Seminar on ReinsuranceJune 2, 2003

Michael Kerner

Ceded Reinsurance -Analyzing Reinsurer’s Financial Security

Analyzing Reinsurer’s Financial Security

• Credit Quality - Current Events

• Security Review Process

• Other Issues - Terrorism

Why Is Security Important?

• Primary Company Capitalization• Under Pressure• Capital is Expensive - Providers Demanding High ROEs• Opportunities driving Capital Demand

• Increase in Reinsurance Recoverables

Why Is Security Important?

• Ability To Pay

• Willingness to Pay• Focus on Contracts• Increase in Disputes

Why Is Security Important?

• Large Number of Rating Downgrades

– 70% of World’s Reinsurance Premium Suffered Downgrade in Past Year

• Large Amount of Premium on Negative Outlook

• Buffet Comments

• V.J. Dowling Newsletter

Global Premium/Rating Shift

% Premium % PremiumRating 2001 Current DifferenceAaa/AAA 61.9% 11.9% -50.1%

Aa/AA 28.3% 68.8% 40.5%

A 9.8% 14.1% 4.3%

Below A 0.0% 5.2% 5.2%

Total 100.0% 100.0% 0.0%

Negative Outlook 69.3%

Source: Morgan Stanley

Reinsurers’ Balance Sheets Stressed• Published Results are Generally Poor (through 12/02).

• Where has all the Ceded Gone?– Reserve Strengthenings

– Insolvencies and Stressed Primaries

• “We simply think it unlikely that U.S. reinsurer’s $6 billion + adverse reserve development in calendar year 2002 fully captures these adverse underlying claim trends” -- Morgan Stanley

Not all Reinsurers Will Survive• Balance Sheet Repair Efforts will be Hindered

• New Capacity

• Market Showing Signs of Flattening

• Ample Capacity Available at the Right Price

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United States: Interest Rates

Source: Guy Carpenter

Availability - New Capital Post 9/11 (as of May 21, 2002)

$ Billions

• Capital Raised:

– 2001 $20.5

– 2002 $4.1

• Total $24.6

• Bermuda Start-ups: $8.5

Source: Guy Carpenter

Security Process

Security Review Process

• Group Level Activity

• Multidisciplined Team– Finance– Risk Management– Ceded Reinsurance

• Exception Process

Focal Points of Security Review

• Analysts Ratings– A.M. Best– Standard & Poor’s– Moody’s– Other

• Strengths– Independent Evaluation– In Depth Knowledge of Company– Relatively Consistent

• Weakenesses– Not All Companies Have Ratings– The Shifting “Bar”

Focal Points of Security Review

• Detailed Proprietary Financial Analysis

• Strengths– Consistent Evaluation– Process Promotes an In Depth Analysis of the Reinsurer– Customizable Based on Our View of the World

• Weakenesses– Resource Intensive– Generally doesn’t benefit from Non-Public Information

Focal Points of Security Review

• Other Items– Size

– Experience & Longevity of Organization

– Experience & Longevity of Management and Underwriting Team

– Organizational Structure

– Current Relationship

Security Review - Other Considerations

• New Capital Vs. Old Capital– The devil you know vs. the devil you don’t

• Short-Tailed Vs. Long-Tailed

• Collateralization– Partial or Full

• Line Size Limitations

Terrorism

U.S. Terror Bill

• Retention

• Quota Share

• Terror Definition– Foreign Vs. Domestic

– Fire Policy Issue

Outline of Legislation

• Key Features

– Run by Department of Treasury

– Act is Triggered when Secretary of Treasury, Secretary of State and Attorney General Certify an Event as an Act of Terrorism

– Covers Acts of International Terrorism Only

– Act terminates 12/31/2005

– Also covers Acts of War but only for Workers Compensation

– Losses must exceed $5MM for Act to be triggered

– Only Acts of Foreign Terrorism (eg. Excl. Oklahoma Federal Building)

Outline of Legislation

• Structure of Act

– All Commercial Insurers must participate and must offer Terrorism Coverage during first 2 years of program

– Insurer Deductibles are a Percentage of Direct Premiums from Previous Calendar Year

– 1% in Transition Period– 7% in Year One (2003)– 10% in Year Two (2004)– 15% in Year Three (2005

– Above Insurer Deductible, Federal Government Share is 90% and Insurers’ Share is 10%

– Losses Capped at $100 Billion

Terror Risk: Modeling

1. First Wave - Risk Analysis

2. Second Wave - Accumulation Controls

3. Third Wave - Probabilistic Models- Hazard Module- Vulnerability Module- Exposure Module

Terrorism - Market Reaction

• Inconsistent

• Stand Alone Covers Available, but Expensive

• Some Coverage Available in LOB Placements

• Certified Vs. Non-Certified

• NCB

QUESTIONS ?