Insurance Risk Study - Aon

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Insurance Risk Study U.S. Risk Parameters The U.S. portion of the Insurance Risk Study uses data from nine years of NAIC annual statements for 2,265 individual groups and companies. The database covers all 22 Schedule P lines of business and contains 1.4 million records of individual company observations from accident years 1992-2009. The charts below show the loss ratio volatility for each Schedule P line, with and without the effect of the underwriting cycle. The effect of the underwriting cycle is removed by normalizing loss ratios by accident year prior to computing volatility. This adjustment decomposes loss ratio volatility into its loss and premium components. Coefficient of Variation of Gross Loss Ratio | 1992-2009 Products Liability – Claims-Made 8 Private Passenger Auto 14% Auto Physical Damage Commercial Auto Workers Compensation Warranty Medical PL – Occurrence Commercial Multi Peril Other Liability – Occurrence Special Liability Medical PL – Claims-Made Other Liability – Claims-Made Products Liability – Occurrence Homeowners Other Reinsurance – Liability International Fidelity & Surety Reinsurance – Property Reinsurance – Financial Special Property Financial Guaranty All Risk No Underwriting Cycle Risk 17% 24% 28% 31% 32% 34% 37% 39% 40% 43% 47% 51% 52% 67% 68% 70% 85% 91% 102% The U.S. Underwriting Cycle Volatility for most lines of business is increased by the insurance underwriting and pricing cycle. The underwriting cycle acts simultaneously across many lines of business, driving correlation between the results of different lines and amplifying the effect of underwriting risk to primary insurers and reinsurers. Our analysis demonstrates that the cycle increases volatility substantially for all major commercial lines, as shown in the table. For example, the underwriting volatility of other liability increases by 47 percent, workers compensation by 46 percent, medical professional liability by 43 percent, and commercial auto liability by 42 percent. 104% 163% 13% 15% 17% 19% 31% 27% 25% 32% 29% 28% 29% 32% 43% 45% 49% Impact of the Pricing Cycle Line 54% 54% 54% 59% 47% 62% 106% Impact of the Pricing Cycle Reinsurance — Liability 50% Other Liability — Occurrence 47% Other Liability — Claims-Made 47% Workers Compensation 46% Medical PL — Claims-Made 43% Commercial Auto 42% Special Liability 33% Commercial Multi Peril 24% Homeowners 21% Private Passenger Auto 9%
Industry Reserve Adequacy: How Long Can Favorable Development Continue? U.S. P&C industry reserves continue to show redundancy at the end of 2009. Standard actuarial reserving methods applied to the industry Schedule P indicate that there is approximately $22 billion of excess reserves across all lines of business. The market is unlikely to harden again as long as the industry has more than adequate reserves according U.S. Reserve Volatility by Line Line Reserve to Premium Ratio % Reserves Over 10 Yrs Old Ultimate Reserve CV One Year Reserve CV % CV Emerging in One Year Aon Benfield to these metrics. Calendar years 2007, 2008 and 2009 saw favorable reserve development, helping to prolong soft market conditions. We estimate that reserve redundancies will be depleted in two to three years if favorable development continues at the pace it has from 2007 to 2009. A summary of adequacy by major market segments appears below. U.S. Reserve Estimated Adequacy ($B) Line Estimated Reserves Booked Reserves Favorable/(Adverse) Development 2007 2008 2009 Average Remaining Redundancy Years at Run Rate Personal Lines 123.0 129.0 5.9 5.4 5.8 5.7 6.0 1.1 Commercial Property 37.9 41.7 1.7 2.6 2.4 2.2 3.8 1.7 Commercial Liability 223.1 237.3 1.0 5.2 3.8 3.3 14.2 4.3 Workers Compensation 114.8 114.0 1.0 1.1 (0.5) 0.6 (0.8) n/a Total Excl. Financial Guaranty 498.7 522.0 9.5 14.4 11.5 11.8 23.2 2.0 Financial Guaranty 34.1 32.8 (1.2) (12.6) 7.0 (2.3) (1.4) n/a Total 532.9 554.7 8.3 1.7 18.6 9.5 21.9 2.3 Reserve Risk and Leverage Insurers face two sources of risk from reserves. The first source is volatility of reserve values over time to settlement. The second source comes from leverage. The longer the average duration of the claim payout, the larger the reserve balance becomes relative to the premium base. As reserve leverage increases, the sensitivity of calendar year combined ratio results compared to changes in reserve balances magnifies. The first source of volatility has traditionally been measured with methods such as the Mack method, which calculates the volatility of the link ratio estimate of ultimate losses coming from a loss triangle. More recently, Merz and Wuthrich have published a methodology that calculates the same estimate, but over a one-year time horizon to be consistent with Solvency II. Using these methods, we can estimate the total reserve volatility and how much of that volatility is expected to emerge in the next 12 months. We can also estimate the potential impact of reserve volatility on next year’s combined ratio. Using the U.S industry aggregate workers compensation paid triangle as an example, the total reserve volatility is estimated at 3.3 percent based on an adjusted Mack method. The one-year reserve volatility is 2.2 percent based on an adjusted Merz Wuthrich method, meaning that 66 percent of the triangle’s volatility emerges in one development year. The Mack and Merz Wuthrich methods were both adjusted to account for reserves more than 10 years old. With reserves levered at 3.4 times premium, the impact on combined ratio of a one standard deviation change is 7.5 points. For a normal distribution a one standard deviation move, up or down, is a one in three year event. One Year Combined Ratio Impact Homeowners 0.3 1.0% 5.1% 4.8% 94.0% 1.5% Private Passenger Auto 0.9 4.0% 2.1% 1.7% 79.1% 1.5% Commercial Auto 1.5 4.9% 2.5% 1.8% 69.4% 2.6% Commercial Multi Peril 1.2 9.0% 4.6% 3.8% 81.4% 4.6% Workers Compensation 3.4 26.0% 3.3% 2.2% 66.0% 7.5% Medical PL - CM 2.5 2.7% 5.1% 4.0% 78.9% 10.0% Other Liability - Occ 3.4 26.2% 5.2% 3.2% 62.1% 10.8% Other Liability - CM 2.5 2.3% 6.3% 5.1% 79.7% 12.8% Products Liability - Occ 7.0 47.4% 9.9% 5.0% 50.9% 35.1% Ultimate reserve CV calculated using the Mack method applied to industry paid triangles by line. One-year reserve CV uses the Merz Wuthrich method. Both methods adjusted to account for reserves more than 10 years old. 9
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: Solvency II Correlation Coefficient
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 and 20: Managing Inflation Risk Risk manage
Page 21 and 22: Global Market Review With rates con
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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