Fourth Quarter 2016 Reinsurer Earnings...

Aon Benfield Analytics | Market Analysis Proprietary and Confidential

Risk. Reinsurance. Human Resources.

Fourth Quarter 2016 Reinsurer Earnings Conference Call Highlights For Select Reinsurance Groups on MarketReView March 2017


Market Analysis Update: 4Q 2016 Reinsurer Earnings Conference Call Highlights 2

Table of Contents Common Themes 3

Arch Capital Group Ltd. 4

Argo Group International Holdings, Ltd. 6

Aspen Insurance Holdings Ltd. 7

AXIS Capital Holdings Ltd. 9

Chubb Limited 11

Everest Re Group, Ltd. 13

Fairfax Financial Holdings Limited 15

Greenlight Capital Re Ltd 17

Lancashire Holdings Limited 18

RenaissanceRe Holdings Ltd. 19

Validus Holdings Ltd. 21

XL Group Ltd. 23

Contact Information 25



The primary objective of this report is to summarize the more important commentary during the most recent public earnings conference calls for a select group of insurance and reinsurance groups.

Important Note: The common themes and individual company commentary in this report represent the views of the senior management of the insurance and reinsurance groups that participated on the earnings calls and do not represent the views of Aon Benfield.

Common Themes Earnings: Fourth quarter 2016 (4Q2016) operating earnings for nine of the 12 groups followed in this

report exceeded analyst earnings estimates. However, all but three groups reported lower operating earnings year-over-year (YOY), generally due to higher catastrophe losses and lower reserve releases vs. 4Q2015. Additionally, net income Return on Equity (ROE) results drifted lower as rising interest rates, particularly post-U.S. election, led to unfavorable mark-to-market adjustments in fixed income portfolios. While higher reinvestment rates are expected to benefit investment income in 2017, groups will still need combined ratios below 100% to earn single-digit ROEs.

Market Conditions: Reinsurance marketplace conditions remain challenging, although the pace of rate deterioration appears to be decelerating. At the recent 1/1 renewal, the magnitude of price declines was generally lower across the reinsurance portfolio (to low single-digit range) compared to the prior year renewal. International rates were down slightly more than the U.S. rates. Property cat and London-based specialty lines continue to see pricing pressure and larger accounts were incrementally more competitive.

Buying Behavior: Some ceding insurers continue to consolidate reinsurance panels, combining programs and consolidating core reinsurers across similar lines and geographies.

Growth: Despite the challenging marketplace conditions, several groups continue to add business via geographical expansion in areas such as MENA and Asia-Pacific. Solvency II is creating some uptick in reinsurance demand in the London and European markets, particularly for pro rata structures. Mortgage insurance and reinsurance continues to be an area of significant growth fueled by the continued transfer of risk to the private market by Government Sponsored Entities (GSEs).

PMLs: Most groups continue to manage down their PMLs across all zones. The groups are capitalizing on lower pricing fueled by third party capital via traditional reinsurers or ILS transactions. For example, XL estimated a 20-30% decline in its North America windstorm tail exposure, as its Galileo Cat bond funds climbed to $1.9B.

Share Buybacks: The return of capital to shareholders (via share buybacks and/or dividends) varied by group. Several groups sought to return the majority of operating earnings, while some groups retained capital due to pending or recent M&A activity.

Tax Reform: Groups said it is too early to predict what will happen with U.S. corporate tax reform and/or a potential border adjustment tax. However, they are following these developments closely and believe they have the platform flexibility to accommodate any significant change(s). Most view reinsurance transfers across borders as “exporting risk” rather than “importing capital”.

M&A: Gaining scale and operational efficiencies continues to drive M&A activity. Some groups have benefited from the fallout of M&A activity, particularly in hiring key individual and underwriting teams.



Arch Capital Group Ltd. Earnings

Arch reported 4Q2016 operating income of $1.13 per share (4Q2015: $1.15), which exceeded the street estimate of $0.97. The 4Q2016 annualized operating income ROE was 8.7% (4Q2015: 9.9%). For the full year, operating income ROE and net income ROE were 9.4% (-0.3pp YOY) and 10.9% (+2.0pp YOY), respectively.

4Q2016 net catastrophe losses totaled $34M, stemming mainly from Hurricane Matthew, New Zealand Earthquake and Tennessee wildfires.

Other underwriting income improved to $57M in 2016 (2015: $35M), due to Watford Re’s improved underwriting and investment performance.

Insurance and Reinsurance market conditions and rates

Overall, the level of P&C rate decrease has slowed somewhat, but it is still broadly negative (especially for larger accounts). Thus, both insurance and reinsurance segments continue to move towards less competitive, smaller accounts and more specialized areas of the market. Arch continues to move away from lines such as excess liability, E&S property and property cat, while focusing on less volatile and specialized lines such as travel, differentiated programs and agricultural reinsurance.

Insurance:

– The primary U.S. P&C margins eroded 40 basis points for all lines in 4Q and ~100 bps for FY2016. For the controlling and low volatility segments (~70% of the insurance portfolio), rates increased 210 basis points, while the cycle managed business (30%) experienced a 410 basis point decrease.

– UK operations saw 4Q rates drop 7.6% (across all product lines).

– On a group-wide basis, modest 4Q premium growth came in construction, national accounts, travel and alternative markets lines. In contrast, executive assurance and E&S were areas where current rate levels lead Arch to a more defensive strategy.

Reinsurance:

– Overall, Arch estimated single-digit rate decreases across its reinsurance portfolio.

– Arch is focused on opportunities with “relative rate strength and more favorable returns”, such as facultative, agriculture and motor.

– Arch continues to shrink its business in the more commoditized segments which continue to experience rate decreases, such as property cat, excess liability and marine.

Mortgage Insurance and Reinsurance:

– Arch said the combination of Arch MI and United Guaranty Corporation (UGC; acquisition closed at YE2016) creates the world's largest mortgage insurer and the integration is going very well as the two companies had similar cultures (i.e. pricing philosophy based on risk assessment and dedication to analytics and technology development). With the acquisition of UGC, Arch has multiplied its U.S. primary risk-in-force by 5x, with over 87% of the exposure written after 2008 (“a period in which the underwriting quality of the insurance written has been at its peak”).

– On a combined basis, Arch estimates its primary U.S. mortgage market share at 25-26% (although this is expected to fall to the low 20’s over time). Additionally, Arch continues to lead in the U.S. GSE risk sharing transactions with ~$2.2B of risk-in-force.

– Arch increased the level of its Australian mortgage quota share retrocession (3-yr) to 37.5% from 25%, for all business going back to inception (May 2015).



– Arch believes there are two constants in mortgage which will not change: (1.) pressure by Congress to put mortgage risk to the private markets and (2.) recognition by elected officials that securitization without the ultimate guarantee of the federal government is not possible.

Capital Management (Share Buybacks)

There will be no share buybacks in 2017, as they want to rebuild their balance sheet strength in case of any new opportunities and to remain in good standing with the rating agencies.

Debt-to-total capital jumped to 21% at YE2016 (3Q2016: 11%), due mainly to debt issued to help finance the acquisition of UGC.

Risk Management/PMLs

Overall, Arch does not want to expose more than 25% of equity capital on any line of business (including mortgage).

As of January 1, 2017, Arch’s largest 1-250 year PML for a single event remains the Northeast decreasing modestly to $492M (or 6.6% of shareholders' equity).

Mortgage: Arch is in the third iteration of a model that calculates the aggregation of risk, including both underwriting and macroeconomic risk, changing unemployment, housing prices, etc. However, they said disclosure of the model/results will be limited as they don’t want competitors to understand what they’re doing.

U.S. Tax Reform and Border Adjustment

Corporate Tax: Arch said that a reduction in the corporate tax rate would be positive, particularly in light of the UGC acquisition which is going to increase their U.S. earned income.

Border Adjustment Tax: It’s too early to say what will happen, but Arch believes that reinsurance transactions across borders are more “exporting risk” rather than “importing capital”. Arch said it has alternatives to react to any tax changes.

Other

The composition of the UGC investment portfolio is “markedly different” than Arch’s portfolio. UGC’s portfolio is longer duration in nature and comprised much more heavily of municipals and corporate credits and lower rated corporate credits. Arch expects investment portfolio to change this over time.



Argo Group International Holdings, Ltd. Earnings

Argo reported 4Q2016 operating income of $0.65 per share (4Q2015: $0.78), which exceeded the street estimate of $0.62. FY2016 operating income ROE increased 0.5pp YOY to 7.0%, while net income ROE decreased 1.3pp to 8.5%. Net income ROE has averaged 9.8% over the last four years.

2016 cat losses were ~2.5x higher YOY at $62M (4.4pp on the loss ratio).

E&S business (27% of 2016 GPW) peaked in 2006, and then declined until a modest rebound post-2011 (but not to 2006 levels, due to thin margins in commercial auto and other lines). E&S business is originated by wholesalers. Nearly all E&S business is written on a non-admitted basis which provides “a lot of rate and form flexibility”.

Commercial specialty business has grown significantly in recent years, to 32% of GPW in 2016.

At Lloyd’s (29% of 2016 GPW), Argo has large marine and energy portfolios with a broad spread of risk. This business has grown slowly in recent periods, due to competitive market conditions.

In 2016, Argo pulled back in international specialty (12% of GPW) due to more competitive reinsurance conditions.


Over the last seven years, Argo returned ~$0.5B to shareholders (vs. $1.4B total equity at the start of that period), and outstanding shares are down by about a third.

Growth/M&A

Argo has taken advantage of the fallout of M&A activity, by hiring underwriting staff.

Other

The Ariel Re acquisition will slightly change the insurance / reinsurance premium mix, from 90/10% to 88/12%, respectively. Argo said it would be one of the 10 largest syndicates at Lloyd’s. The acquisition was intended achieve: (1) critical mass in the Bermuda reinsurance marketplace (Argo and Ariel each had “fairly small portfolios” of property cat reinsurance, at less than $200M each), and (2) economies of scale at Lloyd’s (because “Lloyd’s is a very expensive market to operate in today...and regulatory compliance hurdles are quite high”).



Aspen Insurance Holdings Ltd. Earnings

Aspen reported a 4Q2016 operating loss of $0.34 per share (4Q2015: $1.21), which missed the street estimate of $0.38. Operating income ROE and net income ROE decreased to -0.7% (2.6%) and -2.9% (3.8%), respectively. These results followed the company’s January 30 pre-announcement that underwriting results would be negatively impacted by costs from the exit of certain insurance lines (including $160M of reinsurance purchases), as well as higher cat losses YOY in reinsurance. FY2016 operating income ROE and net income ROE decreased to 4.8% (10.0%) and 5.8% (10.0%), respectively.

As previously announced, Aspen completed a comprehensive 4Q review of its insurance operations, with the goal of portfolio optimization, expanded margins and profitable growth in 2017. Most insurance lines were meeting or exceeding requirements, including UK, P&C, professional lines, credit and political risk, surety, and crisis management. However, some lines did not meet underwriting requirements, particularly primary casualty (including program business). Approximately $150M, or 5% of the portfolio was not renewed.

Aspen purchased additional reinsurance to protect itself from the runoff of this discontinued business (see Risk Management section below). The expense of additional reinsurance purchases negatively impacted Q4 results, as did the increase in loss activity and some of the repositioned lines.

In 2016, 80 people were hired in the insurance business and ~30 were released, which was done in an effort to “upgrade the talent.”

Reinsurance net cat losses in 2016 totaled $113M, leading to a combined ratio of 90%.

Reinsurance market conditions and rates

Casualty reinsurance market conditions remain difficult, however, Aspen achieved “very satisfactory underwriting margins” due to “a smaller portfolio, strict pricing requirements and careful responses to tough term conditions.” A small rate increase was achieved at 1/1, which was the first increase in many renewals.

Within property reinsurance, Aspen observed the deepest rate reductions over the last few years, and they responded by carefully managing net exposures toward better priced business.

1/1 Renewals: Overall rates declined just under 2%, which represented a lower rate of decline compared to the prior year. Terms and conditions and commissions paid did not change significantly. Property cat rates fell 3% in the U.S. and 5% outside the U.S. Aspen achieved “good outcomes with existing reinsurance clients and favorable pricing”, attributable to its “breadth of products offered and geographic spread of distribution.” One example cited was the U.S. Regional Clients initiative (launched three years ago), where it has doubled the client base and grown GPW from $20M to $50M.


Aspen repurchased $25M of shares in 4Q2016 and $75M for all of 2016. The board approved a new $250M share repurchase program.

The approach to share repurchases has not changed. Aspen returns excess capital to shareholders when it is financially more attractive than deploying it elsewhere.



Growth/M&A

Aspen Re’s regional strategy has driven top-line growth, including organic growth through the hub in Dubai (serving the MENA region) and further penetration in Asia-Pacific via business in Sydney, Australia and Shanghai (through Lloyd’s).


Aspen purchased additional reinsurance to protect itself from the runoff of some of the aforementioned discontinued business (which provides for up to ~40% duration in expected losses for this book).

Aspen purchased “considerably more” pro rata reinsurance in 2016 in an effort to reduce earnings volatility going into 2017 (e.g. 50% QS in mid-Nov. covering casualty, financial, and professional insurance; separate QS in July covering various marine and energy classes).

The overall net retention rate for 2017 is expected to drop to 70% from 75%.



AXIS Capital Holdings Ltd. Earnings

AXIS reported 4Q2016 operating income of $1.14 per share (4Q2015: $1.23), which exceeded the street estimate of $0.87. However, operating income ROE and net income ROE declined to 7.6% (9.2%) and 9.9% (10.3%), respectively. FY2016 net income ROE decreased 2.5pp to 9.0%.

The 2016 combined ratio increased 1.2pp YOY, despite a 3pp increase in the cat loss ratio. AXIS noted that industry cat losses were above the 10-yr average, but theirs was 3pp lower than its own 10-yr average. AXIS credited its portfolio optimization and more strategic used of reinsurance and 3rd party capital (for property cat, liability and professional lines).

2016 cat losses doubled to $204M ($100M), including Hurricane Matthew of $52M (split: insurance $39M / reinsurance $13M) which was at the low end of AXIS’ estimated range.

New money yields “spiked” to 2.8% in 4Q, which will benefit investment income in 2017.

Insurance market conditions and rates

Overall, insurance rates declined 2% in 4Q, vs. a decline of 3% in both 3Q2016 and 4Q2015.

U.S. P&C rates increased 3% in 4Q. Casualty lines continued to see positive rate movement, while property lines witnessed a slowing of rate declines.

International rates declined 5% in 4Q, although market pressures decelerated. London is seeing some very tentative signs of improving market rates. Energy, property, and aviation represented the most competitive conditions.

Professional lines rates declined 2% in 4Q (same as 3Q). E&O rates were flat, with some softening in excess cyber coverages. D&O rates declined 4%, with excess and side-A experiencing more significant declines.


AXIS observed continued price pressure in most lines and markets in 4Q, with the most pressure coming in cat exposed property and London-based global specialty lines. Competition remains intense on larger accounts.

Overall, reinsurance clients are increasingly consolidating panels and differentiating between core reinsurers and secondary carriers. There was increased interest in combined programs and consolidating across similar lines of business and geographies.

Although pricing continues to soften YOY, AXIS was encouraged by increased discipline from some competitors in certain lines and regions, and the magnitude of price declines was generally lower across the reinsurance portfolio.

At the January 1 renewal (represents ~55% of global reinsurance book ex-agriculture), AXIS grew GPW by 10% on expiring business, however, this is expected to be offset by higher cessions to strategic capital partners in 2017.

AXIS noted that governments and non-governmental agencies are increasingly concluding that the private re/insurance market is a good partner for risk transfer.

AXIS saw growth opportunities in motor, where clients are addressing pressures from Solvency II.

AXIS will also look to expand its reinsurance product and geographic scope in mortgage, flood, and regional multi-line.




AXIS returned $644M to shareholders in 2016 (~160% of operating income) via common share dividends and repurchases. Over the last five years, AXIS has returned more than 100% of aggregate operating income and the break-up fee ($315M) earned from PartnerRe.

AXIS starts each year assuming they will return 100% of operating income to shareholders.

Growth/M&A

In 2016, AXIS extended its geographic reach by expanding its presence in Dubai and setting up a Miami office to address the Latin American market.

AXIS recently decided to redirect its U.S.-based resources and key personnel to the U.S. wholesale E&S market for property, primary casualty, and excess casualty lines.

AXIS increased scale and market relevance in key sectors via organic growth and new teams. It also recently announced the acquisition of European specialty aviation re/insurer Aviabel.


AXIS has been ceding more of its reinsurance business to strategic capital partners, particularly in liability and professional lines due to the launch of Harrington Re in 3Q2016, as well as increased retrocessions of catastrophe and property business throughout 2016.

AXIS now has >$1B of additional capacity available via strategic capital partners (including $600M Harrington Re). The 2016 fee income related to this business was $22M.


There has been much discussion on these items, but it’s too early to predict what will happen. AXIS believes it has the flexibility built into its organizational structure which will allow it to react and take necessary steps to optimize its portfolio.

AXIS said the House Republican blueprint on border adjustment tax does not provide much specificity as to how it would apply. So with respect to re/insurance companies, it's unclear whether a U.S. cedent would be considered to be “importing a service” or “exporting a risk” to a foreign reinsurer. If the former, AXIS supports efforts to carve out financial service payments, including re/insurance payments from the adjustment provisions.



Chubb Limited Earnings

Chubb reported 4Q2016 operating income of $2.72 per share (4Q2015: $2.38), which exceeded the street estimate of $2.42. 4Q2016 annualized operating income ROE was 13.3% (4Q2015: 9.4%). FY2016 operating income ROE and net income ROE declined to 10.5% (-1.0pp) and 9.0% (-0.7pp).

4Q2016 net cat losses totaled $268M, mainly from Hurricane Matthew ($190M) and New Zealand Earthquake ($60M). Chubb purchased an additional $206M in reinsurance protection in Q4, bringing the total for the year to $650M. Net realized and unrealized losses in 4Q2016 totaled $1B, led by a $1.3B loss from Chubb’s investment portfolio, due largely to rising interest rates and foreign exchange loss of $300M.

Insurance and Reinsurance market conditions and rates

The same themes from prior periods prevailed, that is, “strong retentions of business, less new business due to market conditions, modestly more new business due to cross-selling and the strength of the organization and a revenue penalty due in large part to merger-related underwriting actions, including the purchase of additional reinsurance.”

The commercial P&C insurance market globally is soft and conditions vary, depending on the territory, line of business and size of risk. Rates are generally flat or declining, depending on class of business, size of customer and territory. Terms and conditions have been softening a bit in a number of classes.

For large account business, particularly shared and layered, it is more competitive than mid-sized. However, the middle market is also becoming more competitive, particularly in the U.S. and Europe. Wholesale is more competitive than retail.

Renewal pricing overall ranged from flat (in Chubb’s U.S. middle-market business) to down 2% (in both U.S. major accounts and international retail commercial P&C businesses).

The North America commercial P&C business renewal retention rate was ~89%, with the middle market at 88% and major accounts at 92%. Overall, new business writings for North America commercial lines were down about 8%.

North America personal lines business retention remained quite strong for the Chubb and ACE portfolios, at ~95%.

In North America, retail general and specialty casualty related pricing ranged from flat to down 1.5%, financial lines ranged from flat to down 2% and property-related ranged from down 1.5% to down 5%. Internationally, general and specialty casualty related pricing ranged from up 3% to down 3%, financial lines ranged from flat to down 3% and property-related ranged from down 1% to down 5%.


The Board recently authorized a $1B share repurchase program through YE2017. Chubb’s dividend policy is to pay out roughly 30% of the after-tax earnings.


Evan Greenberg stated, “In the quarter, I was encouraged by what I hoped is the beginning of a shift towards a greater fiscal related stimulus policy in the U.S., including tax reform, reduced business regulation and increased infrastructure investment in place of an over-reliance on monetary policy, which in my judgment has more than run its course.”

Chubb believes that tax reform is important, as the U.S. economy would improve with faster growth, which would benefit the insurance industry.



Other

Chubb believes that they are on track or ahead of the objectives underpinning the ACE merger. “We are ahead of where we expected to be in both per-share and tangible book value growth, with the latter now down 16%, versus an initial 29% at the time of the merger closing and on track to hit pre-transaction levels in 3.25 years.”

– Total integration related savings in the 4Q2016 and full year were $123M and $325M, respectively. Annual run-rate savings of $800M by the end of 2018 are on track. Total revenue synergies produced in the 4Q2016 and for the year, were $83M and $297M, respectively.

In 2020, Chubb will transition from a traditional defined benefit pension program to a defined contribution program, and, after 2025, it will eliminate a subsidized U.S. retiree health care plan that had been in place for certain employees. These changes improved book value by $322M.



Everest Re Group, Ltd. Earnings

Everest reported 4Q2016 operating income of $8.83 per share (4Q2015: $8.17), which exceeded the street estimate of $3.56. 4Q2016 annualized operating income ROE was relatively level at 18.5% (4Q2015: 19.0%). For the full year, operating income ROE and net income ROE both declined to 12.8% (-2.2pp and -0.4pp YOY, respectively).

GPW reached a new high in 2016 at more than $6B (split: reinsurance $4.2B, insurance $1.8B). Net cat losses for the year climbed to $301M from $54M (including $158M from Hurricane Matthew). The insurance segment reported adverse development, mainly in construction defect claims (from runoff books of business) and asbestos.


Everest said that the market (both insurance and reinsurance) is challenged from a rate perspective, however, they believe rates are beginning to bottom out based on industry returns relative to cost of capital.

Global insurance GPW reached a record $1.6B (+21% YOY), influenced by nearly a dozen new underwriting divisions.

In worker's compensation (largest line by premium), Everest experienced moderate rate pressure in the mid-single-digit range. Favorable underwriting results in the largest workers comp market, California, “were greeted with steady rate pressure throughout the year.”

Commercial auto (5% of overall P&C premium): Although this line continues to be challenged, average rates increased in the low-double digits in Q4. Over 85% of this book received rate increases as Everest attempts to address the (negative) frequency and severity trends experienced in recent periods.

General liability and umbrella markets rates increased slightly, while professional liability rates decreased in the mid-single-digit range.

The U.S. property market remains very competitive, but Everest senses that the market is trying to find the bottom on rates as “the industry has reached a point that there are no additional rate reductions to be had.”


Rates continue to be under pressure globally, except where material catastrophes occurred, such as Canada.

In U.S. Reinsurance, Everest walked away from a significant volume of underpriced pro rata property business. However, this was partially offset by the new strategic crop reinsurance deal and continued growth in alternative risk products (including mortgage reinsurance).

Everest said clients are demanding solutions that address their operational threat, increasingly complex capital requirements and unusual risks.

Property rates were down mid-single digits across most markets unaffected by material losses. Competition remains heavy. Everest substantially re-underwrote its property portfolio, reallocating capacity from underpriced business to more attractive layers of programs.

– Everest is “exploring huge structures that will strengthen core client relationships well into the future.” This may include: (1) strategic relationships with some core clients (“not just be a large reinsurer to them”), (2) expanding capacity with global clients (who have “too much concentration with some of the big directs or they want to narrow their reinsurance panels”) and (3) strategizing about how to grow more with the reinsurance brokers.



Causalty markets were mixed, with reinsurance terms easing somewhat but the economics of certain underlying segments still tracking in the wrong direction. Everest achieved improvements on classes with material losses and they are increasingly focusing on structured and credit-related deals (e.g. Mortgage).

In London, excess of loss (XOL) rates declined between 2.5% to 5%, while other international markets declined 5% to 10%.


Everest did not purchase any shares in 4Q2016 in light of Hurricane Matthew, however, nothing has changed in the capital management strategy (i.e. typically buyback less than earnings).

Growth/M&A:

Everest said scale has been one of the more relevant drivers of M&A, and it will continue to put pressure on many of their competitors (i.e. to seek partners). They expect scale and efficiency will continue to be the trend going forward.

Everest won’t rule out M&A if it makes sense, but they are “not a fan of putting a ton of goodwill on the books” and “acquisitions are difficult to assimilate and may come with a portfolio which [we] do not wish to be engaged in.”


It is too early to know what the outcome will be, however, the company said a cross-border tax adjustment would not have had much of an impact its overall effective tax rate. Rather, “The bigger question comes in a year where cat losses are not expected or maybe even higher-than-expected. That's the great unknown.” Everest has different platforms globally where it can underwrite business.

Other

Regarding the divestiture of the crop insurance business Heartland in 2H2016, Everest cited two main benefits. First, they realize a meaningful improvement in expenses, as they were unable to achieve economies of scale given the size of the premium. Second, they struggled to develop a broad, diversified insurance portfolio, so individual localized weather events were causing more volatility in the book as an insurance play. As a result, Everest is now going to get the benefit of a larger book on a reinsurance quota share basis with reduced volatility.

Solvency II is causing demand uptick in London and European markets, specifically for pro rata structures.



Fairfax Financial Holdings Limited Earnings

Fairfax reported a 4Q2016 net loss of $30.77 per share (4Q2015: $4.10 gain) which missed the street estimate of a $22.04 per share loss. This was driven by a sizable net investment loss of $1.1B, including $2.7B of realized loss from the exit of its defensive equity hedges and closing of all short positions in the Russell 2000, S&P 500 and S&P/TSX 60. The latter reflected Fairfax’s changing view of potential economic changes following the U.S. presidential election (i.e. higher growth, stronger business development).

Fairfax also exited most of its U.S. Treasury and U.S. muni investments (realized gains = $2.3B), and the bond portfolio duration declined to only ~1 year at YE2016. Fairfax said the risk in the bond portfolio from rising interest rates has been eliminated, and the volatility in earnings from holdings of long bonds and equity hedges is over.

At YE2016, Fairfax maintained its CPI-linked derivatives ($110B notional amount; original cost $670M; market value $83M; weighted avg. life = 5.6 years) as insurance for unexpected events, such as “a collapse in world trade, a problem in China, or the disintegration of the EU.”

All operating segments reported 2016 combined ratios below 100%, including: Northbridge 94.9%, Crum & Forster 98.2%, Zenith 79.7%, Brit 97.9%, Fairfax Asia 86.4%, and OdysseyRe 88.7%. Total cat losses were 5.4pp in 4Q2016 and 0.6pp in FY2016. OdysseyRe’s underwriting profit fell to $235M from $337M, principally reflecting higher current period cat losses, the impact of lower net premiums earned, lower writings of higher margin property cat business, and continued rate pressure. Brit recorded $76M of cat losses.

At YE2016, debt-to-total capital increased to 28.7% (2015: 21.8%), primarily due to debt issued to fund acquisitions. Fairfax said it was focused on lowering this ratio during 2017.

Since its formation 31 years ago, Fairfax has accumulated $10B in un/realized investment gains.


Fairfax said that given the very low interest rates and reduced loss reserve redundancy “there was no place to hide for the industry”, and “combined ratios have to remain well below 100% for the industry to make a single-digit ROE.”

Pricing is under pressure in all of Fairfax’s companies worldwide, with rates down between zero and 5%. Pricing at Brit was down ~2.9% in insurance and ~4.5 to 5.0% in reinsurance.

Fairfax has instructed all of its companies not to focus on top line growth, but rather on favorable combined ratios and good reserving.

Growth/M&A

Fairfax has acquired numerous companies over 31 years. Generally, it uses a decentralized, “fair and friendly culture approach, allowing existing management teams to run the company as they see fit.” Allied World will be no different, and there not expected to be any integration issues as the deal rationale was for revenue synergies (not cost synergies).

In January 2017, Fairfax agreed with OMERS for the latter to invest $1B to help fund the pending Allied World acquisition. Fairfax is in final rounds of further negotiations with a number of other parties to raise an additional $500M, and potentially up to $1.5B. Fairfax noted Allied World’s ROE of 12% over the last 15 years, and if Fairfax’s 7% investment return were to be put on Allied World’s combined ratios, the ROE would be ~20%.

Fairfax continues to be excited about the potential in India.




Fairfax stated, “The new administration's proposed policies of reducing corporate taxes to 15-20%, rolling back regulation in business like Obamacare, Dodd-Frank and a myriad of other regulations, and significant infrastructure spending, has the potential of boosting economic growth significantly in the U.S.” While Fairfax indicated that stock market valuations appear to be relatively high, the aforementioned factors can still have a significant impact on certain companies (essentially, it’s a “stock pickers market”, so certain companies can do well even if overall markets are flat).

Fairfax said that when the $20T US economy does well, much of the world does well too. Thus, “concerns about China or Europe precipitating a worldwide recession/depression have been significantly reduced but not eliminated.”

Fairfax has played defense in its investment portfolio over the past few years, which has weighed on book value growth (i.e. roughly flat over the last 5-6 years). However, Fairfax is now expecting to play more offense in light of the U.S. administration change, yet always with its long-term value oriented investment philosophy.

On a cautionary note, Fairfax said that any change(s) in U.S. trade policies “could precipitate a collapse in world trade”.



Greenlight Capital Re Ltd Earnings

Greenlight reported 4Q2016 operating earnings per share of $1.31 (4Q2015: $1.17 per share loss), which missed the street estimate of $1.52.

Underwriting results for the year improved from the prior year, despite the difficult market environment. The entire underwriting loss related to the financial commutation of the legacy construction defect business. Greenlight is hopeful that results will improve and the ongoing book is not showing signs of deterioration.

Greenlight reported relatively small losses from property catastrophe events, namely the Canadian wildfires and Hurricane Matthew (combined ~$4.5M in losses).

The investment return was 5% in Q4 and 7.2% in 2016.


Despite facing headwinds in 2016, from both difficult market conditions (pricing and terms) as well as a rating downgrade in Q4, Greenlight reported FY2016 premium growth due to a combination of growth in the renewal portfolio as well as new business.

The company did not lose any of their existing clients despite the rating downgrade, and they were very pleased with the results of the January 1 renewals.

Greenlight is seeing favorable signs that the pace of rate reductions and loosening of terms in general is slowing. While the market remains “extremely competitive”, they believe the market is beginning to be more disciplined.

Greenlight continued to expand its client and broker network, and entered new lines of business such as mortgage insurance, which they believe provide attractive risk-adjusted returns.


With respect to its property catastrophe aggregate, the maximum exposure to a single event is $196M and maximum exposure to all events is $230M.

Other

This was the last conference call led by CEO Bart Hedges, who is leaving the company after 11 years. Greenlight is in the process of recruiting its next leader and hopes to conclude the process in the next few quarters.

The company maintained its position in gold, although it was the largest detractor in Q4 investments as it lost two-thirds of the gains from the first three quarters of 2016. While rising interest rates were most responsible for the recent decline in gold, Greenlight’s long-term outlook on gold remains bullish. The company said the new U.S. administration “comes with a high degree of uncertainty and its policy initiatives appear to be focused on stimulating growth, and, with it inflation.”

In response to the U.S. election, Greenlight made several changes to the macro portfolio. Specifically, they eliminated various long positions in sovereign fixed income, added some additional short positions in sovereign fixed income and added to long equity exposure.

Greenlight began exiting Florida Homeowners business roughly two years ago by reducing lines on homeowner quota shares. By June 1, 2016, they were effectively out of the Florida business. However, they developed a new relationship with United Insurance in 4Q2016, thus, they have added some Florida Homeowners exposure again. Greenlight noted that United Insurance is more than just a Florida company, operating in a number of other states.



Lancashire Holdings Limited Earnings

Lancashire reported 4Q2016 operating earnings per share of $0.25 (4Q2015: 0$.27) which exceeded the street estimate of $0.17. The 4Q2016 operating ROE was stable at 3.4% (4Q2015: 3.3%), while net income ROE decreased slightly to 2.8% (4Q2015: 3.5%).

Lancashire expected to have losses on Hurricane Matthew. While there hasn't been a great deal reported so far, they have booked some reserves at both Lancashire and Cathedral. There were a few other small property losses in 4Q, but nothing “individually significant”.

In-line with expectations, given the Federal Reserve’s decision to raise rates (and subsequent rise in interest rates, Lancashire recorded a small loss on the investment portfolio in 4Q. They are positioning for higher interest rates.

Given Lancashire’s current business mix and reinsurance spend, they expect the acquisition cost ratio to be ~26-27% going forward.


Lancashire’s January 1 renewal was in line with their expectations, and they renewed their core portfolio of clients. They saw new opportunities, both via the new underwriters hired as well as existing underwriting teams. Lancashire said, “The quantum of rate reductions for reinsurance business has definitely slowed, but specialty lines can be patchy, which is disappointing.”

Lancashire renewed most of its larger reinsurance placements at January 1. They continued their strategy of reducing risk through the purchase of well-priced retrocessional reinsurance across all lines of business. In some cases they broadened coverage at a reduced premium, thereby spending a similar amount on reinsurance in 2017 as they did in 2016.

Lancashire sees little change to the overall market outlook and underwriting environment for 2017, so no changes in strategy are expected. They continue to see declines in pricing with underwriting margins that are thin in most, if not all classes of business. They continue to believe that the pricing environment will not improve until capital is impaired and capacity decreases.

Lancashire noted that their Lancashire, Cathedral and Kinesis business models continue to produce excellent results for shareholders despite the challenging market.


Total capital returned for the 2016 financial year was $179M, or ~113% of comprehensive income. The dividend yield was 10.5%

Other

Cathedral

– Within property reinsurance, the entire team was replaced during the past 12 months.

– The premium for this portfolio in 2016 declined by less than 5%, against a portfolio Renewal Price Index of 94% (demonstrating that the book was simply renewed).

Energy, marine and aviation business experienced larger YOY reductions, due to market conditions and disciplined underwriting. These teams were unaffected by personnel changes.



RenaissanceRe Holdings Ltd. Earnings

RenRe reported 4Q2016 operating income of $2.92 per share (4Q2015: $3.07), which exceeded the street estimate of $1.22. 4Q2016 operating income ROE and net income ROE decreased to 10.8% (12.5%) and 6.3% (8.5%), respectively. FY2016 operating income ROE decreased to 7.8% (11.4%), but net income ROE increased to 11.0% (9.8%), which reflected higher investment returns of 3.5% (0.9%).

The FY2016 net negative impact from notable loss events was $103M, including the Fort McMurray wildfire ($19M), Texas events ($33M) and Hurricane Matthew ($51M).

Managed cat premiums fell 5% in 2016, as “market pricing continues to be pressured by capital supply, increasing at a faster rate than demand for reinsurance.”

Casualty and Specialty (now ~50% of the total book) GPW jumped 35% YOY in 2016, reflecting continued growth in mortgage reinsurance (+50%) and the inclusion of Platinum (since March 2015). RenRe noted increased signings on existing programs where clients consolidated their reinsurer panels, as well as new lines and development of a marine and energy book at Lloyd’s.


January 1, 2017 Renewals: Property cat rates declined, but the reduction was smaller than in prior renewals and again driven by “oversupply and relatively flat demand”. U.S. rates fell ~5%. International rates were down slightly more than the U.S. rate and retro prices were down slightly. Nonetheless, the property segment grew at 1/1, driven by new opportunities and growth on existing lines. After all retro purchases and use of various joint ventures, RenRe retained roughly half of its property GPW.

Casualty & Specialty reinsurance terms were relatively flat, but there was “some rate competition in underlying books being ceded that required careful underwriting and monitoring.” Ceding commissions were flat. Much of the mortgage growth was from legacy business, “so future opportunities will be more constrained.”

RenRe is a “significant participant” on the NFIP flood reinsurance program, which “could see considerable expansion” in 2017. Other areas of targeted growth include regional multi-line business and marine and energy reinsurance at Lloyd's (as RenRe has built up capabilities in this area). RenRe also anticipates growth in commercial multi-line business (written out of the Chicago office) and U.S. casualty business (New York office).

RenRe said clients are consolidating panels and “looking for reinsurers who can add value beyond capital, trading with markets on a more composite basis.”


Share repurchases totaled $309M, or ~91% of operating income available to RenRe shareholders (vs. 2015: $260M and 54%, respectively).

RenRe maintained capital level for DaVinci, however, they continued to raise capital in other areas including: Upsilon, Medici, and the newest venture (sidecar) Fibonacci Re ($140M; variable interest entity but not consolidated into RenRe).

The total committed capital in Upsilon and Fibonacci Re is ~$200-250M. The Upsilon appetite is primarily worldwide retro. Fibonacci Re is more top-end cover (U.S. risks only), mostly as a complement to large participations within RenRe Ltd.




RenRe is keeping a close eye on the U.S. legislation (e.g. Ryan and Neal bills). While there is a lot of discussion and uncertainty, they are comfortable that their platform affords a lot of flexibility to react accordingly. RenRe highlighted the December upgrade (i.e. S&P to “AA-“) of its New York/U.S. platform (i.e. former Platinum U.S.).

RenRe said the new U.S. administration has “signaled several changes to economic policy that could have wide-ranging impacts on the insurance and financial services industry broadly. Additionally, we have already seen interest-rate volatility that has affected the results of insurance companies across a range of businesses including life and property-casualty.”

Other

This was the first earnings call with new CFO Robert Qutub (Jeff Kelly retired in September).

RenRe changed its reporting segments to: Property, Casualty & Specialty and Other.



Validus Holdings Ltd. Earnings

Validus reported 4Q2016 operating income of $0.80 per share (4Q2015: $.1.24), which exceeded the street estimate of $0.74. 4Q2016 operating income ROE was 6.9% (4Q2015: 11.6%). For the full year, operating income ROE was 8.6% (-2.7pp YOY) and net income ROE was 9.7% (-0.6pp).

Validus produced a full-year profit in each of their 11 years in business. The company incurred two notable loss events in Q42016, including Hurricane Matthew ($27M) and the New Zealand EQ ($22M).


Talbot

– Talbot recorded a rare underwriting loss in Q4, driven by difficult trading conditions on a macro level.

– Across the entire Talbot portfolio, rates were down 5.8% for the year. Energy accounts showed the largest rate decreases of 13% to 14%, followed by political violence at 10%.

Western World

– Western World’s combined ratio was 101% in Q4 and 102% for FY2016, which were a couple points above previously stated guidance.

– Overall rates increased 0.5%. Validus continues to roll out new products through Western World, which accounted for about half their growth in the year. Validus likes the smaller end of the E&S market, as competition has reduced and they see good opportunities to grow existing products.


The U.S. property market renewal was very orderly and rates were down approximately 2.5% on the cat portfolio. The spread between quoted terms and firm orders was tighter than recent periods, and demand was flat. Broker sources indicated that total capacity authorized by the industry was down year-over-year. These factors contributed to a more disciplined pricing environment.

The international property market was more challenging as rates were down 4%. Validus’ international cat premium is down 30% from a peak in 2012. In the Australian market, since 2010, there's been over $15B of ceded cat losses in the industry. Validus estimated that compounded rate reductions were almost 30% during this period.

Rates in mortgage and political risk were down by low single digits, while terms and conditions were broadly unchanged.

Marine and energy renewals showed discipline, but revenues continue to suffer from the impact of lower oil prices. Also, premiums continue to shrink due to rate reductions and the absence of new construction projects.

In the cargo market, the SpaceX explosion was the most significant loss in 2016. Loss affected layers experienced rate increases of 5% to 15% and loss free contracts were flat to down 5%.

Rates in U.S. casualty were down. Validus added that loss trends remained favorable and overall the market remains disciplined.


The company returned $328M of capital via share repurchase and dividends in 2016, which closely aligns with its goal to match FY net operating income ($319M in 2016).



Growth/M&A:

The company is generally looking to grow organically and cited various examples: (1.) taking certain Talbot products out of the UK building out in the U.S., (2.) there are natural extensions in the E&S market that they don't currently participate in, (3.) they are not involved much in professional liability (except a D&O team in New York) and (4.) there are an “abundance of classes out there that we haven't scratched the surface of.” As Validus sees opportunities, they will look to add underwriters to grow organically.

Nonetheless, while they do not feel acquisitions are necessary, they said CRS was a good example/opportunity and that they would acquire another CRS tomorrow if available.


The 1-in-100 year U.S. wind PML declined 1.3% from 3Q2016 and 6.5% from January 1, 2016.

Validus renewed their retro program with expanded coverage and at slightly reduced risk adjusted rates. They also purchased worldwide aggregate protection in addition to protection on their marine and specialty portfolios.


It’s too early to say what’s going to happen, but they view risk as being exported (rather than “importing capital”).

Validus said, “The global industry is structured perfectly to reduce the cost of risk for American businesses and consumers. Any changes in U.S. tax policy in that regard is only going to increase the cost of risk by localizing volatility… that volatility is much more efficiently dealt with across the world, across the global balance sheet.”

Other

As of January 1, 2017, AlphaCat assets under management totaled $2.7B, including $2.5B from third parties (+20% since January 1, 2016). $1.3B of limit was deployed during 1/1 renewals (and $2.6B of limit was in-force).

Acquisition of Crop Risk Services (CRS):

– Validus looked at virtually every crop insurer that has been sold in last 6 years, but never “pulled the trigger”. They believe that CRS’s business model is unique, resulting in them being one of the only crop insurers to grow market share organically over the last few years. CRS has pioneered the use of drone technology in the claims settlement process and stands out for rapid and accurate payment of claims to farmers. Western World will acquire CRS and be the policy issuing company.

– Validus will continue to buy third party XOL reinsurance for the CRS book, however, Validus Re Switzerland will provide the coverage from 2018 onward (via 50% quota share).



XL Group Ltd. Earnings

XL reported 4Q2016 operating income of $0.47 per share (4Q2015: $0.65), which exceeded the street estimate of $0.35. 4Q2016 operating income ROE fell 2.0pp YOY to 4.6%. FY2016 operating income ROE and net income ROE declined to 4.1% (-2.4pp) and 3.9% (-7.2pp), respectively.

4Q2016 net cat losses totaled $246M (split: $126M Insurance / $120M Reinsurance). XL made some changes in how they record catastrophes post-Catlin acquisition. Specifically, in the Insurance segment, they record all weather-driven losses (regardless of event size) as cat losses (no change in Reinsurance segment, as they only record cat losses >$5M per event).


2016 insurance segment GPW increased 15% YOY, driven by the Catlin acquisition.

A new P&C operating model was adopted (effective January 1) and it has been fully executed according to plan, with no adverse impact on clients or brokers. While the impetus for the new model was greater accountability, clearer roles and improved decision-making, it also drives improvements in efficiency.

Pricing remained broadly consistent at minus 3% for 4Q2016 and FY2016.

Casualty pricing was flat in 2016, as meaningful increases in E&S, North America construction and environmental lines were mostly offset by moderate rate decreases in excess casualty.

Professional lines were down 2%, driven by the U.S. professional D&O book, which was partially offset by lower single-digit rate increases in cyber lines.

Specialty was down 3%, driven by continued competitive conditions in aviation and marine.

Energy, property and construction declined 6%, attributable to low double-digit reductions in the energy book in 1H2016.


4Q Reinsurance segment GPW jumped to $536M from $206M, driven by a large multi-line quota share with one core client. Otherwise, GPW would have fallen to $176M, driven by cancelled business as XL continues to maintain underwriting discipline.

The operating environment continues to be challenging in most classes. Rate decreases decelerated in most lines and regions and some classes appear to be reaching a bottom. XL noted that some deals came back to the marketplace to be re-priced.

For the full year, overall reinsurance rates declined ~3%.

– Global property cat fell 5% (2015: -8%), and non-cat property treaty fell 2.5%.

– Casualty rates were flat vs. 2015.

– The remainder of all classes was down low-single digits.

At the recent 1/1 renewals, rates were down 1.3% across the portfolio. Property cat declined 3.5% and international rates fell more than the U.S. The casualty treaty book was up 1%, while the remainder of the book was flat to down 2%.


Capital Management: XL expects to buyback at least $700M worth of shares in 2017. In 2016, XL bought back $1B (higher than its original $700M forecast).




XL makes use of quota share, catastrophe occurrence, catastrophe aggregate and catastrophe bonds to protect the entire group portfolio. For 2017, XL reduced its exposure to certain peak natural catastrophes, predominantly via increased issuance of the Galileo CAT funds (which now totals $1.875B). XL expects that based on today's exposure, the increased reinsurance protection will reduce its North American windstorm tail exposure by roughly 20% to 30%.


XL said that they don’t run their business based strictly on the tax implications, but rather on competing and winning business. “The idea that reforms are going to be a huge competitive disruption is nonsense.”

Reducing the corporate tax rate would be a plus, as the U.S. has been at a global tax disadvantage. Lower tax rates can help stimulate U.S. economic activity.

It’s too early to predict what border tax adjustment will be proposed and what will result. But there is no doubt that it will be “a very complex legislative process.” XL is comfortable with its position regardless of the outcome.

Other

XL has recently seen more clarity on the process and substance of Brexit, and they have observed signs of recognition that a mutual arrangement covering financial services might be in everyone’s interest. The timeline and outcomes remain in doubt, but in any case, there will be a long transition. XL said it will not wait to give clients certainty to continue serving them as they do today, saying they have “tremendous global flexibility”. They noted the transition a few years ago of its U.K. carrier to SE form, making relocation within the EU far simpler.



Contact Information Mike Shaffer Aon Benfield Market Analysis, Americas +1.952.886.8389 [email protected] Chris Cortese Aon Benfield Market Analysis, Americas +1.215.751.1595 [email protected] Steve Le Aon Benfield Market Analysis, Americas +1.215.751.1293 [email protected]

Mike McClane Aon Benfield Market Analysis, Americas +1.215.751.1267 [email protected] Mike Van Slooten Aon Benfield Market Analysis, International +44.020.7522.8106 [email protected]

Sources: Arch Capital Group Ltd., Argo Group International Holdings, Ltd., Aspen Insurance Holdings Ltd., AXIS Capital Holdings Ltd., Chubb Limited, Everest Re Group, Ltd., Fairfax Financial Holdings Limited, Greenlight Capital Re Ltd, Lancashire Holdings Limited, RenaissanceRe Holdings Ltd., Validus Holdings Ltd., XL Group Ltd., SNL Financial and Aon Benfield Market Analysis

About Aon Aon plc (NYSE:AON) is the leading global provider of risk management, insurance and reinsurance brokerage, and human resources solutions and outsourcing services. Through its more than 66,000 colleagues worldwide, Aon unites to empower results for clients in over 120 countries via innovative and effective risk and people solutions and through industry-leading global resources and technical expertise. Aon has been named repeatedly as the world’s best broker, best insurance intermediary, best reinsurance intermediary, best captives manager, and best employee benefits consulting firm by multiple industry sources. Visit aon.com for more information on Aon and aon.com/manchesterunited to learn about Aon’s global partnership with Manchester United.

Copyright 2017 Aon Inc. This document is intended for general information purposes only and should not be construed as advice or opinions on any specific facts or circumstances. The comments in this summary are based upon Aon Benfield's preliminary analysis of publicly available information. The content of this document is made available on an “as is” basis, without warranty of any kind. Aon Benfield disclaims any legal liability to any person or organization for loss or damage caused by or resulting from any reliance placed on that content. Aon Benfield reserves all rights to the content of this document.

mailto:[email protected]





http://www.aon.com/

http://www.aon.com/risk-services/default.jsp

http://www.aon.com/reinsurance/default.jsp

http://www.aon.com/human-capital-consulting/default.jsp

http://www.aon.com/human-capital-consulting/hrbpo/default.jsp

http://aon.mediaroom.com/

http://www.insurancejournal.com/news/international/2012/12/12/273624.htm

http://www.aon-esolutions.com/

http://www.aon.com/human-capital-consulting/default.jsp

http://aon.mediaroom.com/2013-02-21-Risk-Insurance-magazine-honors-47-Aon-brokers-and-consultants-with-Power-Broker-designation

http://www.aon.com/human-capital-consulting/consulting/health_benefits_consultants.jsp

http://aon.com/

http://www.aon.com/manchesterunited

http://www.manutd.com/Splash-Page.aspx

Fourth Quarter 2016 Reinsurer Earnings...

Documents

Transcript of Fourth Quarter 2016 Reinsurer Earnings...