December 11th, 2009

Week’s Top Stories: Dec 5 - 11, 2009

Posted at 1:00 AM ET

A Survey of Capital Allocation Metrics: Co-xTVaR: Co-xTVaR has almost the opposite advantages and disadvantages of standard deviation. It is calculated as the amount by which each risk is worse than its expectation in those situations in which the totality of risks being modeled exceeds its expectation. Co-xTVaR can be viewed as the amount by which a segment is “over budget” in those scenarios in which the company as a whole is “over budget.” In other words, co-xTVaR looks at the average amount by which each segment exceeds its mean in the scenarios in which the company result exceeds some threshold.

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Five Ways to Achive Competitive Compliance for Solvency II: Solvency II compliance should provide more opportunity than burden … if executed properly. The ability to use approved internal models results in a Solvency Capital Requirement (SCR) that’s tailored to the risks in your portfolio - which in itself is advantageous. This benefit translates into more effective capital management, as it reflects the risks you actually cover (rather than the output of a standard formula). Improved operations through the internal model approach may also free capital for deployment elsewhere — if the model-determined SCR is lower than that from the Solvency II standard formula. The newly available capital can be invested in any number of initiatives that can lead to a competitive advantage.

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A Survey of Capital Allocation Metrics: Illustration: To understand the differences in proportional capital allocation methods, it helps to have a reference point. Consider a simple hypothetical insurer that writes auto, general liability, workers’ compensation and property business. The loss distributions are a bit exaggerated to highlight some of the differences among metrics. A profile of the company’s business is shown in Figure 1.

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Group-Level Implications of Solvency II: Group support will not be permitted when Solvency II becomes effective in 2012. As a result, the flexibility to use capital held anywhere in the group in calculating the Solvency Capital Requirement (SCR) will not be available. Rather, each entity will have to calculate its SCR based on the capital it has, regardless of its group’s position as a whole. This last-minute change to eliminate group support could prompt some European insurance groups to change their structures - or at least rethink how much risk they will take in each entity.

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Third Quarter 2009 Cat Bond Update*: The third quarter is usually quiet for the catastrophe bond market, and 2009 was consistent with past years. Issuers completed two transactions, bringing USD412 million in risk capital to the market. Nonetheless, risk capital issued was up by a third relative to the same quarter last year, as both catastrophe bonds issued were upsized considerably. The consensus estimate for the entire year remains USD3 billion to USD4 billion, implying a strong fourth quarter for primary issuance.

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And, you may have missed …

Reinsurance Brokers: Orderly Markets and Optimized Results, Part V: Conclusion: The term “broker” implies a transactional focus, but in the (re)insurance business, a wide range of activities is necessary, far beyond merely bringing buyers and sellers together. To complete a transaction in a manner that gives both insurers and reinsurers the ability to make their capital as productive as possible, the intermediary analyzes data, runs catastrophe and model scenarios to immobilize the element of surprise. Each task contributes to the ultimate determination of capital sources and completion of risk transfer.

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* Securities or investments, as applicable, are offered in the United States through GC Securities, a division of MMC Securities Corp., a US registered broker-dealer and member FINRA/SIPC. Main Office: 1166 Avenue of the Americas, New York, NY 10036. Phone: (212) 345-5000. Securities or investments, as applicable, are offered in the European Union by GC Securities, a division of MMC Securities (Europe) Ltd., which is authorized and regulated by the Financial Services Authority. Reinsurance products are placed through qualified affiliates of Guy Carpenter & Company, LLC. MMC Securities Corp., MMC Securities (Europe) Ltd. and Guy Carpenter & Company, LLC are affiliates owned by Marsh & McLennan Companies. This communication is not intended as an offer to sell or a solicitation of any offer to buy any security, financial instrument, reinsurance or insurance product. David Priebe is the Chairman of Global Client Development at Guy Carpenter & Company LLC.

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