Property & Casualty Insurance CFO Survey. The Current Market. Property Significantly harder. Somewhat harder. About the same.

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1 Insights March 2 Property & Casualty Insurance CFO Survey Trends in Reinsurance and Alternative Forms of Capital As the market for insurance-linked securities and other alternative forms of capital has experienced explosive growth, insurance company CFOs have started to look more favorably upon these options to complement their companies traditional reinsurance arrangements. At the same time, the property & casualty (P&C) reinsurance market is viewed as being softer than the primary insurance market, which CFOs attribute directly to these alternative forms of reinsurance capital and the general strength of the capital base of the industry. These are some fi ndings from the sixth installment of Towers Watson s North American P&C Insurance CFO Survey, which examined major trends in the P&C reinsurance market as well as drivers and consequences of current market conditions. Key Findings Over half of respondents believe the property reinsurance market is softer than the primary property insurance market, and about one-third believe the same is true for the U.S. casualty business. The majority of respondents don t currently use alternative forms of capital but look favorably on its potential future use. Less than a quarter of respondents believe there is a need for consolidation among reinsurance companies or that consolidation will take place in the next two years. Pending regulatory and accounting changes are likely to alter the current ceded reinsurance structure of only 1% of respondents. Surprisingly, companies said their enterprise risk management (ERM) processes have also not signifi cantly changed their purchasing decisions. The Current Market A signifi cant percentage of respondents believe the U.S. reinsurance market is softer than the primary market 55% for the property reinsurance market and 4% for the casualty market (Figure 1). Figure 1. Reinsurance market conditions Do you believe that reinsurance market pricing for U.S. property and casualty business is than the primary insurance market? % 1% 2% % 4% 5% 6% Property Significantly harder Somewhat harder 1 About the same Somewhat softer Significantly softer 1 Casualty Significantly harder Somewhat harder About the same Somewhat softer Significantly softer

2 Insights March 2 This assessment is reinforced by the perception of a majority of participants that the terms and conditions for P&C reinsurance contracts have stayed about the same, and not strengthened to the benefi t of reinsurers, over the past 12 to 24 months. Slightly over half (52%) of respondents believe the strength of U.S. property reinsurance contracts has not changed substantially; the fi gure rises to 59% for casualty reinsurance contracts. Signs of hard market conditions persist in the primary U.S. P&C markets, as we noted in our fi fth CFO survey. But reinsurers hoping to benefi t from this hardening by charging higher rates may be disappointed. We continue to believe that a hard primary market may be relatively short-lived and shallow, largely because prices have not been damagingly low, and there may still be reserve redundancies to draw upon. In addition, in the primary property market, and to a lesser degree in the primary casualty market, the capital base is a market driver. As long as there are reserve redundancies, that capital base will not be suffi ciently eroded to signifi cantly harden the primary market. In the primary property market, contingent capacity, largely in the form of reinsurance alternatives, may also become a major market driver. Ample available capital may dampen any signifi cant primary insurance market hardening, and especially may prevent or dampen a hardening of the U.S. P&C reinsurance market. In fact, 9% of our current survey respondents have seen or expect to see decreasing prices driven by alternative forms of reinsurance, and we have seen a signifi cant acceleration of these vehicles, even since the opening of our survey in September 21. Despite this threat of overcapacity, less than a quarter of CFO participants believe there is a need for consolidation among reinsurance companies or that consolidation will take place in the next two years. However, they also believe that prolonged soft market conditions and competing alternative capital sources could drive reinsurance market consolidation. Alternative Forms of Capital A majority of our respondents said they don t yet use alternative forms of capital, but our panel also indicated they do look favorably on their use in the future (Figure 2). Nearly all respondents (9%) use traditional reinsurance, and the remainder said they are very likely to use it. But a sizable 59% already use collateralized reinsurance or are likely to use it 2% for insurance-linked securities (such as catastrophe bonds) and 2% for hedge fund-owned reinsurers. The overwhelming preference for traditional reinsurance refl ects its availability, price and the familiarity many market participants have with it. It is also a market segment built on relationships that encourage the continued use of this risk transfer option. The high degree of favor placed on collateralized reinsurance may refl ect the similarities it has with the traditional reinsurance market. The main differences are that investors such as private equity, pension funds and hedge funds act as a reinsurer, assuming the risk ceded by the insurer by providing collateral for the full potential obligation of the reinsurance treaty. The collateralized reinsurer benefi ts by both the terms of the treaty and the diversifi cation of the investment. It may also produce better yields than are currently available in other investments. Figure 2. Use of alternative forms of capital How likely are you to consider purchasing reinsurance from the following types of entities to protect your business? % 2% 4% 6% 8% 1% Traditional reinsurer Collateralized reinsurer Insurance-linked security (e.g., catastrophe bond) Hedge fund-owned reinsurer Currently using Very likely Likely Neutral Unlikely Very unlikely 2 towerswatson.com

3 Insights March 2 The more muted response for insurance-linked securities and hedge fund-owned reinsurers may well be explained in Figure. Although an overwhelming 88% of respondents recognize the benefi t of the lower cost of capital afforded by alternative reinsurance options, approximately two-thirds cited disadvantages, including the complexity of the contract or deal structure, the ambiguity related to contract triggers, and frictional and transaction costs. Purchasing Decisions According to our panel of CFO respondents, ERM processes haven t changed reinsurance purchasing decisions signifi cantly. The vast majority of respondents in all categories cited no change in purchasing decisions (Figure 4, page 4). The one exception is for catastrophe reinsurance purchases, where nearly a third of respondents replied that ERM prompted them to buy signifi cantly or somewhat more coverage. One possible reason is that the increased severity of catastrophic weather events or man-made events such as terrorism are becoming more highly ranked in these ERM systems and may be affecting reinsurance purchasing decisions. It is also likely that ERM programs, aided by improved technology and the increasing availability of big data, will continue to evolve and fi ne-tune risk detection. As ERM programs become more seamless and more effective at linking different kinds of risks, the resulting analyses may, and in many cases should, change reinsurance purchasing decisions. Pending regulatory and accounting changes are also holding little sway with reinsurance purchasers, with only 1% of respondents indicating they would be very likely to change their current ceded reinsurance structure to accommodate new requirements such as the pending Own Risk and Solvency Assessment regulations, International Financial Reporting Standards, and proposals issued by the International Accounting Standards Board and the U.S. Financial Accounting Standards Board. Figure. Advantages and disadvantages of alternative capital use What advantages/disadvantages do you see in using alternative reinsurance vehicles? % 2% 4% 6% 8% 1% Advantages Cost of capital Frictional/Transaction costs 22 Complexity of contract/deal structure Ambiguity related to triggers Basis risk Disadvantages Complexity of contract/deal structure Ambiguity related to triggers Frictional/Transaction costs Basis risk Cost of capital Cost/Lower price (two mentions) Added capacity Diversification Limit fully collateralized Long-term sustainability (two mentions) Exposure mismatch Lack of expertise in claims Claim settlements uncertain Understanding of vehicles and related risks However, signifi cantly more respondents expect increased industry use of reinsurance as a result of these regulatory and accounting proposals. In particular, more than % of respondents expect the use of catastrophe, aggregate loss cover and quota share structures to increase, while less than 15% expect decreased use of aggregate loss covers and aggregate risk transfer structures. towerswatson.com

4 Insights March 2 Respondents may be waiting for the greater clarity that will come with fi nal guidance from regulators. They may also need more time to fully understand the implications of these complex proposals before any purchasing decisions are made. Once these pending regulatory and accounting regime changes, and their impact on capital requirements, are better understood, a more signifi cant change in reinsurance purchasing decisions might occur. In particular, all of these regulatory requirements are expected to focus more on overall risk to company capital. We therefore expect reinsurance structures that provide protection for extreme events to see an increase in demand relative to traditional quota share and working-layer excess structures that protect annual earnings. For Reinsurers: Looming Competition in a Soft Market Reinsurers need to be aware of the near-term realities of a relatively soft reinsurance market and the longerterm potential of the alternative risk transfer market. Given the increase in reinsurance and alternative capital supply, reinsurers are faced with a property catastrophe market that is likely to soften unless there are major catastrophic events with very large losses. Lower-impact events will not deter capital from entering the market. This softening may be exacerbated as primary companies develop more advanced modeling and understand how to better identify risks that are well served by reinsurance or alternative risk transfer options. Reinsurers may face a classic economic example of reduced demand and increased supply that drives prices lower. Direct writers ERM programs should capture risk more seamlessly. As ERM models evolve and become more sophisticated, and as more data become available either generated by insurers or obtained from external sources a holistic view of enterprise risk will be easier to achieve. And once direct writers can look at risk holistically, they may be able to further leverage their ERM programs and gain an even better understanding of previously hidden risks and the capacity to handle the risks they face. This awareness could improve the effi ciency of reinsurance. It may also prompt direct writers to move beyond a mere conceptual acceptance of alternative forms of risk transfer and take steps to more actively participate in that market. In fact, the opportunities in the alternative risk transfer market are just starting to be fully realized. Many possible fresh sources of capital, such as pension funds, are seeking investments that are uncorrelated with their existing investment portfolio holdings. Figure 4. ERM influence on reinsurance purchasing Have your company s ERM processes changed your reinsurance buying patterns/decisions such that you purchase more or less reinsurance? % 2% 4% 6% 8% 1% Catastrophe Aggregate risk transfer 1 Aggregate loss covers 1 Per risk excess of loss Quota share Significantly/Somewhat more No change Somewhat/Significantly less Building on the momentum in the catastrophe bond market, many (re)insurers are also looking to securitize their liability portfolios to access capital. The complexity of alternative risk transfer contracts and transactions cited by our survey respondents will improve over time as participants become more comfortable with this growing market. This improvement will, in part, be facilitated because primary companies will get smarter as they refi ne their ERM programs and understand their risks better. There will continue to be a need for traditional reinsurance. However, new market realities will require the reinsurance market to adapt and operate more effi ciently to provide a value proposition that continues to attract the primary P&C market. Reinsurers that can participate effectively in either (or both) the alternative or traditional reinsurance spectrums, realize the effi ciencies of alternative capital while maintaining the relationships and platforms already built around traditional reinsurance solutions, and offer primary companies real solutions to their risk needs will be the ultimate winners. For more information about the survey results, contact: Stuart Hayes stuart.hayes@towerswatson.com; or Alejandra Nolibos alejandra.nolibos@towerswatson.com towerswatson.com

5 Insights March 2 Participant Profi le Towers Watson s North American P&C CFO Survey was open to CFO participants from September 25 through October 2, 21. Twenty-nine (%) of the 9 registered program members participated. Figure 5. Survey respondents represent a variety of types of business % 1% 2% % 4% Figure 6. Respondents represent a variety of ownership structures % 1% 2% % 4% 5% Figure. Respondents include local and regional carriers, along with nationals and multinationals % 1% 2% % 4% Commercial lines insurance 1 Stock 48 National (U.S.) 8 Personal and commercial insurance 24 Mutual (including mutual holding companies) 42 Local (i.e., single state or province) 1 P&C insurance and reinsurance 21 Risk retention group/captive/pool Multinational/Global P&C reinsurance 11 Multiline (life and P&C) Personal lines insurance Multiline reinsurer insurance/reinsurance (e.g., life, health, disability) Reciprocal exchange North America (significant presence in at least two of U.S., Canada, Bermuda and Mexico) Regional or provincial National (Canada) 5 towerswatson.com

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