Insurance Risk Study - Aon

1 Insurance Risk StudyFifth Edition 2010reDEFININGC apital | Access | Advocacy | InnovationPortfolio RiskSystemicMarket RiskSystemicInsuranceRiskNa ve ModelInsurance Portfolio RiskAsset Portfolio RiskContents3 | Foreword4 | Global Risk Parameters6 | Evaluating Solvency II Factors8 | Risk Parameters10 | Best of Times, Worst of Times12 | Correlation and the Pricing Cycle16 | Modeling Dependence17 | Size and Correlation18 | Macroeconomic Correlation19 | Managing Inflation Risk21 | Global Market Review25 | Afterword: The Greatest RiskAbout the StudyRating agencies, regulators and investors today are demanding that insurers provide detailed assessments of their risk tolerance and quantify the adequacy of their economic capital.

2 To complete such assessments requires a credible baseline for underwriting volatility. The Insurance Risk Study provides our clients with an objective and data-driven set of underwriting volatility benchmarks by line of business and country as well as correlations by line and country. These benchmarks are a valuable resource to CROs, actuaries and other economic capital modeling professionals who seek reliable parameters for their portfolio theory for assets teaches that increasing the number of stocks in a portfolio will diversify and reduce the portfolio s risk, but will not eliminate risk completely; the systemic market risk remains.

3 This is illustrated in the left chart below. In the same way, insurers can reduce underwriting volatility by increasing portfolio volume, but they cannot reduce their volatility to zero. A certain level of systemic Insurance risk will always remain, due to factors such as the underwriting cycle, macroeconomic factors, legal changes and weather (right chart below). The Study calculates this systemic risk by line of business and country. The Na ve Model on the right chart shows the relationship between risk and volume using a Poisson assumption for claim count a textbook actuarial approach.

4 The Study clearly shows that this assumption does not fit with empirical data for any line of business in any country. It will underestimate underwriting risk if used in an ERM model. Number of StocksPortfolio RiskVolumeInsurance Risk3 ForewordSince the first internal Aon Benfield Insurance Risk Study in 2003, the Insurance world has been shaken by mega-catastrophes and threatened by financial market turmoil. Industry best practice in enterprise risk management has evolved almost beyond recognition, and techniques for risk quantification and capital modeling have advanced from nascent specialties into mainstream core despite change and progress, much remains constant.

5 Risk quantification still relies fundamentally on accurate parameterization and realistic stochastic models. An incorrectly specified model is often worse than no model at all. Bad models can lead the user astray, as was shown by numerous examples during the financial crisis. Aon Benfield has consistently focused on the need to provide our clients the robust data and fact-based parameters published in this Study to complement state-of-the-art financial modeling tools such as our ReMetrica software. The Study is a cornerstone of Aon Benfield Analytics integrated and comprehensive risk modeling and risk assessment capabilities.

6 > Our reinsurance optimization framework, linking reinsurance to capital, relies on the Study for a credible assessment of baseline frequency and severity volatility > Our global risk and capital strategy practice, providing ERM and economic capital services, uses the Study to benchmark risk, quantify capital adequacy and allocate capital to risk drivers > Our ReMetrica risk evaluation and capital modeling software provides easy access to the Study parameters and risk insights2010 s Fifth Edition has again expanded in scope and coverage from previous editions.

7 It includes: > Results from 46 countries, comprising more than 90 percent of global premium > A global market review showing premium, historical loss ratio and volatility parameters for the top 50 countries > A new approach to loss ratio volatility that measures year-over-year changes illustrating the magnitude of historical planning misses > A focus on the potential impact of inflation on P&C companiesThe massive database underlying the Study is supported by more than 450 professionals within the global Analytics team who are available to work with you to customize the basic parameters reported here to answer your specific.

8 Pressing business Benfield s Insurance Risk Study , now in its fifth edition, continues to be the industry s leading publicly available set of risk parameters for modeling and benchmarking underwriting risk. We are pleased to offer the Study for the advancement of risk management within our industry. For convenient reference, you can find earlier editions of the Study at I welcome your thoughts and suggestions, which you can share with an e-mail to Stephen Mildenhall CEO, Aon Benfield Analytics 4 Insurance Risk StudyTaiwanMexicoPeruGreeceSingaporeHong KongNicaraguaIndonesiaHondurasColombiaRo maniaBrazilArgentinaDominican KoreaHungaryBoliviaVietnamEl AfricaIsraelNicaraguaGreeceHong KongPanamaIndonesiaSingaporeDominican RepublicSlovakiaSouth AfricaDenmarkRomaniaEcuadorHondurasEl RepublicAustriaAustraliaIsraelSouth

9 KoreaTaiwanTurkeyJapanHungary8%13%16%17% 18%18%18%19%21%22%22%25%26%27%28%28%31%3 1%32%36%37%38%38%38%40%42%42%43%44%45%46 %51%51%53%54%54%58%58%62%67%71%73%91%92% 98%4%5%6%7%7%7%8%8%8%9%9%9%9%9%9%10%10%1 1%11%11%12%12%12%13%15%15%15%16%16%18%18 %18%18%18%21%23%24%25%25%25%27%29%35%43% 46%64%AmericasAsia PacificEurope, Middle East & AfricaMotorPropertyGlobal Risk ParametersThe 2010 Insurance Risk Study quantifies the systemic risk by line for 46 countries worldwide, up from 26 last year. Systemic risk in the Study is the coefficient of variation of loss ratio for a large book of business.

10 Coefficient of variation (CV) is a commonly used normalized measure of risk defined as the standard deviation divided by the mean. Systemic risk typically comes from non-diversifiable risk sources such as changing market rate adequacy, unknown prospective frequency and severity trend, weather-related losses, legal reforms and court decisions, the level of economic activity, and other macroeconomic factors. It also includes the risk to smaller and specialty lines of business caused by a lack of credible data. For many lines of business systemic risk is the major component of underwriting systemic risk factors for major lines by region appear on the next page.