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Global firms’ profits slide in 2011
Marketwatch: Transatlantic buyout proves stock booster to Alleghany
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● Group of 34 global (re)insurers posted combined $30bn cat losses, 58% net profit drop and COR of 110% ● Smaller firms worst hit while larger firms fared better; overall the group turned a profit despite heavy losses
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According to the old adage, the bigger they are, the harder they fall. But this was largely not true for global (re)insurers in 2011, according to Global Reinsurance’s study of the 2011 results of the industry’s most prominent firms. The year was a tough one for firms of all sizes, thanks to the onslaught of natural catastrophes. The group of 34 global (re)insurers studied suffered combined catastrophe losses of $30.3bn. As a result, 16 of the companies made a loss, and those lucky enough to turn a profit made a far smaller one than they had in 2010. The group’s combined net profit plummeted 58% to $10.6bn in 2011, from $25.6bn in 2010. The average combined ratio across the group shot up almost 20 percentage points to 109.6%, from 90.6%. Only two firms – Swiss Re and White Mountains – boosted profits (see chart 5), and both these increases were company-specific anomalies. Swiss Re’s 2010 profit was eroded by $1.1bn owing to the interest on the convertible bond it issued to Berkshire Hathaway.
The bond was paid off in late 2010, and so the charge did not recur in 2011. White Mountains’ 2011 profit, meanwhile, was boosted by a gain on the sale of its Esurance business. The study shows that the smaller companies suffered most at the hands of Mother Nature, while the larger companies generally weathered the storm better. Lloyd’s (re)insurers Omega and Hardy are the smallest companies studied measured by gross written premium and shareholders’ equity. They occupy the lower size tier of the listed Lloyd’s companies and came off badly last year. Hardy’s catastrophe loss as a percentage of 2010 shareholders’ equity was the largest of the 34-strong group of companies (chart 8). Hardy also suffered the largest year-on-year percentage drop in net profit of the group, and saw shareholders’ equity fall by 30% – the second-biggest drop reported. Omega had the third-worst combined ratio of the group, posted the third-largest decline in shareholders’ equity and
reported the third-worst return on equity (chart 4). The worst performer overall was Flagstone Re. The company had a torrid 2011 by many measures. Its combined ratio and return on equity were both the worst of the group (charts 2 and 4), and the company suffered the second-largest reduction in profitability and relative level of
Flagstone Re had a torrid year by many measures catastrophe losses. In addition, the company saw the biggest erosion of shareholders’ equity of its peers of 30.5%. The events of 2011 wiped £346m from Flagstone’s capital base. Like Hardy and Omega, Flagstone is among the smallest of its peers, with shareholders’ equity of less than $1bn. When Global Reinsurance did
● This month sees a new entry into the top 10 listed (re)insurance groups, following the acquisition of Transatlantic Holdings by Alleghany Corporation. The decision to buy one of the world’s largest reinsurers has clearly impressed Alleghany’s shareholders. The stock has been on a strong upward trajectory all year.
an early temperature check of the market last month, after the largest players had reported their 2011 results (see Global Reinsurance March, page 4), PartnerRe and Platinum Underwriters were the worst performers in terms of losses and shareholders’ equity erosion. However, they have been overtaken by Flagstone and the smaller Lloyd’s firms. In contrast, the larger firms did well. Perhaps unsurprisingly given their collective size, Berkshire Hathaway’s (re)insurance businesses posted the largest profit of nearly $5bn, while Munich Re suffered by far the biggest catastrophe loss of the group of $5.8bn but still turned a profit of $919m. The rest of the big European groups were all in the top 10 in terms of 2011 profit levels. These firms also reported the smallest percentage reductions in profit. While performance was variable in 2011, overall the industry should be pleased. It suffered heavy losses but still turned a profit overall, and shareholders’ equity increased to $315.2bn, from £304.9bn.
● The top reinsurers generally had another good month on the back of rising investor confidence. Both Swiss Re and Munich Re turned in good performances, with share price rises of 9.9% and 5.7%, respectively. ● Not all companies fared well. Shareholders are still digesting PartnerRe’s lacklustre 2011 performance and subsequent rating agency warnings, and its stock has shown some dips. ● The biggest faller, however, was Korean Re, whose stock dropped 10.7%. The reason is unclear, but perhaps shareholders are concerned about the company’s exposure to catastrophe zones around the world.
10.1%
Alleghany was this month’s biggest riser *All prices expressed in local currency 17 February-16 March 2012
Berkshire Hathaway 'A' 125k 120k 115k 110k
Everest Re 95 90 85 80
Hannover Re 40 38 36 34
Korean Re 16k 15k 14k 13k
Munich Re 110 100 90 80
PartnerRe 66 64 62 60
Reinsurance Group of America 56 54 52 50
SCOR 21 20 19 18
Swiss Re 55 50 45 40
Alleghany 275 250 225 200
Best and worst: How global reinsurers fared in 2011 1. COR 2011 ranking (%): Best five 100 94.6
80 60
95.9
98.1
98.2
3. ROE 2011 ranking (%): Best five Alterra Transatlantic Re ACEMaiden Re
63.7
Transatlantic Re Alterra
20
Mapfre Re Re Transatlantic
16.2
SwissRe Re Swiss
9.6
9.3
9.0
5
Transatlantic Mapfre Re Re White Mountains Arch
0
0
2. COR 2011 ranking (%): Worst five 200
100
15
5. Profit change 2010-11 ranking (%): Best five ArchMountains White
19.8
Allied World Assurance Allied World Assurance 10 ACE Re Maiden
40
150
20
153.6
4. ROE 2011 ranking (%): Worst five PartnerRe Flagstone Re Montpelier Re Platinum Underwriters
143.3
134.3 131.1 125.4
50 0
6 APRIL 2012 GLOBAL REINSURANCE
0
-12.5
-10
Omega Omega -15 PlatinumRe Underwriters Montpelier Flagstone Re PartnerRe
-20
-26.5
-25 -30 -35
-33.9
-23.7
-9.5
Platinum Underwriters Hardy Omega Omega Hardy Underwriters Platinum Flagstone Re Amlin
787.7
204.3 -19.1 -21.1 -30.8
0 -100 -204.0
-200 -300 -400
8 7 6 Hannover Hannover Re Re 5 Swiss Re 4 SCOR 3 White Mountains (Sirius COR) Berkshire Hathaway* 2 1 *profit before tax 0
-500
-181.1 -167.4
Amlin Hardy XL Flagstone Re
-435.8
XL Maiden Re 7.2 6.2
ACE ACE Berkshire Hathaway White Mountains
3.9
1.3
White Mountains Berkshire
XLMaiden Re
1.9
8. Cat losses as % of shareholders’ equity: Worst five 50 40
Platinum Underwriters Platinum Underwriters 30 XL Flagstone Re Hardy Amlin
-460.4
7. Cat losses as % of shareholders’ equity: Best five
Berkshire Hathaway* White Mountains SCOR Swiss Re
6. Profit change 2010-11 ranking (%): Worst five Amlin Flagstone Re
-5
800 700 600 500 400 300 200 100 0 -100
20
PartnerRe Hardy
47.6
Platinum Underwriters Flagstone Re
37.7
Amlin Amlin
28.9
25.9
24.8
FlagstoneUnderwriters Re Platinum Hardy PartnerRe
10 0
DATA: COMPANY RESULTS
Sponsor’s word Simon Gallagher, insurance group head, Moore Stephens
The upside of Solvency II The cost of Solvency II to the industry has been estimated at around £2bn ($3.18bn), and the current schedule is for implementation in 2013 and compliance by 1 January 2014. Simon Gallagher However, with the Omnibus II decision and parliament’s vote both delayed, it could push into 2015. Yes, this delay has an impact on firms, but it also impacts the regulator and its ability to give clear guidance. It may be that there is a transition period where Solvency I and II rules are running together. Lloyd’s has delayed submission of its model from April to July. Lloyd’s and the FSA are maintaining their programme of activity, and insurance companies should take the delay in the same spirit and carry on with their plans, using the extra time as breathing space to resolve final issues, such as improving data quality, refining the modelling, and further strengthening governance and risk management required under Pillar II. Sovereign debt risk The capital guidance section of the current Solvency II rules treat sovereign debt as risk free. Recent economic developments show this is potentially not the case, however. The industry is questioning if the capital rules and model formula will change. Probably not. Companies using their own internal model will already account for the risk of any debt, including sovereign debt. You can’t change risks and capital charges under the standard model, but adopting Pillar II risk management may lead to different investment strategies – opting out of sovereign debt, for example. So if the system works properly, it is almost self-regulating. There has been no announcement suggesting a complete overhaul of the formula, but it is possible it could be recalibrated to take account of such influencing factors. A head start Those businesses that have made an early start on compliance should already see benefits, such as: • more effective purchase of reinsurance; • better capital efficiency; • increased awareness of risk management; • improved business understanding; • stronger corporate governance; and • improved reputation and competiveness. The reason people are feeling the pain now is that we are in a phase of frictional change, climbing the hill of what is a difficult project for any firm. Firms should take advantage of the delay and achieve ‘business as usual’ as quick as possible. They should see it as a business initiative, not purely a compliance one! GLOBAL REINSURANCE APRIL 2012 7
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Political wrangling continues over ‘ill thought-out’ Solvency II
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● Crucial Omnibus II vote is delayed again and UK PM goes on the attack after Prudential threat to quit UK The hearing on Omnibus II One driver behind a possible Directive adoption has again move by the Pru is continued been delayed, according to uncertainty about Solvency II. reports. The European The UK, which is further Parliament, preoccupied with ahead in preparations than the the Eurozone crisis, has put the rest of Europe, has invested plenary vote back to September. hundreds of millions of pounds. Talks over the directive’s Yet more delays are anticipated proposed amendments to and the finer details of the Solvency II have, it seems, regime are yet to be confirmed. been difficult. Outside the Omnibus II Continuing uncertainty Economic and Monetary Affairs “There continues to be Committee, political quarrels uncertainty in relation to the have also escalated. implementation of Solvency II UK prime minister David and implications for the group’s Cameron, disappointed with business,” said Prudential. Prudential’s threat to move its “Clarity on this issue is not headquarters from London to expected in the near term.” Hong Kong, has described The original vote over Solvency II as “ill thought-out”. Omnibus II was due at the end The new rules governing of last year. It was delayed to insurance and reinsurance January and then to March. companies in Europe risk Many think the final vote may “endangering a great British not be cast until September. business that should have its Omnibus II suggests some headquarters in the UK”, he transitional measures for said during prime minister’s Solvency II, such as for the questions on 7 March. treatment of hybrid capital and But in response, European third-country equivalence, with Commission head of insurance potential delays up to 10 years. and pensions Karel van Hulle “Everything is based on insisted all parties had been Omnibus II being signed off,” involved “at each and every says Lane Clark & Peacock state of the process”. insurance consulting “We badly need Solvency II practice principal Wendy Hawes, now,” said Van Hulle. “You who recently moved from the can’t do regulation right for FSA. “They can’t implement everybody, therefore you need to Solvency II without Omnibus II set priorities and that is difficult.” being agreed, because it makes The European Commission some significant changes. said it fundamentally disagreed “There are definite rumblings that Solvency II left some in the market that, because of the insurance companies with no delay in getting Omnibus II choice but to leave the EU, finalised, that first date, on which insisting that Solvency II “will the supervisory authorities will improve the international take on the power – 1 OWN RISK AND competitiveness of January 2013 – will not SOLVENCY insurers, not undermine it”. ASSESSMENT be achievable.” REMAINS A “There are a few issues Further delays could CHALLENGE – that indeed remain to be force the UK to WILLIS RE solved,” it said. “But they implement Solvency II should not be exaggerated. before the rest of FIND OUT And we count on all Europe. This could give MORE ONLINE parties involved, including UK firms a ‘first mover’ goo.gl/2039E Prudential, to work advantage, allowing constructively to find them to realise the suitable solutions.” benefits first and giving 8 APRIL 2012 GLOBAL REINSURANCE
them more time to embed the models within their business. But others argue that late changes to Solvency II could be harder to implement for firms that are further down the road, leading to a competitive disadvantage. For UK insurers and reinsurers about to go through the internal model approval process, lack of clarity on Omnibus II is also causing concern that there could be additional costs associated with Solvency II. In 2007, the CEA (European Insurance and Reinsurance Federation) estimated the industry would spend around €3bn ($4bn) in initial one-off Solvency II costs. It’s now clear this is a major underestimate and, for the UK alone, the FSA puts the cost of preparation at £1.9bn ($3bn). The Lloyd’s market – which had a demanding timetable for syndicates last year – reckons Solvency II will cost it £300m. The UK will inevitably incur higher costs than other markets. With London home to so many large international (re)insurers, a much higher proportion of UK firms are seeking internal model approval than their Continental European counterparts. Under the standard formula, firms would be penalised with excessive capital requirements, which do not provide adequate diversification credit, particularly for capital-intensive property catastrophe perils.
Formula for fear But the standard formula remains a worry – even for those designing internal models – with a worry it will become a benchmark for regulators. Firms looking to start using internal models next year may also have to renew their ICAS models for another year if there are further delays. Meanwhile, the FSA has told the market to continue preparing for 2014
Solvency II: timeline
NOV 2009 APPROVED
MAR 2012 ECON VOTE
SEP
2012 POSTPONED
JAN 2013 TRANSPOSED
CFO interview
Stuart Bridges
The Solvency II directive is approved by Ceiops, and will be adopted by all 27 EU member states
ECON committee votes on Omnibus II directive, confirming 1 January 2014 implementation
The vote on Omnibus II is postponed until 10 September 2012 – a further threemonth delay
The date by which all local laws and regulators will need to have transposed the Solvency II directive
implementation. FSA director of insurance Julian Adams said on 27 February that the regulator would keep to its timetable. “You’ll be aware that the timetable is tight, particularly in the context of a legislative process that has been far from straightforward,” he said. “We await a key vote in the European Parliament at the end of March, and it would clearly not take much further slippage in this to put transposition in January 2013 at risk, but this would not necessarily affect the implementation date in January 2014,” he said. “What it might do instead is merely compress the period between transposition and implementation. “It therefore remains our assumption that the new regime will apply from January 2014.” ■ See this issue’s Global Market Report, page 25.
Stuart Bridges from Hiscox on making a return in a low interest rate environment, the eurozone debt crisis, and how Solvency II will affect what he does
Q A
What are your biggest concerns as a CFO in the current environment? At Hiscox we are very focused on making a healthy return for our shareholders. The real challenge in this environment is: how do I deliver this return, recognising that we are in a low interest rate environment, potentially for some time, but also recognising that US reinsurance rates, for example, are very healthy? The challenge is getting your level of capital right to deliver a healthy return; not taking too much risk, yet taking opportunities.
Q A
What is your approach to tackling the low interest rate environment? The key to life in this environment is not to chase yield. Our portfolio is short-duration. We have a good weighting of corporates in it, which gives us a yield pick-up, and we don’t feel we are paid much for extending our duration at the moment. Within that, we increased the equity weighting in our portfolio last year, because we think equities look quite attractive. The difficulty with them is they are high volatility, but if I wanted to move the portfolio further I would increase the equity weighting at this point. The other key is that you have to run the business accepting that it is going to be a low interest rate environment for some time. The challenge is making the underwriters understand the dynamic of creating returns in the lower investment rate world. In a lower interest rate environment, an underwriter has to change his targets. But if an underwriter has been writing to a specific combined ratio for many years, it is difficult to change that.
Q A
How big an issue is the eurozone debt crisis for the non-life (re) insurance industry? It is likely to extend the low interest rate environment for us for a while. Because we have a large insurance book across Europe, with offices across Europe, we have to have contingency plans in case there is a breakdown of the euro in any country. Having said that, we’re not active in Greece, so that is in our favour. The other thing we are watching carefully is not just the countries and governments that we’re invested in, but also financial institutions. Every sensible finance director
‘The challenge is not taking too much risk, yet taking opportunities’ is keeping a very close eye on individual exposures to individual banks, which we are monitoring on at least a weekly basis. Because you may have bonds, cash and other exposures with the banks, it is a matter of having systems that allow you to monitor your total exposure and make sure you are happy with it on an individual bank basis.
Q A
How is Solvency II affecting your job, and how will it do so following implementation? Solvency II is the biggest project in the company. It is not just myself and the direct teams involved with it. It is very broad across the management of the group in terms of the training, the implementation and the fact that we are using the Solvency II models more and more as we implement it. In two years’ time, I think it will be business as usual. Solvency II is giving us a much more holistic view of how we run the group. We have used modelling for catastrophes and
investments for a long time and use those to control risk within the group. But Solvency II is bringing together the risks in the business and how they interrelate. That has already led to much more of a focus on underwriting risks at some of our board meetings and elsewhere. It is a vast amount of work. But the more you use it, the more you see the benefits.
Q A
How do approach managing capital across a diverse, global business? We have carriers in Bermuda, the USA, Guernsey, Lloyd’s carriers and a single European carrier based in the UK. The bulk of our capital sits in Bermuda. The capital is quite fungible between the entities. We keep large credit facilities as well, which allow us to manage the funds at Lloyd’s very effectively. But we have the capability, at a group level, to manage that capital. The interesting thing is that a lot of capital demands are driven by the rating agencies. What interests us is the group view versus individual carrier view of the rating agencies. Understanding the evolving nature of how rating agencies look at groups is one of the key issues at the minute.
Q A
Are you planning to make any changes to your capital structure? I am happy with where our capital structure but it is something you have to constantly monitor to make sure that it stays efficient.
Q A
What qualities does a (re)insurance chief financial officer need? You need a deep understanding of the reinsurance industry and of the participants in it. The CFO’s role these days is not just making sure the numbers add up. Solvency II emphasises the need to look at risks across the business. The CFO has to understand those risks, be it reinsurance purchasing or the risk of expanding in certain areas such as emerging markets, or taking increased risk in Japan if the rates go up. You need to do a lot of reading and very much understand the industry as a whole. GLOBAL REINSURANCE APRIL 2012 9