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Enhancing Shareholder Value through capital risk management – an Insurer’s perspective
PRMIA Members Luncheon
Tony ColemanChief Risk Officer and Group Actuary
20 February 2003
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Presentation Overview
• Capital Management
• The Risk Environment
• The Risk Control Cycle & Management of volatility
• Climate Change – new uncertainty
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• Balancing “conflicting” stakeholder expectations
– customers
– shareholders
• Capital provides support in face of adverse outcomes from:
– insurance activities
– investment performance
– operations
• Implications for capital management
– need for an integrated approach
Capital Management
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Maximum capital
Minimum target capital
Excess capital
Operating zone for capital
management
Minimum additional capital
Regulatory capital
Liabilities
Components of Capital
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• Inwards Reinsurance/GIO Re
• 11 September / Terrorism
• HIH / Corporate Governance
• Asbestos Liabilities
• Medical Indemnity
• Tort Law Reform (Public Liability)
• Natural Catastrophes
• Industry Consolidation
• Poor Equity Markets
• Pricing Cycle
Some Recent Risks for Insurers
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Stock markets vs. premium Stock markets vs. premium ratesrates
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Effective Insurance Management
Risk management uses a control cycle
Performance
management
Pricing
Risk management
Reserving
Capital
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• Establish risk appetite
– decide what risks are essential, shed others
– decide target financial strength (“risk of ruin”)
• Identify and assess risks
– understand ALL material risks (including operational)
– quantify the distribution of outcomes from the risks
undertaken
• Keep risks “in control”
– monitor exposures and outcomes
– respond to “out of control” outcomes
Role of Risk Management
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AssetAllocation
InvestmentsInsurancePortfolio
InvestmentReturn
PremiumIncome
Claims andExpenses
ReinsuranceProgram
Profit
Shareholders
Dividends Capital infusions RewardRisk
Dynamic Financial Analysis
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• Volatility and the risk / return trade-off
• Dimensions of volatility
– business process / operational
– balance sheet
– strategic
Management of Volatility
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High ReturnCompanies
Low ReturnCompanies
Earnings Volatility
Earnings VolatilityEarnings Volatility
Earnings Volatility
High
High High
HighLow
Low Low
Low
Volatility and Shareholder Value
Low Earnings Growth Companies
High Earnings Growth Companies
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• Holistic, enterprise-wide, risk management in response to
changing environment
• Increasing sophistication – in-house capital measurement
models
• Importance of earnings predictability
• Focus on drivers of long term value
The Way Forward
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Global temperatures have increased. 1990’s were the warmest decade and 1998 the warmest year since records began in 1861. Further increases are projected.
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• Insurers calculate, price and spread risk across the
community
• Claims paid represent largest cost of an insurer (claims >
80% of home and motor premiums)
• If frequency or severity of claims increases, insurers have to
increase premiums or mitigate risk to stay viable
• Climate change is expected to increase BOTH the frequency
and severity of claims incurred
Weather and Climate are core business for insurers
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$0
$20,000,000
$40,000,000
$60,000,000
$80,000,000
$100,000,000
$120,000,000
$140,000,000
$160,000,000
More of these events will increase premiums dramatically
A few extreme events cause majority of losses(NSW, NRMA Building Insurance Top 20 Storm Events 1987-2002)
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Small increases in wind speed can significantly increase losses (NSW, NRMA Building Insurance only)
0
100
200
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400
500
600
700
Under 20 knots 20-40 knots 40-50 knots 50-60 knots
% In
crea
se in
Dam
ages 25% increase in peak gust causes 650%
increase in building damages
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• What are the implications under various Climate Change
scenarios?
• Very little research in this area at present
• Climate Change means that historical records become less
relevant
• Modelling and our capacity to predict become extremely
important
How will hailstorms be affected by climate change?
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18/3/1990
14/4/1999
21/1/1991
3/10/198628/10/1995
Many people and properties at risk
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• This modelling is on the cutting edge – using state of the
art models and technical expertise
• Initial analysis based on the April 1999 event
• How much larger or more intense is possible?
• How will their characteristics and behavior change?
• How much more likely are they to occur?
• The answers were surprising!
IAG’s storm modelling and climate change
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Economic losses doubling every 10
years
Costs of global disasters are increasing
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• Proactive – at a policy level, we support initiatives that reduce greenhouse emissions
• Corporate ecology
– corporate energy efficiency initiatives
– procurement policies
• Research
– Weather-related risks and climate change
– new products and services which create business value and
encourage sustainable behaviour
IAG’s response