Agenda

1
Agenda

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

2
How did booming stock markets influence insurers
behavior in the recent soft market phase?
Change in Stock Market Capitalization( Dec- Dec,
mn. USD)
8 000 000
6 000 000
4 000 000
2 000 000
0
-2 000 000
-4 000 000
-6 000 000
93
94
95
96
97
98
99
00
01
02
DAX30 Germany
SP500 US
TOPIX Japan
CAC 40 France
FTSE 100 UK
AEX Netherlands
3
Extreme and highly correlated price fluctuations
in reinsurance and commercial lines
4
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?

5
Possible explanations

• Lack of information, time-lag in raising prices-
  (Re-)insurers dont care about prices (dont
  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

6
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?

7
The current situation

• The PC 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 PC insurance
  industry as many companies cannot afford to
  invest in stocks anymore

8
Several shocks result in depletion of capital
In billions

• 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

Sources III, A.M.Best, Moodys, Swiss Re
Economic Research Consulting
9
The major reason for under-capitalization Stocks
lost 40 to and 60 of their value since 2000
stock index, 1980100
Source Datastream
10
Lower investment yields demand for better
underwriting result
Asset leverage 263 Tax rate 21 NPW/surplus 92.
3 Inv yield 7.2
ROE
6.5
7.26.25.2
110.2
99.7
Combined Ratio
11
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

12
Will history repeat? Yes!

• Same players -gt 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

13
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