Comparing Solvency II Standard Scenarios for Windstorms with Catastrophe Model Outcomes - Updated Study: With the generalized use of catastrophe models to measure the natural catastrophe exposure of insurance portfolios, the outcomes of these models have more and more influence in the determination of reinsurance needs. With the introduction of the Solvency II regime, the decision on reinsurance purchase should also be an integral part of a company’s risk management process.
Risk Profile, Appetite, and Tolerance: Fundamental Concepts in Risk Management and Reinsurance Effectiveness: Prior to the recent turbulence in the financial markets, insurers and reinsurers were increasing their use of enterprise risk management to make risk and capital management decisions. While this was driven in part by rating agencies and regulators, many carriers began to recognize the value of metric-based frameworks and capital models in evaluating their portfolios.
Assessing Future Reserve Development: By extrapolating reserving trends, it may be possible to assess the sector’s reserve adequacy. Two cyclical patterns are clear: 1) The cycle turned on an accident year basis in 2004. Industry-wide accident year deterioration now appears imminent. 2) Guy Carpenter’s view of the cycle shows that over the last 30 years, accident years that begin to show deteriorating results continue to deteriorate.
Chart: Valuations Remain at Long-Term Low: With the sector exposed to a debt crisis, emerging catastrophe risks and a deteriorating reserving cycle, it should come as no surprise that valuations stand at or near 20-year lows. As shown in Figure 1, reinsurers’ average price-to-book ratios remained near 0.90 during the first half of 2012 - approximately one and half standard deviations below the 20-year mean.
Resilient Capital Levels: Another driver of low valuations has been sector book value or capital growth (the denominator in the price-to-book ratio). Figure 1 shows the increase in reported capital since the middle of 2011 for the Guy Carpenter Reinsurance Composite. This growth has been particularly impressive as the sector experienced an exceptional series of costly catastrophe losses during this time. Yet, as the primary sources of capital growth are net income and unrealized gains, it is important to ask: how tangible and sustainable are these sources of growth?
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Catastrophe Activity: Increasing Cold Spots: In addition to the challenging macroeconomic environment, the sector has had to contend with heavy catastrophe losses over the last few years, particularly in areas not previously considered peak risks. Since 2010, (re)insurers have been hit by powerful earthquakes in Chile and New Zealand and devastating floods in Thailand and Australia. The result has been unexpectedly expensive “cold spot” losses at a time of increased insurance demand in regions such as emerging Asia and Latin America.