Finite Risk in 2003Finite Risk in 2003...It Isn’t 1998 Anymore...It Isn’t 1998 Anymore

Edward S. Hochberg, CPA, CPCUEdward S. Hochberg, CPA, CPCUMark Callahan, FCAS, MAAAMark Callahan, FCAS, MAAADavid Koegel, ACAS, MAAADavid Koegel, ACAS, MAAA

Finite Risk in 2003Finite Risk in 2003

Edward S. Hochberg - SVP Pegasus AdvisorsPMA Re, Deloitte&Touche

Mark Callahan - SVP XL ReM&R, Scruggs

David Koegel - SVP Enterprise/Imagine Deloitte&Touche, Gil&Roeser, Am Re, AIG, ISO

Finite Risk in 2003Finite Risk in 2003

Topics to be covered:

• Finite Risk Market Overview

• The Buyer’s Perspective

• The Seller’s Perspective

• Example Transactions

• Underwriting environment-traditional

• Underwriting environment-finite

• Interest rate environment

• Accounting and disclosure issues…post-Enron

Finite Risk in 2003Finite Risk in 2003Market OverviewMarket Overview

• The world in 1998…The world in 1998…– VERY soft pricing and

terms

– No lack of capacity

– Virtually anything could get done at attractive (buying) pricing and terms

• The world in 2003…The world in 2003…– Market much harder post

9/11

– While there is often ample capacity, it comes at high (often unattractive) prices

– Difficult to get coverage for certain lines, classes, and exposures

Finite Risk in 2003Finite Risk in 2003Market Overview-Traditional EnvironmentMarket Overview-Traditional Environment

• The world in 1998…The world in 1998…– VERY soft pricing and terms– No lack of capacity– Virtually anything could get

done at attractive (buying) pricing and terms-everything had a price

– Adverse selection and risk aggregation

– Many active market participants

– Reputation risk rarely considered

• The world in 2003…The world in 2003…– Market much harder post

9/11…pricing and terms

– Several very active markets have exited the business (e.g. Stockton, Scandinavian, OPL, Commercial Risk)

– Not everything has a price

– Market much more intelligent about risk aggregation, credit risk, and other exposures

– Reputation risk considered

Finite Risk in 2003Finite Risk in 2003Market Overview-Finite EnvironmentMarket Overview-Finite Environment

• The world in 1998…The world in 1998…– The 10-year US Treasury

was 5.80% (4/28/98)

– Time value of money was a significant/dominant component of many finite risk transactions

• The world in 2003…The world in 2003…– The 10-year US Treasury

was 3.90% (4/28/03)

– Significantly changes the economics of many finite risk transactions…much less reliance on time value of money

Finite Risk in 2003Finite Risk in 2003Market Overview-Interest Rate EnvironmentMarket Overview-Interest Rate Environment

• The world in 1998…The world in 1998…– “Enron” had not yet occurred

– Relatively few scandals involving reinsurance

– Relatively less stringent focus on application of reinsurance accounting standards

– Less focus from rating agencies and analysts

• The world in 2003…The world in 2003…– Post-Enron…Sarbanes-enough

said– Scandals/Insolvencies:

Independent, HIH, PHICO, Reciprocal Group

– Very stringent application of accounting standards and auditing thereof; specific focus on accrual issues and quota share reinsurance

– Analysts and rating agencies increased focus…end of “in-the-money” transactions

Finite Risk in 2003Finite Risk in 2003Market Overview-Accounting and DisclosureMarket Overview-Accounting and Disclosure

• The world in 1998…Buyer MotivationThe world in 1998…Buyer Motivation– Discounting of losses– Spreading of catastrophe losses– Y2K– Unusual exposures…e.g. credit, “integrated risk”, etc.

• The world in 1998…Product ExpectationsThe world in 1998…Product Expectations– Inexpensive, with loose terms, plenty of capacity– Lack of attention to credit risk and other issues– Relatively few accounting issues

Finite Risk in 2003Finite Risk in 2003Buyer PerspectiveBuyer Perspective

• The world of buying finite risk in 2003The world of buying finite risk in 2003– Accounting issues

– More scrutiny—rating agencies, analysts, auditors

– More expensive—stricter terms and conditions

– Less benefit from time value of money

• WHY IS DEMAND INCREASING?WHY IS DEMAND INCREASING?

Finite Risk in 2003Finite Risk in 2003Buyer PerspectiveBuyer Perspective

• Increase in DemandIncrease in Demand– The main reason finite risk is used (reconciliation of

accounting models to underlying economics still exists)

– Better underwriting environment is pressuring leverage limits for many companies

– Significant increases in cost for many classes of traditional reinsurance are making finite risk structures a cost-effective solution for many companies (e.g. workers’ compensation, medical malpractice)

– May be the only cost-effective way to deal with certain exposures (e.g. terrorism, mold, others)

Finite Risk in 2003Finite Risk in 2003Buyer PerspectiveBuyer Perspective