review - Willis Re

willis re analytics
review
2012 Issue 1
In this issue
Analytics Q&A with John Cavanagh.............................................. Page 3
Diving into the warm pool............................................................... Page 4
Solvency II: does it matter?............................................................ Page 7
Managing extremes in a changing reinsurance environment..... Page 8
The New Madrid earthquake: 200 years later............................... Page 9
ORSA comes to the U.S.................................................................. Page 10
Predictive modeling: beyond the buzzword................................. Page 12
A.M. Best rating actions: raising the bar....................................... Page 14
Upcoming events
May 2 - 4, 2012 2012
ICMIF Meeting of Reinsurance Officials (MORO) 2012
Paris, France
June 26 - 28, 2012
Solvency II Summit
London, UK
May 10, 2012
Reactions Solvency II Forum
Paris, France
June 27-29, 2012
Risk and Investment Conference
Leeds, UK
May 24, 2012
ICMIF Solvency II Solutions One Day Seminar
London, UK
September 9 - 12, 2012
Rendez-Vous de September
Monte Carlo, Monaco
May 24 - 25, 2012
Risk and Capital Management Conference
London, UK
September 16 - 19, 2012
NAMIC Annual Convention
Grapevine, TX
June 3 - 5, 2012
CARe meeting
Boston, MA
September 29 - October 3, 2012
CIAB: Insurance Leadership Forum
Colorado Springs, CO
June 7 - 8, 2012
Groupe Consultatif European Congress of Actuaries
Brussels, Belgium
October 21 - 25, 2012
Baden-Baden Reinsurance Meeting
Baden Baden, Germany
June 19, 2012
TINtech – Insurance Industry Network Technology
Conference
London, UK
October 28 - 31, 2012
Property Casualty Insurers Association of America Annual
Meeting
Dana Point, CA
Page 2
Analytics Q&A with John Cavanagh,
Chief Executive Officer, Willis Re
John Cavanagh was appointed CEO of Willis Re in 2012. Based in London since 2009,
he is responsible for Willis Re’s worldwide operations. Prior to joining Willis, John was at
international specialty reinsurance broker RK Carvill for 21 years. He is a member of the
Willis Group’s Executive Committee, the senior management team setting and executing
Willis’ global strategy.
Here, he answers some questions about Willis Re’s Analytics offering, the role of analytics in today’s market, and
developments in the industry over the last decade.
How has the requirement for analytics support
developed in the reinsurance industry over the last
decade?
Would you say these regulatory changes have defined
the development of the Willis Re analytics team?
Absolutely – but certainly not solely. As a result of the increased
demands from our clients we have increased our resources
in analytics and deployed them in a better way to understand
our clients’ needs. Couple this with 2011 as the second worst
catastrophe year for the market on record with insured losses
in excess of $100 billion and reinsured losses of $50 billion and
significant catastrophe model changes: it is essential that we
improve our understanding of the nature of these hazards in
order to help our clients manage the risks associated with them.
This work will also form a core offering to our clients of helping
them meet the regulatory requirements of having a better
understanding of their risk.
Quantifying risk is now fundamental in the decision-making
processes of all insurers. From establishing underwriting
guidelines to capital management, risk management is now
at the core of an insurer’s corporate strategy. Directors of
insurance companies are now expected to have a broad
understanding of the risk models used in their business: their
assumptions, strengths and limitations, and the relationship
between risk and reward is considered before every major
decision is made. The cultural change over the last decade has
been enormous.
“We provide the support and
expertise that our clients need
through our analytics team.”
How significantly does Willis Re rely on analytics in
placing business?
This means the offering our customers are looking for
has developed significantly over the last ten years. Their
requirements are now more sophisticated and they look at us
to be their trusted advisor and provide this value added work.
This changing risk environment, which is broadly triggered
by extreme events over the last decade, from 9/11 to a global
financial crisis to tsunamis and floods, and the imminent
introduction of new regulatory requirements such as Solvency
II have placed significant demands on our clients (and
consequently us) in terms of risk modeling, capital management
and advice. As a result, alongside the usual risk analysis, helping
our clients grow now entails capital modeling – including
catastrophe modeling, dynamic financial analysis, portfolio
optimization, regulatory support, and credit analysis of their
portfolios. We provide the support and expertise that our clients
need through our analytics team. It’s an absolutely essential
part of our offering.
The insurance and reinsurance industries are far more technical
than they used to be – necessarily so – and there is no doubt
that our superior analytics offering gives Willis Re an edge, but I
don’t see analytics and technology as a substitute for experience.
Models do not replace underwriting or our assessment of a
risk on behalf of our client. Good judgement and experience
continues to be a very important part of the transaction at Willis
Re. This is the main reason we have analysts sitting within
our business units and not functioning as a separate entity.
Market intelligence aligned with our analytics products, and the
information that we gain from managing a global risk portfolio,
all combine to provide a balanced view to our customers that
is not overly analytical or market driven, but a combination
of the two. We know our clients, we know our risks, and it is
important that the analytics – which are an absolutely vital part
of our offering – contribute to the whole and are not seen as an
independent function, alternative or add on.
Page 3
Willis Re Analytics Review • May 2012
In which area is Willis Re analytics making the most significant progress in terms of development and
understanding?
In the two and half years I have been at Willis Re, I have become
accustomed to the analytics resources we have at our disposal
here, and have seen modeling and analytical developments in
a multitude of fields. I am continually impressed with the work
the team produce – from economic capital modeling to helping
our clients develop their own view of risk to developing quick
techniques to model an insurer’s portfolio during the Thailand
floods. In fact, there are some excellent developments being
made in this area at the moment. Willis Re has many excellent
client relationships in the Asia Pacific area, and we want to do
everything we can to assist our clients in managing, tracking,
and wherever possible, predicting the risks in the region. The
region had a very trying 2011, and our team is working very
closely with our customers and using our extensive analytics
resources to help them mitigate the impact of events such as last
year’s occurring in the future. There are, and will continue to be,
a number of unknown elements to risks such as uncertainties
in Japanese earthquake and tsunami modeling, but our job is to
present our clients and markets as accurate a picture as we can.
Our clients minimize the impact of such events by managing
extreme risks through purchasing reinsurance products – and
the area where analytics has had the most significant progress
within Willis Re is in helping find cost-efficient and optimal
reinsurance solutions that are aligned with our clients’ needs
and risk appetite. 
Diving into the warm pool
Do warmer sea surface temperatures mean more hurricanes making landfall in North America?
Recent research sponsored by the Willis Research Network dives into this question.
The past two U.S. wind seasons have been extraordinary in
terms of activity and landfall rates – and yet the effect on the
U.S. insurance industry from hurricanes has remained benign.
What’s going on here? Is it related to warmer sea surface
temperatures? And will it continue?
As shown below, both 2010 and 2011 seasons had above average
activity. Each had 19 named storms, tying for the third busiest
season on record. But only 11 of the 2010 tropical storms – and
only 6 in 2011 – gained hurricane strength. Florida continued
to escape hurricane-strength storms, making now 6 consecutive
years without significant landfall in Florida.
2010
2011
100°W 90°W 80°W
70°W
60°W
50°W
40°W 30°W
20°W 10°W
0°
100°W 90°W 80°W
2010 North Atlantic
Hurricane Season
60°N
Tropical Storm
Hurricane
Major Hurricane
60°N
60°N
70°W
60°W
50°W
40°W 30°W
20°W 10°W
2011 North Atlantic
Hurricane Season
Tropical Storm
Hurricane
Major Hurricane
0°
60°N
50°N
50°N
50°N
40°N
40°N
40°N
40°N
30°N
30°N
30°N
30°N
20°N
20°N
20°N
20°N
10°N
10°N
10°N
10°N
50°N
100°W 90°W 80°W
70°W
60°W
50°W
40°W 30°W
20°W 10°W
0
0
0
0
0°
100°W 90°W 80°W
70°W
60°W
50°W
40°W 30°W
20°W 10°W
0°
All storm tracks for the 2010 and 2011 U.S. hurricane seasons. The yellow boxes indicate the Gulf of Mexico Region (left) and the
Main Development Region (right). Tracks taken from HURDAT (2012).
Willis Re’s clients have asked: “Is all this related to a changing climate, and if so is it indicative of future behavior?”
Willis Re Analytics Review • May 2012
Page 4
Current climate
Both 2010 and 2011 showed
higher than average ocean
temperatures in the North
Atlantic – the so-called
“Atlantic Warm Pool” (AWP)
was more extensive than usual.
Scientists such as Dailey and
Wang have linked unusually
warm sea surface temperatures
to elevated storm activity.
Storm genesis locations (dots) and
mean sea surface temperature (shading)
(a) Large AWP years
30N
Warmer
years
29
28
20N
27 10N
10N
EQ
110W
25
years
90W
70W
50W
30W
10W
(b) Small AWP years
21
90W
70W
50W
30W
10W
(d) Small AWP years of TCs in MDR
40N
30N
20N
20N
10N
EQ
110W
EQ
110W
50N
23 30N
22
(c) Large AWP years of TCs in MDR
30N
26
Cooler
storm tracks
40N
20N
24
More intense storms develop in
the central to eastern Atlantic
in years with a large warm pool.
The greater number of storms,
and greater intensity of those
storms, can be related to the
additional energy of the warmer
ocean temperatures.
50N
Main Development Region
10N
90W
70W
50W
30W
10W
EQ
110W
90W
70W
50W
30W
10W
Source: Wang et al. 2011
The other thing that happens with a large warm pool is a weakening of the high pressure system over the Northeast Atlantic known
as the “Subtropical High.” This high pressure system, which is more or less stationary, acts as a barrier – it blocks the poleward
movement of storms and steers them instead towards the U.S. When the Subtropical high is weaker, storms forming in the Main
Development Region (MDR) are more likely to “hook” north and east, reducing the chance of landfall in the U.S. The storms that do
make it further west, however, have ample time to intensify over warm oceans; they become the most intense storms observed in the
North Atlantic.
Simulated sea level pressures and storm tracks
Simulated
warmer years
Simulated
cooler years
CAM3: Model Result ASO
50N
50N
40N
40N
30N
30N
20N
20N
10N
10N
0
100W
80W
60W
40W
20W
CAM3: Model Result ASO
(b) SLP (SAWP)
(a) SLP (LAWP)
0
0
100W
80W
60W
40W
20W
0
Source: Wang et al. 2011
Dr. Angelika Werner, WRN Climate Risk Coordinator, worked together with Willis Research Fellow, Dr. James Done of NCAR Earth
System Laboratory to investigate these effects in relation to the high level of activity but reduced frequency of landfalling storms
observed in 2010 and 2011.
We analyzed historic storms during the 10 largest and 10 smallest AWP years between 1970 and 2009. Historically, the absolute
number of landfalling storms increases during warm (large AWP) years due to the larger total number of storms generated in
those years. On the other hand, storms arising in the Main Development Region during warm years show a small relative decrease
in the likelihood of U.S. landfall: from 25% in small AWP years to 22% in large AWP years. If 2010 and 2011 are considered, this
percentage drops more significantly, to 18% – consistent with the theory, but suggesting that the database is too small to form any
final conclusion.
Page 5
Willis Re Analytics Review • May 2012
Future climate
What might the future hold? We investigated this using climate
models, simulating day-to-day weather over the U.S. and North
Atlantic. We compared simulations for a decade of current
climate conditions with two future decades of 2020 - 2030
and 2045 - 2055. Our results show increases in both hurricane
frequency and hurricane intensity, with the strongest hurricanes
becoming even stronger in the future. These increases are
different from many other studies (e.g., Knutson et al. 2010),
but these uncertainties do not affect the following conclusions.
What it all means
In summary, we can state that:
Our projections show considerable variability in the size of
the AWP for the period 1995 - 2060, but an overall increasing
trend. Our simulations agree with the suggestion by Wang et al.
(2011) that storms forming in the eastern tropical North Atlantic
are less likely to make U.S. landfall during future years as the
AWP grows; however, the signal is weak and subject to large
uncertainty.
•The relationship between Atlantic Warm Pool size and the
proportion of storms forming in the Main Development
Region that make U.S. landfall is weak and subject to other
factors that are likely to mask the signal
•A slight decrease in the proportion of storms making
landfall in the U.S. is likely to be masked by a strong overall
increase of total storms developing
•Storms that do make it through from the MDR are likely to
be among the most intense system
•Climate simulations show further expansion of the AWP
over the next 100 years (IPCC 2007), subject to various
ongoing discussions
For more information, or to learn about other Willis Research Network projects, please contact your Willis Re team. 
Further reading:
Dailey, Peter S., Gerhard Zuba, Greta Ljung, Ioana M. Dima, Jayanta Guin (2009): On the Relationship between
North Atlantic Sea Surface Temperatures and U.S. Hurricane Landfall Risk. J. Appl. Meteor. Climatol., 48, 111–129.
DOI: http://dx.doi.org/10.1175/2008JAMC1871.1.
Wang, C., Liu, H., Lee, S.-K. and Atlas, R. (2011): Impact of the Atlantic warm pool on United States landfalling
hurricanes. Geophys. Res. Lett., 38, DOI: 10.1029/2011GL049265.
Done, J., G.J., Holland, C. Bruyère, and A. Suzuki-Parker (2011): Effects of Climate Variability and Change on Gulf
of Mexico Tropical Cyclone Activity. Paper OTC 22190 presented at the Offshore Technology Conference, Houston,
Texas, May 2 - 5.
Done, J., Holland, G., and A. Werner (2102): Impacts of warm North Atlantic Ocean temperatures on U.S. landfalling
tropical cyclones. WRN Research Newsletter, February 2012.
Page 6
Solvency II: does it matter?
There is some debate about when discussions about Solvency
II, Europe’s new insurance regulatory regime, began. David
Simmons, who leads the Enterprise Risk Management practice
for Willis Re London, notes that he became aware of it around
2005 – back when implementation was meant to occur in
2008. “Comfortingly,” David comments, “implementation has
remained an average of three years away ever since.”
After a delay last year, implementation is now due in 2014. But
another delay is quite possible.
It’s very easy to get cynical about Solvency II. Will it ever
happen? Does it really matter? The answer to the first
question is at best “probably” – but the answer to the second is
“definitely.”
So why the new delay? Solvency II has suffered from the
difficulties of agreeing on a common regulatory standard across
27 countries – each with very different regulatory and business
cultures, and with insurance industries of various histories
and technical competencies. As the process approaches the
endgame, political issues have come to the fore.
The European Union’s approval procedures are complex. In
essence, the revised Solvency II directive must be agreed by the
Economics Committee of the European Parliament (ECON),
and then the gloriously named “triologue” needs to take place
between the European Commission, the Council of Europe
and the European Parliament. Finally, the measure requires
approval by a vote of the full Parliament.
A revised text was agreed by ECON on March 21, though
a number of major issues remain to be fully resolved. The
European Parliament had previously pushed back its vote on
the revised standard to July in anticipation of problems, later
pushed back again to October. In theory, this new timetable
still allows for implementation at January 1, 2014 – but that
would be very tight, as a slew of additional implementation
measures and binding technical standards remain to be agreed.
For Solvency II, the devil is not only in the details but also in the
underlying principles.
In the U.K., Solvency II has raced up the political agenda.
Recently, the U.K. company ranked 25th largest by London
Stock Exchange capitalization, Prudential plc (not to be
confused with Prudential Financial in the U.S.), threatened to
move its domicile to Hong Kong. The company said that “certain
versions” of Solvency II would create problems for investments
in corporate bonds, infrastructure and some bank assets. It
is also concerned about its Jackson Life subsidiary becoming
uncompetitive in the U.S. due to Solvency II applying higher
capital requirements than local regulation.
This prompted U.K. Prime Minister David Cameron to call
Solvency II a “good example of ill thought-out E.U. legislation.”
Prudential plc’s concerns focused on capital charges for certain
asset classes – particularly long-term corporate bonds, equity
and property – and on the thorny issue of “equivalence.” If a
company operates a subsidiary in a country whose regulation is
not deemed equivalent to Solvency II, the subsidiary’s capital
must be calculated according to Solvency II rather than the local
rules. Based on current draft rules, this would make Jackson
Life uncompetitive with its U.S. peers.
Hong Kong is one of those jurisdictions that have recently
applied for equivalence. But the state-by-state regulation of
insurance that prevails in the U.S. does not fit well with E.U.
rules. The European Commission has recently said that a
“different approach” is required for U.S. equivalence, which
seems to be an invitation for a fix of some kind.
Despite all the problems and delays, the basic tenets of Solvency
II are sound. Solvency II seeks to protect the policyholder by
ensuring not only that the company has an adequate capital
buffer, but also that it can demonstrate understanding and
prudent management of its risks. This is entirely consistent with
parallel developments in banking regulation and with emerging
best practices in the insurance industry, now recognized by
ratings agencies including S&P and A.M. Best. The philosophy
also aligns with the international consensus on insurance
regulation developed by the International Association of
Insurance Supervisors (IAIS). A company that embraces the
principles of Solvency II will be better managed, better focused,
more robust and ultimately more profitable. A company that
sees Solvency II, or similar regimes, as a compliance issue only
will bear all the expenses with none of the benefits.
Willis Re is well positioned to assist you with these issues.
We can help you select and implement the most efficient
reinsurance structures within the new regulatory environment –
and we can also provide advice on required capital calculations,
whether you’re using a standard formula or an internal capital
model. Our team includes leading experts on the Enterprise
Risk Management framework that wraps Solvency II and
similar regimes; we can help you define risk appetite, perform
stress testing and scenario testing, and incorporate Willis Re
performed peril modeling within an approved internal model.
Switzerland’s experience shows that it is possible to introduce an
intelligent Solvency II style framework with relatively little pain.
Countries outside the E.U. may look more towards the Swiss
Solvency Test than Solvency II as a template. No matter where
your firm operates, Willis Re can help you find the opportunities
in the changing regulatory environment – maximizing the gain
while minimizing the pain. 
Page 7
Willis Re Analytics Review • May 2012
Managing extremes in a changing
reinsurance environment
“The immediate and long term
implication of these climatological and
demographic trends for insurers and
reinsurers is staggering.The art and
science of insuring and reinsuring
extreme weather events is simply
going to have to become more
sophisticated.”
At the beginning of March, Willis Re hosted a seminar
titled “Managing Extremes in a Changing Reinsurance
Environment.” We wanted to share with our clients and
reinsurers an opportunity to learn more about the impact
of extreme weather, model change, and other technological
developments on the insurance and reinsurance landscape. In
our industry, change is a given: it is part of our role to provide
our clients with the very best knowledge and tools to manage
change.
Experts from Willis Re and the wider industry – including
A.M. Best, RMS and WeatherBELL – joined 150 clients and
prospects for the seminar, held at St. Joseph’s University
located near Philadelphia. A senior executive from Allied World
Reinsurance described the event as “one of the best seminars I
have attended.”
In 2011, more than $100 billion in loss from around the world
was caused by tornadoes, droughts, excessive rainfall, wildfires,
floods, blizzards, cyclones, earthquakes, hurricanes and heat
waves. As Willis Re Chairman Peter Hearn pointed out in his
opening remarks, “With the exception of an asteroid strike we
did not miss much.”
Scott Rubenstein, Vice President of Willis Re, explained that
many clients are concerned about the extreme conditions
encountered in 2010 and 2011.
“A lot has changed in our industry,” said Rubenstein. “Some
of the change may be cyclical, such as the increased frequency
of natural disasters, particularly tornado activity. On the other
hand, RMS significantly changed its hurricane model, and
overnight insurance companies
had to re-think their business plan.
A knock-on effect of the model
change for insurance companies
was and still is how rating
agencies will ‘score’ catastrophe
management going forward. These
were all issues our clients and
prospective clients have expressed
concern about over the last few
months – so having Joe Bastardi
from WeatherBELL, Michael
Kistler from RMS and Michelle
Baurkot from A.M. Best join us to
discuss these points was hugely
beneficial.”
Willis Re Analytics Review • May 2012
Hearn explained: “Extreme weather can be anything that differs
substantially from the historical norm. Extreme departures from
the historical record can be in terms of severity, duration or
frequency. An extreme weather event triggers a disaster when
its severity, duration or frequency causes damage that exceeds
an area’s physical and economic resources; in other words, its
ability to cope.”
Since 2006, federally declared disaster areas in the United
States have affected counties housing 242 million people – that
means four out of five Americans. During the same period,
weather-related disasters have been declared in every U.S. state
with the sole exception of South Carolina. More than 15 million
Americans live in counties that have averaged one or more
weather related disasters per year since 2006 – a statistic with
significant impact on the reinsurance industry.
“The immediate and long term implication of these
climatological and demographic trends for insurers and
reinsurers is staggering,” said Hearn. “The art and science of
insuring and reinsuring extreme weather events is simply going
to have to become more sophisticated.” 
Page 8
The New Madrid earthquake: 200 years later
Key scientific updates to the USGS hazard maps for the Central
and Eastern U.S. include:
In the winter of 1811 - 1812, a series of three large
earthquakes violently shook the central Mississippi valley.
The first occurred on December 16, 1811 with an estimated
magnitude of 7.7; a second quake hit January 23, 1812
with a magnitude of about 7.5; and a third earthquake
with a magnitude of about 7.7 struck on February 7, 1812.
Two hundred years later, scientists continue to debate the
likelihood that events like these might happen again along
the New Madrid fault, as well as the uncertainty associated
with seismic hazard estimates for this region.
There are about 39 million
people at risk in 6 states
in this region. More than
50% of potentially exposed
housing stock is at least 30
years old. In much of the area,
statewide building codes are
not mandatory. Little of the
building stock in this seismic
zone has experienced any
moderate ground shaking in
the recent past – which makes
it very difficult to estimate
vulnerability.
•Updates to earthquake source models for the New Madrid
Seismic Zone, varying event magnitudes (severity) and
recurrence rates (frequency)
•A new source model for nuclear facilities
•Updates to the earthquake catalog and assessments of
magnitude uncertainty
•New ground motion prediction models (also called
“attenuation equations”)
New Madrid Seismic Zone States
Arkansas
Illinois
Indiana
Kentucky
Missouri
Tennessee
2010 Population*
2,915,918
12,830,632
6,483,802
4,339,367
5,988,927
6,346,105
2010 Housing units*
Year structure built
Post 1999
1980-1999
Pre 1890
1,316,299
5,296,715
2,795,541
1,927,164
2,712,729
2,812,133
13%
36%
51%
9%
20%
71%
11%
26%
64%
12%
32%
56%
11%
28%
61%
14%
35%
51%
Statewide
building code
No statewide
building code
Mandatory
Statewide
statewide building code
building code
No statewide
building code
Statewide
building code
Building Code
Source: http://quickfacts.census.gov/qfd/states
A repeat of the 1811 – 1812 events today could have
significant impact on the insurance industry and the overall
economy: insured losses could be $65 to $80 billion.
In January 2012, Prasad Gunturi of Willis Re’s Catastrophe
Management Services team hosted an industry webinar
marking the occasion of 200-year anniversary of the
New Madrid earthquake. This webinar brought together
speakers from modeling companies AIR, EQECAT and
RMS to discuss earthquake risk in the New Madrid region.
We wanted to help our clients, prospects and industry
business partners prepare for earthquake model changes
anticipated in 2014 - 2015 and understand the uncertainty
surrounding New Madrid earthquake risk estimates.
National Seismic Hazard Maps (NSHM) provided by the
United States Geological Services (USGS) are a key source
of information for earthquake models. The USGS updates
its hazard maps on a 6-year cycle, following the latest
research. Work is currently underway to revise hazard
maps that will be available in 2014. We expect significant
changes for the New Madrid zone in this update. Some of
these changes could influence catastrophe modeling results
used by the insurance industry.
Updates to frequency and severity of events on the New Madrid
fault could have the effect of decreasing loss estimates for
many portfolios. New attenuation equations might significantly
change loss estimates and could also make it necessary for
insurers to modify underwriting rules based on distance to fault.
Willis Re will continue to monitor the latest developments on
the USGS National Seismic Hazard Maps as well as information
related to AIR, EQECAT and RMS earthquake model upgrades
for 2014-2015. We will provide regular updates, with balanced
advice based on our range of skills from model development
to the practical implementation of portfolio management and
underwriting objectives.
Meanwhile, please contact your Willis Re team with any
questions or to access the recorded version of our New Madrid
webinar. 
Page 9
Willis Re Analytics Review • May 2012
ORSA comes to the U.S.
A significant new risk-related regulatory requirement for U.S.
insurers is on the way. As part of an augmented Risk Based
Examination process, the Own Risk and Solvency Assessment
(ORSA) moves U.S. solvency regulation into new territory.
Company management will now be asked to articulate their own
judgment about the adequacy of their firm’s capital. The idea
is that such a management view will provide a better reflection
of the company’s risks, risk management capacity, capital
and future plans than standard regulator-specified capital
requirements can offer.
But for some insurers, the new standards will require
establishing more formal ERM processes and additional risk
measurement capabilities. Boards and management will also
need to be prepared for the initial ORSA summary report – and
stay up to date on ORSA developments, as well as the firm’s risk
management processes.
Many of the largest U.S. insurers are able to do this already –
but mid-sized insurers may need to get to work.
How did this get started?
In October 2010, the international insurance regulatory
community adopted a set of Insurance Core Principles (ICPs).
One of these – ICP 16, titled Enterprise Risk Management –
calls for an ORSA. The ORSA concept, embedded in Pillar 2 of
Solvency II, was adopted by the U.S. National Association of
Insurance Commissioners (NAIC) in late 2011. Implementation
by the states is expected to mean effective dates in 2014 and
2015.
Europe and the U.S. are not alone in adopting such a
requirement. In Bermuda, it will be called the Commercial
Insurers Solvency Self Assessment. In Australia, it takes the
same name as a similar process for banks, the Internal Capital
Adequacy Assessment Process (ICAAP). Other regulators in
other countries are expected to join in.
What will you have to do?
For those insurers with well-established formal ERM programs,
ORSA requirements will just mean documentation of their
existing processes. Current expectations are that only a 3 to 5
page confidential summary will need to be filed with the NAIC;
but a much more extensive report, similar to that required
under Solvency II in Europe, must be available for inspection by
the regulators during the quadrennial examination. Companies
belonging to an international group and filing a Solvency II
ORSA will be able to use the same report in the U.S.
The ORSA will require a consistent and efficient measurement
of solvency resources and a determination of capital quality. In
addition, the ORSA will look for an effective ERM framework
including:
•Risk culture and governance
•Risk identification and prioritization
•Risk appetite, tolerances and limits
•Risk management and controls
•Risk reporting and communication
This framework should be documented as the ERM Policy
Statement of the insurer.
ORSA requirements for ERM policies in other countries are
similar.
U.S. insurance groups will be exempt from the ORSA
requirements if their annual U.S. premium writings are under
$1 billion; insurance companies with less
than $500 million in premium are also
exempt. According to NAIC statistics, this
will capture at least 80 percent of U.S.
premium while relieving a large number of
smaller insurers.
How will you need to
assess economic capital?
Most firms will focus on the ORSA
“resource assessment.” ICP 16
specifies that the ORSA plan ahead for
up to five years; the NAIC guidance
manual allows for a two- to five-year
look forward. The assessment should
include foreseeable and material
risks, and employ both quantitative
and qualitative methods. Stochastic
modeling is not specifically required; in
fact, the ORSA practice seems to favor
stress testing.
ORSA requires the management and
board to decide on the adequacy of the
firm’s capital and overall Enterprise
Risk Management (ERM) system, based
on their own assessment of the firm’s
future plans, risks and risk capacity. Risk
capacity should be determined based on
funds available and the quality of risk
management systems.
Willis Re Analytics Review • May 2012
Page 10
The NAIC will require insurers to calculate economic
capital, specifying how each of the following is handled:
1.Definition of solvency
•Cash flow basis, balance sheet basis or other
2. Time horizon of risk exposure
•One year, lifetime or other
Why ORSA?
3. Risks modeled
4. Risk measurement process
•Stress tests, stochastic modeling, factor-based
formulas
5. Measurement metric
•Value at risk, tail value at risk,
For the ORSA, insurers must assess capital adequacy in a
stressed environment using either a stress testing methodology
or a stochastic model. Since the ORSA specifically requires a
multi-year view of future capital needs, some firms that have
already developed internal models may need to enhance those
models.
probability of ruin,
or other
6. Company target level of capital
7.Diversification effects
In Europe, regulators expect that ORSA parameters may
differ from those of the internal Solvency II capital model.
The internal model is calibrated to risk assumptions specified
by the regulators, while the ORSA reflects management’s risk
assumptions.
Consequences for noncompliance have not yet been specified;
at a minimum, failure to comply will mean additional scrutiny
during the regulatory review process, but it’s possible that
noncompliance could result in a public report declaring the
firm’s risk management practices to be inadequate. The exact
ORSA requirements for U.S. companies are still evolving. Based
on feedback they have received to date, the NAIC is adapting
the ideas of ICP 16 to fit the existing U.S. regulatory and
industry environment. But the concept behind ORSA is firmly
in place: the insurer – not the regulator – should be responsible
for determining the capital that the firm needs; and this
determination should reflect the risk management capabilities,
the risks and the capital of the firm. 
For the ORSA,
insurers must assess
capital adequacy
in a stressed
environment using
either a stress
testing methodology
or a stochastic
model.
Page 11
Predictive modeling: beyond the buzzword
We’re now fifteen plus years
into the predictive modeling
“craze” in Property / Casualty
insurance and predictive
analytics is finally starting to
lose its mystique in the U.S.,
moving beyond the buzzword
and into the mainstream. Over
the past 50 years, predictive
modeling has moved through
a progression of increasing
approachability:
•1940s and 1950s: Cutting edge, rocket-science unobtainium,
when the statistical theory was beyond our computational
ability
•1980s: Big Data; multi-million dollar projects by hardware
vendors and the big accounting / consulting firms
•1990s: In-house dedicated predictive modeling departments
by firms such as Progressive and Geico, which enjoyed a
significant competitive advantage
Complicated?
Not really. It’s merely a mathematical model that takes available
data and makes a prediction. It’s the same thing that fleshand-blood underwriters do day in and day out. The math in
the predictive model is probably less complicated than what
the underwriter is doing – but it’s able to find relationships in
the data that are “hidden” to the underwriter. Much like the
underwriter’s brain, a predictive model:
•Looks at all available data points on a particular risk
•Gives insight about what that data means
•Helps the company better select and price risk
Expensive and / or impractical?
Like any other underwriting tool, predictive modeling is
valuable if it can increase profitability. Like any other tool,
assessing the value is straightforward:
•What are the costs?
•What are the benefits?
•Can it be implemented here?
The question of implementation goes beyond just systems and
IT – there are also legal issues and palatability problems:
•Mid-2000s: Off-the-shelf third party models and boutique
modeling firms bring predictive analytics to a wider
spectrum of companies
•Legal – can this be used in our jurisdiction?
•Palatability – will underwriters and management be able
•2010: Kaggle.com (“We’re making data science a sport”)
•2011: FarmVille monitors player behavior to offer them
to accept what the model is indicating, even if it’s counter
intuitive to underwriting conventional wisdom?
customized in-game incentives
It’s interesting to note that the statistical tools used in predictive
modeling haven’t changed much in the last 30 years. The
modeling methods that Big Data had in the 80s are what Kaggle
contestants are using now – it’s just that, rather than requiring
a mainframe to calculate, these models can now be completed
during a morning subway commute on an average notebook.
So why isn’t every carrier embracing predictive modeling? It’s
probably partially due to the (mistaken) beliefs that predictive
modeling:
•Is extremely complicated
•Is extremely expensive
•Takes years to implement
•Won’t work for small carriers or specialty coverages
In reality, none of these are generally true. In fact, any carrier
not already using predictive modeling should be able to identify
and rapidly implement a predictive model that may yield
increased profitability.
Willis Re Analytics Review • May 2012
The palatability paradox
Don’t underestimate the palatability issue; it’s a common
stumbling block for small carriers with a rich underwriting
tradition, just starting to explore predictive modeling.
By definition, a predictive model will only provide value
if it provides information the underwriters don’t already
know. Therefore, any effective model will be, by definition,
counterintuitive. The trick is to have an objective understanding
of the model’s predictive power, and a realistic estimate
of its financial benefit, before you ask whether or not a
counterintuitive result can be accepted.
Finally, expect that a predictive model will be implemented not
to replace the underwriting process, but to supplement it; a good
predictive model puts a powerful tool in the underwriter’s hands
that will make his or her job both easier and more effective. The
result? Potentially increased profits.
Page 12
Should we do it?
There’s a very rational process for objectively evaluating
a predictive model. Following this outline will help you
understand, in quantitative terms, the model’s predictive power
and potential value to the company. Just ask (and answer) five
questions:
1.Will the model work?
•This is the easiest question to answer
•Evaluate by “predicting” past results, and compare to actual
•If the model doesn’t work, drop it and quickly move on to
something else
Two novel solutions
Willis Re has identified a couple of novel predictive modeling
solutions that are perfect for organizations with smaller data
and smaller budgets. They allow rapid resolution of the five-step
evaluation plan outlined above, and offer a perfect first step into
predictive modeling for many carriers who have yet to make
that move. Willis Re has negotiated discounted rates on these
products for our clients. We receive no financial incentive when
our clients use these services; instead we offer independent
third party advice as they investigate the potential fit and during
model implementation.
•Valen Technologies’ InsureRight service is an extremely
powerful Workers’ Compensation model which provides risk
scoring on Workers’ Comp policies countrywide. Because it’s
based on Valen’s data warehouse, model development and
implementation is very fast, with a 45 day target. The service
is low cost, and based on a transactional model – so clients
pay only for the scores they request from the system.
2.Will it be better than relying on traditional underwriting
alone?
•A strong model is no good if it only tells you what you
already know
•A valuable model will tell you something your underwriters
do not currently use
•ISO RiskAnalyzer is available for U.S. Homeowners as well
as Commercial and Personal Auto. The products are based
on ISO’s vast database of industry statistics, leveraging
those statistics to produce loss relativity predictions at a
geographic level of detail much finer than the standard ISO
rate plans. RiskAnalyzer products are subscription-based,
with a modest annual fee, and have zero development time:
just sign up and start using the model results immediately.
3.Can it be implemented here?
•IT compatibility
•Legality
•Palatability
4.Will the benefits justify the costs?
If you’re not currently using predictive analytics in your
company, now is the time to take predictive modeling beyond
the buzzword and into action.
•At this stage, you’ve verified that the model works, that it
has value, and that it can be implemented
•Measure past results “as if” the model had been
implemented last year
•Compare to the projected model cost, including vendor, IT,
legal, and so on
For more details on these products, or how predictive
modeling might fit in your organization, please contact your
Willis Re team. 
•What’s the possible improvement to the bottom line?
5.Should we implement it?
•Unfortunately, this is usually the first question people ask
– frequently leading to analysis paralysis, as firms look for
“just one more run” to make up their minds
•Instead, move this question to the end – by now you’ve got
the answer. If the answer to the previous four questions is
“Yes” then there may well be no reason NOT to move ahead.
Page 13
Willis Re Analytics Review • May 2012
A.M. Best rating actions: raising the bar
The year just past was a challenging one for the insurance industry. Insurers faced significant catastrophe activity, a difficult
economic environment, and prolonged soft market conditions. Capital levels for the industry as a whole remain robust, but
individual carriers – especially regional carriers – experienced surplus declines.
In this context, it’s apparent that A.M. Best has raised the bar for its higher rating categories. To achieve or maintain these ratings,
insurers’ performance measures need to be stronger than ever before. During 2011, we observed that A.M. Best:
•Heightened their evaluation of Enterprise Risk Management (ERM)
•Incorporated higher PMLs in Best’s Capital Adequacy Ratio (BCAR) analysis due to catastrophe model changes
•Focused even more strongly on underwriting and operating performance
•Showed less tolerance for earnings volatility, particularly for higher-rated companies
•Sharply increased the percentage of negative rating actions, particularly in Q3 and Q4
•Imposed many downgrades with a drop of 2+ rating levels and / or continued negative outlook
Although the majority of 2011 ratings were affirmed – as is the case every year – downgrades and negative outlooks outpaced
upgrades and other positive rating assignments. And in the second half of the year, negative rating actions picked up due to
catastrophe losses that added stress in an already challenging underwriting climate.
2011 A.M. Best Rating Actions (excluding affirmations)
2011 Full Year
2011 Q3 and Q4
Downgraded
Source: A.M. Best
Downgraded under review
Under review with negative outlook
Upgraded, or under review with positive outlook
Negative rating actions outweighed positive actions in 2011.
The proportion of negative rating actions increased in the second half of 2011 from 66% to 73%.
Willis Re Analytics Review • May 2012
Page 14
2011 in review
While catastrophe activity declined in
the fourth quarter, many companies
had downgrades based on third quarter
filings. The effect of multiple “smaller”
catastrophe losses in the U.S. was especially
painful given the trend toward increased
reinsurance retentions over the past
15 years. As firms have sought higher
limits for their catastrophe reinsurance
to protect against large events, many
managed costs by raising their retentions
and co-participations. They were left with
significant net losses after reinsurance.
Willis Re’s 1st View report, released in
January 2012, estimated global insured
losses at over $100 billion, with more
than 50% of this amount covered by
reinsurance. In the first half of 2011, the
global reinsurance market bore the brunt of the Japanese and
New Zealand earthquakes; Thailand Flood losses are reducing
earnings for the fourth quarter. Capacity is still available,
but individual reinsurers are assessing their respective risk
tolerances and the cost of capital deployed.
continued negative outlook; in fact this happened to many of
the “A-” to “B+” level companies that were downgraded in 2011.
Overall, A.M. Best is scrutinizing underwriting and operating
performance more closely, and tolerating less volatility of
results, for the higher rated companies – regardless of capital
strength.
A.M. Best reported that through 9 months of 2011, U.S. insured
pre-tax catastrophe losses were $38.6 billion – one of the
costliest years on record. The U.S. industry’s combined ratio for
this 9-month period increased to 108.3%, an 8.5-point increase
from the comparable 2010 period. Underwriting challenges and
a weak investment market brought the U.S. industry’s 9-month
net income down to $12.8 billion, from $33.0 billion the prior
year. Net written premiums increased 3.3%, while policyholder
surplus decreased 3.1%.
In total, the insurance industry’s capital level remains strong,
but leverage ratios are under pressure. And while A.M. Best
anticipates that companies will continue to release reserves,
adequacy has declined. The first three quarters of 2011 saw
$10.5 billion of industry reserve releases, driven in large part
by State Farm, Berkshire Hathaway and Travelers. Such actions
will likely lead to continued deterioration of calendar year
results in the future. Though rates are improving in catastrophe
prone regions, a wholesale market turn is not anticipated for
2012.
A.M. Best actions
In the past, A.M. Best rated most companies soon after annual
results were reported; they tended to take at most one action
on a given company over the course of a year. But A.M. Best
has become less optimistic that results will bounce back in
the near term. So even after a downgrade they may assign a
Catastrophe model changes were another crucial factor. Willis
Re’s market surveillance and feedback from our clients indicate
that A.M. Best closely scrutinized companies perceived as slow
to enact model changes. Catastrophe risk management and risk
appetite were hot-button topics. Since the agency continues to
frown on “model shopping,” companies must demonstrate a
solid understanding of the cat models and a sound rationale for
their strategy. Our Catastrophe Management Services team has
helped many clients achieve a better understanding of the new
model results, as well as helping them prepare to explain their
position to A.M. Best.
Outlook for 2012
A.M. Best’s ratings outlook for 2012 is mixed. While personal
lines and global reinsurers have maintained “stable” outlooks,
the agency continues a negative outlook on commercial lines.
We expect 2012 to be another sensitive ratings year. In that
context, we’re working closely with our clients to assist with
rating advisory, capital and reinsurance management, strategic
analysis and financial forecasting. Our experienced team can
help with initial rating assignments, upgrade roadmaps, rating
pressure defenses, strategic planning implications, and mergers
and acquisitions analysis.
Please contact your Willis Re team to discuss further. 
Page 15
Willis Re Analytics Review • May 2012
Global and local reinsurance
Willis Re employs reinsurance experts worldwide. Drawing on this highly
professional resource, and backed by all the expertise of the wider Willis Group, we
offer you every solution you look for in a top tier reinsurance advisor. One that has
comprehensive capabilities, with on-the-ground presence and local understanding.
Whether your operations are global, national or local, Willis Re can help you make
better reinsurance decisions - access worldwide markets - negotiate optimum terms
– and boost your business performance.
How can we help?
To find out how we can offer you an extra depth of service
combined with extra flexibility, simply contact us.
Begin by visiting our website at www.willisre.com
or calling your local office.
Willis Limited
The Willis Building
51 Lime Street
London EC3M 7DQ
Tel: +44 (0)20 3124 6000
Fax: +44 (0)20 3124 8223
Willis Re Inc.
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200 Liberty Street
3rd Floor
New York, NY 10281
Tel: +1 212 915 7600
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