making decisions without knowing all the risks.
Facilitating good decisions The word is spreading that DFA models facilitate good decisions and insurance companies in the fastgrowing economies of Asia and the fi nancial centres of the Middle East are working with regulators and industry associations to take advantage of the sophisticated new technology. They are using DFA models to prepare for
the impact of unanticipated events and to decide the level of risk to take in relation to their company’s capital. The daunting list of risks confronting any insurer or reinsurer today requires more than traditional risk assessment tools to know the range of outcomes produced by different scenarios. At Ultimate Risk Solutions, our DFA model Risk Explorer™ will: simulate hundreds of thousands of random scenarios for corporate portfolios;
The value of DFA software is recognised by regulators around the world evaluate reinsurance, investment, and underwriting strategies; help manage catastrophe exposures; analyse strategic business options; and quantify risk costs. Risks cut across all aspects of a company’s business. Without a formal ERM programme, the different risks cannot be singled out, compared to other company risks and analysed in terms of their collective impact on the company. This is the holistic approach that leads to good decisions, and any successful ERM programme depends on state-of-the-art DFA. This insight into a company’s future balance sheets is vastly superior to the current ‘what if?’ or series of ‘stress tests’ that an organisation may perform.
Global economic model If your company does business in different parts of the world, it is essential to know the risks in the other national and regional economies where you operate. Our new product, URS Real World™ is a global economic model that meets this need. It employs revolutionary modelling ideas and approaches to help corporate executives measure the impact of macro-economic volatilities on fi nancial results of their
companies in multiple economies where they do business. These scenarios include the simulated values of GDP growth, inflation, unemployment and wage growth rates, as well as investment rate and interest rate yield curves, corporate and municipal bond spreads, stock market indexes and exchange rates. Each scenario can include any number of future years. We are celebrating the 10th anniversary of URS this month. When we opened, DFA was in its infancy. We were determined to create a model, Risk Explorer™, that would be fast, flexible, and user-friendly. Today, our model is used by many of the world’s leading insurers, reinsurers, and brokers. We are the only independent fi nancial risk software provider. We’re an innovative company focused on only one thing: providing the best software solutions for our clients. I believe our single-minded dedication to designing, implementing and maintaining the best models in the market is why companies are turning to URS. We have no other priorities. The URS R&D staff is composed of highly trained mathematicians, actuaries and software designers. They are determined to provide analytical products that are at the frontier of computer technology to serve the emerging needs of insurers and reinsurers in today’s interdependent, international economy. We stand ready to work with companies across the world that are looking to install state-ofthe-art fi nancial risk software. GR Alex Bushel is chief executive of Ultimate Risk Solutions (URS). URS is an actuarial software company providing software products in the areas of economic capital modelling, stochastic reserving and dynamic financial analysis
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Special Report: Financial Modelling The modelling of catastrophe risk lies at the heart of many (re)insurers’ approach to enterprise risk management. With major updates to the industry’s vendor catastrophe models, what does this mean as the Atlantic wind season begins?
Model management The major catastrophe events so far in 2011 and now a significant catastrophe model update – RMS version 11 – have introduced a great deal of controversy and uncertainty ahead of the mid-year ‘Florida Book’ renewals. The result is an expected rise in demand for reinsurance, which could cause prices to turn after several years of softening. The fact that the latest version of RMS’s US Hurricane Model (released at the end of February) is making such an impact is testament to the three vendor models’ significance in the industry. “It’s based on a few more years of data and their methodology, which gives a lot more weight to the likelihood of there being much higher losses further inland than their prior model version did,” explains BMS Group executive vice-president and chief actuary David Spiegler. “It has a big impact everywhere but in certain areas it has a massive impact, like Texas and the mid-Atlantic states. So if your portfolio happens to be concentrated in those areas, you can see RMS’s measure of your exposure doubling or more.”
A brief history Catastrophe models have evolved and developed because catastrophe risk is such a significant exposure for many (re)insurance firms. In the past, a major hurricane loss – such as Andrew in 1992 – had the potential to cause widespread insolvencies. Today, a major shock-loss should not lead to failures, as companies should have a better grip on their exposures and be adequately capitalised in order to better absorb potential losses. “The use of catastrophe models in the industry – even with all the issues with the models themselves – has made the risk management of the industry vastly superior to what it was prior to those models being developed,” says Spiegler. “Companies know where their exposures are, they know not to accumulate too much in any one area and certainly not in areas prone to catastrophes. Japan is one example and Florida is another where companies know a lot more about their risks now than they ever did before.”
The history of catastrophe models dates back to the 1980s when it first became possible for computers to perform analytical calculations based on scientific information (such as meteorological and seismic data) and historical claims data to simulate the potential outcome of catastrophes such as hurricanes and earthquakes. Armed with this insight, reinsurance companies began to use the model outputs to better manage their books of business. While most property catastrophe reinsurers adopted the use of cat models after Hurricane Andrew, their widespread usage throughout the industry is much newer. “Catastrophe modelling has very quickly grown in importance from being something that was perhaps slightly peripheral only a few years ago to being at the heart of everyone’s insurance thinking,” says Lockton Companies LLP partner Adam Sayers. The influence of the models on a fi rm’s risk management will vary depending on how much catastrophe business it writes. “We have clients who purely write in catastrophe-prone areas like Florida. It’s their only sphere of operation; their catastrophe modelling is at the heart of
‘The use of cat models has made risk management vastly superior to what it was before’ David Spiegler, BMS Group
any dynamic fi nancial analysis (DFA) they’re doing,” explains Sayers. “For a more well-rounded insurance company it is only one component of the DFA, because there are all sorts of other things you need to throw into the pot.”
Setting the agenda While many (re)insurers and brokers have built their own in-house
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Special Report: Financial Modelling catastrophe modelling teams, the benchmark continues to be set by three independent fi rms: RMS, AIR Worldwide and EQECAT. “Virtually everybody uses the model outputs from RMS and AIR and others as the baseline from which they’re going to take their own views, so that’s why the huge changes that RMS 11 have thrown out so severely affect what companies can look to do,” says Sayers. The vendor models have become more sophisticated over time as improvements in computing are fed back into the models along with better data from catastrophes and the occasional leap forward in scientific understanding of major hazards. “In terms of the amount of data we are able to analyse, it’s grown by leaps and bounds even in the last several years,” says Lockton Re catastrophe analytics manager Jeff Tennis. “Models have become much more robust and much more refined at a much higher resolution than the models offered four, five or six years ago – it’s captured at such a granular resolution now it’s a much more refined model than what was previously offered.” Nevertheless, the models remain imperfect approximations of reality and are often unable to precisely predict the outcome of any given catastrophe. This is particularly the case when dealing with major events like the magnitude 9.0 Japanese earthquake and resulting tsunami, which hit the country’s northeast coast on 11 March. The event was so powerful it shifted Earth on its axis. Coming after last year’s magnitude 8.8 Chile quake it might appear such massive earth temblors are fairly common, but the reality is they occur infrequently and as a result modellers are forced to rely on patchy historical data in order to build a complete picture. “As events occur like the Japan earthquake we still see how much we really don’t know about catastrophe risk, in particular mega-catastrophes,” continues Tennis. “The classic example in the USA is do we really know what would happen if a moderate to severe earthquake occurred in the New Madrid seismic zone right in the central part of America? And the answer to that is no, we don’t, because the historic record is very short and very sparse.” By contrast, there is a wealth of information on hurricanes given their frequency. Each time a major landfalling disaster occurs, modellers are able to accumulate further understanding by analysing the claims data. “Fortunately, as these events occur we do get a better understanding of what we don’t know and what we need to start thinking about,” says Tennis.
It is precisely this sort of analysis that has led RMS to update its US wind model – an update which has come at a critical time for the industry, according to Tennis. “A perfect storm has come up where we have significant worldwide catastrophes occurring in Japan
‘Models have become more robust and more refined than the models previously offered’ Jeff Tennis, Lockton Re
and elsewhere, in the USA we have a weakening US dollar which could make the reinsurance spend for our clients more expensive, and we have a new updated version of the model which has dramatically increased loss estimates.”
Greater inland exposures The model used claims data from recent events, including Hurricane Ike in 2008 which penetrated much further inland than had been expected despite being a Category 2 storm. It was this and numerical weather prediction models that revealed an increased exposure for areas inland from the coast. “We have also done a lot of additional research on hurricane loss outside Florida – we had a lot of claims data in Florida from 2004 and 2005 – in particular in Texas with Ike,” explains RMS chief research officer Robert Muir-Wood. “We did a lot of digging into claims data – to see if lessons from a storm like Ike could have implications for other regions in the Gulf of Mexico or even up the East Coast.” The impact on insurers from this change could be profound depending on their portfolios. For those writing a lot of coastal business, their probable maximum loss (PML) under RMS 11.0 could actually come down. But most are expecting to see their PMLs rise. Muir-Wood notes that many reinsurers had already been making their own adjustments to model results having witnessed the inland penetration of storms such as Ike and Hurricane Isabel in 2003. “It may have come as a surprise to some people,” he says. “For others they have told us they had already made an adjustment to the model because they thought it was too low inland. The market is very diverse and a lot of the market doesn’t simply use the results that come out of models – especially
reinsurers. They tend to apply their own factors on top and sometimes those factors simply reflect worst case.” Sometimes model updates will show an enhanced view of hazard risk, other times the risk will come down as a result of new understanding. Each time it creates a buzz, as it has the potential to impact the level of capital or contingent capital companies are required to hold. “In 2009 we released our updated model for California earthquakes in which the results went down,” says Muir-Wood. “So we were quizzed quite strongly by reinsurers to test us about the evidence that the losses were going to go down and that was something quite hard for them to swallow. This time round insurers are rightly quizzing us to show all the evidence for why they’ve gone up. At the same time we have discussions with reinsurers asking whether they can now take all these extra factors off.”
Mid-year uncertainty With the impact of the updated RMS model still sinking in, clients are in the midst of trying to establish what it means for them and whether they will need to purchase more reinsurance or retrocession, or write less business. At the time of writing in late May there was still not much Florida business in the market as both clients and reinsurers were continuing to come to terms with the impact of recent catastrophes and RMS 11. “Just from standing still we’ve got clients in Florida who are looking at a 100% increase in their model outcome,” says Lockton’s Sayers. “So they have to take notice of it because their reinsurers will, and the reinsurers have to take notice of it because the rating agencies will. It’s something which hasn’t fed through the whole system yet but it will do.” “It puts them under tremendous pressure to buy a lot more reinsurance because if you’re buying to your 1-in-100 year loss then in most cases that will have significantly increased according to RMS 11,” he continues. “If you’re a privately held company, you’re not under any obligation to buy to those levels and you should look at the RMS model as one of the factors when you buy your programme, but nevertheless that’s the one that has got all the alarm bells ringing for a lot of companies.” GR
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Special Report: Financial Modelling URS managing director Patrick Grealy sets out the ingredients of an economic capital model that will see your business through the uncertain years to come
The magic number Why is it that when you are waiting for a bus, three come along at once? And that people say after two unfortunate events you should be careful because bad luck always happens in blocks of three? It seems that three is a number that has certain powers. As it happens, three is also the number of factors that property casualty modellers need to consider when seeking to develop a comprehensive economic capital model (ECM). This is especially true in the era of Solvency II.
Combine the effects of taxation, expenses, bad debt and multiple balance sheets and the economic capital model seems more complicated
Economic scenario generators So what are these three key ingredients? First, you need to have access to some way to generate the economic scenarios (ESG) that govern the movements of many of the fi nancial items that affect an insurance undertaking. When performing an ECM analysis (this is particularly the case in Solvency II) you need to model your opening balance sheet and also the balance sheet one year from now. For starters, the assets you hold now will certainly have different valuations in 12 months, and this will directly affect the free capital you have at that time. Interest rates, foreign exchange rates and equity and property values are likely to change during this period. Depending on your asset profi les (type, term, nature, currency and security) you need to be able to revalue these assets on the future scenarios that are created by a comprehensive ESG.
Adequate reserving Unless you are a brand new company with no prior liabilities, you will have during the past earned exposures that cause you to hold a reserve for unpaid claims relating to these exposures. In the history of insurance and reinsurance, the run-off of these liabilities – substantially larger than you reserved for in your opening balance sheet – has been the single largest cause of company failures. Therefore, you will need to be able to simulate how these liabilities will perform in future and see if your existing capital will be sufficient (at least with a very high probability) to keep you solvent until these liabilities are fully paid off. You will need to be
able to simulate the expected reserve in one year’s time and, therefore, what may have further eroded your capital.
And if you have future business that you are about to write, then you are very keen to ensure that this business is profitable, particularly when you take account of the extensive and complex reinsurance you might be considering purchasing to limit your exposure. Many people seem to have tools to model this latter aspect more so than the fi rst two. However, all three ingredients are combined and woven together, since changes to economic scenario generators and deterioration in prior year’s business can have a significant, simultaneous effect on your new business too. Combine the effects of taxation, expenses, bad debt and multiple balance sheets, and the economic capital model task now appears to be more complicated and involved than it might fi rst appear. So the next time that those three buses appear at the same time, remember that it doesn’t happen without a good reason. Patrick Grealy is a fellow of the Institute of Actuaries in the UK and is managing director of Ultimate Risk Solutions (URS) in Europe
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Reinhard Seitz The head of outwards reinsurance at Brit Insurance enjoys diversity in his work, but also admires those who maintain stability and old-fashioned values amid a rapidly changing industry
Reinhard Seitz has an axe to grind. Brit Insurance’s head of outwards reinsurance – a strapping German who loves tree-felling in his spare time – loathes reinsurers who rescind on contracts when the going gets tough. Formerly of Swiss Re, Seitz began his career with an apprenticeship at a health insurer in Munich. After completing his degree in economics, banking and finance, Seitz returned to the reinsurance industry and has never looked back. A 28-year insurance veteran, Seitz says it is challenging to keep up with the rapid changes in the industry, but this is also his main motivation for remaining on the outwards buying side. “The beauty of the reinsurance buying position in a fi rm is that you deal with all lines of business,” he says.
Q: PHOTO: YIANNIS KATSARIS
How would you describe the current pricing situation in the reinsurance market?
A: Following the 11 March Japan earthquake, the market is hardening in almost all lines of business. Mainly in property, but also in other lines. Overall, I see this as a good sign.
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How do you decide what to buy and how to structure your reinsurance programmes?
A: We have an overall strategy to use outwards reinsurance to manage risk, reduce volatility, control aggregates and create capital efficiency. Outwards reinsurance is a tool Brit Insurance uses to optimise its risk profi le. Q:
What, in particular, is important to your company as part of this process?
A: I would say the most important part is to manage the portfolio to comply with our set risk appetite and within our tolerance. The risk appetite matrix is the most important tool that we use. It forms part of our internal model and is what we use to manage the realistic disaster scenarios to keep within our stated tolerances. Q:
How has current pricing affected your buying strategy?
A: We didn’t buy more when the market was softening in the past two years. Our buying is not that reliant on pricing. Obviously it must make economic sense, but in principle we have to manage the volatility and get close to the decided risk appetite of the group. In a harder market, we get more premiums on the inwards side that allow us to spend more on the outwards side than in a softer market. The exposure could be the same in both soft and hard markets and that’s what I have to manage. Q:
How has your buying strategy changed post-fi nancial crisis?
A: It didn’t change. The strategy and philosophy has been more or less unchanged. Obviously we have looked more closely at our counter-party risk exposure and monitored the overall capital situation. But in our case it has been more or less stable over the post-fi nancial crisis period. Q:
What impact will Solvency II have on the purchase of reinsurance?
Solvency II will lead to a further centralisation of buying decisions. Brit Insurance did that two years ago by introducing a central buying position. That is my job, in fact. It is easier to
manage your risk appetite matrix if you have central buying, rather than divisional or fragmented buying. Also, I think the buying strategy will revolve around the internal model. For us, that will not mean a dramatic change. We could see changes to how credit risk exposure is treated. It might get slightly more weight.
How much premium do you cede to reinsurers?
A: Over the years it has been about 15% of our premium income. Q:
To what extent do you make use of alternative reinsurance structures such as catastrophe bonds?
A: We constantly monitor the market. When our Fremantle bond expired in 2010, we did an in-depth analysis of the market and compared the traditional versus the non-traditional products. In the end, it is a management decision if the risk that you take on with the non-traditional cover is worth the difference in price. It always depends on where you plan to use your non-traditional cover – in earnings protection or balance sheet protection. That is what drives the decision. Q:
What do you most look for in reinsurers?
A: Stability, continuity – just old-fashioned values, basically. The ability and willingness to pay. They really should be there when you need them. A example is that we had a programme in the market with two layers and we had quotes that expired on 11 March (the day of the Japan earthquake). One reinsurer decided to withdraw the quote, while the other stood by his quote and accepted that in a long-term, professional relationship that is how you deal with your partners. Q:
How is the success of your reinsurance purchasing measured?
A: Among other factors, it is usually measured by how close we come to our plans. But it is also important to have the best-rated companies on the panel. It is not just quantitative, it is also qualitative.
Q: What do you most look for in reinsurers? A: They should be there when you need them. In a long-term, professional relationship, that’s how you deal with your partners Q:
How did you become involved in buying reinsurance?
A: I came into reinsurance buying due to my position in underwriting. I was always involved in buying. Then, over time, I specialised. As a result of continuing specialisation, your box gets smaller and smaller in terms of lines of business. But the outwards reinsurance job offers so much variety. Q:
Describe your average day.
A: I might have a meeting on motor reinsurance in the morning. Then I may go and see marine brokers or reinsurers for lunch. I may spend time analysing speciality line exposures and deal with property reinsurances in the afternoon. It’s very diverse and that is what makes it so interesting. Q:
Who do you most admire in the insurance industry and why?
A: I admire the pioneers of the insurance-linked securities market – the people who introduced that to the reinsurance world. I think they brought a lot of additional capital to the market and also a different way of thinking about risk management. Q:
What do you do in your spare time?
A: Going into spring and summer, it is golf and gardening. In the winter, it is skiing and tree-felling in Bavaria. GR FIND OUT MORE ONLINE: BRIT ADDS FORMER PARIS RE CHIEF TO BOARD To read this article and for more on Brit, see globalreinsurance. com, or goo.gl/Zt6GN
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Winds of change 2011 has been nothing if not riddled with catastrophes, and all eyes are now on the upcoming North Atlantic hurricane season. Experts predict that serious damage is inevitable, so the market must hunker down in preparation. Mark Leftly reports
‘We can’t count on luck to get us through this season. We need to be prepared’ Jane Lubchenco, NOAA
La Niña has a rather prosaic Spanish translation, ‘the little girl’, for a climatic phenomenon that helps cause some of the most devastating hurricanes known to man. Sea-surface temperatures in the tropical Pacific slowly fall – once in the late 1980s once by as much as 4˚ – and easterly trade winds intensify. This affects the position and strength of the jet streams and, ultimately, these changes increase the chances of hurricanes hitting the USA and the Caribbean islands. There were fears last year that the Gulf of Mexico clean-up operation following the Deepwater Horizon rig explosion would be harmed by the development of La Niña. As it was, the impact in many US states was just a fiercely cold winter. However, the USA was lucky last year. Despite extreme hurricane activity over
the oceans, with Hurricanes Igor, Karl and Julia among those raging, the coast escaped being struck. Bar 2004-05, very few hurricanes have reached the shore, or ‘landfall’, as it is known in the trade. With experts expecting a pronounced increase in Class 3 hurricanes – those that have winds blowing at 111mph or more – this pattern is not likely to continue. After the Japanese tsunami and New Zealand earthquake, reinsurers are ploughing their way through the latest La Niña data as they try to mitigate losses in what could be a turbulent North Atlantic hurricane season (which runs from 1 June to 30 November).
Warning signs Early signals from meteorologists have not been encouraging. The US National Oceanic and Atmospheric Administration (NOAA) has forecast up
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Claims to 10 hurricanes, of which six could turn into those particularly violent Class 3 phenomena, well exceeding the current annual average of six hurricanes and two Class 3s during the season. “The USA was fortunate last year. Winds steered most of the season’s tropical storms and all hurricanes away from our coastlines,” NOAA’s administrator undersecretary of commerce for oceans and atmosphere, Jane Lubchenco, says. “However, we can’t count on luck to get us through this season. We need to be prepared, especially with this above-normal outlook.” An average hurricane season causes $10bn-$11bn of losses for the insurance sector. Every one in four years sees an above-average hit. After two years of no major hurricanes reaching the coast – just the dying remnants of those that had blown their course, such as the weakened tropical storm Bonnie that hit the Bahamas and Gulf Coast in 2010 – there is a 60% chance of the losses exceeding $11bn. Should the hurricane have the strength of the notorious Katrina in 2005, which devastated New Orleans and hit a major metropolitan area, losses could potentially be more than $50bn. With so many losses potentially in the offing, demand on reinsurers to provide cover will inevitably increase, with rates growing as a result. They will also have to be sure that the cover does not convert into further losses in what has been an extraordinarily eventful first half of 2011.
A storm in a teacup? In itself, however, a bad hurricane season would not greatly alter the reinsurance industry. Ratings group AM Best has gone as far as to say that any storm damage should not be a “material event” for the reinsurance market. What a slightly-above-average year of damage would lead to is a fi rming of rates, while a Katrina-like episode would lead to a hardening, according to Karen Clarke, the chief executive at risk management group Karen Clarke & Company. In its spring report, broker Bowring Marsh agreed that any further catastrophes could impact the overall market for reinsurance pricing. But the fi rming or hardening of rates is really only a subtle difference. What makes the potential of this hurricane season more worrying is how early in the year so many other catastrophes have occurred. “There are several factors, none of which on their own would be significant enough to change the market,” explains Clarke. “But after the earthquakes, the bad storms in the Mid West, the
tornadoes ... And if we do have significant hurricane losses, that adds up.” Marsh chief executive Nicholas Bacon is reported to have said that reinsurers will have to put more capital on their balance sheets to cover any potential losses. “Any future catastrophe losses this year are more likely to directly impair the capital positions of reinsurers than impact earnings, which could drive rates higher,” he argued. Dr Adam Lea is a research fellow at University College London and a scientist at Tropical Storm Risk, a forecasting venture between RSA Insurance, reinsurance intermediary Aon Benfield and claims management group Crawford & Company. He says: “The pre-season forecast is that [hurricanes] are 20%-25% above normal. This is not as active as last year, but I would still expect a couple of landfalls in the USA.” He adds that the damage is unlikely to be anything like the scale of the Japan and New Zealand devastations – “that would be incredibly exceptional” – but that the USA was unlikely to get lucky again.
Luck is running out Lea’s colleague, Professor Mark Saunders, has pointed out the storms cannot keep missing the USA. “If a major hurricane does not strike the USA in 2011, it will be the fi rst occasion going back to at least 1900 where six consecutive years have passed without such an event.” That’s a pretty stark statistic for any company that bases its whole business model on risk. Just as dangerously, it is felt that the industry hasn’t yet got a handle on the full impact of this year’s earlier waves of destruction. RSA group reinsurance director Alan Fowler argues that losses “to date are within the bounds of reinsurers’ plans and their estimates for the year”. However, with the full scale of losses in Japan in particular not yet known, it is perfectly plausible that the losses are still mounting. “The situation is unclear. Only time will tell,” Fowler concedes. One factor confusing the situation is that La Niña is starting to dissipate, though that may be too late for its effects to not be felt in the hurricane season. Professor William Gray of Colorado State University is widely regarded
A hurricane similar in size of Katrina could cost the industry
An average hurricane season causes
$10bn-$11bn of losses
as one of the doyens of hurricane forecasting. In a recent report, co-authored with scientist Philip Klotzbach, he came up with some bold figures: a 72% probability of the US coastline being struck, up from an average of 52% last century, and 61% chance of hurricanes tracking into the Caribbean, against a 42% mean. Reinsurers will have to take these warnings seriously, as the report’s authors make a good case for their accuracy. “Our new early April statistical forecast methodology shows strong evidence over 29 past years that significant improvement over climatology can be attained. We would never issue a seasonal hurricane forecast unless we had a statistical model developed over a long hindcast period that showed significant skill over climatology.”
Hurricane history That extensive database has also meant that Gray and his team have been able to plot a long-term trend that could see the likelihood of the hurricanes hitting the coastline significantly increase. In April, Gray warned: “We remain – since 1995 – in a favourable multi-decadal period for enhanced Atlantic Basin hurricane activity, which is expected to continue for the next 10 to 15 years or so.” This is technical speak for ‘things can only get worse’. The more hurricanes that form, the greater the risk that one reaches, and badly damages, a major urban area. There seems little doubt that insurers will have to get far more cover than they have in the past. In some states, they have even been mandated to do so by local government. For example, in the Sunshine State, insurers are forced to buy significant amounts of reinsurance protection from the Florida Hurricane Catastrophe Fund, known colloquially as the Cat Fund. That undoubtedly offers the opportunity of some big business for the reinsurance industry. But the increased prospects of damage mean that the situation could be perilous. Insurers and reinsurers will have to hope that the US’ extraordinary run of luck continues and bucks the history books. GR GLOBAL REINSURANCE JUNE/JULY 2011 31
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London Market Roundtable Peter Hughes
Left to right: David Matcham, Clive O’Connell, Paul Corver
City of changes In this year’s Global Reinsurance London Market Roundtable, seven industry experts gathered together to debate the idea of competitiveness amid shifting market forces and constantly changing regulation We live in the age of the global nomad. In order to succeed in an internationally competitive market, reinsurers are required to engage in a constant process of reinvention and rejuvenation. At the annual Global Reinsurance London Market Roundtable, held in the City of London’s iconic Dome Room, seven of the industry’s fi nest gathered to debate how best to tackle this market metamorphosis at a time of seemingly unrelenting economic instability. The panellists began by questioning the innate competitiveness of the London market. Barlow Lyde & Gilbert partner Clive O’Connell said London is not fiscally competitive, nor should it hope to be. “Its excellence comes from the excellence of the people and
LONDON MARKET ROUNDTABLE PRESENTED IN ASSOCIATION WITH:
skillset,” he said. “That is how it has to compete. There is no way London can hope to compete fiscally with the likes of Switzerland or Bermuda.” Litmus Analysis director Peter Hughes agreed with O’Connell, but added: “I think, on top of the people skills, the market needs to continue to seek ways to improve its efficiency. Efficiency is what will help it continue to thrive.” Oxygen Insurance director Hugo Gibbs said attempts to decentralise the market had proven difficult and often unhelpful. “By calling it the ‘London market’ we are creating our own hurdle anyway,” he said. “If we keep thinking about it as London, we are probably going to lose the game. We need to start thinking about what chunk of the global market we have. If we stay away from the London-centric idea, we will be on better footing.” But Philip Heitlinger, a senior consultant with PRO, argued that the real issue with the London market was that old habits died hard. “I think London is still viewed with suspicion by many companies in continental
Left to right: Hugo Gibbs, Michael Tagg
Europe who have had bad experiences in placing or writing business in it,” he said. “We have to guard against complacency, because there is not universal affection for the market.” Looking forward, O’Connell said London’s dominance would need to come from tapping emerging markets. “In future, the only way the market will create dominance is by growth,” he said. “And the only place to achieve growth, realistically, is in the developing world. That is where London has to step up to the mark and focus.”
Too taxing One matter that the panellists universally agreed on was that the UK government’s recent budget had not adequately addressed taxation issues, leaving the London market vulnerable to further domicile desertion. “The budget didn’t make any difference,” Gibbs said. “Simply put, we’ve lost many insurers to foreign domiciles over the past 10 years because of the level of corporation tax. It hasn’t come down enough to woo them back.” Heitlinger said the London market needed to actively tackle the issue. “More needs to be done to lobby the government to make sure the tax system is much more user-friendly,” he said. KPMG Insurance Solutions director Michael Tagg said tax reform in other domiciles may naturally return London
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London Market Roundtable to a state of competitiveness. “Some of the other jurisdictions we are competing against – the likes of Ireland and Switzerland – may be forced to raise tax rates and so they might see their fiscal advantages diminish,”he said, While criticism flowed thick and fast for the government in terms of tax reform, the seven panellists agreed that fi nancial regulation in the current form of the FSA has been effective. They pointed out, however, that it needed a modern makeover. International Underwriting Association chief executive David Matcham said: “I believe that, while it was a good regulator in its heyday, it has lost its lustre. It has become slow, unresponsive and confused about its own future, which is a shame.” Matcham was also critical of the UK government’s decision to abolish the FSA, splitting its powers into two different authorities, but he remains hopeful of a positive outcome for the market. “I still think it was a shame to do the split,” he said. “I don’t think that was the right decision. But our hope is it will be able to get its act together in future – to be co-ordinated and reduce the duplication. Otherwise it will never regain its lustre.”
Who wants perfection? O’Connell and Hughes agreed that while the success of the FSA could be measured by a virtually zero-failure rate in terms of insurer insolvency, its dogged determination to achieve perfection was harmful to the long-term success of the market. “I think we have a growing culture of blame and an expectation of perfection,” said Hughes. “It is a shame that we don’t seem to be able to accept that perfection isn’t really attainable. I don’t believe we can afford to manage organisations that will never fail.” For O’Connell, the dark side of perfection was the stifl ing of innovation. He said: “Perfection is not only unattainable; it is probably not desirable either, because without failure there is no chance for people to succeed. “What regulation can do is breed mediocrity. It won’t be attractive to entrepreneurial spirit. It won’t be attractive to characters that will really develop the industry. And, ultimately, it won’t be attractive to investors.” Gibbs concluded that attaining perfection would undoubtedly affect the competitiveness of the London market. “The unique selling point of London has always been its agility and its ability to adapt really quickly. The more you slow that process down with regulation, the less competitive we’ll be.” GR
Far left: Philip Heitlinger
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London Market Roundtable
Time to get tough Contingent commissions are refusing to go away and, for many, continue to undermine the market. The regulators’ hands appear to be tied, but can anything be done? The issue of contingent commissions has resurfaced in the London market. How big an issue is this, and what needs to be done?
suicidal deals done by brokers in order to win or retain business. It seems you either consolidate or die at the moment.
Philip Heitlinger: If this cancer is to be eliminated, this surely has to be a problem for the regulators to address, it can’t just be left to the market players to address. Solvency II regulations don’t address this issue at all. If we are to have a fair and transparent market, it needs to be addressed head on.
Philip Heitlinger: It is also about being more transparent about what added value the broker brings to the party. If the parties can agree in terms what the broker actually does – a way in which the non high value-added functions can be dealt with in a sensible way. Perhaps that would create more transparency.
Hugo Gibbs: The regulators did try, especially post-Spitzer. They tried hard, particularly in the States. But legally it wasn’t possible to ban contingent commissions because ultimately it is a contract between two people.
Peter Hughes: I also think there is a culture of secrecy in the market and this doesn’t help. They will spend a lot of time bringing in actuarial and creative minds to build new ways of thinking. But they keep them to themselves.
David Matrchum: And it’s for that reason the market association can’t do much. It is a commercial proposition between two adults. There is a review in the Intermediation Directive in Brussels that may result in some more draconian treatment. The fear there is that it may go too far and threaten the whole subscription market. Our greatest fear is these arrangements will cloud perfectly satisfactory arrangements.
Broker remuneration in general, where brokers take a cut of the premium rather than paying a client-agreed fee, has also come under attack. To what extent do you think there needs to be a reform of how brokers are paid?
Peter Hughes: Brokers are really struggling to make sense of their existence at the moment. I think this issue is a question of value. It’s about understanding how they price the value that they add. What strikes me is the London market has two key elements – Lloyd’s and the brokers. Lloyd’s brings something to the piece but it is the brokers who are the distribution arm for Lloyd’s. I think everyone in the London market owes it to the brokers to help them find a way of reestablishing a simple way of being able to survive and succeed. I don’t think that is being thought about and there is no acceptance that brokers add value to the market. Hugo Gibbs: At the moment, it is a rush to the bottom, which is quite scary. We’ve seen some
LONDON MARKET ROUNDTABLE PRESENTED IN ASSOCIATION WITH:
Hugo Gibbs: There is massive change going on already. The more commodotised the business, the more straightforward the contingent commissions. One big broker has stopped taking commissions on global wholesale business but of course that doesn’t mean they aren’t taking commissions on every individual contract – up to 25% on some of these deals. Yet they will hold their hand up and say they do not take commissions as a wholesale business. It’s more smoke in the mirror. Clive O’Connell: The need for brokers is different to what it was. What brokers need to do is not merely be transparent, but to ensure that people understand what they are charging and why. And they need to be upfront about the services they are performing. Once you have those set out in black and white, everybody knows where they stand. Peter Hughes: If we have regulation more heavily focused on capital, then we have a situation where organsations have to be more globally efficient. When insurance starts becoming a capital issue, it suddenly achieves a higher status in the organisation. It starts moving into the finance director’s space. This would mean the value that brokers add will be more readily seen by the people that matter and contracts will stop being based solely on price.
Soapbox Contingent commissions are an absolute cancer on our market and they need to be stamped out. They are the opposite of transparency. These fees are basically evidence of the insurance broking market not being able to adequately demonstrate their value to their client base. They are undermining their own value and are not being confident enough in their own skills. In my opinion, the only way you can promote a market is if you are 100% accountable for what you earn. A broker not being accountable creates mistrust. For me, mistrust is one of the biggest inhibitors to doing good business. Business is all about trust ultimately, because you need it to get a deal done. Brokers are just sucker-punching the market into complicity. Why the market itself allows it is beyond me because they are all powerful enough to say ‘go jump’. Though, having said that, Lloyd’s has been quite good at pushing back. It is a big issue and there is only one way to address it – just ban it all. The more you cloud and muddy the waters about revenues and earnings, the less trust is involved in the transaction and the less you can rely on your buyers to hold up the flag. A user-pay system would be much more enjoyable for everyone. What it comes down to is the inability of the broking community to express their value adequately. We have consistently undermined our own value as a market. And as far as I am concerned, anything that is going to make us less transparent is going to make us less competitive as an industry over time. Hugo Gibbs, Oxygen Insurance
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London Market Roundtable
Double-edged sword Solvency II may cause some companies to panic, but the London Market Roundtable panellists agree it will provide both opportunities and disadvantages. How can the London market strike a fruitful balance? Solvency II, which is due to come into force on 1 January 2013, presents a mix of unique opportunities and unique issues for the London market. The panellists debated at length the advantages and disadvantages of the new regulation, including perplexing resource shortages, issues with UK regulators and cultural idiosyncrasies. Barlow Lyde & Gilbert’s Clive O’Connell ignited the discussion by questioning whether London is helped or harmed by the new regulation. “The London market is not harmed by Solvency II in a competitive way because everyone else in the EU is suffering the same burden. In many ways, the London market is probably better prepared. It may be that London market players will have an advantage.” Litmus Analysis director Peter Hughes said looking for advantageous opportunities outside the London market will mean many insurers will benefit from a wealth of potential acquisitions in the European market. “We are looking at a period where some of these companies are going to have to reorganise. There is going to have to be some mergers and they will be looking to the London market for some solutions to their problems. I think London will gain from that.”
Foreign influence One disadvantage the panel discussed is how the regulators will deal with foreign branches within the market. KMPG’s Michael Tagg said: “The branch issue is a mainly London phenomenon given that it has about 55 branches in the market regulated by the FSA. This differentiates it from the rest of the European market. Many of these branches have US parents. I think it’s still undecided as to how the Solvency II regulations will impact on non-EU parents, particularly US parents. “The options for those companies will either be that the US parent has to comply with Solvency II or convert the branch into a company. But both of those cost money, time and effort,” Tagg added.
Insurers’ QIS5 resources Average resources used for QIS5 in person months: Actuarial
Large: Total QIS5: 10.4 months (QIS4: 5.4)
Medium: Total QIS5: 8.4 months (QIS4: 6.4)
Small: Total QIS5: 3.9 months (QIS4: 7.7) Source: FSA
Another area of concern is the perceived lack of resources required to effectively and efficiently comply with the upcoming requirements. “People do not have the resources to carry out all the necessary tasks,” said PRO Insurance’s Peter Heitlinger. “Some of which are very time consuming but very important, like ensuring granularity and integrity of data.” Heitlinger added that companies are reluctant to seek external help. “Many insurance companies like the idea of being self-reliant. They feel it is a bad mark against them if they need to go external for assistance. But I think that will change as panic rises.” Hughes added that the London market is struggling to fi nd balance. “The biggest problem for the London market is that their resources are being forced into Solvency II and the other plates in the company are spinning on the edge. I think they need to think how they can outsource the Solvency II work and bring in skills to help them.”
Skills are stretched But Hughes also argued that the notion of the London market suffering a skills
shortage is a fallacy. “I am perplexed by the claim there is a skills shortage. I did a survey last year and within a day I found 40 independent practitioners who said they can help with Solvency II issues. And their day rates weren’t particularly exciting. There is a pool of talent not being used.” Heitlinger disagreed with Hughes, adding that the skill shortage has hit regulators just as hard as the market. “The shortage of resources goes right through the market to the FSA. It is taking the FSA a long time to provide routine answers and I think it’s an indication of how stretched they are.” Heitlinger added: “I think there is a strong feeling out there that the FSA is gold-plating Solvency II. The FSA is being more zealous than the other EU regulators. That is an issue that needs to be addressed. Other regulators respond more easily to concerns expressed by their local insurers.” Randall & Quilter Investment Holdings head of captives and roundtable chairman Paul Corver said one reason the FSA may seem overzealous when compared with other regulators is because the UK insurance industry has embraced the new regulations so effectively. “The numbers for the QIS5 internal model applications show that in the UK there were 100 but in Germany there were four. Has the UK got itself into a pattern of gold-plating Solvency II? One hundred internal models, compared to four, seems an astounding amount.” Hughes said cultural differences make any comparisons unfair. “The British way of doing things tends to be to build something that you think might work and then give it a go, test it, refi ne it. The German culture tends to be to design something to the nth degree before they launch it. I think the ‘four’ might be misleading here. I am sure there are a lot of companies in Germany that are a lot further down the line than that suggests.” But Hughes said the London market shouldn’t lose sight of the big picture when it comes to Solvency II. “I think for every action in that direction there tends to be a reaction, which in this case is to do with the fight for real quality. I think for an organisation in a strict regulatory regime, you will tend to attract better business.”
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London Market Roundtable What impact could the Bribery Act have on the London insurance market? Peter Hughes, director, Litmus Analysis: “My problem with it is that it makes for a very serious world. Look at rating agent analysts, for example. They can’t even accept a sandwich lunch if it is the value of more than $20.” David Matcham, chief executive, International Underwriters Association: “The problem with the Bribery Act is that it is just another compliance area.” Hugo Gibbs, director, Oxygen Insurance: “It is going to make the industry so serious it will put people off. We want to make the industry attractive so it’s not helping.” Michael Tagg, director, KPMG Insurance Solutions: “It’s not really going to stop someone who wants to undertake bribery or accept a bribe. It may just turn out to be another layer of compliance that results in very little reduction in unsavory practices.” Paul Corver, ARC and event chairman: “Insurance has always been a relationship business so it will be hard if that element is taken away. Especially if our lunches become regulated.”
LONDON MARKET ROUNDTABLE PRESENTED IN ASSOCIATION WITH:
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London Market Roundtable
All change, please The London market’s aversion to technological advancement is only holding it back, agree the roundtable panellists. But why is it so important to change something that has so far worked just fine? It is not the strongest or most intelligent who survive, said Charles Darwin, but those who adapt best to change. Indeed, technology has successfully infi ltrated and revolutionised every area of modern business – except the London market. The oft-theorised ideal is for a single process trading platform across the market, with ease of usability for all involved. But taking ideals from theory to practice has proved difficult in the highly complex and stubbornly traditional London market. Roundtable chairman Paul Corver asked the panel for their thoughts on the reasons for the slow adoption of technology in the market and what measures can be employed to encourage further development. Oxygen Insurance director Gibbs began the discussion succinctly: “There is an aversion to technology in the insurance market.” Hughes agreed with Gibbs but pondered the reason for such an antipathy, asking: “Do you think there is a cultural inertia? There is a lifestyle that people in the insurance industry enjoy and want to keep.” Gibbs argued that if it works for the banking sector, why not insurance? “They managed to move to electronic trading. The lifestyle for them hasn’t changed but the dynamics in the market may have.”
Lloyd’s initiatives Lloyd’s corporation is the driving force behind technology initiatives in the London market. Below is a snapshot of the latest project statistics. The Exchange: Since its inception, 3008 messages have been sent through the Lloyd’s system. According to Lloyd’s, 28 brokers, 20 underwriters and all managing agents are participating. iPad pilot: Eight broking firms are participating in the programme to place contracts using the tablet computing format. The first electronic, fully placed contract via iPad, as well as the message exchange, took place in January 2011 using the Qatarlyst-owned RI3K programme. Claims Transformation Project: The first phase began in January 2010 with marine, property and casualty treaty lines involved. Only standard claims – under £100,000 ($163,000) – are being handled currently. Phase 2 begins in July 2011, with mid-tranche and complex claims (£100,000 to more than £5m) to be handled electronically. The aim of the programme was to improve efficiency by 25% but Lloyd’s reports an efficiency increase of 40% so far in 2011.
Different strokes But Hughes says the change that has occurred in the banking world may not be a desirable outcome for the insurance industry. “Banking seems to be a much more serious place than the insurance industry. And I don’t mean that in a positive sense.” Heitlinger said: “There is a strong resistance to technological change within the insurance industry, which you don’t find in the banking world. If you really want change, you are going to have to improve the calibre of people in the market. Until quite recently, you used to be able to get a job in this
market if you spoke well and had neat handwriting.” Speaking from the unique perspective of the International Underwriters Association, Matcham believes the answer is simple: the London market is not ready to adapt. “The whole trading situation as a single type of technology or a single process is way in the future. It’s too hard to do at the moment.”
Pushing progress However, as O’Connell said, if there is a will there is a way. “The fact that there are participants proves there is
a will there to change. What we have seen over the past 10 or 15 years has been an extraordinary leap forward. Contract certainty has improved. One thing it has eliminated is any jurisdictional disputes. There has been a massive step forward but there is a will to take it further.” Despite the best efforts of Lloyd’s, the avid embracement of technology for endorsements and for placing couldn’t be further apart. Matcham said: “Professional indemnity is the next class of business to experiment with endorsements. It will be interesting to see how that goes, but it is the placing world that is the difficult nut to crack.”
‘Banking seems to be a much more serious place than the insurance industry. And I don’t mean that in a positive sense’ Peter Hughes, Litmus Analysis
O’Connell argued the sheer complexity of reinsurance contracts is the reason the market is resisting placing technology, but Corver said there is a simple answer to the perceived complexity issue. “I think the placing situation is cured by having a set number of fields that are standard and therefore easily portable. But you are always going to need to have that attachment that needs to be thumbed through. It will be a mixture of those two.” Whatever the reason for the London market’s resistance to technology, the panel concluded the time to embrace change is nigh as this avoidance is causing London to lose fiscal traction in a globally connected marketplace. GR
LONDON MARKET ROUNDTABLE PRESENTED IN ASSOCIATION WITH:
38 MAY 2010 GLOBAL REINSURANCE
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Country Focus COUNTRY FOCUS
Russia has the potential to be a key global player and is ripe with opportunity, says Lauren Gow, but those looking to invest must be aware of the contrast between plans for stricter regulation and an enduring tradition of bribery and corruption
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Country Focus Reinsurers looking to invest in Russia should tread carefully. While the insurance ground in Russia is fertile, the business world as a whole remains largely unstable following decades of damaging corruption and government interference. Premium volume in Russia’s reinsurance market had been in steady decline over the past five years, according to Russian insurer SOGAZ’s deputy chairman, Alexey Leonenko, but the onset of the global fi nancial crisis in 2008 accelerated the process. “There are two main reasons for the decline in premiums in the market. The fi rst one is mass renunciation of operations on incoming reinsurance by primary insurers, mainly because of the lack of capital needed to obtain a licence. The second reason is the state struggle against pseudo-insurance, which in particular caused three companies from the top five to leave the market in 2009,” Leonenko says. Russian insurers have been facing a losing battle since the fi nancial crisis hit, with many suffering significant capital losses. A reduction of investment income due to the 2008 stock market crash left the Russian insurance market severely shaken, which Leonenko says meant some players in the market slipped into old, troubling ways, including tax evasion using non-existent insurance. But Lloyd’s director of international markets Jose Ribeiro is convinced the market’s dark days are behind it. “The Russian economy is growing strongly, which is a natural consequence of the commodities prices we are seeing worldwide. Russia is a big commodities exporter and increased interest in commodities from places like China has benefited Russia. As a result of this, the insurance market is also growing.” From his standpoint working immediately inside the market, Leonenko is skeptical about the insurance market’s growth post-2008. “One can hardly say that the insurance market has overcome the consequences of the crisis. The insurance market responded to the crisis later than other branches of the economy and will recover more slowly.” Despite Leonenko’s scepticism, recent figures from international accounting firm PricewaterhouseCoopers and Russian rating agency Expert RA show promising market growth. Premium volumes grew by 6.9% to RUB549bn ($19.6bn) in 2010, though average combined ratios remained unprofitable at 101.6%. The forecasted growth rate for 2011 is 12%-15%, with key growth drivers including a recovery of retail lending, increased manufacturing and increased demand for commercial insurance
policies following natural and industrial catastrophes in 2010 and 2011.
Under the table Old habits die hard, as Russia’s reliance on systemic corruption continues to be the main burden limiting the Russian insurance market’s growth, both domestically and internationally. But Ribeiro says corruption is commonplace in most emerging markets, including the other BRIC countries. “It is not an issue that is unique to Russia. There is corruption in Russia but many other emerging economies are also dealing with those issues.” One source, who wished to remain anonymous and has extensive insurance experience in Russia, says: “The way it works in Russia is that the state is allpowerful and it is the state structures that are corrupt. Nothing happens without the state’s approval. From the top down, the whole structure is utterly corrupt. They’re comfortable with it and that’s the way it has always been. That’s not something that you can change overnight.” On 31 March 2011, Lloyd’s stepped into Russia with both feet, launching SeaLine, its fi rst coverholder in Russia. Lloyd’s is working in partnership with Chaucer, Russian reinsurer Nakhodka Re in Moscow and Lloyd’s broker RFIB. Ribeiro admits Lloyd’s needs to tread carefully with the venture. “The business we see is from the local insurers and we don’t deal directly with local clients. Once we have an office on the ground, that will help us to understand those issues better. Once you understand them and know how
‘Insurance companies have no intention of destroying their balance sheet by paying claims corruptly. It is a professional system, once you have paid off the politicians’ An anonymous source
to deal with them, you can basically mitigate the impact of corruption. You have to be aware of it and have a model that allows you to understand how it works and keep away from it.” But the source says separating legitimate business from corrupt practices is not a simple process. “If you want to function there as a business,
you have to fi nd a way to get around it. If you open an office in Russia and you want telephones connected or a power supply, you have to pay someone off to get that done.” However, below this government level, the source says businesses function in a normal commercial way. “People think the whole place is the Wild East but it’s not like that at all. Insurance companies, for example, have no intention of destroying their balance sheet by paying claims corruptly. Loss adjusters and courts are used. It is a professional system, once you have paid off the politicians.” While Russia may be ripe with opportunistic fruit, the UK Bribery Act, which is due to come into force on 1 July 2011, will further restrict UK (re)insurers wishing to operate in emerging markets like Russia. Managers face 10 years imprisonment for any breaches by staff or subsidiaries. “When the Bribery Act comes into force – and we don’t know the effect of it yet – it is going to make it very difficult for anyone to do business with countries like Russia,” says the source, adding: “The corporation of Lloyd’s has decided to go in so it must have decided it can live with the consequences of UK legislation.” But Ribeiro doesn’t see any material
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The top ten insurers including Rosgosstrakh, SOGAZ and Ingosstrakh accounted for 57.8% of the general insurance market in 2010. Government initiatives to increase solvency and tackle insurance fraud reduced the number of insurers in the market by more than 100 in 2010. Population: 142.9 million GDP: $2.263 trillion GWP: RUB549bn ($19.74bn)
impact from the impending Bribery Act for Lloyd’s. “We only deal with the insurance companies and that business comes through global brokers, so the business that comes to us is already fi ltered.”
Stricter contol In March, the Russian government decided to merge the Federal Financial Market Services Agency (FFMSA) and the Federal Insurance Regulatory Agency (FIRA), in a move it says will “improve efficiencies”. Allen & Overy’s senior associate in Russia, Anton Mogilevsky, says the government’s decision demonstrates a growing interest in the industry. “The merging of the two regulators indicates there is now more interest from the government in the sector. There is going to be more focus on the insurance market as there is a lot of room for improvement. It is going to be more strictly regulated than under the previous single regulators.” Mogilevsky adds: “In some ways, it may be good for the market as the regulations will be more clear and precise. But from the other side, the supervision will be so strict the insurers will struggle to get away
with even minor violations.” Until recently, Russia was oversubscribed, with more than 1,000 insurance companies and 200 reinsurance companies. Ribeiro says a recent Russian government decision to align itself with European regulators by introducing more stringent capital requirements has helped to curb this issue. “There has been regulation to increase solvency capital in the Russian market and as a result of that, many have disappeared. The requirements were introduced to ensure the industry is robust and can deal with the risks they are handling.” Gradual improvements in the Russian economy, which are being sparked by a peaking interest in the country’s commodity assets, will in turn fuel growth to the insurance market. “I foresee opportunities in niche lines,” Ribeiro says. “There will be opportunities for international insurers in new product classes, in casualty certainly and possibly in renewable energy. There may also be opportunities in the technology sector as Russia is developing its own version of the Silicone Valley.” While the future of the Russian insurance market as a whole remains uncertain, pockets of prosperity are giving hope across the board. Leonenko agrees the recent regulatory changes have improved the market but even stricter controls are required if Russia is to become a global player. “It is crucially important that the government and state authorities pay much more attention to the industry. More purposeful and tighter control is sure to favour both quantitative and qualitative improvements in the industry,” he says. GR
Major exports: natural gas, oil, coal, wood and wood products and precious metals
Insurance market forecast RUB600bn RUB500bn
19.5% 16.2% 486
RUB300bn RUB200bn RUB100bn -7.5%
GWP (not including CHI) Share of commercial insurance GWP in total GWP
Insurance market structure forecast RUB180m
2009 2010 forecast 2011 forecast
163.3 RUB160m RUB140m RUB120m 101.8
24.7 21.8 21.4 8.3
L c e nc e nc e nc e nc e r g o s k s nc e i TP an a a a a r Ca ly r u r a u r su r su r su r C M su s b ns n n n n n M li ti em y i y i i fe i yi s s i l it c a e r t de n e r t i L a d e d r op c c i r op ab an Li A p y m al p n e r t i a io a ct nt erc iv lu ru Pr m t o s V m n Co Co o ot
SOURCE: EXPERT RA, FSSN, PWC
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Monty Boys will be boys: fasten your seatbelt for wood-chopping, guitar solos and some fruity language
While the onset of winter sends some people indoors with mulled wine and a good book, others – like myself – enjoy hitting the slopes of the Swiss Alps. But I have heard there is one German in the London market who enjoys an entirely different winter activity – tree-felling. Brit Insurance cedant Reinhard Seitz is a trained tree-feller who buys half a dozen trees in a Bavarian forest each year and personally chops his own fi rewood. As the Monty Python team would put it: “He’s a lumberjack and he’s okay ...”
As a long-time music lover, I was delighted to discover the insurance industry has its very own would-be star in the mix. Had fate turned a different way, Novae chief executive Matthew Fosh could have been at the top of the pop charts. I have heard that Fosh, a keen 12-string guitar player, was once in a band with two members of 1980s UK pop group Red Box – currently topping the charts in Poland. So if there are any drummers or bassists in the market, rumour has it Fosh might be looking to start his own band.
CAT’s got talent
One of the best (and sometimes worst) aspects of global travel is discovering what’s on TV in your hotel room. In May, catastrophe modelling firm EQECAT rolled into town for its annual conference and I had a coffee with my old friend, president Bill Keogh. I noticed he seemed tired, so I asked if it was due to the time difference (Keogh is based in New Jersey, USA). He quickly assured me it was his own doing. He’s a big fan of British television and had spent most of the previous night watching Britain’s Got Talent. Sorry mate, you missed the auditions this year. But there’s always next year.
Amazon delivery In the past few years, I’ve spent many a night in the beer halls of Leadenhall Market, pondering the consequences of the London market’s stubborn resistance to adopting new technology. It’s even had a hand in the misfortunes of adventurer Ed Stafford, the fi rst person to walk the length of the Amazon. Stafford thought he could do the trek in a year but only got half way in that time. Unfortunately, this was also the point at which his Lloyd’s insurance policy ran out – and although Stafford was equipped with a satellite phone and laptop, Lloyd’s was unable to renew it electronically.
Risk managers aren’t necessarily associated with all things risqué. But that didn’t stop former London mayor Ken Livingstone using some smutty language in his keynote speech to the Airmic conference in Bournemouth in June. I listened with a combination of horror and mirth as Red Ken took to the microphone at the annual conference, using the words “b****r me” and “b****cks” with gusto. Not sure what my fellow conference goers thought, but if I were organising next year’s Airmic, I’d be sure to invite Red Ken back – he was defi nitely the most interesting speaker in attendance.
If I were organising next year’s Airmic, I’d be sure to ask Red Ken back
In the driving seat Still on Airmic, I was intrigued by the latest development in the infamous poaching wars between the big brokers. But this time it wasn’t the usual story of an entire team being stolen from a rival fi rm. As I wandered through the exhibition, I did a double-take when I saw The Stig doing his bit on the JLT stand – the Top Gear icon was on Marsh’s stand last year. One Marsh executive later grumbled to me about JLT stealing its ideas. No doubt Aon and Willis will be left to fight over whose turn it is to have him next time round. Play nice now, guys. GR
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Uncovered: the systemic corruption – as well as the reinsurance opportunities – in Russia