Transcript Impacts on Insurers - Insurance Information Institute

2008: A Make or Break
Year for the
P/C Insurance Industry?
National Council on Compensation Insurance
Annual Issues Symposium
Orlando, FL
May 8, 2008
Robert P. Hartwig, Ph.D., CPCU, President
Insurance Information Institute  110 William Street  New York, NY 10038
Tel: (212) 346-5520  Fax: (212) 732-1916  [email protected]  www.iii.org
Presentation Outline
• Weakening Economy: Insurance Impacts & Implications
 Implications of Treasury “Blueprint” for insurers
•
•
•
•
•
•
•
•
•
Profitability
Underwriting Trends
Premium Growth
Rising Expenses
Capacity
Investment Overview
Catastrophic Loss
Shifting Legal Liability & Tort Environment
Presidential Politics & P/C Profitability
A STORMY ECONOMIC
FORECAST
What a Weakening Economy & Credit
Crunch Mean for the Insurance
Industry
What’s Going On With the US and
Global Economies Today?
Fundamental Factors Affecting Global Economy in 2008
• Puncture of Not One, But Two Bubbles: Credit and Housing in US
 Burst BubbleAsset Price Deflation
 Subprime mortgage market was first part of credit bubble to burst
• Expanding Credit Crunch: Some credit markets have effectively seized
• Flight to Quality/Security: US Treasury securities are the most sought after
in the world
• Global Contagion Effect: Securitization of asset back securities, derivatives
based on those securities amplified via leverage produced contagion effect
 Many financial institutions around the world found they are exposed
• Global Economic Impacts: Global Economic Slowdown




GDP growth in US down sharply, employment falling; Deceleration abroad too
Crashing dollar
Inflation accelerating
New bubbles forming in commodities and currencies
Source: Insurance Information Institute.
Real GDP Growth*
2.9%
09:4Q
2.0%
09:1Q
2.8%
1.9%
08:4Q
2.1%
0.6%
08:1Q
0.1%
0.6%
07:4Q
1%
0.6%
0.8%
2%
09:3Q
4.9%
3.8%
2.9%
1.6%
3%
3.1%
3.6%
2.5%
4%
3.7%
5%
2.6%
Economic growth
is slowing
dramatically in
2008
6%
09:2Q
08:3Q
08:2Q
07:3Q
07:2Q
07:1Q
2006
2005
2004
2003
2002
2001
2000
0%
*Yellow bars are estimates/forecasts.
Source: US Department of Commerce, Blue Economic Indicators 4/08; Insurance Information Institute.
Toward a New World Economic Order
1.
Credit Crunch (incl. Subprime) Issue Will Ultimately Cost
Hundreds of Billions Globally
•
2.
Heavy Toll on Capital Base of Some Large Financial
Institutions Worldwide (e.g., Bear Stearns)
•
•
3.
Problem exacerbated by leveraged bets taken by some financial
institutions therefore its reach extends beyond simple defaults
Cash infusions necessary; Sovereign Wealth Funds important source
Federal Reserve forced into playing a larger role; must improvise
Most Significant Economic Event in a Generation
•
US economy will recover, but will take 18-24 months
4.
Shuffling of Global Economic Deck
• China, oil producing countries hold the upper hand
5. IOUs are Being Redeemed
•
6.
Stakes in hard assets/institutions demanded
Good News: No Shortage of Available Capital
•
Central banks are (generally) making right decisions; Dollar sinks
Source: Insurance Information Institute
What’s Being Done to Fix the
Economy?Impacts on Insurers
Economic Fix
Fed Rate Cuts
Fed Debt
Swaps
Bear Stearns
Bailout
Impacts on Insurers
•Reduces bond yields (65% - 80% of portfolio)
•Potentially contributes to inflation longer run
•Fed will swap up to $200B in bank holdings of
mortgage back securities for Treasuries;
Improves bank finances
•Fed on 3/14 (via J.P. Morgan) provided Bear
Stearns with cash after what is effectively a
“run on the bank”
•“Too Big to Fail” doctrine is activated
•Fed acting to prevent broader loss of
confidence
Source: Insurance Information Institute
What’s Being Done to Fix the
Economy?Impacts on Insurers (cont’d)
Economic Fix
Stimulus
Package
Housing
Bailout (?)
Regulatory/
Legislative
Action (?)
Impacts on Insurers
•Hope is that $168B plan boosts overall economic activity
and employment (by 500,000 jobs) and therefore P/C
personal and commercial exposures
•Contributes to already exploding budget deficits—
Washington may expand its search for people and
industries to tax
•Keeps more people in their homes and hopefully paying
HO insurance premiums
•Abandoned and neglected homes have demonstrably
worse loss performance
•Treasury March 31 “Blueprint” affects all financial firms
•For insurers, major recommendation is established of
Optional Federal Charter under Office of National
Insurance within Treasury
Source: Insurance Information Institute
Post-Crunch: Fundamental Issues
To Be Examined Globally
•
•
•
•
Adequacy of Risk Management, Control & Supervision at
Financial Institutions Worldwide



Colossal failure of risk management (and regulation)
Implications for ERM?
Includes review of incentives
Effectiveness and Nature of Regulation





What sort of oversight is optimal given recent experience?
Credit problems arose under US and European (Basel II)
regulatory regimes
Will new regulations be globally consistent?
Can overreactions be avoided?
Capital adequacy & liquidity
Accounting Rules



Problems arose under FAS, IAS
Asset Valuation, including Mark-to-Market
Structured Finance & Complex Derivatives
Ratings on Financial Instruments

New approaches to reflect type of asset, nature of risk
Source: Insurance Information Institute
SUMMARY OF TREASURY
“BLUEPRINT” FOR
FINANCIAL SERVICES
MODERNIZATION
Impacts on Insurers
Treasury Regulatory Recommendations
Affecting Insurers
•
•
Establishment of an Optional Federal Charter (OFC)
 Would provide system for federal chartering, licensing,
regulation and supervision of insurers, reinsurer and
producers (agents & brokers)
 OFC insurers would still be subject to state taxes, provisions
for compulsory coverage, residual market and guarantee
funds
 OFC would specify specific lines covered by charter;
Separate charters needed for P/C and Life
OFC Would Incorporate Several Regulatory Concepts
 Ensure “safety and soundness” (solvency)
 Enhance competition in national and international markets
 Increase efficiency through elimination of price controls,
promote more rapid technological change, encourage product
innovation, reduce regulatory costs and provide consumer
protection
Source: Department of Treasury Blueprint for a Modernized Financial Regulatory System, March 2008.
Treasury Regulatory Recommendations
Affecting Insurers (cont’d)
•
•
Establishment of Office of National Insurance (ONI)



Establishment of Office of Insurance Oversight (OIO)




•
Department within Treasury to regulate insurance pursuant to OFC
Headed by Commissioner of National Insurance
Commissioner has regulatory, supervisory, enforcement and
rehabilitative powers to oversee organization, incorporation, operation,
regulation of national insurers and national agencies
Department within Treasury to handle issues needing immediate
attention such “reinsurance collateral”; OIO could focus immediately
on “key areas of federal interest in the insurance sector”
OIO: lead regulatory voice on international regulatory policy
Would have authority to ensure states achieved uniform
implementation of declared US international insurance policy goals
OIO would also serve as advisor to Treasury Secretary on major
domestic and international policy issues
UPDATE: HR 5840 Introduced April 17 Would Establish
Office of Insurance Information (OII)

Very similar to OIO
Source: Department of Treasury Blueprint for a Modernized Financial Regulatory System, March 2008.
INSURANCE & THE
ECONOMY
Important But Somewhat
Muted Impacts
A Few Facts About the Relationship
Between Insurance & Economy
• Vast Majority of Insurance Business is Tied to Renewals
 Approximately 98+% of P/C business (units) is linked to renewals
 A very large share of P/C insurance premiums are statutorily or de facto
compulsory (e.g., WC, auto liability, surety, usually HO…)
 P/C insurers have marginal exposure impact due to economy
 Most life revenues and units are renewals, but some products (e.g.,
variable annuities are sensitive to market volatility)
 Life insurers who manage 401(k) assets seeing more loans and hardship
withdrawals;
• Insurers are Sensitive to Interest Rates
 About 2/3 of P/C invested assets and 75% if Life assets are fixed income
 Historically, yield on industry portfolios has tracked 10-year note closely
 All else equal, lower total investment gain implies greater emphasis on
underwriting
 Historically, industry’s best underwriting performances are rooted in
periods when interests rates were low and/or equity market performance
poor (1930s – 1950s, early 2000s gave rise to strong 2006/07)
Source: Insurance Information Institute.
5%
0%
-5%
Real NWP Growth
-10%
6%
4%
78
5.2%
79
-0.9%
80-7.4%
81 -6.5%
82
-1.5%
1.8%
83
84
4.3%
85
86
87
5.8%
88
0.3%
89
-1.6%
-1.0%
90
91
-1.8%
92
-1.0%
3.1%
93
94
1.1%
95
0.8%
96
0.4%
97
0.6%
98
-0.4%
99
-0.3%
1.6%
00
01
5.6%
02
03
7.7%
04
1.2%
05
-2.9%
06
-0.5%
-2.8%
07
08F
-2.7%
Real NWP Growth
15%
10%
8%
2%
0%
-2%
Real GDP
Sources: A.M. Best, US Bureau of Economic Analysis, Blue Chip Economic Indicators, 2/08; Insurance Information Inst.
-4%
Real GDP Growth
20%
P/C insurance industry’s growth is
influenced modestly by growth in the
overall economy
13.7%
25%
18.6%
20.3%
Real GDP Growth vs. Real P/C
Premium Growth: Modest Association
Summary of Economic Risks and
Implications for (Re) Insurers
Economic Concern
Subprime Meltdown/
Credit Crunch
Housing Slump
Lower Interest Rates
Stock Market Slump
General Economic
Slowdown/Recession
Risks to Insurers
•Some insurers have some asset risk
•D&O/E&O exposure for some insurers
•Client asset management liability for some
•Bond insurer problems; Muni credit quality
•Reduced exposure growth
•Deteriorating loss performance on neglected,
abandoned and foreclosed properties
•Lower investment income
•Decreased capital gains (which are usually
relied upon more heavily as a source of
earnings as underwriting results deteriorate)
•Reduced commercial lines exposure growth
•Surety slump
•Increased workers comp frequency
1.56
1.54
1.51
1.45
1.10
1.36
1.38
2.07
I.I.I. estimates that each incremental
100,000 decline in housing starts costs
home insurers $87.5 million in new
exposure (gross premium). The net
exposure loss in 2008 vs. 2005 is
estimated at $954 million.
1.80
1.85
1.71
1.60
1.64
1.57
1.47
1.35
1.48
New home starts plunged
34% from 2005-2007;
Drop through 2008
trough is 53% (est.)—a
net annual decline of
1.09 million units
0.98
1.01
1.29
1.20
1.46
1.62
Impacts also for commercial insurers
with construction risk exposure
1.19
2.1
2.0
1.9
1.8
1.7
1.6
1.5
1.4
1.3
1.2
1.1
1.0
0.9
Exposure growth forecast for HO
insurers is dim for 2008/09
1.96
New Private Housing Starts,
1990-2014F (Millions of Units)
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07F08F 09F 10F11F 12F 13F 14F
Source: US Department of Commerce; Blue Chip Economic Indicators (10/07), except 2008/09 figures from
4/08 edition of BCEF; Insurance Information Institute
Change in Home Values from
Maximum Price, by City*
-3.4%
-6.3%
-6.9%
-7.4%
-7.8%
-8.0%
-9.1%
-13.5%
-14.7%
-17.5%
-20.8%
-21.6%
-22.1%
-23.2%
-23.8%
Home prices are
falling across the
country; Down
14.8% on average
La
sV
eg
Ph a s
o
Sa eni
x
n
D
ie
g
D o
et
ro
it
Lo Mia
sA m
ng i
el
Sa T es
a
n
F r mp
a
a
W nci
as sco
C hin
om g
po ton
M site
in -20
ne
a
C pol
lev is
el
an
Bo d
st
C on
hi
N cag
ew o
Yo
r
A k
tla
n
D ta
en
ve
D r
al
la
Se s
at
Po tle
rt
C land
ha
rl
ot
te
-30%
-24.1%
-25%
-24.5%
-20%
-19.8%
-15%
-14.8%
-10%
-10.2%
-5%
-5.1%
0%
*Calculated as of Feb. 2008 (latest available) by III from monthly Case-Schiller price index data. Date of
maximum price varies by city (July 2006 for 20-city composite).
Source: Case-Schiller Home Price Index at Standardandpoors.com; Insurance Info. Institute
Auto/Light Truck Sales,
1999-2014F (Millions of Units)
18.0
17.5
17.8
17.5
17.4
New auto/light trick sales are
expected to experience a net
drop of 1.4 million units
annually by 2008 compared
with 2005, a decline of 9.5%
Weakening economy,
credit crunch and high
gas prices are hurting
auto sales
17.1
16.9 16.9
17.0
16.6
16.9 16.8
16.6 16.7
16.5
16.5
16.4
16.1
16.0
15.7
Impacts of falling auto sales will
have a less pronounced effect on
auto insurance exposure growth
than problems in the housing
market will on home insurers
15.5
15.0
14.5
15.3
14.0
99
00
01
02
03
04
05
06
07F
08F
09F
10F
11F
12F
13F
Source: US Department of Commerce; Blue Chip Economic Indicators (10/07), except 2008/09 figures from
4/08 edition of BCEF; Insurance Information Institute
14F
US Unemployment Rate,
(2007:Q1 to 2009:Q4F)
6.0%
5.4%
5.5%
4.8%
4.5% 4.5%
4.0%
5.6%
5.5% 5.5%
5.2%
5.0%
4.5%
5.5% 5.5%
4.9%
4.6%
Rising unemployment rate
could negatively impact
workers comp exposure
3.5%
3.0%
07:Q1 07:Q2 07:Q3 07:Q4 08:Q1 08:Q2 08:Q3 08:Q4 09:Q1 09:Q2 09:Q3 09:Q4
Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (4/08); Insurance Info. Inst.
Wage & Salary Disbursements (Payroll
Base) vs. Workers Comp Net
Written Premiums
Wage & Salary Disbursement (Private Employment) vs. WC NWP
$ Billions
$ Billions
7/90-3/91
$7,000
$6,000
3/01-11/01
Wage & Salary
Disbursements
WC NPW
$45
$40
$35
$5,000
$30
$4,000
$3,000
$2,000
Shaded areas indicate recessions
$1,000
Weakening wage
and salary
growth is
expected to cause
a deceleration in
workers comp
exposure growth
$25
$20
$15
$10
$5
$0
$0
89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07*
*As of 7/1/07 (latest available).
Source: US Bureau of Economic Analysis; Federal Reserve Bank of St. Louis at
http://research.stlouisfed.org/fred2/series/WASCUR; I.I.I. Fact Books
Inflation Rate (CPI-U, %),
1990 – 2009F
6
5
4.9 5.1
Inflation was just 2.2% in 2007 but is accelerating.
Medical cost inflation, important in WC, auto liability
and other casualty covers is running far ahead of
inflation. Rising inflation can also lead to rate
inadequacy and adverse reserve development
4
3.0 3.2
3
2
4.0
3.8
3.3 3.4
3.4
3.0
2.9 2.8
2.6
2.4
2.5 2.3
1.9
1.5
2.2
2.4
1.3
1
0
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08* 08F 09F
*12-month change March 2008 vs. March 2007;
Source: US Bureau of Labor Statistics; Blue Chip Economic Indicators, Mar. 10, 2008; Ins. Info. Institute.
PROFITABILITY
Profits in 2006/07 Reached
Their Cyclical Peak;
By No Reasonable Standard Can Profits
Be Deemed Excessive
$49,900
$65,777
$44,155
$38,501
$30,029
$3,046
$20,559
$30,773
$21,865
$10,870
$10,000
$19,316
$20,000
$5,840
$30,000
$14,178
$40,000
Insurer profits
peaked in 2006
$36,819
$50,000
$24,404
$60,000
$20,598
$70,000
2001 ROE = -1.2%
2002 ROE = 2.2%
2003 ROE = 8.9%
2004 ROE = 9.4%
2005 ROE= 9.6%
2006 ROE = 12.2%
2007 ROAS1 = 12.3%**
$61,940
P/C Net Income After Taxes
1991-2008F ($ Millions)*
*ROE figures are GAAP; 1Return on avg. surplus. **Return on Average Surplus; Sources: A.M. Best, ISO,
Insurance Information Inst.
08F
07
06
05
04
03
01
-$6,970
00
99
98
97
96
95
94
93
92
91
-$10,000
02
$0
ROE: P/C vs. All Industries
1987–2008E
20%
P/C profitability is cyclical, volatile and vulnerable
15%
10%
Sept. 11
5%
Hugo
Katrina,
Rita, Wilma
Lowest CAT
losses in 15 years
0%
Andrew
Northridge
4 Hurricanes
US P/C Insurers
2008 P/C insurer ROE is I.I.I. estimate.
Source: Insurance Information Institute; Fortune
All US Industries
08F
07
06
05
04
03
02
01
00
99
98
97
96
95
94
93
92
91
90
89
88
87
-5%
Personal/Commercial Lines &
Reinsurance ROEs, 2006-2008F*
18%
2006
2007E
16%
14.0%
2008F
10%
8%
16.8%
13.2%
14%
12%
ROEs are declining
as underwriting
results deteriorate
9.8%
9.4%
12.3%
10.7%
9.8%
6.3%
6%
4%
2%
0%
Personal
Commercial
Sources: A.M. Best Review & Preview (historical and forecast).
Reinsurance
Profitability Peaks & Troughs in the P/C
Insurance Industry,1975–2008F*
25%
1977:19.0%
1987:17.3%
2006:12.2%
20%
1997:11.6%
15%
10%
5%
0%
1975: 2.4%
1984: 1.8%
1992: 4.5%
2001: -1.2%
75
76
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07E
08F
-5%
*GAAP ROE for all years except 2007 which is actual ROAS of 12.3%. 2008 P/C insurer ROE is I.I.I. estimate.
Source: Insurance Information Institute, ISO; Fortune
Insurance Stocks: Mixed Performance
Compared to S&P 500 Index in 2008
Total YTD Returns Through May 2, 2008
P/C, Life insurance stocks even
with S&P—not affected as much
as some financial stocks by
credit, subprime concerns
Mortgage & Financial
Guarantee insurers were
down 69% in 2008
S&P 500
-3.71%
All Insurers
-12.74%
-3.94%
P/C
-3.59%
Life/Health
-14.70%
Multiline
-6.28%
Reinsurance
-47.62%
Mortgage*
-1.75%
-60.0%
-50.0%
-40.0%
-30.0%
-20.0%
-10.0%
*Includes Financial Guarantee.
Source: SNL Securities, Standard & Poor’s, Insurance Information Inst.
Brokers
0.0%
Factors that Will Influence the
Length and Depth of the Cycle
• Capacity: Rapid surplus growth in recent years has left the industry with
between $85 billion and $100 billion in excess capital, according to analysts
 All else equal, rising capital leads to greater price competition and a liberalization
of terms and conditions
• Reserves: Reserves are in the best shape (in terms of adequacy) in decades,
which could extend the depth and length of the cycle
 Looming reserve deficiencies are not hanging over insurers they way they did
during the last soft market in the late 1990s
 Many companies have been releasing redundant reserves, which allows them to
boost net income even as underwriting results deteriorate
 Reserve releases will diminish in 2008; Even more so in 2009
• Investment Gains: 2007 was the 5th consecutive up year on Wall Street. With
sharp declines in stock prices and falling interest rates, portfolio yields are
certain to fallContributes to discipline
 Realized capital gains are already rising as underwriting profits shrink, but like
redundant reserves, realized capital gains are a finite resource
 A sustained equity market decline (and potentially a drop in bond prices at some
point) could reduce policyholder surplus
Source: Insurance Information Institute.
Factors that Will Influence the
Length and Depth of the Cycle (cont’d)
• Sarbanes-Oxley: Presumably SOX will lead to better and more conservative
management of company finances, including rapid recognition of deficient or
redundant reserves
 With more “eyes” on the industry, the theory is that cyclical swings should shrink
• Ratings Agencies: Focus on Cycle Management; Quicker to downgrade
 Ratings agencies more concerned with successful cycle management strategy
 Many insurers have already had ratings “haircut” over the last several years they
way they did during the last soft market in the late 1990s; Less of a margin today
• Finite Reinsurance: Had smoothing effect on earnings; Finite market is gone
• Information Systems: Management has more and better tools that allow
faster adjustments to price, underwriting and changing market conditions
than it had during previous soft markets
• Analysts/Investors: Less fixated on growth, more on ROE through soft mkt.
 Management has backing of investors of Wall Street to remain disciplined
• M&A Activity: More consolidation implies greater discipline
 Liberty Mutual/Safeco deal creates 5th largest p/c insurer. More to come?
Source: Insurance Information Institute.
ROE vs. Equity Cost of Capital:
US P/C Insurance:1991-2007
18%
The P/C insurance industry achieved its cost of
capital in 2005/6 for the first time in many years
16%
12%
4%
2%
0%
-2%
-4%
The cost of capital
is the rate of return
insurers need to
attract and retain
capital to the
business
US P/C insurers missed their
cost of capital by an average 6.7
points from 1991 to 2002, but on
target or better 2003-07
91
92
93
94
95
96
97
98
99
Source:The Geneva Association, Insurance Information Inst.
-0.1 pts
6%
+0.2 pts
-13.2 pts
8%
-9.0 pts
10%
+1.8 pts
+1.7 pts
14%
00
01
02
ROE
03
04
05
06
07
Cost of Capital
FINANCIAL STRENGTH
& RATINGS
Industry Has Weathered the Storms Well,
But Cycle May Takes Its Toll
P/C Insurer Impairment Frequency vs.
Combined Ratio, 1969-2007E
Combined Ratio
115
Combined Ratio after Div
P/C Impairment Frequency
2
1.8
1.6
110
1.4
1.2
105
1
100
0.8
0.6
95
0.4
0.2
69
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07E
90
2006 impairment rate was 0.43%, or 1-in-233
companies, half the 0.86% average since 1969;
2007 will be lower; Record is 0.24% in 1972
Source: A.M. Best; Insurance Information Institute
0
Impairment Rate
120
Impairment rates
are highly
correlated
underwriting
performance and
could reach nearrecord low in 2007
Reasons for US P/C Insurer
Impairments, 1969-2005
2003-2005
Affiliate
Problems
8.6%
Catastrophe
Losses
8.6%
1969-2005
Deficient
Loss
Reserves/Inadequate
Pricing
62.8%
Deficient
Loss
Reserves/Inadequate
Pricing
38.2%
Investment
Problems*
7.3%
Alleged
Fraud
11.4%
Rapid
Growth
8.6%
Reinsurance
Sig. Change
Failure
in Business
3.5%
4.6%
Misc.
9.2%
Deficient
reserves,
CAT losses
are more
important
factors in
recent years
Affiliate
Problems
5.6%
Catastrophe
Losses
6.5%
Alleged
Fraud
8.6%
Rapid
Growth
16.5%
*Includes overstatement of assets.
Source: A.M. Best: P/C Impairments Hit Near-Term Lows Despite Surging Hurricane Activity, Special Report, Nov. 2005;
UNDERWRITING
TRENDS
Extremely Strong 2006/07;
Relying on Momentum &
Discipline for 2008
P/C Insurance Combined Ratio,
1970-2008F*
Combined Ratios
120
115
110
1970s: 100.3
1980s: 109.2
1990s: 107.8
2000s: 102.0*
105
100
95
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08F
90
Sources: A.M. Best; ISO, III
*Full year 2008 estimates from III.
P/C Insurance Combined Ratio,
2001-2008F
120
115.8
110
As recently as 2001,
insurers were paying
out nearly $1.16 for
every dollar they
earned in premiums
107.4
2006 produced the best
underwriting result
since the 87.6 combined
ratio in 1949
100.7
100.1
100
2007/8 deterioration due
primarily to falling rates, but
results still reasonable
assuming normal CAT activity
98.6
98.3
95.6
2005 figure benefited from
heavy use of reinsurance
which lowered net losses
92.4
90
01
02
03
Sources: A.M. Best; ISO, III. *III estimates for 2008.
04
05
06
07
08F
Ten Lowest P/C Insurance Combined
Ratios Since 1920 vs. 2007
97
95
2007 was the 20th
best since 1920
The 2006 combined
ratio of 92.2 was the
best since the 87.6
combined in 1949
92.1 92.3 92.4 92.4
93
95.6
93.0 93.1 93.1 93.3
91.2
91
The industry’s best
underwriting years
are associated with
periods of low
interest rates
89
87.6
87
85
1949
1948
1943
1937
2006
1935
1950
1939
1953
1936
Sources: Insurance Information Institute research from A.M. Best data. *2007: III Early bird survey.
2007
35
30
25
20
15
10
5
0
-5
-10
-15
-20
-25
-30
-35
-40
-45
-50
-55
Insurers earned a record underwriting profit of
$31.7 billion in 2006, the largest ever but only the
second since 1978. Cumulative underwriting deficit
from 1975 through 2007 is $422 billion.
75
76
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
$ Billions
Underwriting Gain (Loss)
1975-2008F*
Source: A.M. Best, Insurance Information Institute
Impact of Reserve Changes on
Combined Ratio
$10
$5
$0
($5)
0.1
$0.4
$18.9
$15
$22.8
3.5
$36.9
$25
$20
$33.4
6.5
$10.8
Reserve Development ($B)
$35
$30
($10)
00
01
02
03
10
9
8
Reserve
7
adequacy has
6
4.5
improved
5
substantially
4
3
2
1
-1.2 -1.6 -1.3 -1.1
0
(1)
(2)
($5.0)
($5.3) ($7.0)($6.0)
(3)
04
05
Source: A.M. Best, Lehman Brothers estimates for years 2007-2009
06
07F
08F
09F
Combined Ratio Points
8.6 8.9
$40
PY Reserve Development
Combined Ratio Points
PERSONAL LINES
90
98.6
95.6
94.3
96.4
105.3
104.5
Recent strong results
attributable favorable frequency
trends and low CAT activity
94.3
95
98.4
100
102.7
99.8
104.9
103.5
104.5
105
103.9
110
109.9
115
110.9
Personal Lines Combined Ratio
1993-2007E
85
93
94
95
96
97
98
99
Source: A.M. Best; Insurance Information Institute.
00
01
02
03
04
05
06 07E 08F
COMMERCIAL LINES
Commercial Lines Combined Ratio
1993-2008F
04
90
91.2
Recent results benefited from
favorable loss cost trends, improved
tort environment, low CAT losses,
WC reforms and reserve releases
95
97.5
102.5
03
100
94.0
111.1
112.3
109.7
110.2
102.0
105
103.9
107.6
110
110.2
112.5
115
110.3
120
105.4
125
Outside CAT-affected lines,
commercial insurance is
doing fairly well. Caution is
required in underwriting
long-tail commercial lines.
122.3
Commercial coverages
have exhibited significant
variability over time.
85
93
94
95
96
97
Sources: A.M. Best (historical and forecasts)
98
99
00
01
02
05
06 07E 08F
PREMIUM GROWTH
At a Virtual Standstill
in 2007/08
Strength of Recent Hard Markets by
NWP Growth*
25%
1975-78
1984-87
2001-04
Post-Katrina period
resembles 1993-97
(post-Andrew)
20%
15%
10%
5%
0%
-5%
2007: -0.6% premium growth
was the first decline since 1943
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007F
2008F
-10%
Note: Shaded areas denote hard market periods.
Source: A.M. Best, Insurance Information Institute
Personal/Commercial Lines &
Reinsurance NPW Growth 2006-2008F
30%
25%
20%
Net written premium growth
is expected to be slower for
commercial insurers and
reinsurers
28.1%
15%
10%
5%
2.0%-0.1%1.4%
3.5%
0%
-5%
-10%
-15%
-1.5%-2.3%
2006
2007E
Personal
2008F
Commercial
Sources: A.M. Best Review & Preview (historical and forecast).
-5.0%
-8.5%
Reinsurance
WEAK PRICING
Under Pressure in 2007/08 Especially
Commercial Lines
Average Expenditures on
Auto Insurance
$650
$847
$851
$847
$838
$823
$724
$690
$685
$668
$700
$651
$750
$703
$800
$705
$850
Countrywide auto insurance
expenditures are expected to fall
0.5% in 2007, the first drop since
1999
$691
$900
$780
$950
Lower underlying
frequency and modest
severity are keeping auto
insurance costs in check
$600
94 95 96 97 98 99 00 01 02 03 04 05* 06* 07*
*Insurance Information Institute Estimates/Forecasts
Source: NAIC, Insurance Information Institute
Average Expenditures on
Homeowners Insurance**
Countrywide home insurance
expenditures rose an estimated
$868
$835
4% in 2006
$787
Homeowners in non-CAT
$729
zones have seen smaller
$668
increases than those in CAT
zones
$900
$850
$800
$750
$700
$650
$593
$600
$536
$550
$508
$488
$481
$500
$455
$440
$450 $418
$400
95 96 97 98 99 00 01 02 03 04 05* 06* 07*
*Insurance Information Institute Estimates/Forecasts
**Excludes cost of flood and earthquake coverage.
Source: NAIC, Insurance Information Institute
Average Commercial Rate Change,
All Lines, (1Q:2004 – 1Q:2008)
0%
Source: Council of Insurance Agents & Brokers; Insurance Information Institute
1Q08 -13.5%
-12.0%
4Q07
2Q07
1Q07
4Q06
3Q06
2Q06
1Q06
4Q05
3Q05
2Q05
1Q05
4Q04
3Q04
2Q04
1Q04
-16%
3Q07 -13.3%
KRW Effect
-11.8%
-5.3%
-3.0%
-2.7%
-4.6%
-14%
-11.3%
-12%
-9.6%
-10%
-8.2%
-8%
-9.7%
-5.9%
-6%
-9.4%
-4%
-7.0%
-3.2%
-0.1%
-2%
Magnitude of rate decreases diminished
greatly after Katrina but have grown again
Cumulative Commercial Rate Change
by Line: 4Q99 – 1Q08
Commercial account pricing
has been trending down for 3+
years and is now on par with
prices in late 2001, early 2002
Source: Council of Insurance Agents & Brokers
Most Layers of Coverage are Being
Challenged/Leaking
$100 Million
Retro
Reinsurance
$50 Million
Excess
$10 Million
Primary
$2 Million
$1 Million
Reinsurers losing to
higher retentions,
securitization
Excess squeezed by
higher primary
retentions, lower
reins. attachments
Lg. deductibles,
self insurance,
RRGs, captives
erode primary
Retention
Source: Insurance Information Institute from Aon schematic.
Risks are comfortable
taking larger retentions
RISING EXPENSES
Expense Ratios Will Rise as
Premium Growth Slows
Personal vs. Commercial Lines
Underwriting Expense Ratio*
30%
Personal
31.1%
32%
29.4%
Commercial
30.0%
30.8%
29.9%
29.1%
28%
26%
25.0%
24.3%
24%
25.6% 25.6%
23.4%
27.0% 27.5%
26.6%
26.3%
25.6% 26.4%
27.1%
26.6%
25.0%
24.5%
26.1%
24.8%
24.7%
24.4% 24.6%
Expenses ratios will likely rise
as premium growth slows
22%
20%
96
97
98
99
00
01
*Ratio of expenses incurred to net premiums written.
Source: A.M. Best; Insurance Information Institute
02
03
04
05
06
07E
08F
CAPACITY/
SURPLUS
Accumulation of Capital/Surplus
Depresses ROEs
U.S. Policyholder Surplus:1975-2007*
$550
$500
$450
Capacity as of 12/31/07 was
$517.9B, 6.5% above year-end
2006, 81% above its 2002 trough
and 55% above its 1999 peak.
$400
$ Billions
$350
$300
$250
$200
The premium-to-surplus
fell to $0.85:$1 at yearend 2007, approaching
its record low of
$0.84:$1 in 1998
$150
$100
$50
“Surplus” is a measure of
underwriting capacity. It is
analogous to “Owners
Equity” or “Net Worth” in
non-insurance organizations
$0
75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07
Source: A.M. Best, ISO, Insurance Information Institute.
*As of December 31, 2007
P/C Insurer Share Repurchases,
1987- Through Q4 2007 ($ Millions)
Reasons Behind Capital BuildUp & Repurchase Surge
•Strong underwriting results
$22,322.6
•Moderate catastrophe losses
$310.1
$658.8
$769.2
93
94
95
$7,094.1
$5,266.0
$5,242.3
$763.7
$566.8
92
$1,539.9
$418.1
91
$2,764.2
$952.4
90
$4,297.3
$311.0
89
$4,586.5
$646.9
88
98
$564.0
87
$5,000
$2,385.6
$4,497.5
$10,000
Returning capital owners
(shareholders) is one of the
few options available
2007 repurchases to
date equate to 3.9% of
industry surplus, the
highest in 20 years
96
$15,000
•Reasonable investment
performance
•Lack of strategic alternatives
(M&A, large-scale expansion)
$20,000
$4,370.0
$25,000
2007 share buybacks shattered
the 2006 record, up 214%
Sources: Credit Suisse, Company Reports; Insurance Information Inst.
07
06
05
04
03
02
01
00
99
97
$0
INVESTMENT
OVERVIEW
More Pain,
Little Gain
Property/Casualty Industry Investment
Results, 1994-2007
$39.6
02**
03
04
$9.0
$54.6
$38.7
01
$52.3
$9.3
$36.7
00
$35.6
$37.1
99
$3.5
$59.2
$55.8
$48.9
$45.6
$6.9
$44.0
$6.9
$16.9
$40.8
98
$13.7
$18.0
$10.8
97
$38.6
96
$39.9
95
$41.5
$9.2
$38.0
$40
$36.8
$6.0
$50
$30
$63.6
$57.9
$52.3
$33.7 $1.7
Billions
$60
Realized capital
gains rising as
underwriting
$57.7
results slip
$9.7
Capital Gains/Losses
Investment Income
$49.5
$70
06
07E
$20
94
05
*Primarily interest, stock dividends, and realized capital gains and losses.
**Not shown: $1.1B capital loss in 2002.
2005 figure includes special one-time dividend of $3.2B.
Sources: ISO; Insurance Information Institute.
CATASTROPHIC
LOSS
What Will 2008 Bring?
$60
$40
$20
$9.2
$6.7
$3.1
$80
$61.9
$100
2006/07 were welcome respites.
2005 was by far the worst year
ever for insured catastrophe losses
in the US, but the worst has yet to
come.
$100 Billion
CAT year is
coming soon
$7.5
$2.7
$4.7
$22.9
$5.5
$16.9
$8.3
$7.4
$2.6
$10.1
$8.3
$4.6
$26.5
$5.9
$12.9
$27.5
$120
$ Billions
$100.0
U.S. Insured Catastrophe Losses*
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08:Q1
20??
$0
*Excludes $4B-$6b offshore energy losses from Hurricanes Katrina & Rita.
Note: 2001 figure includes $20.3B for 9/11 losses reported through 12/31/01. Includes only business and
personal property claims, business interruption and auto claims. Non-prop/BI losses = $12.2B.
Source: Property Claims Service/ISO; Insurance Information Institute
Inflation-Adjusted U.S. Insured
Catastrophe Losses By Cause of Loss,
1987-2006¹
Fire, $6.6 , 2.2%
Civil Disorders, $1.1
, 0.4%
Wind/Hail/Flood,
$9.3 , 3.1%
Earthquakes, $19.1 ,
6.4%
Winter Storms,
$23.1 , 7.8%
Terrorism, $22.3 ,
7.5%
Water Damage, $0.4
, 0.1%
Utility Disruption,
$0.2 , 0.1%
Nat CAT
Plan a
possibility in
2008?
Tornadoes, $77.3 ,
26.0%
Insured disaster losses
totaled $297.3 billion from
1987-2006 (in 2006 dollars).
Wildfires accounted for
approximately $6.6 billion of
these—2.2% of the total.
All Tropical
Cyclones, $137.7 ,
46.3%
1 Catastrophes are all events causing direct insured losses to property of $25 million or more in 2006 dollars.
Catastrophe threshold changed from $5 million to $25 million beginning in 1997. Adjusted for inflation by the III.
2 Excludes snow. 3 Includes hurricanes and tropical storms. 4 Includes other geologic events such as volcanic eruptions
and other earth movement. 5 Does not include flood damage covered by the federally administered National Flood
Insurance Program. 6 Includes wildland fires.
Source: Insurance Services Office (ISO)..
THE 2008 HURRICANCE
SEASON:
Predictions are for
an Active Season
Outlook for 2008 Hurricane Season:
60% Worse Than Average
Average*
2005
2008F
9.6
49.1
5.9
24.5
2.3
28
115.5
14
47.5
7
15
80
8
40
4
5
7
9
Accumulated Cyclone Energy
96.2
NA
150
Net Tropical Cyclone Activity
100%
275%
160%
Named Storms
Named Storm Days
Hurricanes
Hurricane Days
Intense Hurricanes
Intense Hurricane Days
*Average over the period 1950-2000.
Source: Philip Klotzbach and Dr. William Gray, Colorado State University, April 9, 2007.
REINSURANCE
MARKETS
Reinsurance Prices are Falling in
Non-Coastal Zones, Casualty Lines
Share of Losses Paid by
Reinsurers, by Disaster*
70%
60%
50%
40%
30%
Reinsurance is playing
an increasingly
important role in the
financing of megaCATs; Reins. Costs are
skyrocketing
30%
25%
60%
45%
20%
20%
10%
0%
Hurricane Hugo Hurricane Andrew
Sept. 11 Terror
2004 Hurricane
2005 Hurricane
(1989)
(1992)
Attack (2001)
Losses
Losses
*Excludes losses paid by the Florida Hurricane Catastrophe Fund, a FL-only windstorm reinsurer, which was
established in 1994 after Hurricane Andrew. FHCF payments to insurers are estimated at $3.85 billion for
2004 and $4.5 billion for 2005.
Sources: Wharton Risk Center, Disaster Insurance Project; Insurance Information Institute.
US Reinsurer Net Income & ROE
1985-2007*
$7.96
$9.68
5%
0%
-5%
ROE
07*
06
05
04
-10%
03
02
99
98
97
96
95
94
93
92
91
90
89
88
87
86
01
($2.98)
($4)
85
15%
ROE
$2.51
$3.41
$3.17
$1.31
$4.53
$1.47
$1.95
$2.52
$1.79
$1.17
$1.87
$2.03
Net Income
($2)
20%
10%
00
$0
$1.95
$1.94
$2
$1.38
$4
$1.22
$6
$3.71
$8
$0.12
Net Income ($ Bill)
$10
$1.99
$12
$5.43
Reinsurer profitability
rebounded post-Katrina but
is now falling
Source: Reinsurance Association of America. *2007 ROE figure is III estimate based return on average 2007 surplus.
SHIFTING LEGAL
LIABILITY & TORT
Is the Tort Pendulum
Swinging Against Insurers?
•Former partner in class action firm Milberg Weiss
•Admitted felon. Guilty of paying 3 plaintiffs $11.4
million in 150+ cases over 25 years & lying about it
repeatedly to courts
•Will serves 1-2 years in prison and forfeit $7.75
million; $250,000 fine
“King of Torts” Dickie Scruggs
•Won billions in tobacco, asbestos and Katrina litigation
•Pleaded guilty for attempting to offer a judge $40,000
bribe to resolve attorney fee allocation from Katrina
litigation in his firm’s favor. His son/othersguilty on
related charges
•Could get 5 years in prison, $250,000 fine
Source: Wall Street Journal, 3/15/07
“King of Class Actions” Bill Lerach
Source: San Diego Union Tribune, 9/19/07
Bad Year for Tort Kingpins*
Personal, Commercial &
Self (Un) Insured Tort Costs*
$250
Commercial Lines
Personal Lines
Self (Un)Insured
Total = $216.7 Billion
Billions
$200
$45.5
Total = $159.6 Billion
$150
Total = $121.0 Billion
$30.0
$85.6
$20.4
$100
$70.9
Total = $39.3 Billion
$51.0
$50
$0
$85.6
$5.2
$17.1
$17.0
$49.6
$58.7
1980
1990
2000
*Excludes medical malpractice
Source: Tillinghast-Towers Perrin, 2007 Update on US Tort Cost Trends.
2006
Tort System Costs, 1950-2009E
Tort System Costs
$250
2.24%
1.82%
1.98%
1.34%
$150
$265
$247.0
$246.0
1.87%
$179.2
1.53%
$200
2.24%
$277
2.5%
1.83% 2.0%
$158.5
1.5%
$130.2
1.03%
1.22%
$100 0.62%
1.0%
$83.7
$50
$1.8 $3.4 $5.4 $7.9
0.5%
$42.7
$13.9$20.0
$0
0.0%
50
55
60
65
70
75
80
Tort Sytem Costs
85
90
95
00
03
06 08E 09E
Tort Costs as % of GDP
Source: Tillinghast-Towers Perrin, 2007 Update on U.S. Tort Costs as % of GDP
Tort Costs as % of GDP
$300
After a period of
rapid escalation, tort
system costs as a % of
GDP are now falling
The Nation’s Judicial Hellholes (2007)
Some improvement
in “Judicial
Hellholes” in 2007
Watch List
Madison County, IL
St. Clair County, IL
Northern New Mexico
Hillsborough County,
FL
Delaware
California
NEVADA
Clark County
(Las Vegas)
ILLINOIS
Cook County
NEW JERSEY
Atlantic County
(Atlantic City)
West Virginia
Dishonorable
Mentions
District of Columbia
MO Supreme Court
MI Legislature
GA Supreme Court
Oklahoma
TEXAS
Rio Grande
Valley and
Gulf Coast
Source: American Tort Reform Association; Insurance Information Institute
South Florida
PRESIDENTIAL
POLITICS & P/C
PROFITABILITY
Political Quiz
• Does the P/C insurance industry perform
better (as measured by ROE) under
Republican or Democratic administrations?
• Under which President did the industry realize
its highest ROE (average over 4 years)?
• Under which President did the industry realize
its lowest ROE (average over 4 years)?
P/C Insurance Industry ROE by
Presidential Administration,1950-2008*
16.43%
15.10%
Carter
Reagan II
10.45%
8.93%
OVERALL RECORD:
8.65%
1950-2008*
8.35%
7.98%
Republicans 8.92%
7.68%
6.98%
Democrats 8.00%
6.97%
Party of President has
5.43%
5.03%
marginal bearing on
4.83%
profitability of P/C
4.43%
insurance industry
3.55%
G.W. Bush II
Nixon
Clinton I
G.H.W. Bush
Clinton II
Reagan I
Nixon/Ford
Truman
Eisenhower I
Eisenhower II
G.W. Bush I
Johnson
Kennedy/Johnson
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
*ROE for 2007/8 estimated by III. Truman administration ROE of 6.97% based on 3 years only, 1950-52.
Source: Insurance Information Institute
Summary
• Results were excellent in 2006/07; Overall profitability reached its
highest level since 1988
 Strong 2007 but ROEs slipping; Momentum for 2008
• Underwriting results were aided by lack of CATs & favorable
underlying loss trends, including tort system improvements
• Property cat reinsurance markets past peak & more competitive
• Premium growth rates are slowing to their levels since WW II;
Commercial leads decreases.
• Rising investment returns insufficient to support deep soft
market in terms of price, terms & conditions as in 1990s
• How/where to deploy/redeploy capital??
• Major Challenges:
 Slow growth environment ahead; cyclical & economic
 Maintaining price/underwriting discipline
 Managing variability/volatility of results
 Maintaining vigilance against changes in tort environment
 Managing regulatory/legislative activism
Insurance Information Institute
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