State of the Reinsurance Market and Implications for Primary InsurersSouthern California Casualty Actuarial Club

Bob Fox, ACAS, MAAAManaging Director, Catastrophe ActuarialAon BenfieldJune 6, 2013

2

Agenda SlideSection 1 State of the Reinsurance MarketSection 2 Implications for the Property Insurance Market

Section 1State of the Reinsurance Market

4

ERM

5

ERM

EnterpriseReinsuranceMinimization

6

Reinsurance Premiums by Line

2000 20120

5

10

15

20

25

30

35

40

45

50

CasualtyProperty

Bill

ions

Source: SNL

7Source: Aon Benfield Analytics

2012 very similar to average of 10 prior years Five years of severe weather has people asking if this is the “new normal”

$47.4b$48.4b

Global Catastrophe Losses by Year

CharlieFrances

IvanJeanne

KatrinaRita

Wilma

Ike

JoplinTuscaloosa

TohokuChristchurch

Thai Floods

Irene

8

1 Subject to change as loss estimates are further developed2 Includes losses sustained by private insurers and government-sponsored programs

2012 Top 10 Global Insured Loss Events

Drought/heatwave losses highlight the growth of Crop/Hail Insurance

9

Largest diameter: 945 miles– Previous record: 920 miles, 2010’s Hurricane Igor

Largest wave in New York Harbor: 32.5 feet– Previous record: 25.0 feet, 2011’s Hurricane Irene

Second NE event in two years for which hurricane deductibles did not apply– Deductible language variable across companies– Wind speed, hurricane category, etc.– Events do not drive tail, but generally not modeled correctly

“2/3 of all New York City homes damaged by Superstorm Sandy were outside of FEMA’s existing 100-year flood zone.”– Wall Street Journal– Estimate flood return period: 90 years

“With respect to storm surge, we think the [NOAA] SLOSH model generally performed well, and we calibrated our US storm surge expectations from that.” – Kean Driscoll, CEO, Validus Re

Super Storm Sandy – Overview

10

PCS Claims: ~ 1,152,000 Insured Loss Estimate: $18.75 billion

– Personal Lines Claims: $6.997 billion (average claim: $6,558)– Commercial Lines Claims: $9.024 billion (average claim: $44,563)– Automobile Lines Claims: $2.729 billion (average claim: $10,894)

Impact Forecasting $16 to $22 billion 80 to 90 Year Return Period

RMS $20 to $25 billion ~90 Year Return Period (NY, NJ)

AIR $16 to $22 billion ~85 Year Return Period

EQECAT $10 to $20 billion 70 to 90 Year Return Period

Super Storm Sandy – US Insurance Loss Estimates

Industry wind event return period: 5-10 years

11

Hurricane Sandy Impact on Shareholder Funds Average impact of Hurricane Sandy reported to date is 4.9%

**Alleghany SHF as of March 31, 2012 to incorporate Transatlantic acquisitionMid-points used where a range of loss was disclosedChart represents most recent disclosureSource: Individual company reports, Aon Benfield Analytics

12

ABA Historical Reinsurer Combined Ratio 2012 ABA showed improved combined ratio of 92.6% resulting from a 60% decline in total

catastrophe losses

Source: Individual company reports, Aon Benfield Analytics

-0.7% -2.4% -5.0% -4.0% -4.9% -5.0% -4.3%

27.3% 28.4% 28.7% 29.1% 29.8% 29.8% 30.0%

60.8% 60.0% 64.2% 62.6% 60.0% 60.3% 59.4%

0.9% 2.7%

6.6%1.7%

8.8%20.0%

7.5%88.3% 88.6%94.4%

89.4%93.8%

105.1%

92.6%

-10%

10%

30%

50%

70%

90%

110%

FY 2006 FY 2007 FY 2008 FY 2009 FY 2010 FY 2011 FY 2012Prior year reserve adjustment Expense ratio Attritional loss ratio Total catastrophe losses

13

Reinsurer Capital (USD Billions) by Year Year end 2012 reinsurer capital increased 11% over year end 2011 Reinsurer capital increased by USD5B throughout Q4 2012; a slower pace than earlier in the year Supply continues to exceed demand in all global regions

Source: Individual Company Reports, Aon Benfield Analytics

14

Source: Aon Benfield Securities, Inc.

Despite a decrease in Q4 2012 issuances from the prior two years, 2012 issuances reached an all time high of $6.3b based on the increased issuance activity in the first half of 2012

650 300 1,015

1,493 810

2,350 742

2,095

411

232

854

775

1,600

2,393 1,990

1,888

3,471

5,275

4,601

6,251

-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

2009 2010 2011 2012

$ M

illio

nsQ1 Q2 Q3 Q4

Cat Bond Issuance by Quarter

15

1.00% 1.50% 2.00% 2.50% 3.00%2%

4%

6%

8%

10%

Expected Loss

Risk

Pre

miu

m

1.00% 1.50% 2.00% 2.50%4%

8%

12%

16%

Expected Loss

Risk

Pre

miu

m

2013 ILS Market

Source: Aon Benfield Securities' RLS Indicative Price Sheets

As of May 31, 2013

New inflows of capital continue to outstrip supply, and spreads have decreased to historic lows– US multi-peril spreads are down 35% -

45% from 2012– Non-US peril spreads are down 15% -

20% from 2015

State Farm's Merna Re IV, covering New Madrid earthquake, was issued with the lowest spread for a cat bond since 2008

Allstate’s Sanders Re, providing US multi-peril coverage on index basis, priced blew market guidance and with Sharpe ratios at new lows

Twelve property cat bonds with a total of US$ 3.49 billion limit and one health bond with US$ 0.15 billion limit have closed

US Multi-Peril Spreads

Current Trendline

■ 2009 ■ 2010

■ 2011■ 2012

40%

36%

45%

Non-US Peril Spreads

Current Trendline

■ 2009 ■ 2010

■ 2011■ 2012

18%19%

18%

16

Seeking 600 to

800bps on dive

rsifyi

ng products

as yields o

n other credit r

elated asset c

lasses

press lo

wer

Risk per unit of capital

Insurers & Reinsurers

Pensions, Life Insurers,Endowments & Family Trusts

TI

ME

Risk adjusted returnon invested assets

Convergence

Seeking 1000 to 1600bps on

decreasing leverage

Insurance and capital markets are converging – global capital is growing ($ trillions) and looking for returns in a low interest rate environment

All amidst increasing insurer capabilities, increasing insurer demands, pricing pressure on brokers, declining demand for traditional reinsurance…

Insurance and Capital Markets are Converging

17

Pension assets of 13 countries

~$30T

Global capital supply figuresHighly Preliminary

Sovereign wealth funds~$5T

Private Equity~$3T

Insurance Capital~$3.4T

Reins. Capital~$505B

Non-lifeCapital~$1.9T

Source: Swiss Re, Bain, Towers Watson, Aon Benfield Analytics

Other, unquantified large pools of capital also exist• High net worth individuals• Retail investors• Hedge funds• Mutual funds• Exchange traded funds• Trusts• Other

Non-Traditional Capital is Massive and Has Begun to Enter our Space

18

SpecialtyInsurer

PersonalLines Insurer

Multiple LinesInsurer

Lloyd’sSyndicate

EmergingMarket Insurer

Life & AnnuityInsurer

Commercial Insurer

Health Insurer

Pension Funds

Life Insurers

High Net Worth Individuals

Hedge Funds

EquityInvestors

Insurer Debt &Mezzanine Investors

RetrocessionReinsurers

SPVs, Sidecars

and Managed

Funds

Utilize appropriate

capital sources for risks assumed

SelectRisks

All NetRisks

Form relationships

Understand a very wide range

of risks

Select from those risks

suitable business

Manage cycles and events

Managing Dynamic Portfolio of Risks

Assumed

ModernGlobal

Reinsurers

Managing Dynamic CapitalAssuming Risk

Modern Global Reinsurers and the Debt Challenge

19

Increasing Supply

Decreasing Supply

Exploding Investor Capital

Record Reinsurer

Capital

Reinsurer Stock

Repurchases

Reinsurance Supply Summary

20

Reinsurance Supply and Demand

P

Q

supplydemand

P0P1

Q0 Q1

21

What About Demand?

Source: Individual Company Reports, Aon Benfield Analytics

Insurer capital increased 10% from year end 2011 to year end 2012 Growth occurred due to lower catastrophe losses and higher primary premiums

22

Increasing Demand

Decreasing Demand

Low Investment Returns

Competitive Markets

Sluggish Insurance Demand

Strong Insurer Capital

Sovereign Debt Issues

Solvency II Capital Requirements

Insurer Stock Repurchases

Reinsurance Demand Summary

23

Reinsurance Supply and Demand

P

Q

supplydemand

P0

Q0

P1

Q1

Section 2Implications for the Primary Insurance Market

25

History of Homeowners Profitability

26

History of Homeowners Profitability

27

History of Homeowners Ratemaking

20’s-60’s• 5% Profit Provision

70’s-80’s• Offset for investment income

1990’s• Rise of auto specialists• Increase in hurricane activity leads to introduction of catastrophe models

2000’s• Profit models using P/S or R/S ratios• Reinsurance cost recovery standard in almost all states

2010’s• Cost of equity capital held to support catastrophe risk

28

Traditional Profit Model

Premium $150

Required Surplus @1.5 $100

Required Return @15% $15

Investment Return $6

Underwriting Return $9

Catastrophe Surplus $100

Investment Return $5

Cat Risk Margin

Total Return $20

Total Surplus $200

Return on Surplus 10%

29

Profit Model with Cat Risk Margin

Premium $150 $150

Required Surplus @1.5 $100 $100

Required Return @15% $15 $15

Investment Return $6 $6

Underwriting Return $9 $9

Catastrophe Surplus $100 $100

Investment Return $5 $5

Cat Risk Margin $10

Total Return $20 $30

Total Surplus $200 $200

Return on Surplus 10% 15%

30

Cost of Capital

Decreasing reinsurance premiums present an

opportunity to build in cost of capital

Accepted by Most Regulators

Understand drivers

Allocate in detail

31

California Example – Cost of Capital

Gross NetRequired Catastrophe Capital* 181,933,425 88,961,820 Target GAAP ROE 12.0% 12.0%SAP/GAAP Ratio 0.9 0.9Federal Income Tax Rate 35.0% 35.0%Investment Rate of Return 3.0% 3.0%Pre-tax Underwriting Return = [(2)/(3)]/[1-(4)]-(5) 17.5% 17.5%Cost of Required Catastrophe Capital 31,861,674 15,579,724

Fictitious California-only writer Based on AM Best Stressed BCAR Model Fire Following PML estimate from RMS RiskLink 13.0 Assumes reinsurance from 10-year to 100-year PML

32

California Example – Total Cost of Catastrophes

Without Reinsurance

With Reinsurance

Average Annual Loss 9,579,770 9,579,770 Net Cost of Reinsurance - 6,385,943 Cost of Net Required Catastrophe Capital 31,861,674 15,579,724 Total 41,441,445 31,545,437 Reinsurance Savings 9,896,007

California RatemakingRecoverable in Rates 9,579,770 9,579,770 Not Recoverable in Rates 31,861,674 21,965,667

Lesson: Don’t let regulatory restrictions dictate reinsurance purchase decisions How would this exhibit look for a national insurer with the same California exposure?

33

California Example – Total Cost of Catastrophes

Without Reinsurance

With Reinsurance

Average Annual Loss 9,579,770 9,579,770 Net Cost of Reinsurance - 6,385,943 Cost of Net Required Catastrophe Capital 31,861,674 15,579,724 Total 41,441,445 31,545,437 Reinsurance Savings 9,896,007

California RatemakingRecoverable in Rates 9,579,770 9,579,770 Not Recoverable in Rates 31,861,674 21,965,667

Lesson: Don’t let regulatory restrictions dictate reinsurance purchase decisions How would this exhibit look for a national insurer with the same California exposure?

– AAL unchanged– Lower reinsurance cost (California is diversifying risk to reinsurers)– Lower capital cost (diversification benefit within company)– Most of reinsurance and capital cost recoverable in rates

34

Potential Unintended Consequences of Regulatory Restrictions

• Excessive reinsurance• Excessive rate indications• Greatest harm to insurers concentrated in state

Allow Reinsurance but not Capital Cost

• Inefficient single-state towers• Excessive rate indications• Greatest harm to multi-state insurers

Allow Reinsurance but Limit Allocation

• No savings due to reinsurance• Excessive rate indicationsAllow Capital Cost

but not Reinsurance

• Inadequate rates• Availability may be limited• Greatest harm to insurers concentrated in state

Allow Neither Reinsurance Nor

Capital Cost

35

Potential Unintended Consequences of Regulatory Restrictions

• Excessive reinsurance• Excessive rate indications• Greatest harm to insurers concentrated in state

Allow Reinsurance but not Capital Cost

• Inefficient single-state towers• Excessive rate indications• Greatest harm to multi-state insurers

Allow Reinsurance but Limit Allocation

• No savings due to reinsurance• Excessive rate indicationsAllow Capital Cost

but not Reinsurance

• Inadequate rates• Availability may be limited• Greatest harm to insurers concentrated in state

Allow Neither Reinsurance Nor

Capital Cost

36

Potential Unintended Consequences of Regulatory Restrictions

• Excessive reinsurance• Excessive rate indications• Greatest harm to insurers concentrated in state

Allow Reinsurance but not Capital Cost

• Inefficient single-state towers• Excessive rate indications• Greatest harm to multi-state insurers

Allow Reinsurance but Limit Allocation

• No savings due to reinsurance• Excessive rate indicationsAllow Capital Cost

but not Reinsurance

• Inadequate rates• Availability may be limited• Greatest harm to insurers concentrated in state

Allow Neither Reinsurance Nor

Capital Cost

37

Potential Unintended Consequences of Regulatory Restrictions

• Excessive reinsurance• Excessive rate indications• Greatest harm to insurers concentrated in state

Allow Reinsurance but not Capital Cost

• Inefficient single-state towers• Excessive rate indications• Greatest harm to multi-state insurers

Allow Reinsurance but Limit Allocation

• No savings due to reinsurance• Excessive rate indicationsAllow Capital Cost

but not Reinsurance

• Inadequate rates• Availability may be limited• Greatest harm to insurers concentrated in state

Allow Neither Reinsurance Nor

Capital Cost

38

Potential Unintended Consequences of Regulatory Restrictions

• Excessive reinsurance• Excessive rate indications• Greatest harm to insurers concentrated in state

Allow Reinsurance but not Capital Cost

• Inefficient single-state towers• Excessive rate indications• Greatest harm to multi-state insurers

Allow Reinsurance but Limit Allocation

• No savings due to reinsurance• Excessive rate indicationsAllow Capital Cost

but not Reinsurance

• Inadequate rates• Availability may be limited• Greatest harm to insurers concentrated in state

Allow Neither Reinsurance Nor

Capital Cost

39

Potential Unintended Consequences of Regulatory Restrictions

• Excessive reinsurance• Excessive rate indications• Greatest harm to insurers concentrated in state

Allow Reinsurance but not Capital Cost

• Inefficient single-state towers• Excessive rate indications• Greatest harm to multi-state insurers

Allow Reinsurance but Limit Allocation

• No savings due to reinsurance• Excessive rate indicationsAllow Capital Cost

but not Reinsurance

• Inadequate rates• Availability may be limited• Greatest harm to insurers concentrated in state

Allow Neither Reinsurance Nor

Capital Cost

40

• Excessive reinsurance• Excessive rate indications• Greatest harm to insurers concentrated in state

Allow Reinsurance but not Capital Cost

• Inefficient single-state towers• Excessive rate indications• Greatest harm to multi-state insurers

Allow Reinsurance but Limit Allocation

• No savings due to reinsurance• Excessive rate indicationsAllow Capital Cost

but not Reinsurance

• Inadequate rates• Availability may be limited• Greatest harm to insurers concentrated in state

Allow Neither Reinsurance Nor

Capital Cost

Potential Unintended Consequences of Regulatory Restrictions

41

Potential Unintended Consequences of Regulatory Restrictions

• Excessive reinsurance• Excessive rate indications• Greatest harm to insurers concentrated in state

Allow Reinsurance but not Capital Cost

• Inefficient single-state towers• Excessive rate indications• Greatest harm to multi-state insurers

Allow Reinsurance but Limit Allocation

• No savings due to reinsurance• Excessive rate indicationsAllow Capital Cost

but not Reinsurance

• Inadequate rates• Availability may be limited• Greatest harm to insurers concentrated in state

Allow Neither Reinsurance Nor

Capital Cost

42

State Summary – California

Proprietary & Confidential

DPW ($M) Mkt Sh (%)Rank California 2012Y 2012Y 5-yr 10-yr 15-yr 5-yr 10-yr 15-yr 5-yr 10-yr 15-yr 15-yr SD

1 Auto 19,431.2 100.0 (0.9) 1.6 2.4 96.5 94.6 96.4 71.5 70.0 71.9 5.1 2 Home 7,039.2 100.0 1.7 4.4 5.3 82.5 84.4 87.5 54.8 56.8 59.6 14.3

Top 5 Auto Carriers1 Farmers Insurance Group of Cos 2,718.4 14.0 (3.9) (1.8) (1.0) 97.5 96.1 96.9 69.9 69.9 71.6 4.4 2 State Farm Mutl Automobile Ins 2,687.8 13.8 1.6 1.6 1.4 101.5 96.3 99.0 77.3 73.6 76.3 8.0 3 Allstate Corp. 1,745.2 9.0 (2.9) 1.4 3.0 97.5 93.9 95.7 71.6 68.4 70.4 7.4 4 Auto Club Exchange Group 1,688.4 8.7 (1.2) 1.4 3.5 85.8 84.7 87.0 63.8 63.4 65.7 5.1 5 Mercury General Corp. 1,642.5 8.5 (3.6) 1.5 3.8 100.1 96.1 95.4 71.7 68.7 68.7 4.6

1 Farmers Insurance Group of Cos 2,718.4 14.0 (3.9) (1.8) (1.0) 97.5 96.1 96.9 69.9 69.9 71.6 4.4

Top 5 Homeowners Carriers1 State Farm Mutl Automobile Ins 1,555.3 22.1 3.5 3.8 4.9 86.4 85.7 91.1 60.0 59.5 64.0 18.8 2 Farmers Insurance Group of Cos 1,165.7 16.6 (0.2) 2.7 4.4 86.0 89.3 92.3 51.0 55.4 59.5 18.2 3 Allstate Corp. 632.2 9.0 (6.1) (0.1) 2.5 80.8 80.4 81.9 57.4 57.4 58.1 14.0 4 AAA Northern CA NV & Utah Ins 463.2 6.6 1.3 7.3 8.7 81.9 77.5 81.7 50.7 48.1 52.9 14.0 5 Liberty Mutual 388.2 5.5 5.2 5.4 4.5 81.3 83.4 88.1 49.3 52.4 57.0 16.0

2 Farmers Insurance Group of Cos 1,165.7 16.6 (0.2) 2.7 4.4 86.0 89.3 92.3 51.0 55.4 59.5 18.2

CA Catastrophe Risk Regulatory Summary Cat/Non Cat Split DemographicsCombined Ratio to Achieve 14% ROE 93.5% 15-yr PCS Loss % of Total Loss Total PopulationCatastrophe Models Projected Population Change (2012 - 2017)

Total HouseholdsReinsurance Cost Median HH Income ($)

Unemployment RateCapital Cost

CommentaryRegulatory Environment

Homeowners Filing SummaryCompany Effective Date

Days to Approve Indicated Requested Approved

Auto Club Southern California 9/30/2012 257 0.7% 0.2% 0.2%Farmers 6/16/2012 224 21.1% 6.9% 6.9%

Catastrophe Residual Market SummaryResidual Market Premium (% Statewide Property Premium)0.5Assessment Mechanism Unlimited Assessments (Plan Deficits)Recoupable No specific statutory provision, possible rate increase request250 year Industry Assessment Exposure ($M)

% of Statewide Property Premium #VALUE! Modeled AAL based on the average NT RMS v11 and NT AIR v13

Very Challenging

Cat % of HO Premium

- Industry HO and auto results have been profitable over past 15 yrs

- Despite what is perceived as a generally difficult regulatory environment

- This excludes EQ as that is written on a different line than HO

Prop 103 governs all ratemaking

Combined Ratio (%)DPW CAGR (%) Loss&LAE Ratio (%)

Models permitted only for EQ fire following and must be certified to actuarial standards (ASOP 38)

Not permitted

Not permitted (except for earthquake and medical malpractice)

37,707,477 3.4%

12,743,499 57,385

9.4%

0.0

5.0

10.0

15.0

20.0

25.0

97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Amou

nt (

$B)

Industry - Auto

5%0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

15-yr PCS LR Modeled AALto 2012 DPW

Non-Hurricane Hurricane

0.0

2.0

4.0

6.0

8.0

97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Amou

nt (

$B)

Industry - Homeowners

DPE Loss & LAE

PCS Cat,

10.0%

Non-Cat,

90.0%

Questions?