CAS Special Interest SeminarThe Changing Insurance Market

Assuming New RiskAssuming New Risk

Moderator: Barry Franklin - Aon Risk Consultants

Panelists: Mark Ames - MMC Enterprise Risk

State of the Market Pre-9/11/01

• Prices Firming– Property, D&O, WC; Some pressure on excess liability

• Retentions Increasing– Property; Aggregates on multi-year multi-line covers

• Limits Challenged– Global Property seen as too high; D&O seen as too low

• Capacity Shrinking– Property catastrophe; Combined aggregate/ERM covers

State of the Market 9/11/01-12/31/01

• Prices Skyrocket– Initial estimates for all lines was 100%+, 200%+,...

• Retentions Increasing Substantially– Initial estimates for all lines was 100%+, 200%+,...

• Limits Unavailable– Particular issue for excess liability, aviation, WC, D&O

• Capacity Withdrawn– Reinsurance expectations, “knee-jerk” risk avoidance– Concern over war/terrorism exclusions, event triggers

State of the Market 1/1/02-Current

• Prices Higher, but Stabilizing– Some lines still >100%, but many more moderate

• Retentions Higher, but Stabilizing– Property, D&O and Excess Casualty most affected

• Limits Reduced– WC, D&O, Excess Casualty

• Cautious New Capacity– New Bermuda entrants; seen as “cherry picking” at times,

but providing some capacity and stability

$-

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

$7.00

$8.00

$9.00

$10.00

Co

st p

er $

1000

of

Rev

enu

e

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002?

Cost of Risk

1992-2000: RIMS Benchmark Survey Data2001-2002: Aon Risk Consultants Estimates

The Same Old Market Cycle?• Sharp increase in rates and coverage restrictions

follow years of declining prices;– Remember the “end” of cash-flow underwriting?

• Cooling economy and low interest rates reduce insurer investment returns;– Remember what Paul Volcker did before Andersen?

• Questions arise regarding industry’s ability to absorb emerging (mold) and re-emerging (asbestos) risks.– Remember pollution and asbestos (round I)?

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1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

Co

st p

er $

1000

Rev

enu

e

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

Cost of Risk - Estimated vs Fitted

Estimated

3% Trend

3.9% Trend

Something Completely Different?• Concurrent contractions in all segments;

– 1980’s was primarily a liability crisis

• Competing sources of “risk capital”;– Financial services convergence in 1980’s was Sears

• RRG’s, captives, finite reinsurance and other “relief valves” already in place;– Liability Risk Retention Act passed in 1986 – Captive usage has more than quadrupled since 1982

• Companies aware of risk bearing capacity– Fungible nature of risk more widely appreciated– Insurance viewed as a hedging tool, not an expense

More/Better Options

• Captives and RRG’s

• Finite Reinsurance

• Contingent Equity and Contingent Debt

• Multi-line, Multi-year Aggregate Covers

• Reserve Swaps

• Multiple Trigger Risk Transfer

• Global Markets

Companies Formed After 9/11/01

• Primus Guaranty, Ltd.

• XL Winterthur Excess Casualty Unit

• Endurance Specialty

• Davinci Re

• Axis Specialty

• White Mountains

• Hampton Re

Other Capital Added After 9/11/01

• Glencoe Insurance, Ltd.

• IPC Holdings

• ACE

• Partner Re

• Arch Capital

• Many more….

More/Greater Risks

• Greater SIR’s and Deductibles on All Lines

• Excess of Policy Limits Exposures

• WC Statutory Limits Unavailable/Expensive

• WC Insurers Avoiding Concentrations

• Terrorism Exclusions

• Global Economy == Global Risk Exposure

• K&R, D&O Exposures Growing

More/Better Tools & Resources

• PC Hardware & Software

• Monte Carlo Simulation & DFA

• Risk Mapping

• Catastrophe Models

• Benchmark Data

• Consulting Industry More Accessible

PC Hardware/Software

• Moore’s Law - speed doubles in 18 months

• History shows this to be fairly accurate from a research & develop standpoint - chip speed doubles every 24 months or less

• Micro-processor speed has increased by a multiple of over 600 since the IBM PC

• Gains in peripheral speed moves the effective speed cycle closer to 18 months

State of the Art PC - 1987

• IBM PS/2 Desktop• 80386 Processor• 20 Megahertz• 3.5” Floppy Drive• 40 Megabyte HD• Lotus 1-2-3• MS-DOS

State of the Art PC - 2002

• Dell Latitude C840• Pentium 4• 1.6 Gigahertz+• 3.5” Floppy Drive• CD-ROM Drive• 60 Gigabyte HD• MS Office/Excel• Windows XP

DFA/Simulation Analysis

Allows companies to fairly easily look at the impact of alternative risk retention, risk financing and risk transfer structures on…..

Program Comparison

$10.50

$10.55

$10.60

$10.65

$10.70

$10.75

$10.80

0.1% 1.0% 10.0% 100.0%

Cumulative Probability (log scale)

Ave

rag

e A

fter

-tax

EP

S

SI

Trad'l

Alt-1

Alt-2

After-t

ax EPS

After-t

ax EPS

Program Comparison

25.25%

25.50%

25.75%

26.00%

26.25%

0.1% 1.0% 10.0% 100.0%

Cumulative Probability (log scale)

Ave

rag

e A

fter

-tax

RO

E

SI

Trad'l

Alt-1

Alt-2

After-ta

x ROE

After-ta

x ROE

Retained Property Loss by SIR

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$14,000

$0.5 M $ 1.0 M $2.0 M $3.0 M $4.0 M $5.0 M

Per Claim SIR

An

nu

al L

oss

es (

$000

)

99%

95%

90%

70%

50%Retained Losses

Retained Losses

Risk-Return

Risk-Return

Tradeoffs

Tradeoffs

Insurance Program Risk/Return Options

-0.05

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

0.00 0.50 1.00 1.50 2.00 2.50 3.00

Increase in 90th %tile Risk ($M)

Exp

ecte

d A

nn

ual

Sav

ing

s ($

M)

Current

Alt I

Alt II Alt III

Alt IV

Risk Maps

Provide a means for companies to combine qualitative and “light” quantitative information on various risks, and make meaningful visual comparisons to prioritize risks for further analysis/action ...

N2

$1m

$10m

$25m

$50m

$100m

$200m

$250m

Low

High

S

E

V

E

R

I

T

Y

L1

O3

N1

O1

L3

N3

E3

L2

L2 L1

L1

F2 F1

F1

E2

E2

F3

F3L1

O2

E1

E1L4

Low

HighUninsured

Partially insured

Insured

F R E Q U E N C Y

Liability Risks

L1 Product Liability

L2 E & O

L3 Auto liability

L4 D &O

Natural Risks

N1 Earthquake

N2 Fire

N3 Contingent BI

Financial Risks

F1 Spark Spread

F2 Interest Rate

F3 Counter-Party

Operational Risks

O1 Forced Outage

O2 Information Security

O3 Rogue Trading

Employment Risks

E1 Benefits

E2 Workers Comp

E3 Employer’s Liability

Example of Risk Map

Likely

Moderate

Probability ofOccurrence

Unlikely

Remote

Insignificant Minor Moderate Major Catastrophic

Magnitude of Impact

3

2

AlmostCertain

1

CriticalHighMediumLowRisk Identifier

Companies Today Are Able to:

• Evaluate/prioritize risks using risk maps

• Measure and model the marginal impact of significant risks on financial results

• Construct innovative structures to optimize risk retention/finance/transfer options

• Insure non-traditional risks and take advantage of alternatives for treating risks that have traditionally been insured

Bottom Line

• Some risks are new - others just more “real”

• Risk transfer IS more expensive today

• The insurance pricing cycle is systemic

• Risk transfer might still be the best option

• Companies have many options available

• Don’t necessarily expect the current “hard market” to follow historical patterns