Contents Executive Summary: Steady Market, Slow Growth 1 Supply Matches Prior Peak to Support Current and Future Demand 2 Peak Zone Reinsurance Demand Relatively Flat 3 Second Quarter 2016 Catastrophe Bond Transaction Review 5 Elevated Global 1H Insurance Losses Led by Active Second Quarter of Disasters 7 Demand from Rating Agency Changes Slow to Mature 9 La Niña on the Way: Will the US Major Hurricane Landfall Drought End? 10 Contact Information 13 1 Reinsurance Market Outlook
Executive Summary: Steady Market, Slow Growth Reinsurance capital increased again through Q1 to USD580 billion, up 3 percent since year end 2015 and matching its previous peak supply reached Q1 2015, while alternative market capacity increased at a slower pace, up 1.4 percent to USD 73 billion. In the aggregate, insurers continue to benefit from high supply in reinsurance capacity and relatively low catastrophe losses in most regions, with abundant capacity to fund insurer growth aspirations. June and July 2016 catastrophe reinsurance program renewals predominately include US hurricane exposed insurers with this being the key renewal for regional Florida insurers, most Australia and New Zealand exposed insurers, a smaller segment of Asia ex-japan exposed insurers and Latin American exposed insurers. Ultimately, increases in private market demand for the peak catastrophe zone renewals in Florida were offset by a number of other factors. While insurers continued to privatize Florida Hurricane Catastrophe Fund (FHCF) capacity, the expectation of the FHCF offer its full USD17 billion in funding will result in some offset as individual company limits increase to make use of the capacity. In addition, although depopulation and new covers were purchased, a reduction in private market capacity by Florida Citizens served to offset the impact on aggregate demand. Terms and conditions continued to improve as insurers continued to benefit from additional multi-year coverage, as well as extended hours clauses and movement to cascading reinsurance layers. Overall demand for property catastrophe reinsurance has increased slightly throughout the private market as insurers continued to benefit from accretive reinsurance capital in many regions. In addition, continued evaluation of rating agency changes has a resulted in increased demand from some insurers. Coinciding with the financial year, the majority of placements in Australia also renew at July 1. These programs saw slight increases in multi-year protections as insurers weighed long-term benefits with reinsurer relationships and future structure flexibility. In addition, small and mid-tier insurers moved to more proportional reinsurance as an alternative for 2016. Catastrophe loss activity throughout the first half of 2016 was slightly higher than the median 10 year result ending the period at an estimated USD28 billion. While severe convective storm comprised 40 percent of the total insured losses, Horse Creek Fire in Fort McMurray City has been estimated at more than USD3.5 billion in insured loss making it the costliest event in Canada s history. Looking to the remainder of 2016, historical loss trends resulting from the expected transition to La Niña by the latter half of 2016 suggest that global catastrophe losses could increase. Note: This reinsurance market outlook report should be read in conjunction with our firm s views on rate on line, capacity and retention changes for each cedent s market. Our professionals are prepared to discuss variations from our market sector outlook that apply to individual programs due to established trading relationships, capacity needs, loss experience, exposure management, data quality, model fitness, expiring margins and other factors that may cause variations from our reinsurance market outlook Aon Benfield 1
USD billions Supply Matches Prior Peak to Support Current and Future Demand Reinsurer supply increased to USD580 billion ending Q1 up 3 percent compared to year end 2015 and returned to prior peak level reached at Q1 2015. A number of larger companies demonstrated strong growth in shareholders funds in the period. The growth was largely derived from retained profit and unrealised investment gains and was enhanced by a 4 percent positive movement in the EUR/USD exchange rate in the period. Exhibit 1: Change in global reinsurer capital -17% 18% 18% -3% 11% 7% 6% -2% 3% $410B $340B $400B $470B $455B $505B $540B $575B $565B $580B 2007 2008 2009 2010 2011 2012 2013 2014 2015 Q1 2016 Source: Individual company reports, Aon Benfield Analytics Alternative capital Alternative capital increased slightly over the period to USD73 billion, with continued growth in collateralized reinsurance, up nearly USD1 billion. Catastrophe bonds outstanding also increased slightly during the period to USD25 billion, while ILW capacity remained unchanged and sidecars fell slightly to USD7.6 billion. Exhibit 2: Bond and collateralized market development 80.0 70.0 60.0 50.0 40.0 30.0 20.0 10.0 0.0 Source: Aon Securities Inc. Col Re Col ILW Sidecars Bonds 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Q1 2016 2 Reinsurance Market Outlook
Insurer capital Insurer capital increased 3 percent since year end 2015 to USD4.2 trillion. Demand for reinsurance remained stable at June and July renewals and the value proposition for reinsurance continued to improve in major renewing regions. 12% 1% 7% 4% 6% -2% 3% -29% 34% $3.4T $2.4T $3.2T $3.5T $3.6T $3.8T $4.0T $4.2T $4.1T $4.2T 2007 2008 2009 2010 2011 2012 2013 2014 2015 Q1 2016 Peak Zone Reinsurance Demand Relatively Flat A number of different factors had positive and negative influences on overall demand for peak zone Florida reinsurance limit throughout 2016 renewals. In line with our April market outlook, net demand increases from the private market were largely offset by reductions in reinsurance demand from Florida Citizens. Buyers of peak zone Florida reinsurance at the June and July 1 renewals continued to enjoy the positive trend in the reinsurance value proposition. The vast majority of insurers achieved improvements in risk adjusted reinsurance pricing, a continuation of multi-year agreements, and/or improvement in terms, such as expansion of hours for wind and cascading limits amongst other coverage enhancements. Increases in reinsurance demand were largely driven by depopulations from Florida Citizens, opportunistic reinsurance purchases, and other primary market growth. In total, this accounted for approximately USD750 million of additional reinsurance demand. Aon Benfield 3
Additional demand was also created by certain insurers electing to privatize the capacity offered through the Florida Hurricane Catastrophe Fund (FHCF). In total, 16 companies elected to decrease their FHCF participation while only 6 increased their participation percentage. The increase in privatized FHCF totaled approximately USD1 billion, though not all of this limit was ceded to traditional reinsurers as some companies elected to secure additional capacity from the catastrophe bond market. Evidence of the movement away from all insurers electing the 90 percent participation of the FHCF can also be seen in the blended FHCF participation ratio. Up until 2015, the blended average participation was 89.9 percent. 2015 elections saw the average drop to 81.6 percent and 2016 elections resulted in a further decrease to 76.3 percent. While the reduction in insurers electing a 90 percent participation typical translates to a corresponding increase in private market demand, it also results in higher layer limits for all insurers as the FHCF is expected to make best efforts to deploy the full capacity of USD17 billion if funding is available. This increased limit at least partially offsets the movement to the private market of certain insurers. Citizens Property Insurance Corporation, which has been a purchaser of reinsurance since 2011, reduced its program by approximately USD1.5 billion in 2016. Since 2011, Citizens exposures have declined by more than 50 percent as a result of significant depopulations and despite the reduction in private market capacity, remains at one of the highest catastrophe protection coverage levels in recent history relative to exposure. That said, some exposure growth in the corporation is expected over the next twelve months. Lastly, the FHCF, a newcomer to private reinsurance in 2015, renewed its USD1 billion reinsurance purchase in 2016, with no incremental impact on aggregate private market demand. 4 Reinsurance Market Outlook
USD millions Second Quarter 2016 Catastrophe Bond Transaction Review Following the record breaking first quarter for catastrophe bond issuance, issuance in the second quarter of 2016 was relatively light. Total catastrophe bond issuance reached USD800 million, in what is typically one of the most active quarters. Such contraction can in part be attributed to competition from traditional markets that resulted in some placements being absorbed into traditional limit programs as well as some sponsors election to enter the alternative market earlier in the season. The impact of the light issuance was exaggerated by the significant amount of catastrophe bonds maturing in the quarter with USD2.9 billion in limit coming off-risk. Risk transferred to capital market investors during the quarter was at a relatively higher risk level a trend that began in late 2015. The weighted average risk interest spread was 8.40 percent corresponding to a weighted average expected loss of 5.05 percent. This is the highest average risk interest spread for a quarter seen in the catastrophe bond market in four years, when risk transfer costs were considerably higher on a relative basis. Exhibit 3: Catastrophe bond issuance by quarter 9,000 Q1 Q2 Q3 Q4 8,000 7,000 6,000 5,000 1,888 1,877 1,621 2,075 250 1,525 700 4,000 3,000 2,000 804 2,095 3,303 4,492 2,962 800 1,000 0 2,215 1,493 1,410 1,694 670 2012 2013 2014 2015 2016 Source: Aon Securities Inc. Aon Benfield 5
The table below summarizes the terms of the five catastrophe bond transactions that closed during the second quarter. Exhibit 4: Second quarter 2016 catastrophe bond issuance Beneficiary Issuer Series Class Size (millions) Covered perils Trigger Rating Expected loss 1 Interest spread Second Quarter United Services Automobile Association ( USAA ) Residential Reinsurance 2016 Limited 2016-1 10 $65.0 11 $75.0 13 $110.0 US HU, EQ, ST, WS, WF, VE, MI, OP Indemnity Not Rated Not Rated BB- (S&P) 8.80% 11.50% 2.47% 4.75% 0.73% 3.25% Münchener Rückversicherungs- Gesellschaft Aktiengesellschaft ( Munich Re ) Queen Street XII Re dac $190.0 US HU, EU Wind Industry Index Not Rated 2.90% 5.25% Security First Insurance Company First Coast Re Ltd. 2016-1 A $75.0 FL HU, ST Indemnity Not Rated 1.31% 4.00% United Property & Casualty Insurance Co. ( UPC ), Family Security Insurance, Inc. ( FSIC ), Interboro Insurance Company. ( IIC ) Allianz Risk Transfer (Bermuda) Laetere Re Ltd. 2016-1 Blue Halo Re Ltd. 2016-1 A $30.0 2.76% 6.00% B $40.0 US HU, EQ Indemnity Not Rated 5.98% 9.50% C $30.0 13.18% 17.50% A $130.0 8.56% 13.75% Industry Not US HU, EQ B $55.0 Index Rated 13.19% 19.75% Total Priced During Q2 2016 $800.0 1 Expected loss represents initial one-year figures on a sensitivity basis Source: Aon Securities Inc. Legend: EU Europe FL Florida US United States EQ Earthquake HU Hurricane MI Meteorite Impact OP Other Perils ST Severe Thunderstorm VE Volcanic Eruption WF Wildfire WS Winter Storm 6 Reinsurance Market Outlook
USD billion (2016) Elevated Global 1H Insurance Losses Led by Active Second Quarter of Disasters Preliminary insured catastrophe losses were elevated during the first half of 2016 as an above-average number of events (150+) caused significant damage across each major continent. Through the first six months of the year, the public and private insurance industry has sustained estimated losses of USD28 billion. While is 9 percent below the recent 10-year average of roughly USD31 billion, 2016 losses are 11 percent higher than the median result. Exhibit 5: Q1/Q2 Insured Losses by Year (2006-2016) 120 100 80 60 40 95 20 0 12 21 27 20 34 23 28 29 19 28 31 25 Source: Aon Benfield Analytics The first half of the year was dominated by no fewer than five individual catastrophe events which caused more than USD1.0 billion in insurable losses. Preliminary data showed that the top three first-half insured loss events all occurred outside of the United States. The costliest natural disaster was the magnitude-7.0 earthquake in Japan s Kumamoto region on April 16 preceded by a strong foreshock on April 14 that caused an estimated USD4.5 billion in insurable loss from physical damage and business interruption. The costliest weather disaster was the Horse Creek Fire which burned roughly 10 percent of the city of Fort McMurray in Canada s province of Alberta. Tentative insured losses were in excess of USD3.5 billion. This event became the costliest disaster in Canada s history. Aon Benfield 7
USD billion (2016) Other notable events included significant late May and early June flooding and storms in Europe, and several major severe convective storm outbreaks in the United States during March, April and May. Slightly less than half of the insured losses (46 percent) were sustained in the United States, with most of the losses attributed to the severe convective storm peril as several major hailstorm events pelted densely populated areas in Texas. Excessive hail damage was noted in major metropolitan regions including San Antonio and Dallas-Fort Worth. No fewer than nine events in the United States caused at least USD500 million in insurable losses. Seven of the nine were thunderstorm-related. Beyond the US, the highest percentage of insured losses occurred in APAC (23 percent), the Americas (17 percent), and EMEA (14 percent). Exhibit 6: 2016 YTD Insured Losses Compared to Recent Annual Averages by Region 18 16 14 12 14 13 16 2015 2016 YTD 2006-2015 Avg. 10 8 6 4 2 0 6 5 5 4 3 2 2 1 United States Americas EMEA APAC 8 Source: Aon Benfield Analytics The USD28 billion in global insured losses were primarily led by the severe convective storm peril. The more than USD11 billion in losses accounted for 40 percent of the overall Q1/Q2 total. Other perils accounting for more than 10 percent of the first-half total included: earthquake (18 percent), flooding (17 percent) and wildfire (13 percent). Should current trends from the first half of the year continue, 2016 is on pace to become the first year since 2012 to surpass the most recent 10-year average (USD52 billion). Given the dissipation of the strong El Niño phase of ENSO (El Niño-Southern Oscillation) and current transition to La Niña by the latter half of 2016, historical trends suggest that global catastrophe losses will be on the rise. For a more detailed analysis of global catastrophe losses by ENSO-phase, please refer to the 2015 Annual Global Climate and Catastrophe Report. For the most up-to-date global catastrophe loss data for 2016, and other historical loss information, please visit Aon Benfield s Catastrophe Insight website: www.aonbenfield.com/catastropheinsight 8 Reinsurance Market Outlook
Demand from Rating Agency Changes Slow to Mature As a result of the initial market feedback reported by A.M. Best on May 5 as a follow up to their release on March 10, we expect demand increases to meet new capital criteria to materialize at a slower pace than previously forecast. A.M. Best pointed to levels of model uncertainty at higher return periods (e.g., 500 year and 1,000 year) and lack of benchmarking consistency in their initial comments, as well as a desire to maintain course with their stated objectives in changing the criteria. While they expect these higher return period events will remain part of their overall company review, possibly better suited as a component of ERM, the weight of impact at these levels is under evaluation. However, insurers are continuing to evaluate purchases of additional limit to mitigate potential shortfalls in measured capital adequacy from the proposed criteria, with some companies electing to make incremental changes towards higher overall capacity throughout 2016 and 2017 renewals. Aon Benfield 9
Hurricanes La Niña on the Way: Will the US Major Hurricane Landfall Drought End? With the close of the 2015 Atlantic Hurricane Season, the United States extended its historic streak without a major landfalling hurricane to 10 consecutive years. This is the longest such streak since official data records began being kept in the mid-1880s. For reference, a major hurricane is defined as a storm with winds greater than 111 mph (179 kph), or Category 3 on the Saffir-Simpson Hurricane Wind Scale. Much of the discussion surrounding the probability of hurricane frequency and landfall opportunity in the Atlantic Basin surrounds the meteorological phenomenon known as ENSO (El Niño-Southern Oscillation). ENSO phases (El Niño, La Niña, Neutral) lead to warmer or cooler than normal ocean temperatures that affect weather patterns around the world by influencing high and low pressure systems, winds, and precipitation. During El Niño years, there are often below-average sea surface temperatures in the Atlantic Ocean s Main Development Region (MDR), increased wind shear, and higher pressure levels. These factors reduce favorability for cyclogenesis. Opposite conditions are present during La Niña phases, which often make conditions more favorable for tropical cyclones to develop and threaten landfall in areas of the Caribbean, Gulf of Mexico and the East Coast of the US and Canada. As seen in Exhibits 7 and 8, there is a noticeable uptick in the overall frequency of hurricanes in the Atlantic Ocean Basin during La Niña years in comparison to El Niño. This also corresponds to more landfalls across the basin. Similar trends are noted when looking solely at the United States and the number of historical hurricane landfalls dating to 1950. Exhibit 7: Atlantic Basin Tropical Cyclone Frequencies by ENSO Phase 8 7 6 La Niña (21 Years) El Niño (22 Years) Neutral (23 Years) 1950-2015 Average 5 4 3 2 1 0 Hurricanes Category 3+ Hurricanes Landfalling Hurricanes Landfalling Category 3+ Hurricanes Source: Aon Benfield & NOA 10 Reinsurance Market Outlook
Hurricanes Exhibit 8: United States Tropical Cyclone Frequencies by ENSO Phase 2.0 1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 La Niña (21 Years) El Niño (22 Years) Landfalling Hurricanes Neutral (23 Years) 1950-2015 Average Landfalling Category 3+ Hurricanes Source: Aon Benfield & NOAA However, it is important to point out that ENSO phase is not the only influencing factor on the overall number of storms in the Atlantic Ocean. The Atlantic Multidecadal Oscillation (AMO) is another important climate variable that impacts sea surface temperature and atmospheric favorability for cyclogenesis. AMO phases (Positive/Warm or Negative/Cool) typically last in 25 to 40 year intervals and can lead to high and low-activity eras for tropical cyclone development. A warm phase of the AMO has been present since 1995, but the last three hurricane seasons 2013-2015 have seen reduced activity. Researchers from NOAA and the academic field are currently debating whether the warm phase has come to an end. Other variables that influence the number of storms and landfall probabilities in the Atlantic Basin include the Saharan Air Layer, trade winds, location of the Bermuda High, thermohaline circulation, and luck. The question then becomes: How does this translate into potential insurance impacts? During the current 10-year major hurricane landfall drought in the US, global insured losses related to the tropical cyclone peril have largely trended downward. This is entirely due to the United States being the primer driver of these losses. As seen in Exhibit 9, the years with the biggest spikes in global tropical cyclone losses occurred in tandem with significant US landfalls: 1992, 2004, 2005, 2008, 2012. It is worth noting that the costliest year on record 2005 was during a La Niña year. Historical data indicates that tropical cyclone losses are historically higher during La Niña than any other phase of ENSO. Final takeaway: Any year can experience a heightened level of hurricane losses. It only takes one major event to entirely change the perception and trajectory of a season from a financial perspective. The next major US hurricane landfall is not a matter of if, but when. The greatest unknown remains where. Aon Benfield 11
USD billion (2016) Exhibit 9: Global Insured Tropical Cyclone Losses (1980-2015) 120 107 100 80 60 40 20 0 43 33 29 20 14 9 8 10 11 1 2 1 4 1 2 5 2 4 3 3 2 2 4 3 2 1990 1995 2000 2005 2010 2015 Source: Aon Benfield Analytics Forecasters: Slightly more tropical cyclones expected in the Atlantic Ocean The three main hurricane season prognosticators (National Oceanic and Atmospheric Administration (NOAA), Colorado State University (CSU) and Tropical Storm Risk (TSR)) have all forecast near-normal or slightly above-normal hurricane activity for the Atlantic Hurricane Season. Each agency cites the transition from ENSO-neutral conditions to an anticipated arrival of La Niña in the Central and Eastern Pacific Ocean by the second half of the year. This should lead to warmer sea surface temperatures in the main development region of the Atlantic Ocean and more favorable atmospheric conditions for cyclogenesis. Exhibit 10: Atlantic Hurrican Season Forecasats Named Storms Hurricanes Major Hurricanes TSR (May 2016) 1950-2015 Average 11 6 3 2016 17 9 4 CSU (June 2016) 1981-2010 Median 12.0 6.5 2.0 2016 14 6 2 NOAA (May 2016) 1981-2010 Average 12 6 3 2016 10-16 4-8 1-4 Sources: Tropical Storm Risk (TSR), Colorado State University (CSU), NOAA 12 Reinsurance Market Outlook
Contact Information Bryon Ehrhart Chairman of Aon Benfield Analytics Chairman of Aon Securities +1 312 381 5350 bryon.ehrhart@aonbenfield.com Paul Mang Global Chief Executive Officer of Analytics Aon Center for Innovation and Analytics, Singapore +1 312 381 5193 paul.mang@aon.com George Attard Head of Analytics, International Aon Benfield +65 6239 8739 george.attard@aonbenfield.com Greg Heerde Head of Analytics & Inpoint, Americas Aon Benfield +1 312 381 5364 greg.heerde@aonbenfield.com Tracy Hatlestad Chief Operating Officer Aon Benfield Analytics +65 6512 0244 tracy.hatlestad@aonbenfield.com Aon Benfield 13
About Aon Benfield Aon Benfield, a division of Aon plc (NYSE: AON), is the world s leading reinsurance intermediary and fullservice capital advisor. We empower our clients to better understand, manage and transfer risk through innovative solutions and personalized access to all forms of global reinsurance capital across treaty, facultative and capital markets. As a trusted advocate, we deliver local reach to the world s markets, an unparalleled investment in innovative analytics, including catastrophe management, actuarial and rating agency advisory. Through our professionals expertise and experience, we advise clients in making optimal capital choices that will empower results and improve operational effectiveness for their business. With more than 80 offices in 50 countries, our worldwide client base has access to the broadest portfolio of integrated capital solutions and services. To learn how Aon Benfield helps empower results, please visit aonbenfield.com. Aon Benfield 2016. 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