Insurance Risk Study - Aon

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Insurance Risk Study Managing Inflation Risk Insurers can seek to manage this risk in several ways. Interest Rate Risk Management — An interest rate risk management process should distinguish between inflation duration and real interest rate duration, thus enhancing an asset-liability management framework. It is often assumed that asset and liability portfolios with equal present values and with the same duration will respond similarly on a discounted basis to changes in bond yields. However, this may not be the case if the changes are driven by changes in inflation rates. In the previous balance sheet example, a 200 basis point increase in inflation caused a $21.2 billion increase in the undiscounted loss reserves, and if interest rates rose as well, then there would also have been an increase in the amount of discounting leaving discounted reserves approximately unchanged. On the asset side, a bond portfolio of comparable size and duration would have decreased by $17.9 billion as a result of the same change in interest rates. Despite being “matched”, the net effect would be a three percent decrease in surplus. Asset Allocation — Several asset classes, including inflation-indexed bonds (TIPS), commodities and real estate, offer varying degrees of inflation hedging and can be considered as a natural part of insurers’ asset portfolios. However, careful consideration must be given to the impact on expected investment returns — in the case of TIPS especially — and to the additional volatility and portfolio management skills needed for these asset classes. Equity Allocations — The conventional wisdom is that equities are a natural hedge against inflation, since companies can pass rising costs along to consumers. But over short horizons, equities have not always outperformed inflation. In the 1970s, inflation soared well above 10 percent even as real equity returns were negative. An investment in the S&P 500 made in 1973 would only have broken even in real dollar terms in 1986. When operating performance is measured over a five-year or ten-year period, these results suggest that insurers holding equities may face flat or even negative investment returns while their liabilities increase in value. 20 Inflation CPI-U, 1970-2009 15% 10% 5% 0% 1970 1975 1980 1985 S&P 500 Year 1-Year Change 40% 20% 0% -20% -40% 1970 1975 1980 1985 1990 1990 1995 1995 2000 2000 S&P 500 Cumulative Real Index Value vs. CPI-U 4% 3% 2% 1% 0% 1970 Base Year = 1970 1975 1980 1985 1990 1995 2000 2005 2005 2005 The experience of the 1970’s suggests that a broad index such as the S&P 500 may be less effective than a more carefully constructed equity portfolio. Sectors such as energy, medical services and defense offer a greater degree of inflation hedging than other sectors; value stocks also tend to perform better in inflationary environments than growth stocks. Equities do offer a degree of natural inflation hedging, but history suggests that risk managers should pay careful attention to sector and style allocations. Reinsurance — Inflation is just one of many sources of volatility for liabilities. Rather than isolate and manage this risk separately, an alternative could be to incorporate aggregate stop loss or adverse development covers into reinsurance programs with coverage terms selected to respond appropriately to adverse inflation impacts on current or prior accident year claims.
Global Market Review With rates continuing to soften and investment yields depressed, insurers are under intense pressure to find profitable areas to grow. The following pages present a summary of global insurance markets: the size of each market by premium, premium relative to GDP (insurance penetration ratio), loss ratios, and volatility of loss ratios. We have segmented premium into motor, property and liability lines for the top 50 markets. Global Premium by Product Line Motor: $513B U.S. Middle East & Africa Rest of Europe Property: $388B U.S. Middle East & Africa Liability: $277B U.S. Middle East & Africa Rest of Europe Brazil Brazil Rest of Europe Brazil Canada Rest of Americas China U.K. Japan Germany Rest of EUR Area U.K. South Korea Rest of APAC France Canada Rest of Americas China Japan South Korea Rest of APAC France Germany Rest of EUR Area Canada Rest of Americas China Japan South Korea U.K. Rest of EUR Area Rest of APAC France Germany Top 50 Markets by Gross Written Premium Country P&C GWP ($B) GDP ($B) Premium/ GDP Ratio Aon Benfield GDP Per Capita U.S. 462.33 14,256.30 3.2% 45,954 Japan 76.12 5,067.53 1.5% 39,963 U.K. 71.93 2,174.53 3.3% 35,482 Germany 67.10 3,346.70 2.0% 40,673 France 62.66 2,649.39 2.4% 41,359 Italy 44.09 2,112.78 2.1% 36,370 China 42.10 4,909.28 0.9% 3,691 Spain 33.88 1,460.25 2.3% 36,012 S. Korea 32.55 929.12 3.5% 19,104 Canada 29.02 1,336.07 2.2% 39,576 Australia 21.40 924.84 2.3% 42,984 Brazil 17.02 1,571.98 1.1% 7,817 Netherlands 15.67 792.13 2.0% 47,198 Russia 12.48 1,230.73 1.0% 8,829 Switzerland 11.39 500.26 2.3% 65,621 Belgium 10.58 468.55 2.3% 44,952 Austria 9.13 384.91 2.4% 46,859 Norway 8.64 381.77 2.3% 81,638 Denmark 8.20 309.60 2.7% 56,131 Mexico 7.41 874.90 0.8% 7,779 Sweden 6.89 406.07 1.7% 44,751 Venezuela 6.34 314.15 2.0% 11,540 Poland 5.89 430.08 1.4% 11,181 Argentina 5.76 308.74 1.9% 7,468 Turkey 5.61 617.10 0.9% 7,931 India 5.01 1,296.09 0.4% 1,105 Ireland 4.80 227.19 2.1% 53,455 South Africa 4.66 285.98 1.6% 5,823 Portugal 4.49 227.68 2.0% 21,207 Czech Republic 4.24 190.27 2.2% 18,651 Finland 4.20 237.51 1.8% 45,197 U.A.E. 3.41 198.69 1.7% 39,933 Iran 3.38 286.06 1.2% 4,267 Greece 3.32 355.88 0.9% 33,105 Israel 3.28 194.79 1.7% 26,488 Malaysia 2.84 191.60 1.5% 7,324 Thailand 2.80 263.86 1.1% 3,973 Taiwan 2.77 355.47 0.8% 15,438 Luxembourg 2.73 52.45 5.2% 105,417 Colombia 2.54 230.84 1.1% 5,222 Ukraine 2.39 113.55 2.1% 2,500 Romania 2.29 161.11 1.4% 7,263 Indonesia 2.24 540.28 0.4% 2,224 New Zealand 2.05 125.16 1.6% 29,434 Hong Kong 1.98 215.36 0.9% 30,376 Chile 1.95 163.67 1.2% 9,773 Hungary 1.93 128.96 1.5% 13,053 Singapore 1.81 182.23 1.0% 38,764 Puerto Rico 1.74 67.90 2.6% 17,070 Saudi Arabia 1.68 369.18 0.5% 12,640 Grand Total 1,148.72 54,419.49 2.1% 11,416 21
Page 1 and 2: Insurance Risk Study Fifth Edition
Page 3 and 4: Foreword Since the first internal A
Page 5 and 6: Underwriting Volatility for Major L
Page 7 and 8: Solvency II Correlation Coefficient
Page 9 and 10: Industry Reserve Adequacy: How Long
Page 11 and 12: Year-Over-Year Change in Gross Loss
Page 13 and 14: Germany Japan U.K. U.S. Accident &
Page 15 and 16: Americas - Liability Europe - Liabi
Page 17 and 18: Size and Correlation Insurers of di
Page 19: Managing Inflation Risk Risk manage
Page 23 and 24: Global Premium, Loss Ratio and Vola
Page 25 and 26: Afterword: The Greatest Risk In las
Page 27 and 28: For more information on the Insuran

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