REINSURANCE & FRONTING MARKET UPDATE - 2014

Reinsurance & Fronting Market Update

2014

Michael Woodroffe, President

Agenda

1. Overview of Market in 2013

2. Current Captive Reinsurers

3. Reinsurance Strategies

4. Saving Money Buying Multi-Year

5. Helping Small Captives Buy Reinsurance

Reinsurance capital increased from $505 billion to $525 billion by 30th

September 2013 with large amounts of capital coming into the Insurance Linked Securities sector.

Market in 2013

• Total insured losses at $45 billion.

Calgary Floods - CAN$1.7 billion

German hail storms and floods - $5 billion

US jury awards - $1.2 billion against Dow Chemical – price fixing

- $1.1 billion against Trans Healthcare Inc. Fla resident falls

- $1 billion Briarwood Capital LLC vs Lennar Corp.

• Cat bond issuance increased from $6.5 billion to $7.4 billion.

• Companies no longer reinsuring captives - American Safety Re - in run off

- Torus - division closed

Renewals:• Catastrophe premiums down 11% globally at the 1st January 2014.

• Catastrophe premiums down 20-25% in Florida at 1st January 2014.

• Dramatic changes in terms introduced late in renewal season:– Unlimited hours clauses on some major programs

– Reinstatements pro rata as to time (some with a minimum of 50%)

– Terrorism included in some major programs for free

• Berkshire Hathaway offers to take 7.5% of AON Re book automatically.

• Increasing competition for workers comp catastrophe reinsurance and conversely limited appetite for working layers.

• Casualty Reinsurance renewing flat/down 5% but improvement of terms at 1st

January 2014.

Market in 2013

• Global reinsurance supply will continue to be in excess of demand for2013.

• Although market adequately capitalized there is limited choice of carrierfor captive reinsurance buyer.

• Inflation beginning to grow around the world. Danger to the BondPortfolios valuation for reinsurers and insurers (the ultimate loss?).

• Workers Comp and Transportation lines show signs of hardening in 2012and expected to continue through 2013.

• Domestic insurance markets scrutinize profitability of accounts.

• Medical PL insurance company/captive’s consolidation continues.

Market in 2013Woodroffe’s Predictions in 2013

• 55+ active markets.

• 1,400+ international insurance companies.

• 803+ pure and group captives.

• 113+ captives writing 3rd party business.

• 60% of Florida and Texas Property Cat Premium.

• 25% of the US medical liability insurance and reinsurance market.

• Write nearly $109 billion in global gross written premium.

• More than $170 billion Capital & Surplus. Source: ABIR

AM Best Rating Policyholder Surplus(January 8, 2014) (June 30, 2013)

Alleghany Corp / Trans Re A $6.7bnAllianz A $70.01bnAllied World A $3.37bnAmlin AG. A $2.06bnArch Capital Group Ltd. A+ $5.2bnAspen Insurance A $3.2bnBRIT A $1.05bnCatlin A $3.56bnEverest Re A+ $6.6bn Hiscox A+ $1.39bnMaiden Holdings A- $956mmMarkel A $6.32bnMontpelier Re A $1.6bnRenaissance Re A+ $3.57bnThird Point Re A- $972mmTokio Millennium Re A++ $1.2bnXL Group plc A $11.24bn

Bermuda Specialist Captive Reinsures

AM Best Rating Policyholder Surplus(January 8, 2014) (June 30, 2012)

Alleghany Corp / Trans Re A $6.7bn

Arch Re A+ $5.84bn*

ACE Group A+ $27.3bn*

Axis Re A+ $5.56bn *

Berkley Re A $4.37bn

Discover Re (Travelers) A+ $24.8bn*

General Re A++ $14.1bn*

Munich Re America A+ $34.4mm

National Indemnity A++ $191bn*

Odyssey Re A $3.62bn

Partner Re A+ $6.42mm*

Swiss Re America (re co. ltd) A $30.13mm

TOA Re A+ $626mm

US Specialist Captive Reinsurers

* Group Surplus

Healthcare Reinsurers

ACE Tempest (US)

Amlin (BDA)

Aspen (BDA and UK)

Berkshire Hathaway (US)

BRIT (BDA)

Catlin (BDA)

General Re / Genesis (US)

Hiscox (BDA)

Lloyd’s of London (UK)

Markel (BDA & US)

Munich Re America (US)

Montpelier Re (BDA)

Renaissance Re (BDA)

Swiss Re (US and Switzerland)

Trans Re / Alleghany (US)

Tokio Millennium Re (BDA)

Auto Reinsurers

Ace Tempest (US)

Allianz (BDA)

Amlin (BDA)

Arch Re (US)

Catlin (BDA)

Dorinco (US)

Greenlight Re (Cayman)

Hamilton Re (BDA)

JRG Re (BDA)

Maiden Re (US & BDA)

Mainstreet Group (US)

Markel (BDA & US)

Odyssey Re (US)

Partner Re (US)

Scor Re (US)

Third Point Re (BDA)

Tokio Millennium Re (BDA)

Trans Re / Alleghany (US)

Workers Comp Reinsurers

ACE Tempest Re (US)Amlin (BDA)Arch (US)Aspen Insurance (UK)Axis Re (USA)Bermuda Catastrophe Reinsurers (BDA)BRIT (BDA)Catlin (US/BDA)Greenlight Re (Cayman)Hannover Re (GER)JRG Re (BDA)Lloyd’s of London (UK)Maiden Holdings (BDA)Markel (BDA)Midwest Employers (US)National Union (US)NYMAGIC (US)Safety National (US)Tokio Millennium Re (BDA)Trans Re / Alleghany (US/BDA)

Construction/GL Reinsurers

ACE Tempest (BDA & USA)

Allianz (BDA)

Amlin (BDA)

Arch Re (BDA)

Aspen (BDA & UK)

Berkshire Hathaway (US)

Catlin (BDA)

Hannover Re (GER)

Lloyd’s of London (UK)

Partner Re (US)

Signet Star (W R Berkley) (US)

Reinsurance Rollercoaster Rides Again!

Buy Long• Multi Year contracts wherever possible, with built-in reinstatements to avoid

renegotiating mid crisis.

Lock in aggregate protection • Protect against adverse developments from rising loss ratios across all lines.

Avoid swing rated deals• Stick to for flat rated contracts to avoid ‘double whammy’ of deteriorating losses

whilst being hit with huge additional Reinsurance premium.

Insist on buying Reinsurance separately• Divide & conquer

Reinsurance Strategies

Scrutinize Security

• Fronting Carrier (downgrades for Tower, Meadowbrook, QBE and others?)Review security carefully.

• Reinsurance Security (American Safety Re now in run off)Avoid weak balance sheets, legacy issues and companies with no long term capital commitment.

• Stick with trusted Reinsurers Especially if you have built a “bank” of premium with them.

Reinsurance Strategies

Multi-Year Excess of Loss

• Client buys $10m xs $1m Umbrella from Standard markets every year.

• Premium is $1.5m per annum.

• Limited frequency; one loss every five years.

• 3 years on, client has bought $30m worth of excess insurance with little chance of full utilization. Premium is “Dead Money”.

Multi-Year Excess of LossAnswer:

• Provide client with 36 month policy with one limit of $10m xs $1m stretched over 3 years.

• Cost approx. $1m per annum with profit commission of 30-40% upon commutation at year 5.

• Use of “Trigger” additional premiums to reduce cash flow.

• Provide reinstatement of limit at clearly defined pre-agreed costs.

• Client saves money with no losses, saves money with average losses and has survivability and continuity at no extra cost in the event of catastrophic loss.

• No cap in hand return to excess insurer.

Single Aggregate – Multi Year Limit

2009-2012

2009 2010 2011

Depth of Coverage

Optional

Reinstatement

Optional

Reinstatem

ent

Making Reinsurance Affordable for Small and Start Up Captives

Tactics and Tricks

• First year policy 15 months period.

• Ramp up costs – staggered deposit premiums.– 10%, 20%, 30% and 40%

• Sub limit non-essential coverages

• Cap sideways exposures to reduce costs

Tactics and Tricks cont.

• Make little into big – multi year contracts.

• Mid year adjustments if uncertain about target price.

• Be conservative about estimated premium income.

• Pay as you go reinstatements – only pay for cover if you need it.

Insurance Linked Securities

• Cat bonds allow insurers to get reinsurance protection from a new pool of capital separate from traditional reinsurers – such as money managers, hedge funds and pension funds.

• Investors capital stays in segregated collateral accounts – if event occurs funds are available to make a payment, thereby virtually eliminating credit risk inherent in traditional reinsurance.

• 2013 Guy Carpenter estimate $10bn of new capital entered the reinsurance market largely in the form of ILS, side cars and collateralized retro cover.

• GC securities estimate that the cat bond market alone could reach $23bn by the end of 2016.

Michael Woodroffe, President

Kirkway International Limited

3 Bermudiana Road

Hamilton HM 08

Bermuda

Tel: 441 296 5829

mw@kirkwayintl.com

www.kirkwayintl.com

2014 World Captive Forum

Fronting Overview

Old American Capital

Corporation

Fronting Overview

• Fronting Arrangement

– In its most common form, an insurance carrier (front) writes and issues policies, makes necessary state filings and pays premium taxes. The fronting company will then cede the entirety of the risk to the Captive.

– The fronting company assumes the legal obligation while economically, the risk resides with the Captive

– It is imperative that the interests of the Front and Captive are aligned. Otherwise, complications can arise

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Fronting Overview

• Typical Fronting Relationship

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100% of Premium

100% of Premium less

Fees

100% of Risk

InsuresInsured

Fronting

Company Captive

100% of Risk

Insures

Fronting Overview

• Several Business Reasons Exist for Fronting

Arrangements

– The need for a licensed carrier in a state where the risk resides

– The need for a carrier with a minimum A.M. Best rating

– The need for other financial strength measures

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Challenges Facing Captives

• While Captive formations are on the rise, Fronting

continues to be one of the biggest challenges facing

Captives

• Fronting Fees

– Fees can vary and their magnitude can make it difficult for the Captive to make an adequate margin or stay competitively priced in the market

• Collateral Requirements

– Collateral requirements can potentially be arduous for the Captive

– Collateral typical takes the form of:• Funds withheld from the Captive

• A Trust Agreement funded by investment securities of the Captive

• Letter of Credit issued by a bank on behalf of the Captive

• Financial Strength of the Fronting Carrier

– Failure or downgrade of the Front will likely cause the Captive to seek an alternative, thus disrupting operations and increased costs

– Service issues and personnel changes can also have an adverse effect

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Fronting Utilization & Trends

• Historically, Captives have Utilized Fronting Carriers

for P&C Lines of Business

– Uncertainty around Affordable Care Act could increase the need for Employee Benefits Fronts

– Cyber Liability could also see expanded utilization

• Active Fronting Carriers

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Fortune 500 Specialized

AIG Companion

AmTrust Hudson

QBE Old American

The Hartford SPARTA

Travlers State National

Zurich

Old American County Mutual

• About Our Company

– We specialize in non-standard private passenger automobile insurance, with a tradition of aiding the higher risk auto insurance needs of an underserved, economically diverse customer base.

– Through our partner MGA’s, we offer insurance products and payment plans that provide affordable insurance for Texas customers.

– We partner with and grant contractual rights to approximately 25 skilled MGA’s.

– We cede 100% of our premiums to well capitalized, A rated reinsurers, some of which include:• Dorinco

• Main Street America

• Markel

• JRG Re

• Tokio Millennium

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Managing General Agents

• Old American Primarily Sources Business Through

Specialized MGA’s

• MGA’s Present A Certain Set of Risk Exposures Such

as:

– Misappropriating and/or absconding with funds

– E&O on claims handling (Reinsurance usually has limits on ECO/XPL claims)

– Regulatory Non-Compliance including Insurance Department complaints

– Poor record keeping

– Lack of underwriting standards and controls (impacts Reinsurers)

– Poor claims handling (impacts Reinsurers)

– Concentration/CAT risk

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Enterprise Risk Management

• Old American Mitigates These Exposures Through:

– Initial due-diligence to ensure MGA is sufficiently funded and has proper procedures in place

– Adequate E&O insurance

– Fidelity Bond and Personal Guaranty

– Premium Trust Account

– Annual Premium Cap to control growth (i.e. adverse selection & under-pricing)

– Semi-annual claims and compliance audits; Quarterly if necessary

– Semi-annual loss ratio monitoring

– Automated, state of the art underwriting, with systems that provide real-time data for monitoring pricing, new and renewal business written and claims handling information

– Aggregate CAT reinsurance

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Texas Private Passenger Auto Market

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Texas Auto Market AnalysisTop 10 Insurers

Direct Premiums

Written ($000)

Entity Group 2012State Farm Mutl Automobile Ins State Farm Mutl Automobile Ins 2,510,789

Farmers Texas Cnty Mutl Ins Co Farmers Insurance Group of Cos 1,311,818

Progressive County Mutl Ins Co. Progressive Corp. 1,279,813

Allstate F&C Insurance Co. Allstate Corp. 738,565

Government Employees Ins Co. Berkshire Hathaway Inc. 686,417

Old Amer Cnty Mutl Fire Ins Co Old American Capital Corp. 485,018

Home State County Mutl Ins Co. Home State Insurance Grp Inc. 450,042

United Services Automobile USAA Insurance Group 420,907

Allstate Indemnity Co. Allstate Corp. 400,622Colonial County Mutual Ins Co. Nationwide Mutual Group 346,932

Source: Texas Supplemental A for County Mutuals, NAIC Annual Statements, SNL Financial, Texas Department of Insurance

Old American

County Mutual advantages

• Surcharge Rating flexibility

– County Mutual insurers are exempt from the Texas Insurance Code provisions prohibiting the use of surcharges for motor vehicle violations.

• Assessments

– While not specified by law, most Independent County Mutuals historically have not received TAIPA assessments. This is due to the large number of policies produced in underserved regions and earn credits for producing such policies.

• Regulatory & compliance

– County Mutual insurers eliminate procedural burdens for MGA’s as they respond directly to Texas Department of Insurance (TDI) for matters involving compliance, rate, rule and form filings, complaints and licensing.

• Withdrawal

– MGA’s are not subject to the Withdrawal Plan Guidelines and Restrictions imposed by the Texas Insurance Code, Chapter 827.

County Mutuals still retain a significant advantage making them

a desirable alternative to insurance companies wanting to

write private passenger auto insurance in Texas

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Old American advantages

• Endorsements

– OACM has twenty (20) approved endorsements for use with the standard Personal Auto Policy allowing MGA’s to customize their product and coverage.

• Symbols & Territories

– OACM has developed proprietary Territory, Liability and Physical Damage Symbol Models allowing for sophisticated pricing alternatives.

• Analytics

– OACM skilled and insightful staff can provide a complete array of actuarial services including Product Development and Market Analysis, Pricing, Rate Filing Support and Regulatory Compliance.

• Comprehensive Audits

– OACM’s experienced audit team provides an in-depth review and analysis of MGA’s procedures to help ensure compliance at all levels of the operation.

• Regulatory and Legislative Involvement

– OACM has a strong relationship with the TDI and actively monitors legislative matters relating to Texas automobile insurers and policyholders.

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Contact Information

Andrew Kirkpatrick

Vice President of Business Development

(214) 561-1985

andrew.kirkpatrick@oldam.com

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