Systemic Exposures in the Casualty Market … and how to address them September 2010 Grange Turner, Guy Carpenter & Company Ltd, London Contact: Insurance Practitioners Association Conference – Istanbul September 2010

1 Guy Carpenter Agenda 1. Definitions of event and systemic exposures 2. Examples of clash and systemic exposures 3. Past clash and systemic losses 4. Systemic exposures in a recessionary environment 5. Modelling clash and systemic exposures 6. Methods of protecting against clash and systemic exposures

2 Guy Carpenter 1.Definitions of Event and Systemic exposures What 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.

3 Guy Carpenter 2. Examples of Clash and Systemic Exposures What do we mean by an “event”? Events are generally specific in time and place  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) Event exposure to different classes of casualty business

4 Guy Carpenter Systemic exposures generally have broader scope than events  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 Systemic exposures to different classes of casualty business 2. Examples of Clash and Systemic Exposures What do we mean by an “Systemic”?

5 Guy Carpenter Natural Catastrophes  Earthquake  Hurricane  Virus outbreak Natural Catastrophes  Earthquake  Hurricane  Virus outbreak Man-made failures  Terrorist Attack  Corporate collapse  Infrastructure/ Project failure  Major identity theft 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 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 Economic malaise  Increase in corporate dissatisfaction  House price slump  ‘Credit Crunch’ / Recession 2. Examples of Clash and Systemic Exposures Event Categories

6 Guy Carpenter 3. Past Clash & Systemic Losses A historical perspective….. Wide range of original types of loss…..  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

7 Guy Carpenter 4. Systemic Exposures in a Recessionary Environment Events are generally specific in time and place  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 Effects of a recessionary environment on different classes of casualty business Recession brings increased tendency to litigation and fraudulent claims

8 Guy Carpenter 4. Systemic Exposures in a Recessionary Environment  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 Effects of a recessionary environment on different classes of casualty business

9 Guy Carpenter 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 4. Systemic Exposures in a Recessionary Environment How many Casualty Cat losses could have been predicted without hindsight?

10 Guy Carpenter 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 5. Modelling Clash and Systemic Exposures

11 Guy Carpenter 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 5. Modelling Clash and Systemic Exposures

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

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