Enhancing Shareholder Value through capital risk management – an Insurer’s perspective

PRMIA Members Luncheon

Tony ColemanChief Risk Officer and Group Actuary

20 February 2003

Presentation Overview

• Capital Management

• The Risk Environment

• The Risk Control Cycle & Management of volatility

• Climate Change – new uncertainty

• Balancing “conflicting” stakeholder expectations

– customers

– shareholders

• Capital provides support in face of adverse outcomes from:

– insurance activities

– investment performance

– operations

• Implications for capital management

– need for an integrated approach

Capital Management

4

Maximum capital

Minimum target capital

Excess capital

Operating zone for capital

management

Minimum additional capital

Regulatory capital

Liabilities

Components of Capital

• Inwards Reinsurance/GIO Re

• 11 September / Terrorism

• HIH / Corporate Governance

• Asbestos Liabilities

• Medical Indemnity

• Tort Law Reform (Public Liability)

• Natural Catastrophes

• Industry Consolidation

• Poor Equity Markets

• Pricing Cycle

Some Recent Risks for Insurers

Stock markets vs. premium Stock markets vs. premium ratesrates

Effective Insurance Management

Risk management uses a control cycle

Performance

management

Pricing

Risk management

Reserving

Capital

• Establish risk appetite

– decide what risks are essential, shed others

– decide target financial strength (“risk of ruin”)

• Identify and assess risks

– understand ALL material risks (including operational)

– quantify the distribution of outcomes from the risks

undertaken

• Keep risks “in control”

– monitor exposures and outcomes

– respond to “out of control” outcomes

Role of Risk Management

9

AssetAllocation

InvestmentsInsurancePortfolio

InvestmentReturn

PremiumIncome

Claims andExpenses

ReinsuranceProgram

Profit

Shareholders

Dividends Capital infusions RewardRisk

Dynamic Financial Analysis

• Volatility and the risk / return trade-off

• Dimensions of volatility

– business process / operational

– balance sheet

– strategic

Management of Volatility

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High ReturnCompanies

Low ReturnCompanies

Earnings Volatility

Earnings VolatilityEarnings Volatility

Earnings Volatility

High

High High

HighLow

Low Low

Low

Volatility and Shareholder Value

Low Earnings Growth Companies

High Earnings Growth Companies

• Holistic, enterprise-wide, risk management in response to

changing environment

• Increasing sophistication – in-house capital measurement

models

• Importance of earnings predictability

• Focus on drivers of long term value

The Way Forward

Global temperatures have increased. 1990’s were the warmest decade and 1998 the warmest year since records began in 1861. Further increases are projected.

• Insurers calculate, price and spread risk across the

community

• Claims paid represent largest cost of an insurer (claims >

80% of home and motor premiums)

• If frequency or severity of claims increases, insurers have to

increase premiums or mitigate risk to stay viable

• Climate change is expected to increase BOTH the frequency

and severity of claims incurred

Weather and Climate are core business for insurers

$0

$20,000,000

$40,000,000

$60,000,000

$80,000,000

$100,000,000

$120,000,000

$140,000,000

$160,000,000

More of these events will increase premiums dramatically

A few extreme events cause majority of losses(NSW, NRMA Building Insurance Top 20 Storm Events 1987-2002)

Small increases in wind speed can significantly increase losses (NSW, NRMA Building Insurance only)

0

100

200

300

400

500

600

700

Under 20 knots 20-40 knots 40-50 knots 50-60 knots

% In

crea

se in

Dam

ages 25% increase in peak gust causes 650%

increase in building damages

• What are the implications under various Climate Change

scenarios?

• Very little research in this area at present

• Climate Change means that historical records become less

relevant

• Modelling and our capacity to predict become extremely

important

How will hailstorms be affected by climate change?

18/3/1990

14/4/1999

21/1/1991

3/10/198628/10/1995

Many people and properties at risk

• This modelling is on the cutting edge – using state of the

art models and technical expertise

• Initial analysis based on the April 1999 event

• How much larger or more intense is possible?

• How will their characteristics and behavior change?

• How much more likely are they to occur?

• The answers were surprising!

IAG’s storm modelling and climate change

Economic losses doubling every 10

years

Costs of global disasters are increasing

• Proactive – at a policy level, we support initiatives that reduce greenhouse emissions

• Corporate ecology

– corporate energy efficiency initiatives

– procurement policies

• Research

– Weather-related risks and climate change

– new products and services which create business value and

encourage sustainable behaviour

IAG’s response