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					BAC O N & WO O D R OW LO N D O N MAR K ET S E RVI C E S




Why are reinsurers so
charitable to UK motor
insurers?
Lecture to the Insurance Institute of London

A presentation by
Lis Gibson
11 October 2000



        BACON & WOODROW
        LONDON MARKET SERVICES
Why are reinsurers so charitable to UK
Motor Insurers?


   Why does the UK motor insurance/reinsurance industry
    exist?

   Is the industry really a “charity”?

   Insurance and reinsurance market results

   Who is to blame for this “charity”?

   Conclusions




BACON & WOODROW
LONDON MARKET SERVICES
Why does the industry exist ?


   Why do policyholders buy insurance ?

   Why do insurers write insurance ?

   Why do insurers buy reinsurance ?

   Why do reinsurers write reinsurance ?




BACON & WOODROW
LONDON MARKET SERVICES
Why does the industry exist ?
Why do policyholders buy insurance?

   As a legal requirement

   To smooth their cashflows
        Premiums every year vs massive cost in crash year

   To avoid their own ruin

   To make a profit
        ie. Fraud/opportunism




BACON & WOODROW
LONDON MARKET SERVICES
Why does the industry exist ?
Why do insurers write insurance?

   Meeting policyholders’ legal requirement for insurance

   To help policyholders smooth their cashflows

   To help policyholders avoid financial ruin

   To make a profit




BACON & WOODROW
LONDON MARKET SERVICES
Why does the industry exist ?
Why do insurers buy Motor XOL reinsurance?


    No legal requirement

    To smooth their cashflows

    To avoid ruin and protect solvency level

    To increase profits
         By efficiency of capital
         By arbitrage




 BACON & WOODROW
 LONDON MARKET SERVICES
Why does the industry exist ?
Why do reinsurers write motor XOL?

   No legal requirement

   To help insurers smooth their cashflows

   To help insurers avoid ruin and protect their solvency

   To make a profit




BACON & WOODROW
LONDON MARKET SERVICES
Is the industry really a “charity” ?

   Paternalistic view of insurers

   Mutual organisations

   Pooling of finances and risks of several in order to
    compensate the losses of a few

   Organised charity from the start ?
        Mutuals, cooperatives

   Where is the charity now ?
      Insurers are businesses – aim to make profits ?
      Affinity groups are modern-day charities ?
      Reinsurers behave like captives/mutuals owned by insurers?
        – or are they now trying to make profits ?



BACON & WOODROW
LONDON MARKET SERVICES
Insurance and reinsurance market results
Points about the cycle

   Reinsurance market has been less technically profitable
    than the insurance market

   Evidence that the reinsurance cycle lags the insurance
    cycle by about 2 years

   The cycle is about 9 years long




BACON & WOODROW
LONDON MARKET SERVICES
  Insurance and reinsurance market results
  Motor insurance market results: calculations


Underwriting Year              1993 1994    1995   1996   1997   1998   1999   2000   2001
Operating Ratio               99.1% 95.7% 102.0% 112.3% 119.8% 124.0% 117.0% 110.0% 105.0%

Base Rates y/e                5.5%   6.3%   6.5%    6.0%     7.3%   6.3%   5.5%    6.0%    6.0%
Investment Income             8.3%   9.4%   9.8%    9.0%    10.9%   9.4%   8.3%    9.0%    9.0%

Profit % Premium              9.2% 13.7%    7.8%    -3.3%   -8.9% -14.6%   -8.7%   -1.0%   4.0%

Capital Ratio                  50%   50%     50%     50%     50%    50%     50%     50%     50%

Insurance Return on equity    18.3% 27.4%   15.5%   -6.6% -17.9% -29.3% -17.5%     -2.0%    8.0%
Investment Return on equity    5.5% 6.3%     6.5%    6.0%   7.3%   6.3%   5.5%      6.0%    6.0%
Total Return on equity        23.8% 33.6%   22.0%   -0.6% -10.6% -23.0% -12.0%      4.0%   14.0%


 Operating Ratio = (Claims + Brokerage & Expenses)/Premiums



  BACON & WOODROW
  LONDON MARKET SERVICES
Insurance and reinsurance market results
Operating results in the motor insurance
market
                     140%




                     130%




                     120%
   Operating Ratio




                     110%




                     100%




                     90%




                     80%
                            1987   1988   1989   1990   1991   1992   1993   1994   1995   1996   1997   1998   1999   2000   2001




BACON & WOODROW
LONDON MARKET SERVICES
Insurance and reinsurance market results
Return on equity in the motor insurance
market

                                                                                                                 -30%



                                                                                                                 -20%



                                                                                                                 -10%

        1987   1988   1989   1990   1991   1992   1993   1994   1995   1996   1997   1998   1999   2000   2001
                                                                                                                 0%




                                                                                                                        Return on Equity
                                                                                                                 10%



                                                                                                                 20%



                                                                                                                 30%



                                                                                                                 40%



                                                                                                                 50%




BACON & WOODROW
LONDON MARKET SERVICES
Insurance and reinsurance market results
Results in motor insurance market

                        140.0%                                                                                -30.0%


                                                                                                              -20.0%
                        130.0%

                                                                                                              -10.0%

                        120.0%




                                                                                                                       Total Return on Equity
                                                                                                              0.0%
      Operating Ratio




                        110.0%                                                                                10.0%


                                                                                                              20.0%
                        100.0%

                                                                                                              30.0%

                        90.0%
                                                          Operating Ratio                                     40.0%
                                                          Total Return on Equity

                        80.0%                                                                                 50.0%
                                 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001




BACON & WOODROW
LONDON MARKET SERVICES
  Insurance and reinsurance market results
  Motor XOL reinsurance market results:
  calculations

Underwriting Year                                      1993   1994   1995   1996   1997   1998   1999   2000   2001
Operating Ratio                                      136.0% 126.0% 117.0% 118.0% 123.3% 129.0% 135.0% 140.0% 130.0%

Base Rates y/e                                          6.0%            6.0%             6.0%            6.0%             6.0%            6.0%             6.0% 6.0%                        6.0%
Investment Income                                      35.0%           35.0%            35.0%           35.0%            35.0%           35.0%            35.0% 35.0%                      35.0%

Profit % Premium                                        -1.0%             9.0%          18.0%           17.0%            11.7%             6.0%             0.0%          -5.0%            5.0%

Capital Ratio                                           150%             150%            150%            150%             150%            150%             150%            150%            150%

Insurance Return on equity                              -0.7%           6.0%            12.0%           11.3%             7.8%            4.0%              0.0%          -3.3%            3.3%
Investment Return on equity                              6.0%           6.0%             6.0%            6.0%             6.0%            6.0%              6.0%           6.0%            6.0%
Total Return on equity                                   5.3%          12.0%            18.0%           17.3%            13.8%           10.0%              6.0%           2.7%            9.3%


 Operating Ratio = (Claims + Brokerage & Expenses)/Premiums
     Note: It is unclear the extent to which these ratios include full allowance for recent deteriorations due to the Ogden ruling. It is possible that some reinsurers have made fuller
                                                                                   adjustments than others.




  BACON & WOODROW
  LONDON MARKET SERVICES
Insurance and reinsurance market results
Operating results in the motor XOL
reinsurance market

                             150%



                             140%



                             130%
           Operating Ratio




                             120%



                             110%



                             100%



                             90%



                             80%
                                    1993   1994   1995   1996   1997   1998     1999      2000      2001




Note: The volatility of the reinsurer’s results is significantly impact by the exposure to potentially adverse reserve run-
off. E.g.the recent Ogden ruling could have resulted in 3 digit prior year reserve movement loss ratio impacts, against
current year earnings. These graphs only show UW Year volatility, and so understate the true revenue year volatility
significantly.


BACON & WOODROW
LONDON MARKET SERVICES
Insurance and reinsurance market results
Return on equity in the motor XOL
reinsurance market
         1993   1994   1995   1996   1997   1998   1999   2000   2001
                                                                        0%




                                                                        10%




                                                                              Return on Equity
                                                                        20%




                                                                        30%




BACON & WOODROW
LONDON MARKET SERVICES
Insurance and reinsurance market results
Results in the motor XOL reinsurance
market

                         150.0%                                                                             -5.0%



                         140.0%

                                                                                                            5.0%

                         130.0%




                                                                                                                    Total Return on Equity
       Operating Ratio




                         120.0%
                                                                                                            15.0%



                         110.0%


                                                                                                            25.0%
                         100.0%



                         90.0%           Operating Ratio
                                                                                                            35.0%
                                         Total Return on Equity


                         80.0%
                                  1993      1994        1995      1996   1997   1998   1999   2000   2001




BACON & WOODROW
LONDON MARKET SERVICES
Insurance and reinsurance market results
Long term operating ratios

   In the long term:

        Motor insurers run to operating ratios of 109.4% and return
         on capital of 5.7%

        Motor XOL reinsurers run to operating ratios of 128.3% (but
         this is lots more variable) and return on equity of 10.5%

   Insurers only long-term return comes from investment income on
    their capital

   Reinsurers also make a modest return from their trading, but
    their results are more volatile




BACON & WOODROW
LONDON MARKET SERVICES
Insurance and reinsurance market results
Comparison of operating ratio -
Insurance v Reinsurance companies

                        150.0%



                        140.0%



                        130.0%
      Operating Ratio




                        120.0%



                        110.0%



                        100.0%



                        90.0%
                                    Insurance Companies
                                    Reinsurance Companies
                        80.0%
                                 1993       1994          1995   1996   1997   1998   1999   2000   2001




BACON & WOODROW
LONDON MARKET SERVICES
Insurance and reinsurance market results
Comparison of operating ratio -
Insurance v Reinsurance companies 2 yr lag
                      150.0%


                      140.0%


                      130.0%


                      120.0%
    Operating ratio




                      110.0%


                      100.0%


                      90.0%


                      80.0%


                                      Insurance Companies
                      70.0%
                                      Reinsurance Companies

                      60.0%
                               1991/1993 1992/1994 1993/1995 1994/1996 1995/1997 1996/1998 1997/1999 1998/2000 1999/2001
                                                        Insurance / Re insurance Unde rwriting ye ar




BACON & WOODROW
LONDON MARKET SERVICES
Insurance and reinsurance market results
Comparison of return on equity -
Insurance v Reinsurance companies


                                                                             -30.0%



                                                                             -20.0%



                                                                             -10.0%




                                                                                      Return on Equity
        1993     1994      1995    1996   1997   1998   1999   2000   2001
                                                                             0.0%



                                                                             10.0%



                                                                             20.0%



                                                                             30.0%
           Insurance Companies
           Reinsurance Companies
                                                                             40.0%




BACON & WOODROW
LONDON MARKET SERVICES
Insurance and reinsurance market results
Comparison of return on equity -
Insurance v Reinsurance companies 2 yr lag

                                                                                                    -30.0%



                                                                                                    -20.0%



                                                                                                    -10.0%




                                                                                                             Total return on equity
        1991/1993 1992/1994 1993/1995 1994/1996 1995/1997 1996/1998 1997/1999 1998/2000 1999/2001
                                                                                                    0.0%
                         Insurance / Reinsurance Underwriting Year


                                                                                                    10.0%



                                                                                                    20.0%



                                                                                                    30.0%
              Insurance Companies
              Reinsurance Companies
                                                                                                    40.0%




BACON & WOODROW
LONDON MARKET SERVICES
Insurance and reinsurance market results
Are reinsurers being “charitable” ?

   Why is UK motor XOL reinsurance less profitable than it
    should be ?

        Because the insurance industry is also inadequately
         profitable?

        Perhaps the reinsurers are behaving like a mutual pool for
         the insurers?

   Who is behind this “charity”?




BACON & WOODROW
LONDON MARKET SERVICES
Who is to blame for this “charity”?


   Reinsurance underwriters
   Reporting delays
   Insurers
   Reinsurance brokers
   Insurance policyholders
   Actuaries
   Auditors
   The economy
   Society



BACON & WOODROW
LONDON MARKET SERVICES
Who is to blame for this “charity”?
Reinsurance underwriters

   Many casualty reinsurance underwriters are sophisticated

   … but are they all ?

   They do need to write something
        Pressure from employer/parent ?
        Try to reduce capacity when prices are low, but market
         forces are too strong
        Need to maintain relationships with insurers and brokers

   Long reporting delays don’t help


           “Blame the parents”
BACON & WOODROW
LONDON MARKET SERVICES
Who is to blame for this “charity”?
Reporting delays
   In most cases the claim is reported to the insurer within a
    very few months of the incidence of the claim

   Claims may be reported to the XOL reinsurer a long time
    after the exposure period

   Poor performance may not be recognised until a long time in
    the future
        … often delaying increases to premiums




BACON & WOODROW
LONDON MARKET SERVICES
Who is to blame for this “charity”? Reporting Delays
Reporting patterns for motor insurers
and reinsurers
                                     120%
    Proportion of claim s reported

                                     100%

                                     80%

                                     60%

                                     40%

                                                                        RI Pattern       Direct Pattern
                                     20%

                                      0%
                                            1   2        3          4           5        6            7
                                                Delay betw een accident and report (years)




BACON & WOODROW
LONDON MARKET SERVICES
Who is to blame for this “charity”?
Insurers

   They want the best deal when they buy
    reinsurance

   As a market they drive down reinsurance
    premiums when their insurance rates are low
    (2 year lag)

   Is this exacerbating the cycle and not
    actually in the insurers’ own interests ?




BACON & WOODROW
LONDON MARKET SERVICES
Who is to blame for this “charity”?
Reinsurance brokers

   Becoming increasingly sophisticated
      Use of modelling and actuaries

   Conflict of interest exists for brokers which
    affects their own income
       Insurers want a soft market and best rates
         available
       But brokers’ renumeration is related to the
         premium, so soft rates reduce the brokers’
         reward




BACON & WOODROW
LONDON MARKET SERVICES
Who is to blame for this “charity”?
Insurance policyholders

   Greater propensity to claim

        Exacerbated by media enticements to claim
        Increased blame culture



   Conflict between premiums and claims

        Policyholders want increased awards
        … but don’t want the higher premiums to pay for them




BACON & WOODROW
LONDON MARKET SERVICES
Who is to blame for this “charity”?
Actuaries

   Actuaries becoming increasingly involved in reinsurance
    pricing and reserving

        This should increase the consistency between the two

        … and in return dampen the cycle

        … and reduce the lag between insurers and reinsurers




BACON & WOODROW
LONDON MARKET SERVICES
Who is to blame for this “charity”?
Auditors

   The more reinsurers use reserve
    margins/releases to manage the cycle, the
    worse the cycle becomes

   Can/should auditors be curbing this?




BACON & WOODROW
LONDON MARKET SERVICES
Who is to blame for this “charity”?
The economy

   A fall in the reinsurers’ interest rate from 6% to 3%
    requires a 30% increase in reinsurance premium
    levels for profitability to be unaffected

   Arguably, the reinsurance prices available have not
    responded to the new climate of lower interest rates




BACON & WOODROW
LONDON MARKET SERVICES
Who is to blame for this “charity”?
Society


   Lags in implementation of rate increases to allow for
    society – driven changes

   Recent happenings in the real world
         Blame/Claim culture
         Higher expectations for settlement amounts
         Ogden judgement
         Court of Appeal Pain & Suffering judgement
         Woolf reforms – faster settlement/less investment income
         New Heads of Damage




           “Society is to blame”
BACON & WOODROW
LONDON MARKET SERVICES
Conclusion: charitable problems?


   Is the insurance/reinsurance industry a charity/mutual?

   Aren’t we all here to make money for our shareholders?
       Charity begins at home?




BACON & WOODROW
LONDON MARKET SERVICES
Conclusions
Duties of the market players


    Insurers                Reinsurers        Brokers


                         To their customers

                           To their peers

                     To their shareholders




BACON & WOODROW
LONDON MARKET SERVICES
BAC O N & WO O D R OW LO N D O N MAR K ET S E RVI C E S




 Why are reinsurers so
 charitable to UK motor
 insurers?
 Lecture to the Insurance Institute of London

 A presentation by
 Lis Gibson
 11 October 2000



        BACON & WOODROW
        LONDON MARKET SERVICES

				
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