APRIL 2011
JAPAN CATASTROPHE The full impact of the devastation
ONE TRACK MIND Cat risk models only go so far
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Validus’s Ed Noonan on fighting for what he wants and making $300m in one day
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Amid all the speculation about possible insured losses, it is easy to lose sight of the fact that a country lies devastated
Leader
Talk about the impact of the 11 March earthquake and tsunami in Japan pervades all corners of the (re)insurance industry. From underwriters and brokers walking between the Lloyd’s building and their offices, to delegates at the MultaQa Qatar event – held three days after the catastrophic event hit – the industry is discussing little else. Amid all the speculation about possible insured losses and whether the earthquake will harden the global market, it is easy to lose sight of the fact that a country lies devastated. Thousands of people have been confi rmed dead, and many thousands more are still unaccounted for. It is also worth noting that, as with the tragic events of 11 September 2001, the Japanese earthquake has struck the heart as well as the pocketbook of the industry. While the Tokyo offices of Japan’s mega-insurers are intact and their employees safe, some of the branch and support offices outside the capital have been destroyed, and employees, colleagues and friends of those in the offices are among the missing.
The conversations about losses and their impact are important. These issues are, after all, what the (re)insurance industry is there to deal with. The focus is also understandable, given the event’s timing – only weeks away from the Japanese renewal season on 1 April and in close proximity to the 1 June and 1 July renewals for Australia and the USA. But industry practitioners need to keep these conversations in perspective, and spare a thought for those who have suffered as a result of this catastrophe. There is also a lot of talk about the potential opportunities that could arise from such a big loss. While some of the focus will inevitably be on raising rates, the real opportunity for the industry is to show how good it is at its main function – paying valid claims promptly and supporting clients in the difficult months that follow. Ben Dyson Assistant editor Global Reinsurance GLOBAL REINSURANCE APRIL 2011 1
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April Michael Barber Q&A, page 22
G LOBAL RE I NSU RANCE.COM
Gagging the Twitter bird, page 24
Earth-shattering claims, page 26
News
Cedants
1
Leader
22 Q&A
4
News digest
8
News analysis
Sizing up the impact of the Japan earthquake
Lines & Risks
10 News analysis
Lessons learnt from the New Zealand quake
24 When tweets go bad
Insight into the business thinking of Aviva’s Michael Barber
Reinsurers can offer protection in
the evolving and increasingly risky world of social networking
12 News agenda
The downsides of catastrophe risk modelling
Claims
People & Opinion 16 Christopher Myers 17 Up the ladder
26 On shaky ground
New rules shouldn’t change the game
David Brown of Flagstone Re says this
industry is packed full of characters
18 True grit 32 Diary
Validus chief Ed Noonan on the deal of the decade
Sport, books, Indonesian fi res … all courtesy of Monty
Editor-in-chief Ellen Bennett Tel +44 (0)20 7618 3494 Email ellen.bennett@globalreinsurance.com
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Managing director Tim Whitehouse Group production manager Tricia McBride Senior production controller Gareth Kime Digital content manager Michael Sharp Head of events Debbie Kidman
Catastrophe claims have become all
too common – but that’s not made handling them any easier
Country Focus 28 Standing firm 30 Q&A
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Strong future for powerhouse Germany?
Norton Rose’s Eva-Maria Barbosa weighs up the market
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2 APRIL 2011 GLOBAL REINSURANCE
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News Digest New Zealand: earthquake takes its toll People
AON ANALYTICS BOSS TAKES TOP SPOT IN BRUSSELS Aon Benfield has announced that Jean-François Walhin has taken over as chief executive of its Brussels office, reported Insurance Daily. Walhin, whose appointment took effect from 1 March, was the fi rm’s head of analytics in Benelux and succeeds outgoing chief Bernard Suys. The role of Benelux analytics chief will be assumed by Jürgen Wielandts, who will focus on the fi rm’s regional analytical skills and capabilities and delivering high-quality services to clients. Aon Benfield Benelux chief executive Richard Dudley praised Suys’ achievements as Brussels chief and said Suys would help Walhin take up his new role with the fi rm. 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
CHRISTCHURCH LOSSES MOUNT A magnitude 6.3 earthquake hit the New Zealand city of Christchurch on 22 February, killing at least 166 people and causing extensive damage to property. JP Morgan Chase analyst Michael Huttner estimated insured losses could top US$12bn. >>> see News Analysis, page 10
ZURICH CHIEF JOINS ASPEN Aspen Insurance has appointed former Zurich global corporate chief executive Mario Vitale president of US insurance, reported Global Reinsurance. Vitale joins the Aspen group executive committee and will report to co-chief executive of Aspen, John Cavoores. Cavoores said: “Mario is a seasoned industry veteran, whom I have known for a number of years. I have tremendous respect for the breadth and depth of his knowledge and understanding of the insurance industry.” (goo.gl/olbhX ) NEW CHAIR FOR ENDURANCE Endurance Specialty Holdings has appointed William Bolinder board chairman, reported Global Reinsurance. Bolinder replaces Ken LeStrange, who resigned as Endurance chairman on 2 March. Bolinder has served as a member of Endurance’s board of directors since 2001 and as its lead director since 2006. (goo.gl/o4PVe)
Claims HANNOVER RE ESTIMATES $208M IN CHRISTCHURCH QUAKE LOSSES German reinsurer Hannover Re has reported that it expects to suffer a net loss of €150m ($208m) from February’s earthquake in Christchurch, New Zealand, reported Global Reinsurance. The reinsurer’s estimate has been based on an industry-wide insured loss figure of NZ$8bn to NZ$10bn – approximately US$6bn to US$7.5bn. Hannover Re said that even if the industrywide insured loss figure increases, Hannover Re’s loss expenditure will not rise thanks to its retrocession structure. (goo.gl/7Ttj5)
VALIDUS COUNTS COST OF CATASTROPHES THIS YEAR Bermuda based (re)insurer Validus Holdings expects a loss of between $25m and $50m from the most recent New Zealand earthquake, reported Global Reinsurance. Validus is basing its loss estimate from the most recent quake on an industry-wide loss of NZ$8bn to NZ$10bn – approximately US$6bn to US$7.5bn at current exchange rates. The (re)insurer added that it does not expect the aggregate losses from the catastrophes that have occurred so far this year to have a material impact in its shareholder equity. In addition, it expects to report positive net operating income for the first quarter of the year. Alongside the New Zealand earthquake, loss events so far this year have included the January floods and Typhoon Yasi in Australia, as well as civil unrest in the Middle East. (goo.gl/zvyJm)
PHOTO: CRAIG GREENHILL/NEWSPIX/REX FEATURES ILLUSTRATION: PATRICK BLOWER
BERMUDA ORGANISATION APPOINTS NEW BOSS Trade organisation Business Bermuda has elected Endurance chief executive David Cash as its new chairman, reported Global Reinsurance. Cash replaces Vicki Coelho, who has completed a two-year term. Cash will be responsible for working with Business Bermuda chief executive Cheryl Packwood to promote Bermuda’s international business offerings both on this island and around the world. Packwood said: “I am excited to work with David and build bridges between Business Bermuda’s members and the insurance community. A united effort from all international businesses in Bermuda will bring even more energy and focus that I am confident will yield great results for our entire jurisdiction.” (goo.gl/iJ6BT)
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News Digest HARTFORD BEEFS UP ITS CATASTROPHE PROTECTION Hartford Financial Services Group, the insurer that repaid a US bailout last year, is adding to the protection it receives through catastrophe bonds as investors seek to buy securities with higher returns, reported Bloomberg. The latest bond, sold on 15 February, provides $135m of coverage and pays five percentage points more than three-month Treasury bills, according to data compiled by Bloomberg. It matures in 2015 and protects Hartford against US hurricanes. The insurer, which is based in the Connecticut city of Hartford, issued a separate $180m catastrophe bond last year, also to protect against US hurricanes.
View from Insurance Times: M&A ‘Reinsurers must think of the risk and cost of insurance in new ways’ Christopher Myers, Aon Benfield
>>> see People & Opinion, page 16
Reinsurance GOLDMAN SACHS TEAMS UP WITH TPG IN CHAUCER MOVE A consortium comprising investment bank Goldman Sachs and US private equity form TPG is interested in buying Lloyd’s insurer Chaucer, reported the Daily Telegraph. City traders indicated that the consortium could pay up to 61p a share for the insurer, the newspaper said.
Capital SWISS RE ADDS TO CAT BOND Swiss Re has taken another $305m in protection from its Successor X catastrophe bond programme, covering North Atlantic hurricane and California earthquake risks, reported Global Reinsurance. The three-year deal is Swiss Re’s fourth takedown of the Successor X programme, after a bond for $150m in December 2009, a second for $120m in March 2010 and a third for $170m in December. Swiss Re head of non-life risk transformation Martin Bisping said: “Successor’s flexible shelf programme enables us to quickly move on favourable market conditions and secure multi-year protection.” (goo.gl/keJ5x)
HISCOX SLAMS BROKER PAY Hiscox chairman Robert Hiscox has slammed the practice of insurers paying brokers, describing competition for fees as “ridiculous”, reported Insurance Times. In a statement accompanying the Lloyd’s insurer’s 2010 results, Hiscox branded insurers giving brokers a cut of the premium as “a deficiency in the insurance market”. “This not only leads to conflicts, but also made clients believe they got the services of brokers for nothing. I just hope the issue will be resolved before a solution is imposed by the law or again by a crusading regulator.” (goo.gl/fob8r)
The height of the tsunami
It was surely meant to be like this: if RSA had taken over Aviva, it would have celebrated its 300th birthday perched at the top of the tree as the UK’s largest insurer. Instead, the City is awash with rumours that RSA could lose its cherished independence to a takeover from a rival. The latest speculation is that Zurich is interested in making a bid for RSA. Rewind a few weeks and there was gossip that Finnish giant Sampo was on the hunt. The white noise just will not stop. This is a classic example of what can happen when a company fails to take over its target. Investors start asking awkward questions: why did you need to make the bid in the first place? Is there a weakness in your business? So instead of RSA being a hunter, it is now seen as viable prey. RSA is fundamentally a very good business. It is performing well in a challenging UK market, is well placed in emerging markets, and is led by a strong management team. Testament to its strong performance is the fact that it is priced at 1.5 times net tangible book assets, against a market sector average of 1.1. Any business would have to pay a high price for RSA, at a time when the market is still soft. And let’s face it, could Zurich’s management, in the middle of its own UK clean-up operation, really improve RSA? Doubtful. Nevertheless, none of these considerations will stop the constant speculation about RSA being consumed by a bigger beast. Chief executive Andy Haste and the RSA management have opened Pandora’s box, and they don’t know what’s going to happen next. For more news and views from the general insurance industry, visit:
Filled colours show the maximum computed tsunami amplitude in centimetres during 24 hours of wave propagation. The contours show the computed tsunami arrival time. DATA: NOAA / PMEL / CENTER FOR TSUNAMI RESEARCH
.co.uk
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News Digest Japan: massive earthquake and tsun View from StrategicRISK: European risk management association Ferma has called for the revised European Insurance Mediation Directive (IMD) to include binding standards of transparency for brokers in their relationship with insurance buyers, no matter what the risk. Ferma’s demands came in response to the consultation on the revision of the IMD, launched by the Internal Market and Services Directorate General of the European Commission. In November 2010, Ferma and the European Federation of Insurance Intermediaries (BIPAR) signed a protocol on the transparency of intermediation in business insurance, which both federations recommend their member associations use. “The existence of this protocol shows the need to regulate relationships,” said Ferma. But although the protocol shows a consensus is possible between buyers and intermediaries, said Ferma, it is not binding and its application is left to the goodwill of BIPAR and Ferma members. The principles of the protocol should underpin relationships between brokers and commercial insurance buyers and be made mandatory, states Ferma. It added that an integration of the principles of the protocol into a binding instrument would be the appropriate response to the concerns raised by the Competition Directorate in its 2007 business insurance inquiry. “The review of the IMD represents a unique opportunity to incorporate undisputed standards of transparency into binding European legislation,” Ferma told the EC. Ferma’s 19 member bodies represent more than 4,000 corporate commercial insurance buyers in 17 European countries. For more news and views from the risk management industry, visit:
.co.uk
Reinsurance TOKIO GETS GREEN LIGHT TO WRITE IN AUSTRALIA The Australian Prudential Regulation Authority (APRA) has authorised Tokio Millennium Re’s Australian branch to write insurance business in the country, reported Global Reinsurance. Tokio Millennium Re Australia (TMRA), based in Sydney, has been capitalised with $80m of assets. It will produce property and casualty treaty opportunities in Australia and New Zealand, which Tokio Millennium in Bermuda will underwrite. All Australian business underwritten by Tokio Millennium will be bound by TMRA in Australia. “Establishing a branch in Sydney will allow us to work with our clients and brokers. We will gain a better understanding of their needs, the opportunities available to us and the risks involved,” said TMRA managing director Russell Brooke. “The region has suffered an unprecedented frequency and severity of losses. The timing of our approval will be mutually beneficial.”
‘Information can spread so fast and it is global. And once it is out there, you can’t remove it’ Marcus Alldrick, Lloyd’s
>>> see Lines & Risks, page 24
NEW YORK GRANTS XL REDUCED COLLATERAL Two of XL Group’s Bermudabased subsidiaries have gained approval from the New York Insurance Department (NYID) to qualify for reduced collateral status in the state of New York, pursuant to requirements of New York insurance regulation, reported Royal Gazette. The news gives XL Insurance (Bermuda) and XL Re a competitive advantage, as they will have to post collateral for only 20% of loss reserves rather than the 100% required of non-eligible non-US insurers. New York is the second state, after Florida, to lower collateral entry barriers to non-US insurers. To qualify, the NYID requires companies to be considered financially strong by credit rating agencies and other industry regulators, among other criteria.
FLORIDA EASES UP ON TOKIO The Florida Office of Insurance Regulation has granted Tokio Millennium Re the right to only post collateral equivalent to 20% of the risk it writes in the state, reported Global Reinsurance. Non-US insurers writing in Florida must typically post 100% collateral, but the state has been gradually relaxing this for certain reinsurers. Bermuda-based Tokio Millennium Re is the seventh non-US reinsurer to be allowed to post lower collateral in Florida. The changes follow legislation in Florida in 2007 to allow collateral requirements to be lowered for highly rated reinsurers. (goo.gl/wOFWf ) 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
PHOTO: AP PHOTO/THE YOMIURI SHIMBUN ILLUSTRATIONS: PAUL DAVIZ, MICHAEL CRAMPTON
The IMD
6 APRIL 2011 GLOBAL REINSURANCE
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News Digest unami rock Far East
DEVASTATION On 11 March, a 9.0 magnitude earthquake struck the north-east coast of Japan. The epicentre was 130 kilometers off the east coast of the Oshika Peninsula of Tohoku near Sendai. The earthquake triggered a tsunami, which devastated the island with waves up to 10 metres high. The country has suffered severe damage to roads, railways, properties and a dam collapse. The Fukushima Nuclear Power plant also suffered three explosions caused by hydrogen build-up in its outer containment areas. AIR Worldwide estimated that insured property losses will range from $15bn to $35bn. At the time of going to press, the death toll stands at 5,692 with a further 9,506 still missing. >>> see News Analysis, page 8
Results PROFIT DIP FOR LANCASHIRE Lancashire Holdings has turned in its results for the fourth quarter and year ended 31 December, reported Insurance Daily. Q4 net profits rose from $129.6m to $131.8m, with net operating profits up $1m to $123.4m; gross written premium fell from $103.4m to $94m and net written premium from $100m to $93.7m. Annual net profits fell by almost $55m from $385.4m to $330.8m. Fully diluted earnings per share rose on a quarterly basis from $0.69 to $0.76, but annually from $2.05 to $1.86.
HISCOX TURNS IN PROFIT DESPITE CAT-FILLED YEAR Lloyd’s insurer Hiscox made a profit after tax of £178.8m ($286m) for the full year of 2010, down 32% from the £280.5m it made in 2009, reported Insurance Times. Profit before tax for 2010 stood at £211.4m, down 34% on 2009’s £320.6m. Meanwhile, return on equity was 16.5% in 2010, compared with 30.1% the previous year. The dip in profits was in part caused by £165m in catastrophe claims as a result of the high number of events in 2010. It was also attributed to a 45% drop in the investment result to £100.2m in 2010 from £183.2m in 2009. “Mother Nature has well and truly tested us this year and a pre-tax profit of £211.4m is further strong evidence of the resilience of our business,” chairman Robert Hiscox said in a statement. (goo.gl/9hwCP)
SCOR REPORTS 13% UPLIFT IN ANNUAL NET INCOME French reinsurer SCOR has reported a 13% rise in net income to €418m ($580m) in its 2010 full-year results, reported Global Reinsurance. Gross written premium also rose for the group – up to €6.69bn from €6.38bn in the previous year. SCOR’s non-life reinsurance net combined ratio was 98.9% in 2010, in spite of major loss events during the year, such as Storm Xynthia in Europe, earthquakes in Chile, Haiti and New Zealand, and floods in Australia. For shareholders, return on equity remained flat at 10.2% year-on-year. SCOR chairman and chief executive Denis Kessler commented: “SCOR records very good performances in 2010 across all lines of business. The record net income of €418m enables the group’s management to propose a dividend of €1.10 per share, representing an increase of 10% compared with the previous year and an unchanged payout ratio.” (goo.gl/QQJvd) STRING OF CATASTROPHES LEAD OMEGA TO $43M LOSS Lloyd’s insurer Omega has made a loss after tax of $42.8m for the full year of 2010, compared with a profit of $43.6m in 2009, reported Insurance Times. The firm’s combined ratio jumped to 114.4%, and the company has decided not to pay out a fi nal dividend for 2010. It had already paid out 6 cents a share during the course of the year. The loss was caused by a series of catastrophe and large singlerisk loss events, including the earthquakes in Chile and New Zealand, the Deepwater Horizon oil rig explosion in the Gulf of Mexico, the Australian floods and the sinking of the Aban Pearl submersible. The company said the loss burden was exacerbated by price reductions putting pressure on margins. This was reflected in the increase in attritional loss reserves and the need to strengthen reserves in some areas. “Clearly this is a disappointing result, and one that must not be repeated,” said Omega chief executive Richard Pexton, who took the reins from Richard Tolliday in March last year. (goo.gl/jQDB1)
‘It’s not that easy to make $300m in a day, but we did that with the acquisition of IPC’ Ed Noonan, Validus Holdings
>>> see Profile, page 18 CHAUCER PROFIT SLUMPS 20% DESPITE GWP UPTURN Lloyd’s insurer Chaucer made a profit after tax of £22.5m ($36m) for the full year of 2010, down 20% on the £28.1m it made in 2010, reported Insurance Times. Profit before tax was £32.9m, down 22% on the previous year’s £42m, and the insurer’s reported combined ratio for the year increased to 99% from 93%. The profit reduction comes despite a 6.7% increase in gross written premium to £848.7m in 2010 from £795.6m in 2009. Chaucer’s UK business made another underwriting loss, posting a combined ratio of 106%. But this was an improvement over 2009’s 109%. Thanks to rate increases taken during the year for motor business, Chaucer said the underwriting year combined ratio for 2010 would be 98%. (goo.gl/uS4Gm) MUNICH RE PROFIT TARGET IN JEOPARDY German reinsurance group Munich Re’s 2011 profit target is in trouble, reported Insurance Times. The reinsurer reaffirmed its €2.4bn ($3.3bn) profit target for 2011 on 10 March, but said that this would only be achievable if major losses for the rest of the year came in below expectations. A day later, however, Japan was devastated by a 9.0-magnitude earthquake and the resulting tsunami. (goo.gl/RuJxz) GLOBAL REINSURANCE APRIL 2011 7
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News Analysis Japanese earthquake
A moving picture The true scale of reinsurance losses following the catastrophe in Japan could belie the horrors depicted in the media. Ben Dyson gets behind the headlines
After the initial shock of the 11 March earthquake and resulting The source also pointed out that fi shing vessels are typically tsunami in Japan, a clearer picture has started to emerge about the covered by a pool arrangement not insured in the private market. size of the global (re)insurance industry’s exposure to the event. Speaking at the MultaQa Qatar conference on 14 March, outgoing On the morning of that day, a magnitude 9.0 earthquake struck Aon Benfield UK chairman Charlie Cantlay said TV images could lead off the coast of northern Japan, causing severe shaking across wide the industry to believe it faced “an absolute monster of a loss”, but swathes of the country. The quake in turn triggered a 3 metre-high added: “The truth is we simply don’t know at this point.”. wave that slammed into the east coast of Honshu – Japan’s main Endurance chief executive David Cash said that while one or two land mass – swamping Fukushima, Ibaraki, Iwate and Miyagi catastrophe fi rms may fi nd themselves over-exposed to Japan and prefectures in particular. be forced to rethink their strategy, the effect on the wider global The event has clearly been devastating from a humanitarian (re)insurance industry would be more subdued. perspective. At the time of going to press, about 5,400 people had “I believe this provides some sort of support, for the global been confi rmed dead, with a further 9,500 thought to be missing. And reinsurance market: it is not a market-changing experience,” he judging by initial estimates, said. “The fact that this event which range from $10bn to is plausible and doesn’t cause Japan’s government earthquake scheme $35bn, total insured losses will us to think our models were JERC pays the first ¥115bn ($1.42bn). Losses exceeding this are paid by the Japanese government, JERC be in line with those from last defective is important. It and private insurers. JERC and the private insurers’ share of the losses reduces after ¥1.9 trillion. year’s Chile earthquake at best. allows the reinsurance market Liability of JERC Liability of insurance companies Liability of government It is also worth noting collectively to be a little more ¥115bn ¥1,925bn ¥5,500bn that some of the numbers stable than people imagined.” released to date, including That is not to say (re)insurers ¥905bn AIR Worldwide’s $15bn-$35bn can breathe a sign of relief. insured loss figure, exclude Much uncertainty remains. ¥115bn ¥3,396bn estimates from non-modelled The early loss estimate ranges ¥504bn ¥401bn events such as tsunamis and are wide and some have yet ¥89bn ¥89bn indirect business interruption. to factor in the implications of DATA: JAPAN EARTHQUAKE REINSURANCE However, international the tsunami. reinsurers’ share of the eventual AIR Worldwide said in its loss losses will be limited because the market structure will keep a lot of estimate that the tsunami was the “main event”. It plans to use Japan the risk in the country. Meteorological Agency tsunami wave data, and other information as A large proportion of the property losses are thought to be it becomes available, to estimate the tsunami loss. It will then issue a residential rather than commercial. Residential property policies combined loss estimate for the quake, subsequent fi res and tsunami. written by traditional non-life insurers are covered by the There are many other sources of potential loss and complication government-backed earthquake insurance scheme, Jisai. that are still emerging, such as business interruption and the The scheme provides ¥5.5trillion ($68bn) in cover, which the environmental liability impact of the explosions at the Fukushima government assumes, ceding a portion of it to the Japan Earthquake Daiichi nuclear power station. Reinsurance Company (JERC) and private market (see diagram, There is also the potential for aftershocks. Mitsui Sumitomo above). Crucially, Japanese insurers have to retain all the risk they at Lloyd’s – a division of Japan’s largest insurer, MS & AD Group – assume from the scheme, so cannot share the burden with reinsurers. warned on 16 March that the situation in Japan remained volatile and There are exceptions to this – policies written by foreign insurers there was a risk of further significant aftershocks. (which have a small market share) and co-operatives. These fi rms Understandably, many companies are shying away from putting are not part of the government earthquake scheme and can buy even a rough number on initial losses. While some tentative initial reinsurance in the private market. Some contend there will be an estimates have been released – ACE has put its losses at between agricultural portion to the losses, which could fi nd their way to the $200m and $250m – most company statements have said that it is too international market. early to say. While there will undoubtedly be commercial losses, a good Although some are sceptical that the Japan loss alone would be proportion of which could end up in the international reinsurance enough to harden the global reinsurance market, others believe the market, these might not be as bad as the news images suggest. psychological impact of the event – coming as it does after a busy 2010 One source, for example, mentioned that according to figures catastrophe year and a string of losses already in 2011 – will hit harder from the Japanese tariff association, the combined probable than the insured losses. maximum loss for cargo in the ports of the two hardest hit As one source told Global Reinsurance: “I would be surprised if prefectures was ¥6.4bn. there was no effect from everything that has gone on.” GR 8 APRIL 2011 GLOBAL REINSURANCE
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WITH SOME PARTNERS, IT CAN BE HARD TO SEE EYE TO EYE.
www.hannoverlifere.com
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News Analysis Christchurch earthquake
Think globally, not locally Too much reliance was placed on New Zealand’s own perception of its hazards, writes Lauren Gow. A better understanding of risk differentiation is imperative and international reinsurers must put up a stronger challenge to any assumptions being made
Reinsurers have taken a severe beating on the catastrophe front in on modern building codes when classifying overall risk. the fi rst quarter of 2011. Following months of flooding and cyclonic “The building code’s focus is to prevent loss of life, not loss activity in Australia, and severe winter storms in the USA and of property. In Christchurch, they had a lot of vulnerable buildings Europe, an earthquake in New Zealand was not what the market and not all buildings were up to modern building codes. A perfect ordered. This event also directly preceded the devastating March example of this was Christchurch cathedral, which was one of the earthquake in Japan (see page 8). fi rst to fall.” On 22 February, a 6.3 magnitude earthquake struck six Larson also says the industry should be concerned about the use miles south-east of Christchurch – the country’s second of unsuitable building materials in terms of assessing risk. “In a most populous city. At least a third of the city was reduced to pre-earthquake survey, about half of the buildings in Christchurch’s rubble. Catastrophe modelling company AIR Worldwide has central business district were unreinforced masonry. About 60% of reported that insured losses could those are now destroyed.” top NZ$11.5bn ($8.42bn). At the Muir-Wood agrees with Larson but Loss estimates for 22 February quake time of going to press the death adds there has been too much reliance toll stood at 166, with 118 people on New Zealand’s own perception of its Company Predicted loss missing. hazards. Munich Re $981.5m But rather than being one blow too He says: “When something is Swiss Re $800m far, analysts believe the Christchurch internationally reinsured, there needs to earthquake – the second to affect the be a greater challenge to the assumptions Everest Re $140m-$210m city within six months – could give being made by local scientific surveys Hannover Re $208m reinsurers valuable lessons in and where they get their understanding RenaissanceRe $190m risk differentiation. of seismotectonics.” Loss amplification is a major concern Earthquake modelling is Catlin $125m for reinsurers. RMS chief researcher undeniably complicated, but vital if ACE $115m Robert Muir-Wood says: “The the reinsurance industry is to profitably XL $70m-$85m issue is being exacerbated because classify risk in the region. Arch $35m-$70m Christchurch is built on a swamp. Larson says: “Differentiation The EQC [Earthquake Commission, is key when working with Lancashire $45m-$55m a government-owned entity that underwriters – you fi nd a model Validus $25m-$50m provides cover for natural disasters] that helps them understand good Endurance $45m promises to pay people for damage risk from bad risk and to price them to the ground underneath their accordingly.” Chaucer $30.5m property, which is highly unusual Muir-Wood says RMS has Alterra $15m-$20m for earthquake insurance.” been conducting experimental DATA: COMPANY REPORTS FIGURES SUPPLIED WERE CONVERTED TO US DOLLARS USING EXCHANGE RATES ON 18 MARCH 2011 According to Muir-Wood, the work into providing better models for reinsurance industry will bear the combinations of earthquakes, brunt of the commission’s unusual stance. “The EQC is going to go as opposed to single events. “We are aware there is a huge effect through its policy limits in a lot of cases, and more of the losses will if a reinsurer is hit by two earthquake claims in the same be passed onto private insurers who cover the excess. There is going contract period.” to be a different proportionality of loss passing to reinsurers between Better modelling will also reduce confusion when differentiating the EQC and the rest of the insurance market.” an aftershock from a separate event in contracts – a move sure Muir-Wood says there have been suggestions that people will be to please reinsurers. banned from rebuilding in some parts of the city, but he says this will “A lot of people assume that aftershocks don’t produce as much increase claims made against the reinsurance industry. damage as the initial earthquake, but aftershocks are often bigger “There is an estimate that about one-sixth of the population has than the primary quake. For a reinsurer, it may or may not be in the already left the city and moved elsewhere. The EQC policy doesn’t same contract year and can cause extra nuances because of some cover alternative living arrangements, so private insurers may of the terms of the contract,” Muir-Wood says. be encouraged to pay for people’s expenses if they have had to move Many in the industry will see recent events in Christchurch as a out of their property.” welcome wake-up call. “For reinsurers, it is a poignant reminder Better understanding of risk differentiation in New Zealand that risk differentiation remains the focus for underwriting. These is now imperative for underwriters. EQECAT senior vice-president attributes that we are seeing demonstrate that we have to remain Tom Larson says there is a false economy in relying too heavily vigilant,” Larson says. GR 10 APRIL 2011 GLOBAL REINSURANCE
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News Agenda
The advent of sat-nav has been a boon for motorists. No more getting lost, asking strangers for directions or wrestling with oversized maps: one press of a button and you know where you are and where to go. Reinsurance underwriters experienced a similar epiphany when catastrophe risk models came into their own around 20 years ago. Models presented them not only with a widely accepted indication of potential catastrophe exposures, but also a benchmark against which to compare the risk of different portfolios or regions. The chairman of Lloyd’s insurer Beazley’s group underwriting committee, Neil Maidment, who has been involved in the propertycatastrophe reinsurance market for roughly the same amount of time as the models themselves, likens the pre-model method of assessing catastrophe exposures to driving using only the rear-view mirror.
“Before Hurricane Andrew [in 1992], the industry would look back at a historic event and try to recalculate what the loss would be if it happened again, which set their parameters of what they thought could happen,” Maidment says. “The models look at a range of outcomes and therefore people have a more reasonable expectation of what an extreme event might cost.” Despite her recent public criticisms of the efficacy of near-term models, Karen Clark, founder of risk modelling fi rm AIR Worldwide and now president and chief executive of catastrophe risk management consultancy Karen Clark & Company, adds: “I don’t think you can write a book of property-catastrophe reinsurance without the models.”
Misguided Models are far from infallible, however. Just as the popular press is littered with tales of how sat-navs have misdirected drivers – sometimes almost to their deaths – insurance
journals and industry forums are awash with criticisms of models’ prediction abilities. “We don’t believe in any of the models. Whatever they call the risk, it is always wrong,” collateralised reinsurance fund CATCo’s chief executive, Tony Belisle, told Global Reinsurance last month when explaining his fund’s decision not to invest in catastrophe bonds. The dissent was perhaps loudest in the aftermath of North Atlantic hurricanes Katrina, Rita and Wilma in 2005, all of which hit the US Gulf coast in the space of three months. Critics pilloried the commercial vendor risk models for failing to prepare them for the extent of the losses, which hardened the global reinsurance market and led to the formation of the classof-2005 reinsurers. Following this, modellers scrambled to update their assumptions. The impact of catastrophe model updates on (re)insurers’ risk
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News Agenda
For the
road
ahead Just as motorists have come to rely on sat-navs to show them the best course to take, insurers depend heavily on catastrophe risk models. But as Ben Dyson discovers, such dependence can lead to disappointment
assumptions has retaken centre stage with the issue of a US hurricane model update by Risk Management Solutions (RMS) at the end of February. The update was no minor bug fi x. RMS said it expected to see wind risk increase for all hurricane states on an industry-wide basis. While warning that the effect would differ by portfolio, the risk modeller said increases in loss results on the market portfolios analysed ranged between 20% and 100%. Model updates can pull the rug from beneath the feet of users. While not faulting RMS for wanting to include the latest knowledge, understanding and technology in its US hurricane model, chief actuary of Lloyd’s and London market insurer Markel International Nicholas Line says: “If you are the board of a company and you suddenly receive different numbers as a result of a model change, it is very disruptive.” Such is the expected impact of the recent RMS release that Lloyd’s insurer Novae has been considering setting up
a sidecar reinsurer in order to capitalise on the expected additional demand for reinsurance.
More harm than good? Upheaval caused by model updates is only likely to get worse, according to Line. “With the advent of Solvency II, it is possible it will be even more disruptive because we have to explain what we are doing to the regulators, which links into enterprise risk management and risk appetite,” he says. Modellers acknowledge that updates can be a challenge for the industry and try to cushion them against the impact. “We have been pre-communicating for over a year about what the drivers of the model change are in terms of more data and more computing power available to us, and over the past three to four months we have been communicating on expected changes and results,” says RMS vice-president of natural catastrophe and portfolio solutions Claire Souch.
This kind of pre-warning can only help so much. The full effects of the RMS model are still being determined. “We won’t really know the impact until we get it running,” Line says. “That will go for every company in question.” There is also a question about whether the updates really improve the models. Risk modellers’ announcements proudly list details such as the new technology employed and the amount of claims data analysed, but in some cases updates could do more harm than good. “Modellers are always using actual events to calibrate their models,” Clark says. “If one or two of those events are relied upon too heavily for a model update, that can skew your results too much in one direction.” A good example of this, Clark argues, is Hurricane Ike, which slammed into Texas in 2008. Ike was unusual in that its damage was felt further inshore than typically occurs. “Some of the reasons for this are not even related to the storm,” Clark says. “If you calibrated your model to Ike, you would be over-estimating the inland damage for most storms.” In addition, the fact that models need to be updated calls into question their reliability as a risk benchmark. “Assuming models are reasonably good at estimating losses, if you then have an update that increases the modelled loss output by 100% or 200%, are those numbers good now?” Clark asks. Modelling fi rms themselves, perhaps not surprisingly, defend the updates. Souch argues, for example, that every area of assumption-based decisionmaking is subject to the same types of revisions to take account of new information and processes. However, modellers acknowledge the criticism levelled at model accuracy in particular, and admit that at least some of the fault for this lies with them. “Models are not perfect,” AIR Worldwide senior vice-president of research and modelling Jayanta Guin says. “We at AIR take our share of the blame for the shortcomings in models. Models have, in certain cases, shown weaknesses, so part of the criticism is fair.” Souch adds that she is not surprised criticism still exists in spite of, but also because of, continual improvements. “It is understandable that the market can see a sudden change or maybe a model prediction miss for an event and not understand immediately why that is,” she says. Guin cites models’ loss estimates for commercial property as one of their weaknesses in recent years. “That is GLOBAL REINSURANCE APRIL 2011 13
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News Agenda Modellers argue that reinsurers need to improve the data they feed into the models. “The models can only do so much,” Guin says. “If the data being fed into the models is of inferior quality, the models cannot work magic.”
something we underestimated in the past,” he says. A further example is water seeping into buildings via windows during high-speed winds: so-called winddriven rain. “We have been surprised there, and we have taken some measures in our latest release to make sure we are adequately reflecting the risk.” AIR updated its hurricane model in 2010.
Knowing the limitations
User error However, part of the blame for the disappointment with model performance must also lie with the users. Some reinsurers simply expect them to do too much. Anyone expecting accurate predictions of losses from a particular event is bound to be disappointed with catastrophe risk models or indeed any models. “They don’t give reinsurance companies or any insurance companies precise numbers. They just get companies in the ballpark,” Clark says. “They are very good tools, but they are blunt tools.” Some believe those relying too heavily on models deserve all they get. “I tend to be unsympathetic towards people who complain,” Markel International’s Line says. “You can’t outsource your understanding of risk. If you have done that, you are always going to be disappointed.” Reinsurers’ model usage has become much more sophisticated. Many companies now take the output of models from the three main vendors – RMS, AIR and EQECAT – and weight them according to their strengths in a particular region or risk. They will often also combine this with their own assumptions or modelling. Furthermore, few will only rely on modelled output of any kind to make an underwriting or capital management decision. “We use catastrophe models in our pre-underwriting analytics, portfolio management and loss estimation processes. However, the volatility of risk means that models can never be wholly relied upon,” says Lloyd’s insurer Kiln Group head of insurance operations Rob Stevenson. “We would not depend solely on the outcomes of any model – they are just one step in our underwriting process.” But, even when they are using models intelligently, reinsurers can fi nd their efforts confounded. Rating agencies, for example, may place more importance in individual models’ outputs than the reinsurers, which, given the importance and power of ratings, can have a direct influence on reinsurers.
‘You can’t outsource your understanding of risk. If you have done that, you are always going to be disappointed’ Nicholas Line, Markel International
“It is a problem that rating agencies such as AM Best are asking companies for point estimates for their one-in-100year and one-in-250-year probable maximum loss,” Clark says. “These numbers are highly uncertain. It is false precision to require a company to manage their business based on these highly volatile numbers. The most recent updates show how volatile the numbers can be.” Equally, while savvy reinsurers can adjust for what they perceive as unnecessary changes to models, regulators may be difficult to convince. Though acknowledging that reinsurers should use models to inform decisions rather than make them, Line asserts this is easier said than done. “Catastrophe models feed into the capital and you may well have told your board and your regulator that you are going to link RMS into your capital model directly,” he says. “If RMS changes the number and your capital goes up, the regulators will expect you to follow suit. You can’t suddenly say: ‘RMS is 10% too heavy. We are going to knock a bit off’.” There is clearly room for improvement in risk modelling practices, both on the part of the modellers and the users.
A key to effective model use is understanding what is excluded. Even with the many advances in computer technology, engineering and data capture made over the 20 years since models started to be taken seriously by the reinsurance industry, there are certain risks that models cannot cope with. For example, some still struggle with business interruption, and few stray into the territory of lossadjustment costs. Modellers say they have taken steps to make any omissions or exclusions as clear as possible. “We have upped the ante on that aspect since Hurricane Katrina,” Guin says. “Katrina caused a lot of disappointment among the model users and part of that disappointment was down to recognition of what the model covers and does not cover. Since then, for every model we have become more vocal and more explicit in stating what aspects of risk we account for and what we don’t account for, and that could be additional sources of risk.” But there is more to be done. As well as expressing what is excluded, some would prefer any weaknesses to be flagged up too. “It would be helpful if modellers could say where they have had to make big assumptions because of poor data, for example, and how the numbers would have changed if they made different assumptions,” Line says. “If that happens we can say: ‘You told us that part was uncertain, so we understand that is why the number has moved’.” Others require more customisation. “Model vendors could improve their offering by providing greater flexibility in their software,” Kiln’s Stevenson says. “This would enable companies to manipulate the results generated by the system. Doing so could greatly enhance efficiency within the industry.” Models may be imperfect, and work may still be needed to get the most from them, but they are clearly better than the old rear-view mirror technique of 20 years ago. Nonetheless, like the older techniques, they can be dangerous when used in isolation. “Nobody drives staring at a sat-nav because they would hit something,” Line says. “If you are purely running your business based on a model, whether it is a cat model or a capital model, you will come unstuck.” GR
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People & Opinion For exclusive opinion and insight from Global Reinsurance and its sister publications, visit
globalreinsurance.com
TOP 10 GLOBAL RISKS The political risk environment is much ‘broader’ in 2011, according to Eurasia Group strategicrisk.co.uk
RISK OF LARGE AFTERSHOCKS REMAINS IN JAPAN – MITSUI MS & AD Group ‘well positioned’ to deal with the quake and tsunami insurancetimes.co.uk
In my view Keep your eye on the ball As European players face a punishing schedule of rule changes, Christopher Myers believes the trick will be for regulators to keep reinsurers focused on the main plan – protecting clients The chief fi nancial officers and chief risk officers of insurance companies are challenged by multiple stakeholders with differing concerns. This is creating an environment where compliance, regulation and rules are changing the way insurers do business for customers. European (re)insurers in particular face daunting expectations over the next few years: • significant changes in accounting standards under the forthcoming phase two of International Financial Reporting Standards for insurance (IFRS 4); • differences in how risk capital is measured and expectations around risk governance with the upcoming Solvency II regime; and • the evolution of criteria and expectations
from rating agencies, especially over enterprise risk management (ERM) and economic capital modelling (ECM). The demand for accounting, actuarial and risk management expertise to help managers navigate these challenges is extensive. It is true that the purpose of such standards is to foster an environment where the interests of policyholders, creditors and investors are the priority and, in turn, aligned with managers’ behaviour. Without guidelines and standards, there is a risk that the quality of products or services produced by an industry will fall to unsafe levels. But regulation is only as relevant as the effort put in and its
assessment by the regulators. There is likely to be a point at which the underpinnings of regulation begin to run contrary to their intent, inhibiting the creation of products or services or making the cost of production too expensive.
IFRS 4 Extensive changes to insurance accounting and disclosure were proposed in the latter half of 2010. These include new methods to calculate insurance liabilities, assets and related revenue and earnings. In addition, statements of fi nancial position and profit and loss will be structured in dramatically different ways than the industry is accustomed to. Ultimately, the changes inspire a more consistent and transparent understanding of insurance accounting. However, (re)insurers will need to think of the risk and cost of insurance in different ways, which may make insurance more expensive to the buyer in some cases or less available in others.
Solvency II The Solvency II regime addresses risk capital, risk governance and risk disclosure, setting out extensive standards and expectations for each, including documentation, testing and validation and controls. To address these requirements, both (re)insurers and regulators have had to employ additional accountants, actuaries and other risk specialists. Accountancy fi rms and risk consultants have in a sense created an industry around advisory services relating to regulatory, compliance and governance standards. All of this adds cost to the insurance risk transfer and risk management process. 16 APRIL 2011 GLOBAL REINSURANCE
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People & Opinion FERMA: IMD MUST INCLUDE LARGE RISKS Ferma tells EU Commission to include large risks within the scope of IMD revision strategicrisk.co.uk
Rating agency criteria The ratings and related rationales provided by rating agencies provide signals to the market of the ongoing fi nancial strength of (re)insurers. Those without a favourable rating are often put at a disadvantage. Yet the criteria for rating conclusions are extensive. Standard & Poor’s and AM Best have raised the bar with their focus on ERM in the ratings process. In January, Standard & Poor’s introduced ECM review criteria that resemble Solvency II capital review requirements. These include standards the market may not currently be able to meet. Meanwhile, AM Best is expanding its supplemental ratings questionnaire to include a full ERM section enquiring about risk governance, tolerances and risk modelling. Rated (re)insurers must be prepared to put resources into their ERM frameworks and raise awareness in many areas and in extensive ways.
Weblog Natural catastrophes in the Asia-Pacific region piqued the interest of (re)insurers for a third consecutive month, as the market braced itself for claims following the earthquake in Japan. Readers welcomed Jefferies analyst James Shuck’s early estimate that Japan claims could be limited to $10bn – which he stands by despite far higher estimates emerging. News of Swiss Re’s strong results got readers clicking. A 74% profit rise showed the reinsurer had made up ground lost in the past two years. It will be interesting to see the impact of catastrophe losses in Australia, New Zealand and Japan on its 2011 results. Xchanging Insurance Services (XIS) chairman Richard Bucknall’s attempts to quell London market fears after parent Xchanging issued a profit warning also proved popular. Bucknall insisted XIS was a separate company
and that shareholders would be able to buy out Xchanging’s 50% stake “in the unlikely event that any shareholder ceases as a going concern”. The (re)insurance market loves a people story. In fourth place is news that SCORbacked Channel Syndicate 2015 at Lloyd’s hired David Leathem to head is property arm. The French reinsurer said he was to be joined by a team of underwriters shortly, leaving readers to ponder who might be on the team. Finally, when Robert Hiscox speaks, the market listens. At five is our story about the Hiscox chairman slamming broker remuneration as “a deficiency in the insurance market”. He didn’t hold back, urging the issue to be resolved “sensibly” before “crusading regulators” step in. To contribute to the website, email Ben Dyson at ben.dyson@globalreinsurance.com
Online top five 1. JAPAN CLAIMS COULD BE $10BN Loss will affect local cat rates but not turn market 2. SWISS RE PROFITS UP 74% DESPITE CAT LOSSES ROE of 3.6% compared with 2.3% in 2009 3. XIS CALMS LONDON MARKET FEARS XIS set to hold together if parent troubles continue 4. SYNDICATE HIRES PROPERTY HEAD David Leathem joins new Lloyd’s operation 5. HISCOX HITS OUT AT REMUNERATION Rivals’ underwriting discipline also slammed
Looking forward Today’s fi nancial and insurance markets and their risks are more complex than ever. Concerns over issues such as climate change and political unrest create a lot of unknowns that some industries may wish to avoid. Recent catastrophes in Japan, Chile, New Zealand and Haiti are just a small sample of extreme events that show that insurance is needed to transfer risk to institutions with the capacity to assume those risks. That can only happen when (re)insurers believe the cost of regulation and compliance is not too high and the price for the risk is reasonable. The rule-makers face a difficult mandate. They must make sure their requirements and criteria set meaningful standards while making them achievable. Otherwise managers may spend most of their time complying with standards rather than executing effective strategy and decision making, and providing the necessary risk transfer products and services to the market that the rule-makers are trying to protect. GR Christopher Myers is global head of ERM at Aon Benfield Analytics
Up the ladder How did you make it to where you are today? Centre Re founders Steven Gluckstern and Michael Palm persuaded me to leave Ernst & Young, where for 10 years I had specialised in reinsurance, and enter the industry as a principal rather than a service provider. How has the industry changed since you joined it? Professionalism and discipline has improved dramatically. The regulatory and ratings environment has certainly changed. Rating agencies were tougher with the class of 2005 than with the class of 2001. Frankly, it is a great thing – the discipline has partly come about because the rating agencies got tougher. What are the key challenges for you and the industry? One has to be modelling all the risks we underwrite, not just part scenarios. At Flagstone, we’ve invested in building proprietary systems to model the risks we write. As an industry, we
must keep working on getting the most accurate information to people writing the risks. And what are the biggest opportunities? After a period of market softening, recent events will provide the best opportunities since 2005. Some of the best openings for investors will be in insurance-linked securities vehicles, which will allow them to target classes of business in a defined timescale. What comes to mind when you think of friends and contemporaries in the market? One of the best things about our industry is the people I meet. It’s full of characters and smart, interesting people. What do you do to relax? Spend time with my family and anything to do with water – fishing, sailing, swimming, diving. David Brown is chief executive of Flagstone Re
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Profile
Validus boss Ed Noonan can quip with the best of them, but beneath the grin lies a tough customer, as his company’s hostile takeover of IPC proved. He talks to Ben Dyson about the deal of the decade – and what’s next on the agenda Ed Noonan likes a joke. The Validus Holdings chief executive can’t resist throwing humorous comments into his chat with Global Reinsurance. When we point out that he has been in the reinsurance industry for some time, he quips: “Over 600 years – I started with the Venetians in the marine reinsurance business.” Amiable and easygoing he may be, but Noonan is no soft touch. Just ask Marty Becker, his opposite number at the company now known as Alterra. In 2009, when Alterra was still Max Capital, the two locked horns over the purchase of catastrophe specialist IPC. The battle was bitter and drawn out. Not only did Noonan disrupt what looked like a done deal for Max by putting in an unsolicited counter-bid for IPC in March of that year, he sued both Max and IPC in April when IPC rejected Validus’s offer, challenging a $50m termination fee in Max’s initial merger agreement. He also upped the Validus offer several times over the four months it took to secure an agreement. Noonan’s tough tactics paid off and Validus succeeded in striking a deal with IPC in July for $7.50 cash and 0.9727 Validus shares for each IPC share, also beating off a last minute challenge from fellow class-of-2005 reinsurer Flagstone Re. Validus said at the time that the $31.73 a share paid was a 24.9% premium to IPC’s share price before it made its initial offer. The deal fi nally closed on 4 September 2009.
Worth fighting for Noonan describes the fight to buy IPC as “gentlemanly, if a bit rugged”. “Our industry is not one where you see many hostile takeovers. It’s very hard to do, and it has probably been close to 30 years since anybody had done it,” he says. “But to accomplish something significant, you have to be
willing to fight for it. We were convinced this was a great step forward for Validus and we were willing to fight very hard to accomplish that.” Now the deal has had 18 months to bed in, and the company has reported its fi rst full-year results as a combined entity, has IPC proven to be worth the estimated $1.7bn and not inconsiderable effort to buy it? And with the soft market looming and rumours swirling that Validus is seeking further takeover targets, where does Noonan take the company, and indeed his own career, now? For Noonan, winning IPC was a resounding success. “It has been a home run on several different levels,” he says.
‘Our industry doesn’t see many hostile takeovers. But to accomplish something significant, you have to be willing to fight for it’ While Validus paid a premium to IPC’s share price, Validus snagged the company at a discount to net tangible assets. The result was a $287.1m one-off gain booked in Validus’s 2009 results. “It’s not that easy to make $300m in a single day, but we were able to do that with the acquisition of IPC,” Noonan says. Shareholders were also happy: IPC’s owners were paid a dividend of $400m on completion of the deal. Validus has also bought back $947.2m of its own stock since the deal completed. Best of all for Noonan, however, was how the enlarged fi rm was received by the property-catastrophe reinsurance market. Individually, Validus and IPC
Getting the edge Validus’s extra bulk has come in handy for distinguishing the company from the rest of the Bermuda set, which Noonan argues are all well capitalised, well run – and increasingly difficult to tell apart. “We are able to trade effectively at a much higher rating category because of our capital level,” he asserts, adding: “We are able to use our size to have influence over placements.” Not even rating agency and analyst gripes have been enough to take the shine off the IPC deal. AM Best, for example, expressed concerns that combining two property-catastrophe heavy companies like IPC and Validus would create a concentration of risk and put Validus’s A- rating under review, with negative implications. But Noonan asserts that the combined entity has kept its catastrophe exposures in check. He says that the company does not allow its one-in-100-year probable maximum loss expectation from catastrophes to exceed 25% of capital. Before the IPC acquisition, it was 21%, and it still is. “I think that concern has been disproven,” he says. The IPC acquisition added to Validus’s 2007 purchase of Lloyd’s insurer Talbot, which added insurance business to its portfolio as well as several new classes of business. Since that acquisition, Validus Holdings has had two operating units: Validus Re, which writes purely reinsurance from Bermuda, and Talbot. Both the insurance and reinsurance markets, with a few exceptions, are softening, which could make further
ILLUSTRATION: MICHAEL CRAMPTON
True grit
had shareholders’ equity of $2bn and $1.8bn, respectively. Following the combination, return of capital and buy-backs, the combined entity now has shareholders’ equity of $3.5bn. In particular, IPC expanded Validus’s footprint considerably in the European catastrophe market. “It suddenly made us a very large, meaningful player on almost every programme we participated in, and made us strategically more important to the marketplace,” Noonan says. “I underestimated that aspect of the transaction. I thought it was a good transaction and would improve our business, but quite frankly we have much more influence than we could possibly have had as a smaller company.” Noonan adds that he regularly notices the size impact when doing business in the market now. “Brokers who place a programme of any size in the global market almost have to come through Validus.”
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Profile
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Profile growth challenging. Noonan is clearly not willing to sacrifice profitability for volume, stating: “Underwriting profit is the only altar we pray at.” “We don’t see great room to grow Validus Re in the near term due to global competition,” he says, although he adds that the recent catastrophes in Australia and New Zealand could present some opportunities. “We are at a point where we are quite content to underwrite the business well, and write business we can get paid for appropriately. If that means we have to shrink a bit, that’s okay – we’re fi ne with that.” He argues that Talbot is in a similar situation, although there are strong rate increases in areas such as marine liability and offshore energy following the Deepwater Horizon oil rig explosion, and war and terrorism following the recent Middle East unrest. “In our existing businesses, we feel pretty good about where we are,” he says. “If the market isn’t there, we are happy to shrink, and we will just manage our capital to the size of the opportunity we have.”
Changes in one year Gross written premium
2010 $1.99bn
2009 $1.62bn
Net written premium
$1.76bn
$1.39bn
Net income
$402.6m
$897.4m
Combined ratio
86.2%
68.9%
Learning from experience One area that Validus is likely to shun in particular is US long-tail liability. Noonan knows from bitter experience
Results in context At first glance, Validus’s 2010 results might appear a disaster. Profit after tax dropped 55% to $402.6m in 2010 from $897.4m in 2009, and the combined ratio worsened to 86.2% from 68.9% (see chart, above). Noonan is rather pleased with the outcome given the circumstances, however. The 2009 result was propped up by a $287.1m one-off gain from the purchase of IPC Re, and there was a series of major catastrophes and large single losses in 2010, among them the Deepwater Horizon explosion and the Chile earthquake. Coupled with this, interest rates were low, depressing investment returns. “Two of our key classes suffered major, major losses, and we still generated attractive return on equity (ROE). Our insurance combined ratio in both London and Bermuda was excellent,” he says. According to Global Reinsurance calculations, Validus’s ROE was 10.7% for 2010, down from 30.1% in 2009. While some have cautioned about Validus’s heavy catastrophe exposure, Noonan believes the company’s profitability in such a year is proof that his business model is working. “We have achieved very significant geographic and product diversification around the world so that, in a year when we have earthquakes in Chile and major oil rigs exploding, we also have a relatively quiet year in terrorism and war risk. There is significant diversification built into our business model and it worked for us in 2010.”
how challenging this line can be. Aside from running Validus since inception in 2005, Noonan is perhaps best known in the market for his time at American Re, a New Jersey-based reinsurance group that was bought by Munich Re in 1996 and is now known as Munich Re America. He ran the reinsurance division of American Re from 1987 to 1996 and was chief executive of the entire company between 1997 and 2001. He describes the fi rst of these two periods as “fantastic years”, but adds: “It is easy in a time like that to convince yourself that you’re Lance Armstrong, without realising you are pedalling downhill.” The truth hit home in the soft market of 1997 to 2001 when American Re, along with several of its peers, was hit hard by severe US casualty losses, in particular from old asbestos-related claims. “More than anything, I came away with a great respect for how quickly the (re)insurance business can change,” Noonan says. “I have a very profound respect for the need to understand a multitude of underlying factors when thinking about underwriting casualty business – which is one of the reasons we really don’t underwrite third-party liability business today.”
Looking elsewhere There are, however, future growth opportunities to be considered. Noonan says his company is under-represented in the USA in general: the company writes US-exposed catastrophe business but does little else. “The day will come when North American pricing will start to turn attractive. It is the biggest market in the world and therefore, at that point in time, our biggest opportunity,” Noonan says. “We look forward to that day. It is an area we can grow organically through the syndicate and we can certainly grow organically in our reinsurance business.”
Assuming the right market conditions, Noonan would be open to setting up a US platform, either from scratch or through acquisition. Other areas where Noonan is open to making acquisitions are the growth hotspots of Asia and Latin America. Talbot has a presence in the Lloyd’s Singapore platform, and Validus Re has an Asian representative office in Singapore. Validus Re also writes Latin American risks from its offices in Miami and Santiago. “The growth of the global economy for the rest of our lifetimes is going to take place disproportionately in Asia and Latin America,” Noonan says. “We are seeing opportunities to grow it, and it is another area where, if there was an interesting opportunity, we wouldn’t hesitate to pursue it through acquisition, as well as organically.”
Next steps Following its success with IPC Re, rumours have surfaced that Validus might try to buy another of its Bermudian peers, this time Ariel Re. News reports have suggested the two companies are in advanced talks. Noonan declined to comment, but conceded that further consolidation among Bermuda’s reinsurers would make sense. “Bermuda is an excellent market, but there are so many of us with similar strategies, so it is difficult for investors to differentiate between companies,” he says. “We have proved the point with IPC that you can take two companies, each of whom has $2bn of capital, and create a better company out of it and still return the vast majority of capital to shareholders. There is capital that should be liberated in the industry, and consolidation would do that.” With Validus proving resilient to catastrophe losses and a force to be reckoned within the global catastrophe reinsurance market, might it be time for Noonan to look for another challenge? He says there is plenty going on at the company to keep him interested for some time yet. “Validus is my passion,” he asserts. “I feel like we have only scratched the surface for long-term opportunities for the company, and so I am anxious to see how the second act plays out. I look forward to being a part of it.” You get the impression that Noonan’s not joking about that. GR FIND OUT MORE ONLINE: VALIDUS EXPECTS UP TO $50M LOSS FROM LATEST NZ QUAKE To read this feature, and for more on Validus Holdings, go to globalreinsurance.com or goo.gl/rzlYz
20 APRIL 2011 GLOBAL REINSURANCE
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22/02/2011 16:09
Cedants
Q&A with
Michael Barber
Twenty-five years with Aviva have taken Michael Barber from underwriting novice to reinsurance guru. A dedicated Manchester City follower, he tells Global Reinsurance what lies behind his own game plan
When Michael Barber joined Aviva’s Manchester branch in 1987, he could not have foreseen a successful career spanning 25 years with the UK insurance giant. In 1996, Barber moved to London to join the head office underwriting team, where he performed a number of underwriting roles. By 2003, Barber’s thirst for a change took him into the reinsurance side of the business, which involved him joining Munich Re’s Global Scholarship programme in Munich. Upon his return to London, he joined Aviva’s reinsurance team and has never looked back. Following a promotion to head of reinsurance in 2004 and then to director of reinsurance in 2008, Barber was appointed Aviva’s global reinsurance director within the chief capital officer’s function in February this year.
Q:
PHOTO: YIANNIS KATSARIS
How would you describe the pricing situation in the reinsurance market – would you say we are in a soft market at the moment?
A: The consensus view from the various 1 January renewal reports is that rates continued to soften in most lines – other than in loss-affected territories – with a surplus of capacity in the market.
22 APRIL 2011 GLOBAL REINSURANCE
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Cedants Q:
How do you approach deciding what to buy and structuring your reinsurance programmes?
A: It depends on the class of reinsurance being purchased, but a number of factors are taken into account in the design of our programmes. In respect of our catastrophe protection, which is a capital-driven purchase, we are able to evaluate the cost of reinsurance capital being purchased compared with internal hurdle rates required if we retained that risk and allocated the appropriate capital internally. We also assess the impact on the gross and net risk profile of different reinsurance structures at a territory, regional and group level compared with internal risk appetites. For non-catastrophe protections, it is largely influenced by our risk appetite for earnings volatility at portfolio level, again from a territory, regional and group-wide perspective. Q:
What is important to your company as part of this process?
A: Reinsurance purchasing decisions are viewed through several lenses, all of which are important – group risk appetite, impact on economic capital, economic gain, earnings volatility and our retained risk profi le. Q:
How has the current pricing affected your buying strategy?
A: We have taken the opportunity to broaden protection in areas where we believe it has created real value to do so. Q:
How has your buying strategy changed post-fi nancial crisis?
A: Reinsurance is always aligned to internal risk appetites set at group level. Risk appetite is reviewed annually and agreed with the group executive through the governance committees. While the level of our risk appetite has varied slightly in recent years, when considered against all other internal and external influences, we were broadly comfortable with the levels of risk retained at a group level, so our strategy has not changed significantly. Q:
What impact will Solvency II have on the purchase of reinsurance?
A: It is too early to be definitive and is, of course, dependent on the fi nal rules. But we believe there are
real opportunities for Aviva from a reinsurance and risk pooling perspective, due to the diversification within our business across geographies, lines and classes of business. We are also taking the opportunity to revisit our group-wide reinsurance strategy and risk retention approach.
Q:
How much premium do you cede to reinsurers?
A: In respect of our major nonproportional programmes, we ceded £250m last year across the general insurance business. Q:
To what extent do you make use of alternative reinsurance structures such as catastrophe bonds?
A: We regularly evaluate the insurance-linked securities market and compare against traditional reinsurance cover, taking all factors into account – cost, basis risk, collateralised capacity and other factors. We will continue to monitor this closely. Q:
What do you most look for in reinsurers?
A: Financial strength and long-term security are very important to us. Consistency is also important. We don’t really want to trade with fi rms that have no long-term proposition. We value the long-term relationships we have with many of our reinsurance partners. Q:
How is the success (or otherwise) of your reinsurance purchasing measured?
A: There are a number of factors and metrics against which reinsurance purchasing is measured. Clearly, extent of coverage within the contract is very important. Q:
How did you become involved in buying reinsurance?
A:
I have nearly 25 years’ experience in general insurance, mainly in commercial underwriting. I always had an interest in reinsurance and in 2003 was fortunate enough to be offered the opportunity to represent Aviva on the Munich Re Global Scholarship programme. It was when I returned from Munich that I moved across from underwriting to reinsurance – and the rest is history.
Q: Who do you most admire in the industry? A: Warren Buffett. I love the way he simplifies complex issues to the basics. He usually calls it right Q:
Describe your average day.
A: Today, I started with an 8am meeting with a reinsurance broker, then a catastrophe reinsurance project meeting about the 1 April renewals. This was followed by an internal meeting with the economic capital and Solvency II director. In the afternoon, I had an internal meeting with colleagues on portfolio optimisation and cycle management, followed by a meeting with risk modelling firm RMS. My day finished with a staff meeting for the chief capital officer’s function – reinsurance has just moved to this central group function. And then I tried to catch up with my emails. Q:
Who do you most admire in the insurance industry and why?
A: Without a doubt Warren Buffett. I love his passion for the insurance and reinsurance business and the way he simplifies complex issues to the basics. And, of course, he usually calls it right. I fi nd him incredibly fascinating and enjoy following his investments, views and predictions. Q:
What do you enjoy doing in your spare time?
A: I enjoy most sports and am a season ticket holder at Manchester City. I relax spending quality time with my family – my 20-month old son, Casper, keeps me very busy. As I am away from home for most of the week, every minute is precious. GR This interview was conducted before the Japanese earthquake and tsunami on 11 March FIND OUT MORE ONLINE: IT’S NOT JUST WHO YOU KNOW To read this article and for more on cedant relationships, see globalreinsurance.com, or goo.gl/SKz2x
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Lines & Risks
When tweets
go bad
Social media platforms such as Facebook and Twitter are providing companies with new ways to boost their profile and connect with customers. But, as the WikiLeaks scandal proves, Web 2.0 has its risks – and that’s where (re)insurers can help. Tim Evershed reports 24 APRIL 2011 GLOBAL REINSURANCE
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Lines & Risks Web 2.0 is here: the internet is fi rmly into its second phase of life, dominated by websites that encourage user interaction. Websites such as Facebook, Bebo, Twitter and, in the corporate world, LinkedIn have changed the way individuals and companies alike use the internet. Despite being less than a decade old, Facebook has more than 600 million users and earlier this year was valued at $65bn. Its success is down to its ability to connect individuals with groups of people they choose and allowing them to communicate quickly and efficiently. However, with great opportunity comes risk, and it now appears that companies are beginning to recognise the pitfalls associated with social networking. The list of organisations that have fallen foul of social media faux pas includes the Red Cross, Southwest Airlines and Habitat. In Habitat’s case, it blamed an intern for a marketing campaign that involved adding unrelated tags, such as ‘#iPhone’ and Iranian election contender ‘#Mousavi’, to its Twitter messages to boost exposure. The outcry from the Twitter community was significant, and Habitat was forced to remove the offending ‘tweets’ and make a public apology.
ILLUSTRATION: PAUL DAVIZ/STRATEGICRISK
Crisis management Damage to reputation is just one of many possible outcomes of social networking mistakes. (Re)insurers are starting to wake up to the new liabilities that social media creates and are incorporating it into their cover. CFC Underwriting says it has developed a comprehensive policy that bridges the gaps between the fields of old media and new technology, which is aimed at authors, publishers, broadcasters and media professional service fi rms. “The new breed of social networking sites such as Facebook and Twitter have pushed traditional media companies into new areas – but also represent a unique challenge for insurers,” says CFC Underwriting business development director Graeme Newman. “The platforms’ rate of growth, coupled with the highly uncertain legal landscape in which they operate and the lack of historical data, has made their risk hard to quantify and even harder to price. As a result, there have been few, if any, viable insurance options,” he adds. Meanwhile, Chartis says it has improved its directors’ and officers’ policy with an extension to cover threats from social media. The cover focuses on the reputational damage that the misuse of social media can cause. It will pay
for public relations expenses to help either mitigate a crisis that results from a credible threat of a company’s confidential information being posted on a social media website, or manage the reputational damage to a company caused once such disclosures are made. “The domination of the global news headlines regarding WikiLeaks’ publication of leaked government documents is a vivid illustration of the power of social media,” says Chartis vice-president, fi nancial lines, David Walters. “Although the focus has been on government, there is, however, no room for complacency for business.” But as with any new area of coverage for (re)insurers, the question is do they understand the risks that they are covering? Jardine Lloyd Thompson communications, technology and media partner Kip Berkeley-Herring says: “I’m not sure the insurance industry has got its head around what social networking can bring in risk terms, though it is starting to wake up to it. It is good to see organisations recognising that cyber risks should not be looked at in isolation. Social networking is just the modern way of getting into hot water.”
‘People leave information on Facebook that they would never dream of telling strangers in the pub’ Kip Berkeley-Herring, Jardine Lloyd Thompson
He adds: “It comes down to privacy, fraud and the management of customer data. These are the key areas where social networking can increase the risk a company faces. One concern is the level of disclosure on websites. People leave the sort of information on Facebook they would never dream of broadcasting to strangers in the pub.” US law fi rm Goldberg Segalla’s global insurance services group chairman, Dan Gerber, says: “Traditional liability policies may or may not respond to certain social media claims under the advertising injury coverage of the policies. Courts have not yet been asked to fully vet the issue.” Gerber continues: “The larger question is whether there is complete agreement between cedants and reinsurers as to what is covered under existing policies. It is quite possible that cedants will extend coverage where reinsurers would not. This may lead to disputes over the scope of coverage. Clearly, there is a void here for additional cyber policies and affi rmative social media coverage.”
Assessing the true risks Much of the risk that comes with social networking is that, once information is posted online, it takes on a life of its own. Lloyd’s chief information security officer Marcus Alldrick explains: “The term ‘viral’ is absolutely accurate, because information can spread so fast and it is global; there are no boundaries. And once it is out there, you cannot remove it.”
And the risk is increasing, as people are not just connected at work and at home now; access to the internet is getting even easier via smartphones and other gadgets. Many organisations are concerned about the pitfalls of allowing staff access to social networking sites, and may even be tempted to ban their use entirely to eliminate the risk. However, most experts agree that this is not a sensible step. “Banning the use of social media is not a practical way of managing the risk,” Newman says. “If you do that, how will you know what people are saying about your company? The problems just get magnified.” Instead, a properly thought-out media strategy needs to be implemented as part of an organisation’s corporate governance and staff training. Alldrick says: “Employees need to be authorised to use it and use it properly, being made fully aware of the risks involved, such as the danger of posting something defamatory. At Lloyd’s we highlight cases where the perils have played out. “You need to bring it to life for your employees. Then you need to monitor their use, but that does not have to be in an intrusive manner.”
It pays to keep up The risk of an online faux pas becoming a legal matter is a real danger. This area of law is murky, as it struggles to keep pace with the net, and is complicated further by the international nature of the web. “You are also dealing with multijurisdictional issues, and you can be liable in countries where information is downloaded, not where it was published,” Newman says. “We now have the strange phenomenon of Californians jurisdiction-shopping defamation issues in the UK.” The genie is out of the bottle, and companies must recognise the opportunities as well as the risks, or face being left behind by their competitors. “We are seeing more and more companies using new media strategies, and it can pay dividends if used properly,” Alldrick says. “You have a massive audience, on a global basis. More and more people are fi nding that it is quick, cost-effective and efficient.” Love it or hate it, social media is here to stay, and the (re)insurance industry – like any other – will need to get to grips with the risks it poses to their organisation and their policyholders. GR FIND OUT MORE ONLINE: IN MY VIEW: THAT’S SO 1850S … To read this article, and for more on technology and the web, go to globalreinsurance.com or goo.gl/zSZ9h
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Claims The past 18 months have proved a whirlwind of activity for reinsurers as 2010 claimed high fatalities and huge losses for the industry. And the frenetic pace shows little sign of slowing. The 6.3-magnitude earthquake in Christchurch, New Zealand, in February, followed more recently by the 9.0-magnitude quake and tsunami in Japan, have kick-started another hyperactive year. A total of 950 natural catastrophes were recorded last year, of which 90% were weather-related. This makes 2010 the year with the second highest number of natural catastrophes since 1980 and exceeds the annual average for the past 10 years (785 events per year). Overall losses amounted to $130bn, of which about $37bn was insured. According to Munich Re, this puts 2010 among the six most loss-intensive years for insurers since 1980. “The year 2010 showed the major risks we have to cope with. There were severe earthquakes. The hurricane season was also eventful – it was just fortunate that the tracks of most of the storms remained over the open sea,” Munich Re reinsurance chief executive Torsten Jeworrek says. Such activity has posed many challenges to reinsurers handling claims from large catastrophes – issues related to specific events, claims practices, squabbles with cedants over policy wordings, and accessing the correct data to determine overall losses.
Aftermath: the damage caused by the earthquake in Christchurch, New Zealand
On shaky
ground As catastrophes wreak havoc across the world, reinsurers face the all too familiar aftershock of claims handling. Muireann Bolger examines the continuing learning curve
Access to data and data mining techniques have improved dramatically in the past few years. Satellite technology and aerial mapping, for example, can help reinsurers determine the scale of damage and losses more quickly than ever. Lloyd’s senior claims manager Phil Godwin says: “Over the past five to 10 years, the sophistication of data capture in the market has accelerated considerably. You now have risks geocoded, so you know exactly the latitude and longitude of where that risk exists.” Yet despite such improvements in data collection, some catastrophes prove far more complex than others. Earthquakes in general are much trickier for reinsurers than windstorms, making loss assessments difficult. “With hurricanes, there is a reasonable expectation that most of the damage will be visible. But with earthquakes, there’s a high probability you are going to have structural damage that is hidden from sight,” says Godwin. RMS chief research officer Robert
Muir-Wood believes the biggest catastrophes are not always the most complex. Chile was last year’s most expensive natural catastrophe and the fi fth strongest ever measured, with overall losses of $30bn and insured losses of $8bn. But the potential damage was mitigated by Chile’s strict building codes, which take account of the country’s high earthquake exposure, and the lack of severe secondary effects such as after shocks. But even if the event itself is straightforward, the systems within the claims processes can still bring trouble. Godwin says reinsurers need to be careful of the rules and procedures surrounding projected settlements. Following 9/11 and Hurricane Katrina, projected settlement clauses in contracts have increased to allow reinsurers to advance settlements to the cedant company before the fi nal loss
assessments are calculated. The aim is to assist cedant companies that face cashflow problems after a catastrophe. Godwin says reinsurers should have the processes in place to ensure the correct level of advanced payments have been paid out. “The industry could enhance the quality of clauses,” he says. “It is in the reinsurer’s interest to speed up the process as the trusted reinsurance partner. But at the same time you have to create the appropriate rules around the way that money is advanced.” Willis Re executive director Spencer Pardoe says LIoyd’s was not fully prepared for the Chilean earthquake because the London market did not have enough projected settlement clauses written into contracts. He points out that a huge lesson was learnt by Lloyd’s when it was put under pressure to agree large sums on behalf of reinsurers. “But I think the market will be better prepared. In future, there should not be
PHOTOS: CRAIG GREENHILL/NEWSPIX/REX FEATURES, BRAD FLEET/NEWSPIX/REX FEATURES
Assessment challenge
26 APRIL 2011 GLOBAL REINSURANCE
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Claims many contracts out there without these clauses built in,” he says. Lloyd’s is critical of the practice of passing advanced settlements via brokers rather than directly to the cedant company. This, argues Godwin, can create problems with currency fluctuations. “There is a great appetite to send the money direct to mitigate exchange rate issues,” he says. But Willis Re executive director Gus Newell believes this process enhances the claims process following catastrophe losses. “With money going through the broker, it should avoid timeand resource-consuming reconciliation issues down the line.”
Ground control Disputes over claims practices aside, reinsurers face ongoing challenges in ensuring they have enough expertise on the ground in the aftermath of a disaster. A dearth of loss adjusters and engineers, especially in developing countries, can delay the claims process and create problems. The Chilean government’s strict rules over deployment of loss adjusters in the country delayed aspects of the claims process, says Godwin. According to Muir-Wood, there were also complaints about the lack of a joined-up approach by claims handlers on the ground. “In Chile, the complaint was that every insurer had a different claims form. The industry had not got its act together in terms of a collaborative approach. It can take a large catastrophe to teach people how they can improve things,” he says. While the logistics of the claims processes surrounding the earthquake in Chile may have presented problems, they were small compared with the complexities generated by the disasters that hit Australia and New Zealand. This year, natural catastrophes in Australia/Oceania totalled 16% of global losses. Complex environmental factors and policy wording issues have exacerbated the difficulties for reinsurers. New Zealand’s third-largest city, Christchurch, was hit by an earthquake on 4 September 2010, but this was followed by a more deadly one on 22 February. The combined losses are expected to reach NZ$8bn-NZ$10bn (approximately US$6bn-US$7.5bn). Reinsurers say environmental factors conspired to turn these earthquakes into a much bigger challenge. Liquefaction of the soil in New Zealand, for example, intensified the losses. “Liquefaction is when the soil is sandy and behaves like a liquid, so there is more potential for shaking and damage,” explains Willis Re catastrophe
risk analyst Rashmin Gunasekera. In addition, says Muir-Wood, the policies of state-backed insurer the New Zealand Earthquake Commission are unusually worded and cover damage to the ground under which a property is built. The organisation also has a limit of NZ$100,000 (US$74,000) per dwelling. He believes this could create problems. “Given the connection between the two earthquakes in September and February, I think the commission will attempt to capture all the damage to an individual property under a single aggregate limit across both earthquakes. Once the damage spills over, that loss is going to be passed on to the underlying insurer of the property and then the reinsurer.” Most reinsurers, however, will consider the earthquakes as two events. This in turn will confl ict with the commission’s defi nition of a single event, adding complications to further loss calculations. The saga doesn’t end there. Muir-Wood says the New Zealand government has closed down the central business district in Christchurch, which will ramp up business interruption claims. “A number of complex factors are pushing up the losses in a Katrinalike way,” he says.
How many floods? The floods in Australia have also created a conundrum for reinsurers. As Munich Re head of claims management and consulting Nicholas Roenneberg explains, a dearth of models for flooding
Floodwaters surrounding properties in Darwin, Australia
continues to pose challenges. The Australian floods are also creating policy wording issues. MuirWood says there is uncertainty over whether the flood should be defi ned as a single event or a series of events. “There has been a question of the event defi nition used by reinsurers for what constitutes a single event for reinsurance requirements. “We would recognise from a climatological point of view that this is one period of flooding associated with very high rainfall, which caused the sea
surface temperatures around Australia to be exceptionally high,” he says. “This was one whole sequence of flooding over a period of a month but we know that for reinsurance recoveries, it is going to be broken into different periods.” To make matters worse, there are
‘It can take a large catastrophe to teach people how they can improve things’ Robert Muir-Wood, RMS
squabbles over the defi nition of a flood, as reinsurers differ over what constitutes a flash flood and a river flood. “There is inconsistency in how floods are defi ned,” Muir-Wood says. He points out that in the case of high-profi le catastrophes such as the Australian floods or Hurricane Katrina, politicians can put pressure on insurers to pay out. This in turn can lead to ugly scenes with reinsurers. In the aftermath of the Australian flood, Munich Re warned insurers that they should adhere to the wordings of their insurance contracts. Godwin points out that reinsurers are realising from past experiences that swift communication with the cedant company is vital in the aftermath of a catastrophe and are becoming much more hands-on in their approach. “We have seen in the past few years a greater appetite from reinsurers to sit down with their buyers and understand fi rst hand their strategy for dealing with the claims,” he says. “There is significant value after a catastrophe to mobilise your team and to go and visit the ceding companies on location through that process.” Munich Re’s Roenneberg believes communication is vital: “It is important to talk to cedants to make them aware of the challenges – if they are not aware of the exposure, how can we be aware of the exposures?” The past few months may have kept reinsurers busy, but the fall-out of this unusually active period will keep them occupied for many more to come. GR FIND OUT MORE ONLINE: RISK OF LARGE AFTERSHOCKS REMAINS IN JAPAN – MITSUI To read this, and for more on the recent devastation in Japan, go to globalreinsurance.com or goo.gl/GXgpu
GLOBAL REINSURANCE APRIL 2011 27
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Country Focus
Standing firm Nobody would argue with Germany’s impressive show of strength through the financial crisis. But the fight isn’t over yet as interest rates drop, Solvency II steps up and Zurich emerges as a serious contender. Helen Yates reports floods), which pushed its combined ratio above 100%. The reinsurer’s primary insurance group, ERGO – Germany’s second largest direct insurer – also had a good year, almost doubling its profit to €355m. Gross premiums in the primary insurance segment grew by around 5% to €17.5bn, with growth strongest in international business. The high incidence of claims from natural catastrophes – such as the long winter and spring flooding in Germany and international cat events – led to a combined ratio of 100.4%. It is thanks to resilient financial profiles that Standard & Poor’s outlook on the German insurance industry remains stable, although it does see hurdles ahead. Low interest rates are a growing challenge by virtue of an altered approach to investment, with a shift away from equities towards fi xed income. Long-tail lines of business such as liability and motor are particularly affected by low interest rates, while competition in motor and the high incidence of claims are making it tough to turn a profit in this dominant class of
‘The capital position seems much improved. I think we’ll see German insurers being much better off than the international market abroad’ Michael Pickel, Hannover Re
A good year The big professional reinsurers also posted solid profits for the year, with Munich Re leading the charge. Despite the high level of global catastrophes in 2010 – including the Chilean and New Zealand earthquakes – the German giant turned a profit of €2.43bn. But it revealed a catastrophe loss of €495m for the fi nal quarter of 2010 (including €267m from the Queensland
business – which accounts for 40% of the market. “A prolonged period of subdued demand and low interest rates will likely reduce earnings in the sector even further,” writes S&P in its November German market analysis. “We expect that underwriting performance will therefore be one of the main factors
influencing our ratings on property/ casualty insurers in 2011. “Nevertheless, we expect German insurance groups that benefit from strong property/casualty business to withstand the adverse operating conditions. This is, in particular, owing to what we see as their typically strong capital bases and diversification into more profitable non-motor lines.”
Also in the ring Continuation of competitive market conditions is on the cards for 2011, with the primary market looking to hold fi rm on rates in spite of downward pressure. “Germany still has a very high number of insurance companies and, year by year, attracts new market entrants, mostly from abroad,” Guy Carpenter Munich managing director Axel Flöring says. “Examples include the industrial business and the motor market. As a consequence, competition in almost all lines of business is fierce and this results in high pressure on rates.” “In motor, which represents almost 40% of the non-life premium income, the market seems to have reached a turning point,” he continues. “Rates have been increasing market-wide by between 2.5% and 7%. This has been necessary as insurers on an accident-year basis make
PHOTO: PER LINDGREN/REX FEATURES
The fi nancial crisis provided the ultimate test to Germany’s major insurance and reinsurance companies. Yet most showed great resilience, emerging in good health from the downturn. And a snapshot of 2010 results reveals that they remain comfortably capitalised. But low interest rates, a softening market and the impending Solvency II regime will continue to test their superior business models for the foreseeable future. For now, despite the drop in investment income and a competitive market, companies are in good shape. “I think everybody had a good year in 2010 and the German underwriting result has slightly improved,” Hannover Re executive board member Michael Pickel says. “The capital position seems to have much improved. I think what we’ll see in respect of the German insurers is they’re much better off than the international market because we haven’t had any major claims in the past year.” Market leader Allianz’s 2010 year-end results – with a net income of €5.2bn ($7.35bn), a 12% increase from €4.7bn in 2009 – demonstrates resilience in a fragile economic environment, according to Moody’s. But natural catastrophes and poor rate environments in some of its key markets depressed property casualty results. “Shareholders’ equity of €44.5bn and a solvency ratio of 173% demonstrate the strong capital position of Allianz, and it remains resilient to deteriorations in equity markets or the interest rate environment,” Moody’s vice-president and senior credit officer Paul Oates says.
28 APRIL 2011 GLOBAL REINSURANCE
GR_28-29 Germany.indd 28
18/03/2011 16:10
Country Focus
COUNTRY FOCUS
Germany Combined ratio: the fall and rise Gross combined ratio of German insurance industry according to GDV statistics Net combined ratio of rated insurers based on Standard & Poor’s calculations
102% 100% Combined ratio
98% 96% 94% 92% 90% 88% 86% 84% *forecast
losses of up to 15%, which can only be mitigated by run-off profits from former business years.” While Germany’s big international reinsurers – including Munich Re, Hannover Re and Berkshire Hathawayowned General Reinsurance AG (formerly Cologne Re) – continue to maintain a strong market share in Germany, Europe and the rest of the world, competition is growing. Despite the catastrophe losses in 2010 – with the Chilean earthquake costing the industry up to $8bn (€5.8bn) – the majority of claims emanate from events in non-peak regions and there were no costly US-landfalling hurricanes. As a result, capacity has remained stable and rates reduced by up to 5% on loss-free programmes at the 1 January renewals, according to Guy Carpenter. The emergence of Zurich as a hub, and the likely impact of Solvency II, could see the once steadfast direct proportional market alter. Among the companies to set up a presence in Switzerland in recent months are Amlin, Allied World, Ariel, Aspen Re, Catlin, Novae, Partner Re and XL. Even within Switzerland, Munich Re has moved its headquarters for New Re from Geneva to Zurich to take advantage of the developing reinsurance infrastructure there.
’02
’03
’04
’05
’06
’07
’08
’09
’10*
’11*
Source: GDV and company data, Standard & Poor’s
Assuming Switzerland achieves third-country equivalence under Solvency II – as it is widely expected to – these companies will continue to have direct access to the Continental European market, including Germany. “I think competition is coming out of the Bermudan companies in Switzerland,” Hannover Re’s Pickel says.
Solvency II – weighing the impact While reinsurers are expected to benefit from Solvency II, as demand for catastrophe reinsurance grows and insurers seek contingent capital, Pickel does not think the impending regulatory framework will result in a dramatic shift in buying behaviour. “It will be a beneficiary but I would not be so foolish to say we are the only solution. I think reinsurers are one capital provider.” The fact that capital requirements may not be as burdensome as initially thought could limit Solvency II as a potential driver of consolidation in the market. “The preliminary feeling with QIS5 is that a major part of the market is adequately capitalised, even taking into account everything in QIS5,” Pickel says. “I don’t mean that mergers and acquisitions won’t occur but that will be in the middle to high market segments, or for smaller companies
where there’s too much volatile business on board.” Nevertheless, Solvency II is expected to have some impact, with a shift towards non-proportional business becoming more evident as cedants look to offset some of the increased capital charges under the standard formula. The role of the reinsurance broker in the market is changing, with intermediaries no longer just used to place catastrophe business, a trend the new regulatory regime is likely to influence. “Today, brokers are becoming a trusted adviser to their clients and the consultancy part has gained equal importance to the transactional part of the business,” Flöring says. He thinks the impact of Solvency II will be felt most intensely in the life sector. “Due to the low interest rate environment, in conjunction with the expected sharpening of solvency requirements, the market is under pressure,” he explains. “Quite recently, six German life insurers have ceased writing new business and put their companies into run-off.” Munich Re-owned insurer Ergo, for example, put its Victorian Leben subsidiary into run-off last year. The pressures are largely a result of low interest rates, along with expected increases in capital requirements under Solvency II, notes S&P, given that most companies still rely on traditional products that are highly capital intensive. “The market is expected to consolidate due to the complexity of the new regulations and the increased capital needs,” Flöring says. “It is also expected that there will be a greater focus on the active management of business that has been put into run-off with the aim of freeing up capital.” GR
GERMANY COUNTRY FOCUS IS PRESENTED IN ASSOCIATION WITH:
GLOBAL REINSURANCE APRIL 2011 29
GR_28-29 Germany.indd 29
18/03/2011 14:40
Country Focus
QEva-Maria &A with
Barbosa
Norton Rose’s of counsel gives the lowdown on what German reinsurers can expect from Solvency II, the ECJ gender ruling and the legal world in general Q: What impact is Solvency II likely to have on the German market? A:
Looking at the German reinsurance market, the impact will be less visible than one might expect. Despite the fact that the new regime introduces new capital requirements, the main focus of the reinsurers will remain on the capital requirements of the rating agencies. German reinsurers generally have a very comfortable capital backing. If you take a look at the highly fragmented German direct insurance market, the answer is different. There are a number of small and midsized insurers and, in particular, life insurers, that are somewhat weak on the capital and ROI side. They will need to fi nd novel solutions for the capital requirements or review certain lines of business in the light of those requirements. This may well result in a higher restructuring and consolidation activity in Germany in the next five years. That said, the reinsurers will most defi nitely provide the full scope of solutions from fi nancial reinsurance to hybrid debt to the direct insurance market in order to help balance the effect on the insurers. On a global scale, there are two aspects of Solvency II to be considered. One is the non-EU reinsurers and insurers active in the German market, who will fi nd that there will be changes in the way reinsurance agreements are drafted and concluded under the Solvency II regime, as well as a different approach to them from the side of the direct insurer. The other aspect is the treatment of non-EU affi liates of German
reinsurers and their integration into the German groups on the capital and risk management side.
many products, and they will have an opportunity to adjust rates. It will take some time for the market to recalibrate but, initially at least, I would not be surprised if it led to an increase in rates for a number of products. The important thing for reinsurers is that new unisex statistics will have to be produced, and it may not be so easy to relate them to the existing historical data.
Q:
So will Solvency II benefit the reinsurance market?
Q: What are some of the challenges ahead for German (re)insurers?
A: All the benefits of Solvency II are going to be available from the start, whereas at least some of the burdens of Solvency II are being delayed until the future. So it makes Solvency II look more like an opportunity, in particular for a market as well capitalised as the German one. In addition to that, we expect the German reinsurers to broaden reinsurance solutions to cater for the needs of all sizes of direct insurers under Solvency II. I would count the option to have an internal model as one of the benefits, and the ideal candidates to implement internal models quickly are based in Germany. But even under the standard model, insurers can get almost full credit if they transfer risk to reinsurers with an excellent credit rating. In particular for non-proportional reinsurance, the solvency capital relief will improve significantly compared to the current situation.
A:
Q: What are some of the legal trends affecting the market? A:
Germany generally has a very stable legal environment. The biggest impact we can expect is going to come out of the new obligations for financial institutions. Also the judgment by the ECJ on gender is going to be a significant change. Insurers will have to redesign
In anticipation of Solvency II’s pillar II, for the direct insurance side the system of governance under Solvency II and numerous new reporting and back-testing systems will undoubtedly be a huge administrative burden. For the large German groups, our impression is that they have come very far in the preparation and will get the credit for internal models sooner rather than later, which is impressive. This is equally true on the reinsurance side where companies will need to get to grips with the treatment of their non-EU affi liates and may even start a redomiciliation discussion to optimise the consolidation under Solvency II. Clever investing will be both a challenge and a market trend. We are seeing reinsurers go out into alternative investments, such as renewables, more than they did before.
Q: What are you focusing on over the next year? A:
We are quite active in supporting the preparation for Solvency II in terms of products, systems of governance and compliance. Besides that, the run-off market is developing significantly – also in anticipation of Solvency II – and this is a big area of focus. Finally, restructuring and M&A activity may become active again before the end of the year. GR
30 APRIL 2011 GLOBAL REINSURANCE
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21/03/2011 15:56
Rewind
Monty Our man takes a bookish turn this month, but fear not – he still has plenty of dirt to dish
From one superhero to another …
was sited on land that was full of barrels of highly flammable liquid, which were ignited by a static spark when someone was fi lling one of them. Try modelling that.
If you’re like me, you await Warren Buffett’s annual letter to shareholders with bated breath. He usually has a go at something or someone, and there’s always some nugget of industry genius that makes everyone go: “Now why didn’t I think of that?.” Uncle Warren was a bit light on the criticism and advice this time around, apart from having a customary go at other reinsurers for writing rubbish business. That said, his words of praise for Berkshire Re superman Ajit Jain just keep getting better. “Even Kryptonite bounces off Ajit,” he said. Priceless.
Hopes for a happy ending Ask anyone in this industry what they do in their spare time and the chances are they’ll say golf. As a result, it’s always nice to hear when someone does something different with their spare time. Kelly Fegan, client services director at RI3K, is working on a novel, inspired by people and events from his 27-year insurance career. I just hope the fi rm’s takeover by Qatarlyst hasn’t distracted him from the tricky task of fi nishing it.
It’s just not cricket tea Good old Frank O’Halloran. On presenting Australian insurer QBE’s 2010 results to the press corps in London, I’m told by one of my journalist pals that he opened proceedings not by rattling off the headline figures but by lamenting his country’s drubbing in the Ashes. He then went on to discuss the state of the Wallabies team. Good to see he has his priorities right. But cracks might be appearing in Frank’s all-Australian veneer. An Aussie mole tells me that instead of serving lamingtons and Bundaberg ginger beer at the results event, the hacks got Danish pastries and Swiss mineral water. He’d never get away with that Down Under.
When sparks fly I don’t usually give underwriters free advice, but you can have this titbit for nothing: always do a site visit for a risk, especially if the supporting information is in a foreign language. An old Lloyd’s hand told me the other day about an Indonesian bicycle factory he once underwrote, which he assumed from the name was surrounded by unused land. But as he flew into Jakarta airport, his jet went through a worrying plume of black smoke, which it later transpired was the bike factory. Turns out it
Kiss and tell
Buffett’s words of praise for Berkshire Re superman Ajit Jain just keep getting better
Speaking of books, does anyone recall Bad Boy by one-time Lloyd’s underwriter Stephen Gray? If you don’t (it came out six years ago), it gives a lurid account of the naughty things that go on behind the scenes at Lloyd’s and in Monte Carlo. What you might not know is that the book is endorsed by long-tongued bass player Gene Simmons of US rock band Kiss – apparently a good mate of Gray’s. “Engrossing. To use the American vernacular, Bad Boy rocks!” Mr Simmons says on the back cover. Who said insurance was boring?
LeStrange turn of events Finally, it’s with some sadness that the industry bids a (hopefully temporary) farewell to Ken LeStrange, who has stepped down as chairman of Endurance, having given up the job to David Cash last year. I get the impression from people in the know that it got a bit emotional, with one of the senior team shedding a tear or two. You can’t blame the person in question – Endurance is a force to be reckoned with thanks to LeStrange. They’ve never accepted the dodgy risks I’ve tried to palm off on them, anyway. GR
32 APRIL 2011 GLOBAL REINSURANCE
GR_32 Monty.indd 32
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