Flood funding

Written evidence submitted by Aon Benfield

1. Aon plc is a leading global provider of risk management, insurance and reinsurance brokerage, and human resources solutions and outsourcing services. With more than 62,000 colleagues worldwide, Aon empowers results for clients in over 120 countries via innovative and effective risk and people solutions and through industry-leading global resources and technical expertise.

2. Aon has been named repeatedly as the world’s best broker, best insurance broker, reinsurance broker, captives manager and best employee benefits consulting firm.

3. Aon comprises three key divisions: Aon Risk Solutions, Aon Hewitt, and Aon Benfield.

Aon Benfield

4. Aon Benfield is the world’s largest reinsurance broker, with a global network spanning more than 80 offices in 50 countries. It is also the largest reinsurance broker for UK business.

5. The firm has more than 3,000 employees, whose primary role is to understand, manage and transfer a diverse range of risks from insurance companies to reinsurance companies. These risks may relate to the property, marine, energy and motor sectors, among many others.

6. Aon Benfield’s trading partners comprise the world’s prominent insurers and reinsurers.

7. Aon Benfield ensures that the protection offered by reinsurers to insurers is appropriate in regard to its price, and in regard to the terms and conditions of the coverage. The firm also provides a wide range of services around the analysis of risk.

About reinsurance

8. Reinsurance is insurance for insurers. While consumers generally purchase insurance for single items, such as buildings insurance for their property or motor insurance for their car, insurers also buy cover, to protect their financial position. For instance, they might purchase reinsurance for a group of properties they insure in a specific country or region. Whatever interest the insurer may be insuring – whether it be assets such as property, vehicles, or marine vessels; or financial exposures such as credit risk – the reinsurer will generally offer a similar product to enable risk (i.e. potential losses) to be transferred from the insurer to the reinsurer. This risk transfer process happens mainly via one or more of three key mechanisms – a reinsurance treaty, facultative reinsurance, or insurance-linked securities (ILS).

9. A reinsurance treaty transfers risk from the insurer to the reinsurer en masse. For instance, a property reinsurance treaty may comprise many thousands of insured properties. In a treaty structure, the reinsurer will either:

a. Take a pre-agreed share of the risk (potential loss) and reward (premium) with the insurer (called a "proportional" or "pro-rata" treaty), or;

b. Agree to indemnify the insurer in excess of a certain level of loss (the insurer’s "retention") for an agreed premium. This is called an "excess-of-loss" treaty (or "XoL").

10. Facultative reinsurance is the reinsuring of a single asset, e.g. an insurer may wish to reinsure a single skyscraper.

11. Insurance-linked securities (ILS) transfer insurance risks to capital markets investors, such as pension funds, via customised financial vehicles.

12. An insurer’s risks can be transferred to either a single reinsurer, or a group of reinsurers, whereby each reinsurer agrees to take a specific share of an insurer’s risks.

13. Lloyd’s of London is one of the leading markets in the global insurance and reinsurance industry, and is a significant trading partner of Aon Benfield.

The UK reinsurance market for catastrophes (including flooding)

14. All insurance companies in the UK buy some form of reinsurance protection for their property exposures (risks). It is a robust, proven, and well regulated mechanism for transferring risk and protecting insurers’ financial positions.

15. The most common form of reinsurance for these exposures is Catastrophe Excess of Loss reinsurance (see 10b above), which is designed to respond to an accumulation of losses arising out of large "catastrophic" events, such as the 1953 floods in the UK.

16. The protection is generally purchased for a 12-month period (although the timescale is flexible) and will respond to losses which exceed a predetermined level, known as the Excess, and up to a predetermined level, known as the Limit.

17. Losses which fall below the Excess, or exceed the Limit, are retained by the insurance company, and are covered by its own funds.

18. Aon Benfield maintains a database of UK reinsurance purchasing activity, which contains data pertaining to almost 70% of the UK market. Annually, the UK insurance industry purchases approximately GBP12 billion of Catastrophe Excess of Loss Limit, in excess of GBP1.1 billion.

19. Some companies also purchase Aggregate cover, which protects them against the sum of all losses (within a specified band) across the whole year, and is designed to protect insurers from attritional losses, as were seen in insurance payments relating to the 2011 UK flood and freeze conditions.

Flood Re proposal

20. Aon Benfield has been working closely with the UK’s insurance trade body, the Association of British Insurers (ABI), on how reinsurance can play its part in the ABI’s "Flood Re" proposal.

21. The aim of Flood Re is to ensure that flood insurance remains available and affordable to consumers, by allowing insurers to cede (transfer) the element of flood protection within the household policies they write into a not-for-profit fund at a set price.

22. The fund would be expected to break-even over time, and reinsurance has a key role to play in managing its "Survivability" (the ability to meet its obligations) and "Sustainability" (the ability to survive and trade forward after an event).

23. Reinsurance achieves this through substantially reducing both the probability of failure (thereby increasing the Survivability) and the volatility of results (thereby increasing the Sustainability).

24. Income to the pool would be represented by:

Policy Holder Premium

Levy Premium

Reinsurance Recoveries

25. Outgoing from the pool would be represented by:

Retained Losses

Reinsurance Premium

Operating Expenses

26. The ability of reinsurance to reduce the volatility of results, will assist the development of a stronger and more stable fund which benefits policyholders through lower premiums and/or enhanced coverage.

27. Aon Benfield’s proposal for Flood Re is aligned to the advice we would provide to any insurance entity in respect of flood risk. Therefore, Flood Re is designed to protect a "standard" portfolio of properties, albeit with a non-standard level of risk, taking into account the underlying exposures, the loss potential, the protection required, and the premium available.

28. Working in partnership with major reinsurers, Aon Benfield would design and execute a comprehensive reinsurance programme. This would be built from various reinsurance products, for instance Proportional cover, Catastrophe Excess of Loss cover, and Aggregate Excess of Loss cover.

29. Based on our preliminary analysis, we estimate Flood Re’s requirement for single catastrophic event cover to be in the region of GBP2 billion, in excess of GBP250 million.

30. This level of cover would ensure the fund has the ability to meet claims arising from a catastrophic event up to GBP2 billion, which is far in excess of the estimated premium income.

31. We would recommend that this level of cover is considered in conjunction with an Aggregate protection, to limit the financial impact of a series of smaller losses.

32. Any, and all, of these figures would increase or decrease dependant on variability in the fund’s financial position, its risk appetite, and the interaction of the final reinsurance protections.

February 2013