Review

Risk management

Active management of underwriting risk

A key strategic objective is to maintain an attractive cross-cycle return on capital through the operation of excellent capital management and the maintenance of a diversified portfolio of business. The diversification across lines of business and territory provides a strong balance of catastrophe versus non-catastrophe exposures and reduces the risk that any one event causes an unacceptable net loss to the Group.

In this way the economic modelling of our insurance portfolio is carried out using the Dynamic Financial Analysis (DFA) model developed by our actuarial team. The catastrophe downside risk can be viewed against the likely profits and the tangible net assets of the Group. It is understood that as expected margins increase the Group is able to expand its risk appetite. Conversely, as opportunity for profit reduces, the appetite is reduced by reducing exposures or purchasing more reinsurance.

The production of quarterly realistic disaster scenarios is a very useful indicator of changes in exposure and the amount of reinsurance protection available for the major potential catastrophe losses.

A feature of the management of catastrophe risk over the past year has been the fall in value of sterling against many currencies, including those of key catastrophe exposures, namely European windstorm, USA earthquake and windstorm, and Japanese earthquake.

For US dollar exposures, there are three mitigating factors: firstly, our Bermuda company balance sheet is held in US dollars; secondly, the group holds substantial US dollar premiums reserves and finally our reinsurance programme limits are expressed in US dollars, as well as sterling.

European exposures are also partly offset by euro currency amounts held and also by the fact that much of the exposure is UK based.

However, for yen exposures, the picture is different as can be seen with our maximum RDS KPI exceeding our appetite at 31 December 2008. Here the rate has moved more substantially and the exposure has increased in sterling terms. The bulk of our yen exposures are renewed at 1 April, and in the interim we have purchased short term reinsurance protection to reduce the potential loss. By the end of February 2009 the RDS was reduced to 109% of risk appetite or 36 % of NTA.

This demonstrates our active approach to risk management.