Managing the UW Cycle

CAReHamilton Bermuda

June 2005

John Doucette

I. The Underwriting Cycle

II. Company Strategies

III. Actuaries and the Cycle

Introduction

I. The Underwriting Cycle

“Insurers sell a non-proprietary piece of paper containing a non-proprietary promise. Anyone can copy anyone else’s product. No installed base, key patents, critical real estate or natural resource position protects an insurer’s competitive position. Typically, brands do not mean much either. What counts in this business is underwriting discipline.”

“There seems to be some perverse human characteristic that likes to make easy things difficult.”

Source: USAIG

According to Warren Buffett

I. The Underwriting Cycle

1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2004

115.9%118.0%

116.3% 115.7%

120%

115%

110%

105%

100%

95%

90%

World Trade Center LossReturn on Average Invested AssetsCombined Ratio

14%

12%

10%

8%

6%

4%

2%

0%

P&C Insurance Market Combined Ratio1955 to 2004

Source: General Re

II. Company Strategies

Fundamental Strategy : Long Term Book Value Growth

• The ability to compound real book value per share over time is the single most important measurement tool (Total Value Creation) when comparing property/casualty (re)insurers.

• Creating value over time is the sum of:i. traditional insurance operating results ii. capital gains and losses on the investment portfolio

iii. capital management decisions

Source: Dowling & Partners

II. Company Strategies

To achieve fundamental strategy throughout a cycle

• First decide on total allocation of capital to (re)insurance based on where in the cycle

• Hard Capital• Equity• Debt• Dividend strategy

• Soft Capital• Amount of reinsurance support• Form of reinsurance

• Capital Management

II. Company Strategies

To achieve fundamental strategy throughout a cycle

• Then decide where to best to allocate the total amount of capital• Insurance vs. reinsurance

• Class / Line: • Short tail vs. long tail vs. specialty• Various lines by adequacy

• Form of coverage offered

• Liability risk vs. asset risk

• Fee income vs. underwriting risk

II. Company Strategies

To execute that strategy, a (re)insurer needs to know

1. Where are we in the cycle?

2. What is the expected cost of goods sold?

3. What is an appropriate capital allocation methodology• Top down vs. bottom up• Risk capital vs. rating agency capital vs. other constraints

4. Based on (2) and (3), what is technical price?

Bottom line: (Re)insurers need quantitative power to understand and execute the fundamental strategy

III. Actuaries and the Cycle

In hard market, need actuaries / quantitative skills for

• Capital planning• Strategic business planning• Pricing lines of insurance / reinsurance treaties• Allow for translation of results for various audiences

• Underwriters• Management• Shareholders• Rating agencies• Regulator• Clients

• Improve transparency

In hard market, actuaries have skill sets that can provide more impact on rank ordering the opportunity set to optimize risk adjusted return (Strength)

III. Actuaries and the Cycle

In softening market

• Aspects as per the hard market are required and more

• Lower hit ratio on transactions

• More analysis of profitability by line

• More analysis of reinsurance / retrocessional strategy

In soft market, actuaries have skill sets that can provide more even more value to (re)insurance company (Strength)

III. Actuaries and the Cycle

Lessons learned from CEO survey about actuaries

• Too narrow and too technical

• Reserve analysis only because of certification required

• “Actuaries pursuing greater precision in areas of decreasing relevance.”

• Need to develop general business skills

• Need to enhance their value – communication / execution

Reality, or perception of that reality by key actuarial clients (senior management), that actuaries are too technical and not business savvy(Weakness)

III. Actuaries and the Cycle

First the good news for actuaries

• Our industry is becoming more quantitative• Pulled by regulators

• SOX• SEC• Lloyds / RBC / ICA• FSA

• Pushed by competitive forces

• Broader number and type of risks to be managed

• More transparency required

Going forward, more demand for quantitative skills (Opportunity)

III. Actuaries and the Cycle

Now the bad news for actuaries

• Quantitative skills do not mean CAS actuaries are required

• Cat modelers

• Technically strong underwriters

• Large US insurer(s) training recent college grads (non-actuaries) to fill actuarial pricing role

• Chief risk officers

Supply needed to meet quantitative demand may not filled by actuaries???(Threat)

Traditional Actuarial Roles

94%

Non-Traditional Roles6%

III. Actuaries and the Cycle

Non-traditional Roles for Actuaries

President/ CEO50%

Underwriting15%

RiskManagement

22%

Finance/Investment

7%

III. Actuaries and the Cycle

Non-traditional Roles for Actuaries

Conclusion

The UW cycle- Non-transparency of risk / pricing- Classic supply and demand- Inevitability

Company Strategy throughout the cycle- Compound real book value per share over time- Diversification only works if lines / deals create (and not destroy) book value growth

Actuaries- Consider SWOT analysis- Look to CEO lessons learned- Try to proactively add value to company in different ways