our insight, your advantage. financial review april 7, 2015 appearances can be deceiving ·...

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BEST’S SPECIAL REPORTOur Insight, Your Advantage.

Appearances Can Be DeceivingDuring 2014 the reinsurance industry continued to face increased challenges in terms of price declines, increased commissions and tougher terms and conditions. However the industry did manage to deliver solid results for the year with most companies reporting strong combined ratios and profi table returns. The benign level of cats and the never-ending favorable reserve releases was once again the determining factor for such strong performance.

Regardless of how the industry has been performing and delivering profi table results, A.M. Best does recognize the warning signs and in August of 2014 we revised our outlook for the industry from stable to negative. The main reasons for our decision was our view that the industry continues to face serious challenges in terms of the overfl ow of capital, softening premium rates, low interest rates, and the possibility of lax underwriting by some in order to maintain business.

The competitive landscape continued during the January renewal with increased retentions, higher ceding commissions and broader terms and conditions. While competition was most pronounced on U.S. property catastrophe programs, the overfl ow of capacity to other business classes and regions continues to place pressure on business across the board. January 1 2015 renewals once again reported a decline in reinsurance prices between 5-15% depending on risk and loss experience. The dramatic price declines in 2014 and for January 1 continued to be attributed to the lack of market-changing losses, increased retentions and the abundance of capital in the market. For global companies, however, the approach to risk selection appears to be orderly and the industry is expected to remain cautious on the risks they elect to write as capacity remains high and the market becomes increasingly more competitive. Portfolios continue to shift more toward primary business given that pricing continues to be relatively more attractive and access to the business easier than on the reinsurance side. Reinsurers also continue to increase their utilization of retro-reinsurance capacity as a means to reduce their cost of capital.

In addition, on the investment side things do not look much better. The persistent low interest rate environment has continued to put pressure on returns leading to the need for better underwriting returns. That said, some companies have started investing into riskier assets in search of yield. This has been done in a measured manner and we expect that companies remain mindful of excessively risky investments that could damage the strength of rated balance sheets.

M&A activity took center stage in 4Q14 and during the fi rst part of 2015 with some signifi cant merger deals announced. XL Group signed a defi nitive agreement to buy Catlin, RenRe to buy Platinum Underwriters and Partner Re and Axis signed an agreement to combine into a single company through a merger of equals and most recently Endurance Specialty Holdings Ltd. (Endurance) has signed to acquire Montpelier Re Holdings Ltd (Montpelier).

M&A activity is expected to continue as the need for scale, global presence and diversifi ed books of business continues to place pressure on companies.

Capital management was also a focus in 2014 and is expected to remain in 2015 as companies continue to actively return capital to shareholders in the form of dividends and share buybacks. Global reinsurers returned approximately $17 billion of total capital in 2014 (exhibit 1) which accounted for over 60% of the total net income reported for the year. Valuations remain low and companies remain proactive in managing capital given its abundance in the market. Given that

Financial ReviewApril 7, 2015

analytical Contacts:

Mariza Costa, Oldwick+1 (908) 439-2200 Ext. [email protected]

Greg Reisner, Oldwick+1 (908) 439-2200 Ext. 5224Greg [email protected]

Robert DeRose, Oldwick+1 (908) 439-2200 Ext. [email protected]

“Results masked by low Cats and continued reserve releases”

Global Reinsurance

2

Special Report Global Reinsurance

companies maintain very strong balance sheets, it is expected that share buybacks, absent any signifi cant CAT event, will continue to be part of companies’ capital management strategy for the near term.

Financial Performance – Results Driven By Yet another Benign Year The analysis of A.M. Best’s global reinsurer composite clearly illustrates underwriting profi tability in 2014 and improvement in overall earnings as the sector benefi ted from another year of record low catastrophe losses. The composite produced a calendar year combined ratio of 89.5% as compared to 88.6% in 2013 and 92.0% in 2012. According to Munich Re, insured catastrophe losses for the entire year totaled only $31 billion, same as in 2013, as compared with the 10 year average of $58 billion. The largest loss came from snow storms in Japan which reported overall losses of $5.9 billion and insured losses of $3.1 billion. U.S. winter storms led to insured losses of $2.3 billion (total losses of $4 billion) and UK fl oods led to $1.1 billion of insured losses (total losses of $1.5 billion) during 2014.

Given that overall CAT losses remained below average in 2014, results for the global reinsurance market remained strong. The reported calendar year combined ratios of 89.5% for 2014 (exhibit 2) also refl ect the continuation of favorable loss reserve development that amounted to 5.3 points in

Exhibit 1Global Reinsurance Shareholders' Equity plus Cumulative Share Repurchases and Dividends Since 2009

Exhibit 2Global Market Reinsurance Trends For Ratios and Reserve Development

Exhibit 3Global Reinsurance Market Trends for Return on Equity

Exhibit 5Combined Ratios by Reinsurance Sector

Exhibit 6Return on Equity by Reinsurance Sector

Exhibit 4Net Investment Income as a % of Total Revenue

Source: Company reports, Imetrix, Bloomberg

Source: Company reports, A.M. Best Research



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Shareholders' Equity (End of Period) Share Repurchases Common and Preferred Dividends (as of 2010)

58.9% 63.8% 76.1%60.7%

56.5% 56.4%63.2%

30.6%31.6%

31.3%

31.3% 32.2% 33.1%31.4%

89.5%95.4%

107.4%

92.0% 88.6% 89.5%94.6%

0.0%

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2009 2010 2011 2012 2013 2014 5yr AvgLoss Ratio Expense Ratio Fav. Loss Dev.

14.7%

10.6%

2.5%

12.1%13.1%

11.4%

0%

2%

4%

6%

8%

10%

12%

14%

16%

2009 2010 2011 2012 2013 2014Return on Equity 5YR Avg Return on Equity

94%87% 86%

99%95% 93%

107% 108% 107%

91% 91% 93% 91%87% 87%

92%88% 87%

0%

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60%

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BigFour

Lloyd's US &Bermuda

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Lloyd's US &Bermuda

2009 2010 2011 2012 2013 2014Loss Ratio Expense Ratio

-5%

0%

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2009 2010 2011 2012 2013 2014

European "Big Four" US & Bermuda Market Lloyd's Five Year Average


Source: A.M. Best Research

0%

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14%

16%

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U.S. & Bermuda Lloyds Euro "Big Four"2009 2010 2011 2012 2013 2014











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58.9% 63.8% 76.1%60.7%

56.5% 56.4%63.2%

30.6%31.6%

31.3%

31.3% 32.2% 33.1%31.4%

89.5%95.4%

107.4%

92.0% 88.6% 89.5%94.6%

0.0%

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45.0%

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14.7%

10.6%

2.5%

12.1%13.1%

11.4%

0%

2%

4%

6%

8%

10%

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16%


94%87% 86%

99%95% 93%

107% 108% 107%

91% 91% 93% 91%87% 87%

92%88% 87%

0%

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BigFour

Lloyd's US &Bermuda

BigFour

Lloyd's US &Bermuda

BigFour

Lloyd's US &Bermuda

BigFour

Lloyd's US &Bermuda

BigFour

Lloyd's US &Bermuda

BigFour

Lloyd's US &Bermuda


-5%

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2009 2010 2011 2012 2013 2014




0%

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3


2014 compared with 5.7 points in 2013 and 6.1 points in 2012. Since 2007, the global reinsurance sector has benefi ted from $56 billion in favorable reserve development. That said, the benefi t from favorable development is expected to decline going forward as we believe older accident years have given as much as they can and more recent accident years are leaner in terms of potential redundancy.

Underwriting profi ts along with investment income and realized capital gains produced another solid year for the global reinsurers. That said, returns are starting to show signs of a decline compared with prior years. The sector generated a return on equity (ROE) of 11.4% in 2014 compared with 13.1% in 2013 and 12.1% in 2012 (exhibit 3). The general expectation going forward is for an ROE in the high single digits, given the continued decline in rates, higher commissions, less reserve redundancy, and low investment yields.

Investment income remains an important element of the sector’s total returns, however, investment returns continue to decline as yields remain at historically low levels (exhibit 4). In order to battle this trend of lower yields, increased competition and higher expenses companies are moving portions of their investment portfolios into higher return alternative investments at a gradual pace. It remains to be seen how aggressive companies will be in allocating capital to such assets classes.

U.S. and Bermuda, “Big Four” and LloydsAnalyzing the performance between the U.S. & Bermuda, European reinsurers, and Lloyds the market showed continued signs of strength. Each segment achieved solid underwriting and overall profi table results. The U.S. and Bermuda market appeared to have outperfromed from an underwriting perspective, producing a combined ratio of 87.5%, marginally better than Lloyds’ 88.1% result (exhibit 5). Last year Lloyds marginally outperformed the U.S. and Bermuda. This years’ slight deterioration in combined ratios from Lloyds could be attributable in part to the recent aviation tragedies around the world. The European “Big Four” (Munich, Swiss, Hannover and SCOR) produced a very acceptable 92.4% combined ratio refl ective of their broader portfolio diversifi cation and less dependence on U.S. property catastrophe business. Over the longer term this will prove to be a distinguishing factor and an advantage in their future performance relative to other markets and companies.

On a fi ve-year basis, the U.S. & Bermuda market produced an average combined ratio of 93.1% as compared to a 93.6% for Lloyds and 96.5% for European reinsurers (exhibits 8, 9, 10). These fi ve











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58.9% 63.8% 76.1%60.7%

56.5% 56.4%63.2%

30.6%31.6%

31.3%

31.3% 32.2% 33.1%31.4%

89.5%95.4%

107.4%

92.0% 88.6% 89.5%94.6%

0.0%

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14.7%

10.6%

2.5%

12.1%13.1%

11.4%

0%

2%

4%

6%

8%

10%

12%

14%

16%


94%87% 86%

99%95% 93%

107% 108% 107%

91% 91% 93% 91%87% 87%

92%88% 87%

0%

20%

40%

60%

80%

100%

120%

BigFour

Lloyd's US &Bermuda

BigFour

Lloyd's US &Bermuda

BigFour

Lloyd's US &Bermuda

BigFour

Lloyd's US &Bermuda

BigFour

Lloyd's US &Bermuda

BigFour

Lloyd's US &Bermuda


-5%

0%

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2009 2010 2011 2012 2013 2014




0%

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58.9% 63.8% 76.1%60.7%

56.5% 56.4%63.2%

30.6%31.6%

31.3%

31.3% 32.2% 33.1%31.4%

89.5%95.4%

107.4%

92.0% 88.6% 89.5%94.6%

0.0%

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14.7%

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12.1%13.1%

11.4%

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94%87% 86%

99%95% 93%

107% 108% 107%

91% 91% 93% 91%87% 87%

92%88% 87%

0%

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BigFour

Lloyd's US &Bermuda

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Lloyd's US &Bermuda

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Lloyd's US &Bermuda

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Lloyd's US &Bermuda

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Lloyd's US &Bermuda


-5%

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2009 2010 2011 2012 2013 2014




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4


year averages for the global reinsurance market includes the signifi cant losses from the CAT events of 2011 (Japan, Australia, New Zealand, Thailand, U.S. tornadoes) and Superstorm Sandy in 2012.

Lloyds was the best performer in 2014 in terms of ROE reporting 14.7% compared with 11% for the European “Big Four” and 10.6% for U.S. and Bermuda (exhibit 6). Over the past fi ve years, Lloyds has reported an average ROE of 13% versus 10.4% for U.S. & Bermuda and 10.0% for the European Big Four. Each segment continues to benefi t from favorable reserve development. Lloyds and the U.S. & Bermuda market have averaged 6.1 points and 6.6 points respectively of favorable development over the past fi ve years versus 4.0 points for the European Big Four (exhibits 8, 9, 10).

In terms of capital, shareholders’ equity grew 7% in 2014 compared with 2013. This compared with fl at growth for the market in 2013 versus 2012. The increase during 2014 could be attributed to the industry’s strong results given the lack of signifi cant losses as well as capital gains. Contributions to rated capacity from earnings totaled $25.7 billion in 2014.

However, let’s pause for a moment and take a short trip back in time to the year 2006. We are talking about the reinsurance sector post Hurricanes Katrina, Rita and Wilma and the fi nancial crisis was still a couple of years away. Now, it’s true that 2006 was an exceptional year and those market dynamics can’t be expected to return anytime soon. Nonetheless, for perspective, think about that the fact that the U.S. & Bermuda market that year reported a combined ratio of 87%, which included less than 1 percentage point of favorable loss reserve development but the average ROE that year was an astonishing 19.4%, with several companies reporting ROEs in excess of 20%. This provides a sense of the rate on line and investment returns companies were achieving back then. Today, benign cats years and a heaping pile of favorable reserve development allows the sector to barely scrape out a double digit return.

m&a expected to continue in 2015The end of 2014, early 2015 marked the move towards M&A in the reinsurance industry, particularly











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58.9% 63.8% 76.1%60.7%

56.5% 56.4%63.2%

30.6%31.6%

31.3%

31.3% 32.2% 33.1%31.4%

89.5%95.4%

107.4%

92.0% 88.6% 89.5%94.6%

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14.7%

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94%87% 86%

99%95% 93%

107% 108% 107%

91% 91% 93% 91%87% 87%

92%88% 87%

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BigFour

Lloyd's US &Bermuda

BigFour

Lloyd's US &Bermuda

BigFour

Lloyd's US &Bermuda

BigFour

Lloyd's US &Bermuda

BigFour

Lloyd's US &Bermuda

BigFour

Lloyd's US &Bermuda


-5%

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2009 2010 2011 2012 2013 2014




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5


in Bermuda where several major deals have been announced - RenRe/Platinum, XL/Catlin, PartnerRe/AXIS and Endurance/Montpelier.

The increase in mergers and acquisitions is likely a function of the current market environment that is only expected to become more challenging as the year progresses. Recently announced deals seem to address the need for greater global scale and diversifi ed product lines and distribution. Cedents want companies that have a wide product offering and a strong market presence which seems to be replacing the days of specialty focused reinsurance companies. Competition for a shrinking amount of business is intensifying and companies understand that they must change the way they do business and the way they see the market. Expense controls, capital adequacy, disciplined underwriting, strong ERM and anticipation to what is emerging in the market needs to remain the focus for companies.

M&A seems to address some of the challenges currently affecting the industry and the deals have been, and will likely continue to be, strategic in nature. Companies have mentioned the need for expense saving and most seem to believe multi-million dollar savings is possible. Others indicate that customers want fewer; strong partners to work with and that programs are getting smaller and sometimes more complex. The need for global, experienced, strong, and well diversifi ed companies is driving the M&A wave and we believe this will continue in the medium term

Reinsurance Ratings Outlook Remain Negative A.M. Best is maintaining its outlook for the reinsurance sector at negative, citing the signifi cant ongoing market challenges that will hinder the potential for positive rating actions over time and may translate into negative rating pressures. As current market conditions continue to place a strain on profi tability it is expected that rated balance sheets could experience some negative pressure. Our current view is longer term than our typical 12-18 months. While A.M. Best does not anticipate a signifi cant number of negative outlooks or downgrades over the very near term, the market headwinds at this point present signifi cant longer-term challenges for the industry.

Declining rates, broader terms and conditions, unsustainable fl ow of net favorable reserve development, low investment yields and continued pressure from alternative capital coming into the market are all negative factors that we expect will adversely affect risk-adjusted returns over the longer term.











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58.9% 63.8% 76.1%60.7%

56.5% 56.4%63.2%

30.6%31.6%

31.3%

31.3% 32.2% 33.1%31.4%

89.5%95.4%

107.4%

92.0% 88.6% 89.5%94.6%

0.0%

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14.7%

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94%87% 86%

99%95% 93%

107% 108% 107%

91% 91% 93% 91%87% 87%

92%88% 87%

0%

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BigFour

Lloyd's US &Bermuda

BigFour

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-5%

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6


Cycle management has been a key strategy for those companies that are able to move between primary and reinsurance lines of business. Companies have been focused on new growth opportunities and investments into new geographies. On the investment side, companies are moving slightly more towards higher return investments in search of yield, making investment portfolios slightly riskier than over the past few years.

Companies with diversified books of business, advanced distribution capabilities and broad geographic scope are better positioned to withstand the pressures in this type of operating environment and have greater ability to target profitable opportunities as they arise. The recent uptick in M&A activity may also serve as a release valve on ratings pressure as organizations gain increased scale, capital efficiency and broader product and distribution capabilities.

Overall, this remains a challenging market, but the reinsurance industry posted solid results for 2014, which was once again driven in part by the lack of large cat losses, continued share repurchases and favorable reserve releases. Conditions will remain competitive and challenging, as primary companies are expected to continue to retain more business and/or seek higher ceding commissions or multi-year contracts. Margin compression also will likely continue as third-party capital seeks a larger piece of the pie. As a result, A.M. Best is forecasting underwriting performance to produce an average combined ratio of 94.8% and an average ROE of 8.2%, representing the current difficult market environment and a normal level of cat activity. Despite the forecast for these dreary returns, risk-adjusted capital should remain strong as companies also reduce their retained exposure to less attractively priced business classes. A.M. Best also continues to expect significant share repurchases for the global reinsurance segment, depending on the level of future catastrophe activity and market opportunities.

A possible change in the ratings outlook back to stable would be based on A. M. Best’s view of future earnings capability and risk-adjusted returns on capital. If the reinsurance market turns, rates start to increase and operating fundamentals start to improve, A.M. Best will consider a revision of its current ratings outlook.

7


Exhibit 7Global Reinsurance Market - U.S. & Bermuda, European “Big Four” and Lloyd’s Trend SummaryUSD billions

5-Yr Avg 2014 2013 2012 2011 2010 2009NPW (P&C only) 138.1 156.1 158.0 146.6 137.0 128.0 120.9 Net Earned Premiums (P&C only) 136.6 152.5 151.5 143.7 133.4 126.7 127.8 Net Investment Income 26.8 25.2 25.3 27.3 26.0 24.3 31.0 Realized Investment Gains / (Losses) 3.6 11.3 1.7 7.6 2.4 10.6 (4.2)Total Revenue 232.2 240.2 250.3 250.4 226.4 227.9 206.0

Net Income 20.5 25.7 28.5 24.9 4.9 20.3 24.1

Shareholders’ Equity (End of Period) 202.0 235.3 218.9 218.4 194.3 193.9 184.3

Loss Ratio 63.2% 56.4% 56.5% 60.7% 76.1% 63.8% 58.9%Expense Ratio 31.4% 33.1% 32.2% 31.3% 31.3% 31.6% 30.6%Combined Ratio 94.6% 89.5% 88.6% 92.0% 107.4% 95.4% 89.5%

Favorable Loss Reserve Development -5.4% -5.3% -5.7% -6.1% -6.3% -4.9% -3.9%

Net Investment Ratio1 19.7% 16.5% 16.7% 19.0% 19.5% 19.2% 24.2%Operating Ratio 74.8% 73.0% 71.9% 72.9% 87.9% 76.2% 65.3%

Return on Equity 10.6% 11.4% 13.1% 12.1% 2.5% 10.6% 14.7%Return on Revenue 8.8% 10.7% 11.4% 9.9% 2.2% 8.9% 11.7%

NPW (P&C only) to Equity (End of Period) 68.3% 66.3% 72.2% 67.1% 70.5% 66.0% 65.6%Net Reserves to Equity (End of Period) 284.1% 237.1% 268.4% 264.2% 298.4% 292.8% 296.7%Gross Reserves to Equity (End of Period) 315.0% 260.3% 296.0% 293.5% 326.6% 326.6% 332.2%

1 Net Investment Ratio based on PC NPESource: Company reports, Imetrix, Bloomberg

Exhibit 8U.S. & Bermuda Reinsurance Market Trend SummaryUSD billions

5-Yr Avg 2014 2013 2012 2011 2010 2009NPW (P&C only) 54.9 63.6 59.8 56.7 55.0 52.6 50.3 Net Earned Premiums (P&C only) 54.0 61.7 56.6 55.5 54.4 52.4 51.1 Net Investment Income 7.6 7.3 6.8 7.1 7.6 8.1 8.2 Realized Investment Gains / (Losses) 1.3 1.0 1.4 2.2 (0.1) 2.2 0.8 Total Revenue 66.3 73.6 69.6 68.6 64.6 65.7 63.1

Net Income 9.4 11.6 12.1 10.1 0.9 11.2 12.4

Shareholders' Equity (End of Period) 96.1 110.4 101.4 101.7 93.7 95.1 88.4






1 Net Investment Ratio based on PC NPESource: Company reports, Imetrix, Bloomberg

8


Exhibit 10Lloyd’s Market Trend SummaryUSD billions

5-Yr Avg 2014 2013 2012 2011 2010 2009NPW (P&C only) 29.6 31.1 33.4 31.4 28.6 27.3 27.4 Net Earned Premiums (P&C only) 28.8 30.4 32.5 30.2 28.0 26.5 26.6 Net Investment Income 1.8 1.6 1.4 1.6 1.4 1.9 2.8 Realized Investment Gains / (Losses) 0.0 0.1 (0.1) 0.1 0.1 - - Total Revenue 30.8 32.0 33.5 32.3 29.5 29.5 29.5

Net Income 3.7 4.9 5.3 4.5 (0.8) 3.4 6.2




Net Investment Ratio 6.5% 5.3% 4.3% 5.4% 5.0% 7.4% 10.6%Operating Ratio 87.1% 82.8% 82.5% 85.8% 103.1% 87.2% 76.9%

Return on Equity 13.0% 14.7% 16.2% 15.1% -2.8% 11.9% 24.9%Return on Revenue 11.9% 15.3% 15.8% 13.9% -2.7% 11.5% 20.9%


Source: Company reports

Exhibit 9European “Big Four” Trend SummaryUSD billions

5-Yr Avg 2014 2013 2012 2011 2010 2009NPW (P&C only) 53.6 61.4 64.8 58.5 53.4 48.1 43.1 Net Earned Premiums (P&C only) 53.9 60.4 62.4 58.1 51.0 47.8 50.2 Net Investment Income 17.4 16.3 17.1 18.6 17.0 14.3 19.9 Realized Investment Gains / (Losses) 2.3 10.1 0.4 5.2 2.4 8.3 (5.0)Total Revenue 135.0 134.6 147.2 149.4 132.3 132.7 113.5

Net Income 7.5 9.3 11.1 10.2 4.7 5.7 5.5







1 Net Investment Ratio based on PC NPESource: Company reports


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