Systemic Exposures in the Casualty Market … and how to address them

1. September 2010 Systemic Exposures in the Casualty Market…and how to address them Grange Turner, Guy Carpenter & Company Ltd, London Contact: +44 207 357 1424 grange.turner@guycarp.com Insurance Practitioners Association Conference – Istanbul September 2010

2. Agenda • Definitions of event and systemic exposures • Examples of clash and systemic exposures • Past clash and systemic losses • Systemic exposures in a recessionary environment • Modelling clash and systemic exposures • Methods of protecting against clash and systemic exposures

3. Definitions of Event and Systemic exposuresWhat do we mean by “clash”, “event” and “systemic”? • Clash – a single loss, or series of losses, deriving from more than one original policy • Event – a loss scenario, usually definable in time and place, which may involve multiple policies • Systemic – exposures derived from a broad industry wide practice, or from a general social or economic trend Note – these are working descriptions of the terms, not legal definitions.

4. Events are generally specific in time and place 2. Examples of Clash and Systemic ExposuresWhat do we mean by an “event”? Event exposure to different classes of casualty business • General Liability – multiple producers involved in the same faulty product or project • Employers Liability – workers for multiple insureds injured / killed in the same explosion • Motor – multiple vehicles involved in the same accident/Catastrophe • Professional / Financial lines – multiple advisers involved in the same financial collapse (bankruptcy)

5. Systemic exposures generally have broader scope than events 2. Examples of Clash and Systemic ExposuresWhat do we mean by an “Systemic”? Systemic exposures to different classes of casualty business • General Liability – a similarly faulty manufacturing process leads to numerous similar losses • Employers Liability – a business practice common to a sector leads to a number of similar injury / disease claims • Motor– an increase in the number of accidents caused by unusual weather patterns • Professional / Financial lines – professional advisers from a number of firms following a similar pattern of practice

6. Natural Catastrophes • Earthquake • Hurricane • Virus outbreak • Man-made failures • Terrorist Attack • Corporate collapse • Infrastructure/ Project failure • Major identity theft • Business practices • Tax shelters • Late Trading in US Mutual Funds • Contingent Commission practices • Product widely mis-sold • Economic malaise • Increase in corporate dissatisfaction • House price slump • ‘Credit Crunch’ / Recession 2. Examples of Clash and Systemic ExposuresEvent Categories

7. Wide range of original types of loss….. 3. Past Clash & Systemic LossesA historical perspective….. • Asbestos – multiple claimants from multiple firms for disease related claims spread over many years • Enron – US corporate collapse which drew in multiple advisers, and other firms with a business link • World Trade Centre – terrorist attack resulting in numerous deaths and injuries (WCA claims) and suits against various professional advisers • Pension opt-outs – multiple investors were wrongly advised to leave their corporate pension schemes • Sub–Prime – numerous failed investment products derived from sub-prime lending practices in the US • Wembley Stadium – architects and building companies involved in late-running construction project

8. Events are generally specific in time and place 4. Systemic Exposures in a Recessionary Environment Effects of a recessionary environment on different classes of casualty business • General Liability • Lack of investment in new plant / equipment • Reductions in the number of suppliers • Reduction in number of workers • Employers Liability • Cut-backs in a firm’s safety schedule • Fewer workers doing same workload • Lack of investment in new plant / equipment Recession brings increased tendency to litigation and fraudulent claims

9. 4. Systemic Exposures in a Recessionary Environment Effects of a recessionary environment on different classes of casualty business • Motor • Injured parties making claims where previously would not have done; • Staged accidents • Increased number of fraudulent claims • Professional / Financial lines • Increased tendency to sue professional advisers in event of investment/business failure • Collapsing property values lead to increased claims against valuers

10. How many Casualty Cat losses could have been predicted without hindsight? 4. Systemic Exposures in a Recessionary Environment Other factors affecting systemic casualty exposures in the long term • Long-tail characteristics • Potential for changes in legal environment • Potential for changes in policy interpretation • Political/regulatory intervention

11. 5. Modelling Clash and Systemic Exposures Guy Carpenter’s approach to modelling Casualty Clash involves the following; 1. Portfolio Exposure Analysis • Provide a catastrophe profile of your Casualty / Liability portfolio • Identify: • Which portfolio segments are most accumulative; facilitate price loading • Data capture that’s essential in casualty accumulation reporting • How casualty catastrophe losses could impact your portfolio

12. 5. Modelling Clash and Systemic Exposures 2. Realistic Disaster Scenarios • Customise a classic/systemic cat event set using a uniform network-based system • For each scenario, stochastically model the business relationship links • allowing for type of jurisdiction • providing a distribution of possible outcomes • Demonstrate to stakeholders / regulators that you have a transparent identification process of allocating risk capital to defined long-tail disaster scenarios • a vital part of ERM tool for Solvency II

13. 5. Modelling Clash and Systemic Exposures Example of Business Relationship Links Case Study: Chemical/Industrial Gas Manufacturer

14. Available Coverage Single Insured Multiple losses on an ‘Any One Claim’ form Mono-Line More than 1 insuredSame coverage Non-Systemic Several Ins’ds/policiesSingle event/ series loss StandardSystemic Multi Ins’ds/ CoveragesEvent = similar behaviour Broad Form Systemic Even broader basis of accumulation Sole Judge Systemic Reinsured is sole judge of event Less More Difficulty of defining ‘Event’ Reinsurance capacity More Less Pricing Light Heavy 6. Protecting Against Clash and Systemic Exposures Reinsurance Options Whole Account Multiple Sectors

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