GLOBAL REINSURANCE APRIL 2012 7

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APRIL 2012 GLOBAL REINSURANCE6

Financial Briefi ng

10.1%Alleghany was this month’s biggest riser

*All prices expressed in local currency 17 February-16 March 2012

Best and worst: How global reinsurers fared in 2011

8090

100110Munich Re

110k115k120k125kBerkshire Hathaway 'A'

34363840Hannover Re

18192021SCOR

50525456Reinsurance Group of America

200

225250275Alleghany

13k14k15k16kKorean Re

60626466PartnerRe

80859095Everest Re

40455055Swiss Re

The cost of Solvency II to the industry has been estimated at around £2bn ($3.18bn), and the current schedule is for implementation in 2013 and compliance by 1 January 2014. However, with the Omnibus II decision and parliament’s vote both

delayed, it could push into 2015.Yes, this delay has an impact on fi rms, but it also

impacts the regulator and its ability to give clear guidance. It may be that there is a transition period where Solvency I and II rules are running together.

Lloyd’s has delayed submission of its model from April to July. Lloyd’s and the FSA are maintaining their programme of activity, and insurance companies should take the delay in the same spirit and carry on with their plans, using the extra time as breathing space to resolve fi nal issues, such as improving data quality, refi ning the modelling, and further strengthening governance and risk management required under Pillar II.

Sovereign debt riskThe capital guidance section of the current Solvency II rules treat sovereign debt as risk free. Recent economic developments show this is potentially not the case, however. The industry is questioning if the capital rules and model formula will change.

Probably not. Companies using their own internal model will already account for the risk of any debt, including sovereign debt. You can’t change risks and capital charges under the standard model, but adopting Pillar II risk management may lead to different investment strategies – opting out of sovereign debt, for example. So if the system works properly, it is almost self-regulating. There has been no announcement suggesting a complete overhaul of the formula, but it is possible it could be recalibrated to take account of such infl uencing factors.

A head startThose businesses that have made an early start on compliance should already see benefi ts, such as:• more effective purchase of reinsurance;• better capital effi ciency;• increased awareness of risk management; • improved business understanding;• stronger corporate governance; and• improved reputation and competiveness.

The reason people are feeling the pain now is that we are in a phase of frictional change, climbing the hill of what is a diffi cult project for any fi rm.

Firms should take advantage of the delay and achieve ‘business as usual’ as quick as possible. They should see it as a business initiative, not purely a compliance one!

Sponsor’s wordSimon Gallagher, insurance group head, Moore Stephens

The upside of Solvency II

Simon Gallagher

In association with

1. COR 2011 ranking (%): Best fi ve 3. ROE 2011 ranking (%): Best fi ve 5. Profi t change 2010-11 ranking (%): Best fi ve 7. Cat losses as % of shareholders’ equity: Best fi ve

2. COR 2011 ranking (%): Worst fi ve 4. ROE 2011 ranking (%): Worst fi ve 6. Profi t change 2010-11 ranking (%): Worst fi ve 8. Cat losses as % of shareholders’ equity: Worst fi ve

Transatlantic Re White Mountains White Mountains Maiden Re

Flagstone Re Flagstone Re Hardy Hardy

ACE Transatlantic Re Swiss Re Berkshire

Platinum Underwriters Hardy Flagstone Re Flagstone Re

Allied World Assurance Swiss Re Hannover Re ACE

Omega Omega Platinum Underwriters Amlin

Maiden Re Mapfre Re SCOR White Mountains

Montpelier Re Platinum Underwriters XL Platinum Underwriters

Alterra Arch Berkshire Hathaway*

*profi t before tax

XL

PartnerRe Amlin Amlin PartnerRe

0

20

40

60

80

100 Alterra

Maiden Re

Allied World Assurance

ACE

Transatlantic Re

0

5

10

15

20 Arch

Mapfre Re

Swiss Re

Transatlantic Re

White Mountains

012345678 XL

White Mountains

ACE

Berkshire Hathaway

Maiden Re

0

10

20

30

40

50 PartnerRe

Platinum Underwriters

Amlin

Flagstone Re

Hardy

-1000

100200300400500600700800 Berkshire Hathaway*

SCOR

Hannover Re

Swiss Re

White Mountains (Sirius COR)

0

50

100

150

200 PartnerRe

Montpelier Re

Omega

Platinum Underwriters

Flagstone Re

-35

-30

-25

-20

-15

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Platinum Underwriters

Omega

Hardy

Flagstone Re

-500

-400

-300

-200

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Flagstone Re

Hardy

63.7

19.8

16.2

9.6 9.3 9.0

787.7

-460.4 -435.8

-204.0 -181.1 -167.4

204.3

-19.1 -21.1 -30.8

-9.5-12.5

-23.7-26.5

-33.9

153.6143.3 134.3 131.1 125.4

94.6 95.9 98.1 98.2

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37.7

28.925.9 24.8

1.9

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6.27.2

Global fi rms’ profi ts slide in 2011● Group of 34 global (re)insurers posted combined $30bn cat losses, 58% net profi t drop and COR of 110%● Smaller fi rms worst hit while larger fi rms fared better; overall the group turned a profi t despite heavy losses

According to the old adage, the bigger they are, the harder they fall. But this was largely not true for global (re)insurers in 2011, according to Global Reinsurance’s study of the 2011 results of the industry’s most prominent fi rms.

The year was a tough one for fi rms of all sizes, thanks to the onslaught of natural catastrophes. The group of 34 global (re)insurers studied suffered combined catastrophe losses of $30.3bn. As a result, 16 of the companies made a loss, and those lucky enough to turn a profi t made a far smaller one than they had in 2010.

The group’s combined net profi t plummeted 58% to $10.6bn in 2011, from $25.6bn in 2010. The average combined ratio across the group shot up almost 20 percentage points to 109.6%, from 90.6%. Only two fi rms – Swiss Re and White Mountains – boosted profi ts (see chart 5), and both these increases were company-specifi c anomalies.

Swiss Re’s 2010 profi t was eroded by $1.1bn owing to the interest on the convertible bond it issued to Berkshire Hathaway.

The bond was paid off in late 2010, and so the charge did not recur in 2011. White Mountains’ 2011 profi t, meanwhile, was boosted by a gain on the sale of its Esurance business.

The study shows that the smaller companies suffered most at the hands of Mother Nature, while the larger companies generally weathered the storm better.

Lloyd’s (re)insurers Omega and Hardy are the smallest companies studied measured by gross written premium and shareholders’ equity. They occupy the lower size tier of the listed Lloyd’s companies and came off badly last year.

Hardy’s catastrophe loss as a percentage of 2010 shareholders’ equity was the largest of the 34-strong group of companies (chart 8). Hardy also suffered the largest year-on-year percentage drop in net profi t of the group, and saw shareholders’ equity fall by 30% – the second-biggest drop reported.

Omega had the third-worst combined ratio of the group, posted the third-largest decline in shareholders’ equity and

reported the third-worst return on equity (chart 4).

The worst performer overall was Flagstone Re. The company had a torrid 2011 by many measures. Its combined ratio and return on equity were both the worst of the group (charts 2 and 4), and the company suffered the second-largest reduction in profi tability and relative level of

catastrophe losses. In addition, the company saw the biggest erosion of shareholders’ equity of its peers of 30.5%. The events of 2011 wiped £346m from Flagstone’s capital base.

Like Hardy and Omega, Flagstone is among the smallest of its peers, with shareholders’ equity of less than $1bn.

When Global Reinsurance did

an early temperature check of the market last month, after the largest players had reported their 2011 results (see Global Reinsurance March, page 4), PartnerRe and Platinum Underwriters were the worst performers in terms of losses and shareholders’ equity erosion. However, they have been overtaken by Flagstone and the smaller Lloyd’s fi rms.

In contrast, the larger fi rms did well. Perhaps unsurprisingly given their collective size, Berkshire Hathaway’s (re)insurance businesses posted the largest profi t of nearly $5bn, while Munich Re suffered by far the biggest catastrophe loss of the group of $5.8bn but still turned a profi t of $919m. The rest of the big European groups were all in the top 10 in terms of 2011 profi t levels. These fi rms also reported the smallest percentage reductions in profi t.

While performance was variable in 2011, overall the industry should be pleased. It suffered heavy losses but still turned a profi t overall, and shareholders’ equity increased to $315.2bn, from £304.9bn.

Flagstone Re had a torrid

year by many measures

Marketwatch: Transatlantic buyout proves stock booster to Alleghany● This month sees a new entry into the top 10 listed (re)insurance groups, following the acquisition of Transatlantic Holdings by Alleghany Corporation. The decision to buy one of the world’s largest reinsurers has clearly impressed Alleghany’s shareholders. The stock has been on a strong upward trajectory all year.

● The top reinsurers generally had another good month on the back of rising investor confi dence. Both Swiss Re and Munich Re turned in good performances, with share price rises of 9.9% and 5.7%, respectively.

● Not all companies fared well. Shareholders are still digesting PartnerRe’s lacklustre 2011 performance and subsequent rating agency warnings, and its stock has shown some dips.

● The biggest faller, however, was Korean Re, whose stock dropped 10.7%. The reason is unclear, but perhaps shareholders are concerned about the company’s exposure to catastrophe zones around the world.

DATA: COMPANY RESULTS

In association with

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Financial Briefi ng

CFO interview

Stuart Bridges

Q What are your biggest concerns as a CFO in the current environment?

AAt Hiscox we are very focused on making a healthy return for our

shareholders. The real challenge in this environment is:

how do I deliver this return, recognising that we are in a low interest rate environment, potentially for some time, but also recognising that US reinsurance rates, for example, are very healthy? The challenge is getting your level of capital right to deliver a healthy return; not taking too much risk, yet taking opportunities.

Q What is your approach to tackling the low interest rate environment?

A The key to life in this environment is not to chase yield. Our portfolio is

short-duration. We have a good weighting of corporates in it, which gives us a yield pick-up, and we don’t feel we are paid much for extending our duration at the moment.

Within that, we increased the equity weighting in our portfolio last year, because we think equities look quite attractive. The diffi culty with them is they are high volatility, but if I wanted to move the portfolio further I would increase the equity weighting at this point.

The other key is that you have to run the business accepting that it is going to be a low interest rate environment for some time. The challenge is making the underwriters understand the dynamic of creating returns in the lower investment rate world.

In a lower interest rate environment, an underwriter has to change his targets. But if an underwriter has been writing to a specifi c combined ratio for many years, it is diffi cult to change that.

QHow big an issue is the eurozone debt crisis for the non-life (re)

insurance industry?

A It is likely to extend the low interest rate environment for us for a while.

Because we have a large insurance book across Europe, with offi ces across Europe, we have to have contingency plans in case there is a breakdown of the euro in any country. Having said that, we’re not active in Greece, so that is in our favour.

The other thing we are watching carefully is not just the countries and governments that we’re invested in, but also fi nancial institutions. Every sensible fi nance director

is keeping a very close eye on individual exposures to individual banks, which we are monitoring on at least a weekly basis.

Because you may have bonds, cash and other exposures with the banks, it is a matter of having systems that allow you to monitor your total exposure and make sure you are happy with it on an individual bank basis.

QHow is Solvency II affecting your job, and how will it do so following

implementation?

A Solvency II is the biggest project in the company. It is not just myself and the

direct teams involved with it. It is very broad across the management of the group in terms of the training, the implementation and the fact that we are using the Solvency II models more and more as we implement it. In two years’ time, I think it will be business as usual.

Solvency II is giving us a much more holistic view of how we run the group. We have used modelling for catastrophes and

investments for a long time and use those to control risk within the group. But Solvency II is bringing together the risks in the business and how they interrelate. That has already led to much more of a focus on underwriting risks at some of our board meetings and elsewhere.

It is a vast amount of work. But the more you use it, the more you see the benefi ts.

Q How do approach managing capital across a diverse, global business?

AWe have carriers in Bermuda, the USA, Guernsey, Lloyd’s carriers and a

single European carrier based in the UK. The bulk of our capital sits in Bermuda. The capital is quite fungible between the entities. We keep large credit facilities as well, which allow us to manage the funds at Lloyd’s very effectively. But we have the capability, at a group level, to manage that capital.

The interesting thing is that a lot of capital demands are driven by the rating agencies. What interests us is the group view versus individual carrier view of the rating agencies. Understanding the evolving nature of how rating agencies look at groups is one of the key issues at the minute.

Q Are you planning to make any changes to your capital structure?

AI am happy with where our capital structure but it is something you

have to constantly monitor to make sure that it stays effi cient.

Q What qualities does a (re)insurance chief fi nancial offi cer need?

A You need a deep understanding of the reinsurance industry and of the

participants in it. The CFO’s role these days is not just making sure the numbers add up. Solvency II emphasises the need to look at risks across the business. The CFO has to understand those risks, be it reinsurance purchasing or the risk of expanding in certain areas such as emerging markets, or taking increased risk in Japan if the rates go up. You need to do a lot of reading and very much understand the industry as a whole.

Stuart Bridges from Hiscox on making a return in a low interest rate environment, the eurozone debt crisis, and how Solvency II will affect what he does

The hearing on Omnibus II Directive adoption has again been delayed, according to reports. The European Parliament, preoccupied with the Eurozone crisis, has put the plenary vote back to September.

Talks over the directive’s proposed amendments to Solvency II have, it seems, been diffi cult.

Outside the Omnibus II Economic and Monetary Affairs Committee, political quarrels have also escalated.

UK prime minister David Cameron, disappointed with Prudential’s threat to move its headquarters from London to Hong Kong, has described Solvency II as “ill thought-out”.

The new rules governing insurance and reinsurance companies in Europe risk “endangering a great British business that should have its headquarters in the UK”, he said during prime minister’s questions on 7 March.

But in response, European Commission head of insurance and pensions Karel van Hulle insisted all parties had been involved “at each and every state of the process”.

“We badly need Solvency II now,” said Van Hulle. “You can’t do regulation right for everybody, therefore you need to set priorities and that is diffi cult.”

The European Commission said it fundamentally disagreed that Solvency II left some insurance companies with no choice but to leave the EU, insisting that Solvency II “will improve the international competitiveness of insurers, not undermine it”.

“There are a few issues that indeed remain to be solved,” it said. “But they should not be exaggerated. And we count on all parties involved, including Prudential, to work constructively to fi nd suitable solutions.”

One driver behind a possible move by the Pru is continued uncertainty about Solvency II.

The UK, which is further ahead in preparations than the rest of Europe, has invested hundreds of millions of pounds. Yet more delays are anticipated and the fi ner details of the regime are yet to be confi rmed.

Continuing uncertainty“There continues to be uncertainty in relation to the implementation of Solvency II and implications for the group’s business,” said Prudential. “Clarity on this issue is not expected in the near term.”

The original vote over Omnibus II was due at the end of last year. It was delayed to January and then to March. Many think the fi nal vote may not be cast until September.

Omnibus II suggests some transitional measures for Solvency II, such as for the treatment of hybrid capital and third-country equivalence, with potential delays up to 10 years.

“Everything is based on Omnibus II being signed off,” says Lane Clark & Peacock insurance consulting practice principal Wendy Hawes, who recently moved from the FSA. “They can’t implement Solvency II without Omnibus II being agreed, because it makes some signifi cant changes.

“There are defi nite rumblings in the market that, because of the delay in getting Omnibus II fi nalised, that fi rst date, on which the supervisory authorities will

take on the power – 1 January 2013 – will not be achievable.”

Further delays could force the UK to implement Solvency II before the rest of Europe. This could give UK fi rms a ‘fi rst mover’ advantage, allowing them to realise the benefi ts fi rst and giving

them more time to embed the models within their business. But others argue that late changes to Solvency II could be harder to implement for fi rms that are further down the road, leading to a competitive disadvantage.

For UK insurers and reinsurers about to go through the internal model approval process, lack of clarity on Omnibus II is also causing concern that there could be additional costs associated with Solvency II.

In 2007, the CEA (European Insurance and Reinsurance Federation) estimated the industry would spend around €3bn ($4bn) in initial one-off Solvency II costs. It’s now clear this is a major underestimate and, for the UK alone, the FSA puts the cost of preparation at £1.9bn ($3bn). The Lloyd’s market – which had a demanding timetable for syndicates last year – reckons Solvency II will cost it £300m.

The UK will inevitably incur higher costs than other markets. With London home to so many large international (re)insurers, a much higher proportion of UK fi rms are seeking internal model approval than their Continental European counterparts.

Under the standard formula, fi rms would be penalised with excessive capital requirements, which do not provide adequate diversifi cation credit, particularly for capital-intensive property catastrophe perils.

Formula for fearBut the standard formula remains a worry – even for those designing internal models – with a worry it will become a benchmark for regulators.

Firms looking to start using internal models next year may also have to renew their ICAS models for another year if there are further delays. Meanwhile, the FSA has told the market to continue preparing for 2014

OWN RISK AND SOLVENCY ASSESSMENT REMAINS A CHALLENGE – WILLIS RE

implementation. FSA director of insurance Julian Adams said on 27 February that the regulator would keep to its timetable.

“You’ll be aware that the timetable is tight, particularly in the context of a legislative process that has been far from straightforward,” he said.  

“We await a key vote in the European Parliament at the end of March, and it would clearly not take much further slippage in this to put transposition in January 2013 at risk, but this would not necessarily affect the implementation date in January 2014,” he said. “What it might do instead is merely compress the period between transposition and implementation.

“It therefore remains our assumption that the new regime will apply from January 2014.”

■ See this issue’s Global Market Report, page 25.

‘The challenge is not taking too much

risk, yet taking opportunities’

Political wrangling continues over ‘ill thought-out’ Solvency II● Crucial Omnibus II vote is delayed again and UK PM goes on the attack after Prudential threat to quit UK

Solvency II: timelineThe Solvency II directive is approved by Ceiops, and will be adopted by all 27 EU member states

ECON committee votes on Omnibus II directive, confi rming 1 January 2014 implementation

The vote on Omnibus II is postponed until 10 September 2012 – a further three-month delay

The date by which all local laws and regulators will need to have transposed the Solvency II directive

APPROVED

ECON VOTE

POSTPONED

TRANSPOSED

NOV2009

MAR2012

SEP2012

JAN2013

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