White Cover Slide; Title Is Arial Bold, 28pt., 1.15 Line ... · Capital Allocation | June 4th, 2012...

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Capital Allocation | June 4th, 2012 0

Capital Allocation

François Dagneau

Senior Vice President

Aon Benfield Analytics Caribbean

Presentation to IAC


Agenda

Section 1 What is Capital Allocation? Why ECM?

Section 2 Introduction to ECM

Section 3 Practical ECM and Capital Allocation

Section 4 Conclusion

Presentation to IAC


Section 1: What is Capital

Allocation? Why ECM?

Presentation to IAC


What is Capital Allocation?

Economic Capital Modeling

– To determine how much capital an entity requires overall

Capital Allocation

– It is breaking down the required capital by line of business, island, etc. to ensure that each bucket

pays for the capital is uses;

– Why do it?

• To increase profitability (and avoid antiselection)

• Avoid cross subsidies

• To deploy capital more efficiency

– As more diversified a company, the more important

Enterprise Risk Management is often the next station on that road

Reinsurance Structure Optimization

Presentation to IAC


All this from 35,000 feet

Asset Risk

Non-Cat

Catastrophe

Market

Credit

Underwriting Risk

Net U-W

Results

Re

ins

ura

nc

e

Reinsurance Optimization

Ec

on

om

ic C

ap

ital M

od

elin

g

En

terp

rise R

isk M

an

ag

em

en

t Operational +

Strategic

Risks

Reserves

Cap

ital A

lloca

tion

Presentation to IAC


Why ECM-ERM?

Survival

Valuation (if public company)

Rating Agencies

Regulators

Presentation to IAC


ERM: What – Winners and Losers 1987-present

'87 Company '06 Disposition '87 Company '06 Disposition '87 Company '06 Disposition

1 State Farm 1 34 America exited 67 Orion Capital bought by Royal

2 Allstate 3 35 Employers Re bought by GE, Swiss Re 68 Teledyne spun off into Unitrin

3 Aetna sold P/C to Travelers 36 Zurich 16 69 NJ Manufacturers 48

4 AIG 2 37 Motors 29 = GMAC 70 Westfield 47

5 Liberty Mutual 7 38 Progressive 8 71 Utica National 92

6 Nationwide 6 39 Commercial Union bought by White Mountain 72 John Hancock no longer writing P&C

7 Hartford 10 40 Cal State Auto Assn 34 73 Foremost bought by Farmers

8 Farmers bought by Zurich 41 Sentry 39 74 State Auto Mutual 53

9 Travelers 5 42 Associated Insurance bought by Travelers 75 Country Companies 38

10 CIGNA sold P/C to ACE 43 Auto Owners 20 76 Selective 46

11 CNA 13 sold pers/l (ALL); reins (WTM) 44 Erie Ins. Exch. 21 77 Clarendon bought by Hannover Re

12 Continental bought by CNA 45 PMA under supervision 78 American Mutual Lbl. >100

13 USF&G bought by St Paul 46 Interins Exch Auto Cl. >100 79 Shelter Ins 63

14 Crum & Forster bought by Fairfax 47 Auto Club of MI 52 80 Mercury General 26

15 Fireman's Fund bought by Allianz 48 Berkshire Hathaway 4 81 Skandia America In runoff

16 Chubb 11 49 Southern Farm Bur. 41 82 Employers Mutual 58 = EMC

17 Kemper in run off 50 Cincinnati Financial 24 83 Zenith National 58

18 St. Paul bought by Travelers 51 Munich Re 32 84 California Casualty >100

19 Royal in run off, bt.by mgmt, Arrow Point 52 Employers of TX >100 85 Alfa 68

20 USAA 12 53 Swiss Re 23 86 ALLIED bought by Nationwide

21 General Re bought by Berkshire Hathaway 54 Metroplitan 27 now Met P&C 87 Argonaut 77

22 Lincoln National sold P/C to Am States/Safeco 55 Old Republic 37 88 Arkwright merged with FM Global

23 Home bought by Zurich 56 Federated Mutual 57 89 Fremont Calif WC, Unicover

24 Prudential bought by Liberty Mutual 57 Ford Motor sold? 90 Allendale merged with FM Global

25 American General bought by AIG 58 Colonial Penn run off / no longer in P&C 91 Medical Liab Mut, NY 70

26 American Financial 31 = Great American 59 Nationale-Nederlanden no longer writing 92 Penn National 99

27 Transamerica spun off to TIG (Fairfax) 60 Amica Mutual 52 93 Central Benefits Mutual exited P/C

28 Reliance insolvent 61 Atlantic Mutual >100 Balboa partnership 94 Hartford Steam Boiler bought by AIG

29 Safeco 15 62 Winterthur bought by CSFB, XL 95 Commercial Credit

30 GEICO bought by Berkshire Hathaway 63 20th Century rescued by AIG 96 Grange Mutual 63

31 American Family 14 64 Amerisure Cos 93 97 SAIF >100 Oregon state fund

32 General Accident no longer in US P/C 65 Harleysville 56 98 American Bankers bought by Assurant

33 Ohio Casualty 50 66 W. R. Berkely 18 99 Motorists Mutual 89

100 Indiana Farm Bureau >100 bought by Liberty Mutual

Presentation to IAC


ERM: What – A. M. Best Impairment Study

Primary Causes of P/C Impairments 1991 - 2002

Catastrophe

Losses

8%

Fraud /

Overstated

Assets

12%

Change in

Business

1%

Impairment of

Affiliate

8%

Deficient Loss

Reserves /

Rapid Growth

60%

Misc

11%

Approximately 650 impairments* over

38 year period 1969-2006

Source: A. M. Best Impairment Study, 2007

* A. M. Best defines impairment as restrictive regulatory action

Cause (1969-2006) Pct Total

Deficient Loss Reserves 37.6%

Rapid Growth 15.7%

Alleged Fraud 8.1%

Catastrophe Losses 7.7%

Impairment of Affiliate 7.2%

Overstated Assets 6.9%

Significant Change 4.4%

Reinsurance Failure 3.3%

Miscellaneous 9.0%

Insurance risk is the main killer of

P&C companies

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Return, Volatility and Valuation – US Listed Company Experience Aon Benfield Hit/No Hit Price to Book Regression Study

No earnings hits >150% of average quarterly operating income: 1 point increase in prospective ROE increases P:B by 5.7 points

1 or more earnings hits: 1 point increase in prospective ROE increases P:B by only 2.9 points

Valuation differential has persisted through time

0

0.50

1.00

1.50

2.00

2.50

3.00

3.50

0.0% 5.0% 10.0% 15.0% 20.0% 25.0%

Prospective 2011 ROE

Pri

ce

to

Bo

ok R

atio

No Hit 1+ Hit

Price to Book, Prospective ROE Link

Prospective

ROE 1+ Hits No Hits Delta

7.5% 0.76 0.97 27.3%

10.0% 0.83 1.11 33.2%

12.5% 0.91 1.25 38.2%

15.0% 0.98 1.39 42.5%

20.0% 1.12 1.68 49.3%

Price to Book Assuming

Price to Book Regression HistoryValuation Differentials

Dec '10 May '10 Feb '10 Nov '09 Aug '09 Apr '09 Nov '08 Mar '08 Dec '07 May '07 Nov '06

At a 10% ROE 33.2% 28.5% 17.2% 15.4% 24.0% 33.6% 42.0% 31.1% 12.1% 11.0% 12.5%

At a 15% ROE 42.5% 54.3% 32.4% 36.0% 31.8% 48.4% 40.7% 48.8% 30.3% 44.5% 26.8%

Presentation to IAC


Examples of proposed requirements:

– A risk tolerance statement setting out overall

quantitative and qualitative risk tolerance levels

and limits considering material risks and their

interactions

– ERM framework must use risk tolerance levels

and limits in business strategy and day-to-day

operations

– The internal company risk assessment should

include the rationale and level of planned risks in

relation to the company’s risk appetite, and

financial resources required

Solvency Modernization Initiative

Five Focal Areas

Capital Requirements

Governance and Risk

Management

Group Supervision

Accounting / Financial Reporting

Reinsurance

Sources:

-NAIC Solvency Modernization Initiative ROADMAP, May 20, 2011

-NAIC U.S. Own Risk and Solvency Assessment Proposal, February 11, 2011

Presentation to IAC


Solvency II: “Three Pillars”

Quantitative

Requirements

-Capital modeling

and requirements

-Fair value balance

sheet

-Solvency Capital

Requirement

-Minimum Capital

Requirement

Pillar 1

Supervisory

Review

-Systems of

governance

-Own Solvency Risk

Assessment (ORSA)

-Supervisory review

process

-Assessment of

quantitative and

qualitative

requirements

Pillar 2

Disclosure

Requirements

-Solvency and

Financial Condition

Report (SFCR)

(Investor

transparency)

-Report to

Supervisors (RSR)

(quarterly / annually)

Pillar 3

A key consideration for those with operations in Europe or Bermuda

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Section 2: Introduction to ECM

Presentation to IAC


Five Point Modeling Philosophy

Risk modeling should focus on the most material risk sources

– Limited resources need to focus efforts

Modeling should use data-driven parameterizations

– Avoid “garbage-in, garbage-out”

Modeling must stress test material parameters

– Dependency structure between lines

Multi-method approach needed to produce durable and robust indications

– Over-dependence on single method can be unstable over time

Management needs a clear summary of results

– Thoughtful output exhibits are a need-to-have, not nice-to-have

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Company Specific Underwriting Volatility

Company Data

Aon Benfield

Insurance Risk Study

Remetrica

Simulation

Engine

Lines of Business

Premium and Loss Volume

Limit/Deductible Profile

Payout Pattern

Industry Gross Loss Ratio

volatility by LOB

LOB correlations

Catastrophe Model

Output

Catastrophe Model Output

Sys

tem

ic R

isk

P

rocess R

isk

Gross

Volatility &

By Line

Correlations

Net Volatility

& By Line

Correlations

Company

Reinsurance

Program

Modeling Detail

– By line of business: 2 to 20+ lines

– By exposure element within line: 1 to 1000’s

• Layer, attachment, inwards percent etc.

Typical model breaks portfolio into 100-10,000 separately modeled exposure

elements

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Economic Capital Model Governance C

apital A

dequacy

Asset Risk

Non-Cat

Catastrophe

Market

Credit

Parameter Risk

UW Cycle

Duration

Volume

Key Risk

Drivers

Peril

Concentration

Volatility

Correlation

Duration

Volume

Concentration

Credit Quality

Volume

Characteristics

Correlation and volatility are results of cat model driven by exposures and geography

Correlation and volatility input assumptions

Divergence between fundamental and market measures of volatility and correlation

Divergence between fundamental and market measures of volatility and correlation of spreads

Do we

have

enough

capital?

How much of the

risk is insurance vs.

asset risk related?

Views on nature of risk, time horizon to be used, data

available for parameterization, and intended business

uses influences model structure

Underwriting Risk

Presentation to IAC


Aon Benfield Insurance Risk Study Systemic Insurance Risk

Understanding insurance risk prerequisite for effective modeling

Systemic insurance risk includes line of business uncertainty caused by pricing cycle, frequency and severity trends, economic activity, loss reserve uncertainty, legal and judicial changes, weather

Common action of these factors drives part of correlation between lines

– Underwriting cycle

– Medical inflation

– Summer lines (boating, general aviation ) vs. winter lines (medical and health, personal accident)

Naïve

Model

Systemic

Insurance

Risk

Volume

Insura

nce R

isk

Portfolio

Risk

Systemic

Market Risk

Number of Stocks

Port

folio

Ris

k

Asset Portfolio Risk Insurance Portfolio Risk

Presentation to IAC


Economic Capital Statement

Seeks to limit probable maximum pre tax loss to 25% of shareholders equity at 1 in 250 event

Quantitative

Definition

Capital required at VaR 99.5%

This is the capital we need to have

Solvency II

Regulatory

+ Rating

Agencies

Current

Capital This is the capital we have

Presentation to IAC


Economic Capital Formulas

17 Proprietary & Confidential

VaR TVaR

Risk Adjusted Probabilities Investor Tolerance

Management Behavior

Don ’ t

Care

Loss

Risk

Aversion

CARE

CARE

MORE

Plan Operating

Loss

B+

Rating

Don ’ t

Care

CARE

THE

MOST

Loss vs. Peers | Cause of Loss? | Market Reaction?

Don ’ t Care

Don ’ t Care

CARE

Loss

Risk

Aversion

Don ’ t Care

CARE

Loss

Risk

Aversion

Loss

Risk

Aversion

CARE

CARE MORE

CARE EVEN MORE Lose

Money

Ratings Downgrade

Care

Presentation to IAC


Credit Crisis Lessons Asset Risk Modeling Challenges

Through December 2006,

calibrating asset risk to

historical data would have

been driven by stressed

scenarios of the LTCM

bailout and 9/11.

October 2008 increase in spreads would have been an 11-18 sigma event on top of a September that was a 4-8 sigma change

Calibrating to historical data prior to 2007 is like basing earthquake risk

estimates upon the volatility of daily paid earthquake losses

Monthly Change in Corporate Credit Spreads

-1

-0.5

0

0.5

1

1.5

2

De

c-9

1

De

c-9

2

De

c-9

3

De

c-9

4

De

c-9

5

De

c-9

6

De

c-9

7

De

c-9

8

De

c-9

9

De

c-0

0

De

c-0

1

De

c-0

2

De

c-0

3

De

c-0

4

De

c-0

5

De

c-0

6

De

c-0

7

De

c-0

8

De

c-0

9

AAA BBB

LTCM

Crisis 9/11

Presentation to IAC


Capacity, Tolerance, Appetite and Limits

Capacity

Ultimate ability to assume and

absorb risk

Tolerance

Undesirable risk that is tolerated

Appetite

Desirable risk, subject to the

reward being adequate

Risk Limits

Silo-based criteria to help guide

transactional risk-taking

Risk Capacity

Risk Tolerance

Risk Appetite

Presentation to IAC


Section 3: Practical ECM and

Capital Allocation

Presentation to IAC


3 Line Of Business Example

3 line of business portfolio, each with:

– $100M premium

– 30% expense ratio

– 65% loss ratio

– 95% combined ratio

Volatility:

– LOB 1: CV loss ratio = 75%



Correlation

– LOB 2,3 = 50%

– LOB 1 with LOB 2, LOB 3 = 10%

Proprietary & Confidential 21

Summary UW Result Statistics ($millions)

LOB 1 LOB 2 LOB 3

Simulated

Total

Mean UW Result 5 5 5 15

Mean Loss 65 65 65 195

Std. Dev. 49 20 10 57

Scaled Std. Dev. 75% 30% 15% 29%

0.10% -249 -82 -34 -338

0.20% -246 -66 -29 -279

0.40% -222 -61 -26 -244

0.50% -198 -60 -25 -193

1.00% -172 -50 -21 -160

2.00% -137 -43 -18 -137

5.00% -82 -32 -13 -91

10.00% -48 -22 -8 -50

20.00% -19 -10 -3 -20

30.00% -1 -3 -1 -1

40.00% 10 3 3 17

50.00% 19 9 5 28

70.00% 34 17 10 49

80.00% 41 21 13 61

90.00% 49 27 17 74

UW Percentiles

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Capital Allocation Results: 250 Yr Return Period


0.4% Risk Capital Threshold

Capital Allocations - Percentage

Business Unit VaR Eq Risk VaR TVaR

Eq Risk

TVaR St Dev

Phillips

TVaR MP VaR MP TVaR Wang RAP

Correlated

S.D

LOB 1 71% 69% 72% 70% 63% 91% 88% 92% 86% 76%

LOB 2 20% 21% 20% 21% 25% 6% 10% 6% 10% 17%

LOB 3 9% 9% 8% 9% 13% 2% 2% 2% 3% 7%

Total 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%

Capital Allocations - ($Millions)


Eq Risk

TVaR St Dev

Phillips


Correlated

S.D

LOB 1 187 183 228 224 200 292 177 216 227 243

LOB 2 53 57 64 66 79 21 21 14 27 54

LOB 3 24 25 27 29 40 7 4 5 9 22

Total 264 264 319 319 319 319 201 235 264 319

Indicated Premium to Surplus Ratios


Eq Risk

TVaR St Dev

Phillips


Correlated

S.D

LOB 1 0.5 0.5 0.4 0.4 0.5 0.3 0.6 0.5 0.4 0.4

LOB 2 1.9 1.8 1.6 1.5 1.3 4.8 4.8 7.1 3.7 1.9

LOB 3 4.2 4.0 3.8 3.5 2.5 15.0 28.6 19.5 11.1 4.5

Total 1.1 1.1 0.9 0.9 0.9 0.9 1.5 1.3 1.1 0.9

Stand-Alone Portfolio Based



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Capital Allocation Results: 20 Yr Return Period


5% Risk Capital Threshold

Capital Allocations - Percentage


Eq Risk

TVaR St Dev

Phillips


Correlated

S.D

LOB 1 63% 61% 68% 65% 63% 86% 77% 87% 84% 76%

LOB 2 25% 26% 22% 24% 25% 10% 15% 9% 12% 17%

LOB 3 12% 13% 10% 11% 13% 4% 8% 4% 5% 7%

Total 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%

Capital Allocations - ($Millions)


Eq Risk

TVaR St Dev

Phillips


Correlated

S.D

LOB 1 65 63 110 106 102 141 58 100 87 124

LOB 2 26 27 36 39 41 16 11 10 12 27

LOB 3 12 14 16 18 20 6 6 5 5 11

Total 104 104 163 163 163 163 75 114 104 163

Indicated Premium to Surplus Ratios


Eq Risk

TVaR St Dev

Phillips


Correlated

S.D

LOB 1 1.5 1.6 0.9 0.9 1.0 0.7 1.7 1.0 1.2 0.8

LOB 2 3.9 3.7 2.7 2.6 2.5 6.1 8.7 10.0 8.2 3.7

LOB 3 8.0 7.3 6.1 5.5 4.9 17.2 16.5 21.2 21.1 8.8

Total 2.9 2.9 1.8 1.8 1.8 1.8 4.0 2.6 2.9 1.8




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Modeled Return on Risk-Adjusted Capital by Line

Proprietary & Confidential 24

Modeled ROE Summary ($B)

Rank LOB

Operating

Income

Total

Capital Pre-Tax ROE

1 Auto Phys Dam 3.3 12.6 26.0%

2 Property 3.5 20.4 17.2%

3 All Other Lines 1.9 14.4 13.3%

4 Reinsurance Lines 1.2 19.2 6.3%

5 Commercial Auto Liab 0.7 10.8 6.1%

6 Other Liab Occur 1.9 32.5 5.7%

7 Other Liab Claims Made 0.6 22.1 2.9%

8 Workers Comp 0.4 41.1 1.0%

9 Medical Malpractice 0.1 15.3 0.4%

10 CMP 0.0 33.8 0.1%

11 Farm & Homeowners -5.5 56.8 -9.8%

12 Personal Auto Liab -5.2 44.0 -11.9%

13 Financial Guarantee & Surety -8.8 20.9 -42.1%

Total -6.0 343.9 -1.7%

Investment Yield: 4.0%

Loss Discount Rate: 3.0%

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Reinsurance Evaluation

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Capital Allocation | June 4th, 2012 26 Aon Benfield Analytics | SGI 7

Gross Risk Risk Transferred

Undiscounted Discounted Undiscounted Discounted

Premiums earned 135,744 133,029 Premiums earned 17,037 16,696

Losses and ALAE incurred 90,948 89,130 Losses and ALAE incurred 9,928 9,729

Underwriting expenses incurred 38,008 37,248 Underwriting expenses incurred 1,749 1,714

Underwriting gain (loss) 6,787 6,651 Underwriting gain (loss) 5,360 5,253

Standard deviation 19,597 19,205 Ceded Standard deviation 10,614 10,633

1% Tail Value at Risk (114,198) (109,749) 1% Tail Value at Risk (77,844) (77,426)

Loss and ALAE ratio 67.0% 67.0% Loss and LAE ratio 58.3% 58.3%

Combined ratio 95.0% 95.0% Combined ratio 68.5% 68.5%

Net Risk Reinsurance Capital and Ceded ROE

Undiscounted Discounted Re Capital Ceded ROE

Premiums earned 118,707 116,333 Economic Capital Model (1%)

Losses and ALAE incurred 81,021 79,400 Gross Capital Required 140,910

Underwriting expenses incurred 36,259 35,534 Net Capital Required 71,013

Underwriting gain (loss) 1,427 1,399 Reinsurance Capital 69,897 5.3%

Standard deviation 8,983 8,572

1% Tail Value at Risk (36,354) (32,322)

Loss and ALAE ratio 68.3% 68.3%

Combined ratio 98.8% 98.8%

Volatility transferred:

Standard deviation 54.2% 55.4%

1% Tail Value at Risk 68.2% 70.5%

(in $000's)

Promutuel ReAll Classes, Proportional and Cat Retrocessional Program

ReMetrica Executive SummaryTreaty Year 2012

Current Program

Q1. Reduction in

Volatility

Q2. Cost of

Reinsurance

Program

Includes allowance

for reinsurer

credit risk

Q3b. Cost of

Reinsurance

Capital = after-tax cost

of program /

capital benefit

Programs below

current cost of

capital are accretive

programs above are

dilutive Q3a. Capital Benefit

computed using

rating agency, regulatory,

or economic viewpoints

Gross, Net &

Ceded

Undiscounted &

Discounted Views

ReMetrica

simulation

engine

estimates

volatility of

u/w result

Presentation to IAC

Capital Allocation | June 4th, 2012 27 8

Ceded Ceded

ROE Capital

$ 2,120 $ 2,078 $ 2,444 $ - $ 257 10.0% 2,567

s 2,158 s 2,108 % 0.0%

$ 311 $ 305 $ 554 $ - $ 174 12.5% 1,395

s 1,021 s 1,002 % 0.0%

$ 1,391 $ 1,363 $ 2,586 $ - $ 856 10.0% 8,559

s 3,106 s 3,044 % 0.0%

$ 594 $ 582 $ 1,451 $ - $ 608 2.0% 30,408

s 2,796 s 2,740 % 0.0%

$ 460 $ 451 $ 1,202 $ - $ 526 5.0% 10,517

s 2,909 s 2,851 % 0.0%

$ 883 $ 866 $ 2,337 $ - $ 1,030 7.0% 14,710

s 8,206 s 8,041 % 0.0%

$ 4,169 $ 4,085 $ 6,123 $ 1,714 $ 226 13.0% 1,741

s 625 s 613 % 28.0%

TOTAL $ 9,928 $ 9,729 $ 16,696 $ 1,714 $ 3,677 5.3% 69,897

MCR QS

Undiscounted Discounted NPV Premiums Commission

Liability XOL

AllClasses 10x5

Cat 15x15

Cat 20x30

Cat 110x50

NPV Profit

Per Risk 3x2

Selected Losses NPV Premiums & CC Ceded ROE

NPV Ceding A/Tax Ceded

(in $000's)

Promutuel Re

All Classes, Proportional and Cat Retrocessional Program

ReMetrica - Losses, Profit and Ceded ROE by LayerLosses, Profit and Ceded ROE by Layer

Current Program

Aon Benfield Analytics | SGI

Presentation to IAC


ReMetrica MonitorPromutuel Re

All Retrocessions

Treaty Year 2012

Executive Summary of Retrocession Current ALT 1 ALT 2 ALT 3 ALT 4

($CAD, in thousands)

GROSS NET

Premium $135,744 $118,707

Losses and ALAE $90,948 $81,021

Expenses $38,008 $36,259

Underwriting gain (loss) $6,787 $1,427U/W gain(loss) std. dev. $19,597 $8,983

Loss and ALAE ratio 67% 68%

Combined ratio 95% 99%

Premium $133,029 $116,333

Losses and ALAE $89,130 $79,400

Expenses $37,248 $35,534

Underwriting gain (loss) $6,651 $1,399 $600 $1,800 $1,100 $1,400U/W gain(loss) std. dev. $19,205 $8,572

Loss and ALAE ratio 67% 68%

Combined ratio 95% 99%

Capital Required: Economic Capital Model (1%) $140,910 $71,013 $60,000 $85,000 $71,000 $80,000

CEDED

Undiscounted premium $17,037

Undiscounted losses and ALAE $9,928

Undiscounted expenses $1,749

Undiscounted Ceded profits $5,360

Discounted premium $16,696

Discounted losses and ALAE $9,729

Discounted expenses $1,714

Discounted Ceded Profits $5,253

NPV Reduction in Std Dev Profit (Benefit) $ $10,633

NPV Reduction in Std Dev Profit (Benefit) % 55.4%

NPV Before-Tax Cost of Reinsurance $5,253

NPV After-Tax Cost of Reinsurance $3,677

Capital Required: Economic Capital Model (1%) $69,897

Ceded ROE based on capital provided through:

Economic Capital Model (1%) 5.3%

Notes:

Underwriting Gain (Loss): Expected Net Premiums, less Expected Net Losses

Und. Gain(Loss) std. dev.: Standard Deviation of Underwriting Gain(Loss); measure of volatility

NPV Reduction in Std Dev Profit (Benefit): Reduction in volatility of Net results through use of Reinsurance. The lower this number, the more risk is being retained Net.

As this number decreases, additional surplus may be required to maintain solvency levels.

NPV Cost of Reinsurance : Expected Ceded Premiums, less Expected Ceded Losses, after discounting for time value of money. Net expected economic cost of reinsurance.

Ceded ROE: NPV Cost of Reinsurance as a percentage of Surplus relief obtained through reinsurance purchase. Analogous to Cost of Capital. The cost, percentage-wise, of surplus relief.

Economic capital model: Aon Benfield model to calculate capital based on Value-at-Risk (VaR) of cash flows.

UN

DIS

CO

UN

TE

DD

ISC

OU

NT

ED

CE

DE

D R

ES

UL

TS


Presentation to IAC


$1,399

$600

$1,800

$1,100

$1,400

0

200

400

600

800

1000

1200

1400

1600

1800

2000

50000 55000 60000 65000 70000 75000 80000 85000 90000

Rew

ard

: E

xp

ec

ted

Net

U/W

Res

ult

Risk: Net Capital Required

2012 Reinsurance Program - Risk/Reward

Increasing

Increasing Reward


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Section 4: Conclusion

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Conclusion

Economic Capital Modeling

– To determine how much capital an entity requires overall

Capital Allocation

– It is breaking down the required capital by line of business, island, etc. to ensure that each bucket pays for the capital is uses;

• To increase profitability

• To avoid cross subsidies

• To deploy capital more efficiency

Enterprise Risk Management is often the next station on that road

• Survival

• Valuation (if public company)

• Rating Agencies

• Regulators

Reinsurance Structure Optimization

• Largest budget item

• Critical purchasing decision

• Greatest risk to capital

Questions

Presentation to IAC


Contact Information

François Dagneau

Senior Vice President

Aon Benfield Analytics

[email protected]

Jason Machtinger

Vice President

Aon Benfield Analytics

[email protected]

Or your favorite Aon Benfield Caribbean broker….

mailto:[email protected]

mailto:[email protected]

White Cover Slide; Title Is Arial Bold, 28pt., 1.15 Line ... · Capital Allocation | June 4th, 2012...

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