Investors are more tolerant of earnings volatility among reinsurers than primary insurers, a reinsurance brokerage study has found.
Aon Re Global, a subsidiary of Chicago-based Aon, said 2005 catastrophes–especially Hurricane Katrina–provided an opportunity for analysts to review the investors' response to the related earnings and capital volatility.
"Katrina is the first significant natural catastrophe since Northridge and Andrew to truly test the risk and capital management plans of insurers and reinsurers," said Mike Bungert, chief executive officer of Aon Re Inc.
Mr. Bungert said, "The relative intolerance of catastrophe risk from shareholders as seen through these events is instructive. Shareholders represent a tighter constraint on capital and earnings than rating agencies."
Most of the industry discussion post-Hurricane Katrina has focused on the actions rating agencies demand for increased capital for some reinsurers and the need for changes in catastrophe models for the future, Aon said.
Aon asserted that the study tells the investor side of the story and represents an important addition to the information needed to optimize catastrophe retentions, limits and the use of the varying forms of underwriting capital including equity, policyholders' surplus, hybrid instruments, reinsurance and alternative risk transfer products.
"Investors clearly understand the differences between insurers and reinsurers and have set differing tolerances for each," said Stephen Mildenhall, Aon Re Services executive vice president and author of the study.
Mr. Mildenhall continued, "Our study confirms that investors expect higher earnings and capital volatility from reinsurers than they expect from insurers.
"Key points in the regression [statistical analysis] showed that insurers were allowed capital volatility of 3-to-6 percent and were allowed to lose slightly more than a quarter of pre-Katrina consensus earnings before significant shareholder value deterioration occurred.
"Reinsurers, on the other hand, were allowed capital volatility of 12-to-19 percent and were allowed to lose an entire year of pre-Katrina consensus earnings before significant shareholder value deterioration occurred," he said.
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