Tail Risks – How does a CEO think about them?

10th September 2013

Bronek Masojada

Hiscox Ltd

Business Motivation

Create a business which serves customers distinctively with specialist insurance/reinsurance products in a way which maximises return on equity within a well defined risk appetite

2

Maintain Balance

3

Products + Profits

Risk +Returns

Maintain Balance

4

Products + Profits

Risk +Returns

Maintain Balance

5

Products + Profits

Risk +Returns

Maintain Balance

6

Products + Profits

Risk +Returns

A few beliefs

• A model will never fully reflect the real world

• We cannot run our businesses without models

• Individuals will always seek to game the system

• More data and/or analysis doesn't always help you understand a risk

• You can have too much of a good thing

7

There are limits to how well a model can ever reflect real life

8

Boxplot and whisker diagram of modelledHiscox Ltd net loss (US$m) June 2013

Mean industry loss US$bn

Industry loss returnperiod and peril

Lower 5%- upper 95% range

Modelled mean loss

Hur

rican

e K

atrin

a $5

0bn

mar

ket l

oss

21 y

ear

retu

rn p

erio

d

Hur

rican

e A

ndre

w $

56bn

mar

ket l

oss

25 y

ear

retu

rn p

erio

d

Nor

thrid

ge Q

uake

$24

bn m

arke

t los

s 40

yea

r re

turn

per

iod

Sup

erst

orm

San

dy -

$20

bn m

arke

t lo

ss, 7

yea

r re

turn

per

iod

1987

J $

10bn

mar

ket l

oss

15 y

ear

retu

rn p

erio

d

Lom

a P

rieta

Qua

ke $

6bn

mar

ket l

oss

15 y

ear

retu

rn p

erio

d

JP EQ – Japanese earthquakeUS EQ – United States earthquakeEU WS – European windstormUS WS – United States windstorm

2011

Toh

oku

Qua

ke $

25bn

mar

ket l

oss,

45

yea

r re

turn

per

iod

5-10 year 10-25 year 25-50 year 50-100 year 100-250 year

01 02 05 19 04 07 09 39 19 18 14 69 38 32 19 103 66 40 26 160

His

cox

Ltd

loss

(U

S$m

)

9

Do people game the system?

10

Confusing mysteries with puzzles

Puzzles are attractive because they come to clean conclusions. Puzzles can always be solved if you just pay attention to the right information, which is all there for you.

Unfortunately, many of the big problems that we face are not puzzles, but rather mysteries. Mysteries are messy, and the methods that solve puzzles don’t work for mysteries, and they might actually make them worse.

Open Secrets by Malcolm Gladwell

11

Hiscox focus – No single class overwhelms

Total Group controlled income for 2012 100% = £1,792m

Global errors and omissions

Large property

Marine and energy

Tech and media errors and omissions

Specialty – kidnap and ransom, contingency, personal accident

Local errors and omissionsand commercial

Art and private client

Specialty – terrorism, specie, political risks, aerospace

Reinsurance 28%

18%

3%

14%

5%8%

10%

2%

7%

5%

Small property

12

Done well – create a symbiotic relationship

Profit generator

Value creator

Profit generator

Value creator

• Larger premium, catastrophe exposed

• Shrinks and expands according to rates

• Excess profits allow investment in retail development

Internationally traded lines

• Steady premium growth

• Pays dividends

• Brand builds strong market position

• Profits act as additional capital

Local specialty lines

13

Managing the tail

1

Micro and Process Focus

• Individual, business unit, and executive authorities and limits

• Business plan and business process review and performance

• Day to day risk management processes

• Process for identifying new risks, dealing with them and triaging them into business as usual

1

Macro and Strategic Focus

• Regular reviews of the top 10 risks in the business

• Discussion and debate on business unit and overall organisations strategy and ambitions

• What happens when the Capital models or risk controls fail?

• Grey swan brainstorming and thinking – 1 in 10 to 1 in 50.

• Thematic reviews

Rationale

• Avoid a focus on controls and processes as the sole determinants of effective governance in an organisation

• Manage scale of information flows

• Focus on bigger issues means that gaming becomes harder

Manage the tail

14

Maintain Balance

15

Products + Profits

Risk +Returns

Maintain Balance

16

Products + Profits

Risk +Returns

Maintain Balance

17

Products + Profits

Risk +Returns

Maintain Balance

18

Products + Profits

Risk +Returns

Achieve Balance

19

Products + Profits

Risk +Returns

Tail Risks – How does a CEO think about them?

10th September 2013

Bronek Masojada

Hiscox Ltd