December 4th, 2009

Week’s Top Stories: Nov 27 - Dec 4, 2009

Posted at 1:00 AM ET

Capital Allocation Metrics: Introduction: Capital allocation is a discipline without consensus. Some believe in sticking strictly to allocating the cost of capital, while others believe in allocating capital itself. Meanwhile, the methods for allocating capital (and its attendant costs) vary, ranging from the simplest — standard deviation — through the increasingly complex covariance, co-xTVaR and shared assets approaches. The exercise becomes one of managing tradeoffs, as risk managers balance the simplicity of effort against the potential benefits of capital optimization.

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Capital Modeling in the Age of Systemic Risk, Part I: Hidden risks lurk in nearly every insurance portfolio. Unexpected accumulations, correlated threats and unimagined financial market developments can take shape quickly and severely. When disaster strikes — either because of a storm or an economic shift - insured and asset losses can drain balance sheets, impair return on equity (ROE) performance and destroy shareholder value. The cost of systemic and hidden risks can impact every link in an insurer’s financial supply chain, with today’s losses causing capital costs to rise for months, even years.

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Protect Your Balance Sheet from Casualty Catastrophe Risk: Indications of an economic recovery and fairly flat renewal are already beginning to obscure the experience of the past year. For professional liability insurers, this is particularly disconcerting, for even as balance sheets grow stronger, the implications of the largest casualty catastrophe in more than 70 years are still unfolding. The lawsuits and claims may take years to resolve, suggesting that the effects of September 2008 will be with us for quite a while. As the situation develops, professional liability insurers should use what they learn to revisit accumulations in their portfolios and take action to protect their capital — and shareholder value — from future worldwide chain reactions of liability exposure.

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Inflation: Not All Bad News for European (Re)Insurers: Inflation is always a major risk factor for the casualty industry. For the past seven years, monetary inflation has been low across most of Europe, and this has helped keep interest rates low. For casualty insurers, this can lead to a challenge, because the key cost-drivers of long-tail liability claims — salaries and wages, pensions and most notably medical care costs — have been growing much faster than monetary inflation.

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GC Podcast 12 — Cat Modeling (John Tedeschi): John Tedeschi, Managing Director and Chief  of Catastrophe Modeling in Guy Carpenter’s Instrat® Unit, discusses catastrophe modeling in this new GC Capital Ideas podcast. Click the audio player below to listen to the interview, or download the interview in a file that will work with your iPod.

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Stability Returns: At the end of 2008, the normal pre-renewal uncertainty was magnified by the effects of the most severe financial crisis in more than 70 years. Financial markets were in turmoil, and the cost of capital was rising. Yet, these pressures were counterbalanced by capital positions that remained sufficient, despite the impairment of investment assets. The outcome was relatively benign, but anxiety was endemic before the January 1, 2009 reinsurance renewal. Now, 12 months later, the marketplace is much different, indicating the remarkable recovery that has occurred in 2009.

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