Willis Re Analytics Review 2012

willis re analytics

review2012 issue 1

in this issueAnalytics Q&A with John Cavanagh ............................................. Page 3Diving into the warm pool .............................................................. Page 4Solvency II: does it matter? ........................................................... Page 7Managing extremes in a changing reinsurance environment .... Page 8The New Madrid earthquake: 200 years later............................... Page 9ORSA comes to the U.S. ................................................................ Page 10Predictive modeling: beyond the buzzword ................................ Page 12A.M. Best rating actions: raising the bar ...................................... Page 14

Upcoming eventsMay 2 - 4, 2012 2012ICMIF Meeting of Reinsurance Officials (MORO) 2012Paris, France

May 10, 2012 Reactions Solvency II ForumParis, France

May 24, 2012 ICMIF Solvency II Solutions One Day SeminarLondon, UK

May 24 - 25, 2012 Risk and Capital Management ConferenceLondon, UK

June 3 - 5, 2012 CARe meetingBoston, MA

June 7 - 8, 2012 Groupe Consultatif European Congress of ActuariesBrussels, Belgium

June 19, 2012 TINtech – Insurance Industry Network Technology ConferenceLondon, UK

June 26 - 28, 2012 Solvency II SummitLondon, UK

June 27-29, 2012 Risk and Investment ConferenceLeeds, UK

September 9 - 12, 2012Rendez-Vous de SeptemberMonte Carlo, Monaco

September 16 - 19, 2012 NAMIC Annual ConventionGrapevine, TX

September 29 - October 3, 2012CIAB: Insurance Leadership ForumColorado Springs, CO

October 21 - 25, 2012 Baden-Baden Reinsurance MeetingBaden Baden, Germany

October 28 - 31, 2012 Property Casualty Insurers Association of America Annual MeetingDana Point, CA

analytics Q&a with John cavanagh, Chief Executive Officer, Willis ReJohn cavanagh was appointed ceO of willis re in 2012. Based in london since 2009, he is responsible for Willis Re’s worldwide operations. Prior to joining Willis, John was at international specialty reinsurance broker RK Carvill for 21 years. He is a member of the Willis Group’s Executive Committee, the senior management team setting and executing Willis’ global strategy.

Here, he answers some questions about Willis Re’s Analytics offering, the role of analytics in today’s market, and developments in the industry over the last decade.

How has the requirement for analytics support developed in the reinsurance industry over the last decade?

Quantifying risk is now fundamental in the decision-making processes of all insurers. From establishing underwriting guidelines to capital management, risk management is now at the core of an insurer’s corporate strategy. Directors of insurance companies are now expected to have a broad understanding of the risk models used in their business: their assumptions, strengths and limitations, and the relationship between risk and reward is considered before every major decision is made. The cultural change over the last decade has been enormous.

This means the offering our customers are looking for has developed significantly over the last ten years. Their requirements are now more sophisticated and they look at us to be their trusted advisor and provide this value added work. This changing risk environment, which is broadly triggered by extreme events over the last decade, from 9/11 to a global financial crisis to tsunamis and floods, and the imminent introduction of new regulatory requirements such as Solvency II have placed significant demands on our clients (and consequently us) in terms of risk modeling, capital management and advice. As a result, alongside the usual risk analysis, helping our clients grow now entails capital modeling – including catastrophe modeling, dynamic financial analysis, portfolio optimization, regulatory support, and credit analysis of their portfolios. We provide the support and expertise that our clients need through our analytics team. It’s an absolutely essential part of our offering.

Would you say these regulatory changes have defined the development of the Willis Re analytics team?

Absolutely – but certainly not solely. As a result of the increased demands from our clients we have increased our resources in analytics and deployed them in a better way to understand our clients’ needs. Couple this with 2011 as the second worst catastrophe year for the market on record with insured losses in excess of $100 billion and reinsured losses of $50 billion and significant catastrophe model changes: it is essential that we improve our understanding of the nature of these hazards in order to help our clients manage the risks associated with them. This work will also form a core offering to our clients of helping them meet the regulatory requirements of having a better understanding of their risk.

How significantly does Willis Re rely on analytics in placing business?

The insurance and reinsurance industries are far more technical than they used to be – necessarily so – and there is no doubt that our superior analytics offering gives Willis Re an edge, but I don’t see analytics and technology as a substitute for experience. Models do not replace underwriting or our assessment of a risk on behalf of our client. Good judgement and experience continues to be a very important part of the transaction at Willis Re. This is the main reason we have analysts sitting within our business units and not functioning as a separate entity. Market intelligence aligned with our analytics products, and the information that we gain from managing a global risk portfolio, all combine to provide a balanced view to our customers that is not overly analytical or market driven, but a combination of the two. We know our clients, we know our risks, and it is important that the analytics – which are an absolutely vital part of our offering – contribute to the whole and are not seen as an independent function, alternative or add on.

“We provide the support and expertise that our clients need through our analytics team.”

Willis Re Analytics Review • May 2012

Diving into the warm poolDo warmer sea surface temperatures mean more hurricanes making landfall in North America? Recent research sponsored by the Willis Research Network dives into this question.

The past two U.S. wind seasons have been extraordinary in terms of activity and landfall rates – and yet the effect on the U.S. insurance industry from hurricanes has remained benign. What’s going on here? Is it related to warmer sea surface temperatures? And will it continue?

As shown below, both 2010 and 2011 seasons had above average activity. Each had 19 named storms, tying for the third busiest season on record. But only 11 of the 2010 tropical storms – and only 6 in 2011 – gained hurricane strength. Florida continued to escape hurricane-strength storms, making now 6 consecutive years without significant landfall in Florida.

2010 2011

All storm tracks for the 2010 and 2011 U.S. hurricane seasons. The yellow boxes indicate the Gulf of Mexico Region (left) and the Main Development Region (right). Tracks taken from HURDAT (2012).

Willis Re’s clients have asked: “Is all this related to a changing climate, and if so is it indicative of future behavior?”

In the two and half years I have been at Willis Re, I have become accustomed to the analytics resources we have at our disposal here, and have seen modeling and analytical developments in a multitude of fields. I am continually impressed with the work the team produce – from economic capital modeling to helping our clients develop their own view of risk to developing quick techniques to model an insurer’s portfolio during the Thailand floods. In fact, there are some excellent developments being made in this area at the moment. Willis Re has many excellent client relationships in the Asia Pacific area, and we want to do everything we can to assist our clients in managing, tracking, and wherever possible, predicting the risks in the region. The region had a very trying 2011, and our team is working very

closely with our customers and using our extensive analytics resources to help them mitigate the impact of events such as last year’s occurring in the future. There are, and will continue to be, a number of unknown elements to risks such as uncertainties in Japanese earthquake and tsunami modeling, but our job is to present our clients and markets as accurate a picture as we can. Our clients minimize the impact of such events by managing extreme risks through purchasing reinsurance products – and the area where analytics has had the most significant progress within Willis Re is in helping find cost-efficient and optimal reinsurance solutions that are aligned with our clients’ needs and risk appetite.

In which area is Willis Re analytics making the most significant progress in terms of development and understanding?


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2010 North Atlantic Hurricane Season Tropical Storm

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Current climateBoth 2010 and 2011 showed higher than average ocean temperatures in the North Atlantic – the so-called “Atlantic Warm Pool” (AWP) was more extensive than usual. Scientists such as Dailey and Wang have linked unusually warm sea surface temperatures to elevated storm activity.

More intense storms develop in the central to eastern Atlantic in years with a large warm pool. The greater number of storms, and greater intensity of those storms, can be related to the additional energy of the warmer ocean temperatures.

Storm genesis locations (dots) and mean sea surface temperature (shading)

Main Development Regionstorm tracks

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The other thing that happens with a large warm pool is a weakening of the high pressure system over the Northeast Atlantic known as the “Subtropical High.” This high pressure system, which is more or less stationary, acts as a barrier – it blocks the poleward movement of storms and steers them instead towards the U.S. When the Subtropical high is weaker, storms forming in the Main Development Region (MDR) are more likely to “hook” north and east, reducing the chance of landfall in the U.S. The storms that do make it further west, however, have ample time to intensify over warm oceans; they become the most intense storms observed in the North Atlantic.

Simulated sea level pressures and storm tracks

Simulated cooler years

Source: Wang et al. 2011

Dr. Angelika Werner, WRN Climate Risk Coordinator, worked together with Willis Research Fellow, Dr. James Done of NCAR Earth System Laboratory to investigate these effects in relation to the high level of activity but reduced frequency of landfalling storms observed in 2010 and 2011.

We analyzed historic storms during the 10 largest and 10 smallest AWP years between 1970 and 2009. Historically, the absolute number of landfalling storms increases during warm (large AWP) years due to the larger total number of storms generated in those years. On the other hand, storms arising in the Main Development Region during warm years show a small relative decrease in the likelihood of U.S. landfall: from 25% in small AWP years to 22% in large AWP years. If 2010 and 2011 are considered, this percentage drops more significantly, to 18% – consistent with the theory, but suggesting that the database is too small to form any final conclusion.

Simulated warmer years

Source: Wang et al. 2011


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Future climateWhat might the future hold? We investigated this using climate models, simulating day-to-day weather over the U.S. and North Atlantic. We compared simulations for a decade of current climate conditions with two future decades of 2020 - 2030 and 2045 - 2055. Our results show increases in both hurricane frequency and hurricane intensity, with the strongest hurricanes becoming even stronger in the future. These increases are different from many other studies (e.g., Knutson et al. 2010), but these uncertainties do not affect the following conclusions.

Our projections show considerable variability in the size of the AWP for the period 1995 - 2060, but an overall increasing trend. Our simulations agree with the suggestion by Wang et al. (2011) that storms forming in the eastern tropical North Atlantic are less likely to make U.S. landfall during future years as the AWP grows; however, the signal is weak and subject to large uncertainty.

what it all meansIn summary, we can state that:

• The relationship between Atlantic Warm Pool size and the proportion of storms forming in the Main Development Region that make U.S. landfall is weak and subject to other factors that are likely to mask the signal

• A slight decrease in the proportion of storms making landfall in the U.S. is likely to be masked by a strong overall increase of total storms developing

• Storms that do make it through from the MDR are likely to be among the most intense system

• Climate simulations show further expansion of the AWP over the next 100 years (IPCC 2007), subject to various ongoing discussions

Further reading:Dailey, Peter S., Gerhard Zuba, Greta Ljung, Ioana M. Dima, Jayanta Guin (2009): On the Relationship between North Atlantic Sea Surface Temperatures and U.S. Hurricane Landfall Risk. J. Appl. Meteor. Climatol., 48, 111–129. DOI: http://dx.doi.org/10.1175/2008JAMC1871.1.

Wang, C., Liu, H., Lee, S.-K. and Atlas, R. (2011): Impact of the Atlantic warm pool on United States landfalling hurricanes. Geophys. Res. Lett., 38, DOI: 10.1029/2011GL049265.

Done, J., G.J., Holland, C. Bruyère, and A. Suzuki-Parker (2011): Effects of Climate Variability and Change on Gulf of Mexico Tropical Cyclone Activity. Paper OTC 22190 presented at the Offshore Technology Conference, Houston, Texas, May 2 - 5.

Done, J., Holland, G., and A. Werner (2102): Impacts of warm North Atlantic Ocean temperatures on U.S. landfalling tropical cyclones. WRN Research Newsletter, February 2012.

For more information, or to learn about other Willis Research Network projects, please contact your Willis Re team.

There is some debate about when discussions about Solvency II, Europe’s new insurance regulatory regime, began. David Simmons, who leads the Enterprise Risk Management practice for Willis Re London, notes that he became aware of it around 2005 – back when implementation was meant to occur in 2008. “Comfortingly,” David comments, “implementation has remained an average of three years away ever since.”

After a delay last year, implementation is now due in 2014. But another delay is quite possible.

It’s very easy to get cynical about Solvency II. Will it ever happen? Does it really matter? The answer to the first question is at best “probably” – but the answer to the second is “definitely.”

So why the new delay? Solvency II has suffered from the difficulties of agreeing on a common regulatory standard across 27 countries – each with very different regulatory and business cultures, and with insurance industries of various histories and technical competencies. As the process approaches the endgame, political issues have come to the fore.

The European Union’s approval procedures are complex. In essence, the revised Solvency II directive must be agreed by the Economics Committee of the European Parliament (ECON), and then the gloriously named “triologue” needs to take place between the European Commission, the Council of Europe and the European Parliament. Finally, the measure requires approval by a vote of the full Parliament.

A revised text was agreed by ECON on March 21, though a number of major issues remain to be fully resolved. The European Parliament had previously pushed back its vote on the revised standard to July in anticipation of problems, later pushed back again to October. In theory, this new timetable still allows for implementation at January 1, 2014 – but that would be very tight, as a slew of additional implementation measures and binding technical standards remain to be agreed.For Solvency II, the devil is not only in the details but also in the underlying principles.

In the U.K., Solvency II has raced up the political agenda. Recently, the U.K. company ranked 25th largest by London Stock Exchange capitalization, Prudential plc (not to be confused with Prudential Financial in the U.S.), threatened to move its domicile to Hong Kong. The company said that “certain versions” of Solvency II would create problems for investments in corporate bonds, infrastructure and some bank assets. It is also concerned about its Jackson Life subsidiary becoming uncompetitive in the U.S. due to Solvency II applying higher capital requirements than local regulation.

This prompted U.K. Prime Minister David Cameron to call Solvency II a “good example of ill thought-out E.U. legislation.”

Prudential plc’s concerns focused on capital charges for certain asset classes – particularly long-term corporate bonds, equity and property – and on the thorny issue of “equivalence.” If a company operates a subsidiary in a country whose regulation is not deemed equivalent to Solvency II, the subsidiary’s capital must be calculated according to Solvency II rather than the local rules. Based on current draft rules, this would make Jackson Life uncompetitive with its U.S. peers.

Hong Kong is one of those jurisdictions that have recently applied for equivalence. But the state-by-state regulation of insurance that prevails in the U.S. does not fit well with E.U. rules. The European Commission has recently said that a “different approach” is required for U.S. equivalence, which seems to be an invitation for a fix of some kind.

Despite all the problems and delays, the basic tenets of Solvency II are sound. Solvency II seeks to protect the policyholder by ensuring not only that the company has an adequate capital buffer, but also that it can demonstrate understanding and prudent management of its risks. This is entirely consistent with parallel developments in banking regulation and with emerging best practices in the insurance industry, now recognized by ratings agencies including S&P and A.M. Best. The philosophy also aligns with the international consensus on insurance regulation developed by the International Association of Insurance Supervisors (IAIS). A company that embraces the principles of Solvency II will be better managed, better focused, more robust and ultimately more profitable. A company that sees Solvency II, or similar regimes, as a compliance issue only will bear all the expenses with none of the benefits.

Willis Re is well positioned to assist you with these issues. We can help you select and implement the most efficient reinsurance structures within the new regulatory environment – and we can also provide advice on required capital calculations, whether you’re using a standard formula or an internal capital model. Our team includes leading experts on the Enterprise Risk Management framework that wraps Solvency II and similar regimes; we can help you define risk appetite, perform stress testing and scenario testing, and incorporate Willis Re performed peril modeling within an approved internal model.

Switzerland’s experience shows that it is possible to introduce an intelligent Solvency II style framework with relatively little pain. Countries outside the E.U. may look more towards the Swiss Solvency Test than Solvency II as a template. No matter where your firm operates, Willis Re can help you find the opportunities in the changing regulatory environment – maximizing the gain while minimizing the pain.

Solvency II: does it matter?


At the beginning of March, Willis Re hosted a seminar titled “Managing Extremes in a Changing Reinsurance Environment.” We wanted to share with our clients and reinsurers an opportunity to learn more about the impact of extreme weather, model change, and other technological developments on the insurance and reinsurance landscape. In our industry, change is a given: it is part of our role to provide our clients with the very best knowledge and tools to manage change.

Experts from Willis Re and the wider industry – including A.M. Best, RMS and WeatherBELL – joined 150 clients and prospects for the seminar, held at St. Joseph’s University located near Philadelphia. A senior executive from Allied World Reinsurance described the event as “one of the best seminars I have attended.”

In 2011, more than $100 billion in loss from around the world was caused by tornadoes, droughts, excessive rainfall, wildfires, floods, blizzards, cyclones, earthquakes, hurricanes and heat waves. As Willis Re Chairman Peter Hearn pointed out in his opening remarks, “With the exception of an asteroid strike we did not miss much.”

Scott Rubenstein, Vice President of Willis Re, explained that many clients are concerned about the extreme conditions encountered in 2010 and 2011.

“A lot has changed in our industry,” said Rubenstein. “Some of the change may be cyclical, such as the increased frequency of natural disasters, particularly tornado activity. On the other hand, RMS significantly changed its hurricane model, and overnight insurance companies had to re-think their business plan. A knock-on effect of the model change for insurance companies was and still is how rating agencies will ‘score’ catastrophe management going forward. These were all issues our clients and prospective clients have expressed concern about over the last few months – so having Joe Bastardi from WeatherBELL, Michael Kistler from RMS and Michelle Baurkot from A.M. Best join us to discuss these points was hugely beneficial.”

Hearn explained: “Extreme weather can be anything that differs substantially from the historical norm. Extreme departures from the historical record can be in terms of severity, duration or frequency. An extreme weather event triggers a disaster when its severity, duration or frequency causes damage that exceeds an area’s physical and economic resources; in other words, its ability to cope.”

Since 2006, federally declared disaster areas in the United States have affected counties housing 242 million people – that means four out of five Americans. During the same period, weather-related disasters have been declared in every U.S. state with the sole exception of South Carolina. More than 15 million Americans live in counties that have averaged one or more weather related disasters per year since 2006 – a statistic with significant impact on the reinsurance industry.

“The immediate and long term implication of these climatological and demographic trends for insurers and reinsurers is staggering,” said Hearn. “The art and science of insuring and reinsuring extreme weather events is simply going to have to become more sophisticated.”

Managing extremes in a changing reinsurance environment “The immediate and long term

implication of these climatological and demographic trends for insurers and reinsurers is staggering.The art and science of insuring and reinsuring extreme weather events is simply going to have to become more sophisticated.”


The New Madrid earthquake: 200 years laterIn the winter of 1811 - 1812, a series of three large earthquakes violently shook the central Mississippi valley. The first occurred on December 16, 1811 with an estimated magnitude of 7.7; a second quake hit January 23, 1812 with a magnitude of about 7.5; and a third earthquake with a magnitude of about 7.7 struck on February 7, 1812. Two hundred years later, scientists continue to debate the likelihood that events like these might happen again along the New Madrid fault, as well as the uncertainty associated with seismic hazard estimates for this region.

There are about 39 million people at risk in 6 states in this region. More than 50% of potentially exposed housing stock is at least 30 years old. In much of the area, statewide building codes are not mandatory. Little of the building stock in this seismic zone has experienced any moderate ground shaking in the recent past – which makes it very difficult to estimate vulnerability.

A repeat of the 1811 – 1812 events today could have significant impact on the insurance industry and the overall economy: insured losses could be $65 to $80 billion.

In January 2012, Prasad Gunturi of Willis Re’s Catastrophe Management Services team hosted an industry webinar marking the occasion of 200-year anniversary of the New Madrid earthquake. This webinar brought together speakers from modeling companies AIR, EQECAT and RMS to discuss earthquake risk in the New Madrid region. We wanted to help our clients, prospects and industry business partners prepare for earthquake model changes anticipated in 2014 - 2015 and understand the uncertainty surrounding New Madrid earthquake risk estimates.

National Seismic Hazard Maps (NSHM) provided by the United States Geological Services (USGS) are a key source of information for earthquake models. The USGS updates its hazard maps on a 6-year cycle, following the latest research. Work is currently underway to revise hazard maps that will be available in 2014. We expect significant changes for the New Madrid zone in this update. Some of these changes could influence catastrophe modeling results used by the insurance industry.

Key scientific updates to the USGS hazard maps for the Central and Eastern U.S. include:

• Updates to earthquake source models for the New Madrid Seismic Zone, varying event magnitudes (severity) and recurrence rates (frequency)

• A new source model for nuclear facilities

• Updates to the earthquake catalog and assessments of magnitude uncertainty

• New ground motion prediction models (also called “attenuation equations”)

Updates to frequency and severity of events on the New Madrid fault could have the effect of decreasing loss estimates for many portfolios. New attenuation equations might significantly change loss estimates and could also make it necessary for insurers to modify underwriting rules based on distance to fault.

Willis Re will continue to monitor the latest developments on the USGS National Seismic Hazard Maps as well as information related to AIR, EQECAT and RMS earthquake model upgrades for 2014-2015. We will provide regular updates, with balanced advice based on our range of skills from model development to the practical implementation of portfolio management and underwriting objectives.

Meanwhile, please contact your Willis Re team with any questions or to access the recorded version of our New Madrid webinar.

New Madrid Seismic Zone StatesArkansas illinois indiana Kentucky Missouri tennessee

2010 Population* 2,915,918 12,830,632 6,483,802 4,339,367 5,988,927 6,346,105

2010 Housing units* Year structure built Post 1999 1980-1999 Pre 1890

1,316,299

13%36%51%

5,296,715

9%20%71%

2,795,541

11%26%64%

1,927,164

12%32%56%

2,712,729

11%28%61%

2,812,133

14%35%51%

Building Code Statewide building code

No statewide building code

Mandatory statewide

building code

Statewide building code

No statewide building code

Statewide building code

Source: http://quickfacts.census.gov/qfd/states


Orsa comes to the U.s.A significant new risk-related regulatory requirement for U.S. insurers is on the way. As part of an augmented Risk Based Examination process, the Own Risk and Solvency Assessment (ORSA) moves U.S. solvency regulation into new territory. Company management will now be asked to articulate their own judgment about the adequacy of their firm’s capital. The idea is that such a management view will provide a better reflection of the company’s risks, risk management capacity, capital and future plans than standard regulator-specified capital requirements can offer.

Many of the largest U.S. insurers are able to do this already – but mid-sized insurers may need to get to work.

How did this get started?In October 2010, the international insurance regulatory community adopted a set of Insurance Core Principles (ICPs). One of these – ICP 16, titled Enterprise Risk Management – calls for an ORSA. The ORSA concept, embedded in Pillar 2 of Solvency II, was adopted by the U.S. National Association of Insurance Commissioners (NAIC) in late 2011. Implementation by the states is expected to mean effective dates in 2014 and 2015.

Europe and the U.S. are not alone in adopting such a requirement. In Bermuda, it will be called the Commercial Insurers Solvency Self Assessment. In Australia, it takes the same name as a similar process for banks, the Internal Capital Adequacy Assessment Process (ICAAP). Other regulators in other countries are expected to join in.

What will you have to do?U.S. insurance groups will be exempt from the ORSA requirements if their annual U.S. premium writings are under $1 billion; insurance companies with less than $500 million in premium are also exempt. According to NAIC statistics, this will capture at least 80 percent of U.S. premium while relieving a large number of smaller insurers.

ORSA requires the management and board to decide on the adequacy of the firm’s capital and overall Enterprise Risk Management (ERM) system, based on their own assessment of the firm’s future plans, risks and risk capacity. Risk capacity should be determined based on funds available and the quality of risk management systems.

For those insurers with well-established formal ERM programs, ORSA requirements will just mean documentation of their existing processes. Current expectations are that only a 3 to 5 page confidential summary will need to be filed with the NAIC; but a much more extensive report, similar to that required under Solvency II in Europe, must be available for inspection by the regulators during the quadrennial examination. Companies belonging to an international group and filing a Solvency II ORSA will be able to use the same report in the U.S.

But for some insurers, the new standards will require establishing more formal ERM processes and additional risk measurement capabilities. Boards and management will also need to be prepared for the initial ORSA summary report – and stay up to date on ORSA developments, as well as the firm’s risk management processes. The ORSA will require a consistent and efficient measurement of solvency resources and a determination of capital quality. In addition, the ORSA will look for an effective ERM framework including:

• Risk culture and governance• Risk identification and prioritization• Risk appetite, tolerances and limits• Risk management and controls• Risk reporting and communication

This framework should be documented as the ERM Policy Statement of the insurer.

ORSA requirements for ERM policies in other countries are similar.

How will you need to assess economic capital?Most firms will focus on the ORSA “resource assessment.” ICP 16 specifies that the ORSA plan ahead for up to five years; the NAIC guidance manual allows for a two- to five-year look forward. The assessment should include foreseeable and material risks, and employ both quantitative and qualitative methods. Stochastic modeling is not specifically required; in fact, the ORSA practice seems to favor stress testing.


The NAIC will require insurers to calculate economic capital, specifying how each of the following is handled:

1. Definition of solvency

• Cash flow basis, balance sheet basis or other

2. Time horizon of risk exposure

• One year, lifetime or other

3. Risks modeled

4. Risk measurement process

• Stress tests, stochastic modeling, factor-based formulas

5. Measurement metric

• Value at risk, tail value at risk, probability of ruin, or other

6. Company target level of capital

7. Diversification effects

In Europe, regulators expect that ORSA parameters may differ from those of the internal Solvency II capital model. The internal model is calibrated to risk assumptions specified by the regulators, while the ORSA reflects management’s risk assumptions.

For the ORSA, insurers must assess capital adequacy in a stressed environment using either a stress testing methodology or a stochastic model.

For the ORSA, insurers must assess capital adequacy in a stressed environment using either a stress testing methodology or a stochastic model. Since the ORSA specifically requires a multi-year view of future capital needs, some firms that have already developed internal models may need to enhance those models.

Why ORSA?Consequences for noncompliance have not yet been specified; at a minimum, failure to comply will mean additional scrutiny during the regulatory review process, but it’s possible that noncompliance could result in a public report declaring the firm’s risk management practices to be inadequate. The exact ORSA requirements for U.S. companies are still evolving. Based on feedback they have received to date, the NAIC is adapting the ideas of ICP 16 to fit the existing U.S. regulatory and industry environment. But the concept behind ORSA is firmly in place: the insurer – not the regulator – should be responsible for determining the capital that the firm needs; and this determination should reflect the risk management capabilities, the risks and the capital of the firm.

Complicated?Not really. It’s merely a mathematical model that takes available data and makes a prediction. It’s the same thing that flesh-and-blood underwriters do day in and day out. The math in the predictive model is probably less complicated than what the underwriter is doing – but it’s able to find relationships in the data that are “hidden” to the underwriter. Much like the underwriter’s brain, a predictive model:

• Looks at all available data points on a particular risk

• Gives insight about what that data means

• Helps the company better select and price risk

Expensive and / or impractical?Like any other underwriting tool, predictive modeling is valuable if it can increase profitability. Like any other tool, assessing the value is straightforward:

• What are the costs?

• What are the benefits?

• Can it be implemented here?

The question of implementation goes beyond just systems and IT – there are also legal issues and palatability problems:

• Legal – can this be used in our jurisdiction?

• Palatability – will underwriters and management be able to accept what the model is indicating, even if it’s counter intuitive to underwriting conventional wisdom?

The palatability paradoxDon’t underestimate the palatability issue; it’s a common stumbling block for small carriers with a rich underwriting tradition, just starting to explore predictive modeling. By definition, a predictive model will only provide value if it provides information the underwriters don’t already know. Therefore, any effective model will be, by definition, counterintuitive. The trick is to have an objective understanding of the model’s predictive power, and a realistic estimate of its financial benefit, before you ask whether or not a counterintuitive result can be accepted.

Finally, expect that a predictive model will be implemented not to replace the underwriting process, but to supplement it; a good predictive model puts a powerful tool in the underwriter’s hands that will make his or her job both easier and more effective. The result? Potentially increased profits.

Predictive modeling: beyond the buzzwordWe’re now fifteen plus years into the predictive modeling “craze” in Property / Casualty insurance and predictive analytics is finally starting to lose its mystique in the U.S., moving beyond the buzzword and into the mainstream. Over the past 50 years, predictive modeling has moved through a progression of increasing approachability:

• 1940s and 1950s: Cutting edge, rocket-science unobtainium, when the statistical theory was beyond our computational ability

• 1980s: Big Data; multi-million dollar projects by hardware vendors and the big accounting / consulting firms

• 1990s: In-house dedicated predictive modeling departments by firms such as Progressive and Geico, which enjoyed a significant competitive advantage

• Mid-2000s: Off-the-shelf third party models and boutique modeling firms bring predictive analytics to a wider spectrum of companies

• 2010: Kaggle.com (“We’re making data science a sport”)

• 2011: FarmVille monitors player behavior to offer them customized in-game incentives

It’s interesting to note that the statistical tools used in predictive modeling haven’t changed much in the last 30 years. The modeling methods that Big Data had in the 80s are what Kaggle contestants are using now – it’s just that, rather than requiring a mainframe to calculate, these models can now be completed during a morning subway commute on an average notebook.

So why isn’t every carrier embracing predictive modeling? It’s probably partially due to the (mistaken) beliefs that predictive modeling:

• Is extremely complicated

• Is extremely expensive

• Takes years to implement

• Won’t work for small carriers or specialty coverages

In reality, none of these are generally true. In fact, any carrier not already using predictive modeling should be able to identify and rapidly implement a predictive model that may yield increased profitability.


Should we do it?There’s a very rational process for objectively evaluating a predictive model. Following this outline will help you understand, in quantitative terms, the model’s predictive power and potential value to the company. Just ask (and answer) five questions:

1. Will the model work?

• This is the easiest question to answer

• Evaluate by “predicting” past results, and compare to actual

• If the model doesn’t work, drop it and quickly move on to something else

2. Will it be better than relying on traditional underwriting alone?

• A strong model is no good if it only tells you what you already know

• A valuable model will tell you something your underwriters do not currently use

3. Can it be implemented here?

• IT compatibility

• Legality

• Palatability

4. Will the benefits justify the costs?

• At this stage, you’ve verified that the model works, that it has value, and that it can be implemented

• Measure past results “as if” the model had been implemented last year

• Compare to the projected model cost, including vendor, IT, legal, and so on

• What’s the possible improvement to the bottom line?

5. Should we implement it?

• Unfortunately, this is usually the first question people ask – frequently leading to analysis paralysis, as firms look for “just one more run” to make up their minds

• Instead, move this question to the end – by now you’ve got the answer. If the answer to the previous four questions is “Yes” then there may well be no reason NOT to move ahead.

two novel solutionsWillis Re has identified a couple of novel predictive modeling solutions that are perfect for organizations with smaller data and smaller budgets. They allow rapid resolution of the five-step evaluation plan outlined above, and offer a perfect first step into predictive modeling for many carriers who have yet to make that move. Willis Re has negotiated discounted rates on these products for our clients. We receive no financial incentive when our clients use these services; instead we offer independent third party advice as they investigate the potential fit and during model implementation.

• Valen Technologies’ InsureRight service is an extremely powerful Workers’ Compensation model which provides risk scoring on Workers’ Comp policies countrywide. Because it’s based on Valen’s data warehouse, model development and implementation is very fast, with a 45 day target. The service is low cost, and based on a transactional model – so clients pay only for the scores they request from the system.

• ISO RiskAnalyzer is available for U.S. Homeowners as well as Commercial and Personal Auto. The products are based on ISO’s vast database of industry statistics, leveraging those statistics to produce loss relativity predictions at a geographic level of detail much finer than the standard ISO rate plans. RiskAnalyzer products are subscription-based, with a modest annual fee, and have zero development time: just sign up and start using the model results immediately.

If you’re not currently using predictive analytics in your company, now is the time to take predictive modeling beyond the buzzword and into action.

For more details on these products, or how predictive modeling might fit in your organization, please contact your Willis Re team.


A.M. Best rating actions: raising the barThe year just past was a challenging one for the insurance industry. Insurers faced significant catastrophe activity, a difficult economic environment, and prolonged soft market conditions. Capital levels for the industry as a whole remain robust, but individual carriers – especially regional carriers – experienced surplus declines.

In this context, it’s apparent that A.M. Best has raised the bar for its higher rating categories. To achieve or maintain these ratings, insurers’ performance measures need to be stronger than ever before. During 2011, we observed that A.M. Best:

• Heightened their evaluation of Enterprise Risk Management (ERM)

• Incorporated higher PMLs in Best’s Capital Adequacy Ratio (BCAR) analysis due to catastrophe model changes

• Focused even more strongly on underwriting and operating performance

• Showed less tolerance for earnings volatility, particularly for higher-rated companies

• Sharply increased the percentage of negative rating actions, particularly in Q3 and Q4

• Imposed many downgrades with a drop of 2+ rating levels and / or continued negative outlook

Although the majority of 2011 ratings were affirmed – as is the case every year – downgrades and negative outlooks outpaced upgrades and other positive rating assignments. And in the second half of the year, negative rating actions picked up due to catastrophe losses that added stress in an already challenging underwriting climate.

2011 A.M. Best Rating Actions (excluding affirmations)

2011 Full Year 2011 Q3 and Q4

Negative rating actions outweighed positive actions in 2011.The proportion of negative rating actions increased in the second half of 2011 from 66% to 73%.

Downgraded

Downgraded under review

Under review with negative outlook

Upgraded, or under review with positive outlook

Source: A.M. Best


2011 in reviewWhile catastrophe activity declined in the fourth quarter, many companies had downgrades based on third quarter filings. The effect of multiple “smaller” catastrophe losses in the U.S. was especially painful given the trend toward increased reinsurance retentions over the past 15 years. As firms have sought higher limits for their catastrophe reinsurance to protect against large events, many managed costs by raising their retentions and co-participations. They were left with significant net losses after reinsurance.

Willis Re’s 1st View report, released in January 2012, estimated global insured losses at over $100 billion, with more than 50% of this amount covered by reinsurance. In the first half of 2011, the global reinsurance market bore the brunt of the Japanese and New Zealand earthquakes; Thailand Flood losses are reducing earnings for the fourth quarter. Capacity is still available, but individual reinsurers are assessing their respective risk tolerances and the cost of capital deployed.

A.M. Best reported that through 9 months of 2011, U.S. insured pre-tax catastrophe losses were $38.6 billion – one of the costliest years on record. The U.S. industry’s combined ratio for this 9-month period increased to 108.3%, an 8.5-point increase from the comparable 2010 period. Underwriting challenges and a weak investment market brought the U.S. industry’s 9-month net income down to $12.8 billion, from $33.0 billion the prior year. Net written premiums increased 3.3%, while policyholder surplus decreased 3.1%.

In total, the insurance industry’s capital level remains strong, but leverage ratios are under pressure. And while A.M. Best anticipates that companies will continue to release reserves, adequacy has declined. The first three quarters of 2011 saw $10.5 billion of industry reserve releases, driven in large part by State Farm, Berkshire Hathaway and Travelers. Such actions will likely lead to continued deterioration of calendar year results in the future. Though rates are improving in catastrophe prone regions, a wholesale market turn is not anticipated for 2012.

a.M. Best actionsIn the past, A.M. Best rated most companies soon after annual results were reported; they tended to take at most one action on a given company over the course of a year. But A.M. Best has become less optimistic that results will bounce back in the near term. So even after a downgrade they may assign a

continued negative outlook; in fact this happened to many of the “A-” to “B+” level companies that were downgraded in 2011. Overall, A.M. Best is scrutinizing underwriting and operating performance more closely, and tolerating less volatility of results, for the higher rated companies – regardless of capital strength.

Catastrophe model changes were another crucial factor. Willis Re’s market surveillance and feedback from our clients indicate that A.M. Best closely scrutinized companies perceived as slow to enact model changes. Catastrophe risk management and risk appetite were hot-button topics. Since the agency continues to frown on “model shopping,” companies must demonstrate a solid understanding of the cat models and a sound rationale for their strategy. Our Catastrophe Management Services team has helped many clients achieve a better understanding of the new model results, as well as helping them prepare to explain their position to A.M. Best.

Outlook for 2012A.M. Best’s ratings outlook for 2012 is mixed. While personal lines and global reinsurers have maintained “stable” outlooks, the agency continues a negative outlook on commercial lines.

We expect 2012 to be another sensitive ratings year. In that context, we’re working closely with our clients to assist with rating advisory, capital and reinsurance management, strategic analysis and financial forecasting. Our experienced team can help with initial rating assignments, upgrade roadmaps, rating pressure defenses, strategic planning implications, and mergers and acquisitions analysis.

Please contact your Willis Re team to discuss further.


Global and local reinsurance Willis Re employs reinsurance experts worldwide. Drawing on this highly professional resource, and backed by all the expertise of the wider Willis Group, we offer you every solution you look for in a top tier reinsurance advisor. One that has comprehensive capabilities, with on-the-ground presence and local understanding.

Whether your operations are global, national or local, Willis Re can help you make better reinsurance decisions - access worldwide markets - negotiate optimum terms – and boost your business performance.

How can we help?To find out how we can offer you an extra depth of service combined with extra flexibility, simply contact us.

Begin by visiting our website at www.willisre.comor calling your local office.

This paper and all of the information material, data and contents contained herein (hereinafter “Contents”), are for general informational purposes only, are not presented for purposes of reliance, and do not constitute legal advice, tax advice, investment advice or any other form of professional advice. The Contents herein are not offered as solutions to specific problems or to to produce specific results, are not to be relied upon and any action based on or in connection with anything contained herein should be taken only after obtaining specific advice from independent professional advisors of the reader’s choice and formulating the reader’s independent conclusions and opinions, based upon such independent professional advice. Willis Group Holdings Limited and all of its subsidiaries and affiliates, including but not limited to Willis Re Inc. and Willis Limited (hereinafter “Willis Group”), hereby expressly disclaims any and all liability based upon, arising from or in connection with the Contents herein and disclaims any responsibility or liability for the reader’s application of any of the contents herein in any manner, Willis Group is not liable for any damages, in any form, (including without limitation, compensatory, punitive, exemplary, statutory or multiple damages, legal fees or costs, fines or administrative penalties) whether awarded by any court, arbitrator, arbitration panel, regulator, administrative body or governmental agency or any other entity, or any amounts paid by way of settlement by any third party, under any theory of liability, whether in tort, contract or otherwise, in any manner based upon, arising from or in connection with the Contents herein and/or any use or application of the Contents or any analysis or conclusions based upon, arising from or in connection with the Contents. Willis Group does not guarantee, warrant and is not otherwise responsible, and expressly disclaims any and all liability, pursuant to the general disclaimer set forth above, for the accuracy or completeness of the Contents. Some of the Contents may be compiled from third party sources and Willis Group does not guarantee, warrant and is not otherwise responsible, and disclaims any and all liability, pursuant to the general disclaimer set forth above, for the accuracy or completeness of any of the Contents obtained from or referencing third parties or third party web sites, if any. The Contents herein do not guarantee any particular outcome or result. The views expressed herein are those of the authors and do not necessarily reflect or represent the views of the Willis Group.

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Willis Re Analytics Review 2012

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