Follow the facts-Greg Case

Adrian Ladbury: The news from this year’s Monte Carlo Rendez-Vous and other subsequent events such as the Baden-Baden gathering of Europe’s leading reinsurers and reinsurance buyers seems to suggest that the insurance and reinsurance market is still not ready to turn despite massive catastrophic losses, combined ratios well over 100%, poor investment returns, low interest rates and dwindling redundant reserves. Do you agree that risk managers can expect another year of plentiful capacity on offer at cheap prices? Is the cycle dead and what would actually shift it? Greg Case: Our view now is that we have seen a number of big catastrophic events including the terrible catastrophe in Japan and the resultant market turns have been local rather than global. Many predicted a global turn but that of course has not happened. It is certainly tighter in many markets and we are closer to the global inflection point but the confluence of supply and demand suggests that we are still not at that point. We base our views on best-in-class data and analytics, and this is the case. AL: What do you base this opinion or analysis upon exactly?hideGC: Approximately $60bn of commercial premium flows through Aon annually, in addition to $29bn of reinsurance premium. We have carried out substantial analysis of the market over the last few years to understand the flow and remember this is a ‘real time’ view from Aon based on placements worldwide, not just a survey carried out at a point in time, a test of the wind, which is useful but not as analytically robust. In the fourth quarter of 2010, for example, rates fell by 4.4%. In the first quarter of this year they fell by 3.8% and in the second quarter by 3.3%. This is fact that nobody else has. On the reinsurance side we published our June and July 2011 results well before Monte Carlo and our performance produced rate decreases while all others reported rate increases. For example, property catastrophe treaty rates in the US were flat to down 5% while the others said they would be up 10-15%. We placed about $1.7bn of comparable reinsurance premiums at June and July 1 and our work saved clients about $200m in premium. We perform a fact-based analysis from the largest set of facts in the reinsurance industry. The conclusion is that rates are tightening (the decreases come at a decreasing rate) but it is certainly not a hard market. AL: What will force the market to harden? GC: It will take another event of substantial size so that the catastrophes would take out more than just income, something that would truly represent a depletion of capital. The big risk types for the global market, in order, are as follows: US wind; US earthquake; European wind; Japanese wind and Japanese earthquake—and these perils drive global insurer and reinsurer capital. What we recognised early is that the losses that have occurred—while tragic—have occurred in global segments that do not drive or consume large portions of the insurance and reinsurance industry capital. From a capital perspective, insurers and reinsurers continue to have the capital to support risk at a level that exceeds the demands for insurance from insureds. This surplus capital position means that the overall market will not change dramatically. Also people tend to assume that there will be a cross-over from event to event so that the Japanese earthquake will affect US rates. But this is not necessarily the case as much as it may have been in the past. The extraordinary run of hurricanes Katrina, Wilma and Rita that battered the US coast in 2005 did not affect global wind rates to any measurable degree—particularly not in Japan. US and western European insurers already pay reinsurance margins that are multiples of those paid by Japanese, Australian, New Zealand and Chilean insurers. So where margins are not equally spread, the price change will not be equally spread. The impact would have been greater if capital had been reduced but it wasn’t so nothing changes. For our clients, this means that it is our job to secure the best rates that we can, while we can. AL: What about the wider financial crisis, particularly here in Europe? Surely this will put the market under pressure? Investment returns are not as high as they have been historically and, despite reassurances from the credit rating agencies, the leading European insurers and reinsurers do have exposure to sovereign debt in countries like Greece, Italy and Spain that surely will impact their capital position? GC: The insurance business did a reasonable job negotiating its way through the 2008 capital crisis and more recently. Based on discussions in Monte Carlo with customers about New Zealand and Japan in particular it is clear that the industry performed extremely well dealing with the claims. But one important fact is that a lot of the regulation forced upon the banks as a result of the crisis of 2008 is finding its way back out to the insurance sector. It is a fact that the insurance market for corporate insurance and reinsurance customers managed the crisis quite well. But it is challenging, particularly for those insurers with business in other ancillary sectors that will be more directly affected by the changing regulations. Also it is a fact that all elements of the business have an impact on the cycle such as the overall level of economic growth and impact on underlying demand, plus, of course, returns yielded by investments which have fallen substantially. Inflation has an effect and places another stress on the insurers’ and reinsurers’ balance sheets and trading results but it is not as stressful as what would be needed to turn the market. AL: What about the effect of the poor investment markets upon your results for example? GC: Aon has over $4bn in its investment portfolio and fiduciary funds that it manages on behalf of clients. We manage through it. We have 60,000 Aon colleagues worldwide who empower results for their clients every day. As a company we have changed the portfolio of Aon over the last 6 years. We have sold off about a third of the firm and invested heavily in our risk and insurance capabilities, most notably through the acquisitions of Benfield and Hewitt and through investment in Aon GRIP, our global risk insight platform. We are now in a position to extend and spread from that base. All companies are under tremendous stress currently and every CEO and CFO cares about how their risk is managed. Therefore we are very fortunate that we have built such a strong global platform and can help at a time when that help is needed more than ever before. Whether it is traditional P&C, cyber or terror risk that is on the agenda we have the people on the traditional risk and insurance side and now too on the pensions and benefits and health side. AL: Our Risk Distribution survey carried out among Europe’s leading brokers, insurers and a number of leading European risk managers found that everyone is convinced that the future of brokers is to convert themselves from transactional-based risk distributors to risk consultants. How do you get to that point without disrupting your revenue flow and missing profit targets? GC: For Aon we have a very clear focus on value creation to help clients in a number of ways. First, we look to increase their operating performance by covering the cost of risk. If we can perform this basic role then we will be successful. Second, we look to strengthen their balance sheet. Third, we seek to reduce volatility. If we are focused on helping clients achieve and protect their operating performance and strengthen their balance sheet, then we can quantify the volatility and what is needed to manage it. In this sense the role of the broker, as a distributor of risk transfer in the traditional sense, becomes more important, not less as some may suggest. There is less substitution of one role for another but more about how we add value to the equation and we will continue to do this. It is a natural evolution in the role of the broker and Aon is in a unique position to help our customers manage this evolution and benefit from this. But to do this, and offer the complete risk transfer and advisory role, you have to have data and analysis to back it up. For us this is a natural evolution from that of a traditional transaction-based broker to more of a risk consultant because it is completely driven by what the client needs to be successful. So this is demand pull not supply push and is a powerful fuel for us. We have been on a journey for the past few years and working very well with our colleagues and clients in terms of adding advice. This is not just conceptual for us; it is tangible. At the end of the day, we are adding value and customers are happy to pay if you help to add value. If you don’t add value, then they do not want to pay for it. Our goal is to offer the highest value per euro cost. If the customer gives us €1 then we want to be able to give €2 back in value. We have to be and want to be the highest value to price. AL: What about Aon GRIP? This has generated some debate among risk managers and I recall you being quizzed last year at the DVS conference about the justification for selling this service to the customers from whom you have gathered the data in the first place. What is the strategy of Aon GRIP and how can such initiatives help improve the level of innovation in the market that so many of your customers are worried about currently? GC: In the insurance world, manufacturing and distribution has not been as effective as it could have been. There has been a real lack of understanding and appreciation of what people are buying and at what price. On this basis, we are setting an industry standard. The second part of the equation is to help customers understand new types of risk. Therefore, for us, it is quite straightforward. We asked ourselves: Wouldn’t it be great if we actually understood the global flow of risk? The answer is clearly yes but it turns out that it is actually quite hard to do. We are working on this and making good progress. Aon GRIP provides fact-based insight into our $60bn plus in global premium flow and helps us identify for our clients the best placement option regardless of size, industry, coverage line or geography. We have 100 colleagues based in Dublin who are focused on data input and analysis and that investment goes to the platform and ultimately helps customers make better decisions. Without a thorough and up-to-date understanding of the appetite desired, carriers are not empowered to develop the solutions needed by our clients. Through Aon GRIP Solutions, we are providing insurance carriers with analytical insights regarding their underwriting capabilities and advice to help them better understand the landscape. AL: One key area in which customers would like to see more innovation is supply chain risk. The Japanese catastrophe clearly showed that the process of rapid globalisation and cost-cutting carried out by so many companies in recent years has left them more vulnerable to supply chain risk than ever before. What could and should be done about this? GC: Supply chain is very important today. If you don’t understand your global supply chain, there will be a significant potential volatility there. Japan was a great example of this because it led to a range of interruption problems for companies worldwide. Inevitably everyone said: Wouldn’t it be great if we understood all these interdependencies? We are seeing clients looking more closely at 3rd and 4th tier levels in their supply chain for potential vulnerabilities. This again is a natural evolution about how to protect operating performance and balance sheet strength and improve risk understanding, management and identification. We are committed to helping our customers do just that. Many clients now have greater awareness that supply chain risk goes both ways—supply chain and customer chain—and that attention must be paid to both streams. While most companies are aware of supply chain risk, no one owns it in many cases. Risk managers have the skill set to actually look at it from an overall perspective. It is possible to model supply chain risk to enable the firm to estimate the future financial impact of scenarios for which very little historical data exists and/or for which many types of external influences impact results. We’ve been doing more of that lately. As part of our response to the events in Japan, we created a Situation Analysis Toolkit to support our clients’ efforts to identify and address any loss sustained due to a catastrophe, which is accessible via the Aon Situation Room (Aon.com/situationroom). AL: What about innovation more generally? Our annual Risk Frontiers survey showed that there is a big concern among insurance buyers about the willingness and ability of insurers to meet their changing needs. What could and should brokers like Aon do about this? GC: There are a number of facets to this important area. First, there is innovation and understanding—what data do you have and what analysis are you able to carry out? Second, there is innovation and process—do you have a global process and global fulfillment capability? Third, there are innovative products and the generation of new ideas. This is where Aon GRIP becomes really important as does the operation of the Aon network. Our research recently carried out with Oxford Metrica shows that 80% of our clients will be hit by a reputational event every five years that will wipe out up to 20% of their value. The question is: What is the nature of the hit and what triggers can be identified to provide meaningful coverage? This is why we have created a new product with Zurich and the world’s largest communications services group WPP. This is an innovative product and approach that takes multiple forms. The main goal is to prevent, protect and/or mitigate damage to the insured’s business following a reputation event. The new programme will be underwritten by Zurich with an upper limit of $100m.

Follow the facts-Greg Case

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