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A Berkshire Hathaway Company
Marine Reinsurance in 2008
21 January 2008
2
3 Issue’s and Trends
4 Pricing in the Future
1 Reinsurance Market
2 Basic Principles of Reinsurance
TABLE OF CONTENTS
3
The Insurance Industry – Simplified
INSUREDS
Broker / Agent / Producer
INSURERS
REINSURERS
R/I BROKERS
LLOYDS
1 Reinsurance Market
4
Top Ten Global Property/Casualty Insurance Companies, by Revenues, 2006
1 Allianz Germany $125,3462 American International Group U.S. $113,1943 Berkshire Hathaway U.S. $98,5394 Zurich Financial Services Switzerland $65,0005 State Farm Insurance Cos. U.S. $60,5286 Munich Re Group Germany $58,1837 Millea Holdings Japan $36,0678 Allstate U.S. $35,7969 Swiss Reinsurance Switzerland $32,118
10 Hartford Financial Services U.S. $26,500
(1) Based on an analysis of companies in the Global Fortune 500. Includes stock and mutual companies.(2) Revenues include premium and annuity income, investment income and capital gains or losses, but exclude deposits; includes consolidated subsidiaries, excludes excise taxes. Source: Fortune.
US$ millions
1 Allianz Germany $125,3462 American International Group U.S. $113,1943 Berkshire Hathaway U.S. $98,5394 Zurich Financial Services Switzerland $65,0005 State Farm Insurance Cos. U.S. $60,5286 Munich Re Group Germany $58,1837 Millea Holdings Japan $36,0678 Allstate U.S. $35,7969 Swiss Reinsurance Switzerland $32,118
10 Hartford Financial Services U.S. $26,500
1 Reinsurance Market
5
World Largest Reinsurance Brokers Source: Business Insurance, October 24, 2005
2005 Gross Revenues 2004 Gross Revenues % Change
1 Aon Re Global $920,000,000 $940,000,000 -2% 3,0002 Guy Carpenter & Co. Inc. 838,000,000 868,000,000 -3% 2,6063 Benfield Group Ltd. 589,800,000 558,300,000 16% 1,7004 Willis Re 565,000,000 550,000,000 15% 1,1595 Jardine Lloyd Thompson 155,800,000 145,200,000 7% 4336 Towers Perrin 153,300,000 146,000,000 5% N/A7 Cooper Gay (Holdings) Ltd. 92,800,000 57,550,000 2%8 BMS Group 75,300,000 73,000,000 3% 4759 Gallagher Re 75,000,000 78,000,000 -4% 20010 John B. Collins 52,000,000 48,100,000 8% 311
377
1 Reinsurance Market
6
Top 10 Global Reinsurers by total net written reinsurance premium – 2006 Source: S&P Global RI Highlights ( Sept 2007)
2006 Ranking Company
2006 Net RI Premium Written ($ MM's)
1 Munich Re, Germany 25,4322 Swiss Re, Switzerland 23,8413 General Re/Berkshire Hathaway, US 11,5764 Hannover Re, Germany 9,3535 Lloyd's of London, UK 8,4456 SCOR 4,885
7 RI Group of America 4,3438 Everest Re 3,8759 Partner Re 3,68910 Transatlantic Holdings, US 3,633
* Property & Casualty + Life Premiums
1 Reinsurance Market
7
1.1
0
1.0
8
1.1
0
1.0
3
1.0
2 1.0
6
1.1
4
1.1
3 1.1
7
1.0
1 1.0
6
1.2
6
0.9
5
1.3
9
1.2
1
1.0
6
1.0
7
1.0
7
1.0
9
1.1
8
1.0
7 1.0
8
0.9
1.0
1.1
1.2
1.3
1.4
1.5
85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06
Lo
ss
& L
AE
Ra
tio
Despite the respite in 2006, reinsurers paid an average of $1.11 in loss and expense
for every $1 in written premium since 1985
Hurricane Andrew
Sept. 11
Katrina, Rita, Wilma
Liability Crisis
1 Reinsurance MarketRatio of Reinsurer Loss & Underwriting Expense to Premiums Written, 1985-2006
8
S&P Financial Strength Rating Changes
Ratings as of January 2006
AAA AA+ AA AA- A+ A A- BBB+ Watch / OutlookBerkshire / General Re X StableSwiss Re X Watch - Negative Chubb Re (Federal) X StableAXA Re X PositiveEverest Re X StableHannover Re X Negative Partner Re X StableTransatlantic Re X StableXL Re X StableACE Tempest Re X StableW.R. Berkley X StableMunich Re / American Re X StableRenaissance Re X StableAspen Re X NegativeAxis Specialty X StableEmployers Re / GE Re X Watch - PositiveIPC Holdings X NegativeLloyd’s X StableEndurance Re X PositiveMontpelier Re X NegativePXRE X StableSCOR X StableAlea X StableConverium Re X Stable
This chart was created by Gen Re solely for its use and that of its clients and should not be reproduced or distributed furtherSource: standardandpoors.com
1 Reinsurance Market
9
Development of Corporate Capital at Lloyd’s
PricewaterhouseCoopers Review 2002, updated 2005%
of L
loyd
’s c
apac
ity
0
10
20
30
40
50
60
70
80
90
100
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Individual
Corporate & other
1 Reinsurance Market
10
Suppliers of Lloyd’s Capital (2005)
PricewaterhouseCoopers Review, 2002 updated Lloyds Annual Review, 2005
14%
34%
17%
17%
11%
7%Non-insurance industry
US insurance industry
Bermudian insurance industry
Other insurance industry
Names' conversion capital
Names (unlimited)
62 Syndicates
1625 “Names” (Individual)
1 Reinsurance Market
11
WHAT IS “REINSURANCE ?”
• A way to spread risk
• A contract of indemnity between an Insurer and a Reinsurer
• Original Insured - no contractual right or privity
• Contract between two informed parties
• Always transfer of risk
2 Basic Principles of Reinsurance
12
Major Types of Reinsurance
Treaty
• certain group or class of business reinsured under a single contract
• Obligatory nature – if it “fits” the contract it must be ceded, and accepted.
Facultative
• separate reinsurance contract negotiated on each risk
• No obligation on either party’s behalf to place or accept the risk
Facultative and Treaty
FACULTATIVE HYBRID TREATY
Pro RataPro Rata Excess of LossExcess of Loss
QuotaShareQuotaShare
SurplusShare
SurplusShare
PerOccurrence
PerOccurrence
AggregateExcess of Loss
AggregateExcess of Loss
PerRiskPerRisk
Per RiskExcess of Loss
Per RiskExcess of Loss
Per RiskAggregate Excess of Loss
Per RiskAggregate Excess of Loss
2 Basic Principles of Reinsurance
13
Reasons to Buy Treaty Reinsurance
• Spread of risk
• Stabilization of underwriting results
• Catastrophe relief (one occurrence affecting multiple policies, i.e., Hurricane Andrew)
• Underwriting assistance
• Premium capacity
• Ease of use
2 Basic Principles of Reinsurance
14
Reasons to Buy Fac Reinsurance
• Large line capacity
• Treaty-excluded business
• Treaty protection
• Accommodation for a good agent or insured
• Catastrophe (a large loss affects one policy versus five)
• Underwriting expertise
• Flexibility
2 Basic Principles of Reinsurance
15
Major Types of Reinsurance
Excess of Loss
• also known as NonProportional reinsurance
• reinsurer agrees to indemnify the ceding company for losses that exceed a specified retention up to an agreed-upon limit
Pro Rata
• also known as Proportional reinsurance
• insurance amount, premium and losses under a primary contract are shared between the ceding company and the reinsurer in an agreed proportion
Pro Rata and Excess of Loss
FACULTATIVE HYBRID TREATY
Pro RataPro Rata Excess of LossExcess of Loss
QuotaShareQuotaShare
SurplusShare
SurplusShare
PerOccurrence
PerOccurrence
AggregateExcess of Loss
AggregateExcess of Loss
PerRiskPerRisk
Per RiskExcess of Loss
Per RiskExcess of Loss
Per RiskAggregate Excess of Loss
Per RiskAggregate Excess of Loss
2 Basic Principles of Reinsurance
16
Cession
Retention
Cession
(% or Line)
Retention
Non-Proportional or Excess of Loss Reinsurance
Proportional or shared Reinsurance
2 Basic Principles of Reinsurance
Pro Rata and Excess of Loss
17
Pro Rata Reinsurance (Proportional)
Pro Rata
• How It Works
• Three Types of Pro Rata Reinsurance
– Quota Share
– Surplus Share
– Contributing Excess
ReinsurerParticipation
40%
CompanyParticipation
60%
Quota Share
2 Basic Principles of Reinsurance
18
Pro Rata Reinsurance (Proportional)
Surplus Share
• Retention expressed in $$.
• Often referred to as a “line.”
• Insurer retains 100% of risks up to
the $$ amount of their “line.”
• Cede all amounts in excess of that.
ReinsurerParticipation
75%
Com
pany
Par
ticip
atio
n25
%
2 Basic Principles of Reinsurance
19
Excess of Loss (XOL or Non-Proportional)
• The reinsurer promises to reimburse the ceding company for losses that exceed the ceding company's retention
• The reinsurer reimburses the ceding company up to the reinsurance limit stipulated in the reinsurance contract
• In return for this promise, the reinsurer charges the ceding company a premium
ReinsurerParticipation
CompanyParticipation
2 Basic Principles of Reinsurance
20
Reducing the volatility. How does that work?
Ideal is to keep the predictable and cede the volatile / unpredictable.
Small Losses: Large # of relatively predictable losses; very manageable with right tools
Medium Losses: Some years more, some years less; can afford cost over time but need smoothing
Jumbo Losses: Rare, random, and virtually unpredictable.; usually relatively few exposures in portfolio
Excess of Loss
2 Basic Principles of Reinsurance
21
Total Loss
Fire/Lightning/Explosion
Machinery damage/small fire
Theft/small fire/shortage
2 Basic Principles of Reinsurance
Excess of Loss – marine pyramid view of a risk
22
Often non proportional reinsurance coverage is layered, whereby the deductible of one layer is the sum of deductible and limit of liability of the underlying layer
0
1
2
3
4
5
6
7
8
2. XL: 3 mio xs 4 mio
1. XL: 2 mio xs 2 mio
deductible
2 Basic Principles of Reinsurance
Excess of Loss - Layering
23
• it is easier to place liabilities in smaller amounts
• some smaller reinsurers specialise in particular levels of cover
– lower/“working” layers, or
– higher/“catastrophe” layers (“sleep easy”)
• the nature and extent of risk is different at different levels of cover
2 Basic Principles of Reinsurance
Excess of Loss – Layering - reasons
24
• layering therefore allows more accurate assessment of the appropriate XL premium
• inclusions/ exclusions of specific classes (e.g. CXL treaties covering PA, WC/EL, MTPL, MOD etc)
• different conditions for several layers
– scope of protection
– annual aggregate limits
– reinstatements
2 Basic Principles of Reinsurance
Excess of Loss – layering - reasons
25
• The limit of liability can be provided more than once e.g. 3 reinstatements for a risk layer and 1 for a cat layer
• There is a maximum annual limit equal to the limit of liability plus the limit multiplied by the number of reinstatements
• The reinstatement functions automatically when the original limit of liability or any part thereof is consumed by a loss
• An additional premium is often charged for this reinstatement
2 Basic Principles of Reinsurance
Excess of Loss - reinstatements
26
• The basis of coverage is specified in the contract and determines which losses the reinsurer is liable for:
- Losses occurring during the reinsurance year
- Risk attaching, i.e. losses arising under policies issued or renewed during the reinsurance year.
2 Basic Principles of Reinsurance
Excess of Loss – basis of coverage
27
• Losses occurring basis: all reinsurers involved from 1.1.2000 to 31.12.2000 are liable
• Risk Attaching basis: all reinsurers involved from 1.1.99 to 31.12.99 are liable
x
1999 2000
Loss date 8.1.2000original policy period: 1.4.99 - 31.3.2000
2 Basic Principles of Reinsurance
Excess of Loss – basis of coverage
28
ReinsurerParticipation
75%
Com
pany
Par
ticip
atio
n25
%
Company Retention$ 250,000
EXCESS OF LOSS vs PRO RATA REINSURANCE Loss Treatment Comparison
ReinsurerParticipation
Limit$5M
Excess of LossQuota Share
CompanyParticipation
60%
ReinsurerParticipation
40%
ExcessPro Rata
Surplus Share(3 Lines Retention)
2 Basic Principles of Reinsurance
29
ReinsurerParticipation
75%
Com
pany
Par
ticip
atio
n25
%
Company Retention
EXCESS OF LOSS vs PRO RATA REINSURANCE Loss Treatment Comparison
ReinsurerParticipation
Limit$5M
Reinsurer$1,750,000
Company Participation$250,000
Loss$2M
Excess of LossQuota Share
CompanyParticipation
60%
ReinsurerParticipation
40%
ExcessPro Rata
$800,000 $1,200,000
Surplus Share(3 Lines Cession)
$1,500,000
$500
,000
2 Basic Principles of Reinsurance
30
3 Issue’s and Trends
• Catastrophes
• Security (Basel II)
• Securitization
31
U.S. Insured - Catastrophe Losses ($ Billions)$7
.5
$2.7
$4.7
$22.
9
$5.5 $1
6.9
$8.3
$7.4
$2.6 $1
0.1
$8.3
$4.6
$26.
5
$5.9 $1
2.9 $2
7.5
$56.
8
$100
$0
$20
$40
$60
$80
$100
$120
89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05
20??
Excludes $4B-$6b offshore energy losses from Hurricanes Katrina & Rita.Note: 2001 figure includes $20.3B for 9/11 losses reported through 12/31/01. Includes only business and personal property claims, business interruption and auto claims. Non-prop/BI losses = $12.2B.Source: Property Claims Service/ISO; Insurance Information Institute
$ Billions
2005 was by far the worst year ever for insured
catastrophe losses in the US, but the worst has yet to come.
$100 Billion CAT year is coming soon
3 Issue’s and Trends
32
30%25%
60%
20%
45%
0%
10%
20%
30%
40%
50%
60%
70%
Hurricane Hugo(1989)
Hurricane Andrew(1992)
Sept. 11 TerrorAttack (2001)
2004 HurricaneLosses
2005 HurricaneLosses
Reinsurance is playing an increasingly
important role in the financing of mega-CATs; Reins. Costs
are skyrocketing
Share of Losses Paid by Reinsurers, by Disaster
3 Issue’s and Trends
33
S&P Financial Strength Rating Changes
Ratings as of January 2006
AAA AA+ AA AA- A+ A A- BBB+ Watch / OutlookBerkshire / General Re X StableSwiss Re X Watch - Negative Chubb Re (Federal) X StableAXA Re X PositiveEverest Re X StableHannover Re X Negative Partner Re X StableTransatlantic Re X StableXL Re X StableACE Tempest Re X StableW.R. Berkley X StableMunich Re / American Re X StableRenaissance Re X StableAspen Re X NegativeAxis Specialty X StableEmployers Re / GE Re X Watch - PositiveIPC Holdings X NegativeLloyd’s X StableEndurance Re X PositiveMontpelier Re X NegativePXRE X StableSCOR X StableAlea X StableConverium Re X Stable
This chart was created by Gen Re solely for its use and that of its clients and should not be reproduced or distributed furtherSource: standardandpoors.com
3 Issue’s and Trends
34
Distribution of Capital Requirements
Source: Moody’s Special Comment, Growing Reinsurance Risk Weighs on P & C Insurance Market Recovery, August 2003
3 Issue’s and Trends
35
Increased Reinsurance Leverage
40%
45%
50%
55%
60%
65%
70%
75%
80%
85%
1998 1999 2000 2001 2002
Reinsurance Recoverables as % Industry Surplus
Source: Moody’s Special Comment, Growing Reinsurance Risk Weighs on P & C Insurance Market Recovery, August 2003
3 Issue’s and Trends
36
Moody’s
In the aftermath of a prolonged soft market for property and casualty insurance, the exposure of primary insurers to counterparty risk on reinsurance assets has become a key credit risk for the industry. Insurers that once gorged themselves at the trough of cheap reinsurance are finding their meal was anything but a free lunch. The ultimate tab has yet to be determined, but could well be much higher than insurers bargained for.”
“
3 Issue’s and Trends
37
Moody’s
“ In the face of these emerging concerns over reinsurance exposure, Moody’s is increasing analytic attention on reinsurance risk in our evaluation of ceding insurance firms, most notably in the context of assessing capital adequacy.”
Source: Moody’s Special Comment, Growing Reinsurance Risk Weighs on P & C Insurance Market Recovery, August 2003
3 Issue’s and Trends
38
Securitization: Or, why would an Insurer Securitize ?
• Alternative to catastrophe reinsurance
– Non-existent (reinsurance of last resort)
– Scarce
– Expensive
• Multi-year nature
• Collateralized : minimal / no credit risk
• May seek no payback – “winner” takes all
• Access to Capital markets
• Motivated (intermediaries) determined to make a market
3 Issue’s and Trends
39
Securitization – what is it?
Two Common Examples
• CAT Bonds (Ins. Linked Securities )
– Converts Ins risk to Securities form (capital market)
• Indemnity based - parallels reinsurance
• Indexed : (Industry L/R or Total Loss $$) = easier investor evaluation
• Parametric loss = f (event magnitude, location)
– EQ of magnitude 7.5 in California…
– Windstorm w/ sustained windspeed of XX kph in …
• Sidecars
– Proportional structure
3 Issue’s and Trends
40
CAT Bonds (ILS)
• Sponsor – Insurer / Reinsurer* / Corporation
• Issuer –
– Bankruptcy remote Special Purpose Vehicle
– R/I contract w/ Issuer
– Issues CAT bonds & places proceeds in collateral account
• Swap Counterparty – swaps investment returns to a LIBOR based rate.
• Investors
– Receive coupons (interest pmt) quarterly
– No “event” = receive principal @maturity
– “Event” = receive any remaining principal @ maturity
3 Issue’s and Trends
41
SIDECARS
• Capital market backing
• Little / no infrastructure – easy to dismantle
• Rely on other R/I’s to “manage” business
• Quota Share structure (proportional)
• Capital relief
• “Flexibility”
3 Issue’s and Trends
42
02000400060008000
100001200014000160001800020000
1999 2000 2001 2002 2003 2004 2005
Accounting Year
Global Hull Cargo Liability Energy Total
Global Marine Premium 1999-2005 (US$ Million), as reported
4 Pricing in the Future
43
114.
2 118.
2
97.3
119.
4
109.
5
107.
9
92.4
89.6
102.
0
110.
4 115.
5
107.
2
102.
6
100.
0 104.
1
97.2
118.
4
98.8
109.
2
109.
6
108.
8
115.
7
106.
9
108.
4
106.
4
106.
0
102.
0 105.
9
108.
0
110.
1 115.
8
107.
5
100.
1
98.4 10
0.8
92.5
80
85
90
95
100
105
110
115
120
125
130
89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06*
Ocean Marine All Lines
Combined Ratio: Ocean Marine vs. All Lines
4 Pricing in the Future
44
-5%
0%
5%
10%
15%
20%
25%
75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 0607
F08
F
Profitability Peaks & Troughs in the P/C Insurance Industry, 1975 – 2008F
4 Pricing in the Future
45
Effects of pricing Strategy
• Scenario 1 Scenario 2• (no reduction) (10% reduction)
• POPeye the Sailor man Des Arster ex Ocean Marine Underwriter 2004
• ------------------------------------------------------------------- ---------------------------------------------------------------
• NWP US$23m NWP US$20.7m
• Expenses US$6m Expenses US$6m
• Expected Losses US$13m Expected Losses US$13m
• Expected Profit US$4m (83% CR) Expected Profit US$1.7m (92% CR)
• Result• A 10% decrease in rates results in a 57% decrease ( diff between $1.7 & $4m) in expected • profit.
4 Pricing in the Future
46
• Scenario 3 Scenario 4• (Hold rate but lose 10% of business due to price) (Hold rate but losses 24% of business due to price)• ----------------------------------------------------------------------- -----------------------------------------------------------------------
• NWP US$20.7m NWP US$17.5m
• Expenses US$6m Expenses US$6m
• Expected Losses US$11.7m Expected Losses US$9.9m
• Expected Profit US$3m (85.5% CLR) Expected Profit US$2m (90% CLR)
• Result• Better to lose 10% of your book and keep rates the same than to discount your book by 10%.• Would need to lose 24% of your book to match the expected profit from a 10% decrease in rate.
Effects of pricing Strategy
4 Pricing in the Future
47
Burning Cost versus Exposure
BURNING COST
An estimate of the future loss cost based on the experience of solely one account.
How it’s used
Premium = Total claims over period divided by period = average loss cost + profit + expenses.
Problem = net/gross/claims paid/outstanding/IBNR ?
Pricing error = Ignoring similar account large losses (one account is too small a basis) .
4 Pricing in the Future
48
Original Insured: Costa Lot Fleet. 5 bulkers, youngest 2001, oldest 1980.
Year Premium Claims L/R
2001 300,000 200,000 67%
2002 250,000 300,000 120%
2003 310,000 250,000 81%
Total 660,000 750,000 114%
Renewal premium = Total claims 750,000 divided by 3 = ALC 250,000
250,000 + 35% (profit 15%, expenses 20%) = 337,500.
Therefore renewal premium = 337,500
Burning Cost versus Exposure
4 Pricing in the Future
49
EXPOSURE RATING 1
An estimate of the future loss costs based on the experience from a large group of similar risks.
How it’s used
Statistical claims data over a “book” of similar risks+profit+expenses = rate.
Problem = Selection error;
Hull - vessel type, flag, large enough group.
Burning Cost versus Exposure
4 Pricing in the Future
50
Original Insured: Costa Lot Fleet. 5 bulkers, youngest 2001, oldest 1980.
2001 bulker, value 20,000,000 statistical (exposure) rate = 0.2% Prem. = 40,000
2000 bulker, value 17,500,000 statistical (exposure) rate = 0.222% Prem. = 38,850
1995 bulker, value 15,000,000 statistical (exposure) rate = 0.35% Prem. = 52,500
1985 bulker value 10,000,000 statistical (exposure) rate = 0.85% Prem. = 85,000
1980 bulker, value 5,0000,000 statistical (exposure) rate = 1.25% Prem. = 62,500
Total loss cost = 278,850 + 35% = 376,447.
Burning Cost versus Exposure
4 Pricing in the Future
51
EXPOSURE RATING 2
An estimate of future loss cost based upon the estimation of volatility of layers without claims experience.
Cost of capital.
Expenses.
Volatility charge when possibility of portfolio destabilization due to higher layer exposure.
Burning Cost versus Exposure
4 Pricing in the Future
52
* Both methods have there place.
* The “Exposure” approach is far better suited to large, volatile risks.
* The exposure method better suited on risks of which underwriter has little or no experience - new/no claims data.
* Using the burning cost method to fine tune an exposure rate risk, can aid the individual risk assessment and pricing.
Burning Cost versus Exposure
4 Pricing in the Future
53
And Finally……
It is a difficult business but not a complicated one…
“Unlike the situation prevailing in many other industries – neither size nor brand name determines an insurer’s profitability. Indeed, many of the biggest and best–known companies regularly deliver mediocre results. What counts in this business is underwriting discipline”.
Warren E. Buffet
Berkshire Hathaway
2001 Letter to Shareholders