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INSIDE SPRING 2013 ISSUE 45 20 Hot money 32 Juicing returns 44 Partial recall Non-traditional capital (Re)insurers tap profits Product recall is keeps flowing in from non-core operations back in the spotlight

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Should the insurance industry fear the long arm of Benjamin Lawsky?

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AD iq spring 2013.indd 1 1/29/13 11:53 AM INSIDEINSIDE EDITOR’S TRADING LETTER RISK

The industry prayer Dear friend, neat solution is to infl ict the little Lords with such a terribly aff ected Th ere is a peculiar balancing force manner of speech that the skill of in nature that immediately and eff ective communication is almost unerringly reinstates equilibrium completely removed from them. whenever it encounters An inability to navigate whole imbalances. sections of the alphabet can thus No sooner does a tropical bird end up provoking sympathy in of paradise evolve the ability to even the most inferior of subjects. dominate its environment then Any laws that apply to beasts Mother Nature sets things straight and man will clearly fi nd the by giving it a ridiculously long global insurance industry well and impractical tail that makes it fate. Just sometimes we learn from almost impossible for the wretched our mistakes and those of our avian to fl y. fathers. Th is usually occurs when Th e longer the rear plumage, the “The Lloyd’s of the 20th century we comply with Nature’s other more attractive the unfortunate great canon – the law of natural fowl becomes to a prospective was afﬂ icted with a near justice. mate. Waving the appendage criminal arrogance that clouded In short, the only way to deal about to attract female attention, with the slings, arrows and the feathered gigolo seems to be its collective judgement” boomerangs that outrageous saying to the ladies “look at me – fortune tosses in our direction is I’m in such great shape I can even within their jurisdiction. In to try our best to do what’s right. survive this ridiculous handicap”. this way the Lloyd’s of the 20th PSAs may not have been wrong Of course, we humans are no century was aﬄ icted with a near in themselves, but they ultimately diff erent. criminal arrogance that clouded its smoothed a clear path to the For us, it is arrogance that collective judgement. Slowly but indisputable wrong of bid-rigging. becomes the natural counterpoint inexorably its dominance began to With Spitzer buried and of ability. slip and the Lime Street franchise forgotten, the penance is over and No sooner does an ambitious almost ended up poisoned beyond the hair shirts are in the back of young man get a fi rst pay rise salvation. the wardrobe. than he spends it all (or, in these And no sooner did the East Th is means that there is always credit-fuelled days, more likely Coast royalty of MMC fi nd a a danger that in time our sector’s many multiples of it all) on an world-beating revenue engine in gilded birds of paradise will sprout apartment, a car, a new suit or the form of PSAs than its cosy ever more elaborate new tails, a watch with which to attract clubbable world was violated by each accompanied by myriad new prospective partners. a ferocious broadside from the devices for our own damnation. As soon as the fool fi nds some unlamented New York Attorney Turn to page 15 for a portrait of wealth he almost immediately General, a certain Mr Spitzer. the latest lightning rod for divine makes himself poor again. In turn, Spitzer’s star rose far retribution. And pray, lest the fi rst Th is continues right up the and fast. But, soon enough, keep being made last, let us not be wealth scale except, for cars and the gods made sure he was led into temptation… apartments, one should simply sharply reminded of the laws of substitute mansions, mega-yachts equilibrium with a stiletto-tipped and, of course, sports teams. jab. Or take the English aristocratic So whither salvation? Are classes, born into staggering we doomed to an eternity of wealth and privilege and aff orded wrongdoing and retribution? every advantage of infl uence and Fear not, for within our natural education. limitations we humans are Th ey are clearly too well ahead of occasionally able to avoid a ritual Mark Geoghegan the game. Th us, Mother Nature’s clobbering from the pendulum of Editor www.insiderquarterly.com 03

INSIDE CONTENTS

SPRING 2013 PUBLISHING LTD 2013 Editor SPRING Mark Geoghegan Features Editor Gavin Bradshaw News analysis Risk North American Editor 03 Editor’s letter: The industry prayer David Bull 07 Modelling: Predictive modelling is on the rise 40 The rise of the pension fund Senior Reporters With hedge funds being replaced Adam McNestrie 08 Management : Neal makes his mark Marcus Alcock with QBE overhaul by new, long-term institutional Fiona Robertson investors in the alternative Dividends: European (re)insurers Gavin Davis 10 diverge on dividends reinsurance markets, Fiona asks what it all means Reporters 14 Reinsurance: XL builds on US Robertson Karina Whalley Luke Smolinski property

Sales Director Spencer Halladey Features 44 Partial recall 15 The long arm of Lawsky… The continuing woes of Boeing, Advertising Manager Is the new sheriff in town another Toyota and a host of food Rob Hughes lone ranger in the mould of Spitzer? manufacturers have put product Subscriptions Sales Executives recall into the spotlight as never Annie Lightholder Abby Port 20 Hot money before. Marcus Alcock investigates Gavin Davis ponders whether Head of Marketing catastrophe reinsurers can Amber Bates maintain underwriting discipline as TECHNOLOGY Marketing Executive “hot money” pours into the sector 51 Broken promises: Technologist Emma Wright Kirstin Duffi eld laments the dearth of qualifi ed IT staff and Marketing Assistant 24 It can’t happen here… Himal Patel Is the insurance world free from asks “where is this promised IT Events Manager systemic risk or could fi nancial generation?” Jessica Stacey meltdown happen a little closer to Events Producer home, asks Shirley Beglinger CAPITAL Kusia Pell 54 The alternative evolution: As Events Coordinator 28 Inside the Lloyd’s dream alternative investment products Kelly Stewart With Lloyd’s entry appearing to be multiply, Charles Pears discusses Production Editor tougher than ever, Adam McNestrie the options insurers could consider Peter Williams assesses what it takes to get into to enhance returns Sub-Editor the world’s oldest insurance market

Ewan HarwoodPUBLISHING LTD 57 Access all areas: Jean-Pierre Juicing returns Art Director 32 Darque asks whether (re)insurers reports on how some Paul Sargent David Bull are ready for the Single Euro (re)insurers are looking outside their Director of Finance and Operations Payment Area Adam Park core businesses to fi nd accretive opportunities Managing Director Peter Hastie OTHER FEATURES 36 Here be monsters 61 You’re hired!: Andrew Carrier Mark Geoghegan assesses the tells IQ about Argo Group’s 2013 IG $3bn renewal, following the “Apprentice”-style approach largest and third-largest claims in to employee recruitment and 3rd Floor, 41 Eastcheap, London EC3M 1DT the marine market’s history retention United Kingdom IQ, the sister publication of… 38 Bridging the East-West divide 64 Making connections: IQ speaks Karina Whalley meets the German- to Alex Hearn, the founder of the born duo behind Asia Pacifi c carrier industry’s fi rst dedicated social Peak Re networking and content platform, MySlipcase

Tel +44 (0)20 7397 0615 Fax +44 (0)20 7397 0616 Subscription enquiries Annie Lightholder [email protected] All rights reserved ©2013 IQ is Tel +44 (0)20 7397 0619 Fax +44 (0)20 7397 0616 published under licence by Informed Publishing Ltd [email protected]

04 www.insiderquarterly.com INSIDE CONTENTS

28 Inside the Lloyd's dream Entry appears to be tougher than ever

40 The rise of the pension fund The inﬂ ux of long-term 15 Benjamin Lawsky institutional investors into New York's Superintendent alternative reinsurance of Financial Services

67 Back to the future: The insurance 76 Should I stay or should I go?: 78 When wind and water meet: industry must learn to embrace Trade credit is getting tougher to John M Clark and Michael R Fox technology as its future, says insure, says Michael Feldwick, but unpick the knot of wind and ﬂ ood Stewart Taylor credit risk management solutions coverage issues in the wake of could help insurers stay on clients’ Superstorm Sandy 70 Raging bull: Insurers need to take risks the regulatory bull by the horns 80 Winds of change: John Needham with the restructure of the FSA, assesses the likely outcome for says Michael Luderer UK distribution in the light of increased scrutiny of risk transfer 72 Crouching Tiger, Hidden Dragon: contracts and growing credit risk Dr Jianzhong Yao and Dr Kai-Uwe concerns Schanz assess the prospects for growth and profi tability in China’s 82 PEOPLE MOVES P&C sector www.insiderquarterly.com 05 *References the 2008 Forbes Tax Misery & Reform Index ONE PLACE DIVERSIFYING Qatar. With every new project comes a new insurance opportunity. Behind it all, the QFC is helping Qatar to become the region’s most dynamic economy, and its perfect access point. Benefit from the lowest tax in the world,* 100% ownership, repatriation of all profits and an onshore trading environment. Join us. www.qfc.com.qa Business energy

5929 Diversity ReInsur 279x216.indd 1 11/3/09 10:30:49 Qatar Global Broker Paul Mayes 00 3mm 09 03 09 279 x 216mm 100% ARTWORK Client Amend Yes No Artwork Simp Med Comp INSIDE MODELLING

The rise of the underwriting machine The algorithm-driven trading strategies that transformed the financial markets in the late 1990s are increasingly being applied to P&C underwriting. Where will it all end? “Essentially all models are PL carriers are much more likely to Impact of modelling on Owrong, but some are useful,” detect fraud using predictive modelling. Almost a quarter of PL carriers use loss CL and PL insurers said the statistician George E P Box. Impact on top- and bottom-line And predictive modelling – like the ratio modelling, compared with about 0% 20% 40% 60% 80% 100% kind that transformed investing in the half of CL carriers. PL 96 4 96 4 late 1990s with financial algorithms that Nearly two thirds of PL carriers model Rate accuracy CL

83 17 Bottom line could outperform the human trader – is frequency and severity separately, 83 17 PL 8787 13 13 now increasingly being found useful by compared with a third of CL carriers. PL Loss ratio CL improvement the insurance industry. carriers model separately by coverage 7272 2828 PL Apparently, 85 percent of personal and peril too (early four fifths of 87 13 87 13 Protability lines (PL) insurers call it essential, and personal auto insurers and seven tenths CL 61 39 } large commercial lines (CL) carriers of homeowner insurers model this way). 61 39

PL 65 31 4 increasingly find it very important, PL carriers are more likely to model 65 31 4 Market share 33 61 6 according to a recent survey from for automatic renewal decisions. A third CL 33 61 6 T 48 39 13 consultancy firm Towers Watson. of homeowners’ insurers and over half PL Top line The survey – published in late January of personal auto insurers automatically Renewal 39 48 3950 13 11 retention CL

– reveals much about modelling. This, renew at least four fifths of their policies. 3939 50 1161 in other words, is modelling on the front By contrast, less than 15 percent of PL 22 78 foot. It is the development of algorithm commercial insurers do likewise. There Expansion of 39 61 underwriting CL } appetite driven strategies to be applied to P&C are clear opportunities for progress in 22 78 underwriting. this area. PL (n = 23) CL (n = 18) Positive impact No impact, neither Negative impact PL carriers use results from Other opportunities lie untapped, negative nor positive competitive market analysis for niche the survey indicates. Standard and Source: Towers Watson pricing, base rate changes and product specialty CL carriers have space to use offerings. CL carriers use loss ratio more sophisticated predictive models. cited data and IT constraints as the models most often, while PL carriers They are more likely than PL carriers greatest challenge. The volume of prefer frequency and severity models. to use additional internal and external business may explain this, but legacy Data, people constraints and IT issues risk-specific variables to enhance risk systems are also problematic. cause the most problems. Nevertheless, selection and price accuracy – but there People and cultural differences stay predictive modelling offers bottom-line is still room to improve. high on the list of challenges as well. profits to wised-up carriers. The multivariate interactions and Yet predictive modelling may also Views on modelling differ across the relativities used for current rating reap large benefits. Ninety percent of industry but almost two fifths of small variables have yet to be fully explored. all US respondents said bottom-line to mid-market CL carriers thought CL carriers can use predictive models to performance was the primary reason it “essential”, while about two fifths price individual risks and identify risk why they used predictive modelling. thought it “very important”. selection criteria too. Three quarters of US respondents, However, large CL carriers and Still, the Towers Watson survey much of them PL carriers, cited speciality lines found modelling less suggests, problems remain. A major “competitive pressure”. Eighty seven useful. Over half said it was essential or difficulty when incorporating modelling percent of PL carriers said modelling very important – a small percentage, but techniques is data, with two thirds of all boosted profits and lessened loss ratios; 9 percent higher than last year. carriers citing it as a problem. 96 percent said it boosted rate accuracy. Differences in strategy and use abound. Almost three quarters of large carriers Carriers saw less positive impact on top-line indicators, such as “Leading carriers are leveraging predictive market share, renewal retention and underwriting demand – even though modelling to establish a competitive top-line impacts emerge quicker than advantage, starting with efforts to bottom-line ones. On the face of it, predictive modelling outperform competitors in risk selection looks certain to stay useful in future. and pricing” – Towers Watson But will it one day replace the human underwriter? www.insiderquarterly.com 7 INSIDE QBE

The new order Neal makes his mark with QBE overhaul

A major overhaul of QBE’s Osenior management and a “As the world changes, we need to new strategic vision, driven by Frank O’Halloran’s successor John evolve to continue to meet or exceed the Neal, will mean a freeze on major expectations of our key stakeholders” acquisitions and a drive towards cost effi ciencies throughout the John Neal, QBE Group CEO group’s global businesses. Neal, who replaced the long-standing the Midwest drought and Superstorm as CEO of North American operations O’Halloran as CEO last year, has Sandy claims, pushed the unit’s on 2 April. instituted a major overhaul of the combined ratio up to 106.8 percent Th ere is also a new head for group’s senior management. Th is from 90.6 percent in 2011. QBE’s Asian business following the included the departure of CFO Neil Like much of the group’s international appointment of David Fried, formerly Drabsch – O’Halloran’s lieutenant of footprint, the US operations were of Allianz. two decades – who was rumoured to built on a series of bold acquisitions Neal welcomed Duclos’ arrival, with have had diff erences of opinion with the spearheaded by O’Halloran. a suitably grim nod to the fate of his former Lloyd’s underwriter over QBE’s Th ese include the purchase of forced predecessor and the future challenges November profi t warning last year. place insurer Balboa for $700mn+ faced by the North American unit: Overall, QBE’s underwriting result in 2011 and the Praetorian Group – “I am delighted to announce David’s weakened in 2012 as the combined formerly Hannover Re’s Clarendon appointment as CEO of QBE’s largest ratio slipped from 96.8 percent to 97.1 Group – which was acquired for an and arguably most demanding division, percent. eyebrow-raising $800mn in 2007. North American operations. I cannot Meanwhile, at 1 January the fi rm overplay the depth and breadth of local doubled the size of its catastrophe Management moves US insurance industry experience and aggregate protection to $400mn aft er it Following the retirement of Drabsch in pedigree that David brings to the role.” revealed that its US operations had hurt February 2014, Steven Burns, the CEO group performance. of QBE Europe, is set to relocate to Full integration However, net profi ts for 2012 were up Sydney to take over the CFO role. Th e insurer reported relatively fl at gross 8 percent to $761mn, fuelled by a sharp Richard Pryce, who joined QBE from written premium for the 12 months improvement in net investment income. Ace last year as deputy CEO of Europe, to 31 December 2012, with the top Th e US operations were forced to will step up to replace Burns. line creeping up by only 1 percent to strengthen reserves by $464mn, which, And former XL executive David $18.4bn. together with 2012’s crop losses from Duclos is set to succeed John Rumpler Th e company said that “aft er many

8 www.insiderquarterly.com INSIDE QBE

years of acquisition-led growth”, it will now look to consolidate its businesses and become a “fully integrated global insurer”. Neal also unveiled a new effi ciency drive, which the company estimates will save $250mn per annum by the end of 2015 and is likely to lead to the loss of around 700 jobs. “QBE has been a hugely successful organisation over the last 15 years but, as the world changes, we need to evolve to continue to meet or exceed the expectations of our key stakeholders,” Neal said. QBE’s share price plunged in the wake of a November profi ts warning, which dragged the stock from A$12.87 to as low as A$10.10. However, it has since recovered and was trading at A$13.38 at the time of writing.

Bulking up Partially as a result of slower growth, QBE’s capital position strengthened, with its regulatory capital surplus rising from $2.54bn to $3.68bn at year- end. Th is was equivalent to 1.7x coverage of its capital requirement, compared to only 1.5x at the close of 2011. Nevertheless, following the group’s November profi ts warning, AM Best and Standard & Poor’s placed the group’s ratings on a negative outlook. Th is refl ected the $464mn of reserve strengthening, a 2.5 percent increase in the expense ratio and a 40 basis point increase in the attritional loss ratio to 49.4 percent. Th ese more than countered the lessened impact of cat losses, which fell from 11.3 percentage points on the combined ratio to 6.1 percentage points. Despite a weaker underwriting performance, net profi ts for 2012 were up 8 percent to $761mn. Th is was largely as a result of higher net investment income, which increased by 57 percent to $1.22bn – equivalent to a yield of 4.1 percent. It was partially off set by higher amortisation and impairment of intangibles, which more than doubled to $407mn. QBE also disclosed that it had reduced the excess-of-loss cover on its US force-placed business from $1.3bn to $700mn to refl ect reduced peak zone aggregate. It coupled this with an increase in the size of its group aggregate catastrophe cover (GACC). Th is protection was upsized from $200mn of cover excess a $1bn aggregate deductible to $400mn excess an $800mn deductible. Th e $250mn xs $250mn Equator Re aggregate cover also inures to the benefi t of the GACC. Th e group also said it had purchased $3bn xs $1.5bn of cover for the Australasian region. www.insiderquarterly.com 9 INSIDE CAPITAL

European (re)insurers diverge on dividends Investor pressure as RSA cut attracts market opprobrium

RSA’s shock dividend cut at decision. Euan Stirling, investment Meanwhile, RBC Capital Markets Othe tail end of February director at Standard Life Investments analyst Gordon Aitken said RSA's received a negative reaction from – the fourth-biggest holder of RSA's decision to rebase the dividend would the markets and provoked a fl urry stock with a 4.2 percent stake – put the company's growth plans under of angry shareholder comments. told the Financial Times he was greater scrutiny. Th is is perhaps understandable given disappointed by the management's "We do not expect that investors that the UK composite insurer’s revised "excessively cautious approach". will be keen to pay for RSA's growth dividend policy appeared to be at odds And one top 10 shareholder in the strategy fi nanced by the rebasing of the with those of London market players FTSE 100 insurer said the dividend cut dividend," he said. Hiscox and Lancashire, while one of came like a "bolt from the blue". the industry’s top reinsurers courted shareholders with a generous payout. 2012 dividend yields2012 dividend yields RSA slashed its fi nal dividend by a 16 Ordinary dividend yield third to 3.9 pence per share, citing the 14 Special dividend yield prospects of a "prolonged low bond 12 yield environment". 10 Markets reacted accordingly, sending 8 the fi rm's stock plummeting more 6 than 14 percent in a single day on 20 4 February, wiping out some £700mn of Dividend yield (%) 2 0 market capitalisation. RSA Axa Scor* CEO Simon Lee said the decision to Aviva*Zurich Catlin Hiscox Beazley Amlin* Novae* Allianz Swiss Re Mapfre* Admiral* Generali* "rebase" the dividend was a prudent Lancashire Munich Re move that was "absolutely the right Hannover Re* *Indicates*Indicates dividend dividend yield yieldfrom Bloomberg from Bloomberg or ProQuote. Allor othersProQuote. based on All 2012 others dividends based paid to on closing 2012 share dividends price 22 Feb paid to thing to do". closingSource: Theshare Insurance price Insider 22 Feb But investors reacted angrily to the Source: The Insurance Insider

10 www.insiderquarterly.com INSIDE CAPITAL

Giving it all back... Solvency II rules and pressure from In contrast, investors warmed to Hiscox RSA stockRSA fallsstock falls heavily… heavily… regulators might be limiting the ability and Lancashire, which both unveiled of some players to return capital to 135 strong 2012 results together with shareholders. generous special dividends that 130 The European property catastrophe effectively returned all of the firms’ 2012 programmes of both Aviva and Zurich 125 profits to shareholders. Pence Insurance Group are set to renew at the Hiscox announced a £150mn special 120 1 April renewals – which are otherwise dividend and a 6 percent increase in mostly Asia-focused. As such, the its final dividend following a strong 115 diverging fortunes of the two sectors operating performance in 2012. 20137 Jan and the level of "partnership" between 14 Jan 21 Jan 28 Jan 4 Feb 11 Feb 18 Feb22 Feb Meanwhile, London-listed Lancashire reinsurers and their cedants is likely to said it would return $220mn to dividend flat at EUR4.50 a share for return to the agenda. shareholders – almost all of its $236.8mn the year despite more than doubling The European insurance sector is 2012 net pre-tax profit – as it found it its earnings per share to EUR11.42, one of the highest yielding industry had "significant excess headroom" amid meaning the company paid out less than segments on the continent (see graph a flat pricing environment at the January 40 percent of its earnings. below). renewals. This included a $201mn Conversely, France-based Axa And the sector's champions among special dividend. increased its dividend by 4.3 percent the analyst community have in the past Global reinsurer Swiss Re also despite a 3 percent decrease in earnings used the weak growth opportunities proposed a special dividend of SwF4 per share to EUR1.64, although analysts offered elsewhere amid the continent's per share, along with a 17 percent were generally positive on the insurer's economic torpor as a bullish reason to increase in the ordinary dividend to improving operating fundamentals invest. SwF3.50, representing a total return to below one-off charges. Mature companies will seek to return shareholders of circa $2.8bn. The European duo both reported the majority of their earnings to London market (re)insurer Beazley and improved balance sheet strength as investors, providing a reliable earnings the Bermudian Validus were also among measured by their Solvency I solvency stream, the argument went. the cohort of specialty and reinsurance- ratio, with Allianz' reported ratio up 18 "This results season is certainly stirring focused players to have announced percentage points to 197 percent while things up a little and, most importantly, special dividends in recent weeks, while Axa's improved by 23 percentage points the story of choice in support of the many of their peers continued to return to 206 percent. sector has been somewhat undermined," large amounts capital through share Chris Hartwell, European insurance Hartwell wrote in a 21 February note to buybacks. sector strategist at RBC Capital Markets, clients. Hiscox, Swiss Re, Lancashire and said he was concerned about a "clear "While this yield picture remains Beazley all more than doubled their total divergence within the sector" over what interesting, the fact is that the yield dividend payout for the year. cash is returnable to shareholders and sustainability of the sector has (and And investors have rewarded these what is not. is) being questioned and examined in companies with a buoyant share price Hartwell queried whether incoming further detail," he added. performance in 2012, with the quartet all climbing by at least 10 percent, with Insurer yields are among Beazley leading the pack with a 20 the mostInsurer attractive yields are inamong Europe… the most attractive in Europe… percent gain. Swiss Re’s shares climbed 4.4 percent 8 in response, as it reported net income of 7 FY 1 FY 2 $4.2bn for 2012 – equivalent to growth 6 5 of 60 percent year-on-year. 4 3 ...or holding on tight 2

However, RSA is not alone in dismaying Dividend yield (%) 1 investors. Spanish insurer Mapfre and 0 Paris-based Euler Hermes also cut their Tech Telco Retail

dividends in 2012, while analysts have Autos Banks Media Lesiure Div fins Pharma Utilities speculated over the sustainability of Base res. Insurance Eurostoxx Chemicals Industrials Real estate Real other high-yielding insurance stocks Oil and gas Construction such as Aviva. and bevs Food Pers/household Germany-based Allianz left its Source: Bloomberg, RBC Capital Markets www.insiderquarterly.com 11 FOR PROFESSIONAL CLIENTS ONLY

“If the highest aim of a captain were to preserve his ship, he would keep it in port

forever.” We agree with Thomas Aquinas. In a world of low returns, venturing from port and selectively taking investment risk is a necessity. For insurers faced with high capital charges, maximising the efficiency of every investment risk is critical. This is why at Insight we work with our insurance clients; combining investment expertise and insurance capital management, to deliver bespoke capital-efficient investment solutions.

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“If the highest aim of a captain were to preserve his ship, he would keep it in port

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XL builds on US property XL Group expands US fac as reinsurance drives P&C premium growth

XL Group’s push into North Pen to paper Th e reinsurance segment increased OAmerican high-end property CEO Mike McGavick announced back GWP by 50.1 percent, which XL said and construction markets shows in June 2011 that the company had stemmed “primarily from catastrophe no signs of stalling with the news devised a fi ve-year plan to push into related reinstatement premiums in that it is expanding its property property and construction markets as Bermuda and international, which were facultative (fac) operation in the US. part of the group’s desire to “put our pen higher than in the prior-year quarter due Th e (re)insurer announced in mid- back to paper” in profi table areas. to Storm Sandy”. February that it is opening two new In the investor day announcement, Th e P&C combined ratio for the offi ces in Dallas and Philadelphia to McGavick specifi cally mentioned the reinsurance segment came in at 72.9 write US property fac business. North American construction market, percent, compared to 85.6 percent in Q4 Th e announcement adds further with a focus on large contractors and 2011. weight to suggestions that its surety. reinsurance segment has decided to Th e announcement came soon aft er a Going West concentrate on writing more direct series of hires in XL’s North American Th e company’s latest appointments mean business rather than simply rely on construction team. In total, eight new that the Dallas offi ce will be led by Dean broker distributed business. staff were brought in, fi ve of whom Wolfe, who was recently promoted to XL Group recorded $1.5bn of joined from parts of the Zurich Financial western regional manager of XL’s newly property and casualty (P&C) net Services group. created property fac western region. earned premiums in the fourth quarter, As well as its focus on the North Meanwhile, the Philadelphia offi ce will comprised of $1.0bn from the insurance American property market, particularly be led by senior underwriter Margaret segment and $492.9mn from the high value complex risks, the (re)insurer LoSapio. reinsurance segment. said it would target emerging markets on Wolfe will be responsible for XL’s Compared to the prior-year quarter, the direct and facultative side. reinsurance underwriting operations in XL’s insurance net earned premium It also received approval in December Dallas and Walnut Creek, California, increased by 10 percent, which it 2010 for a Shanghai operation, which reporting to Kip Walker, managing said was primarily attributable to will concentrate on global programme director and manager of property fac professional lines “as well as certain P&C business. reinsurance operations, based in Atlanta. North American casualty programmes In its fourth quarter and full year LoSapio is responsible for helping and construction”. results for 2012, XL Group appeared to grow the property fac book by Th e premium growth is in line with to make good on its plan to promote underwriting national and global XL’s previously stated intention to grow growth in profi table lines, recording a property accounts, reporting to William its US construction book for complex fourth quarter increase in P&C gross Rosa, eastern region manager for the and large accounts. written premium (GWP) of 20.5 percent. property fac division.

14 www.insiderquarterly.com INSIDE REGULATION

Benjamin Lawsky, New York's ambitious Superintendent of Financial Services

Less than five years after Eliot Spitzer’s spectacular fall from grace in the Mayflower Hotel, THE LONG ARM Washington, Benjamin Lawsky appears to be applying the same “shoot first” tactics that enabled Spitzer to strike fear into the insurance industry in 2004-05. Indeed, if his recent actions OF LAWSKY… are anything to go by, the New Should we be worried the popular vote and another York Superintendent of Financial Othat there is a new sheriff on extracting money from Services – who has already in town? Particularly when financial firms nervous about gained the nickname “Long arm said sheriff has a reputation as damage to their already fragile of the Lawsky” – is very much the a lone ranger, with one eye on reputations? O Continued on page 16 www.insiderquarterly.com 15 INSIDE REGULATION

O T he long arm of Lawsky… them over payment of flood continued from page 15 The Lawsky effect… claims last year. This is despite new Sheriff of Wall Street. 1500 Lawsky files lawsuit against the UK bank insurers both paying flood claims In the past six months alone, 1490 and also urging a stonewalling Sheriff Lawsky’s singular 1480 Standard Chartered government to agree a new approach to justice has brought 1470 share price public-private approach to UK the British bank Standard 1460 flood – which, at time of going to Chartered to heel, extracting 1450 press, still hasn’t occurred. some $340mn in fines in the All this demonstrates, of course, 1420 process. is that insurers are ripe for the His post was created in 2011, 1420 occasional shakedown from just one of the many regulatory 1420 politicians – and perhaps also changes imposed by governments aspiring ones. around the world in the 5 Nov 12 Nov 19 Nov 26 Nov 30 Nov Of course, we don’t know what aftermath of the 2008-09 financial 2012 Lawsky’s ultimate ambitions are, crisis. but he is straight out of central It also operates out of the New course, that we’re all as heartless casting for someone aiming for York attorney general’s office, as the Tin Man and have no high office. from which the two previous intention of paying claims). The grandson of immigrants incumbents – Spitzer and And anything Obama can do, from Nazi Germany, Lawsky Andrew Cuomo – went on to the right-of-centre Cameron graduated with honours from become governors on the back can do, as illustrated when Columbia Law School before of their ferocious attacks on the he warned the UK insurance taking a clerk’s position with two wrongdoers of Wall Street. industry that he planned to Republican federal judges and Thus far, Sheriff Lawsky has take a “tough approach” with then moving to Washington to concentrated on banks, but work in the justice department. insurers fall very much under his Later he became a New York jurisdiction. public prosecutor known for his Will he turn his attention to aggressive zeal and then joined the (re)insurance industry, just “Lawsky is very much the attorney general Cuomo, quickly as Spitzer did in 2003 when rising through the ranks to someone pointed out to his office new Sheriff of Wall Street” become his chief of staff. the potential conflicts of interest At a tender 42 years of age, taking place at broking firms that Lawsky has built the perfect were receiving fees from both platform from which to launch their clients and insurers? a bid for the ballot box. But a few more high-profile corporate The popular vote scalps would certainly be helpful We may live in an age where with an electorate who continue banks rank even lower than to regard Wall Street – and, by insurers in the esteem of the extension, financial firms – with general public. But insurers contempt. should not be complacent about Even if Lawsky has political this historical anomaly. There are leanings, it doesn’t mean he votes to be won in giving insurers possesses the same naked a good kick occasionally, as US self-interest that consumed President Barack Obama and UK Spitzer less than a decade ago. Prime Minister David Cameron Nonetheless, it is clear his modus demonstrated within a few weeks operandi has similarities. of each other last autumn. Just take a look at Standard While visiting some of the worst Chartered, a 150-year-old British hit areas of the US east coast after bank that survived the financial Sandy, Obama warned insurers crisis unscathed because it had that they must “show some heart broadly eschewed the temptations and some spirit in helping people of casino banking and Spitzer: Downfall at the Mayflower Hotel, Washington rebuild” (the inference being, of concentrated on the mundane

16 www.insiderquarterly.com INSIDE REGULATION but necessary role of helping its Hurricane Spitzer strikes… personal determination to nail customers trade internationally. MMC, apparently in part due to Th e processing of letters 50 Marsh’s apparent lack of humility 14 October lawsuit filed of credit, bills of lading and 45 when his offi ce was examining foreign exchange in Asia and the the fi rm’s Placement Service emerging economies of Africa 40 Agreements (the term coined might be unfashionable, but it by the broker for its contingent enabled Standard Chartered to 35$ commissions). largely avoid the highly leveraged “Th e leadership of that company 30 MMC share excesses that consumed the banks price is not a leadership I will talk to; it 2004-2005 in Wall Street and Canary Wharf. 25 is not a leadership I will negotiate Nevertheless, Lawsky wiped with,” insisted a furious Spitzer, 25 percent off the bank’s market 20 as he eff ectively held a gun to the capitalisation in November 2012 2004 Apr Jul Oct 2005 Apr Jul Oct 2006 MMC board’s head. when he released bombshell He may as well have been allegations that Standard the broker’s share price in the saying: “Sack [Jeff rey] Greenberg Chartered helped facilitate four trading days following the as CEO or I’ll make it even worse hundreds of billions of dollars complaint, wiping out $11.5bn for you” (the talented Greenberg worth of illegal transactions for of market capitalisation. Even was, indeed, let go – as was a Iran, which is currently under today, MMC’s share price remains whole cadre of the fi rm’s senior sanctions. substantially below the mid- management). Th e bank’s CEO Peter Sands $40s that it traded at before Of course, this is all ancient fi ercely denied the claims, but Spitzer’s civil complaint and the history. But was soon persuaded to enter subsequent those who forget into a “no fault” settlement and $851mn history may be paid $340mn in fi nes, perhaps “restitution” condemned to see infl uenced by the threat of losing fi ne that was it repeated. its banking licence in New York, extracted In other words, which would have crippled an from the will Lawsky turn organisation that is based on broker. his attention to facilitating international trade. Lawsky’s fury o The Insurance insurers and, most obviously, how But Lawsky’s actions sparked with Standard Chartered also Insider on 4 the industry conducts business outrage on the other side of the appeared to have been motivated October 2004 with brokers, just as Spitzer did? predicted Spitzer's Atlantic, where UK politicians in part by the bank's failure actions precisely In fact, he already is, according accused him of playing to the to be suitably humble during ten days before his to a senior legal fi gure that IQ galleries and even of being “anti- negotiations, with the complaint bombshell spoke to recently. British”. alleging that a “group executive Recalling a dinner in early Perhaps those complaints director” showed “obvious 2013 where he sat close to the were predictable, but his actions contempt for US banking New York Superintendent, our also reportedly raised the ire regulations”. It later emerged correspondent said: “Lawsky was of US regulators, such as the that this accusation referred to very much interested in insurers, Federal Reserve, the Treasury Richard Meddings, Standard brokers and their remuneration and the Securities and Exchange Chartered’s fi nance director. practices.” Commission, due to his go-it- Lawsky’s offi ce alleged that He is not the only one, of alone approach and failure to Meddings’ response to warnings course. engage other regulatory bodies. about the bank’s Iranian Since Spitzer strong-armed the It was all remarkably operations was: “You f------big three global brokers – Marsh, reminiscent of Spitzer’s infamous Americans. Who are you to tell Aon and Willis – into signing the attack on Marsh & McLennan us, the rest of the world, that “Spitzer agreements” in 2005, a Companies (MMC) on 14 we’re not going to deal with lot has happened. October 2004, a day that is still Iranians?” All three fi rms have made etched in the memories of many. We do not have Meddings’ a much more conscious Like Lawksy’s move on Standard version of events to know commitment to ensure “full Chartered, Spitzer’s swipe at whether he agrees with this disclosure” of their remuneration MMC was unexpected, and account, but regardless it all practices. Willis – under Plumeri, sparked a 48 percent decline in feels very similar to Spitzer’s O Continued on page 18 www.insiderquarterly.com 17 INSIDE REGULATION

O The long arm of Lawsky… of specialist management “I’m killing myself trying to continued from page 17 information services, such as keep you guys out of the paper at least – even led a campaign Aon’s GRIP, Marsh’s Connect on this one.” Bolt told the against contingent commissions, and Willis’ WillPlace, as well as market that their arrangements the arrangements that Spitzer exclusive underwriting “clubs”. need to be documented and took such a visceral dislike to If Lawsky was minded to look “quantitatively and qualitatively because of the potential confl icts for misgivings about this trend, auditable” to ensure compliance. of interest. he wouldn’t have to search far. “So I need you all to make sure But the irony of Spitzer’s attack Indeed, in London earlier this that you’ve actually documented on Marsh in 2004 – which left year, two industry heavyweights your things correctly,” he the industry’s then leading made their feelings clear – albeit said. “If it’s not a ‘pay-to-play’ global broker shaken and for diff erent reasons. arrangement then make sure that rudderless – is that For Axis founder it’s documented so that it’s not less than 10 years and former CEO a ‘pay-to-play’ arrangement and on the big three are John Charman it you can show that it isn’t from bigger and stronger was because insurers the services you get.” than they have could scarcely aff ord If it is a ‘pay-to-play’ ever been. Th rough these additional arrangement, he suggested with canny lobbying and payments to brokers deliberate understatement that assisted by Spitzer’s when there was so companies may want to think disgrace, they much ineffi ciency whether they should be agreeing have successfully in their back offi ce. to such deals. dismantled all “We have done Of course, the brokers insist of the egregious o Bloomberg, 16 nothing about that no such arrangements exist elements of the Spitzer August 2012 our cost-base for the 42 years and that these initiatives are agreements. Th ey have become I’ve been in the industry,” he designed to improve insurers’ much more effi cient in their use explained, warning that insurers understanding of the business of technology and they have will be increasingly caught in a and to ensure that their clients continued to consolidate (Willis “vice-like grip” between insureds have access to the best markets. buying HRH for $2.1bn, Aon refusing to pay higher prices IQ – which has always believed buying Benfi eld for $1.4bn etc.). and the brokers’ control of the that full disclosure is suffi cient Th ey are also increasingly process. to ameliorate confl icts between successful at leveraging It is unlikely that Lawsky will sophisticated counterparties – their market dominance to be moved by the squeezing of is not going to simply criticise extract revenues not just from insurers’ margins, but he may brokers for monetising their their clients – the insurance listen closer to the fears over dominance of the business buyer – but also from their confl icts and whether insurers process. But it doesn’t really markets, through the provision are being seduced into “pay matter what we think. In this to play” schemes, where they context, it matters much more feel obliged to pay for a broker what a 42 year-old former Meet Lawsky… “service” simply to have a chance public prosecutor, who may be ● A 42 year-old, he is a keen marathon runner of underwriting the business. harbouring political aspirations, ● Grandson of refugees from Nazi Germany, he was At a Lloyd’s lecture in happens to think. born on a naval base in San Diego February, the Society’s head If Lawsky is provided with a ● Graduated with honours cum laude from Columbia Law School of underwriting Tom Bolt smoking gun, perhaps some ● Spent ﬁ ve years as an assistant US attorney in the counselled insurers that they off -message emails produced Southern District of New York prosecuting insider must be careful in documenting by an aggrieved employee trading and terrorism cases and monitoring all their broker masquerading as a whistle- ● Became the ﬁ rst superintendent of the New York arrangements, particularly those blower, then the boy from Department of Financial Services in late 2011 which do not appear on the Columbia Law School may ● Entities supervised by the Department number underwriting slip. conclude it is worth a tilt at the approximately 4,400, with assets of about $6.2tn ● Led the campaign against Standard Chartered, He warned underwriters: insurance industry. settling for $340mn “You’re just as burdened [as the Th ere’s a new sheriff in town. ● He’s married to an attorney named Jessica Roth intermediaries] with the guilt and Th e industry will have no excuse the front of the newspaper risk as if it underestimates him in the the next guy. same way it did with Spitzer…

18 www.insiderquarterly.com 1962 * We know our markets.

* year when a cow was swept off the ground by tornadoes and flew more than 1 km

www.hannover-re.com

hrv_Ad_1962_Insider_Quarterly.indd 2 25.02.13 09:53 INSIDE CAPITAL Hot money Gavin Davis questions whether catastrophe reinsurers can handle the heat and maintain underwriting discipline as “hot money” pours into the sector

Lured by the prospect of on. So, why are traditional 2012-13 sidecars Ostrong and uncorrelated reinsurers so eager to embrace 2013 returns, capital markets this hot money? And – in Vehicle Sponsor Size ($mn)* contrast – why are some AlphaCat 2013 Validus 230 investors remain captivated Harambee Re Argo ? by the prospect of reinsurance industry veterans uneasy about Mt Logan Re Everest Re 250 risk – and, in particular, this trend, which has led to New Point Re V Alterra 247 catastrophe reinsurance. an eruption of joint ventures Upsilon Re II RenaissanceRe 185 But in recent years these between traditional reinsurers 2012 Upsilon Re RenaissanceRe 74 investors have also eschewed and the arrivistes? Accordion Lancashire 250 the option of buying equity Perhaps it is worth first New Point V Alterra 210 in publicly traded reinsurers, taking a step back to examine Timicuan RenaissanceRe 55 Reinsurance III instead they are capitalising the catastrophe reinsurance AlphaCat Re 2012 Validus 70 reinsurance vehicles themselves landscape. This global market Saltire Re I Lancashire 250 and, in many cases, competing worth perhaps $18bn-$20bn *Upsilon disclosed capital limits deployed; Mt Logan target only; others actual capitalisation with traditional reinsurers head a year, has long been at the Source: Trading Risk

20 www.insiderquarterly.com INSIDE CAPITAL

frontline of the so-called people really understand,” he “convergence” between the told an audience of 400 London two sectors. But despite the market executives. dominant market share of the “I believe the industry is in traditional reinsurers, more great danger of diluting its and more industry experts franchise, and [the industry] are claiming a seismic shift needs to be very careful how it had occurred in the fault line deals with this hot money.” between the two sectors. Charman, who described “All distinction between himself as “one of the last traditional and non-traditional “I believe the dinosaurs”, having stepped sources of capital is redundant”, industry is in great down from his role at Axis in claimed Guy Carpenter vice September 2012, also warned chairman David Priebe at the danger of diluting its that the sector’s changing capital industry’s annual gathering in franchise, and [the landscape might skew incentives Monte Carlo last year. “Th e and change underwriting market has converged”. industry] needs to be behaviour. It is not diffi cult to see why very careful how it “Th ere is a grave danger within someone might form that the industry that the seduction conclusion. Aft er all, the past deals with this of hot money will defl ect and few months alone have seen a hot money” weaken the underwriting fl urry of announcements from standards that the global markets (re)insurers looking to channel John Charman have,” he said. the infl ows of “hot money” “Th ese short-term capital into the sector through vehicles And when an industry entrants change underwriting such as sidecars, collateralised veteran describes something practice, because they are reinsurers, fund managers and as “the greatest threat to the buckets that need to be fi lled. cat bonds. underwriting community”, And those buckets that need Indeed, of the listed companies people tend to listen. to be fi lled mean underwriting in our universe of London, Th is is exactly what happened businesses – without a shadow Europe and Bermuda-based at Th e Insurance Insider’s of a doubt – have to compromise listed cat reinsurers, only InsiderScope London event in their underwriting philosophy.” Novae, Platinum and Endurance February, where Axis Capital Charman also argued either do not appear to have founder and former CEO John that greater capital markets a meaningful capital markets Charman aimed both barrels participation meant the peaks venture or have not unveiled a at the gold rush-like clamour of pricing aft er large losses were strategy to undertake one (see among reinsurers to channel fee being suppressed, meaning table page 22). income from “the surplus capital reinsurers were less able to Th is is hardly news, of course. that seems to be pouring into our build reserves and rebuild But what is noteworthy is that industry”. capital. And this fact appears these investors are no longer the “I think the greatest threat to be demonstrated by Guy cold, calculating hedge funds in the near term to our global Carpenter’s rate-on-line index for that leap in and out of markets specialty underwriting business catastrophe premium over the without a second’s thought. is the commoditisation of our past decade (see graph on page 23). Instead, they are other kinds business. Th at’s a great threat, of investors, such as pension and more of a threat than I think The agency problem meets funds, with much lower return reinsurance expectations and longer horizons Th e agency problem that (see “The rise of the pension fund” on Charman described is not unique page 40). to the reinsurance sector. Indeed, many highly regarded fi nanciers The sceptic and economists have cited the O While all may agree the Tom Bolt, poor alignment of incentives marketplace has changed, not director of in the mortgage underwriting performance everybody agrees that it has mamagement, market as one of the key drivers changed for the better. Lloyd's of the O Continued on page 22 www.insiderquarterly.com 21 INSIDE CAPITAL

O Hot money… underwriting standards on Lime continued from page 21 Street, said the sector is capable fi nancial crisis. of dealing with the challenge. “Th e securitisation of Th e banking experience during mortgages added a new the fi nancial crisis provides a dimension of systemic risk. cautionary lesson on how the O Aditya Dutt, Financial engineers claimed they performance of an underlying president of Renaissance were reducing risks through business can be masked by Underwriting geographic diversifi cation: in focusing on fee income, Bolt said Managers, RenRe fact they were increasing them in a recent interview with Th e by creating an agency problem,” Insurance Insider. risk – and not on other wrote the legendary George Banks’ ability to repackage and revenue streams such as fund Soros in 2009. sell on their mortgage exposures management fee income. “Th e agents were more in the form of securities such as interested in maximising fee collateralised debt obligations One portfolio philosophy income than in protecting the meant they became detached If the Lloyd’s market and its 300 interests of bondholders. Th at from analysing their credit risk year-plus history of underwriting is the verity that was ignored when they lent their capital to on behalf of third-party investors by regulators and market borrowers. Motivated instead is the most commonly cited participants alike.” by fee income based on volume, retort to critics of newer forms Although Charman did not banks became increasingly of reinsurance capital, then make this analogy, it is clear reckless, creating the bubble that RenaissanceRe might be the next that as insurance underwriters burst in spectacular style in 2008. riposte in line. become more dependent on “You don’t want to lose sight of Th e Bermuda-based fee income and put less of their your main business,” Bolt said. (re)insurer has been a pioneer own capital at risk, there is But he said that if a in deploying third-party capital greater propensity for an “agency (re)insurer redefi ned what since it launched Top Layer Re in problem” if incentives are not it was doing and considered partnership with the US insurer well managed. In such a scenario, itself as an originator of risk State Farm in 1999. underwriters are incentivised to then the evolution can make Th e company’s CEO Neill merely maximise the origination sense. Th e important thing, the Currie recently told investors of risk before passing it on to Lloyd’s director of performance the company’s capital structure other investors. management acknowledged, is means it “plays ball as if we have But Tom Bolt, the former that (re)insurers’ management got about $10bn of capital, when Berkshire Hathaway executive ensure that their businesses in fact we only have $3bn of charged with guarding remain focused on underwriting common equity”. Aditya Dutt, president of Traditional cat reinsurers' capital markets joint ventures Renaissance Underwriting Sidecars/Lloyd’s special Private sidecars/QS Fronting arrangements Developing managed cat/ILS London/Bermuda Managers at RenRe, told Insider purpose syndicates arrangements (that are transformer funds for outside investors companies with no public known of) actions Quarterly that his company is agnostic about the type of capital, public or private, used to underwrite risks. “From our point of view we just try to be client and shareholder focused. It’s not necessarily ‘is there money coming into the industry or not’, it’s more ‘is it being used in service of the client and shareholders’,” he says. However, the executive acknowledges that the interests of these two groups are not always perfectly aligned: “Your shareholders want you to be disciplined and good

22 www.insiderquarterly.com INSIDE CAPITAL

underwriters and some clients may just want the lowest price. “It isn’t necessarily new money that causes It’s a question of whether the the underwriters to become undisciplined, human being sitting in the middle of that process is being because we haven’t seen that being responsible or not. In the long promoted from the capital market side” term, solid exposure-based underwriting serves both Shiv Kumar stakeholders equally well.” terms and conditions hold up the market have been quick to RenRe has a slogan to describe and have continued to hold up insist they can maintain their its philosophy: matching the within soft and hard parts of discipline and handle the hot right risk with the right capital at the cycle; the pricing has been money without damaging their the right time. generally consistent over the past core business. But Dutt explains that this 15 years,” he adds. Reinsurers such as Everest and sentiment was enforced in XL have said their expansion reality through a governance Caution = irrelevance into funds management would structure that ensured the Despite one of the industry’s not cost their existing investors, company’s incentives were most respected sages preaching as analysts quizzed them during aligned with its capital providers caution, much of the rest of the the February reporting season through co-investment, while (re)insurance sector has on how these moves would affect the incentives of its staff were indicated they intend to their business. designed above all else to reward keep their foot firmly on the Everest Re CEO Joe Taranto underwriting discipline. accelerator pedal for their capital said the firm would not give “We have a one portfolio market plans. up profitability in order to philosophy. Our risk takers aren’t “If the industry is cautious it’s make its mark in the alternative incentivised by taking risks on a going to happen anyway,” Amlin reinsurance space as it fundraises certain balance sheet or a certain CEO Charles Philipps said at an for its $250mn Mt Logan Re class of risk, they’re incentivised Insurance Institute of London sidecar. to make a single portfolio of risk lecture on 14 February. “We’re not looking to take away more efficient,” he says. “There is a weight of pension from anything that we would Subsequently, a different team fund money that has now found want to keep for ourselves,” he to the risk takers is given the reinsurance. There may be said on the company’s earnings task of matching risks to the different speeds at which that call, in response to an analyst’s most efficient capital, ensuring will be deployed from time to questions over whether bringing that no one person or team is time, but my view is that it has in sidecar capacity would detract able to control the process from become an inevitability. If we from its ability to earn income origination to its balance sheet just sit there and say ‘we must be against its own capital. destination, he explains. cautious about it’, we’d actually “Now we’ll try to put ourselves Other participants in the capital lose the business that we do over in the same position with our markets space deny that it is the time.” new partners, so they feel as if influx of “hot” money that leads Some of the newer entrants to it’s really equal trading. But we to ill-discipline by underwriters. are not looking to give away $1 “It isn’t necessarily new money worth of business that we would Global property catastrophe rate-on-line index that causes the underwriters to Cat rates flattening? normally write for ourselves.” become undisciplined, because 450 Montpelier Re CEO Chris Global property cat RoL index we haven’t seen that being 400 Harris also said that the company promoted from the capital 350 was not trying to grow its Blue market side,” says Shiv Kumar, a 300 Water third-party funds business managing director at Goldman 250 “for the sake of just trying to add Sachs. 200 some fee income”. 150

“Cat bonds have remained Rate-on-line index “If we see growth, it is going one of the most disciplined 100 to be because we are responding asset classes within the broader 50 to client needs and developing a reinsurance sector over the past 0 little broader product mix to give

1990 1991199219931994199519961997199819992000200120022003200420052006200720082009201020112012 15 years. They are about the most 1/1/13 us a better chance to optimise well-underwritten products; the Source: Guy Carpenter our portfolio returns,” he said. www.insiderquarterly.com 23 INSIDE SYSTEMIC RISK

It can't happen here… Shirley Beglinger queries the conventional wisdom that the insurance world is free from systemic risk and asks whether the financial meltdown could happen a little closer to home…

I had a lightbulb moment banking which got us into this statistics, and since they didn’t Owhen the Financial mess. But before we could talk actually have to lend the money, Stability Board (FSB) was in about insurance we first needed it seemed as though Bank B London recently. Or rather, to understand what the FSB had was getting a great deal. Bank A several lightbulb moments. been doing about banks. was also delighted with the deal I finally figured out why the because now they could lend government keeps on bailing out Leverage money without ever worrying the bankers; I realised that the And here comes the first lightbulb about about the financial health insurance industry could be next moment. Lehman Brothers was of Corporation X – the credit up the creek without a paddle; allowed to fail in 2008 because default swap functioned as an and I understood at least part of it was “a fairly small-fry bank” unconditional insurance policy. what needs to happen before they whose demise might cause some Then some more bright minds can stop bunging billions down ripples in the global financial reckoned that you should be able the banking black hole. pond, but ex ante nobody believed to buy and sell these guarantees Starting with the banks: I it would create a tsunami. A independent of whether there was could never understand why tsunami is what happened though. any loan outstanding or who was governments have spent billions The first revolution aft er the Big doing the lending. And thus the bailing them out – and all because Bang liberalisation of financial credit default swap went viral – of greedy, foolish, profligate markets in the 1980s was allowing and hallelujah, the era of easy debt bankers. Ringfence the savings banks to take over stockbrokers. was upon us. and let the banks fail. Tip the Suddenly banks could take in Parallel to all of this invention, mangy crooks into the streets to deposits at 5 percent and trade on a steady wave of deregulation was starve with all the people their the stock market for 20 percent. taking place. Or rather, a steady cupidity has harmed, says I. Then a few clever minds began to wave of internationalisation. In the teeth of such public see the possibilities of futures and National rules restricting the opinion, our government burnt options and swaps and swaptions. scope of banking activity were billions of pounds of our tax In about 1995, JP Morgan quietly dropped. Throughout money bailing out banks. That published Credit Risk Metrics on the 1980s and 1990s, the Bank bailout has pushed our nation so the then embryonic internet, and for International Settlements deep into debt that children yet created a vast new field of trading began to establish standards for unborn will still be paying it off. almost overnight in the process. bank capital which were enacted And why? It worked like this: Bank into national laws (Basel I), thus The FSB meeting provided an A would lend money to increasing inter-bank confidence explanation at long last. Officially Corporation X. Bank B would which in turn facilitated cross- the meeting was about insurance agree to guarantee the debt, so border transactions. companies and everyone was if X defaulted, Bank B would at great pains to emphasise that pay in X’s stead. They charged Growing paralysis they understood how different a premium for this calculated And that brings me to my second insurance was from the sort of by reference to the JP Morgan lightbulb moment: we have to

24 www.insiderquarterly.com INSIDE SYSTEMIC RISK

keep on propping the blighters of these banks drops the ball”; doing off-the-wall stuff. But up with tax money because there and develop an international following American International is no international liquidation resolution mechanism – which Group (AIG)’s near-death regime. Banking activity is global, translates as “try to find a way experience, the lesson had been but bankruptcy laws are national to ensure that ALL creditors are learnt and those bits were firmly or even local. treated correctly irrespective of ring-fenced and fiercely watched. The traditional order in which their location versus the bank’s No need to worry about us, guv. creditors line up to collect home location”. Then a banker piped up, and whatever funds the liquidator brought about my third lightbulb can scratch together is (in Bringing it back home moment. For his sins, he descending order): account Which brings us back to specialised in sell-side insurance holders, employees, the tax man, insurance. Six or seven years ago analysis at one of the largest banks the liquidator (for his fees), the G30 think-tank produced a in the world. He highlighted the secured creditors, bondholders, study which stated categorically fundamental weaknesses in the subordinated debt holders and that insurance – being small life insurance industry which will finally the shareholders. But the in comparison to banking and probably cause major problems traditional order only holds good miniscule in comparison to the for all of us – life and general if all of those would-be recipients size of the global financial markets insurance alike. are located in the bank’s country – did not represent any systemic of incorporation. As Lehman’s hasty pre- bankruptcy withdrawal of “The G30 think-tank produced a study which funds from the UK subsidiary stated categorically that insurance did not demonstrated, there is a de facto expectation that creditors and represent any systemic risk. Either things have shareholders within the national changed, or the report was wrong” borders will be first in line before any other obligations are met. Which is why large parts of risk. Either things have changed, Some moments of weakness the banking system are now or the report was wrong. Insurers struggle to value the paralysed. Banks dare not do The FSB meeting under liability side of their balance cross-border business with each discussion here united the great sheet. This is nothing new – we other because their counterparty and the good of the insurance all know general insurers struggle might become insolvent. If their world – chief risk officers (CROs) to accurately quantify third-party counterparty becomes insolvent and CFOs from the major liability claims, but this is also under the current non-regime, European, UK, US and Japanese increasingly true of property they stand to lose all that is owed companies; senior regulators from damage and business interruption. to them – and they too might be around the world; as well as a What we tend to forget is that tipped into bankruptcy. number of people who might best life insurance liabilities are even This is where the FSB comes in. be described as “Central Bank more unquantifiable. The problem At the behest of the G20 group Brains”. is no longer mortality or even of nations, it has identified just The big question was: which dread disease, but longevity. under 30 banks around the world of the major insurers should be Pension commitments made which are classified as systemically treated as sifis? The CROs all decades ago have turned into an important financial institutions struck up a mood music chorus open-ended blank cheque whose (SIFIS). Should one of these about how insurance companies recipients stubbornly refuse to die. become bankrupt, it could cause a in and of themselves pose no When dread disease policies global financial meltdown. threat whatsoever to the global were issued during the 1980s and So, having identified the clear financial architecture. 1990s, the assumption was that and present danger, the FSB’s next Insurance companies, they only 12-24 months of ruinously task is threefold: force SIFIS to harmonised, were users of expensive medication would increase their loss absorbency – financial architecture, not part elapse between diagnosis and which translates as “hold more of it. Grudgingly, one CRO death. But modern medicine can capital”; enforce a more intrusive after another admitted that hold diseases like AIDS, cancer regulatory regime – which his company did have the odd and Parkinson’s at bay for many translates as “make sure none renegade squad of quasi-bankers years, O Continued on page 26 www.insiderquarterly.com 25 INSIDE SYSTEMIC RISK

O It can't happen here… nothing bad happened on his continued from page 25 watch. Or if something bad during which time the fi nancial happened, then the people in obligation continues. his patch would be okay and he But what I hadn’t realised is that “The same challenge applies wouldn’t have to worry about life insurers probably struggle to for insurers as for banks: how anyone else’s national problems. value their assets. Life insurers But reality doesn’t work that way make heavy use of swaps and do you wind one up without and the clocks stubbornly refuse options and swaptions and futures bringing the entire fi nancial to run backwards. Insurers are – all designed to keep their vast international. Financial markets assets somewhat in kilter with system crashing down around are global. Neither is going to their unquantifi able liabilities. our collective ears?” revert to being national and cosy What the clever banker and manageable. So the same underlined was the size and regulators. challenge applies for insurers as complexity of the asset/ Th is would entail setting up for banks: how do you wind one liability models that drive all colleges of regulators to oversee up without bringing the entire of this balancing act. Not just a these international behemoths fi nancial system crashing down spreadsheet in the accounting and formulating plans of action around our collective ears? department, but huge models which address all aspects of the When Uncle Sam bailed out with swathes of assumptions company, not merely national AIG it wasn’t for love of AIG’s regarding market volatility, cost concerns. Faced with this task the shareholders, but because of the of living indexation, interest rate regulators are visibly and vocally realisation that guarantees and projections and so on. Adjust one unenthusiastic. Th is sort of options and futures and swaptions assumption, and wheels turn, cogs coordination might mean putting issued by AIG played a key role in ratchet and whole valuations shift . national interests aside in favour propping up the global fi nancial All of which means that insurers of the greater good, which in turn system. represent vast counterparty risks would not play well with their One way or another, AIG was a in the global fi nancial markets. If political masters. counterparty for billions of dollars Allianz or Prudential or Manulife European regulators don’t say it, of trades. It was the corporate or AIG (or any one of half a but they would actually like to see equivalent of a keystone in an dozen others) were to fail, the an end to EU-wide passporting archway – pull out the keystone shock to fi nancial markets would of fi nancial services. American and the whole arch collapses. So be huge. regulators would like to exclude if AIG went down, it would take Untangling their fi nancials to foreign entities from their market. a large part of fi nancial America establish the true value of their Th e same holds true in Japan, and, by extension, the world with assets would be a challenge. Australia and wherever. Not for it. You’d then have to fi gure out jingoistic reasons, but for purely Th e same is almost certainly true which of their many international practical reasons. of at least half a dozen European counterparts has claims under If an insurer is required to and UK insurers and reinsurers. which contracts. Who gets paid capitalise a subsidiary in each If Allianz, Zurich, Axa, Generali, fi rst? Who gets paid in full, country where it does business, Munich Re or Swiss Re – just to and who receives only partial the subsidiaries can each be name the most obvious candidates payment? Unravelling a life held separately accountable – were to fail, the fi nancial insurer would be even more of for their liabilities. If Big architecture would be even more a nightmare than unravelling a Insurance Company goes bust in distressed than it already is. If bank. Australia, then only Australian contagion reached the insurance policyholders and counterparties OShirley industry’s Lender of Last Resort, Not on our watch need be concerned, as the Beglinger is a Berkshire Hathaway…well, you So for good and proper reasons, obligations of all the other Big director of Shires get the picture. the FSB would like to see the Insurance Companies will still Partnership, an So all we can do is hope the independent largest insurers holding extra be safe. Big Insurance Company’s consultancy FSB fi nds an answer to that capital and submitting to far more capital in the UK would be set specialising in bankruptcy question, and soon. intrusive regulation. Th e insurers against the liabilities of the UK underwriting Because until it does, our hard- would like to see more regulation entity, which in turn would be peer review, earned taxes will still be hostage strategic planning (surprising but true) and greater overseen by the UK regulator. and capital to the banks. And possibly to the coordination between national Each regulator could make sure management insurance industry.

26 www.insiderquarterly.com AW03-0494_IQ_SPRING.indd 1

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Inside the Lloyd's dream With membership so highly prized, Adam McNestrie assesses what it takes to get into the world’s oldest insurance market

Paul Rayner, managing director of GC Securities EMEA, s that Lloyd’s “maintains a high bar” when filtering interest from potential new entrants. Iain Bremner, who heads up Capita’s turnkey provider, says that over the last two years there has been a growing – although not always justified – view among would-be entrants that “the timing wasn’t right to try”. Dennis Purkiss, executive chairman of R&Q Underwriting Management, adds: “Clearly, the more successful Lloyd’s is, the more jealously it’s going to guard its reputation and access to newcomers.” The figures seem to confirm this picture. While 25 syndicates were founded between 2007 and 2010, only four new syndicates were minted between 2011 and 2013 (see table opposite). Lloyd’s franchise performance director Tom Bolt maintains that Lloyd’s “remains open for business” and insists that the Corporation has not changed its standards, with the drop in start- ups reflecting unpromising market conditions. But Bolt is clear that People look at Lloyd’s and so many Lloyd’s aspirants out new entrants must be able to offer Othey see sizeable, there. The execution of Lloyd’s Lloyd’s something in return for all established platforms that membership is, of course, far of the well-documented benefits embody everything that the more difficult and requires real it brings. market is admired for in the originality, perseverance and far- “We don’t need more guys to likes of Catlin, Kiln, Hiscox, sightedness if an application is come in and do what we do now. Amlin, Beazley and so on. to end with anything other than If you want in you have to bring They are strong, innovative, disappointment. something new to the party,” he successful Lloyd’s businesses observes. crammed full of underwriting Fortress Lloyd’s It is a message echoed by the expertise and quality capital and In recent years, it would appear third-party managing agents that take full advantage of the market’s that Lloyd’s is harder to get into work with Lloyd’s to guide new rating, capital structure and than it ever has been before. entrants into the market. licenses. Onlookers see this and Julian Tighe, COO at market- R&Q executive Purkiss says: decide “me too”. leading turnkey provider Asta, “The overarching principle is that It is easy to think this way argues: “You need a Premier you must bring something that and that explains why there are League plan to get through.” And adds to the overall enterprise –

28 www.insiderquarterly.com INSIDE LLOYD'S whether that’s new people, new Lloyd’s Relationship Management Lloyd's start-ups 2007-2013 business or new ideas – it needs Team. Year Lloyd’s vehicle (turnkey provider Syndicate Initial capacity to present something that is Next, you will make a high-level (£mn) accretive.” pitch to Lloyd’s in conjunction 2013 Nephila (Asta) 2357 100 Bolt explains the principle by with their turnkey provider. 2013 R&Q (R&Q) 1991 77 reference to a recent entrant. Th is Assuming that you clear this 2011 White Mountains 1945 66 2011 Scor (Asta) 2015 75 start-up had a company market hurdle – and many don’t – you 2011 Skuld (R&Q) 1897 60 business that was outperforming will then start to work on a 2010 Chubb 1882 42 Lloyd’s in its chosen classes. It detailed business plan. 2010 TSM (Argenta) 1110 53 was also a leader in writing a Bremner says that this plan 2010 Allied World (Capita) 2232 100 subscription book of business – – which will cover everything 2009 Beazley 3622 7 something that would potentially from underwriting philosophy, 2009 Beaufort 1318 35 create new opportunities for other outwards reinsurance and 2009 WR Berkley (Asta) 1967 55 Lloyd’s platforms. “When there’s a governance to controls – tends 2009 Hiscox 3624 60 proposal like that it’s hard not to to grow into a considerable 2009 RenRe (Spectrum) 1458 70 2009 Apollo (Flagstone) 1969 75 say ‘yes’,” he explains. document outlining the applicant’s 2009 Arch (Asta) 2012 100 Tighe says that when Asta is long-term vision of its proposed 2009 Kiln 1880 200 dealing with clients, acting as the Lloyd’s venture. Th e plan will 2008 Beazley 3623 33 fi rst fi lter of potential applicants cover the fi rst three underwriting 2008 HCC 4141 12 for Lloyd’s, it always asks them years at Lloyd’s. Prospective 2008 Arrow/Goldman Sachs (Asta) 1910 65 what they can give to Lloyd’s. entrants then submit this plan 2008 Barbican (Asta) 1955 75 to the Lloyd’s New Entrant 2008 Aspen 4711 88 Nephila Assessment Group (Neag). 2008 Shelbourne 2008 RITC And there are things that Lloyd’s Th e process is then taken both 2008 Antares (Chaucer) 1274 135 2007 CV Starr 2243 10 needs new syndicates for. As out of your hands and those of 2007 Cathedral 3010 20 well as helping it to enter new your sponsoring managing agent. 2007 Pembrace (Spectrum) 2112 34 classes (as with Nephila’s recent Lloyd’s executives will make a 2007 Montpelier (Spectrum) 5151 47 entrance), it needs to replace pitch on behalf of the start-up to 2007 Capita 5555 75 wastage in the market and to the Franchise Board, which has 2007 Icat (Chaucer) 4242 84 ensure that consolidation does the power to grant in-principle 2007 Ark (Asta) 4020 114 not lead to a recurrence of the approval. If the Franchise Board Source: The Insurance Insider over-concentration problem seen gives the putative start-up its necessary. Th e whole process in the past. offi cial imprimatur then it will is likely to take at least nine However, the days of “me too” enter the “making it happen” months. “It’s an emotional ride, start-ups are long gone, says phase. at least as joyful (or painful) as a Tighe. Purkiss echoes the view Every aspect of the start-up’s pregnancy!” Bremner quips. that start-ups have no chance plan is subjected to scrutiny if they are copycat businesses and some have even undergone Inside the tent proposed by people who think signifi cant changes or collapsed Few make it this far, but if your they should be allowed in “simply altogether at this point. start-up does reach the because they have been in Lloyd’s Purkiss describes the whole underwriting fl oor at 1 Lime before”. Rayner agrees that only thing as “an intrusive, robust and Street, you will face a whole host the “right applicants” have a sometimes protracted process”, of new challenges as a fl edgling chance of successfully entering albeit one that is absolutely syndicate. Lloyd’s through this route rather First of all, Lloyd’s charges than through the side door you more for the privilege of provided by M&A. operating there. Central Fund Entrants that are suffi ciently contributions for the fi rst three determined and which show years of a syndicate’s existence are enough promise will pair up with 2 percent of stamp capacity rather one of the three active turnkey than 1 percent. And – far more players – Asta, R&Q and Capita expensively – new syndicates are – and enter the “First Approach” O Dennis forced to accept an additional 20 stage. Purkiss, executive percent capital loading. chairman of R&Q At this point fairly informal Underwriting You will also have to deal with conversations will be held with the Management O Continued on page 30 www.insiderquarterly.com 29 INSIDE LLOYD'S

O Inside the Lloyd's dream… cost, most syndicates look to build continued from page 29 their own managing agency in the all of the Lloyd’s-isms that bedevil early years of their operation. the market. One source explains Bremner describes this as “quite that most new entrants have a a challenge” and it seems that pretty good idea of what to expect, there is no one-size-fi ts-all process but there’s nothing like “the cold for setting up a managing agency. hard truth of having hundreds “You’re ready when you’re ready,” of returns to make” to bring it he says. home to them. “Lloyd’s has a Essentially, businesses are very intensive risk management forced to duplicate functions and “We don’t need more guys to approach,” he explains dryly. run them in parallel for a time Purkiss chimes in: “Th e scrutiny until Lloyd’s is comfortable that come in and do what we do now. on these syndicates is maintained they have attained the necessary If you want in you have to bring through the three years. Lloyd’s standard. At this point the keeps a very close eye to maintain relationship with the turnkey something new to the party” progress against plan.” provider is dissolved and the two Tom Bolt, director of Bolt says that Lloyd’s prefers businesses go their separate ways. new syndicates to come into the Th is can be a costly process, performance management, market with turnkey managing but of course these providers Lloyd’s agents, despite the odd exception are building a saleable asset, like Chubb. with managing agencies succeed as a multi-line player. “We think it is helpful for attracting implicit valuations of Th is sort of scale off ers it access people coming into Lloyd’s to £10mn-£20mn in recent years. to business, the ability to bear its have the umbrella and support A number of Lloyd’s businesses higher Lloyd’s-driven expense of an existing operator, partly to are currently in the later stages of ratio, more effi cient outwards socialise those who aren’t familiar this process, including ProSight, reinsurance buying and various with Lloyd’s – and even those who Torus, the Doré syndicate and other economies of scale. are,” he says. Allied World. Growth can, however, be Th e turnkey providers are A Lloyd’s business that is three diffi cult for these businesses, tasked with ensuring that the or four years old that has just with the Franchise Board broader reporting, planning and created its own managing agency making an increase in stamp governance infrastructure is in and taken off the training wheels capacity a reward for successful place to free up the new syndicate of the turnkey provider could underwriting performance. Some to concentrate on profi tably then have to surmount scale end up in a Catch 22 scenario underwriting to its plan. issues before it can become truly where they are underperforming Tighe stresses – as do his established and successful. because they are sub-scale peers – that there is no essential It is increasingly widely and being refused the right diff erence between a turnkey acknowledged that a standalone to pre-empt because they are managing agency and any other Lloyd’s business must have a underperforming. managing agency. He explains stamp capacity of somewhere Th e issues can be even more that the board of the managing around £300mn-£500mn to acute for private equity-backed agency takes on fi duciary duties to Lloyd’s businesses where the need the capital and is responsible for for owners to exit can precede the the underwriting, as would be the point at which the syndicates have case with an established Lloyd’s reached critical mass. business. Nevertheless, if they can fi nd “We have to remember at all a way to breach the premium times that our role is to behave as threshold then they fi nd if we are a fi rst party manager of themselves the successful grown- the insurance risk in question,” ups of the Lloyd’s world, brushing Bremner agrees. shoulders with established platforms like Atrium, Cathedral and Talbot, albeit still looking Growing up O Julian Tighe, Due to the desire for full control, COO of turnkey up at the giants Catlin, Kiln and rather than as a direct response to provider Asta Hiscox.

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Juicing returns Some (re)insurers are looking outside their core businesses to find accretive opportunities in difficult operating conditions, saysDavid Bull

A tough operating Oclimate on both sides of the balance sheet has severely challenged the (re)insurance sector’s historical benchmark target of a 15 percent return on equity (RoE). But a select group of companies are reaching outside their core operations in an attempt to juice returns by finding alternative revenue streams and increased efficiencies in their businesses. Allied World Assurance Company Holdings (Allied World) has been one of the most active companies in the last six months, with a string of transactions executed by its recently launched financial services division. Meanwhile, the maturing strategies employed by specialty US insurers Markel and Alleghany continued to yield dividends in terms of revenue and profit streams in their full- value for what we were paying in an existing partner in whose year 2012 results. our ancillary businesses, and how economics it hopes to In an interview with IQ we could share in the returns of share through its minority magazine, John Gauthier, the partners we already have,” the shareholding. president of Allied World executive continues. “It helps us build our expertise Financial Services (AWFS) and as we expand our global business CIO at the parent company, Costs and revenues in jurisdictions where we explains the rationale behind his For Allied World the strategy has don’t have claims people and company’s strategy. branched out in three different specialised claims handlers on the “It’s a tough investment directions that share a unifying ground. environment and, while pricing theme. “Also, if we bought it at the is improving, it’s not a panacea The first transaction for right price and it meets its targets on the underwriting side,” he AWFS was its involvement in for growth and profitability we observes. a consortium of investors led think it will provide a lot more “So we said we need to figure by private equity firm CVC return for us than the average out ways of being faster and to recapitalise loss adjustor opportunity we’d see elsewhere smarter, getting more return to and claims administrator in the marketplace,” Gauthier our shareholders with the same Cunningham Lindsey. predicts. resources we have. The deal fits in with the A similar philosophy – getting “We looked at how we could (re)insurer’s core strategic a better deal for Allied World in decrease our expenses, get more philosophy by buying into terms of costs at the same time as

32 www.insiderquarterly.com INSIDE ROE

creating opportunities for upside skillset and raise money, or use from business partners – was the partnership we already had applied to asset management. and grow it. Last October, AWFS announced “Th e reality is that we don’t a deal to take a minority stake in have the track record that some fund manager MatlinPatterson pension funds and endowments where the Swiss-based (re)insurer look at, whereas Aeolus does. also agreed to give management And I think this is a much less of $500mn of its $9bn investment potentially confl icted model portfolio to the fi rm over time. O Scott than some of the sidecars are,” A similar deal was negotiated Carmilani, Gauthier suggests. with Crescent Capital Group in president and As well as generating returns as January, involving a minority CEO, Allied World a scaled up quota share provider, investment and a mandate for the asset management-related Allied World also hopes to fund manager to invest $500mn transaction, and has the option of benefi t from the upside at Aeolus of Allied World’s portfolio, drip- upsizing the existing mandates as as the fi rm continues to grow and fed over the next few years. its balance sheet grows over time. profi t from fees and commissions Both fund managers have as a fund manager. a credit focus, but as well as Bucking the 3rd party trend Gauthier explains that, if the enabling Allied World to diversify Th e third branch of the AWFS quartet of AWFS investments its investment portfolio in search strategy was more closely tied to perform as expected, the of yield, the company will gain Allied World’s core risk-taking average margin of RoE from the from lower costs and, indeed, business. companies should be accretive from a percentage of limited As part of a transaction to to shareholders over time, partners’ management fees as an take a minority stake in Aeolus, generating higher returns than investor. Allied World also increased the Allied World’s investments. Allied World president and quota share support it provides “Part of that is because we’re CEO Scott Carmilani neatly to the Bermudian collateralised buying minority interests, so summed up the benefi ts in reinsurance writer. there’s a discount for that, we’re an interview with our sister But by exposing more of buying into private companies, so publication Th e Insurance Insider its balance sheet to Aeolus’ there’s a discount for that. And if at the time of the MatlinPatterson underwriting, the (re)insurer we realise the ultimate value and transaction. is bucking a trend in the sector get paid against all the discounts “We’ve turned a business for carriers to migrate towards a at the entry point we think we’ll that we were paying for to third party capital management see pretty nice returns,” he says. be managed into a potential model, as they aim to become Of course, Allied World is earnings stream for us… Instead conduits for non-traditional not alone in going outside the of something that was cost capacity that is entering the core model of underwriting and negative, we now have something space. traditional investment portfolio that we expect to be earnings “We’ve looked at the evolution management in order to boost accretive,” he commented. of the collateralised reinsurance returns. Aft er a “digestion” period, the market and realised we had to US (re)insurer Alleghany, for company will consider a further either fi gure out how to take our example, has been an active investor in non-core businesses. AWFS gets active… Th e group – which has its origins Date Invests in Type Investment Note as an investment fi rm – notably Jan '13 Crescent Capital Asset manager Undisclosed minority stake Mandates management of $500mn of Group Allied World's investment portfolio to closed a transformational deal to be deployed across diversiﬁ ed credit buy Transatlantic Re last year. strategies over the next several years But it is also building a Dec '12 Aeolus Capital Property cat fund Undisclosed minority stake Increases its quota share support for Management manager Aeolus' underwriting portfolio of other investments Sep '12 MatlinPatterson Asset manager Undisclosed minority stake Mandates management of $500mn “with non-correlated returns of Allied World's investment portfolio to be deployed in existing and future and/or potential signifi cant liquid credit strategies over time upside if the business plans Sep '12 Cunningham Loss adjuster/ Undisclosed minority stake Expects to negotiate prefential rates develop favourably”, according Lindsey claims manager (as part of CVC-led consortium and utilise global claims handling taking a majority stake) network to president and CEO Weston Source: Company announcements O Continued on page 34 www.insiderquarterly.com 33 INSIDE ROE

O Juicing returns… to the “negative skew” of the the Bermudian Alterra – heralded continued from page 33 insurance industry. the contribution of its non- Hicks, speaking at a recent “We are in the business of insurance arm to comprehensive Bank of America Merrill Lynch collecting premiums and, if we’re income in 2012. Markel Ventures conference. really lucky, we get to collect the has invested in a baker’s dozen premiums. Th e worst case is a of companies. Th ese range from Tooling up for higher returns Superstorm Sandy comes along healthcare companies, private Also in 2012, Alleghany bought and we lose a lot of money. So equity fi rms and other fi nancial machine tool company Bourn the upside is capped, but the services outfi ts to wood suppliers & Koch, which the (re)insurer downside is fairly large. to the North American truck and says has a steady profi t from “We want to couple that with trailer trade and, indeed, bakery replacement parts as well as ‘positive skew’ businesses in equipment manufacturers. capturing upside earnings which we know we are going Revenues were up over 50 potential through highly to lose money initially but, percent to $490mn from the engineered specialty machines. as the businesses develop, we division in 2012 – which Alleghany also has investments believe there’s a potential for comprised 16 percent of group in energy fi rms Stranded Oil the realisation of signifi cant revenues for the year – with Resources Corporation and economic value,” the executive earnings rising by more than 60 ORX Exploration, as well as tech explained. percent to $60mn. patents company Article One Putting the two together, Markel’s president and CIO Tom Partners. he added, ultimately creates Gayner comments: “As the old According to Hicks, such “a more powerful long-term saying goes, when your only tool investments provide access to compounding machine”. is a hammer, everything looks revenue and earnings streams Meanwhile, Markel – which is like a nail. Th e beauty at Markel from so-called “positive skew” in the process of expanding its is that we are not limited to businesses that are not correlated core platform with a deal to buy working with just a hammer.”

15% RoE: A hurdle too high? The industry standard return on equity fi nancial goals should be changed or (RoE) target of 15 percent has been reviewed in the context of the lower Median RoE Bermuda severely challenged in recent years interest rate environment. 20 as a deep soft market has combined “We’ve thought long and hard about 15 with a signifi cant catastrophe loss that and we’ve determined not to do experience and miserable investment that.” % 10 yields to suppress returns. Instead, Benchimol maintained that 5 And the debate over whether that Axis was targeting a return of 15 return hurdle should be recalibrated in percent across the cycle. 0 response to those headwinds sparked The former PartnerRe executive 2008 2009 2010 2011 2012 in February as two Bermudian CEOS said that it was important for Axis -5 offered sharply contrasting views. to maintain the 15 percent target Source: Infi nancials Aspen CEO Chris O’Kane told because “I refuse to believe that Flagstone have delivered negative investors at the Bank of America our best days are behind us”. Axis returns. Merrill Lynch insurance conference achieved a 14.2 percent RoE in its O’Kane said that to deliver a RoE that one could wait the rest of one’s fi rst 10 years of existence, Benchimol in excess of 10 percent – which life to hit the 15 percent target. explained. was achieved by only fi ve of the O’Kane said that such return hurdles Analysis from IQ’s sister title The Bermudians in the period under were born in the days when insurers Insurance Insider shows that for the review – reinsurers had to “do were able to put their money to work fi ve-year period 2008-2012 not only something very different”. in bonds that paid 500 basis points, did the Bermudian reinsurers fail to The revised Aspen strategy is based while at present new money attracts achieve a 15 percent RoE, but also around the idea that US property a return of “not much more than 100 missed the more modest target of 10 insurance with cat exposure is “not basis points”. percent. the most effi cient place to put your But Axis CEO Albert Benchimol gave The peer median RoE for the period capital”. the same conference a very different is 8.6 percent, with top performers Bermuda-domiciled Aspen is looking message. “There has been a lot of Allied World and Arch still just short of to take up to $200mn of capital out of talk over the last few months and the 15 percent mark. this line, and most of it over the next recent years about whether or not Weaker performers like XL and two years.

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Here be monsters After the largest and third largest claims in the marine market’s history, the 2013 $3bn IG renewal promised much, but in the end underwriters were happy to take the money, says Mark Geoghegan

of the wrecked hulls has produced mammoth P&I reserves of $325mn and $744mn respectively. Th e expiring programme had an excess point of $60mn, meaning that reinsurers on the 2011/12 year have incurred some $949mn The global (re)insurance protection and indemnity (P&I) in losses. Oocean is graced with programme has managed to Of this, underwriters on the fi rst a smattering of ‘big beast’ overcome one of the most diffi cult $500mn layer have incurred losses accounts, the size and renewal seasons in its recent of some $800mn in the past two complexity of which can only history. policy years, while programme inspire awe, admiration and Th e 13 not-for-profi t P&I clubs leader Catlin will have taken jealousy in carriers and rival are the elite of the marine casualty approximately $120mn of gross brokers alike. world, collectively covering the losses over the period. Renewals of these mega- lion’s share of the liabilities of the Th e marine market’s woes programmes come and go without global shipping community. did not stop there, however, as remark, but just occasionally Th e clubs band together to buy these expenses aggregated with exceptional loss activity comes, the programme for their collective the $500mn hull loss for the battering down preconceptions benefi t in excess of comprehensive Concordia and a record $2bn-$3bn and throwing up Herculean pooling arrangements and catastrophe bill from Superstorm challenges in its wake. individual club retentions, which Sandy, which hit cargo and specie Th e mega-cat programme now total some $70mn (see particularly hard. protecting the vast Japanese diagram right). As a result, in the run up to mutual Zenkyoren is one such Th e clubs also fund a reinsurance the renewals many of the major monster account. Nevertheless, captive called Hydra, which covers reinsurers and retro providers the programme overcame the shares of the higher layers of the were rumoured to be playing $9bn total loss arising from the $70mn retention and reinsures a hardball for the fi rst time in over Tohuku earthquake of 2011. portion of the fi rst $500mn layer decade. Other such bellwethers of recent of the programme. Understandably, the principal times include the triple loss- For historical reasons all major battleground was the loss-torn struck New Zealand Earthquake P&I contracts run from a 20 fi rst $500mn layer of the IG Commission cat treaty, which February inception date, and programme. When renewing was laid bare by the multiple the structure had run clean for annual treaties reinsurers were earthquakes that hit Christchurch a number of years until October very keen for cedants to specify between 2010 and 2011. 2011, when the fi rst of two major their exact intentions and Next up was the marine market, losses struck. expressed a desire that excess-of- with its own leviathan and its own Th e grounding of the Rena loss protections were not exposed series of unfortunate events with container ship on a reef in New at this level. which to contend. Zealand was swift ly followed by At the 2012/13 renewal the Th e $3bn excess reinsurance the Costa Concordia cruise ship initial terms for this layer were cover for the 13-member loss in January 2012. Th e high understood to include a deposit International Group (IG)’s costs associated with the removal premium of $205mn, with the

36 www.insiderquarterly.com INSIDE MARINE

original rating designed to programme by off ering to write produce a fi nal premium of some a 3 percent line across the board, $246mn. while UK composite RSA also Th is did not take into account off ered increased support to the what was now the $500mn total “As the marine beast descends programme. loss to the layer due to the Costa Market sources also suggested Concordia, since the timing of the to the depths for another that global reinsurance giant disaster meant that the loss was at year, will the opportunities Munich Re took a direct share of too early a stage to be quantifi ed the higher end of the placement meaningfully. endure, or do we only have for the fi rst time in many years. a gradual whittling away of Th e group already participates A hard-fought campaign on lower layers via its Lloyd’s Aside from the Costa Concordia, pricing to look forward to?” syndicate Watkins. last year’s renewal placement was third layer and has also renewed So, as the marine beast descends further complicated by a $50mn with stable pricing. to the depths for another year, deterioration in the reserve for Th e Insurance Insider also will the opportunities endure, or the Rena, pushing the loss to broke the news that the original have, as so many times in the past, $175mn. Th is prompted the IG to reinsurance placement had we had our increases and have make a goodwill gesture of a one- completed without Lloyd’s only a gradual whittling away of off $40mn additional premium markets Ascot and Aegis, both of pricing to look forward to from to assist with completion of the which exited the circa $450mn here on in? When organising order. premium cover. a conference earlier in the year, Th e placements of the key fi rst As the protracted and hard- IQ asked a senior executive with and second excess layers of the fought renewal campaign a longstanding affi nity with the original reinsurance are structured progressed it emerged that the marine market if he would be as a deposit premium, which is pair had declined programme able to talk on the subject of then adjusted as member tonnage leader Catlin’s proposed terms. ‘opportunities in marine following in the 13 clubs to pay for the Late in the process Ascot Costa and Sandy’. additional reinsurance surcharge. returned to the negotiating Th e reply was curt: “Th ere are Perhaps unsurprisingly, passenger table, but it is now clear that this no opportunities in the marine ships were asked to foot the development did not ultimately market!” majority of the increased bill. result in a renewal line from the Aft er a tough renewal, sister syndicate. 2013February IG 2013 programme reinsurance structure publication Th e Insurance Insider Ascot was previously a Est. renewal premium Programme limit revealed that the $500mn xs signifi cant supporter of the (Expiring premium) $3.07bn $70mn fi rst excess layer pays a programme with a $95mn line deposit of $260mn and is priced spread over a 3.73 percent share Collective overspill As expiring to produce $325mn – up from on the fi rst excess layer, 4.81 (one reinstatement) approximately $250mn on the percent on the second and 5.26 expiring year. percent on the third. Meanwhile, $2.07bn Th is represented a rate rise of Aegis had a $20mn line with a Third excess approximately 30 percent. share of 3.31 percent and 0.90 layer (unlimited $40mn flat reinstatements) (as expiring) Th e second $500mn xs $570mn percent on the fi rst and second $1.07bn layer pays a deposit of $48mn to layer respectively. Second excess $60mn $744mn produce $60mn – up from $45mn Th ere was also a 5 percent layer (unlimited reinstatements) ($45mn) a year earlier. decrease in the order on the fi rst $570mn 70% first excess $325mn $325mn However, while the fi rst two excess layer due to an increased layer (unlimited ($246mn) loss-struck layers have yielded participation from Hydra, which reinstatements) 30% Hydra 30% Hydra signifi cant rate increases, the third raised its share to 30 percent, as $70mn 5% individual $60mn retention 10% individual Hydra $1bn xs $1.07bn layer renewed fl at well as new support, which broker retention

$45mn Rena and will again pay $40mn. Miller leveraged in order to get $30mn Concordia Costa Th e $1bn xs $2.07bn collective the programme home. Pool $9mn overspill, which is an aggregate Earlier in the month, Th e $9mn individual club retention cover with one reinstatement, Insurance Insider revealed that IG programme Note: First two excess layers have losses is understood to be placed for Beazley had made a major separate limits for oil and pollution slightly less than the underlying commitment to the $3bn Source: International Group, The Insurance Insider www.insiderquarterly.com 37 INSIDE PROFILE

Bridging the East-West divide Going local seemed the obvious choice for two German-born Crawl before you walk reinsurance executives looking to become Asia Pacifi c pioneers. But why did the formidable pair Karina Whalley meets the people behind $550mn Peak Re limit their focus regionally instead of going global? A pair of German Asia Pacifi c-focused in terms of Hahn explains that the region Oreinsurance veterans may people you hire, your investors is “hugely diversifi ed in terms seem unlikely pioneers to push and your location and clients.” of cultures and economies” and into the Asia Pacifi c frontier, Th e global reinsurers are still has markets large enough to but that has not deterred Euro-centric in terms of strategy, provide Peak Re with suffi cient the founders of Peak Re, who however, and aim to look aft er diversifi cation for the fi rst couple have just set up shop as an their home turf fi rst, he adds. of years. independent player in Hong And despite phenomenal “If you think back, Swiss Re also Kong. growth in many Asia Pacifi c catered fi rst to its home towns,” Franz-Josef Hahn originally countries, only a quarter of the he says. hails from a small town in the economic losses caused by the Roth also highlights the dangers Ardennes close to Germany’s region’s recent spate of natural of “bad diversifi cation”. It is the oldest city, Trier. But just under 25 catastrophes were insured, “crawl before you walk” argument, years ago, Hahn left his European according to Hahn. he says. Although a “pretty home to go east, heading up “You can’t call this a saturated large number” of investors were casualty for Munich Re in Hong market. It’s heavily underinsured,” interested in the new vehicle, the Kong, and he has remained in he says. “Th is situation needs to fi rm made a conscious decision to the vibrant Asian metropolis ever change.” settle on a two-shareholder panel, since. Hahn teamed up with a fellow which together provided $550mn Hahn later switched to rival German lawyer, Eckart Roth, of underwriting capital. Swiss Re, eventually progressing to grow the start-up. Roth was to become CEO of Swiss Re China born 100 kilometres from Hahn O in 1998. But aft er a decade in the in Bonn, the former capital of Franz-Josef Hahn – CEO, role, the German lawyer decided West Germany on the River Peak Re to go solo and start up his very Rhine. With 15 years’ experience own P&C reinsurer dedicated in the reinsurance market, Roth solely to the Asia Pacifi c region. became managing director And thus Peak Reinsurance and global risk offi cer at White Company (Peak Re) was born. Mountains Re before moving to a With his unique perspective of risk management consultancy. both the Eastern and Western As CEO and chief underwriting markets, Hahn explains the offi cer respectively, Hahn and rationale behind his new venture: Roth joined forces to build up the “International reinsurance Eastern-focused P&C reinsurer, companies are doing very well in developing relationships with Asia Pacifi c at the moment. But international brokers and local at this development stage of the insurers over the past two-and- region, you need to be completely half years.

38 www.insiderquarterly.com INSIDE PROFILE

China-focused investment group as well as Indonesia and the Re with $3.7bn. On the other Fosun International Ltd provided Philippines. hand, many smaller local players 85 percent of the backing with “We are the new kid on the have struggled in the aft ermath a $468.05mn investment, while block so we follow the market. of the 2011 catastrophes, with the remaining $81.95mn came We do not undercut on pricing Taiping Re and Asian Re under from the International Finance and only do business on adequate negative review by AM Best while Corporation (IFC), a World Bank rates. We have seen enough Best Re is no longer rated. unit focused on private sector business to do so,” Roth says. development. Peak Re will initially concentrate Hong Kong Th e IFC’s investment arm is on P&C treaty reinsurance, with Peak Re’s founders chose to be pushing for a developing market a particular focus on catastrophe based in Hong Kong because of angle with a focus on China, risk. However, within the its “sound and strong” regulatory India, the Philippines and portfolio there will be a balance environment, its status as a Indonesia. As a regional giant and of property, engineering, liability, leading fi nancial centre in Asia Peak Re’s home territory, China motor and credit lines. Pacifi c and its central location will be by far its largest focus. Peak Re buys retrocession cover within the region. But Hahn says the IFC but Roth notes that the fi rm has a Th ey also reiterate that the fi rm understands that the start-up very sizeable net retention. was not looking to open multiple initially needs to off er services “We do not want to be a offi ces in order to keep costs to the developed markets as well reinsurer in camoufl age,” he says. down and to build a close culture – Japan, New Zealand, Australia Roth tells IQ that there had been within the business. and Korea – in order to “get out of signifi cant improvements in terms Th e reinsurer, like other Hong the garage quickly” and to provide and conditions in the Asia Pacifi c Kong-based fi rms, has its holding diversifi cation. areas hit by 2011 losses. company based in Bermuda – However, there is still room for However, he delicately points out not just to take advantage of the growth in the so-called developed that there remains “fundamental favourable tax environment, but markets, Hahn says, noting the room for improvement” in the also to give investors the option to extent to which the Tohoku vendor models covering Asia fl oat Peak Re in future. disaster in March 2011 exposed Pacifi c risks. He notes that some “Th is is not on the horizon but is the underdevelopment of some perils are still not represented, rather precautionary,” Roth says. parts of the Japanese insurance particularly fl ood and South Sea “An IPO? It’s possible but it’s not market. earthquake risk. our aim. We’re very happy to be Although the equity story is Th e fi rm is therefore building its a privately-run company,” says one of growth in the underlying own in-house models to create a Hahn. insurance market in emerging unique view on risk in the region. “Our angle was never an economies, the 2011 losses In response to concerns of opportunistic one. We have a revealed some fantastic over-capacity in the region, much more long-term vision.” opportunities in the developed Roth says the underwriters that economies of the Asia Pacifi c wrote Asia Pacifi c business for region, Roth reiterates. risk diversifi cation purposes had “certainly learned their lesson”, New kid on the block adding that they had either exited Th e new vehicle was up and the region or were now funnelling running on 28 December 2012, “the proper resources” towards armed with an AM Best fi nancial the area. strength rating of A- and the sole “You need to be a part of the licence necessary for reinsurers fabric of the market and its local to operate in all Asia Pacifi c gossip network and to understand countries. Despite the traditional the products in detail in order 1 April renewal date for Asian to beat the market over time,” he business, Hahn and Roth say explains. OEckart Roth – they were “astonished” with the But there is a substantial body of CUO, Peak Re amount of business the 21-strong local players already dominating offi ce received in the 1 January the region. South Korean-based 2013 renewals. Th e majority of its Korean Re reported a top line of initial business came from China $4.5bn in 2011, followed by China www.insiderquarterly.com 39 The rise of the pension fund Nimble hedge funds are being replaced by new, long-term institutional investors in the alternative reinsurance markets. What does it all mean, asks Fiona Robertson? stability in the share of the 2012 deal, marking ILS investor the fi rst time they had their own base could category. be a “a game Asset managers bought 17 changer” for percent of the sample issuance, the industry. pushing the total 2012 share IQ took time of the two generalist investor out to assess what groups to 31 percent. will determine Th is is well up from 2007, when further pension fund asset managers took up just 12 capital infl ows to the percent of the same transaction, sector and how it will while 27 percent of overall make its infl uence felt over 2007 issuance went to money the coming years. managers. However, the sample Changing investor base transaction featured a notably Swiss Re says pension fund low participation from reinsurers investors played a signifi cant role and hedge funds for last year, in investing in index-linked cat with their respective shares There may still be bonds throughout 2012 and formed falling from 13 percent and 11 Oquestion marks over how part of this pattern of increased percent in 2007 to 1 percent and pension fund investors will stability. 3 percent in 2012. weather a major hurricane Th e reinsurer took the case study Swiss Re fi gures show that in loss, but most commentators of an index-triggered catastrophe contrast these groups played a agree that the investor base bond issued in both 2007 and 2012 greater role in ILS investment that supports alternative (see charts below). Pension fund across 2012, pushing down the reinsurance now looks much investors took a direct 14 percent prominence of pension funds more durable than in the sector's early days. Th is is said to be due to greater Cat bonds: An investor snapshot… numbers of pension funds and other institutional investors 2007 2012 that are seeking a diversifi er to 1% their equity portfolios and are 7% 4% prepared to be in the market for Dedicated fund 11% 14% Dedicated fund the long haul, as opposed to the Reinsurer 3% Reinsurer AM AM more opportunistic hedge funds 12% Hedge fund Hedge fund and other investors who were 56% 17% 61% more dominant in the market's Insurer Insurer Bank 13% Pension fund earlier days. Swiss Re’s head of non-life risk 1% transformation, Martin Bisping, predicts that increasing levels of As of 31 Dec 2012 Source: Swiss Re

40 www.insiderquarterly.com and asset managers in the annual $27tn of assets in pension funds statistics. Th e 2012 annual globally and if everyone was to fi gures gave reinsurers an 8 allocate just 1 percent to ILS percent share of the market and that makes $270bn – it dwarfs hedge funds a 6 percent share, “[Large capital allocators] don’t the ILS market.” while participation from money “It’s a question of what the managers was put at 23 percent – want to impact the overall asset class can handle, because actually down from 2007. opportunity by contributing the total amount of limit placed Th is result could have been is not rising at the same pace infl uenced by signifi cant high- to there being too much that capital market interest in coupon deals that were probably capital chasing those few reinsurance is,” says Goldman especially attractive to hedge Sachs managing director Shiv funds. It is also likely that opportunities” Kumar. “At some point you pension fund investors were less Ryan Bisch, director of exotic would start to see an impact attracted to indemnity deals, on pricing, so that becomes a which made up the majority of alternatives, Mercer natural friction point [stopping] 2012 transactions. new money fl owing into the One constant feature of the commentators say these sums sector.” statistics is that specialist ILS are dwarfed by the institutional Asset managers are also fund managers remain the capital sitting on the sidelines. probably coming to a point dominant players in the market, US pension funds in particular where they will evaluate how although their participation has are starting to become more much more capital they can fallen from the 71 percent peak interested in the sector, following manage, says Mercer’s director recorded in 2010-11. in the footsteps of pioneering of exotic alternatives Ryan funds in Canada, Australia, New Bisch, adding: “It’s a reasonable On the sidelines Zealand and Europe. consideration for any asset Over the past couple of years, the But a number of factors are manager which has seen top 10 ILS fund managers have preventing more pension funds signifi cant growth.” bulked up their assets under from being attracted to the space, Bisch notes that large capital management by $7bn – with fund advisers say. And the small allocators in particular will be pension funds likely to be a size of the reinsurance sector mindful of the need to match signifi cant allocator of capital to is the main constraint on its growth with their allocations in these funds, according to surveys growth. what is still a very small sector. by sister publication Trading “How can it not be a problem?” “Th ey don’t want to impact Risk. says Dan Bergman, head of the overall opportunity by But as signifi cant as infl ows insurance-linked securities (ILS) contributing to there being too into the alternative market have at pension fund AP3. “According much capital chasing those few been in recent years, industry to Towers Watson, there are opportunities.” So how close is the market to Leading ILS fund managers reaching this point? Fund manager Est AuM Est AuM Comment ($bn) Jan-13 ($bn) Feb-12 Towers Watson investment Nephila Capital 8 6 Just launched Lloyd's syndicate consultant Todor Todorov says Credit Suisse Asset 5.4 4.4 Along with Nephila, the market's there is plenty of headroom Management heavyweight for growth as managers are Fermat Capital 3.5 2.5-3 Seo Brothers' well-regarded vehicle easily delivering the 4-6 percent LGT Capital 2.7 2.3 Formerly Clariden Leu; moved to Management LGT mid-year return above cash rates that Catco 2.6 1.5 Qatari-backed, London listed most institutions require from Aeolus 2 1.2 Transformed into fund manager from conservative strategies within private reinsurer during 2011 OTrading Risk the asset class. “Even with a Securis Investment 1.4 1.1 London-based with signiﬁ cant life is the market- Partners focus soft ening market, I still believe leading title Leadenhall Capital 0.9 0.5 Runs two large life mandates covering the we’re not even close to the lower Partners convergence of end of it,” he says. Elementum Advisors 0.5-1 0.5 Chicago-based team spun out of Stark Investments the (re)insurance Kumar predicts that the industry with the Twelve Capital 0.6 0.4 Swiss manager, spun out of Horizon 21 alternative reinsurance capital markets Total 27.8 20.6 www.trading-risk. industry could absorb another Source: Trading Risk com O Continued on page 42 www.insiderquarterly.com 41 O The rise of the pension fund within the ILS market. continued from page 41 He praises the creativity of $5bn-$15bn of new capital specialist cat managers, saying without there being a “signifi cant that they are growing by impact on the dynamics of the attracting tail risk to the market asset class”. that had not been previously Th e alternative reinsurance transferred to reinsurers. market is currently estimated to Th e emergence of new hybrid fund $30bn-$35bn of the $250bn products such as the county- catastrophe reinsurance limit weighted industry loss warranties placed. “Can that $30bn-$35bn pioneered by Guy Carpenter and become $40bn-$50bn? Yes, Nephila have also taken off in that would not be surprising,” signifi cant volumes over the past Kumar says. “Could it become few years. $120bn – i.e. half the size of the However, Bisch said that as ILS reinsurance market? I would very funds expand their investment seriously doubt it.” “Can that $30bn-$35bn [of universe, they should also review Even if ILS premiums fall it alternative capital] become whether they need to bring in does not necessarily mean that more resources to manage their managers are settling for lower $40bn-$50bn? Yes, that would new strategies. per-level risk pricing, provided not be surprising. Could it If another wave of institutional they are taking more “out of the capital came into the sector it money” risk. become $120bn – i.e half the might have to fi nd alternative Th is ability to create a bespoke size of the reinsurance market? I homes, Bisch said. “You may portfolio is one of the great see increased fl ows into the attractions of the ILS asset class seriously doubt it” newer ILS funds or the launch for institutional investors, Kumar Shiv Kumar – managing director, of further reinsurer-sponsored explains. off erings,” he explained. “People look to this sector Goldman Sachs Another potential is for more for a combination of both capital to fl ow back into the diversifi cation and yield; but the that doesn’t make the market any traditional market. beauty of the asset class is it also less interesting.” “Th e viable alternative for allows you to invest at diff erent pension funds can be to start up points in the risk curve,” he says. Finding growth potential their own reinsurance company “As more money comes into Todorov says it is important that or buy up a reinsurer,” Bergman the sector, you may fi nd yourself ILS fund managers have broad told sister publication Trading in a position where given your and fl exible mandates to allow Risk. Indeed, one of AP3’s comfort level of risk you might growth to continue, as it is pioneering peers in ILS, the have to take less return; but still diffi cult to see it occurring solely Ontario Teachers’ Pension Plan, backed reinsurance entrepreneur Pension funds in ILS Domicile ILS allocation Strategies/managers employed Matt Fairfi eld’s launch of his ($mn) start-up insurer ANV last year Ontario Teachers' Pension Plan Canada In-house and external allocations by supporting his purchase of the APG Netherlands Fund of fund manager New Holland Capital Flagstone Lloyd’s business. AP3 Sweden In-house and external allocations “I wouldn’t be surprised to see TIAA-CREF US In-house and external allocations more of that happening. If you Illinois Teachers’ Retirement US 40 AQR ($40mn 2012) System buy a public insurance company Ohio SERS US 30 Nephila ($30mn 2012) you have more correlation to RBS UK £395 equity risk, but take it private San Antonio Fire & Police US 10 DaVinci Re ($10mn 2012) and that issue can disappear,” Oregon Investment Council US 100 Nephila ($100mn 2011) Bergman concludes. BBC Pension Trust UK 124 Nephila (circa $124mn 2011) Pensionskassernes Denmark 150 Twelve Capital ($150mn 2011) Administration (PKA) Pennsylvania Schools (PSERS) US 250 Nephila ($250mn 2011), Aeolus NZ Superannuation NZ 300 Elementum Advisors ($300mn 2010) Source: Trading Risk; Company announcements

42 www.insiderquarterly.com Ten years brings a deeper understanding

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www.bintelligent.co.uk PRECISE. PROVEN. PERFORMANCE. Partial recall The problems experienced by Boeing, Toyota and some food manufacturers in the UK have put product recall into the spotlight as never before. Marcus Alcock takes a peek at this specialist market

It seems these days that what caused the incidents. The Elsewhere, Japanese motor Ohardly a news bulletin financial consequence has been manufacturer Toyota has goes by without mention of severe for some. The entire fleet continued to make the headlines yet another major product at Japan’s All Nippon Airways for the wrong reasons. Recently, recall by yet another global (ANA) was grounded after one the automaker revealed that it manufacturer. of its Dreamliners was forced would recall nearly 1.3 million The bill is headed by Boeing’s to make an emergency landing. cars worldwide for two separate recently launched new fleet of ANA, which had to cancel 459 defects. The first involves 752,000 787 “Dreamliner” planes, with the international and domestic flights units of Toyota Corolla and entire set grounded in January in January, has said it will take a Corolla Matrix small cars from after a battery on one plane 1.4bn yen ($15mn) hit from the the 2003 and 2004 model years, caught fire, while a malfunction grounding of the aircraft. while the second one includes forced another to make an 385,000 Lexus IS luxury sedans emergency landing. from the 2006 to 2012 model As of the beginning of years. February, the US Federal The recall is merely the latest Aviation Administration in a number of high-profile allowed Boeing to difficulties for the manufacturing carry out test flights giant in recent years. Since of Dreamliner planes, November 2009, Toyota has with both regulators recalled about 20 million vehicles and Boeing conducting globally, surpassing all other probes to find out automakers. A few months back,

44 www.insiderquarterly.com it announced a major worldwide recall of 7.43 million vehicles “10 years ago there were a handful of carriers that included more than a dozen models manufactured between offering this. Now there are a dozen primary 2005 and 2010. and a dozen excess markets” And in Europe of late it’s all been about the horses. Regulators such as the UK Food Standards Englishmen, from a technical expanded, with Lloyd’s part of Agency has ordered retailers to standpoint it’s not going to cause that expansion.” test all processed beef products any harm. However, as Steves points aft er food manufacturer Findus out, it’s important not to use withdrew its beef lasagne from A larger fi eld a broad-brush approach here sale having found that some What was once a niche market as there are actually various items contained 100 percent with a rather esoteric product sub markets from a direct and horsemeat. is now becoming much facultative standpoint: “Product It is the latest fi rm to be more mature, according to recall insurance is kind of a caught up in the controversy Bernie Steves, head of crisis generic term and in reality there surrounding contamination of management for the Americas are diff erent types of policies meat products, which has also at Aon: “It’s certainly becoming for diff erent risks, essentially aff ected companies in the UK, a lot more mainstream than it split into consumable and non- the Republic of Ireland, Poland used to be. A lot of our clients consumable. and France. In January, Irish food are new buyers over the last O “Typically, we talk about inspectors announced they had couple of years… the smaller Inside FAC product contamination insurance is the sister found horsemeat in some burgers companies are now stepping publication to with regards to accidental or stocked by a number of UK up. Ten years ago there were a The Insurance malicious product tampering. supermarket chains, including handful of carriers off ering this, Insider and is Th at must be the bread and dedicated to the Tesco, Iceland and Lidl. maybe three or four. Now there global facultative butter of the market. In my What all this proves beyond are a dozen primary markets and reinsurance opinion, 75 percent of those doubt is that we are in a world a dozen excess markets.” markets. policies issued are found to be where product recalls are Th e fi gures back this up, with www.insidefac. contamination policies.” com frequent, severe and have a several new players coming O Continued on page 46 massive impact on the brand and to the table in recent years, reputation of some of the largest especially in London. What was companies on the planet. once a tightly defi ned area of the The $12mn However, as far as the US domestic market is now much facultative (re)insurance market more international in fl avour, peanut stutter is concerned these examples all with a number of new entrants One of the most high-profi le settlements of recent appear to be off the radar. Apart in the last few years. Catlin, years was that between The Hartford and The from some extremely hardy Liberty, XL, Zurich, Allianz and Peanut Corporation of America (PCA), which made the largest food recall in American history. underwriters, aeroplanes and other Lloyd’s syndicates all now It began in autumn 2008 with Georgia-based PCA automobiles are not touched participate. recalling millions of dollars worth of peanuts and by the product recall market Liberty International’s Julie peanut ingredients contaminated with salmonella. generally simply because these Ross expands on the theme: “AIG The food-borne outbreak made more than 700 industries have such a poor track really pioneered this product people sick and killed nine, with 46 states affected. record and very few wish to back in the day, but lately The recall was a huge news story at the time enter such a high-density claims London has been instrumental in and led to federal investigations and several Congressional hearings. PCA eventually ended up minefi eld. creating the market as we know fi ling for bankruptcy protection while being charged Food and beverage, on the it.” with knowingly introducing contaminated peanut other hand, most certainly is an “A lot of companies stay away products into US interstate commerce. industrial sector that is covered. from aerospace and auto to The result? In 2010 a US federal judge approved But the key here, given that we begin with,” she adds. “Th ere are a $12mn settlement for those made ill or killed in are in liability territory, is there markets for auto, written on a the salmonella outbreak. US District Judge Norman needs to be bodily injury. And quota share basis. Th e food and Moon issued a ruling to pay 123 personal injury claims related to the incident, with the highest although eating horsemeat may beverage market has been going individual payment being $2.4mn. be akin to a barbarous act of since the late 1980s and over the vandalism to most God-fearing last fi ve years the market has www.insiderquarterly.com 45 O Partial Recall Continued from page 45 A dirty secret? Liberty’s Julie Ross makes the Federal enforcement key point that in this market a Steves says that there have been “Perhaps the biggest open great deal is hidden and cannot several changes over the years enter the public domain: “When from a trigger standpoint, secret is the involvement we’re talking about this it’s especially in the US. Here, the of facultative reinsurers in important to understand that a Food and Drugs Administration lot of what goes on doesn’t come (FDA) – the body responsible for supporting major global out into the open because of the the regulation and oversight of programmes” nature of the beast. the food and beverage industry – “A lot of contracts have recently extended its mandatory third-party covers, extending it confi dentiality clauses written powers to ordering product to independent suppliers and into them because for many recalls. Th e legislation, which co-manufacturers. Th at’s been a companies, especially in the came into eff ect in 2011, has led really important move over the food and beverage sector, to a number of extensions being past couple of years.” Moving they are potentially opening off ered to cover the eventuality of away from contamination, Steves themselves up to the threat of such enforcement powers. stresses that pure product recall extortion if it becomes known However, by far the most policies are primarily non-food they have commercial insurance signifi cant changes to the policies in nature: “Th e fundamental cover up to a certain limit, themselves concern the move diff erence between recall and which will pay out if they are towards a third-party basis, says contamination policies is that targeted. Steves: “From a covered loss product recall is triggered by the “It’s a bit like the kidnap standpoint, traditionally these recall itself. Th ey have generally and ransom market in this policies have been fi rst-party provided limited fi rst party respect, with so much of what policies, but recently a number coverage but broad third-party goes on subject to confi dential of markets have started off ering coverage.” arrangements.” According to others involved in the market, perhaps the biggest open secret is the involvement Spotlight on US food safety of facultative reinsurers in The US Food Safety Modernization Act prospects. It is on everyone’s mind and a supporting major global (FSMA) was passed in January 2011 to great opportunity for potential new sales.” programmes. give the Food and Drug Administration However, the FSMA has also created Most carriers will have a (FDA) increased authority in regulating and new challenges. Brokers need to be minimum of $5mn in capacity, responding to food product contamination. especially familiar with the wording of going up to $40mn. Essentially, it allows the FDA to product recall forms because of the But there are $200mn limits variety of coverages. In addition, traditional suspend the services and production available in the market, of food distributors or processors if a product recall forms require proof that a contamination is suspected. contamination came from their client’s and these are supported by The FDA can also now require recalls of source to trigger coverage, which means reinsurance. food products, even if there is no proof that insureds would not be covered against Besides, it’s hardly surprising that the contamination came from that the FDA’s new authority. that reinsurers do get involved as source. In addition, facilities are now So far, underwriters have responded this is essentially a catastrophe- required to register as a food facility, to the challenge. XL, for example, was type risk, but the fact is they with the FDA able to suspend a facility’s quick to launch a new endorsement that like to stay on the sidelines. And license to produce food should it deem it specifi cally covers the FSMA. It uses necessary. language taken directly from the act to who could blame them? There’s little doubt that the new regime provide insureds with clarity and cover Aside from the confi dentiality has created potential opportunities in the for Class 1 and Class 2 recalls that are aspect of many of the product recall market. As one broker says: associated with the suspension of a (re)insurance arrangements “The Food Safety Act has a lot of insureds facility’s license to produce food. The themselves, this is an area with and potential customers nervous about carrier also launched a new product a tricky claims history – it’s a what it is food processors will be required recall platform in North America, so it is low frequency, high severity to do and how far-reaching the government now able to offer coverage across three regulations will be. Brokers should be platforms – along with the London and situation, so when the claims hit familiar with the FSMA and mention it to Bermudian markets. they can be nasty stingers. And who would want to publicise a nasty boil?

46 www.insiderquarterly.com

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www.hermespeople.co.uk INSIDE TECHNOLOGY Broken promises Technologist Kirstin Dufﬁ eld laments the dearth of qualiﬁ ed IT staff and asks “where is this promised IT generation?”

At last year’s London OXchanging ICT conference there was a very interesting presentation on the future of the industry in terms of 13 percent drop in the more But of course these are school skills, focusing in particular technical Computing A-level. exams – it’s “education”, which on the expectation that the Globally the UK has slipped comes under government management of the future will from eighth to 28th in maths responsibility. But who will feel bring the long-awaited IT age between 2000 and 2009 and from the eff ects of this downturn? to the insurance industry. fourth to 16th in science over the Private industry certainly However, it struck me that this same period. As one third of the 7 will, when this less IT-literate IT generation may not be quite billion inhabitants of this earth are generation come knocking at as expected. As a technologist it online it is too late for us to ignore our doors for a job. And yet, all may be safely assumed that I am the need to have high quality IT along, current management teams gadgetted to within a terabyte trained staff at every level. have been holding out for this of my life, and yes I have two Both the UK and the US are generation to herald the “coming Windows 8 laptops, a Windows slipping in the IT stakes too. And, of the solution! phone and latest BlackBerry Z10 with that in mind, it is a concern I enjoyed the article in the and my cloud is servicing my that even the transatlantic push of Winter 2012/2013 issue of IQ, by digital needs. data from Acord to be transmitted Stewart Taylor of Hermes People. But that is not the same as being in XML format desperately needs He confi rmed my impression that literate in XML, .NET or SQL and every participating company the skills concern is not restricted here is where I foresee we may on both sides of the pond – to IT, and that the insurance have one almighty problem on the and indeed around the world industry can no longer be serviced horizon. – to actually understand what by school leavers following in In the UK the student take-up XML is and fi nd staff that can their father’s footsteps and the of the ICT GCSE qualifi cation is comprehend it. “Old Boys networks” to get a on the decrease, with a drop of position in a broking house. over 17 percent in 2010 and an The educational cliff Apart from the various graduate overall drop of 67 percent since Th e developed world may well be schemes in the bigger insurers 2004! Th is is staggering. It now hit by a massive problem that no and broking houses it is essential accounts for only 1.1 percent one is prepared for. I am certainly that good quality basic skills are in of GCSE exams sat, yet its fi nding it very hard to fi nd place before young people come syllabus is confi ned to the use of suitably qualifi ed staff , whether as into the industry, and that this is spreadsheets, PowerPoint, some school leavers or postgraduates, followed up by a proactive and low level HTML for a website and who can bring new and innovative continuous learning programme. basic graphics packages. IT skills into the fi rm. During my recent sixth form And just to be sure we don’t I have given up hoping they school mentoring work I was forget the UK’s prized A-levels would have some knowledge of tasked with advising young people – the ICT candidates here have accounts, the fi nancial services to clean up their social media dropped by even more – with industry, compliance and feeds and ensure all references to a whopping 24 percent fall in insurance – those individuals are themselves on the internet give the ICT A-level in 2010 and a like the proverbial hens’ teeth. O Continued on page 52 www.insiderquarterly.com 51 INSIDE TECHNOLOGY

O Broken promises of data morphed into an Excel continued from page 51 spreadsheet, and instead of it an impression they would want to being posted to the underwriter it make to a possible employer. is now an email attachment. Th e value of the youthful mind With the demise of the So do we have a solution? Alas, cannot be underestimated to “ a quick change in secondary replenish ingenuity – and new IT department in the SME education may be a pipedream to ideas are exceptionally valuable insurance market the skill most of us, but for addressing the in a changing market – but the demise of suffi cient IT skills to idea that this new generation is void between client and support an industry that is being IT-literate is a misnomer! supplier is ever increasing pulled into a more digital world, Th ey can use an iPhone, iPad ” the answer is “yes”. or any Android or Windows Every company should adopt 8 tablet wonderfully to record Th e reliance on us, a soft ware willing students at as young an age their travels, video their mate’s house, to provide an ever-wider as possible: inspire them, make misfortune, tweet their every scope of functionality within time for them, build them into move and Skype their friends our soft ware means we need to your long-term plans, advise them around the world, but how many ensure that development serves to where to focus their attention and can read an XML message or meet regulatory and compliance off er modest fi nancial support query a database? requirements; not just what the where appropriate to support their In fact, I would suggest not client wants – or perhaps thinks continued education. many are particularly adept at they want. Careers offi cers are oft en crying putting page numbers in a multi- out for industry involvement section document! We have a Long-term falling and, on a personal level, the rush of highly talented users number of entrants feeling of nurturing better skills is of gadgets but a fast-reducing incredibly cathartic. ‘A’-level subjects number of designers, creators, 90 Many livery companies have inventors and developers of Physics Classical an excellent educational support 80 Economics German enterprise solutions. French Computing programme. 70 Th e Information Technologists’ The sting in the tail 60 Company certainly does – But perhaps we should not fear teaming up with BCS (Th e 50 this? If we don’t, then we must Chartered Institute for IT) and embrace overseas off shore 40 supporting several schools.

development from non-insurance- Entrants ('000) 30 But once they are fully fl edged qualifi ed teams or experienced 20 employees the responsibility soft ware houses. to increase technical skills lies 10 And maybe this is not a problem with your internal education 0 on the surface. However, here 1992 1999 2000 2005 2009 2010 programme – whatever size comes the sting in the tail: who is company you have or work going to design how a programme Source: Morning Data for. Th is should be at the heart will work; and where are the of longevity planning and modern business or process Th is issue is showing its eff ects professional standards, combining analysts going to come from? most prominently in the data CII, BCS, application training and With the demise of the IT transmission arena, where the fi nance as well as business skills, department in the SME insurance Acord XML standards issued such as time management and market the skill void between by Lloyd’s have had a somewhat team building. client and supplier is ever mixed reception and take-up. With regards to insurance increasing. Year upon year, the landscape training I am a fi rm believer this Here at Morning Data we’ve of the digital insurance market should form part of the school ensured every member of the remains largely the same. student experience, together with team, in whatever role, is put Granted, a great deal more basic accounting and economics. onto the Chartered Insurance regulation is evident and the O In this way, future generations Institute development programme requirement for more information Kirstin Dufﬁ eld will at least understand what they is managing and is also put through suitable has increased, but the last major director of are doing when the next fi nancial compliance exams. change was when a faxed table Morning Data crisis hits!

52 www.insiderquarterly.com P16 - Lloyds.pdf 1 01/06/2012 09:24

CM We believe one of the key ingredients to success is working with the right people. Our dedicated insurance MY UNDERSTANDING team build strong relationships through the economic CY cycle based on an in-depth knowledge of the sector. CMY This knowledge is backed by a full range of ﬁnancial K YOUR BUSINESS. solutions that we tailor for each client, including payments, cash management, risk management, funding and capital market solutions. So, whether it is for London, Bermuda or beyond, we get to know your business, its strategy and what we can do to help it succeed. To ﬁnd out more, contact: BILL COOPER + 44 (0) 207 661 4687 [email protected] RICHARD ASKEY + 44 (0) 207 356 1825 [email protected] SEBASTIAN KAFETZ 001 212 930 8944 (New York) [email protected]

Please remember we cannot guarantee security of messages sent by e-mail. Lloyds Bank Corporate Markets, Lloyds TSB Corporate Markets and Lloyds TSB are trading names of Lloyds TSB Bank plc, Lloyds TSB Scotland plc and Bank of Scotland plc. Lloyds TSB Bank plc. Registered Office: 25 Gresham Street, London EC2V 7HN. Registered in England and Wales no. 2065. Lloyds TSB Scotland plc. Registered Office: Henry Duncan House, 120 George Street, Edinburgh EH2 4LH. Registered in Scotland no. 95237. Bank of Scotland plc: Registered Office: The Mound, Edinburgh EH1 1YZ. Registered in Scotland no. SC32700. Authorised and regulated by the Financial Services Authority under registration numbers 119278, 191240 and 169628 respectively. FN47-1011

FN47-TM075AD-1111.indd 1 01/11/2011 10:13 INSIDE CAPITAL

The alternative evolution With the number of alternative conservative alternative help to mitigate any market investment products available to investment solutions available timing issues when making insurers multiplying, Charles Pears for insurers. These products are initial investments, while the designed to provide an attractive large size and cash bases of discusses which options companies combination of positive returns some absolute return funds can could consider to enhance returns and low volatility, irrespective provide substantial liquidity for of the overall direction of the investors, even in stressed market With yields on traditional underlying investment market. conditions. Olow-risk assets such as Given that preserving existing Insurance clients may also wish cash and government bonds capital is an essential pre-requisite to consider diversifying their at near historic lows, insurance to delivering a positive return, absolute return exposure across a companies are increasingly strategies of this nature also aim range of products. This is possible being forced to look elsewhere to provide some level of downside by investing in a number of to generate the returns they protection, although it may not be individual strategies, or by simply needo t meet their liabilities. guaranteed. choosing a one-stop solution to Investment grade credit provides For example, in absolute return absolute returns via a fund-of- a useful yield pick-up, and as fixed income funds, the managers funds vehicle which allocates such is a natural next step for have the flexibility to take short across a range of absolute return insurers. However, the yields positions in duration risk, thereby strategies but which has just one they offer have also fallen steadily potentially protecting investors fee at an overall fund level. as investors have looked for from losses that could occur as a relatively safe homes for their result of rising interest rates. This Capital appreciation capital while also demanding approach provides significant without volatility a more attractive return than benefits for insurers, as it can For those insurers happy to take offered by gilts or cash. reduce the chances of significant on a little more potential These low yields have created capital losses occurring and downside risk in search of higher something of a quandary for impairing the ability of insurers to returns, the logical extension of insurance companies, as the meet short-term claims. absolute return products in the returns arguably now fail to Absolute return strategies have alternative investment universe compensate for the interest rate become available across a range of would be to consider investing in and inflation risks inherent in asset classes, including broad fixed a diversified growth strategy. most traditional fixed income income and equity markets, as Diversified growth funds offer investments. well as more focused approaches investors a cost-effective way to Therefore, insurers need to in the emerging market debt, access equity-like returns with look beyond traditional fixed credit and currency arenas. significantly lower volatility. income portfolios to alternative The flexible mandate of an This could be an ideal solution investment products when absolute return fund contrasts for insurance clients looking to considering ways either to meet with that of a traditional grow their capital base while their liabilities or to invest their index-benchmarked fund, and minimising exposure to the surplus capital for the long-term. the nature of the strategies downside risk inherent in equity We strongly believe that now is employed mean that they are investments. the time to reconsider portfolio not be expected to have a high Specialist diversified growth allocations, potentially with a correlation to the market in funds have access to a wide view to reducing traditional which they are invested, nor variety of asset classes, which “core” exposure to equity and with other asset classes that the improves the prospect of fixed income in favour of more insurer may also hold. This means achieving client objectives via specialist investment strategies. that investing in absolute return diversification. The fund manager products can help to improve can manage market risk further The attraction of diversification in a broader by actively selecting where to absolute return portfolio context. invest at any given time according Absolute return strategies are Furthermore, those with rolling to the prevailing economic typically among the more 12-month positive return targets outlook.

54 www.insiderquarterly.com INSIDE CAPITAL

Good diversifi ed growth funds risks such as equity risk should Five-year returns should therefore have a focus be actively managed, rather than Comparing absolute return and on highly liquid investments, static. enabling dynamic allocation Other exposure to “real assets” diversiﬁ ed growth with UK equities between asset classes to increase is also proving popular with Diversified Growth (Insight Broad Opportunies Strategy, the potential of achieving higher some insurers as they off er clients total return, unit price (net of fees), US dollar hedged) risk-adjusted returns compared an uncorrelated investment UK Equities (FTSE 100 Total Return Index, sterling terms) Absolute Return (Absolute Insight Fund, total return, based to a more traditional static asset that should be less volatile than on unit price (net of fees), sterling terms) allocation approach. equities and oft en avoids the 130 In addition to investing interest rate risk associated with across the traditional asset fi xed income exposure. 120 classes such as equities, bonds, Assets such as infrastructure, 110 commodities and property, commercial real estate loans and diversifi ed growth funds can also farmland in particular have been 100 be active in implementing total gaining in popularity. Availability- 90 return strategies and derivative based infrastructure (which off ers positions that serve as important returns on the basis that the 80

diversifi ers within the portfolio. infrastructure is kept available Rebased (100 = 31/12/2007) Th ese positions ensure that for use) is particularly attractive, 70 diversifi ed growth funds do with underlying exposure and 60 not always rely on directional associated revenues being partly exposure as the primary driver of insulated from potential future Jun-11 Dec-11 Jun-12 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Dec-12 returns. economic downturns. Importantly for insurance Farmland has delivered resilient Source: Insight and Bloomberg, data as at 31 December 2012 clients, specialist providers investment returns over time, is a In light of today’s low bond of both absolute return and natural long-term infl ation hedge yields and unpredictable market diversifi ed growth funds are able and off ers income potential from environment, the case for looking to provide full look-through tenant payments and commodity beyond traditional investment reporting of positions and the sales. approaches has rarely been more underlying risks, making it Commercial real estate loans compelling. possible to effi ciently assess the trade at attractive spreads over Insurers that want to diversify necessary amount of capital to cash, are asset-backed and off er their investment portfolios in this hold against these investments. investors a more liquid route to manner should look at alternative From a performance perspective, gaining property-like exposure investment products, including the benefi ts of holding absolute than direct commercial property. a broad range of absolute return return and diversifi ed growth Alternative investment strategies, as well as a well- strategies during challenging approaches have also benefi ted resourced diversifi ed growth market environments can clearly from the use of derivatives as capability. be seen in the chart (right). part of a robust risk management For those insurers with surplus framework. When employed by capital to invest and long-term Real assets and derivatives skilled managers, derivatives can liabilities to manage, investment Traditionally, some insurers with be used to target and control managers who can combine signifi cant shareholder assets specifi c risks inherent in the capabilities in these areas with a sought to generate excess returns liabilities or in the assets that are strong risk management platform by investing in equity markets. held to match those liabilities. and a range of more esoteric Having experienced signifi cant Th is can be attractive for life real asset options might be volatility in equity markets in insurers with long-term liability particularly eff ective at generating recent years, however, many are profi les looking to mitigate risk-adjusted returns. now seeking a more effi cient interest rate and currency risk NOTE: Past performance is not approach. on their assets, relative to their a guide to the future. Please note Th e emerging regulatory capital liabilities. Used in the appropriate the value of investments and any regime is only one catalyst for manner, derivative overlay income from them will uctuate change. In more general terms, strategies can represent important O and is not guaranteed (this may there is a focus on generating investment tools to curb the Charles Pears is be partly due to exchange rate head of insurance returns in a more risk-controlled infl uence of unintended and at Insight uctuations). Investors may not get and disciplined way, meaning that unrewarded risks. Investment back the full amount invested. www.insiderquarterly.com 55 Legal advice from the heart of the insurance industry

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ADVISORY | DISPUTES | TRANSACTIONS rpc.co.uk INSIDE CAPITAL Access all areas Jean-Pierre Darque asks whether (re)insurers are ready for the Single Euro Payment Area

As the deadline for one of a harmonised Europe- Oimplementing the switch wide standard payments to the Single Euro Payment environment that uses mandatory Area (SEPA) is approaching and consistent ISO 20022 XML fast,n o 1 February 2014, we messaging. consulted a number of insurers Eventually, it will bring in K the U and across Western significant savings to companies Europen o the issues they have by driving down transaction encountered so far. costs and cross-border charging We know already that the most practices. To comply with this new challenging part is not with SEPA regulation, it will require a Europe- CT (Credit Transfer), which has wide consensus to successfully been in place since 2008 and is migrate from current levels of now recognised by most insurers, national market fragmentation but with SEPA DD (Direct Debit) to pan-continental end-to-end and in particular the mandate financial harmonisation. management piece. Through our client engagement, How ready are you? we learnt that about half of the The feedback we received from our corporations we spoke to have clients is that they are aware of not yet started the SEPA project. SEPA and that its importance Despite this, however, research is rising on their agenda, but suggests that insurers are ahead progress is mixed across Europe. of most other companies (albeit, For credit transfers, most possibly only marginally) for the companies are either prepared or simple reason that DDs are such a are in the process of rolling out a critical aspect of their business. solution. defined banking partner. The delay in preparation is For direct debits the situations Secondly, there are the domestic caused somewhat by the lack of vary, with some corporations still insurance companies with information and training on SEPA, in the early stages of analysing the a smaller treasury function, but also by uncertainties about impacts. Here, we identified two which are working rapidly to some of the technical issues such broad groups of companies. understand what is required when as the XML format to be used for Firstly, there are the large pan- implementing SEPA and what payments. European insurers that have a impact this will have on their day- If a solution is not in place in sophisticated treasury approach to-day activities and the required time, this could prove costly for and can give advice to their process changes. For these insurance companies with large affiliates or branches in Europe. companies, banks have a key role volumes of DDs. Most will be looking to implement to play and should aim to propose SEPA is underpinned by the an IT solution that meets the local a mandate management solution Payment Services Directive requirements with the potential, that will help domestic insurers (PSD), which provides the legal eventually, to centralise all the to migrate more quickly and foundation for the creation of collections in one point, using efficiently. Most of the institutions an EU-wide single market for several banks, while others may that we approached valued our payments. The SEPA vision is roll out a global model with a advice O Continued on page 58 www.insiderquarterly.com 57 INSIDE CAPITAL

O Access all areas continued from page 57 “Eventually, SEPA will bring signiﬁ cant savings and found that not all domestic banks are proactively talking to to companies by driving down transaction customers about this change. Th is costs and cross-border charging practices” is despite SEPA off ering banks the opportunity to add value to their customer relationship and to Meeting the deadline old schemes gradually. become their SEPA adviser. SEPA will apply to 32 countries, Following on from the above, it In continental Europe, insurers including the 27 EU members, is possible that banks will refuse have also been receiving guidance three EEA members (Iceland, to accept legacy payments or from their industry bodies, Lichtenstein and Norway), direct debits by closing down such as UNESPA, Th e Spanish Monaco and Switzerland. Th e these options in their own Trade Association for Insurance February 2014 cut-off applies to channels. Companies, or from their IT all SEPA countries that use the Th is could mean that payment systems, ERP service providers or euro as the main local currency. dates may be missed. audit fi rms. Countries in the SEPA area that Even if an insurance company’s Th e main challenge with the do not use the euro as the main own bank still accepts the legacy SEPA DD is that customer currency are required to meet a transactions, there is the risk that information needs to be later deadline of 31 October 2016. the counterparty bank will refuse re-processed in order to meet Local euro clearing in all the transactions (it is within the with regulations – with the Eurozone countries will continue bank’s rights to do so). requirements including a creditor to be available until the February If legacy transactions are no identifi er and a unique mandate 2014 cut-off . Local clearing in longer available and the company reference for each direct debit. As the UK, such as BACS and FPS, cannot use SEPA credit transfers, a result, corporations will need will not be impacted by the SEPA then the company may be forced to fi nd the information from regulation. to make payments using wire their customers and store their In anticipation of this, Barclays transfers at a higher cost. mandates either physically or has already launched SEPA If, for some reason, the legacy electronically. credit transfer services in Spain, schemes are still permitted for To set up the SEPA DD and Portugal, France, Ireland, Italy, a short time aft er 1 February to identify an account, both an Germany and the UK. It is also 2014, banks might increase their International Bank Account making SEPA payment services charges in order to “encourage” Number (IBAN) and Bank available to any customers that fi rms onto the SEPA schemes. Identifi er Codes need to be wish to migrate to SEPA prior used. Th ese codes diff er between to the 2014 deadline, rolling What’s the incentive? countries, which can make for a out SEPA direct debit services Eventually, SEPA will align the challenging and time-consuming and launching both Debtor cost of cross-border transfers task, especially if the insurer has and Creditor services in Spain, with that of domestic electronic customers spread across Europe. Portugal, France, Italy and transfers, resulting in signifi cant Th is work will necessitate Germany. cost reductions, easier access to resource deployment and it is best One of the risks of non- new markets, better control and to seek expert advice on how to do compliance is that the Automated better risk management through this in the most effi cient manner. Clearing House (ACH) schemes the standardisation of payments In essence, insurance companies stop processing legacy payments and processes. have the choice of either using a and direct debits and, therefore, Equally, failure to implement bank-supplied data conversion and that a company will not be able the change and the correct IBAN mandate storage solution, or of to make payments such as tax, details when making EU euro upgrading their own proprietary payroll and accounts payable, or payments will result in failed system. collect funds by direct debit. payments, increased costs and Th e other issues we identifi ed O Jean-Pierre Th e ACH schemes are due to poor customer service. were mostly associated with the Darque is a move to SEPA on 1 February SEPA is a legal requirement that required IT developments, (fl at director in 2014 and it remains to be seen all corporations must eventually fi le or XML) as well as timing the Non-Bank whether this will be a “hard date” comply with, but rest assured that Financial for collection, money fl ows and Institutions team or whether countries will off er a there is still time for them to start potential refunds. at Barclays soft landing by shutting down the their SEPA journey.

58 www.insiderquarterly.com MD eNovus US A4 Ad_Layout 1 25/02/2013 11:32 Page 1

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K INSIDE PROFILE You're hired! Andrew Carrier tells IQ about Argo Group’s approach to improving employee retention – via an “Apprentice”-style competition…

Snaring the brightest the organisation where Th rough this Oyoung university leavers the results of the team programme we’ve onto graduate schemes and are more important established a robust retaining the best underwriting than the results of the annual selection talent are perennial concerns individual. Hiring process for hiring for (re)insurers. raw material in the university grads. As Andrew Carrier, Argo Group’s shape of recent each year goes by the chief underwriting offi cer, who graduates is the best pool of our young has been at the group since 2007, way to invest in talent grows and with it has been pushing forward the building a collective, a sense of camaraderie fi rm’s recruitment eff orts in an collaborative culture and a healthy level of innovative manner. that is so important internal competition Two years ago Carrier launched to our business transpires. Th is leads Argo Group's own version of model. to the emergence of a reality TV series e Apprentice, collaborative, collegial with university graduates from Insider Quarterly atmosphere throughout throughout the UK competing for Is there a problem the organisation. And an opportunity to start a career at within the London I think that culture is the company. (re)insurance market with OAndrew how we strive to set Th e culmination of the feeding and maintaining the talent Carrier is chief ourselves apart from many others competition is the Graduate pool? underwriting in our industry. When you have ofﬁ cer at Argo Assessment Day at Argo Group’s Group and a sense of mutual engagement, offi ces, where fi nalists participate Andrew Carrier president of when everyone’s interests are in activities that include group I think the issue goes beyond the Argo Re aligned, you can convert that presentations, speed interviews London market. Th e way we work into a real advantage in terms and rigorous testing of their has changed dramatically due of underwriting philosophy and numerical and verbal skills. to technology and that’s opened stability of resources. Aft er assessing how the up numerous opportunities and candidates have fared on each possibilities that didn’t exist Insider Quarterly component of the competition, before. But perhaps one of the What can a company like Argo Carrier is tasked with the Alan downsides is not having the old- Group o er to aspiring graduates? Sugar role of saying “you’re fashioned face-to-face modus hired” to the winners of Graduate operandi. I think, in general, we’ve Andrew Carrier Trainee job off ers. lost something of the old learning With our international footprint, environment where you used to be we can off er a breadth of Insider Quarterly able to observe and learn directly opportunity in terms of both e London market can be very from your boss. Th is programme product and geographies. When uid in terms of the ow of is a deliberate attempt to engineer the grads join, they (and we) don’t personnel from one organisation on-the-job training, which leads know exactly where they’ll end up. to another. How important is to great benefi ts in maintaining But the programme gives them employee retention to Argo Group? our talent pool. exposure to many aspects of our business and it gives us the chance Andrew Carrier Insider Quarterly to fi nd the place that best suits Retention is very important to What are your aspirations for this their abilities and interests. So Argo Group as our emphasis graduate programme initiative we off er a breadth of opportunity is on building an organisation and Argo Group’s approach to that rivals many larger fi rms but focused on the long term. We recruitment in general? we also have the mindset of a deliberately strive to embed an smaller company. Th at means underwriting culture throughout Andrew Carrier O Continued on page 62 www.insiderquarterly.com 61 INSIDE PROFILE

O You're hired! these attributes are essential to continued from page 61 success in our business. All of the there’s no steep pyramid of middle fi nalists demonstrate outstanding management – aspiring graduates qualities, but the ones we select work in relatively close proximity “[The industry has] lost are those that we feel are the most to senior management, which something of the old learning well-rounded and demonstrate an provides exposure to what the ability to show purity of thought. future holds for them as well as environment where you used clear communication channels. to be able to observe and learn Insider Quarterly How are the rst-year recruits Insider Quarterly directly from your boss” doing? What impact have they had How would you describe the brief on the organisation? for applicants to the Argo Group to the underwriting culture graduate programme – are all- at Argo Group. We’re a very Andrew Carrier comers welcome, or are you looking entrepreneurial environment and In the fi rst year or two, the for graduates in speci c elds? we encourage new and innovative company’s investment in the ideas. As a specialty insurer, that individual probably outweighs the Andrew Carrier sense of entrepreneurialism helps return we get from them – which Economics or fi nance-related sustain growth in new lines of is what we would expect. We have degrees are obviously an business and goes hand-in-hand been pleasantly surprised by how advantage but, frankly speaking, with disciplined risk-taking. quickly they’ve developed and what we’re looking for are trained, made a material impact on the educated minds – individuals who Insider Quarterly wellbeing of the fi rm. As they are curious as well as disciplined. How are the shortlisted candidates move through their rotations, A history degree, for example – tested during the Graduate they are facilitating the spread someone who studies the past to Assessment Day? of knowledge amongst each be smarter for the future – that’s a other and with other members great fi t for what we do; so there’s Andrew Carrier of the teams. Th ey’ve essentially really no restriction as to specifi c It’s a pretty rigorous day that starts become conduits of best practice degree or educational background. with a verbal reasoning test. We throughout the organisation. then put them through a time- Insider Quarterly sensitive role-play case study to Insider Quarterly How many applicants did you get test their business acumen and How would you describe the for the rst year and the second provide us with an opportunity (re)insurance job market today year? to observe how they work in compared to when you were teams. Th en there’s a series of starting out? Andrew Carrier short one-on-one interviews with We had around 400 applicants the representatives from across the Andrew Carrier fi rst year and we hired three. Th e organisation. In addition, they When I started out in the early second year, we brought on four spend some time sitting next to 1980s, the insurance and out of a total of 500 applicants. the underwriters in the box to reinsurance sector was probably And that’s for our London-based get a feel for the job. And then, at second fi ddle to the banking part of the business. We also the end of the day, we take them sector, but things have moved on recently replicated the programme down the pub. quite a bit since then. Today, the for our businesses in the US. insurance industry approaches its Insider Quarterly selection of talent with the same Insider Quarterly How did you select the nalists and rigour as any other subset of the e TV version of Th e Apprentice what qualities did they display that fi nancial sector. I think graduates celebrates entrepreneurialism as put them ahead of their rivals? today have a better sense of the well as being a team player. How long-term opportunities that exist important are these qualities to Andrew Carrier in our industry and we’re now (re)insurance underwriting and to It’s really a combination of competing for the best talent out Argo Group? technical acumen and there. And we’ve certainly been interpersonal skills – many pleased with the calibre of talent Andrew Carrier candidates are strong in one and that we’ve been able to attract to Both of these qualities are integral less strong in another. Both of Argo Group.

62 www.insiderquarterly.com Insight and Intelligence on the London & International Insurance Markets Know the news…

How The Insurance Insider first revealed Sagicor at Lloyd’s had appointed JLT to run a sale process on 7 February…

Before it happens…

How Global Re followed up on the 8 February with a remarkably similar article – but 24 hours later…

When you can’t wait. Choose The Insurance Insider

1 www.insuranceinsider.com October 2011/4

II-subs ad_Sagicor at Lloyd's-Feb13.indd 1 28/02/2013 09:32 INSIDE PROFILE Making connections IQ speaks to Alex Hearn, the founder of the industry’s ﬁ rst dedicated social networking and content platform, MySlipcase, about the growing role of social media Insider Quarterly an increasing impact on the search professionals. Some How did you rst arrive at the insurance industry internally organisations have already concept for MySlipcase? and externally and can lead identifi ed the site as a tool to to signifi cant changes for the search for specifi c personnel – for Alex Hearn collaboration between insurers business purposes and also for HR I had to fi nd a way of increasing and intermediaries. I believe, purposes. awareness of company-generated though, that the benefi ts of content. Towards the end of the social media have yet to be fully Insider Quarterly two years I spent as a broker at discovered by the industry. Monetising websites has proved to Willis, the marketing manager in be notoriously di cult for my division left very suddenly and Insider Quarterly companies without a tangible I was handed a number of short- Is there really room for another product to sell. How do you plan to term responsibilities. Th e division social networking site? generate income out of yours? had a vast depth of specialty expertise which was published Alex Hearn Alex Hearn every quarter in specialty reports. MySlipcase is not just another Th ere is an inherent need for a Th ere was, however, no way of social networking site but an distribution channel for company reaching what should have been industry hub using well proven content. MySlipcase enables an extensive audience with this social elements. Having regularly companies to host a page and knowledge. It was clear that not met with communications and to update it with any format of only was the division facing this marketing directors across the their latest media. Any user who issue, but every organisation in industry over the nine months has a business interest in that the industry wanted to build their since our launch, there is a organisation can join their page brand by promoting their thought developing demand for a platform – following which, all uploaded leadership in various formats. And that is absolutely specifi c to this content will be added to the on the fl ipside, every individual industry. LinkedIn provides a user’s unique feed of information. in the industry had an interest profi le for an individual with MySlipcase will be part of an in information from specifi c a job. MySlipcase provides a organisation’s social media/ professionals, organisations profi le for an individual in the marketing budget to enable the and specialties. MySlipcase global (re)insurance industry. communication of content and was developed to make these We have narrowed things down clearer diff erentiation from peers. connections. to a platform that is more specifi c, more relevant and more Insider Quarterly Insider Quarterly customisable – with less hassle. What are your aspirations for the How important is social media to site in a year – and in ve years? doing business in the (re)insurance Insider Quarterly world? Who in the (re)insurance industry Alex Hearn is it aimed at? In a year’s time, MySlipcase will Alex Hearn have at least 25 company pages Th e (re)insurance world has Alex Hearn and will be a “go to” platform for always been social, but has never Th e site is designed for employees in the industry. In fi ve had a platform to support it. commercial and specialty lines years’ time, the ambition is to Business is done with a network professionals globally: insurers, have the majority of all relevant of individuals and organisations intermediaries and relevant organisations with company – and therefore growing and service providers/professionals – pages. Membership will be into understanding this network insurance lawyers, loss adjustors, the tens of thousands and even more can only be benefi cial. risk managers and so on. For O Alex Hearn the most obstinate of industry According to a Gartner September reasons we established very soon is a former professionals will have to dig Willis broker 2012 report of 2,000 insurance aft er creating the site, MySlipcase and founder of deep to fi nd a reason not to be on clients, social media is having is not open to recruitment and MySlipcase MySlipcase.

64 www.insiderquarterly.com New York 2013 9 May 2013, 9:00 – 17:00 (including networking drinks) New York Athletic Club, New York, NY 10019 key Themes: > Are we awash with capital? > Will M&A be the preferred method of capital management in 2013? > US property cat rates – the only way is down, despite Sandy? > Third party capital: friend or foe? > Can the US insurance market sustain its encouraging rate momentum for another year? > Is the real pain yet to come on reserving?

speakers include: ‘As good As Joe beneducci, Chairman, President and CEO, ProSight Specialty Insurance Holdings charles dangelo, President and CEO, Starr Indemnity and Liability Company it gets?’ bryon ehrhart, Chief Strategy Officer, Aon Benfield Securities James Few, CEO, Aspen Re Will 2013 provide a high watermark bill keogh, President, EQECAT for the global (re)insurance business?

your place visit www.insiderscope.com. Alternatively you can email Emma Wright on [email protected]. To book Subscriber delegate rate $695 until 22 March, $795 thereafter. Full delegate rate $945

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What do the Intel Pentium processor and the insurance markets have in common? Not much, it would seem, unless the industry learns to embrace technology as its future, says Stewart Taylor

The ongoing shenanigans Owith the European same aft er where most Union, the North Korean 20 years. Th ese people reading nuclear weapons programme, are: the way insurance this will have a powerful problems with Somalian business changed at Lloyd’s aft er computer within reach in the lawlessness and the US making the terrorist attacks in London; form of their “smart phones” – a noises about Clinton being and how technology has driven so Back to the Future-style sci-fi lined up as the next president many businesses since the launch term if ever I heard one. – these are all too familiar of the Intel Pentium processor. But it wasn’t just the technology headlines. Th ese are not the most obvious that pushed Intel forward – it was Until you ask yourself whether I parallel choices necessarily. also their bold vision to stand out am referring to Bill or Hilary... Insurance and technology have from the competition and raise Well, I guess that depends on never been particularly good the bar; which set the wheels in how old you are and how well you bedfellows, but where the future motion to create an identifi able remember 1993, as these are news of this article lies is why these brand leader. headlines from that year and not separate entities were so game- Th is vision still resonates today this one. changing in their respective with a brand so powerful that it Th e talk back then was of the milieu. ranks above names like Kellogg’s, European Economic Community Disney, Pepsi, Nike and Heinz, eliminating trade barriers and Leaping forward placing it eighth in the top 100 creating a European single Th e Pentium chip established a most valuable brands and a full market; now the question is number of leaps forward, but to 50 places ahead of the fi rst of whether the euro will collapse keep it simple it meant computers only two insurance companies on and cause a global fi nancial were more powerful and could do the list. Can you name any other meltdown! more a lot faster. Th e worldwide computer chip, let alone one with Th e reason for me drawing web was only three years old its own theme tune? these parallels is that we are also and computing was still “big Th e Intel success story was only just months away from the 20th iron” rather than big data, but it part of a wave of technology anniversaries of two signifi cant was starting to move forward at and computing innovations, so events, which stand out for me breakneck speed. why has the insurance industry as examples of what is diff erent Intel’s evolutionary steps are been so backward in moving rather than what remains the now taken for granted in a world O Continued on page 68 www.insiderquarterly.com 67 INSIDE TECHNOLOGY

O Back to the future no doubt would have been the consequence of what happened in continued from page 67 IRA’s greatest victory. London in 1993. Lloyd’s incurred forward with the advancement of Th e terrorists’ bomb had just as the largest loss of any insurer technology in the same timespan? devastating an eff ect on the pool for the attacks on the World of money set aside by insurance Trade Center. People speculated Willingness to change companies to pay for terrorist that it would never be able to I personally don’t believe it’s the attacks as it did on the now meet its claims. But they were lack of appropriate technology long-gone medieval church of St. wrong; so wrong, in fact, that US that has led to the lack of take-up Ethelburga’s. Treasury Secretary John Snow in the market. It’s about people’s In insurance things hadn’t later praised Lloyd’s for how it willingness and appetite to change changed much in the years “stepped up to the plate” and and innovate. leading up to 1993, particularly honoured its obligations following Firms need people to be bold at Lloyd’s. It was still Names the tragedy. If you combine that and courageous to give them the that provided the capital for very American phrase with the edge. I was rather amused but underwriting and it seemed to most English sounding of mottos, full of admiration for whoever look back at its past rather than “utmost good faith”, you have a booked Tim Berners-Lee to be forward to its future. pretty powerful combination. the headline act for “Shaping our Th e government was still But insurance isn’t just about Futures” at the BIBA conference trying to fi nd time to formalise paying to patch things up when last year. Th e English guy who legislation to allow the creation disaster strikes. It enables creative entrepreneurs to take risks on It wasn’t just the technology that pushed Intel business ideas that could change “ the way the world works – things forward – it was also their bold vision to stand like faster computer chips. So, ignoring technology advancement out from the competition and raise the bar” is totally irrational if you are among the people that have created the aforementioned of Pool Re – the vehicle to be set enabled the innovation in the fi rst worldwide web – and here he is up for insuring against terrorist place! being paid to talk to insurance attacks – when one day in April, So how does this all relate? brokers! just a month aft er Intel launched Coff ee may have been Lloyd’s Now Edward Lloyd was not so their revolutionary computer chip, past, but technology is its future, diff erent to Tim Berners-Lee. He everything changed. perhaps in the form of products was also an innovator, a risk taker Th e event – which incredibly like Xchanging’s app-tly-named and someone who thought there still ranks as the second-worst X-Presso mobile app. was a better way of doing things. terrorist act in terms of insurance Anyone that doesn’t take that If the anecdotes we’ve all read property losses aft er 9/11 – view: put away your BlackBerries, are to be believed, Mr Lloyd was may have been a tipping point stop Googling for the best price in the right place at the right time equivalent to the eff ect of the on 5-irons, and don’t record the and, seeing an opportunity to do Pentium launch on the world of rugby on Sky+. rather more than serve coff ee to computing. You can always do it the old way, his clientele, he decided to drive a Within fi ve years dramatic but it doesn’t make sense. Twenty new business forward. changes had taken place at Lloyd’s: years aft er these very diff erent, So let’s fast forward to an event corporates were now part of the but very decisive events, perhaps that brought the ancient Roman fabric; Reconstruction & Renewal now is the time for some more boundary of Bishopsgate in the was in place to put an end to tipping points, and just maybe a City of London to the attention the suing-and-froing; and it was better convergence between the of everyone in the UK and many now regulated by the Financial pen and the box and bit and the around the world. Services Authority. byte. Lloyd’s was not without its We know our history but we challenges in 1993. Recent Stepping up don’t know our future, nor on events had taken their toll, as Less than a decade aft er the what road new opportunities will many of you will recall, and the Bishopsgate bombing many O take us. Or, as Doc tells Marty Bishopsgate bombing would bring argue that the aft ermath of Stewart Taylor in the fi nal scene of Back to the is managing the very near and real collapse, in 9/11 was better handled by the director of Future: “Roads? Where we’re business terms, of Lloyd’s, which insurance companies as a direct Hermes People going, we don’t need roads.”

68 www.insiderquarterly.com BRCS4504 IRLA Congress 2013 ad 280hx216w_Layout 1 20/11/2012 14:44 Page 1

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in a position to handle them. international market where no The one thing that is certain is company can afford to gamble Raging bull that the level of collaboration with its reputation. This is a between regulators will increase genuine danger when responses The insurance industry needs to take significantly when the Financial to regulators are run through the regulatory bull by the horns when Conduct Authority (FCA) and the silos, rather than being properly Prudential Regulation Authority managed and coordinated across the FSA splits into the FCA and PRA (PRA) come into being. the company. this year, says Michael Luderer This will reinforce the need for absolute consistency when Postroom approach The regulatory responding to information And there are countless other risks Oenvironment for the UK requests. It will also demand with this “postroom” approach insurance sector is going to get a much more streamlined and to regulator relationships and a whole lot tougher this year coordinated approach to the way communications management. when the Financial Services insurance companies manage both Good risk and compliance Authority (FSA) splits. their internal communication and managers are hard to come Although little is known about their interaction with regulators. by, and if they think they are the scale of additional reporting Most companies currently spending their time farming requirements, “think the worst deploy a reactive, de-centralised out a seemingly never-ending and double it” seems to be the approach to regulators’ data stream of information requests general industry consensus. requests. This typically involves from regulators rather than The situation is bad enough risk or compliance managers actually doing their proper job already. Even if you put aside the passing requests to the relevant of managing risk, then they are long-rumbling issue of Solvency department – which is seldom not likely to hang around for II, the fact that regulators and a terribly satisfactory way of long. There is, of course, a world Lloyd’s request data from so handling the process because it is of difference between being many different departments prone to error. compliant and managing risk. and functions makes it hard to It also means that few firms have There is also the problem of key keep track. Even though most a global view of the process, while people having to drop what they requests are channelled through risk managers in particular tend to are doing to deal with complex compliance or risk specialists, be overwhelmed by what they see and sudden information requests. too often the people involved are as a low-level administrative task. On occasion, the timing of these simply overwhelmed, As the regulatory pressure on the demands can be excruciatingly furiously sending out insurance sector increases, there bad, such as during a critical regulators’ demands is a growing risk that sooner or moment in a change management for information in later someone is going to make project, when a regulatory the hope that a big mistake. It could happen the recipients so easily. The wrong (or simply will be inconsistent) data is supplied, the regulator gets heavy and suddenly there’s trouble. And it could be big trouble in a highly competitive

70 www.insiderquarterly.com INSIDE REGULATION

deadline is looming, or when with regulators. Th e establishment what the regulators throw at them preparations for the year-end are of a dedicated, centralised in the future. And let’s be clear: reaching their peak. Regulatory Offi ce (RO) to manage that could be a great deal. With nobody in overall charge the corporate relationship with of the process or managing the the authorities is a compelling Working relationships day-to-day relationship with alternative. An RO would control Sounds expensive? Far from it, regulators, there is little or no and supervise all responses to actually. Given the way most scope for negotiated fl exibility; requests for information, project insurance companies currently and nobody is empowered to seek manage the delivery of data to run their regulatory interaction out an alternative source within regulators, and guarantee its and responses, with its attendant the company to respond to the quality, accuracy and consistency. duplication, misuse of valuable regulator’s request. At the same time, the RO will human resources and lack Th is current ad-hoc approach be responsible for building a of planning, the return on to regulation management is working relationship with all investment would be fast and clearly fraught with potential the regulators. Engendering a transparent. operational problems and risks. It’s relationship based on mutual Nobody ever said that it’s easy also ineffi cient and costly because understanding can open a door dealing with regulators. Th ey are there is no overall control over to discreet compromises and powerful and in the ascendancy who is doing what and there will pragmatic solutions that might in the current climate. But the inevitably be duplication. Are the otherwise be closed. Gaining the closer you get to them, the better right people with the right skills inside track on what is really going you understand them and the way and access to appropriate data on at the regulators would enable they work, and gaining this crucial being used? Quality control is another problem area, because compliance “Nobody ever said that it’s easy dealing with and risk specialists cannot regulators. They are powerful and in the possibly underwrite the quality of information they give to the ascendancy in the current climate” regulators if they don’t fully understand the function that it the RO to direct resources where knowledge comes through intense, came from or how accurately it they are most required and to day-to-day relationship-building was produced. And with the best fi nd the most cost eff ective way of between individuals. will in the world, risk managers delivering what will be demanded Th is is a very diff erent cannot have a detailed knowledge of them. proposition from the occasional of all the activities within an Importantly, an RO would back-slapping “Regulator insurance company that regulators be able to manage the critical Relations PR” that many may want to probe. issue of training staff , both up companies misconstrue as doing And does anyone have a and down the organisation, and the same job. A proper working complete picture of all the work in identify and implement business relationship can really only be progress on responses to regulator process improvement initiatives. achieved by creating a centralised information requests? Is there a By adopting this approach, an RO within your company. project management system for RO would be in a strong position Leaving aside all the compelling keeping track of everything that’s to de-risk the whole issue of fi nancial and operational benefi ts going on? Probably not, would be regulator communications and of creating a centralised RO, the answer to both questions for management. there’s one fi nal point worth many companies. Best practice in enterprise making. What would your risk management, supporting shareholders think if they knew Centralising with an RO technology and eff ective project the reputational risks you are In a nutshell, this approach to management, underpinned by taking by running a totally ad-hoc, regulation interaction and current regulatory intelligence, reactive, unmanaged approach compliance is expensive, would all play a part in driving to dealing with regulators? In ineffi cient, demotivates key people cost effi ciencies in the process. It the fi nal analysis, this all boils and is distinctly risky due to the would also enable any insurance O Michael down to shareholder value being lack of eff ective oversight. It also company to run its business as Luderer is at risk, because there is a vibrant managing has the potential to damage an usual and focus on growth free director at Severn relationship between an insurer’s insurance company’s relationships from sudden disruption, no matter Consultancy UK reputation and its share price. www.insiderquarterly.com 71 INSIDE EMERGING MARKETS

Crouching Tiger, Hidden Dragon As China’s insurance market continues to develop at a world-leading pace, its P&C sector will ﬁ nally enter a phase of sustainable growth and underwriting proﬁ tability, predicts Dr Jianzhong Yao and Dr Kai-Uwe Schanz

China’s insurance market percent respectively. slowdown in motor business Ohas resisted the drag of Refl ecting the fragility and growth from 39 percent in 2010 a host of internal and external vulnerability of global conditions, to 17 percent in 2011. Car sales challenges to maintain one of a slowing domestic economy in 2011 fell to the lowest level in the fastest growth rates in the and unabated competition in 13 years as economic stimulus world, albeit the most recent domestic insurance markets, measures expired. Further, traffi c pace of expansion was the 2011growth growthhas slowed by to P&Cits lowest line control schemes and restrictions slowest in four years. level since 2008. However, China on new car registrations were Strong regulatory160 support is remains one of the world’s146.6% fastest- introduced in some large cities shaping disciplined140 development expanding insurance markets, in order to alleviate the growing of the country’s120 insurance market with the sector consistently problems of pollution and traffi c to help growth100 continue on a outgrowing the country’s vibrant congestion. sustainable and80 sound footing. economy. Accordingly, non-life Despite its relatively poor growth China’s P&C insurance60 market is a insurance penetration (premiums performance in 2011, the motor

Growth (%) 42.4% case in point. 40 as 27.7%a share28.1% of GDP) increased 22.6% line remains China’s biggest 16.7% 21.3% 24.2% 19.4% 22.9% In 2011, total20 P&C premiums from 0.7 percent in 1995 to 1.2 P&C insurance segment by far. It in China reached0 478bn yuan percent in 2011 (Source: Swiss accounted for 73 percent of total (source: China Insurance Market Re). In addition, more recently P&C premiums, slightly down Annual Report 2012)Motor or $76bn atCargo underwriting profiCredit tability has Health from 75 percent in 2010. Liability Accident the average exchange rate during improvedAgriculture markedly.Guarantee Th e share of enterprise property Commerical Special risks that period. Th is representsproperty amounted to 7 percent, while growth of 19 percent from the liability and non-motor personal Source: China Insurance Market AnnualMotor continues Report 2012 previous year (see chart), with to dominate lines remain underdeveloped and motor and non-motor business Th e drop in growth is primarily off er substantial room for growth expanding by 17 percent and 25 attributable to a signifi cant and portfolio diversifi cation. Th e chart opposite exhibits the China's P&C premium and growth ratesP&C premium and growth rate 2004-11 growth rate per business line. Credit guarantee insurance grew 500 Premium (in billion yuan) 40 by a stunning 147 percent in 2011, Annual growth rate 34.5% mainly driven by the government’s 32.0% 35 400 30.0% resolve to boost this form of 30 (%) rate Growth coverage, which is of particular 23.2% 22.3% 300 25 importance to SMEs. 18.7% Following the global economic 17.2% 20 14.1% slowdown, many (non-state 200 403 478 15 Billion yuan owned) SMEs in China suff ered 299 245 10 cash shortages as access to loans 100 209 158 became increasingly diffi cult. Both 112 128 5 the central and local governments 0 0 have been pushing insurers and 2004 2005 2006 2007 2008 2009 2010 2011 other fi nancial institutions to help Source:Source: China China Insurance Insurance Market Market Annual Annual Report Report 2012 2012 address this challenge by initially

72 www.insiderquarterly.com INSIDE EMERGING MARKETS

offering small (insurance-based) 2011 growth by 2011P&C growth line obyf P&Cbusiness line loan guarantees to SMEs. 160 146.6% Special risks insurance – which 140 includes aviation/space, nuclear 120 power and offshore energy – also 100 expanded significantly by 42 80 percent. 60 Growth (%) 42.4% 40 27.7% 28.1% 22.6% As of the end of 2011, China 16.7% 21.3% 24.2% 19.4% 22.9% had 60 P&C insurance companies, 20 including 39 domestic and 21 0 foreign firms. The top three Motor Cargo Credit Health Liability Accident insurers were able to defend and Agriculture Guarantee Commerical Special risks even consolidate their dominant property market position, and accounted Source:Source: China China Insurance Insurance Market Annual Annual Report Report 2012 2012 for two thirds of the total premium income in 2011. Report 2012 and the Yearbook combined ratios at historical lows Foreign players still play a of China’s Insurance 2012, total (PICC 94.0 percent; Ping An 92.2 marginal role with a collective reinsurance premium volume percent; CPIC 93.9 percent). market share of 1 percent. One (domestic cessionsP&C premium only) in and growthThe rate market’s 2004-11 loss ratio declined reason for this is their virtual 500 2011 amountedPremium (into billion 79.4bn yuan) yuan by 1.9 percentage points to 61.240 absence from the motor market. ($12.6bn),Annual making growth China rate the percent, as did34.5% the commission 32.0% 35 As most Chinese drivers tend to 400 world’s30.0% third-largest reinsurance ratio, due to effective measures

30 (%) rate Growth purchase both compulsory and market. 23.2% taken by the regulator and the 22.3% 25 voluntary coverage from the same 300 P&C business made up about insurance association18.7% to curb provider, restrictions on foreign 72 percent of the total volume. 17.2%excessive competition – for 20 14.1% 200 insurers writing compulsory The top three P&C reinsurance example, by capping403 commission478 15 Billion yuan motor third-party liability players are China P&C Re, Swiss levels 299through so-called industry 245 10 business have effectively barred 100 Re and Munich Re, which have209 self-discipline agreements. 158 them from entering the motor a combined112 128 market share of 88 By contrast, the expense ratio5 segment. 0 percent. developed unfavourably and 0 2004 2005 2006 2007 2008 2009 2010 2011 However, at 22 percent, the 2011 saw a sharp increase in continued to increase; a major foreign segment grew faster than Source: Chinaceded Insurance business Market Annual as Report the 2012 China reason for this was rising labour the market as a whole in 2011; Insurance Regulatory Commission costs, especially in management and foreign insurers could gain (CIRC)’s commitment to sound compensation. additional market share following and stable solvency levels boosted the opening of compulsory motor demand for capital relief from Challenging investment business (see chart page 82). reinsurers. Meanwhile, solvency environment pressures are expected to remain a Current investment returns Third-largest driver of cession growth in China. declined in 2011. In addition, reinsurance market In addition, the opening of the industry had to cope Retention rates in China’s P&C compulsory third-party liability with impairment losses as a sector are comparatively high, business to foreign insurers result of continuing financial at around 85 percent. Only 15 and the partial deregulation of market volatility, which led to percent of original business commercial motor rates should a sharp decline in insurers’ net is ceded to reinsurers. This is be a further boon to reinsurers, asset position (before capital close to the global average and especially for those that are able to injections). significantly less than in other offer related product development, Strong underwriting profits were countries with comparable GDP pricing, underwriting and not sufficient to offset adverse per capita levels. reserving services. developments on the investment The relatively low cession rate The Chinese P&C market’s side. Returns on equity for the primarily reflects the dominance overall combined ratio further sector generally deteriorated, of motor insurance, which usually improved in 2011 to 95.3 percent, mainly reflecting reduced exhibits higher retention levels from 97.4 percent in 2010. The top “underwriting leverage” (net than commercial lines business, three players made a particularly premiums as a share of equity) for example. According to the significant contribution to this and “investment leverage” (assets China Insurance Market Annual development and recorded as a share of net worth). www.insiderquarterly.com 73 INSIDE EMERGING MARKETS

P&C split by lines of business In short, for the majority P&C lines of business split unlisted fi rms. of Chinese P&C insurers the Commercial Cargo, 2.1% Liability, Last but not least, the dominant property, Accident, growth of premium volumes and property, 3.1% Accident, motor line of business is set to 6.9% 2.2% assets fell short of the amounts undergo major changes in the Agriculture, required for capital injections. 3.6% wake of material regulatory Th ese injections became changes. Firstly, compulsory Credit, 2.4% necessary because of major third-party liability, which has asset impairments, coupled with Other lines, been the prerogative of domestic 6.4% strong business growth, which 6.4% insurers since its inception in Motor put pressure on insurers’ solvency Motor 2006, will be opened to foreign 73.3% margins. 73.3% players. Th is liberalisation should Th e CIRC made it clear to also help overseas entities to boost market participants that solvency their minuscule market share in margins and overall capital Source: ChinaSource: Insurance China Insurance Market Market Annual Annual Report Report 2012 2012 voluntary (commercial) motor adequacy must not be eroded business. P&C market shares 2011 by asset impairments (or rapid P&C market share 2011P&C market shares 2011 However, major obstacles still premium growth). Foreign players, need to be overcome. Th ese China Export & 1.1% Given the exceptional growth Credit Ins., 2.1% include limited distribution momentum displayed by China’s Rest channels and the inability to domestic, insurance markets, sound and Sunshine, 2.8% domestic, fully capitalise on underwriting, 16.2% eff ective regulatory standards are China Continent, client segmentation and pricing China Continent, PICC, 36.3% of the utmost importance. Th e 3.4% capabilities under the current China Life CIRC is committed to ensuring P&C, 3.4% regulatory regime. that regulations keep pace with P&C, 3.4% Another major motor-specifi c China United, CPIC, the challenges characteristic of 4.4% 12.9% development is the forthcoming 4.4% 12.9% Ping An, 17.4% a dynamic market environment deregulation of commercial and has taken (or announced) a rates to replace the current tariff Source: China Insurance Market Annual Report 2012 series of measures to refl ect this Source: China Insurance Market Annual Report 2012 introduced in 2007. However, only commitment. regimes and the three-pillar qualifi ed insurers will enjoy the For example, it has enhanced its approach of Solvency II (which freedom to set their own rates and regulatory standards governing comprises capital adequacy, risk conditions. (enterprise) risk management. management, risk disclosure). Th is Th e most important criterion Both the life and health and P&C system would replace the current to be met is that any qualifi ed sectors are required to strengthen solvency framework in China, insurer will have to have their risk governance frameworks, which is similar to the European maintained a solvency ratio of at for example, by establishing a role Union’s Solvency I regime. least 150 percent in each of the that is equivalent to a chief risk Another recent focus of two preceding years of operation. offi cer. regulatory activity has been Th is could mean that only a Also, information disclosure investment management. In single-digit number of insurers requirements have been tightened. order to provide insurers with will be able to benefi t from the In addition, insurers need to further degrees of freedom in an deregulation of commercial motor adopt quantitative measures increasingly diffi cult investment insurance. ODr Kai-Uwe consistent with the notion of Schanz is a senior environment, the CIRC has In summary, China’s P&C economic capital as their key adviser to Asia permitted them to invest in hybrid insurance industry is entering a risk management tool. Th ese Capital Re and convertible bonds. Insurers phase of more sustainable and requirements include specifi c can also invest up to 50 percent healthy growth, accompanied stipulations on risk appetite and of their total assets in unsecured by improving underwriting risk reporting. corporate bonds – up from 20 performance and far-sighted percent previously. regulatory responses that both Solvency II – Chinese-style Also, under some draft rules, alleviate the pressures from the In this context, the CIRC has insurers would be allowed to current investment environment announced that it is looking to invest up to 10 percent of their and pave the way for China’s gradually establish a solvency total assets in private equity – up adoption of world-class solvency O supervisory system that is Dr Jianzhong from the current 5 percent. Th is regulations and supervisory Yao is senior vice consistent with international president of Asia would potentially unleash fl ows of standards. standards of risk-based capital Capital Re about $50bn of fresh capital into

74 www.insiderquarterly.com Rachel Kemble Photography

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2013InsuranceAds_3.indd 1 2/4/2013 12:31:59 PM INSIDE TRADE CREDIT

Should I stay or should I go? With more businesses failing due to customer debts, trade credit is getting tougher to insure, says Michael Feldwick, but credit risk management solutions could help insurers stay on clients’ risks

High levels of trade credit diffi cult, if not impossible task to Orisk are continuing to provide cover. Th ey knew with put pressure on insurance some certainty that the companies premiums, making life for would fail, what they didn’t know been adopted to describe these credit insurers even tougher was when. organisations, some of which are amid an already competitive Retailers face very specifi c so over-exposed they are unlikely environment. problems, but if customers walk ever to pay their debts – making Most trade credit insurers have into their stores, they are likely them technically insolvent. refi ned their products to improve to be paid for goods supplied Trade credit insurers are right to communication channels with immediately. In most other be wary of clients that could fall customers and ensure more notice sectors, businesses supply goods into the zombie category – this is provided of any imminent and then wait to be paid. It is a type of risk is a step too far for changes in coverage levels. fact that across Europe over a many. Aft er all, how can they Looking at the market it is hard quarter of all businesses fail as feasibly cover companies that to identify major rises in premium a result of customer debts, and are expected to fail? However it’s costs right now, but without a the fi gure is likely to rise as the not a clear cut decision because doubt higher levels of cover will economic crisis continues. statistics show that as many as become more diffi cult to obtain – Recent research from the two-thirds of these zombies will and retain – as companies struggle UK insolvency trade body Th e actually sort out their problems to pay not just their debts, but the Association of Business Recovery and will go on to trade solvently interest on those debts. Professionals showed that in the in the future. Should an insurer In the past couple of months UK alone there are now 160,000 turn them away or instead take a this trend has been illustrated by businesses that are only paying the calculated risk? the failures of high-profi le UK interest on their debt and not the retailers such as HMV, Comet, debt itself. Th e term “zombie” has Using intelligence Blockbuster and Jessops. Although In order to make decisions, each one of these was a sad loss, Industrial breakdown: insurers need a way to assess their it was equally no surprise – European bankruptcies clients’ customer credit risks and particularly in the case of HMV Industry Bankruptcies set the appropriate credit policy and Comet, whose diffi culties Q3 2012 Q3 YoY % Q2 to Q3 % limits. In many cases they can’t were played out in the public change change rely on their clients to do this Manufacturing 1,606 -1.1 -2.9 domain for months prior to their because so many lack clear, timely Transport, telecomms & 1,637 7.4 -3.6 demise. utilities visibility into the fi nancial health Nonetheless, they continued Services 5,551 2.6 -6.2 of their customers. to trade and suppliers were still Finance, insurance, real 1,750 0.5 -8.9 But, by using intelligence, estate prepared to deliver, both for insurers can help clients to gain Construction 3,086 -0.2 -9.2 strategic reasons and because Wholesale & retail trade 4,758 2.0 -9.5 better visibility and control, profi t margins were high enough Primary sector 308 -1.9 -11.0 which will minimise their credit to allow them to take the risk. But Missing 1,348 110.0 -23.6 exposure, allowing them to grow for the credit insurers involved it Total 20,044 5.4 -8.7 their businesses and reduce the must have become an increasingly Source: Bisnode likelihood of increasing insurance

76 www.insiderquarterly.com INSIDE TRADE CREDIT

premiums. For the insurer this European insolvenciesAbsolute bankruptcies solutions that deliver this level of will help to minimise the chances information. 23,000 of the client making a claim and Finally, loss mitigation can will demonstrate a customer 22,000 be supported with information focus and care unmatched by on pre-legal actions, legal competitors. 21,000 proceedings and enforcement, Some credit insurers and many bankruptcy proceedings and 20,000 credit brokers are already using securities – again internationally, credit risk management solutions 19,000 because corporate law and custom to help them provide this service Bankruptcies will be diff erent depending on to clients. So how does it work? 18,000 the location of the debtor and the Firstly, the solution has to provide creditor. access to an extensive database 17,000 At the very least insurers can use of comprehensive customer and intelligence to help to determine market information combining Q1 2011Q2 2011Q3 2011Q4 2011Q1 2012Q2 2012Q3 2012 credit limits for their customers, global and local and public and Source: Bisnode which in turn helps them to private information sources. protect their risk. Th is will not only assess tier of technology onto the companies’ individual payment already overloaded IT stack, but Managing risk histories and behaviour and the solutions are available on the Before the banking crisis really level and nature of their debt, cloud without compromising hit, fi nancial risk taking, the but also their “upstream and any security requirements. And management of risk and risk downstream” assets, liabilities of the best of them are scalable and control were oft en confused supply chains and customer bases, adaptable so they can support with one another. Th is was not the stability of their industries, the core functions of a credit helpful in determining who was countries in which they operate insurance company at every stage, managing the risk, what the and other contributory factors. from the communication portal extenuating circumstances were Th is data forms the foundation of the solution and delivers the credit insurer with profi les “Across Europe over a quarter of all on hundreds of thousands of businesses fail as a result of customer debts, companies worldwide, updated continuously. and the ﬁ gure is likely to rise”

Suitable for clients with customers, to commercial and how it could be measured. Some solutions are ‘white labelled’ underwriting, risk underwriting Th is became very evident as the so that credit insurers and brokers and claim assessment. fi nancial crisis took hold and, can off er the information directly For both insurers and their among all the other diffi culties, to their clients to help better clients, the key emphasis is on businesses found the paths manage their policies, customer managing the loss ratio at an to gaining credit increasingly credit limits requests and policy acceptable level. Th is can be diffi cult to navigate. Of course, it claims, including debt recovery if supported by ensuring clients is still diffi cult to obtain credit but needed. comply with payment terms, the situation is slowly improving Th is has proven very benefi cial so it is worth looking out for and trade credit insurers are beyond credit insurance alone. solutions that are tailored to help implementing strategies to Indeed, corporates using a with bad debts and resolving improve communication with solution of this type can automate disputes – particularly for those their clients so that the risk is and accelerate trade credit that have cross-border customers, minimised – to everyone’s benefi t. management processes, mitigate which may require support for Using available and accurate risk across the business and international bad debt collection. intelligence to manage credit get almost instant decisions on Th e legal issues that arise can be ensures that both insurers and applications and limits – resulting helped with access to networks businesses are equipped to make in lower costs and fewer claims. of professionals, such as lawyers, O informed decisions. Th is is not a Understandably, some credit investigators and bailiff s, not just Michael sure-fi re solution to beating the Feldwick is head insurance companies are in the UK, but overseas too, and of UK & Ireland at worst recession in decades, but it’s reluctant to add yet another again there are comprehensive Tinubu Square certainly a good start. www.insiderquarterly.com 77 INSIDE CATASTROPHE

Standard ood insurance policy

When windResidential dwellingandNon-residential water property meet Superstorm Sandy left a Otrailf o destruction from ⅷ Building ⅷ Building coastal shore towns to major John M Clark and Michael R Fox unpick the knot of wind and – $500,000 metropolitan areas like New flood– $250,000 coverage issues in the wake of Superstorm Sandy ⅷ Personal property York City. ⅷ Contents Wind, water and a combination – $100,000 – $500,000 of the two in the form of storm ⅷ No additional ⅷ No business surge caused massive property living expense interruption damage. Typically, property policies are limited to wind damage while Insuring building water damage falls within the domain of the National Flood components Covered Insurance Program (NFIP). Although seemingly evident, ⅷ drawing a distinction between Foundations, electrical and wind and flood damage can be plumbing systems, central air conditioning, furnaces, water complicated, especially when the heaters and permanently installed combination results in extensive carpeting, panelling, bookcases destruction. and cabinets The distinction is more easily understood with knowledge of o Waves caused shingles, torn fascia, broken Groundp u or roof down? by SuperstormNot covered the basics of each policy and the Sandy crash windows or open holes caused by Issued under the NFIP, the adjustment processes involved. againstⅷ Decks,the patios,fallen swimming trees pools,and branches. Severe Standard Flood Insurance Reaching correct determinations seawallseptics at systems, windswells, fences, can also cause structural Policy (SFIP) is subsidised by on coverage for wind versus flood Townwalks, Beach hot in tubs damage by torqueing the tops of the US federal government and Narragansett, claims, however, will not preclude Rhode Island, on multi-level structures or forcing administered by the Federal policyholder suits that challenge 30 Octoberⅷ Strict 2012 limitationlow for elevation basement buildings off their Emergency Management Agency flood-based denials. structure and contentfoundations. Wind-created (FEMA). This policy’s language Due to the relatively low rates of openings can result in water is federally regulated and only participation in the NFIP and the damage to ceilings, walls, floors provides coverage for flood, limited coverage it offers, some and personal property. while specifically excluding wind policyholders will be looking to damage. their property insurers as sources By law, the amount of coverage of payment. East Coast ood damage under the SFIP is limited, and the The basic homeowners’ or scope is restricted to the necessary Flood policies in eect Recent damage

commercial property policy is as of 30 Nov 2012 estimates components of a building (see issued by private insurers and diagrams left). While the SFIP does provides coverage for loss caused 170,063 in New York 570,000 homes provide protection to property and businesses by wind, but excludes flood. Many owners, the low limits of liability of these policies also include 236,229 in New Jersey 536,000 homes and coverage restrictions usually and businesses anti-concurrent causation (ACC) do not fully compensate claimants language that excludes coverage for their losses. for loss incurred when both Given that the two policies’ Standard ood insurance policy covered (wind) and non-covered coverage is mutually exclusive, Residential dwelling Non-residential property (flood) causes of loss contribute distinguishing between whether

to the damage, as in the case with ⅷ Building ⅷ Building damage is caused by wind, storm surge. Enforcement of these – $250,000 – $500,000 flood or a combination of the provisions varies by jurisdiction ⅷ Personal property ⅷ Contents two determines the allocation and the specific facts of the claim. – $100,000 – $500,000 of coverage and loss to each Typically, wind damage occurs to ⅷ No additional ⅷ No business insurer. The approaches taken by a building’s exterior and includes living expense interruption the flood adjuster and property torn or blown-off roofs, missing adjuster differ. Flood adjusters Insuring building 78 www.insiderquarterly.com components Covered

ⅷ Foundations, electrical and plumbing systems, central air conditioning, furnaces, water heaters and permanently installed carpeting, panelling, bookcases and cabinets

Not covered

ⅷ Decks, patios, swimming pools, septics systems, wells, fences, walks, hot tubs

ⅷ Strict limitation for basement structure and content

East Coast ood damage

Flood policies in eect Recent damage

as of 30 Nov 2012 estimates 170,063 in New York 570,000 homes and businesses 236,229 in New Jersey 536,000 homes and businesses INSIDE CATASTROPHE

are required to receive specialised winds that caused massive entire cost of repairs, leaving a gap training and NFIP certifi cation in devastation with Hurricane that they may look to the property order to adjust claims. Th e NFIP’s Katrina were not present in insurer to fi ll. Adjuster Manual provides “proven Sandy, the storm was considered All too oft en, policyholders do investigative methods” to use when a fl ood event. As a result, claims not read their policies. Th ey pay dealing with fl ood claims that of “indeterminate loss,” where a their annual premiums and assume involve wind. building is completely destroyed that losses will be covered. It is not Th ese methods include and the adjuster has no practical until a natural catastrophe occurs determining the highest wind way to determine the cause of that policyholders discover their speed in the area, the amount of damage, will be minimal. coverage limitations. Aft er paying rainfall, tidal heights, storm surge It is expected that the adjustment premiums – sometimes for many and wave heights. While providing process will yield more clear-cut years without a loss – it is diffi cult evidence on fl ood conditions, claims of divisible damage that for people to accept even valid this information also gives the can be attributed to either wind or denials of their claims. adjuster storm data that can be fl ood. Th at is not to say, however, used to determine if wind caused that litigation will not arise even After Katrina substantial damage to the building from claims where the damage Th ese issues will undoubtedly prior to the fl ood. was caused only by fl ood. For a result in litigation brought by In investigating the loss, number of reasons, policyholders dissatisfi ed policyholders whose fl ood adjusters use a “ground will mount legal challenges to claims were correctly denied, as up” approach and identify the claim denials based on the fl ood well as by those whose claims may exterior and interior water lines. exclusion. Many property owners not have been properly adjusted. Damage below those lines is along the Eastern seaboard who Because coverage issues related typically attributable to fl ooding sustained damage from Sandy to wind, fl ood and storm surge and damage above those lines is did not have fl ood insurance (see have not been extensively litigated typically due to wind. diagram below). Without fl ood in the north-east US, there is no Flood adjusters are required to insurance, the property insurer is developed body of case law for the photograph and document both the only recourse policyholders courts to follow. the fl ood damage as well as losses have for insurance funds to repair Many coverage issues, including caused by wind. orStandard replace a home ood or building. insurancethe policy issue of coverage for storm

Because the London market WhileResidential FEMA dwelling off ers disasterNon-residential surge property and the interpretation of uses independent adjusters, it is assistance in the form of grants and ACC provisions, were litigated imperative to note that a universal loans, ⅷ Building not everyone qualifi es andⅷ Building extensively aft er Katrina. Th e adjusters’ claim manual does not those– $250,000 who do fi nd that the funds– $500,000 general consensus resulting from exist, which can result in varied do notⅷ Personal allow them property to fully repairⅷ Contentsthese cases was that storm surge adjustment procedures. or replace– $100,000 the damaged property.– $500,000 was not covered because it was not ⅷ No additional ⅷ No business Generally, property adjusters Even those property owners with damage that resulted exclusively living expense interruption apply a “roof down” approach fl ood insurance may fi nd that it from wind. OJohn M Clark to determine if wind caused any is chair of the does not adequately cover the Th e majority of courts also damage, and use visible water lines London Market Insuring building determined that insurers should as a point of reference to determine Practice at Nelson pay for damage caused exclusively the extent of the wind damage. Levine de Luca & components by wind and not rely on ACC Hamilton Covered Excess winds cause damage to the clauses to exclude coverage in cases highest and most exposed levels ⅷ with divisible damages. Foundations, electrical and of a building before impacting the plumbing systems, central air Although the Katrina decisions lower levels and interior. Interior conditioning, furnaces, water are not binding in other state heaters and permanently installed damage to ceilings, elevated carpeting, panelling, bookcases courts, it is likely that those surfaces and windows are usually and cabinets decisions will impact the analysis the result of wind damage. of Sandy cases. As a result, insurers Like fl ood adjusters, property Not covered can point to favourable Katrina adjusters are required to decisions as a persuasive authority O ⅷ Decks, patios, swimming pools, photograph and document wind Michael R Fox septics systems, wells, fences, in interpreting coverage provisions and fl ood damage. is a partner in walks, hot tubs and ACC language to limit the Coverage recovery under property policies Practice at Nelson ⅷ Strict limitation for basement Claims and denials Levine de Luca & structure and content to the damage caused exclusively Since the sustained hurricane-force Hamilton by wind. www.insiderquarterly.com 79

East Coast ood damage

Flood policies in eect Recent damage

as of 30 Nov 2012 estimates 170,063 in New York 570,000 homes and businesses 236,229 in New Jersey 536,000 homes and businesses INSIDE DISTRIBUTION

Winds of change Two opposing winds threaten to whip up a UK distribution storm: the FSA’s increased scrutiny of risk transfer contracts and growing concerns from insurers about credit risk. John Needham assesses the likely outcome...

Risk transfer is a positive non-life business, it is normal for that risk as much as possible, at Ofor the distribution chain premium money to pass through least so far as the customer is and goes to the core of the the distribution chain to the concerned. If the intermediary relationships between insurers, insurer, and in many cases it is is operating under a risk transfer brokers and agents. also normal for claims monies to agreement with the insurer, the While MGAs and most of the pass through that chain from the customer does not bear the risk high street broker distribution insurer. of the intermediary failing. Th is network would like more of it – At any stage, when money is in is because the money paid to the as it reduces client money costs the chain, either the customer intermediary is deemed to have – there are two winds blowing in or the insurer is exposed to a been paid to the insurer, so the the opposite direction that could credit risk – i.e. the risk that insurer bears that risk instead. signifi cantly reduce risk transfer the intermediary will fail while Another key issue in a risk in the future. holding their money, or that transfer framework is whether Th e fi rst comes from the the money concerned is used the insurers’ direct intermediary Financial Services Authority for purposes other than those can pass risk transfer down to (FSA) and its heightened scrutiny envisaged by the customer. sub-agents – a practice known as of risk transfer contracts. Many of Th e FSA’s client money rules and cascading risk transfer. these aren’t worth the paper they the concept of risk transfer defi ne If an insurer does provide an are written on and a big exercise who bears that risk and, if it is the intermediary with cascading risk is underway to get such contracts customer, protect the customer transfer, it is also taking on the right. Th is exercise brings the from the risk. If the client money credit risk in relation to any sub- issue into sharp focus for insurers, rules prevail, then the risk lies agent through whom its premium and the more they think about it with whichever party has paid monies or claim monies pass. the less they like the risk transfer money to the intermediary – the arrangement. customer for premium money, Risk transfer vs client money Th e second comes from insurers and the insurer for claim money. Intermediaries are happy to worried about credit risk. Even Th e rules are there to limit operate under risk transfer some large insurers don’t have agreements rather than a client much of a grip on credit risk and money framework because it the sums involved are substantial. means they do not have to comply Providing risk transfer increases with the client money rules, and credit risk and insurers aren’t “Intermediaries are happy to if it has cascading risk transfer, it convinced that they want to go can pass that privilege on to any this route. operate under risk transfer sub-agents producing business At the heart of the issue is the agreements because it means for it. way insurance money is handled Both the intermediary and and the threat posed to that they do not have to comply with the sub-agents concerned money by the risk of failure. In the client money rules” have to comply with whatever

80 www.insiderquarterly.com INSIDE DISTRIBUTION

requirements are set out in its agreements with the relevant “In future, there will be a shift towards risk insurers, but this is normally seen as a considerably less onerous transfer being granted in agency relationships, compliance burden, and thus but not in broking relationships” provides a cost saving – which is not to be gainsaid in diffi cult times. Th e FSA’s drive has raised the but not in broking relationships; Another less obvious point profi le of the issue for insurers, it is not a universal shift , but it is is that some intermediaries, in which have started to ask why a prevailing wind that refl ects a dealing with insurance money they should give risk transfer to commercial logic. outside of a client money rules an intermediary at all – bearing in But there is a competing logic framework, have in fact been able mind that doing so increases their that blows in favour of risk to use that money as working exposure to credit risk. What is transfer. capital for their own business, the insurer getting in return for Some intermediaries may need or indeed to fund acquisitions. taking on that risk? risk transfer to help reduce their Insurers have known about this to own costs. a variable extent, but the practice Agency relationships And in many cases smaller is now entirely frowned upon. A risk transfer framework is a producing sub-agents, which are Th e FSA has criticised the natural fi t for an agency perhaps unable to deal with the standard to which intermediaries relationship between intermediary compliance burden of dealing have followed the client money and insurer, where the with client money, will be frozen rules, and also the failure of the intermediary acts as agent, not out unless an intermediary off ers client money auditors to identify only in selling the insurance cascading risk transfer. breaches and report them. Failing policy and handling any claims, In this situation the ability to comply with the client money but also in receiving and dealing or willingness to provide risk rules can pose a threat to the with the money paid as premium transfer becomes a commercial level of protection aff orded by or claims. diff erentiator for insurers. the client money trusts, and the Th e insurer benefi ts from this Insurers’ business development FSA understandably sees this as business relationship as the agent managers will say that they need a serious risk. Th at suggests the acts on the insurer’s behalf and in to be able to provide risk transfer FSA would be very happy for risk its best interests. Even cascading in order to meet their targets. transfer to be the more prevalent risk transfer can be seen in this From an international framework – and in principle that light. perspective, the regulation is probably right. When the intermediary is acting of brokers and the structures Unfortunately, the FSA has as broker rather than agent, of the distribution chains are also identifi ed that a very large however, the assumption by the diff erent everywhere. In many proportion of the risk transfer insurer of the credit risk feels jurisdictions there is no concept frameworks operated by more commercially questionable. of fi duciary money, but insurers intermediaries are not soundly Th e insurer might reasonably in jurisdictions that are seeking based in clear and unambiguous look to be recompensed somehow Solvency II equivalence status will agreements as is required, in for the risk, for instance through be subject to similar pressures so order for the client money rules lower acquisition costs. far as the provision of capital for not to apply. Th is awareness is becoming credit risk is concerned. Th erefore, the FSA is driving increasingly evident in the To avoid becoming the victims towards only allowing a risk market. Insurers are questioning of change, brokers and agents transfer framework to be operated risk transfer agreements, partly should take the initiative. Th ey if the contractual basis is rock as a matter of good commercial ought to take a detailed look at solid (and that means that risk housekeeping, but also driven all the relevant agreements and transfer agreements need to be by the greater focus brought by identify where they need to be reviewed and oft en revised across Solvency II on the risks they bear changed to meet the regulator’s the whole industry) – otherwise and for which they must hold concerns. During this process compliance with the client suffi cient capital. O they should liaise with insurers money rules must be improved In future, there will be a shift John Needham in order to highlight any of the is a partner with in practice and audited more towards risk transfer being accountancy ﬁ rm insurer’s concerns about credit critically. granted in agency relationships, Littlejohn risk and off er workable solutions. www.insiderquarterly.com 81 Peter Matson is to step down as director of underwriting at Argo Group’s Lloyd’s operation in March. Matson’s role at Argo International will be ﬁ lled by aviation specialist Bruno Ritchie, subject to regulatory approval.

Industry veteran Martin Sullivan, deputy Endurance Specialty Holdings has ended chairman of Willis Group and chairman its search for a global reinsurance CEO and CEO of Willis Global Solutions, is by appointing Jerome Faure, who leaving the broker in May “to pursue will join the ﬁ rm from ILS Capital other interests”. Sullivan, the former Management in March. Faure will be CEO of American International Group, responsible for Endurance’s North joined Willis at the end of 2010. American, Bermudian and international reinsurance operations.

Former Lockton International CEO Ecclesiastical group CEO Michael Julian James is set to take up the Tripp has announced his intention role of president at Allied World to retire from the post “in the Europe on 4 March, subject to course of 2013”. Tripp, who joined regulatory approvals. James, who the company as CEO in January left Lockton in January, had been 2007, has signifi cantly reshaped the CEO of the fi rm’s international company during his time in offi ce. unit since 2008.

Lloyd’s chairman John Nelson is ProSight Specialty Underwriters announced to step down as chairman of UK the appointment of Mark Hewett as and European property company chairman in January, with immediate Hammerson on 9 May 2013. effect. Hewett was previously chairman The move is not expected to of Guy Carpenter (UK), having held change Nelson’s employment the post since 2007, before which he arrangements at Lloyd’s, where the occupied the managing director’s role. executive works a three-day week.

Steve Matanle has resigned from Allianz Global Corporate & Specialty THB. He joined the broker in May has appointed Simon Buxton as 2009 as CEO of its Lloyd’s broking global head of reinsurance, with operation, Thompson Heath & Bond. effect from 1 January. Buxton moves THB group chief executive Frank from Allianz Risk Transfer to succeed Murphy will take on Matanle’s Henning Haagen, who has taken responsibilities in addition to his on the role of EMEA/Asia Paciﬁ c current role. global aviation head.

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