Transcript Client Relationship Management - Marine Seminar

“Boom, Bust or Balance?”
by
Martin Schweighauser
Global Head Energy & Natural Resources, Swiss Re
MARINERS CONFERENCE 2006
Houston, 18th September 2006
Balance…
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Contents
Page 3
1.
Insurance industry from a macro perspective
2.
Why buy insurance……?
3.
Corporate finance and the “right kind of cover”
4.
And how should we deal with NatCat?
5.
Insurance for Energy Companies: “quo vadis”?
6.
Insurance for Offshore exposures
7.
Some Thoughts and Conclusions
Macro perspective
Stock market returns and change
in commercial premium rates
Stock index
1990 = 100
Price index
1994 = 100
500
120
400
100
300
80
200
60
100
40
0
20
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06
S&P500 [left]
ww cat r/i index [right]
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DJSTOXX [left]
Lloyd's non-marine index [right]
Sources: Datastream, Thomson Financial, CBS Private Capital Ltd,, Swiss Re
Macro perspective
Industry Profitability
• stock market “fragile” since
2000
• some upswing but not
widespread
• uncertainty remains
• earnings volatile
market hardening already
started in 2000, asbestos
and Sep11 just accelerated
$
selective market hardening
(e.g. offshore) - but not
widespread
?
• operational income (from
u/w) is key
• big losses in 2001 and
2005
• premiums are not really
offsetting losses
• magnitude of future losses
increasingly difficult to
estimate
?
?
1994
1995
1996
1997
1998
UW Result
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1999
2000
Stock Market
2001
2002
2003
Premium Level
2004
2005
Est.
Macro perspective
Sensitivity of ROE to investment yield
and underwriting result
• high(er)
investment yields
(for insurers) do
not necessarily
lead to higher
ROEs
• performance in
core operations is
key to healthy
ROEs
(
Combined Ratio)
• a combination of a
poor yield and
poor Combined
Ratio leads to:
• equity loss
• rating
Sources:downgrade
A.M.Best, Swiss Re
Economic
Research & Consulting
• (expensive)
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recapitalization
ROE
Year B
investment yield
20%
Year A
investment yield
15%
10.7%
10%
7.0%
5%
2.4%
0%
94%
96%
98%
100%
97.9
for Year B
102%
104%
106%
Combined
Ratio
108%
108.1 for
Year A
Macro perspective
New capacity did not fill the gap left
by destroyed capital
Capital inflows and
the creation of new
players in 2002 were
not enough to restore
health to the
industry…
Quality of new capacity
NR
Source:
Sigma No. 4/2002
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below A-
A- to A+
AA- to AA+
Location of new capacity
AAA
Europe
US
Bermuda
Bermuda start-ups

New capital inflow was ~$30billion +

Decline in capital funds of established players since year-end 2000 was ~$180 bln

Security of raised/new capital was not top quality; many security downgrades too

New capacity has not been upgraded and downgrades have not been reversed - this will
continue to limit availability top-quality capacity

There was some capital base improvement in last 3 years, but not enough

Improvement of the industry’s overall capital funds and earnings stability will be key to
limiting premium volatility
Macro perspective
What drives cycles and hence, the
cost of insurance…….?
 Fluctuations of capital base
 Need for insurance market to be “paid back”
► Underwriting losses recovered by market via higher rates in macro cycle
► At micro level, companies who make claims are priced as higher risks
 Low equity market returns and broad underwriting losses in recent years
 Lack of real substitutes and insufficient exploitation of alternatives to
insurance  insurance remains the main vehicle for cover
 Cost of insurance vs. cost of debt and equity (e.g. GoM today)
 Big loss events which cause great uncertainty and general inability to
plan adequately
► Asbestos and 09/11 were just accelerators adding additional challenges –
and now we have (many)hurricanes too…..
► Vicious circle of:
terrorism; war; general uncertainty; major losses;
slower economic growth; etc……
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Macro perspective
So where do insurers stand today?
 Still affected by:
► i) Asbestos claims; ii) 9/11 impact; iii) massive hurricanes etc.
 Investors’ confidence continues to be rocked by:
► i) Average (at best) performance of insurers, ii) accounting scandals & compliance
issues, iii) hurricanes, iv) still low interest rates etc….
 Equity capital for insurance companies hard to get and/or expensive
 Several years of solid profitability necessary to restore balance sheets
 (Some) strengthening in stock markets helping – but it is not enough
 Some strengthening of capital bases through core (u/w) operations
 Share prices of insurance companies flat to languishing
 Significant regulatory changes: compliance and business scrutiny
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 Nat Cat events (and losses) on the rise
Why buy insurance?
Let us step back and reflect … why do
insureds want insurance in the first
place?
 To keep shareholders from bearing risks they don’t want
 To reduce impact of non-core events on earnings
 To reduce capital required to support debt capacity needed to finance
infrequent loss events
 To enhance financial flexibility:
 diversify funding sources by using the insurance market
 enables access to liquidity for funding losses
 potential lower overall capital cost (through better risk profile)
 For signaling:
 demonstrates identification and management of (potential) financial
consequences of risk exposures;
 avoids disclosure “noise” about things that are ancillary to core strategy;
 regulatory or quasi-regulatory compliance
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Why buy insurance?
The Energy world is an environment
full of risks…
“How much
falls between
the cracks?”
E
n
e
r
g
y
C
o
m
p
a
n
y
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Examples of risks
•Counterparty exposure
•Collateral posting (rating dependent)
•Commodity price / Spreads
Examples of risks
•Business growth
•Future (unforeseen) Liability
Renewable Energy
•Solar
•Wind
•Emissions trading
•Biomass
•etc….
•Spark spread trading
•Power plants
Gas to Power
•Liquefaction plants
•Shipping
•Regasification plants
•End products
Petrochemicals
LNG
Trading
Exploration
&
Production
Oil & Gas
•Finding & Extraction
•Separation
Examples of risks
•Casualty/Environmental
•Volumetric risk
•Property damage
•Business interruption
•Construction
•Other operational
•Earnings volatility
Transportation
Crude oil & gas
•Pipelines
•Shipping
Basic, Integrated Value
Chain
Examples of risks
•Casualty/Environmental
•Property damage
•Business interruption
•Construction
•Other operational
Refining
&
Marketing
Crude --> Refined
•Pipelines
•Shipping
Examples of risks
•Casualty/ Environmental
•Property damage
•Business interruption
•Construction
•Other operational
End
Use
r
Corporate finance
and the “right kind of
cover”
Ultimately, a client needs to satisfy
corporate finance objectives
= very well
… how well are these objectives met?
= very poorly
By:
Doing
nothing
Paying the
(high) rates
Using Finite
structures
Using
Committed
Capital
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Protect
shareholders
from unwanted
risk(s)
Protect
earnings from
non-core
losses
Use capital
efficiently
Enhance
financial
flexibility
Management
signalling
impact
Corporate finance
and the “right kind of
cover”
The worry of every CFO and CRO
….
“Could this
happen to
me?”
Hardware loss:
Magnitude of loss:
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a fractionation column
> US$ 1 billion (PD + BI)
Corporate finance
and the “right kind of
cover”
Risk Management is a Corporate Finance matter
“it is about finding an economically efficient balance”
Firm Capital = f (Firm
All sources of capital help manage a firm’s risk:
Risk)
Transferred
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Contingent Capital
Insurance & Derivatives
Off-Balance-Sheet
Paid-Up
Senior Debt
Mezzanine Finance
Equity
Retained by Firm
Corporate/Firm Risks
Insurance-Linked Securities
Corporate/Firm
Capital
Transferred
Low
Exposure
to risk
High
Linking risk, stakeholders and
finance
“How much
cover? How to
reduce the
premium?”
Company with
low D/E ratio
Off
On-Balance Sheet
Creditors
Company (Banks)
Employees
Creditors
(various)
Insurers
Shareholders
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Insurance & Derivatives
(Senior) Debt
Stakeholders
involved
Company with
high D/E ratio
Off
Low
Low
Mezzanine
Finance
Exposur
e
to Risk
Equity
Transferred Retained Risk
On-Balance Sheet
Insurance & Derivatives
Corporate finance
and the “right kind of
cover”
High
Transferred
(Senior) Debt
Exposure
to Risk
Mezzanine
Finance
Equity
High
Retained Risk
Some questions/dilemmas/pressures/responsibilities etc…..
• Which stakeholders do you want/can you afford to expose to risk?
• How much risk? How much cover? How much premium spend?  What is the right balance?
• What would the financial consequences of a (large) loss be?
• Would the Company go under or would the Debt and/or Equity holders just be angry?
• So…… how much cover? And could the (premium) bill be lowered? How?
Corporate finance
and the “right kind of
cover”
Risk Management becoming more
strongly linked to Corporate Finance
 The financial dimension of firms’ risks are increasingly better
understood
 Tools to manage risks, both operationally and financially, are more
plentiful and sophisticated
 Increasing pressure from the various stakeholders creates the need
to understand and properly manage risks
 Increasing compliance pressures likewise
It follows that all financial tools to mitigate the
financial exposures associated with risk,
including insurance, appear on a CFO’s agenda
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Nat Cat……?
What happened in 2005 ? (global energy only)
LOSSES (some numbers are rough estimates)
Large Refinery
(PD + BI loss)
NatCat was the
major loss
contributor by far!
US$ 1.0 bln
Man made
Loss offshore India
+/- US$ 0.4 bln
Hurricane Katrina
>
US$ 5.0 bln
>
US$ 4.0 bln
>
US$ 0.5 bln
Nat Cat
Hurricane Rita
All Other
TOTAL
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>
Mix
US$ 10-15 bln ?
Nat Cat……?
Changing risk landscape: more
unpredictable & greater in magnitude
Many of the losses
are due to NatCat
events …..
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Nat Cat……?
Some facts and what is being heard…
 Insurance industry’s (non-life) underwriting operations will post/have
posted a loss for 2005
 OIL aggregate limit (of US$ 1 bln) breached twice (?) in 2005 (due to
hurricanes Katrina and Rita)
 Several insurers of the Energy offshore segment very severely hit by
hurricane losses of 2005 (some to the point of extinction?)
 Property onshore segment has had some large losses in 2005 - beyond
just hurricane damage
 Reinsurance rates have gone up significantly – and must not drop
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Energy) Insurance:
“quo vadis”?
Market Performance
?
Commercial Market Losses (Energy – Property onshore)
?
2000
Premium
40
1800
Loss
35
Number of loss incidents
1600
?
1400
millions USD
5-yr Mov. Avg. (Loss)
25
1200
1000
20
800
?
600
15
10
400
5
200
0
0
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Accounting Year
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30
2005
Number of Incidents
5-yr Mov. Avg. (Premium)
Energy) Insurance:
“quo vadis”?
Major trends
 Insurers deploying capacity more selectively and scaling back in
some cases….
 …while for many (large) insureds availability of capacity is an issue
 Pressure for more risk (and rate) differentiation
 Large insurers better positioned to offer solid security
 Compliance is affecting and defining business behaviour significantly
 NatCat losses leading to reassessment of models
 Enterprise risk increasingly a part of strategic corporate finance
 this will create pressure for more
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discipline….
Energy) Insurance:
“quo vadis”?
Premiums, coverage, security, risk quality etc…..
…… while we still grapple with some difficult
issues:
 Pricing for risks is “all over the place”  we need to differentiate
 (Quite a few) insureds take an opportunistic attitude towards their carriers
 Pricing squeezes lead to coverage squeezes  meaningful coverage
requires “proper pricing”
 The industry must avoid excessive price volatility:
there has been too
much, historically
 Often, insureds seem willing to sacrifice security for (lower) price
 Underwriters struggle to underwrite and rate as they should - extreme
price volatilty forces them to go with market
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 Differentiation becomes very difficult – regardless of risk quality
Energy) Insurance:
“quo vadis”?
Compliance is here to stay…..
 Focus on processes, documentation standards, transparency, ethics and
behaviour
 Regulatory bodies have been created or strengthened (e.g. FSA)
 One must demonstrate execution of good/compliant business practices
 Penalties are levied for deviations (e.g. Enron)
 Responsibility and accountability even for highest executives
 This is a global phenomenon
 Adoption of enterprise risk management frameworks in Companies
 Integration into enterprise achitecture
 Actively managed and measured compliance  in- and external audits
 Establishment of a Chief Risk Officer
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Offshore Insurance
Specific Changes in Underwriting…….
 Coverage restrictions in Nat Cat areas per occurrence and in aggregate
for season
 Offshore price rise: up to 500% in GoM, 10% - 30% elsewhere
 Onshore Property pricing: up to +20%; more for very exposed
locations and facilities
 Basis of BI changing – much more restrictive. CBI all scheduled and
sublimited; cover of costs & expenses, not pure loss of profit.
 Much more control over accumulations – much more limited Gulf of
Mexico capacity available
 Emphasis on risk quality and differentiation of certain types of assets
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Offshore Insurance
Conclusions for offshore
insurance
 Capital bases must be restored to health – and stay healthy
 This means appropriate pricing - for direct and re-insurance
 If not, capacity of some key players (even major ones) will be reduced
or disappear completely
 NatCat models must (and will) be reviewed and adjusted
 As insurance becomes an integral part of Corporate Finance, Risk
Managers and CFOs will move ever closer together
 New insurance capital will flow in as rates rise (Bermuda)
 More stringent compliance and regulatory requirements will force more
business discipline and transparency
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Thoughts
and
Conclusions
Boom, Bust or Balance……?
Given that:
1. Boom is good but actually “spoils” us…….
and
2. Bust is bad for everybody…
then
3. Balance really is the best, since we can all happily live with
that…
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So what should we be doing (to avoid
busts)?
Insureds
► Make insurance an integral a part of corporate finance strategy
► Help prevent high rate volatility - by balancing quality and price
Insurers
► Know better what is being underwritten and price accordingly
► Help prevent high rate volatility – by sticking to “true economics”
Brokers
► As risk consultants, encourage clients to think beyond just price
► Help create stability by avoiding a “win the deal at all cost” mentality
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All of us together:
Take a long term view……
Balance…
so we can end up here……….
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Thoughts
and
Conclusions
A last thought….
"If you think insurance is
expensive……. try a loss."
Stelios Haji-Ioannou (CEO Easyjet Group)
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