B / ISSUE FOURTEEN / SPRING 2008 / BENFIELD RESEARCH In this edition of B we take a look at the continues to loom large, but our analysis
innovative techniques for the assessment and suggests that, so far, contagion of the reinsurance
management of risk exposures provided sector is being contained. Looking ahead,
by EuroTempest and ExposureView. We review we have reviewed the 4th Quantitative Impact
underwriters’ response to falling reinsurance Study (QIS 4) which is currently underway
prices which could be described as ‘leaving and represents a milestone for the implementation
business on the table’. The global credit crisis of Solvency II in 2012.
The global risk management industry is particularly affected Likewise, it is critical to businesses that they understand their services and businesses that have exposure to wind risk e.g.
by windstorm events in Europe. Swiss Re figures indicate that exposure to expected weather events. However, the information distribution, emergency services, energy, telecoms, utilities,
between 1970 and 2007 severe windstorms were responsible required by businesses from a forecast is very different from leisure and retail.
for 75–80% of all European insured losses from natural or that needed to maximise public safety and awareness. Given
man-made disasters. Separately, a 2005 study by ABN AMRO, industry’s susceptibility to adverse weather events and the Seasonal outlooks for the 2008–2009 winter windstorm
which included losses from non-catastrophic weather events, wide range of potential impacts, many businesses require season will be available in the summer as the climatic indicators
concluded over 30% of total industry production in Denmark much more detailed and focused information than can be for the winter only manifest between May and July. As things
and the Netherlands is susceptible to loss from adverse gleaned from a generic weather forecast. stand there is no reason to believe that one average season
weather. Other ‘high-risk’ countries, i.e. those where 25–30% will be followed by another. 2005–2006 was extremely quiet
of total production is vulnerable to adverse weather included The innovative weather risk management service, EuroTempest, – only to be followed the next season by windstorm Kyrill – the
the UK, Spain, Italy, Sweden and Norway is able to provide not only analyses of the anticipated weather most damaging European windstorm for more than five years.
but, more importantly, quantitative probabilistic assessments And though there have been a number of notable damaging
On 1 March 2008 Windstorm Emma struck Germany, Austria, of the potential impact of the weather forecast on a specific events since the turn of the millennium it is now nearly ten
the Czech Republic, Poland and Romania, having first caused business. Throughout the 2007–2008 winter windstorm season years since the catastrophic serial events, such as Lothar
some minor damage in the UK, Belgium and the Netherlands. primary insurers using EuroTempest’s services were provided (USD7bn) and Martin (USD3bn), that characterized the winters
It was the most destructive European windstorm of the 2007 with accurate quantitative forecasts of both the number of of the late 1990s.3
–2008 winter season and led to 13 deaths. The total cost to claims and the total insured loss that they could expect from
FIGURE 1 – EUROTEMPEST FORECAST FOOTPRINT
insurers, could reach EUR1bn or more in claims. each expected windstorm up to five days before the storm
struck. Reinsurers using the service had access to alerts
Despite its status as the most damaging storm of the season warning them of severe winds and, soon after each event, an
Emma had a relatively low impact when compared against the assessment of Europe wide peak gust wind speeds at 2-digit
history of European windstorms, even of recent years. In fact, postcode level based on observations from approximately
total insured losses from the European winter windstorms of 1,700 weather observation stations as shown in Figure 2.
2007–2008 are not likely to differ greatly from those of a
typical season. By contrast, in January 2007, when windstorm The high level information provided by EuroTempest enables
Kyrill struck large areas of northern, central and eastern Europe much more informed decision making across all levels of a
it left 54 people dead or missing and estimated insurance business than can be achieved from a generic weather forecast. Peak gust wind speeds for windstorm Johanna 10 – 12 March 2008
losses for this one storm alone reached over USD6bn.1 In EuroTempest allows all levels of the claims management
January 2005, windstorm Erwin, which mainly affected the process to be more effectively managed, it enhances internal FIGURE 2 – EUROTEMPEST REPRESENTATIVE PEAK GUST SPEEDS
UK and Scandinavia, left 18 people dead or missing and communication and therefore external as well. Shareholder
contributed nearly USD2bn to a total seasonal insurance loss confidence can be boosted, and more active capital manage-
from windstorms of nearly USD3bn.2 ment can also be facilitated. Thus EuroTempest can assist in
minimising the impact of severe windstorm events on a
The 2007–2008 European winter windstorm season was, as business, its stakeholders and its customers.
mentioned, relatively benign and the initial months were very
quiet. Set against this backdrop the stronger windstorms, EuroTempest works closely with businesses to define and deliver
notably Emma and Johanna (which affected mainly the UK and precisely the information that will fit their requirements and
northern France on 10 March), generated a great deal of interest integrate seamlessly with their established decision making
both in the media and within the insurance and reinsurance processes. They can provide both windstorm warnings and Wind speed by 2-digit postcode for windstorm Emma 29 February
to 1 March 2008 based on observations from ~1,700 weather stations
industry. Though the media have been criticised at times this assessments of the impact of an event once it has happened.
season for being alarmist, particularly with respect to Johanna, The unique technology developed by EuroTempest is not only For more information on EuroTempest’s range
it is important that the general public are as informed as applicable to the insurance and reinsurance industries. of services visit www.eurotempest.com or email
possible of the potential risks posed by forecast weather. EuroTempest is also able to provide information to a range of email@example.com.
FRANK ROBERTS – EUROTEMPEST 1 Swiss Re, sigma 1/2008. 2 Swiss Re, sigma, 2/2006. 3 Ibid.
Creating a Clearer
A sophisticated exposure management tool which uses information to manage, analyse and evaluate claims, enabling The addition of Storm Tracker, one of the services of the
geographic information systems to create a physical picture underwriters to produce swift exposure evaluations in the Benfield-sponsored Tropical Storm Risk Group (TSR), will
of risks and their accumulations, ExposureView™ has been in wake of a major event. enable users to assess more accurately the potential threat to
use by US insurers since 2003. It is a system which enables their portfolios of tropical cyclones, so better placing them to
them to visualise the potential impact of catastrophe events In order to maximise the accuracy of their analysis using pre-plan such measures as where to deploy loss adjusters.
such as wind, terrorism or wildfire on their portfolios both ExposureView, underwriters can take a highly selective Founded in 2000, TSR offers a leading resource for forecasting
during and after an event. approach to retrieving data, far beyond class of business. the risk from tropical storms worldwide.1
Examples include the ability to isolate information on beach-
Originally developed to provide underwriters with real time front properties or those that are of a wooden construction The TSR scientific grouping brings together climate physicists,
updates on wildfires, the software has now become a valued type. The system’s current library of information includes a meteorologists and statisticians at University College London
underwriting tool and can be used with a wide range of data wide range of data including maps of hurricane wind speeds and the Met Office.
including personal and commercial property, auto business, from past events, footprints of past windstorm events, data
workers compensation risks and offshore platforms. on various US earthquake zones and also a terrorism target Available within 10 minutes of a public forecast advisory being
database. In addition, it can also be used to visualise the issued, the TSR forecast polygons to be incorporated into the
Key to ExposureView’s success is that it not only enables impact of Lloyd’s Realistic Disaster Scenarios. system include:
underwriters to plot and view all individual risks – whether Surface Wind Probabilities which map the likelihood, over
by street address or a specific latitude/longitude – but also Whilst the system’s Benfield-sourced library of hazard shapes the next 5 days, of being struck by one-minute sustained
overlays such information with ‘hazard shapes’ or polygons is currently mainly focused on US exposures, the system has hurricane (74+mph) or by tropical storm strength
that outline the boundaries of areas impacted by events. mapping availability for 63 countries. Users can tailor the (39+mph) winds;
system by incorporating their own libraries of hazard shapes. Forecast Wind Swathes which give, out to 120 hours lead,
Equally important, from an underwriting perspective, the Thus, the system has applications as a base from which the most likely forecast wind swathe;
system also enables insurers both to view specific risks and to insurers can build highly tailored exposure modelling tools, Surface Wind History which maps the regions affected by
see how potential new risks would fit with the overall balance which reflect the particular geographical priorities of their a tropical cyclone's one-minute sustained hurricane and
and underwriting limitation of existing portfolios. For instance, own businesses. tropical storm strength winds; and
where necessary, radius-based exclusion zones can be plotted Advanced Surface Wind History which shows the regions
in conjunction with specific risks, to ensure accumulation Following its success with US underwriters, ExposureView is affected by one-minute sustained winds of tropical storm,
limitations are maintained, e.g. when underwriting terrorism now being made available to a more international audience. cat 1, cat 2, cat 3, cat 4 and cat 5 strengths and also
risks. The map-based output from the system has also been As the first stage in this process, Benfield has established a maps regions affected by gusts, for up to three seconds,
highly valuable to claims teams for use in deploying adjusters London-based hub for the product which is working with a of between 40 mph and 190 mph at 10 mph intervals.
and managing and analysing claims. number of London Market companies on initiatives to enhance
the depth of their US underwriting data. While catastrophic events by their nature remain unpredictable,
One of the advantages of ExposureView, in addition to the greater sophistication in modelling and analysing their
system’s mapping capabilities, is that it enables underwriters, A further development of the system for 2008 is the addition impact is a key to ever more effective risk management for
at the touch of a button, to retrieve their data in spreadsheet of Tropical Storm Tracker’s real-time forecasts out to five days the insurance and reinsurance industry.
format. This facility provides instant access to the necessary lead on all active tropical cyclone systems worldwide.
JULIANNE JESSUP – BENFIELD RESEARCH 1 The TSR consortium is co-sponsored by Benfield, Royal & Sun Alliance and Crawford & Company. For more information, visit www.tropicalstormrisk.com.
Casualties of the subprime and credit crisis continue to therefore faced a problem when accounting rules require ABSs have included mortgage-backed (both commercial and
emerge and the insurance sector has not been immune. While assets to be marked to market. Prominent write-downs residential) and collateralised debt obligations (CDOs).
greatest damage has been done to the monoline financial include UBS (USD37bn), Merrill Lynch (USD23bn) and
guarantee insurers, a number of reinsurers have reported Citigroup (USD20bn).1 For the most part, exposures to subprime on the asset side of
write-downs on their investments. Claims notifications have the balance sheet of conventional reinsurers are negligible.
increased although, to date, many have been accommodated The subprime crisis has prompted the central banks to inject Figure 5 shows the subprime exposed investments as a
within existing reserves. billions of dollars into the money markets to improve liquidity. percentage of 2007 shareholder funds of selected European
The US Fed Funds interest rate has almost halved from 5.25% and Bermudian (re)insurers. It includes only those groups that
As defaults snowball in the US residential mortgage market in September 2007 to the current level of 2.25% as shown in have quantified their investments in this asset class. Holdings
the securitisation of these loans has highlighted the issue of Figure 4. of asset-backed and mortgage-backed securities are very
systemic risk across global financial markets. Insurers and small and mostly in the AAA or “super-senior” tranches.
reinsurers have exposure both as investors and as underwriters The knock-on effect of lower interest rates on investment
of professional indemnity and other business lines. income will be a feature of 2008 earnings. The commentary XL Capital, which has so far reported the greatest exposure of
below concentrates on the impact described in 2007 earnings nearly USD2.1bn or 20.7% of shareholder funds (SHF) and
Rating agencies have downgraded mortgage-backed and statements and can be viewed from the perspective of both approximately 5% of its total invested assets. Most of this
similar securities reflecting the impairment of underlying the asset and liability side of the balance sheet. (93%) was fairly equally split between first lien mortgages and
collateral. In the face of very limited investor appetite, new Alt-A mortgages, with the balance in second lien mortgages
issuance of mortgage-backed securities has slumped, as shown ASSETS and ABS CDOs. Regarding the latter two classes, CIO Sarah
in Figure 3. The trend has continued in 2008 with a year on year (Re)insurers have historically adopted a conservative investment Street commented “These holdings have been particularly
fall of 80% to USD45bn in the first quarter. strategy, restricting investments to traditional asset classes impacted by deterioration in the underlying collateral and as
such as fixed income, equities and property (real estate). US such we have recognised the unrealised losses in their entirety”. 2
The uncertainty surrounding banks’ exposure to subprime debt companies mostly hold the vast majority of their investments As of 31 December 2007, USD233mn or 60% of recognised
has created liquidity problems as banks have been reluctant in fixed income, while European companies have historically losses were associated with these two asset classes.3
to lend to each other. Credit to corporate borrowers has become had a higher allocation to equities and real estate. In recent
more restricted and expensive. Bear Stearns and Northern Rock years, many companies have increased their investment risk Max Capital’s exposure of USD54mn to subprime bonds and
are the most high profile casualties and a number of hedge appetite in response to falling interest rates, in order to USD49mn of Alt-A exposed securities represented approxi-
funds have also failed. generate higher yields. Allocations to corporate bonds have mately 6.5% of SHF. The company did not expect any losses
been increased and investment classes have been widened to from these investments. Axis disclosed exposure of USD211mn
Similarly, the secondary market in such investments has include assets such as private equity and so-called alternative or 4.1% of SHF to subprime and Alt-A mortgages through
virtually dried up, making it nearly impossible to establish a investments, such as hedge funds. Asset-backed securities investments but indicated that the majority were rated AAA
market value for investment holdings. Banks and others have (ABSs) have also become more commonly held investments. or had government agency backing.
FIGURE 3 – US ABS ISSUANCE FIGURE 4 – FED FUNDS RATE FIGURE 5 – SUB PRIME ASSET EXPOSURE
250% 5.5% 25%
% of 2007 shareholder funds
200% 4.5% 20%
150% 3.5% 15%
100% 2.0% 10%
50% 1.0% 5%
0% 0.0% 0%
M iss R
Amx C e
Ax lin pita
Pl nno lier
SC tinu er R
Va res Re
Ca is R
O m e
Source: www.abalert.com Source: www.newyorkfed.org Source: Benfield Research
ANGELA COAD – BENFIELD RESEARCH
FIGURE 6 – INVESTMENTS IN FINANCIAL GUARANTORS
Carrying value as at
Writedown/Realised loss 31 December 2007
Company Investment (USDmn) (USDmn)
ACE Assured Guaranty 73 392
PartnerRe Channel Re 98 0
RenaissanceRe Channel Re 152 0
XL Security Capital Assurance and Primus 770* 0
* Includes an estimate of USD100mn writedown on investment in Primus Guaranty, given disclosure
regarding fair value of Primus stock at approximately USD105mn as at 31 December 2007
Source: Benfield Research, company announcements
Subprime exposure on the asset side mainly relates to realised XL is potentially exposed to further losses from SCA as it LIABILITIES
or unrealised losses from the decline in market value of these guarantees certain subsidiaries of SCA in particular circum- (Re)insurers’ exposure on the liability side arises from:
investments. Accounting rules (including US GAAP and IFRS) stances. These would occur if first, the underlying guaranteed Financial guarantors facing losses related to impairment
require investments to be marked to market; value impairments obligation defaults on payments of interest or principal and of the underlying collateral in mortgage-backed securities;
which are deemed other than temporary have to be charged secondly, the relevant SCA subsidiary (either XL Capital and
to the income statement. In some cases, companies have been Assurance or XL Financial Assurance) fails to meet its obligations Liability claims (Directors and Officers (D&O) and Errors
forced to take a conservative approach, where the absence of under the applicable reinsurance or guarantee. The guarantee and Omissions (E&O)) against investment managers
a liquid market has made it difficult to establish a market value. applies only to business which was written prior to the IPO of and others, from clients who were inappropriately sold
SCA (August 2006) and concerns approximately USD75.2bn investments with exposure to subprime.
AIG, which suffered an USD11.1bn pre-tax (USD7.2bn after of net par value outstanding. CEO Brian O’Hara commented
tax) charge on 2007 results, emphasised the difficulties of this “Given that the large majority of topical exposures are post IPO, The exposure of conventional reinsurers to these risks appears
approach. These losses emerged from the net unrealized market and that SCA’s claimed resources were nearly USD3.5bn as of to be minimal. Most are not engaged in financial guarantee
valuation loss related to the AIG Financial Products Corp. September 30th, 2007, we continue to consider the probability reinsurance: losses here are likely to impact only the specialist
(AIGFP) super senior credit default swap portfolio but AIG of having to make any payments under the guarantee remote.” 6 financial guarantee insurers. XL Capital, as described above, is
stressed such losses are not indicative of the losses AIGFP may an exception as it reinsures SCA. Swiss Re has proved another
realise over time. The group explained that under the terms of Three class action suits have been filed in the US District exception because of its activities in credit derivatives, but this
these credit derivatives, losses to AIG would result from the Court against XL Insurance Ltd by shareholders who bought seems to be an isolated case as other reinsurers do not appear
credit impairment of any bonds AIG would acquire in satisfying SCA shares in a secondary offering of stock (June 2007) and to be active in this sphere. Swiss Re has taken a CHF1.2bn
its swap obligations. Based upon the most current analyses, shortly before. The shareholders allege that the plaintiffs pre-tax mark to market loss arising from its exposure to two
AIG declared that any credit impairment losses realised over failed to reveal that SCA was materially exposed to extreme credit default swaps which had been structured to provide
time by AIGFP will not be material to AIG’s consolidated risky securities relating to subprime real estate mortgages. XL protection for portfolios comprised of residential and
financial condition. Moreover, except to the extent of any such intends to “vigorously defend” the claims.7 commercial mortgage-backed securities. Swiss Re said
realised credit impairment losses, AIG expects AIGFP’s unrealised “unprecedented” ratings downgrades in October and “the lack
market valuation losses to reverse over the remaining life of Partner Re and RenaissanceRe, which owned 20% and 32.7% of any truly liquid market for these securities” precipitated
the super senior credit default swap portfolio.4 of Channel Re respectively, both wrote down the value of the write-down.8
their investments in the company to zero. They do not provide
XL suffered the largest write-downs for investments in any guarantees to Channel Re and are therefore limited in Losses on the liability side of the balance sheet from D&O and
affiliated entities which participated in business severely exposure to the extent of their written down investments. ACE, E&O may still be incurred. Shareholder class action securities
impacted by the subprime fallout. Security Capital Assurance which owns approximately 24% of Assured Guaranty, wrote fraud suits filed in the US law courts include 56 related to
(SCA) was written down to a zero value (as at 31 December down the value of its investment by USD73mn to USD392mn subprime.9 Figure 7 summarises the commentary provided in
2007) from a value of USD669.8mn (as at 30 September 2007) as at 31 December 2007. The write-down represented ACE’s recent 2007 results statements and conferences related to
and Primus Guaranty was also written down to a value of zero. share of the USD300mn derivatives mark-to-market losses business written in the areas of D&O and E&O, most of it
Scenarios of zero had seemed until recently “very far-fetched.”5 announced by Assured Guaranty. Similarly to PartnerRe and specifically in the Financial Institutions (FI) arena. Most
The extent of distress in the credit markets together with the RenaissanceRe, ACE does not guarantee any of Assured companies have indicated that they anticipate any losses
pace of change has taken many by surprise. Guaranty’s business. from such business to be contained within existing reserves.
1 UBS, 2007 Annual Report and Investor release, 1 April 2008; Merrill Lynch 2007 Annual Report; Citigroup 2007 Annual Report. 2 XL Capital Earnings conference call, 6 February 2008. 3 XL Capital SEC filing 10-K. 4 AIG, press
release, 28 February 2008. 5 XL Capital Earnings conference call, 24 October 2007. 6 XL Capital Earnings conference call, 6 February 2008. 7 XL Capital SEC filing 10-K. 8 Swiss Re, press release, 19 November 2007. 9 Insurance
Information Institute, Catastrophes, the Credit Crisis & Insurance Cycle, Robert P. Hartwig, 26 March 2006. 10 Side A provides direct insurance of individual directors and officers, which is triggered if the corporation does not
or cannot provide indemnification to its directors and officers.
FIGURE 7 – SUBPRIME EXPOSURE
ACE Size of total D&O and E&O market premiums estimated at between USD3bn to USD4bn. ACE net premiums of USD143mn with average net limits of USD7.7mn
in D&O and USD3.2mn in E&O. Potential losses are reserved in 2007 loss ratios.
Arch US FI market estimated at between USD3bn and USD4bn. Arch exposures “not significant”. D&O exposure reduction began in 2005 and weighted more to
reinsurance than insurance. Exposure to top six D&O writers limited to one company. Estimated market share in these lines at between 0.4% and 0.8%. Total
insurance FI premium: USD89mn gross, USD46mn net with average limit of USD4.5mn and attachment of USD60mn in 2006, slightly less in 2007.
Aspen Exposure “very small”. A few contracts in international casualty reinsurance and one in US casualty reinsurance. Total exposure USD35mn in reserves, comprising
USD20mn additional reserves above the USD15mn expected level.
AWAC Established and expected loss reserve ratios are adequate to meet potential claims activity. Satisfied with “excess position” (i.e. XoL). Average attachment
about USD120mn on FI, and “a little bit less” on the rest of the portfolio.
Axis Subprime issues not believed to affect D&O portfolio or other professional liability book adversely. No exposure to large FI business and “very limited exposure”
to primary D&O and E&O writers of Fortune 500 companies. 2007 loss picks include “extra provisions”. Exposure manageable in FI area. Participated with
money centre banks on a Side A only basis plus high attachments.10
Beazley Group has limited appetite for professional liability risks within the financial institution sector. The number of claims from subprime related cases is in single
figures. Exposure remains within reserves and reserving philosophy is not anticipated to change.
Brit Industry loss estimated at USD6bn. Received notification from 25 insureds which may or may not turn into actual claims. GBP106.1mn gross reserve
(GBP62.5mn net) set up in respect of potential claims. 2007 gross premium income totalled GBP163mn from the classes of business affected.
Catlin Not a significant insurer in classes such as US D&O and FI that are particularly exposed to claims. The Group does not believe that it has significant exposure
to these types of claims and any losses are expected to be within normal expectations for incurred but not reported losses.
Chaucer Mortgage bankers still viewed as an attractive class with few loss notifications to date. A long-standing general avoidance of D&O exposures and a more specific
avoidance of subprime mortgage specialists. General avoidance of the large investment banks and US public D&O business should protect against significant
loss. However, potential professional liability losses have begun to surface in response to the related global credit squeeze.
Endurance Approx USD115mn premium in professional lines, split USD45mn (reinsurance): USD75mn (insurance). Approximately USD37mn of Insurance is FI related and
some USD5mn related to complex banks, about USD2-3mn D&O classes. Received a “limited” number of notices but not sufficiently developed to case reserve
Everest Additional USD13mn loss for subprime related exposures. D&O less than 5% of total premium. Reduction of D&O exposures began in 2005.
Hannover Re Subprime market loss estimated at USD3bn. Given falling rates in US casualty, especially North American D&O, group has reduced market share to 25% of
premium volume generated in hard market. Thus strain of subprime expected to be slight. Conservative reserves of EUR20mn established.
Hardy Exposure is limited with no D&O and only two US PI risks with smaller limits than the rest of the book thus the group feels relatively well placed.
Hiscox Very limited underwriting exposure which is fully reserved.
Max Capital “Significantly” reduced D&O insurance and reinsurance exposures in 2005. Estimate net loss reserves at USD8mn (insurance) and USD10mn (reinsurance).
No additional reserves posted during the year. Any future development will not have a “meaningful” impact owing to reinsurance and retro protection.
Montpelier “Minimal” E&O business. No D&O business written.
Munich Re Provision made within Corporate Underwriting/Global Clients Division for whole Group for the D&O and professional indemnity losses that could result from
the subprime loan crisis.
Novae Subprime claims have been limited as group withdrew from US liability reinsurance in 2002 and cut back direct in 2004. Contained in general provision.
Speciality division has reserved two claims connected with possible subprime issues.
PartnerRe Total US D&O market estimated at USD8.5bn (suggesting PartnerRe has 1.2% market share). Approximately USD105mn US D&O premium (USD145mn three
years ago) and approximately USD25mn NPW in Europe, together represent about 3.5% of W/W book. USD2.5mn average limit. USD1.168bn reserves for US
specialty casualty business (USD687mn for 2005-7). “Very comfortable” with containment of losses in established loss and unearned premium reserves.
Estimate US D&O “experience” at between USD6bn and USD10bn industry event. No estimate for E&O.
Paris Re No specific liability exposure mentioned.
Platinum Identified six treaties exposed to FI, all XoL basis with generally “quite high” attachment points. USD1mn average limit. Maximum exposure to any one insurer
estimated at USD6.5mn. Estimates worst case loss scenario to three of four accounting firms underwritten at USD30mn. Comfortable with reserve position.
RenRe Some casualty clash business, USD60mn event specific IBNR reserve posted in addition to normal IBNR for line. USD60mn represents a “significant portion
of limit”. Less than two dozen accounts.
SCOR No direct liability risks from monoline companies or subprime.
Swiss Re Since 2004 Swiss Re has materially reduced its exposure to D&O, E&O and professional indemnity business. Swiss Re thus has a low exposure to possible
liability risks from the subprime and credit crisis.
XL USD12mn average policy limit for public D&O. Side A only component is one third of GPW in 2007 and 45% by policy limit. FI business managed through
limited line sizes, higher attachment points, risk adjusted rate levels and greater use of Side-A only. USD270mn of coverage available in USD35 xs USD15mn
layer in professional lines R/I structure. 26 D&O claims or potential claims notices (9 primary, 17 excess policies) received by year end 2007 with three more
by early February. Total net limits associated approximately USD300mn (of which Side-A USD87mn). Assessment is that the lower level of attrition losses and
elevated clash losses are contained in loss ratios. For the period between 6 June 2007 (post secondary offering of shares) and 31 December 2007, XL incurred
case losses of USD300mn and USD51mn on a NPV basis for XoL and facultative reinsurance agreements related to subsidiaries of SCA.
Validus Some exposure to FI business written by Talbot (USD40mn). Small USD1.4mn D&O portfolio. USD14mn professional indemnity portfolio. E&O portfolio has
USD39mn in net limits risk. Portfolio “heavily reinsured” and carries “very high” IBNR percentage relative to total limits outstanding.
Leaving it on
“Hard market softening” was one of the more memorable as evidence that the soft market had not yet arrived, but of a for all lines except for Worldwide Specialty, which rose 6%
phrases used to describe the 1 January 2008 renewals. “hard market softening” as rates declined from a high base.5 due to strong new business volume. Catastrophe premiums
Underwriting discipline was again the watchword of the Patrick Thiele of PartnerRe commented that the market was were down 13% due to exposure to lower prices and smaller
season, and companies characterised prices as still technically increasingly competitive but still rational, which is characteristic participations. P&C premiums were lower on diminished new
adequate. A second year of low catastrophe losses meant the of a market in transition. 6 Swiss Re’s Jacques Aigrain expected business volume. The effect of these reductions was largely
downward drift of reinsurance prices was not in question, a the P&C market to remain challenging in the near term, but offset by new business gained from the acquisition during
trend which went beyond the Property Catastrophe class. added that margins were generally still “satisfactory”. 2007 of renewal rights to the international reinsurance book
With this the case, reinsurers said they had left large pieces of of the Groupe Monceau of France.
unattractively priced business “on the table” resulting in an The emphasis was on profitability over volume. Munich Re
overall decline in renewed premiums. reiterated its “less pronounced growth expectations” until 2010 An important objective of SCOR’s renewal was the successful
and, as at the last renewal, its focus was on profitability. The retention of former Converium business. In the event, 80% was
The six groups with a major European presence (Hannover Re, company said that so far, the down cycle had been more renewed. The overall business attrition rate for the enlarged
Munich Re, Paris Re, PartnerRe, SCOR and Swiss Re) echoed muted than some expected but emphasised it was continuing group was some 20%, which was in line with the projections
several of the main findings highlighted in Benfield’s Global to decline inadequately priced business. Munich Re said it left set out in the Dynamic Lift merger plan. Premiums in most
Reinsurance Market Review1: renewals were often late, amid over EUR250mn on the table in the US excess of loss market, lines were flat to down with some notable exceptions. Within
plentiful capacity leading to premium rate erosion across the in some Motor lines, and in Offshore Energy. the Global P&C division, Proportional Motor premiums rose
board. Common themes which emerged from the companies’ 7% due to stable or increasing primary rates in countries such
commentaries were: Figure 10 compares the premium growth reported by each as the UK and Italy. In Specialty business, Engineering volume
An adherence to strict underwriting and careful risk company, based on constant exchange rates. Munich Re and rose 22% due to the recapture of lost shares and to business
selection; Swiss Re, the largest players by renewal volume, experienced development in emerging markets. Agriculture premiums rose
A continuing trend away from pro-rata to excess of loss significant falls in premiums. 12% helped by increasing commodity prices and by “WTO
treaties; liberalisation”. Declines included a 9% fall in non proportional
Higher client retentions contributing to a reduction in Several factors contributed to Hannover Re’s relative out- Property business, driven by a 10% decrease in non proportional
premiums ceded; performance. Although the number of proportional treaties Property Catastrophe rates in the US, and a 5% decrease in
An overall decline in US Property Catastrophe premium continued to shrink, ceded premiums rose 4%, in contrast to Europe. Decennial premiums fell by 22% due, in part, to a less
volumes for the first time since 2004; and the general trend, driven by growth in German Property and favourable real estate environment in Spain.8
Broadly unchanged terms and conditions at renewal. Credit & Surety classes. This offset reductions in the excess of
loss book which was down 6% due to falls in Marine and Swiss Re was the only company to report a reduction on
Swiss Re CEO Jacques Aigrain summed up the mood when he Catastrophe business. business renewing which was attributed to disciplined under-
said the reinsurance industry was “faced with a softer part of writing and careful risk selection. It mentioned that because
the cycle in Property Casualty business”.2 Where companies Munich Re attributed its lower level of renewed premiums to it had declined large amounts of business, its average premium
did maintain premium volume, they generally did so through “underwriting discipline and cycle management”. Casualty rate reduction of 3% was markedly better than the market as
portfolio restructuring, or through higher exposure and larger business declined the most, with premiums falling 9% due to a whole where it noted falls of “up to 20%” were experienced.
participations. Against this background, Hannover Re and reductions in proportional business. In contrast to the general Prices achieved in non-proportional lines were said to be
Paris Re bucked the trend, reporting flat renewed premiums. picture, Marine premiums were higher with new business at above technical reference prices while proportional lines
Swiss Re’s renewed premiums declined 12%, while Munich Re the Watkins Syndicate at Lloyd’s an important contributor. achieved pricing which only just met technical requirements.
experienced a 4% fall. The contraction at Paris Re and SCOR Business was modestly down in other classes with a 5% fall Non-proportional Property, Accident & Health and Specialty
was limited to 1%. in Aviation attributable to lower fleet rates, and a similar margins were the strongest, while proportional Liability rates
reduction in Credit which was due to the restructuring and faced ongoing pressure. Proportional Property, Liability
The six groups renewed an estimated EUR18.9bn of business cancellation of two major participations. Property premiums and Motor rates were either at or slightly below technical
(based on 1 January 2008 exchange rates) representing over eased 2%. reference prices.
two-thirds of their treaty books as shown in Figure 8. Munich
Re and Swiss Re together accounted for 70% of the total, Paris Re, newly independent of AXA, found business Reinsurers have yet to report on the outcome of the important
while newcomer Paris Re’s presence was just 2%. Financial opportunities with cedants who might previously have been Japanese renewals at 1 April 2008. The trends of the January
strength ratings continued to be an important issue for cedants unwilling to reinsure with its predecessor AXA Re. renewals set the tone, and both reinsurers and cedants
with the most highly rated groups reporting advantageous Nevertheless, it applied the same underwriting criteria to anticipated further price declines. Benfield’s analysis revealed
terms, conditions and participations. Munich Re said some business generated by new clients and rejected technically that, in general, reductions were more modest than initially
cedants had accepted “private terms [and] private conditions inadequate business. Premium growth was strongest in Life, expected. Wind excess of loss rates were flat to down 10% on
to keep Munich Re on board”.3 Accident and Health lines which reflected increased writings a risk-adjusted basis in most cases, while earthquake rates
in emerging markets including the Middle East. Elsewhere, were off by 5–10%, also on a risk-adjusted basis.
The outcome of the renewals was an aggregate 5% decrease premiums generally declined. Credit, Marine and Aviation
in premiums as shown in Figure 9. This compares to effectively premiums fell by 5%. Property was down 3% and Motor and Notwithstanding challenging conditions in P&C reinsurance,
flat premium growth in 2007, adjusting for the effect of the Liability premiums were stable.7 the companies remain positive on the prospects for 2008.
GE Insurance Solutions acquisition by Swiss Re.4 Optimism is grounded in active cycle management and the
According to PartnerRe, premium rates continued to soften prospect of greater profitability from lower volumes of business,
CEOs were anxious to distinguish between a soft market and across most business lines “as was expected”, aside from as well as changes in business mix. Some have pointed to
a softening market. Willhelm Zeller of Hannover Re said there isolated pockets of increased demand and market turmoil the potential for reserve releases which will provide further
was almost no easing of terms and conditions and cited this such as US agriculture. Consequently, premium income fell support for earnings.
FIGURE 8 – PREMIUMS RENEWED AT 1 JANUARY 2008 FIGURE 9 – 2008 TREATY RENEWALS FIGURE 10 – RENEWAL PREMIUM DEVELOPMENT
100% Hannover Munich Paris Partner SCOR Swiss
Gross Premium Written
Decrease on renewal
Total portfolio post renewal
90% Renewing 100% 100% 100% 100% 100% 100%
5 6 1 Munich Re – 43%
4 2 Swiss Re – 27% Cancelled -23% -14% -18% -15% -12% -20%
1 3 Hannover Re – 14%
3 70% Renewed 77% 86% 82% 85% 88% 80%
4 Partner Re – 7%
5 SCOR – 7% Increase on renewal 0% 2% 0% 0% 1% -4%
6 Paris Re – 2% 60%
2 New/restructured 23% 9% 18% 14% 11% 11%
Total – EUR18.9bn 50%
Total estimated 100% 96% 100% 99% 99% 88%
Source: Company information, Benfield Research Source: Company information, Benfield Research Source: Company information, Benfield Research
LEWIS PHILLIPS – BENFIELD RESEARCH 1 Benfield Research, Global Reinsurance Market Review, Changing the Game, January 2008. 2 Swiss Re conference call, 29 February 2008. 3 Munich
Re conference call, 30 January 2008. 4 2007 figures include Converium as a separate entity and do not include Paris Re. 5 Hannover Re conference
call, 5 February 2008. 6 PartnerRe, press release, 24 January 2008. 7 Paris Re press release, 11 February 2008. 8 SCOR Global P&C 2008 renewal
results presentation, 13 February 2008.
QIS 4 Model Feedback
Solvency II represents a fundamental review of the existing would be expected once every 200 years). The SCR is calculated QIS 4 enables companies to propose a personalised catastrophe
Solvency regime in Europe, recasting 14 existing EU insurance using Value at Risk techniques, either in accordance with a calibration, based on their own business, and to calculate their
directives and aiming to establish a new, harmonised set of prescribed standard formula, or using a company’s internal personalised catastrophe scenario impacts. The catastrophe
capital requirements and risk management standards across model. All potential losses, including adverse revaluation of personalisation can include partial or full internal model
Europe. assets and liabilities, over a 12 month period are assessed. The outputs – this is clearly an area where internal models could
SCR reflects the true risk profile of the undertaking, taking be used very effectively. QIS 4 allows firms to make use of
Between April and July 2008, the Committee of European account of all quantifiable risks as well as the net impact of commercial catastrophe models for relevant classes, where
Insurance and Occupational Pensions Supervisors (CEIOPS) will risk mitigation techniques. such models are available.
undertake the 4th Quantitative Impact Study (QIS 4) exercise.
This constitutes a key milestone in the Solvency II process, QIS 4 uses a modular approach (Figure 11) where risks are Assessment of the effect of reinsurance treaties on the non-life
and, with the final implementation date set to be 2012, it will combined using correlation matrices with defined correlation catastrophe risk exposure is based on a twelve month period.
most likely be one of the last quantitative impact studies. coefficients. The SCR calibration with a 99.5% confidence level over this
one-year time horizon is likely, for most firms, to include the
Following the publication of the QIS 3 report, CEIOPS has One of the most significant changes in the Draft Directive is the occurrence of a series of catastrophic events. The impact of
developed QIS 4 technical specifications, focusing on issues that recognition of risk mitigation techniques such as securitisation separate retentions, reinstatements and associated costs on
appeared to be of greatest importance. In particular, QIS 4 will or financial derivatives. The new counterparty default risk the non-life catastrophe should be taken into account.
test the proposed linear approach for the Minimum Capital module under QIS 4 now explicitly encompasses securitisation
Requirement (MCR) and, taking into account QIS 3 feedback, and financial derivatives together with traditional reinsurance DISCOUNTING
CEIOPS has proposed a new treatment for intra-group arrangements and receivables from intermediaries. However, The revised technical specifications (31 March 2008) prescribe
participations and geographical diversification. The linear there are a number of risk mitigation instruments and structures that the risk free rates are derived from swap rates. This is a
approach proposed for the calculation of MCR in QIS 4 that are not fully captured in QIS 4, for example umbrella welcome change from the first draft of the QIS 4 specifications
simplifies the modular approach tested in QIS 3, with a renewed reinsurance and multi-line covers cannot be incorporated in where risk free rates were based on AAA rated government
emphasis on simplicity. It is based on a percentage of technical the lines of business view within the non-life premium and bonds. As the swap curve is the reference curve against which
provisions, with some reference to volume measures. reserve risk area. financial institutions commonly value derivatives, the choice
of the government curve as a basis for discounting valuations
The number of life and non-life respondents to QIS 3, was 1027, QIS 4 HIGHLIGHTS would have introduced a fundamental disconnect.
representing an increase of almost 100% from QIS 2. The VALUATION OF LIABILITIES
expectation is that QIS 4 will represent an important check- The best estimate of liabilities will show the value of the REINSURANCE COUNTERPARTY DEFAULT
point for EU companies and that the participation will remain relevant cash-flows gross of reinsurance. The reinsurance asset The counterparty default charge has changed significantly
on QIS 3 levels or even increase. The following commentary is should then be adjusted to allow for the expected level of compared to QIS 3; in particular, the concept of loss given
based on the December 2007 technical specifications. counterparty default. The cost of capital method must be default is introduced. Reinsurance arrangements, securitisation
used for the risk margin calculations, as set out in the Draft and derivatives and receivables from intermediaries are
Solvency II requirements are based on an economic total Directive. This calculation has to be made net of reinsurance considered separately. Following QIS 3 feedback, a factor of
balance sheet approach. This approach relies on an integrated and by line of business, with no allowance for any benefits of 50% has been included in the formula to allow for the fact that,
appraisal of insurance and reinsurance balance sheets where diversification. even in the case of a default, the reinsurer will usually be able to
assets and liabilities are valued in a consistent manner. meet a large part of its obligations. The reinsurance counterparty
CATASTROPHES default calculation could be time consuming, in particular in
The Solvency Capital Requirement (SCR) corresponds to the A simple factor method is allowed in those cases where no relation to financial derivatives, and the charge is still particularly
economic capital an insurance or reinsurance undertaking regional catastrophe scenarios are provided by the regulator. penal in respect of reinsurance ceded to companies that are
needs in order to limit the probability of ruin to 0.5% (i.e. ruin In addition to the scenario based approach (presented in QIS 3), unrated or BBB rated, as was the case under QIS 3.
PAOLA FONTANA – BENFIELD FINANCIAL MODELLING
FIGURE 11 – MODULES OF THE STANDARD SCR FORMULA
Adj BSCR SCR
SCR SCR SCR SCR SCR
nl mkt health def life
NL Mkt Health Life Life
pr fx lt lapse mort
NL Mkt Health Life Life
cat prop st exp long
Mkt Mkt Health Life Life
conc int wc dis cat
cat – catastrophe eq – equity mkt – market pr – premium/reserve adjustment for the risk mitigating effect of future profit sharing
conc – concentration fx – foreign exchange mort – mortality prop – property
def – default int – interest nl – non-life rev – revision risk
dis – disability long – longevity op – operational risk sp – spread
FIGURE 12 – MODEL USES FIGURE 13 – QIS 4
Key metric QIS 4 requirement
Pricing Risk measure Value at Risk (VaR)
Confidence level 99.5% (1 in 200 years risk of insolvency)
de Capital allocation
Time horizon 1 year
Key modules Operational risk, market risk, credit risk,
Reinsurance decisions underwriting risk (premium and reserves)
OPERATIONAL RISK CHARGE supervisory authorities with an estimate of the SCR determined Calibration test – The internal model must be calibrated
QIS 3 feedback called for a more risk-sensitive method. in accordance with standard formula. This stipulation covers using the risk measure and calibration level defined in
Nevertheless it is still based on a formula approach that uses a two year period following receipt of supervisory approval. the Draft Directive.
the greater of percentages of premium income and technical Use test – It is required that the model that generates the
reserves, with a maximum ceiling of 30% of the Basic SCR There are some obvious consequences of using the standard regulatory capital number is actively used in the manage-
(BSCR). For unit linked business the charge is now expressed formula. The standard formula parameters attempt to capture ment of the business. The internal model must be firmly
as a loading (25%) on the expenses figure. the risk profile of an average company; however the insurance embedded and play an integral role in risk management,
and reinsurance undertakings actually using it will be hetero- decision-making and capital allocation processes.
NON-LIFE UNDERWRITING RISK geneous in terms of size, business mix and jurisdiction. There
QIS 4 attempts to address geographical diversification may be situations in which the standard model does not APPROVAL PROCESS
benefits; however the diversification benefit allowed is limited. accurately portray the risk of a given company and also the The process for approval of internal models is challenging.
Companies are allowed to replace standard factors with formula may well contain conservative parameters. In addition, The UK’s Financial Services Authority (FSA) anticipates that a
undertaking specific parameters for both reserve risk and the standard formula does not capture the effect of some significant number of firms will seek model approval (either on
premium risk. This was strongly supported in feedback on QIS 3. reinsurance features, such as profit-sharing or umbrella, whole a full or partial basis) to allow them to use their own models
Non allowance of expected profit and loss was seen as a back- account and multi-line covers that cannot be incorporated in from the date of Solvency 2 implementation. Therefore, the FSA
ward step by many participants in QIS3 (QIS 2 had included the lines of business view of the non-life premium and reserve is starting to consider what implementation might look like in
allowance of expected profit and loss) and the exclusion risk areas. practice. As a next step, the Internal Models Sub-Group of the
remains for QIS 4. FSA Insurance Standing Group will carry on the discussion on
As a consequence, companies that have developed an internal Level 2 model approval criteria to feed into CEIOPS Internal
ASSESSMENT OF MCR model to determine their capital requirement could potentially Model Expert Group. Preparations for the approval process of
The linear approach proposed in QIS 4 simplifies the modular have capital charges lower than those calculated using the internal models will involve much further engagement with
approach tested in QIS 3. The new formula is based on a standard formula. firms over the next few years.
percentage of technical provisions, with some reference to
volume measures. In particular, given that some risk categories The QIS 3 report stated that only 13% of the participants in the GROUPS
(e.g. market risk) are not included in the calculation using the QIS 3 exercise provided internal model results, possibly due to The treatment of groups is of major significance. The under-
linear approach, the MCR will be unchanged regardless of lack of internal models or to some reluctance to share them. standing of group capital, group risks and group controls
any changes to investment strategy. The proposed testing Feedback on this area is sought again in QIS 4, on an optional should be an important additional part of the European
approach does not represent the final decision on the design basis. It is important to note that overall, the internal models supervisory framework going forward given that 50% of
of the MCR and options tested previously under QIS 3 are of non-life insurance companies produced significantly lower European direct insurance is written by the 20 largest groups,
not excluded. total SCR than the standard formula. The average reduction and given that they operate in a number of Member States
in total SCR was about 25%, mainly in relation to the non-life through different subsidiaries. QIS 3 was not overly successful
SIMPLIFICATIONS underwriting risk capital component. in collating useful information on Groups and CEIOPS felt
According to the proportionality principle, undertakings are that further feedback was needed in QIS 4.
allowed to use simplified methods and techniques to calculate Internal models can be customised to be a true reflection of a
insurance liabilities. The use of simplifications is not linked given undertaking’s specific risk profile, making use of the Groups are required to calculate group capital according to
to the size of the undertaking but to the nature, scale and company’s data and capturing the specificity of the under- four methods:
complexity of the risks supported. writing and risk processes in their entirety. Internal models Standard SCR formula applied to the consolidated
can successfully be used as a tool for internal risk management, group position.
MARKET RISK providing powerful insight into distributions of outcomes, Sum of solo SCRs.
No significant changes to the interest risk, equity risk and and forming the basis on which capital allocation decisions Sum of solo SCRs of each group entity adjusted for
property risk modules have been made in QIS 4. The correlation are made, and therefore become a significant competitive intra-group transactions.
matrix to aggregate the sub-models which constitute market advantage. Figure 12 illustrates the uses of an internal model. Group SCR on the basis of an internal group model
risk is unchanged from QIS 3, with a zero correlation assumed where used.
between equity risk and interest rate risk. The spread risk In addition, rating agency requirements increasingly include
module now covers all tranches of structured credit products incorporation of results of a company’s internal models. The LOOKING AHEAD
(e.g. asset backed securities and collateralised debt obligations Draft Directive lays down three tests that an internal model The industry has the opportunity to influence issues through
and credit derivatives) that are not held as part of a risk must satisfy: participation in QIS 4. In particular, the supervision and the
mitigation policy. A “dampener” formula is also tested as an Statistical quality test – The statistical test is essentially treatment of groups will most likely be an area where the
alternative for the global market equity risk with the objective about the statistical soundness of the modelling methods feedback from QIS 4 is significant.
of discouraging the selling of shares when markets are falling and assumptions, the completeness and accuracy of input
by reducing the capital charge for equity risk. data and the methods of aggregation. It is likely that the The implementation of a flexible and complete internal model
regulatory approval process will focus particularly on a will be the appropriate target for several companies. The
FOCUS ON INTERNAL MODELS firm's governance and controls surrounding the model. approval process for this will most likely be demanding both
The Draft Directive states that insurance and reinsurance Companies will be expected to undertake a regular cycle in respect of time and resources and will most certainly
undertakings may calculate the SCR using a full or partial of model validation that includes monitoring the perform- require significant interaction with the regulator. Establishing
internal model, as approved by the supervisory authorities. ance of the model, reviewing the appropriateness of the data systems and model design at the earliest possible
Undertakings using an internal model will also need to provide specification, and testing outputs against outcomes. stage will be fundamental to success.
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