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Agenda: 

Agenda The cycle: facts and figures What went wrong in the past soft cycles?

How did booming stock markets influence insurers’ behavior in the recent soft market phase? : 

How did booming stock markets influence insurers’ behavior in the recent soft market phase? Change in Stock Market Capitalization( Dec- Dec, mn. USD) -6 000 000 -4 000 000 -2 000 000 0 2 000 000 4 000 000 6 000 000 8 000 000 93 94 95 96 97 98 99 00 01 02 DAX30 Germany S&P500 US TOPIX Japan CAC 40 France FTSE 100 UK AEX Netherlands

Extreme and highly correlated price fluctuations in reinsurance and commercial lines : 

Extreme and highly correlated price fluctuations in reinsurance and commercial lines

Questions: 

Questions Why do prices fall far below reasonable levels? Why do insurers write business, which is not profitable? Why do insurers provide more coverage when prices are low?

Possible explanations: 

Possible explanations Lack of information, time-lag in raising prices - (Re-)insurers don’t care about prices (don’t underwrite). They only react to bad underwriting results or bad overall results Only market share matters - Capacity determines how much coverage is provided. Prices fall until demand meets excess supply - (Re-)insurers are afraid of loosing market share, they expect to be compensated in the hard market for losses in the soft market Principle agent problems - Underwriters and sales people are afraid to lose their job by not writing business in soft market phases - Managers are afraid of missing top-line growth targets dictated by financial analysts

Questions for discussion: 

Questions for discussion What are the impediments for implementing better cycle management? Can insurers reduce market share without threatening the long term market position? How do financial analysts react when premiums go down in the soft cycle? Which lines of business are suited for cycle management? Are big players able to cyclically step in and out? How to adapt capacity to cyclical needs? How to deal with excess capacity?

The current situation: 

The current situation The P&C insurance industry is under-capitalized. As a result the industry is extremely vulnerable to major loss or loss inflation shocks The treasury rate will become the new norm for the investment returns of the P&C insurance industry as many companies cannot afford to invest in stocks anymore

Several shocks result in depletion of capital: 

Several shocks result in depletion of capital September 11 30-50 (18.1 paid) Enron: 3 Other „problem bonds“ 7 Estimated losses on equity investments US Europe 2000 18 n.a. 2001 24 40 2002 39 59 Reserve strengthening of US liability bus. 30-40 In $ billions Sources: III, A.M.Best, Moody’s, Swiss Re Economic Research & Consulting

The major reason for under-capitalization: Stocks lost 40% to and 60% of their value since 2000 : 

Source: Datastream The major reason for under-capitalization: Stocks lost 40% to and 60% of their value since 2000 stock index, 1980=100

Lower investment yields demand for better underwriting result: 

Combined Ratio Asset leverage: 263% Tax rate 21% NPW/surplus 92.3% Inv yield: 7.2% 110.2 6.5% Lower investment yields demand for better underwriting result 99.7 ROE 7.2% 6.2% 5.2%

Impact on insurance: 

Impact on insurance Investment risks and underwriting risks will be reduced, risk management and more conservative underwriting will become top priorities As a result of under-capitalization and to compensate for low investment returns prices will go up further and terms & conditions will tighten Cost reduction will become another top priority. This includes lay off of staff, but also selling unprofitable parts of the business. Price increases, exposure and cost reduction will contribute to internal financing. Many companies will also approach capital markets for additional financing Reinsurance and alternative risk financing will gain in importance

Will history repeat? Yes! : 

Will history repeat? Yes! Same players -> same behavior - The players are the same as in the last cycle, why should they behave different from the past Capacity comes back soon - After a few years of high prices capacity will drive prices down again; Bermuda capacity will accelerate this process Yes but…. Capacity shortage will only be removed in the more standardized business

Will history repeat? No!: 

Will history repeat? No! Long period of capacity shortage - The amount of capacity destroyed is so big that we will see a long period of high prices - US liability claims will create a need for additional reserve strengthening Deliberate change - The corporate landscape in insurance will change. The most cyclical businesses, commercial lines insurance and reinsurance, have become a pure play and will behave different in future - More and more insurers will follow a cyclical management approach. This will impose market discipline Forced change - Competition form capital markets will not allow for recuperation of soft market losses in future. - Due to increased transparency financial analyst and rating agencies will be able to closer observe insurers. - Those who will not stick to cycle management will be unprofitable and forced to leave the market

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