State of the Reinsurance Market

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State of the Reinsurance Market Practical Perspective on Property Reinsurance/Reinsurers

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State of the Reinsurance Market Practical Perspective on Property Reinsurance/Reinsurers

l  Products

l  Markets

l  Macro and Industry Trends

l  Rating Agency View

l  Market Dynamics

l  Managing Property Reinsurance

TODAY’S DISCUSSION

Products Key Products in the U.S. Property Reinsurance Market

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© 2010 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. towerswatson.com S:\EGS\2010\REINS\142511\Rein\Reinsurance Market.ppt

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Key products

l  Traditional l  Quota share l  Per risk excess of loss

l  Property catastrophe excess of loss

l  Structured risk

l  Capital markets

KEY PRODUCTS


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Quota share reinsurance (traditional)

KEY PRODUCTS

Key Features

l  Pro rata sharing of primary subject premium and primary subject losses

l  Ceding commission to cover primary company expenses

l  Occurrence limitation to mitigate reinsurers’ catastrophe exposure

l  No aggregate limitation on treaty recoveries

l  Typically bought in conjunction with other reinsurance (especially cat)

l  Key underwriting issues are portfolio profitability and exposure fit (with reinsurers)

Marketplace Observations

l  U.S. and Bermuda more receptive

l  London less interested in quota share


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Per risk excess of loss reinsurance (traditional)

KEY PRODUCTS

Key Features

l  Excess attachment on losses (per risk, per occurrence)

l  Reinsurance premium set via rate applied to primary subject premium

l  Occurrence limitation used to mitigate catastrophe exposure

l  Ceding commission, if any, built into rate

l  Treaty will have an aggregate limitation on overall recoveries

l  Bought in conjunction with other reinsurance (especially cat)

l  Key underwriting issues are reinsurance rate and exposure fit


l  All markets actively pursuing per risk excess of loss business

l  U.S. more active in lower/middle attachment points

l  London more active in middle/higher attachment points

l  Bermuda active across the spectrum of attachment points


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Property catastrophe excess of loss reinsurance (traditional)

KEY PRODUCTS

Key Features

l  Excess attachment on company’s net losses (per occurrence)

l  Reinsurance premium derived from rate-on-line approach


l  Usually bought in conjunction with other reinsurance (Q/S and Per Risk)

l  Key underwriting issues are reinsurance rate and exposure fit


l  All markets actively pursuing property cat excess of loss business

l  U.S. more active in lower/middle attachment points

l  London and Bermuda active across the spectrum of attachment points


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Structured property reinsurance treaties

KEY PRODUCTS

Key Features

l  Highly customized reinsurance, so features tend to be deal-specific

l  Aggregate stop loss and structured quota shares are most common


l  Usually bought with other reinsurance (Per Risk and/or Cat)

l  Key underwriting issues are balancing risk transfer with upside/downside

l  Post-Spitzer, markets have added more risk to deals

l  More risk = higher premiums, so finding perceived value is harder


l  Highly specialized marketplace, with limited number of players

l  Generally less competitive than traditional reinsurance markets


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Capital markets

KEY PRODUCTS

Key Features

l  Collateralized, multi-year capacity — generally non-reinstated limits

l  Primarily designed for peak peril zones (U.S. Wind, Euro wind, Cal. Quake, Japan quake)

l  Accordion-like capacity that surfaces in hard market conditions

l  In current soft market conditions, most of the capacity comes from dedicated investors that behave in a manner similar to traditional markets

l  Ability to trade risk year round builds seasonality features into pricing


l  Excess capacity exists in this market as well, as money has moved in attracted by non-correlated nature of performance relative to other asset- backed markets

l  In other words, mother nature does not care about the mortgage on the home it is about to destroy


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Capital markets — Cat bonds

l  There are now almost 30 dedicated cat bond and ILS funds l  Continued diversification away from reinsurers with multi-strategy hedge

funds as the main investor base

l  These funds tend to dominate issuance transactions, although many of them are small

l  In some cases, multi-strategy funds and pensions are investing by way of the dedicated cat funds

l  Increased focus on trust account stabilization and quality of collateral l  Rejection of the “total return swap” approach that exposed buyers to Lehman

bankruptcy

l  Inclusion of collateral provisions requiring “top-ups” upon a decrease in the market value of the assets

l  Improved disclosure of assets held in the trust portfolios


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Capital markets — Cat bonds

l  Increasing investor willingness to invest in UNL triggers l  Investors are digging deeper into the third-party models l  Partly as a result of the growth and contraction of the “sidecar” market

l  Secondary trading has seen vigorous growth l  Market absorbed several large BWICs these past two years

l  Volumes for U.S. wind bonds most active l  By some measures, trading volume has exceeded issuance volume

Markets Key Market Centers for U.S. Property Reinsurance



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Global reinsurance market is highly concentrated

Concentrated Global Market

Rank

Top Global Reinsurers

2009 Market Share

S&P Financial Strength Ratings

Current Rating Outlook YE 2001 YE 2008

Oct. 25, 2010

1 Munich Re 21% AAA AA- AA- Stable

2 Swiss Re 14% AAA AA- A+ Positive

3 Hannover Re 9% AA+ AA- AA- Stable

4 Berkshire Hathaway 8% AAA AAA AA+ Stable

5 Lloyd’s of London 6% A A+ A+ Stable

6 SCOR 5% AA- A- A Positive

7 Reins. Group of America 4% A A- A- Stable

8 Transatlantic 2% AA AA- A+ Stable

9 Partner Re 2% AA- AA- AA- Negative

10 Everest Re 2% AA AA- A+ Stable

Top 10 Market Share: 74%


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U.S. property reinsurance marketplace

l  U.S. is the largest market for property and casualty reinsurance l  Most global reinsurers need a major presence in the U.S. market l  Only question is how they will access U.S. property reinsurance

l  Four principal vehicles for accessing U.S. property reinsurance l  U.S. based reinsurers

l  Bermuda based reinsurers l  Lloyd’s of London

l  European based reinsurers

U.S. Property Reinsurance Market


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U.S. property reinsurance marketplace is not dominated by U.S. based reinsurers

l  Few major U.S. based reinsurers have U.S. parents l  National Indemnity/General Re (Berkshire Hathaway) l  Transatlantic Re (Independent)

l  Majority share of U.S. reinsurance ultimately goes to foreign reinsurers l  Munich Re (multiple entities accessing U.S. market, including U.S. sub)

l  Swiss Re (multiple entities accessing U.S. market, including U.S. sub) l  Hannover Re (multiple entities accessing U.S. market, but no U.S. sub)

l  Lloyd’s (accesses primarily through London and Bermuda operations)

l  Bermuda based reinsurers (access directly from U.S. brokers)

U.S. Property Reinsurance Market


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General observations on U.S. based reinsurers

l  Mature and declining platform l  Over past five years, companies reporting to RAA dropped from 26 to 19 l  Trend of reinsurance companies domiciling elsewhere continues

l  U.S. based reinsurers focus on more service-intensive underwriting l  Quota share

l  Working layer property per risk excess of loss l  Low to mid-level property catastrophe excess of loss

l  Characteristics of U.S. based reinsurers l  Write property clients who require higher servicing levels

l  Actuarially and model driven, but also with attention to relationships

U.S. Based Reinsurers


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General observations on Bermuda based reinsurers

l  Bermuda domicile has been vibrant for past 20 years or so l  Regulatory and tax advantages favored start-ups in Bermuda l  Proximity to the U.S. also helped establish it as a favored location

l  However, Bermuda has been losing ground since 2007 l  Companies increasingly moving/starting operations in Europe

l  Movement due to uncertainty over regulations and tax status

l  Bermuda based reinsurers focus on less service-intensive underwriting l  Mid-to-higher-layer property per risk excess of loss


l  Characteristics of Bermuda based reinsurers l  Write transactional portfolios requiring limited service levels

l  Highly technical underwriting approach, with less regard for relationships

Bermuda Based Reinsurers


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General observations on Lloyd’s of London

l  Lloyd’s is the oldest reinsurance market and remains vibrant l  Leading market for U.S. and internationally traded insurance and reinsurance l  Heavily influenced by global regulatory changes as much as by underwriting

l  Lloyd’s tends to be strongest on specialty and exposure rated covers l  Mid-to-higher-layer property per risk excess of loss


l  Characteristics of Lloyd’s based reinsurers l  Write a wide variety of clients due to their long presence in U.S. market

l  Use models/analytics, but are most relationship-oriented market

Lloyd’s of London


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General observations on European based reinsurers

l  European reinsurance market is dominated by industry leaders l  Five of the six largest reinsurers in the world are based in Europe l  Four of the five largest European reinsurers have major U.S. presence

l  Europe has been gaining ground since 2007 l  Companies increasingly moving/starting operations in Europe

l  Switzerland and Ireland have been significant beneficiaries of this trend

l  European reinsurers focus across the board l  Working layers via their U.S. based subsidiaries

l  Higher layer property per risk and property catastrophe directly from Europe

l  Characteristics of European based reinsurers l  Write full spectrum of U.S. placements/clients via multiple access points

l  Tend to be technical underwriters, but also balance with relationships

European Based Reinsurers

Macro and Industry Trends Trends Impacting the U.S. Reinsurance Market



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Major trends impacting U.S. reinsurance market

l  Regulatory changes/uncertainty will have a major impact l  Specter of U.S. threat to Bermuda domicile l  Influence of Solvency II as an agent of global change

l  Stagnant U.S. economy creates multiple challenges l  Erosion of underlying premium base

l  Massive governmental stimulus and its impacts

l  Restoration of capital markets is double-edged sword l  Industry is now in excellent financial health thanks to restored capital base

l  Excess capital in industry serves only to further stimulate competition

l  Depressed values for (re)insurance stocks complicates the situation l  Natural expectation would be for consolidation to wring out excess capacity

l  Consolidation is more difficult with depressed valuations for (re)insurers

Major Trends


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Abundant reinsurance capacity remains a primary driver of softening P&C (re)insurance rates

l  The reinsurance market remains resilient, with capital returning to near 2007 levels as of year-end 2009

l  Since year-end 2009, capital grew an additional 4% through six months, 2010, with no signs of retracting

Industry Trends

Global Reinsurance Aggregate Shareholders’ Equity

Sources: A.M. Best, Towers Watson.

U.S. $ Billions

12% -20% 4%

$100 $110 $120 $130 $140 $150 $160

2007 2008 H1 10

25%

2009


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Several factors contributed to reinsurers’ improved balance sheet strength and overall financial flexibility

l  Rising asset values driven by a strong rebound in the capital markets

l  Relatively quiet 2009/10 U.S. cat season, with U.S. and Bermuda reinsurers reporting a strong combined ratio of 86% in ’09, an improvement over ’08 of 94%

l  Strong liquidity and loss reserve positions

l  Greater discipline fostered by ERM enhancements

Source: SNL Financial

Global Equity Markets Performance

Oct-08 May-10 Oct-10 (20)%

0% 20% 40% 60%

Aug-09 S&P 500 FTSE Nikkei

(20)% 0%

20% 40% 60%

Industry Trends


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Despite a rebound in reinsurer balance sheet strength, financial performance is lagging as reflected by stockholder sentiment

Source: SNL Financial, Towers Watson.

75

100

125

150

175

200

225

10Q3

10Q2

10Q109080706050403020100999897969594939291

Towers Watson Global Reinsurance Price-to-Book Composite

HU Andrew Internet Bubble WTC

KRW Subprime/

Credit

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Industry Trends


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More 2010 catastrophe activity globally than in the U.S.

l  Globally, 725 weather-related natural hazards occurred l  Insured loss estimates of $18 to $20 billion

l  Second highest figure recorded for the first nine months of any given year since 1980

l  Despite producing 19 named storms, the U.S. has been able to avoid major events l  Since 1990, there is no precedent of an Atlantic hurricane season with 10+ hurricanes where none

has struck the U.S.

l  The time period of 2006 through 2010 is one of only three five-year consecutive periods without a U.S. Major Hurricane landfall

l  There has never been a six-year period without a U.S. major hurricane landfall

l  Historically, one in four Atlantic hurricanes strikes the U.S. as a hurricane

Note: Hurricane Earl didn't make landfall and Ike made landfall as a Cat 2. Source: Insurance Information Institute, University College London

0

2

4

6

8

10

12

14

16

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

U.S. Hurricanes 1990 — H1 2010

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Industry Trends


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$8.3 $7.4$2.6

$10.1 $8.3$4.6

$26.5

$5.9$12.9

$27.5

$61.9

$9.2 $6.7

$27.1

$10.6 $7.9

$100.0

$7.5$2.7 $4.7

$22.9

$5.5

$16.9

$0

$20

$40

$60

$80

$100

$120

89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10* 20??

But the U.S. has experienced more than our share of cat losses since 2000

2010 cat losses are running below 2009 Figures do not include an estimate of Deepwater Horizon loss

$100 Billion cat Year is Coming Eventually

First Half 2010 cat Losses Were Down 19% or $1.4B from

first half 2009

($ Billions)

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Industry Trends

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.

* Through June 30, 2010. Source: Property Claims Service/ISO; Munich Re; Insurance Information Institute.

2000s: A Decade of Disaster

l  2000s: $193B (up 117%) l  1990s: $89B


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Top 12 Most Costly Disasters in U.S. History

2009 Insured Losses ($ Billions)

$11.3 $12.5

$18.2$22.8 $23.8

$45.3

$8.5$8.1$7.3$6.2$5.2$4.2

Jeanne(2004)

Frances(2004)

Rita (2005)

Hugo(1989)

Ivan (2004)

Charley(2004)

Wilma(2005)

Ike (2008)

Northridge(1994)

9/11Attacks(2001)

Andrew(1992)

Katrina(2005)

Hurricane Katrina Remains, By Far, the Most Expensive Insurance Event in U.S. and

World History

Industry Trends

Sources: PCS; Insurance Information Institute inflation adjustments.

8 of the 12 most expensive disasters in U.S. history have occurred since 2004; 8 of the top 12 disasters affected Florida


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Increased catastrophe loss activity has had a notable impact on combined ratios

0.4

1.2

0.40.8

1.3

0.3 0.40.7

1.51.0

0.4 0.40.7

1.8

1.10.6

1.4

2.0

1.3

2.0

0.5 0.5 0.7

3.0

1.2

2.1

8.8

2.3

5.9

3.32.8

1.0

3.6

2.9

1.6

5.4

1.6

3.3 3.3

8.1

2.7

1.6

5.0

2.6

3.6

0.9

0.1

1.11.10.8

1960

1961

1962

1963

1964

1965

1966

1967

1968

1969

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Combined Ratio Points

Industry Trends

Notes: Private carrier losses only. Excludes loss adjustment expenses and reinsurance reinstatement premiums. Figures are adjusted for losses ultimately paid by foreign insurers and reinsurers.

Source: ISO; Insurance Information Institute.

The catastrophe loss component of private insurer losses has increased sharply in recent decades

Average Cat Loss Component of the Combined

Ratio by Decade

1960s 1.04

1970s 0.85

1980s 1.31

1990s 3.39

2000s 3.52


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And the issue is even more acute in peak zones such as Florida, Louisiana and Texas*

($ Billions)

$176 , 60% $57.10 ,

19%

$31.20 , 10%

$33.60 , 11%

Florida

Texas

Louisiana

Rest of U.S.

Industry Trends

* All figures (except 2006 – 2008 loss) have been adjusted to 2005 dollars. Source: PCS division of ISO.


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First Half 2010 $3.0 Bn

Thunderstorm losses are a growing problem Annual Totals 1980 – 2009 vs. First Half 2010

l  Thunderstorm losses have quadrupled since 1980

Source: Property Claims Service, MR NatCatSERVICE. © 2010 Munich Re

Industry Trends


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First Half 2010 $2.4 Bn

Erratic winter storms have also grown in significance Annual totals 1980 – 2009 vs. First Half 2010

l  Average annual winter storm losses have increased over 50% since 1980

Source: Property Claims Service, MR NatCatSERVICE. © 2010 Munich Re

Industry Trends

Severe winter storms in early 2010 caused major damage to

energy infrastructure

Rating Agency View Rating Agency Perspective on the U.S. Property Reinsurance Market



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P/C rating issues focus on cycle management, reserve adequacy and expanded risk retentions

l  Battle between growth and profitability l  Soft market is testing insurer’s UW discipline l  Competitive pricing may persist in 2011 as the U.S. economy slowly recovers and

excess capacity remains

l  Focus on long-term profitability in line with expectations l  Differentiate insurers that proactively manage the cycle and mitigate earnings/surplus

volatility l  Best will increasingly challenge insurers to articulate long-term profitability expectations

l  Weakening reserve adequacy l  Adverse development is #1 reason for downgrades l  Best is concerned with premature take-downs

l  Increased risk retentions l  Retentions have increased during past several years from increased reinsurance

pricing and top-line growth pressures l  May not be properly aligned with changes in risk tolerance, financial strength and ERM

enhancements

TOP RATING ISSUES


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While the reinsurance sector remains generally stable, individual markets face many challenges as cited by the rating agencies for 2011… l  Implications of Solvency II expected to extend beyond Europe

l  U.S. government pressures on Bermuda tax havens

l  Constrained market for mergers and acquisitions

l  Reserve redundancies dried up

l  Lower investment returns and conservative investment reallocations

Rating Outlooks by Agency

2010 Expectations

Sector S&P A.M. Best Moody’s Fitch U.S. Personal Lines Negative Stable Stable Stable

U.S. Commercial Lines Negative Stable Negative Stable

Global Reinsurance Stable Stable Negative Stable


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Best’s P/C personal and commercial lines segment rating actions for the first half of 2010

Personal Lines Commercial Lines

Affirmed 66%

Negative Trend 12%

Other 13%

New 1%

Affirmed represents Affirmed/Affirmed Under Review/Under Review Developing Negative Trend represents Downgraded/Downgraded Under Review/Under Review with Negative Implications/Affirmed Downgraded with a Negative Outlook Positive Trend represents Upgraded/Under Review with Positive Implications/Affirmed with a Positive Outlook Other represents a change in NR

Affirmed 67%

Negative Trend 8%

Positive Trend 8%

Positive Trend 6%

Other 18%

New 1%

Source: AMB rating statistics for 355 P/C Personal lines companies and 769 P/C Commercial lines companies as of Aug. 13th, 2010.


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Key risk drivers that may impact future rating trends

l  Pricing management (cycle management)

l  Reserve adequacy

l  Catastrophe risk management

l  Enterprise risk management

l  Macroeconomic conditions

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Market Dynamics What To Expect for 1/1/2011 U.S. Property Reinsurance Renewals



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Primary insurance market remains very competitive

l  “Buyer’s market for insurance persists,” Business Insurance (10/25/10) l  Property pricing down 3% in Q3 of 2010 l  Source = RIMS Q3 Benchmark Survey

l  “Newsflash: Rates remain resolutely soft,” Reactions (PCI Reporter, 10/26/10) l  Overall pricing down 5.2% in Q3 of 2010 (compared to -6.4% in Q2)

l  Source = CIAB Q3 Commercial P/C Market Index Survey

l  “Raters raise reserving concerns,” Reactions (PCI Reporter, 10/26/10) l  “There is moderate to high competition in this soft market”

l  “..into 2011 we think it is a more moderate 0% to 5% reduction”

l  Quote from Damien Magarelli, S&P

EXPECTATIONS FOR 1/1/2011


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Reinsurance market remains competitive but disciplined, suggesting more “orderly softening” as 2011 unfolds

Supply Factors for Reinsurers Supply Effect Demand Factors for Insurers Demand

Effect

Capital restored to near-peak levels + Strong capital position; flat-to-down exposure/premium growth -

“Adequate” profitability and returns on capital + “Weak” profitability may drive higher

retentions -

’09 Benign cat loss activity and risk of unexpected cats in ’10 +/- Lower PMLs for certain key perils from

recent cat model changes -

Increased focus on ERM and risk tolerances +/- Increased focus on ERM and risk

tolerances +/-

Less redundant reserves; lower investment yields - Less redundant reserves; lower

investment yields +

More active cat bond market - Fear of inflation (casualty insurers) + Increased share buy-backs - Reinsurer capital: expected to grow modestly in 2010/11

+ Reinsurance Demand: flat-to-down in 2010/11

-


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What is the impact on each key reinsurance product?

l  Quota share (traditional) l  Declining primary rates are challenging viability of quota shares l  Expense pressures also make ceding away so much premium difficult

l  Expect marginal further softening of pricing/terms, but not by much

l  Property per risk excess of loss (traditional) l  Declining primary rates have companies pushing for per risk rate reductions l  Expect pricing to be slightly down overall, but very much client-specific

l  Key variables will be experience and amount of exposure reduction in layer

l  Property catastrophe excess of loss (traditional) l  Lack of catastrophe losses and excess capital call for further softening l  Specter of RMS v11.0 creates opportunity for reinsurers to push back

l  Pending model changes make market direction difficult to forecast


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Meanwhile, several “wildcard” issues could materially change current expectations for the (re)insurance marketplace at 1/1/2011 l  Significant and/or unexpected catastrophic event(s)

l  Natural cats beyond Chile Quake and Xynthia Winterstorm in Europe l  Terrorism

l  Significant and/or unexpected inflation (economic or social)

l  Impact of Catastrophe Model changes l  RMS v11 release February 2011 l  AIR v12 released August 2010

l  Unexpected regulatory and legislative impacts

l  Lingering effects of global financial credit crisis


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Managing Your Property Reinsurance Practical Guide To Enhancing Your U.S. Property Reinsurance Placements



43 43

Do relationships matter anymore?

l  Relationships do matter l  Long-term planning horizon is different than a short-term horizon l  Long-term allows for lower risk margin due to ongoing trade

l  Relationships = long-term partnerships

l  Property reinsurers are primarily driven by technical analysis/models

l  Influence of relationships is on the margins — relationships… l  Aren’t going to secure radically different pricing

l  Aren’t going to secure radically different terms

l  Do secure capacity, temper rate increases and allow partners to develop increasingly favorable terms and conditions over time

MANAGING PROPERTY REINSURANCE PLACEMENTS


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Markets can be differentiated based on trading style and relative emphasis on pricing and relationship

Risk Transfer Provider Capital Markets

2005 Bermuda Class

2001 Bermuda Class

“Old” Bermuda

Lloyd’s

U.S.

Europe

Asia

Size Indicates Capacity

Technical, Price-based Underwriting

Relationship Value

Low

High

Less Technical Emphasis Highly Technical Moderately Technical

2010 ’08/’09 credit crisis

2010 PROPERTY CAT

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How to get the most from your reinsurance partners

l  Commit to a longer-term view of reinsurer relationships l  Incremental annual gains can create wider benefits over time

l  Seek partners who can provide value-added assistance in: l  Managing your risk appetite via ERM tools and consulting

l  Optimizing property portfolios (return on capital optimization)

l  Providing mapping/management tools to aid in underwriting/claims l  Improving your underlying business via other consulting services

MANAGING PROPERTY REINSURANCE PLACEMENTS


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Documents

State of the Reinsurance Market