Inflation Risk andP C IP-C Insurance:
Overview and OutlookJoint Meeting of the Underwriting, Claims,
and Emerging Issues Committeesand Emerging Issues CommitteesReinsurance Association of America
May 18, 2010 Philadelphia, PASteven N. Weisbart, Ph.D., CLU, Senior Vice President & Chief EconomistInsurance Information Institute ♦ 110 William Street ♦ New York, NY 10038Office: 212.346.5540 ♦ Cell: (917) 494-5945 ♦ [email protected] ♦ www.iii.org
Presentation Outline
1. What Causes Inflation?2 Inflation’s Past and Future2. Inflation s Past and Future3. Inflation’s Effect on Property-Casualty
Insurance ClaimsInsurance Claims4. P-C Premium Growth and Inflation5 Underwriting and Inflation5. Underwriting and Inflation6. Investments and Inflation7. Inflation, Reserve Adequacy, and Impairment
Q&A
2
What Makes Prices Increase?
An increase in the prices of the components (e.g., materials and labor) of the things we buy, if the sellers of those things pass along their increasedsellers of those things pass along their increased costs to buyers
S it f l i l ti t d d If thScarcity of supply in relation to demand. If there isn’t enough of a good or service to meet demand, the price of that item will tend to rise (and some b ill d t ti l /d dbuyers will drop out, creating a supply/demand equilibrium at a higher price)
Expectations. If sellers expect their costs to rise in the near future, they might raise prices now to avoid being caught. This includes the category of “b bbl ”“bubbles.”
What Makes the Prices of Items orComponents from Overseas Rise?
A drop in the value of the U.S. dollar. The price of any component that we buy from overseas couldany component that we buy from overseas could rise for us if the U.S. dollar’s value drops in relation to the value of the seller’s currency. In effect, it takes more U S money to convert to the sametakes more U.S. money to convert to the same price in foreign currency.
Trade-Index-Weighted US Dollar Exchange Rate*
110
115
January 2000 through April 2010Post-crisis
depreciation of dollar
Dollar appreciates in its role as the global “reserve
c rrenc ” is affirmed d ring
95
100
105
110 currency” is affirmed during the global financial crisis
85
90
95
Depreciation of dollar after
70
75
80of dollar after Tech bubble
and post 9-11
Jan00
Jan01
Jan02
Jan03
Jan04
Jan05
Jan06
Jan07
Jan08
Jan09
Jan10
Except in Times of Global Financial Crisis,The U.S. Dollar Has Weakened vs. Other Currencies
*The broad index is a weighted average of the foreign exchange values of the U.S. dollar against the currencies of a large group of major U.S. trading partners. The index weights, which change over time, are derived from U.S. export shares and from U.S. and foreign import shares. Sources: US Federal Reserve, Board of Governors, at http://www.federalreserve.gov/releases/g5/current/ ; Insurance Information Institute.
What Makes the Prices of Items orComponents from Overseas Rise?
New taxes, tariffs, or other charges (e.g., shipping) that increase the effective price of an itemthat increase the effective price of an item.
An increase in the price of the item in the selling countrycountry.
Inflation Rates for Largest European Economies & Euro Area, 2010F-2011F
9% 2010F 2011F
% Change from Prior Year
2010F 2011F
6% Annual inflation is below 2% across
most major European economies
2.6%
1 8%
3%
1.3% 1.1%1.5%
1.1%1.6% 1.5%
1.8% 1.6% 1.5%
0%0%Euro Area Germany UK France Netherlands
Source: Blue Chip Economic Indicators, 5/10/10 edition.
Inflation Rates for MajorEmerging Economies, 2010F-2011F
9 2%10.0% 2010F 2010F
% Change from Prior Year
9.2%
7.2%7.4%7.5%
5.0% 5.0%
6.6%
4.7%5.0%
2.8% 2.9%3.3%
4.2%
3.1%
2 5%
5.0%
Annual inflation is forecast to be above 3% across most
0 0%
2.5% to be above 3% across most major countries from which
we import
0.0%China India Brazil Russia Mexico S. Korea
Source: Blue Chip Economic Indicators, 5/10/10 edition.
“Headline” Inflation Rates,* Emergingvs. Advanced Economies, 2002-2009
10%Advanced Economies Emerging Economies
6%
8%
4%
6%
0%
2%
-2%
%
02 02 03 03 04 04 05 05 06 06 07 07 08 08 09 09
Jan
Jul
Jan
Jul
Jan
Jul
Jan
Jul
Jan
Jul
Jan
Jul
Jan
Jul
Jan
Jul
*12-month change in consumer price index, monthlySource: International Monetary Fund, “World Economic Outlook” update January 2010
This is Odd: “Core” Inflation is Now Higherin Advanced vs. Emerging Economies
5%
12-month change, monthly This spike preceded the
global financial crisis. It
4%
gbegan in early 2008
3%
1%
2%
0%
n 05 l 05
n 06 l 06
n 07 l 07
n 08 l 08
n 09 l 09
Advanced economies
Emerging economies
11
Jan
Jul
Jan
Jul
Jan
Jul
Jan
Jul
Jan
Jul
Note: data are through November 2009Source: International Monetary Fund World Economic Outlook January 2010 update at http://www.imf.org/external/pubs/ft/weo/2010/update/01/data/figure_2.csv
Japan is an Inflation ExceptionAmong Advanced Economies
221
113
115United States, Consumer Prices, All items, SA, Index,USD, 1982-1984=100Euro Zone, Consumer Prices, All Items, Total (ECB),SA, Index, EUR, 2005=100
216
109
111
113United Kingdom, Consumer Prices, By Commodity, Allitems (CPI), Index, GBP, 2005=100Japan, Consumer Prices, Nationwide, All Items,General, SA, Index, JPY, 2005=100
206
211
107
109
201
206
103
105
196
c-06 r-0
7
r-07
n-07 t-0
7
t-07
c-07 r-0
8
r-08
n-08 t-0
8
t-08
c-08 r-0
9
r-09
n-09 t-0
9
t-09
c-09
99
101
Source : Ecowin & SCOR (2010)
déc
févr avr
juin
août oc
t
déc
févr avr
juin
août oc
t
déc
févr avr
juin
août oc
t
déc
Recent Monthly Changesin U.S. Non-Fuel Import Prices
0 4% 0 4% 0 4% 0 4% 0 4%0.5%0.6%
Inflation Rate (%)
Mainly increases in prices for industrial supplies and materials
0.4% 0.4% 0.4%0.3%
0.4% 0.4%
0.1%0.2%0.2%0.2%
0.1%0.2%
0.4%
-0.2%-0.2%
0.0%
-0.6%
-0.4%
0 7%
-0.6%
-0.4%
Overall non-fuel April 2009-to-April 2010 increase was 3.2%. 12-month increase in
industrial supplies and materials was 16.0%-0.7%-0.8%Jan
2009Feb March April May June July AugustSept Oct Nov Dec Jan
2010Feb March April
13Source: http://www.bls.gov/news.release/pdf/ximpim.pdf
Overall Inflation In Some Countries From Which We Buy Is Forecast to Be Modest, But More Severe in Others
Forecasts of 2010-11 Inflation Ratesin Selected Countries
8 3
10
Inflation Rate (%)
8.3
6.47.3 7.4
6
8ChinaIndiaRussiaBrazilSouth Korea
4.4 4.7
2.9 2.9
4.84.0
2.41 8
2.3 2.63.2
2.64
6 South KoreaMexicoEuro ZoneJapanU.K.Australia
1.3 1.6
-0 2
1.8
0
2
-1.0-0.2
-22010 2011
14Source: Blue Chip Economic Indicators Mar. 2010.
Overall Inflation In Some Countries From Which We Buy Is Forecast to Be Modest, But More Severe in Others
Now, Really, What Causes Inflation?
“Too much money chasing too few goods ” When the Federal Reserve andgoods. When the Federal Reserve and the “shadow” banking system provide more money than people need at current y p pprices, prices rise to absorb the extra money.
“Inflation is everywhere and always a monetary phenomenon.” (Milton Friedman)
Inflation and the U.S. Monetary Base Have Roughly Moved Together (1975-2007)
18%CPI-U % change in monetary base
% Change from Start to End of Year
12%
15%The Monetary Base is coins, paper, and bank reserves—
money available for use.
9%
12%
3%
6%
-3%
0%
3%
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
Sources: http://www.federalreserve.gov/releases/H3/hist/h3hist4.txt Insurance Information Institute (calculations).
But the U.S. Monetary Base Exploded in 2008 (Monthly, 1990–2010*)
Billions
$2 000
$2,250The subsequent 6-
month increase, from mid-Sept 2009 to mid-March 2010,
$1,750
$2,000to mid March 2010,
was 16.7%.
$1,250
$1,500
The 12-month increase, from mid-Sept 2008 to mid-
$750
$1,000from mid Sept 2008 to mid
Sept 2009, was 108.5%.
$250
$500
'90 '93 '96 '99 '03 '06 '09
17
*As of end of April 2010; seasonally adjustedNote: Recessions indicated by gray shaded columns.Sources: http://www.federalreserve.gov/releases/H3/hist/h3hist4.txt National Bureau of Economic Research (recession dates); Insurance Information Institutes.
90 93 96 99 03 06 09
What Does the Spike in the Monetary Base in 2008-09 Mean for Future Inflation?
110%CPI-U % change in monetary base
80%90%
100%So far, this hasn’t produced
rampant inflation because banks have been reluctant to lend (and businesses reluctant to borrow)
50%60%70% businesses reluctant to borrow).
But this could change at any time.
20%30%40%
-10%0%
10%
10%
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 09
Source: US Department of Labor, Bureau of Labor Statistics
In 2008, Central Banks in Europe, the UK, andthe US Dramatically Expanded the Money Supply
2500000
3000000
250000
300000US Federal reserve Banks, Total assets or liabilities, dollars
Euro Zone, Eurosystem, Total assets or liabilities, EUR
United Kingdom, Bank of England, assets, GBP
2000000
2500000
uros
200000
250000g g
1500000
oilli
ons
of D
olla
rs o
r E
150000
500000
1000000Mo
50000
100000
0
2006
2006
2006
2007
2007
2007
2007
2008
2008
2008
2008
2009
2009
2009
2009
0
Source : Ecowin
26/0
5/2
26/0
8/2
26/1
1/2
26/0
2/2
26/0
5/2
26/0
8/2
26/1
1/2
26/0
2/2
26/0
5/2
26/0
8/2
26/1
1/2
26/0
2/2
26/0
5/2
26/0
8/2
26/1
1/2
Households and Businesses Are Now “Deleveraging”: Low Inflation Pressure
15%
Percent Change in Debt Held(Quarterly since 2004 at Annualized Rate)
9%
12%
3%
6%
-3%
0%
Home Mortgage Consumer Credit
-6%
3%
4:Q
14:
Q2
4:Q
34:
Q4
5:Q
15:
Q2
5:Q
35:
Q4
6:Q
16:
Q2
6:Q
36:
Q4
7:Q
17:
Q2
7:Q
37:
Q4
8:Q
18:
Q2
8:Q
38:
Q4
9:Q
19:
Q2
9:Q
39:
Q4
Home Mortgage Consumer CreditBusiness Corporate
2004
2004
2004
2004
2005
2005
2005
2005
2006
2006
2006
2006
2007
2007
2007
2007
2008
2008
2008
2008
2009
2009
2009
2009
Source: Federal Reserve Board, at http://www.federalreserve.gov/releases/z1/Current/z1r-2.pdf (latest data as of 5/14/2010)
Conventional Wisdom: Inflation Won’t Threaten Until We’re At Full Capacity
82%
Percent of Manufacturing Capacity
H i
“Full Capacity”
78%
80%Hurricane Katrina
74%
76% Recession began December 2007
70%
72%
hThe closer the economy is
66%
68%
70% March 2001-November 2001
recession
to operating at “full capacity,” the greater the
inflationary pressure
66%
Mar
01
Jun
01
Sep
01
Dec
01
Mar
02
Jun
02
Sep
02
Dec
02
Mar
03
Jun
03
Sep
03
Dec
03
Mar
04
Jun
04
Sep
04
Dec
04
Mar
05
Jun
05
Sep
05
Dec
05
Mar
06
Jun
06
Sep
06
Dec
06
Mar
07
Jun
07
Sep
07
Dec
07
Mar
08
Jun
08
Sep
08
Dec
08
Mar
09
Jun
09
Sep
09
Dec
09
Mar
10
Source: Federal Reserve Board statistical releases at http://www.federalreserve.gov/releases/g17/Current/default.htm 21
But Some Industrial ProductionCapacity Has Vanished
Some unused capacity is gone, and in other industries new capacity is needed, so the economy might be closer to full capacity than the industrial production numbers indicate
Source: Wall Street Journal, Feb. 3, 2009
capacity than the industrial production numbers indicate.If so, this might spur inflation sooner than expected.
Inflation Isn’t Double-Digit Now as It Was in 1974-81
14%
If you started work in the insurance industry 27 years ago, you never experienced
Annual Inflation Rates (%)
10%
12%
g , y pannual inflation as high as 6%
6%
8%
2%
4%
-2%
0%
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 08 09 10F
7 7 7 7 7 7 7 7 7 7 8 8 8 8 8 8 8 8 8 8 9 9 9 9 9 9 9 9 9 9 1
Sources: US Department of Labor, Bureau of Labor Statistics; Blue Chip Economic Indicators (5/2010 issue) (2010 forecast)
A Closer Look: Annual Inflation Rates(CPI-U, %), 1990–2014FAnnual Inflation Rates (%)
The recession and the collapse of commodity prices appear to have reduced inflation, at least for nowTwo years after the last
recession ended prices
3 4 3 4 3 23.8
5.4
4.24.0
5.0
6.0 recession ended, prices started up again
2.92.3
1.62.2
3.42.8
1.62.3
2.73.4 3.2
2.8
2.0 1.92.3 2.4 2.4
3.0 3.02.6 2.8
2.0
3.0
-0.41 0
0.0
1.0
-1.0
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10F
11F
12F
13F
14F
The Annual Inflation Rate (CPI-U) Has Been Below 4% Since 1992. The
25Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators, 3/2010 and 5/2010 issues (forecasts).
The Annual Inflation Rate (CPI U) Has Been Below 4% Since 1992. The Compound Average Growth Rate of Inflation 1992-2009 was about 2.3%.
Forecasts of Yearly U.S. Inflation Rates(CPI-U, %), 2010–2015FAnnual Inflation Rates (%)
Even the pessimistic forecasts don’t see the CPI rising much above 3% in the next 5+ years
2 5
3.23.13.13.12.83
4
Blue Chip AvgPessimistic
Bl Chi
2.0 1.92.3 2.4 2.4 2.5
1.71.5 1.6 1.7 1.8
2.4
2
Blue ChipMedian
Blue Chip AvgOptimistic
1.11
02010 2011 2012 2013 2014 2015
Overall Inflation Is Forecast to Rise Modestly through 2015
26Source: Blue Chip Economic Indicators Mar. 2010 and May 2010 issues.
y gbut Is Not Expected to Become a Major Concern
But Some Economists Say the Fed’s Inflation Target Should be Higher
Headline in Wall Street Journal Monday February 22, 2010:
Low Inflation Always Best? Some Urge a Policy RethinkSome Urge a Policy RethinkHigher inflation brings higher interest rates, giving the g g g g gFederal Reserve “more room” to lower rates when it wants to stimulate the economy.Higher inflation also lessens the debt burden (inflationHigher inflation also lessens the debt burden (inflation pushes incomes up but debt payments are fixed)
P d i fl ti t t 4% (C t t t 2%)Proposed inflation target: 4% (Current target: 2%)
Bernanke’s Recent Views onthe Fed’s 2% Inflation Target
A major inflation driver is expectations regarding the future rate of inflationfuture rate of inflation
Firms will raise prices if they expect their costs to increaseW k ill d d i t ff t t dWorkers will demand pay raises to offset expected higher inflation
Bernanke’s worry: If the Fed changes its target to a y g ghigher inflation level, people might think that the Fed isn’t serious about inflation, and might bid prices up proactivelyproactivelyBernanke: the Fed should maintain its 2% target in order to support current beliefs that the Fed will act to limit inflation to 2%
Source: http://www.federalreserve.gov/newsevents/speech/bernanke20100103a.htm
So If Inflation Isn’t Threatening Now,Why Are We Worried About It?
Rising Claim SeveritiesCost of claims settlement rises across the board (property and li bilit )liability)
Rate InadequacyRates inadequate due to low trend assumptions arising from use of hi t i l d thistorical data
Reserve InadequacyReserves may develop adversely and become inadequate (d fi i t)(deficient)
Burn Through on RetentionsRetentions, deductibles burned through more quickly
Reinsurance Penetration/ExhaustionHigher costs risks burn through their retentions more quickly, tapping into reinsurance more quickly and potentially exhausting th i i i kl
29
their reinsurance more quickly
Inflation’s Effect on Property-p yCasualty Insurance Claims
P-C Claim Severity Generally Has Risen Faster than the CPI
30
Resurgent Inflation Would Shift ClaimSeverity Upward for any Given Distribution
Loss distribution
Claims before inflation resurgenceClaims after inflation resurgence
)
g
roba
bilit
y (%
)Lo
ss p
r
Source : SCORLoss size ($)
Source: Philippe Trainar, “Inflation risk: a long term Pressure scenario for insurance companies,” presentation at the GenevaAssociation’s Amsterdam Circle of Chief Economists, February 11, 2010.
Major Components of the CPI-U,by Weighting
P-C Insurance Doesn’t Pay for the Major Items in the CPI. It FactorsSlightly in Housing, Transportation; Significantly in Medical Care
3 5%
Other
Recreation
Apparel
6.4%
6.4% 3.7%3.5%
Housing
Education & Communication
42.0%6.5%
gMedical Care
16.7%
14.8%Food & Beverages
Nearly 2/3 of this is the rent homeowners pay to themselves for
living in their own h
32Source: BLS News Release, March. 18, 2010 “Consumer Price Index – February 2010”
Transportationhome
Inside the Jan. & Feb. 2010 CPI:*Components Move Differently
2.8%
2 5%
3.0%Jan-10 Feb-10
Percent changefrom prior month
Weights of Selected CPI Components
1.5%
2.0%
2.5%g
Owners’ Equivalent Rent 25.2%Food and Beverages 14.8%Energy 8.6%Medical Care 6.5%
0.2% 0.2%0.5%
0 0% 0.1% 0 0% 0 0%
0.5%0.5%
1.0%
1.5%
-0.1% -0.1%
0.0% 0.1% 0.0% 0.0%
-0.5%-0.5%
0.0%
Overall CPI "Core" CPI Owners' Food & Medical EnergyOverall CPI Core CPI OwnersEquivalent
Rent
Food &Beverages
MedicalCare
Energy
The “Core” CPI Excludes Price Changes for Food and Energy Which Are Generally
*seasonally adjusted.Source: BLS
The Core CPI Excludes Price Changes for Food and Energy, Which Are Generally Volatile. These Items Are Nearly ¼ of the CPI. The Largest Single CPI Component isan Estimate of What Homeowners Would Pay as Rent to Themselves as Landlords.
33
Inside the Jan. & Feb. 2010 CPI:*Components Move Differently
19.1%18%20%
Percent change fromsame month, prior year
Weights of Selected CPI ComponentsOwners’ Equivalent Rent 25.2%Food and Beverages 14.8%Energy 8.6%
14.4%
12%14%16%
Energy 8.6%Medical Care 6.5%
2 6%3.5% 3.6%4%
6%8%
10%
2.6%1.6%
0.4%
-0.2%
2.1% 1.3%0.3%
-0.1%-2%0%2%4%
Overall CPI "Core" CPI Owners'Equivalent
Rent
Food &Beverages
Medical Care Energy
The “Core” CPI Excludes Price Changes for Food and Energy Which Are Generally
*seasonally adjusted.Source: BLS
The Core CPI Excludes Price Changes for Food and Energy, Which Are Generally Volatile. These Items Are Nearly ¼ of the CPI. The Largest Single CPI Component isan Estimate of What Homeowners Would Pay as Rent to Themselves as Landlords.
34
When Prices for Some Items Drop, Check the Prior-Year Surgeg
10.3% 9.7%10%12%
2008 2009(Percent)
3.8%
6.8%
9.7%
4.8%
4%6%8%
10%
2.3%
-0 40%
1.7%
2%0%2%4%
0.40%
-2.9%-4.6%-6%
-4%-2%
Overall CPI "Core" CPI Heating Structural ResidentialOverall CPI Core CPI HeatingEquipment
StructuralSteel
Products
ResidentialMaint &Repair
Sources: Bureau of Labor Statistics; Insurance Information Institute.
Some Costs Related to Construction Spiked in 2008,Far Above the Overall Inflation Rate (CPI), then Retreated in 2009
35
Price Indexes for Elements ofProperty Claims Monthly, Jan 2008-Feb 2010
210
Price Index
Construction materials prices spiked Up 10 7%
Material and Supply Inputs to Construction Industries
205.
0
206.
1
4
205.
4
1.1
205
through the first half of 2008, returned to pre-spike levels by Spring 2009,
but prices for construction materials are climbing again.
Up 10.7% Jan-July
2008.0
200.
4
194.
3
6 7
201
197.
4
195
200
Up 3.4% Mar 2009-Feb 2010
5.5
186.
6
190.
1
193 1
189.
5
189.
9
187.
4
86.3
86.3 18
7.6 188.
9
187.
9 189.
9
189.
5
188.
8
189.
8
190.
2 192.
619
2.
185
190
Annual price increases,
Feb 2010
185 1 18 18
180
185
08 08 08 08 08 08 08 08 08 08 08 08 09 09 09 09 09 09 09 09 09 09 09 09 10 10
p ,2008 over 2007: +8.2%2009 over 2008: -3.9%
Jan
0
Feb
0M
ar 0
Apr
0M
ay 0
Jun
0Ju
l 0
Aug
0Se
p 0
Oct
0N
ov 0
Dec
0Ja
n 0
Feb
0M
ar 0
Apr
0M
ay 0
Jun
0Ju
l 0
Aug
0Se
p 0
Oct
0N
ov 0
Dec
0Ja
n 1
Feb
1
Sources: Bureau of Labor Statistics; Insurance Information Institute calculations.36
Inflation in Legal and Auto Repair Costs Affects P/C Claims More than the CPI Suggests
4.1%3.8% 3.9%
4%
5%(Percent)
1.8%
2.7%3.0%
2%
3%
4%
0%
1%
2%
-0.4%-1%
0%
Overall CPI "Core" CPI Legal US Tort Motor Motor MotorServices Costs Vehicle
Parts &Equipment
VehicleBody Work
VehicleRepair
Repair Parts/Labor and Legal/Tort Costs
Sources: BLS; Legal services and motor vehicle body work are avg. monthly year-over-year change from BLS;Tort costs is 2009 Towers-Perrin estimate.
Repair Parts/Labor and Legal/Tort CostsAre Major P/C Insurance Cost Drivers.
37
In the UK, the Household Rebuilding CostIndex is Also Higher Than the British CPI
Annual Change in the Household Rebuilding Cost Index and Retail Prices IndexAnnual Change in the Household Rebuilding Cost Index and Retail Prices Index
9,00
10,00 Household Rebuilding Cost Index
7,00
8,00
%)
4,00
5,00
6,00
nnua
l Inc
reas
e (%
2,00
3,00
An
B iti h
0,00
1,00
nv-9
8vr
-98
uil-
98oc
t-98
nv-9
9vr
-99
uil-
99oc
t-99
nv-0
0vr
-00
uil-
00oc
t-00
nv-0
1vr
-01
uil-
01oc
t-01
nv-0
2vr
-02
uil-
02oc
t-02
nv-0
3vr
-03
uil-
03oc
t-03
nv-0
4vr
-04
uil-
04oc
t-04
nv-0
5vr
-05
uil-
05oc
t-05
nv-0
6vr
-06
uil-
06oc
t-06
nv-0
7vr
-07
uil-
07oc
t-07
nv-0
8vr
-08
uil-
08oc
t-08
nv-0
9
British CPI
Source : Association of British Insurers
jan av ju o jan av ju o jan av ju o jan av ju o jan av ju o jan av ju o jan av ju o jan av ju o jan av ju o jan av ju o jan av ju o jan
HRCI RPI
All Segments of French Motor Insurance CostsHave Grown Faster than the CPI for Over 20 Years
Average cost of motor insurance
220Liability for materialsTheft & Fire
180
200
Theft & FireGlass breakageAccidental damagesCPI
160
180
00 =
198
7
140
10
100
120
Source : Fédération Française des Sociétés d’Assurance
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Most segments of French home insurance costs have been growing more rapidly than the CPI for more than 20 years
Average cost of home insurance ("multirisque habitation")
300
FireWi d S H il
250
Wind, Snow, HailTheftWater damagesLiabilityGlass breakageCPI
150
200
100
50
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Source : Fédération Française des Sociétés d’Assurance
Of Course, The Prices of Some ThingsP-C Insurers Pay For Have Dropped
120
Plywood & Engineered WoodIndex Price Change from Prior Year2004 7.0%2005 -1.7%
110
120 2006 -5.3%2007 -5.0%2008 1.3%2009 -5.4%
100
90
80
c 03
c 04
c 05
c 06
c 07
c 08
c 09
Dec
Dec
Dec
Dec
Dec
Dec
Dec
Source: Department of Labor (Bureau of Labor Statistics); not seasonally adjusted
Inflation’s Effect is Unusually Strong y gwith Health Care Costs
This Isn’t Just a U.S. Phenomenon
42
Medical Cost Inflation Has Outpaced Overall Inflation for Many Years
380Since 1982-84, (index =100) the cost of
medical care has more than tripled, while the overall cost of living merely doubled
320
4=10
0
the overall cost of living merely doubled
260
ue (1
982-
84
140
200
Inde
x V
alu
80
140
2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9
All Items Medical Care
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 09
Source: Department of Labor (Bureau of Labor Statistics); not seasonally adjustedhttp://www.bls.gov/news.release/pdf/cpi.pdf
French Health Insurance Tells the Same Story (as Does Many Other Countries)
130
135CPIHealth Insurance CPI
125
130
115
120
100
= 19
98
110
1151
100
105
Source : INSEE
1001998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
P-C Claims Tend to Be for Intense Medical Activities,Whose Costs Grew Faster than Medical Care in General
220
Hospital Services Medical CareIndex
200
220From 1997 to 2009, hospital services costs grew 107% while the cost of medical
care overall grew 60%
160
180care overall grew 60%.
120
140
100
120
97 98 99 00 01 02 03 04 05 06 07 08 09
Source: Department of Labor (Bureau of Labor Statistics); not seasonally adjusted; medical care costs re-indexed to 100 in 1997 by III calculations
In France, since 2001 a growing gap between the growth rateof the cost of severe injuries and inflation/GDP growth rate
Average cost of severe French bodily injuries180
160
170 Average costsInflationGDP at current prices
140
150
ost i
n 20
01
130
140
100
= C
o
110
120
Source : SCOR Global Life (2009)
1002001 2002 2003 2004 2005 2006 2007
The Rising Cost of Medical Care AffectsP/C Claims More than 2009 CPI Implies
5.5%6.2%
6%
7%(Percent) The “core” = the overall CPI after
removing the effect of price changes in food and energy
3.1%
4.3%
3%
4%
5%
1.8%
1%
2%
3%
-0.4%-1%
0%
Overall CPI "Core" CPI Medical Care PP Auto WC Med PP Auto No-Bodily Injury
SeveritySeverity Fault Claim
Severity
Healthcare Costs Are Major P/C Insurance Cost Drivers.
Sources: BLS; medical care changes are avg. monthly year-over-year change from BLS; BI and no-fault figures from ISO Fast Track data for 4 quarters ending 09:Q3. WC figure is I.I.I. estimate based on historical NCCI data.
Healthcare Costs Are Major P/C Insurance Cost Drivers.They Are Expected to Increase Above the Inflation Rate (CPI) Indefinitely
47
Shifting Legal Liability & g g yTort Environment
Tort Costs Might Spike Again; but This Isn’t the Conventional SenseThis Isn’t the Conventional Sense
of Inflation
48
The Frequency of Million-Dollar Verdicts*Was Increasing With Moderate Inflation
100%2001-2003 2004-2005 2006-2007
%
80%
90%2001-2003 2004-2005 2006-2007
Across all liability types, million-dollar-plus awards rose from 13% of all awards from
48%
59%
%
53% 60
%
51% 57
%
65%
50%
60%
70% from 13% of all awards from 2001-2003 to 17% in 2006-07.
29% 37
% 41%
33%
30%
30%
40%
50%
0%
10%
20%
0%Business Negligence Government Negligence Medical Malpractice Products Liability
*Verdicts of $1 million or more.Source: Jury Verdict Research; Insurance Information Institute.
In the 1990s and Since 2003, Tort SystemCost Growth Has Moderated vs. Inflation
15% Rate of Tort System Cost Growth Without these two high-growth years tort cost
Growth Rate
9%
12%CPI
growth years, tort cost growth this decade
would have been close to the CPI
3%
6%
9%
0%
3%
-6%
-3%
91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20
Sources: US Bureau of Labor Statistics, Tillinghast-Towers Perrin, 2009 Update on U.S. Tort Costs; Insurance Info. Inst.
So P C Insurance Claim CostsSo P-C Insurance Claim Costs Increase Faster Than Inflation.
But Why?
51
7 Reasons Why P-C Insurance Claims Often Rise Faster than Inflation1. They contain at least an element of moral
hazard, if not also a fraud/abuse dimension that i ’ i i llisn’t present in prices generally.
a. This is reinforced by “bad faith” laws and/or consumer attitudes (surveys show that manyconsumer attitudes (surveys show that many people believe that it’s okay to inflate an insurance claim). So to avoid “bad faith” outcomes insurers
l i th i ht th i h llpay some claims they might otherwise challenge
2. When deductibles apply, they tend to stay fixed pp y, y y(in dollars) over long periods of time, even though the price of the insured item increases (so that a larger percent of the damage is(so that a larger percent of the damage is covered as time goes on)
Why P-C Insurance ClaimsOften Rise Faster than Inflation (cont’d)
3. P-C insurance sometimes pays for open-ended items (e g additional living expenses liabilityitems (e.g., additional living expenses, liability defense costs) which can, through the quantity of the item purchased, inflate the insurer’s l i diclaims spending.
4. For claims that involve health care of severely-yinjured people, the cost of hospital services has far outstripped the CPI
Why P-C Insurance ClaimsOften Rise Faster than Inflation (cont’d)
5. In some cases, competitive price forces don’t operate as strongly on insured goods andoperate as strongly on insured goods and services (vs. non-insured goods and services); for example, they might
a. Be protected from international competitionYou can’t outsource repair of a car or a building to a lower-labor-cost countryff f f &b. Be affected by the changing social value of life &
sufferingThe cost of pain medication for people with chronic pain is far outstripping general inflation
c. Concern services where productivity gains are limited
Examples are defending lawsuits, repairing roofs, clearing debris, etc.
Why P-C Insurance ClaimsOften Rise Faster than Inflation (cont’d)
5. for example, they mightd. Be confident that they car raise prices without fear y p
of a drop in demand for their services If your property is damaged you generally must get it repaired or replacedp p
e. Be affected by shortages of particular skilled labor despite general conditions of high unemployment
If might be difficult to find and keep mechanics with theIf might be difficult to find and keep mechanics with the training and experience to fix today’s complex modern cars
f. Be affected by the cost of acquiring expensivef. Be affected by the cost of acquiring expensive new diagnostic equipment and the “need” to use it (and charge for its use) perhaps more often than necessarynecessary
Why P-C Insurance ClaimsOften Rise Faster than Inflation (cont’d)
6. Demand Surge. In catastrophe (and some other) situations, demand for materials andother) situations, demand for materials and labor is highly concentrated, pushing up prices for scarce resources.
7. Cost-shiftinga The “deep pocket” principle: as long as ana. The deep pocket principle: as long as an
insurer “can afford it,” some Courts will extend their liability (judicial cost inflation)
b. Medical care providers charge higher rates for patients not covered by Medicare or Medicaid
56
P/C Premium Growth and InflationP/C Premium Growth and Inflation
Mainly Driven by the Industry’s Underwriting CycleIndustry s Underwriting Cycle,
Not the Economy
57
P-C NWP Growth Generally Matchesor Exceeds Inflation 1971-2009
25%
CPI-U NPW Growth(Percent)1975-78 1984-87 2000-03
20%
10%
15%
5%
-5%
0%
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 08 09
58
7 7 7 7 7 7 7 7 7 8 8 8 8 8 8 8 8 8 8 9 9 9 9 9 9 9 9 9 9 0 0 0 0 0 0 0 0 0 0
Shaded areas denote “hard market” periodsSources: A.M. Best, ISO, Insurance Information Institute
Other Underwriting-RelatedEffects of Higher Inflation
Rising Insurable ValuesPremium volume and agent commissions will rise even if rates gare flat
Increased Political Response to Rate Increase RequestsRequests
Regulators might reject rate increase proposals to curry favor with insurance consumers
L P fit D t R St th iLower Profits Due to Reserve StrengtheningBurn Through on Retentions
Retentions, deductibles burned through more quickly, g q y
Reinsurance Penetration/ExhaustionHigher costs risks burn through their retentions more quickly, tapping into reinsurance more quickly and potentially exhausting
60
tapping into reinsurance more quickly and potentially exhausting their reinsurance more quickly
An Inflation Spike Would be More Costly for“Long-tail” than “Short-tail” Insurance Lines
Short tail LoBs (mainly property insurance) can quickly adjust to an increase in the ratecan quickly adjust to an increase in the rate of inflation
–Policy periods generally last six months to aPolicy periods generally last six months to a year, or may be on a reporting form, so they adjust premiums frequently
–Claims tend to be paid soon after they’re reported, so an inflation spike won’t affect th hthem as much
–Their asset durations match their liability structure so investment income maystructure, so investment income may increase rapidly with interest rates
An Inflation Spike Would be More Costly for“Long-tail” than “Short-tail” Insurance Lines
Long tail LoBs have more difficulty with resurgent inflationresurgent inflation
–Claims tend to be paid long after they’re reported, so an inflation spike would magnify p , p g yclaims
–Their asset durations match their liability structure, so investment income may increase gradually, while values of existing assets o ld decline ith an inflation spikeassets would decline with an inflation spike
–Needed reserve strengthening would sap profits making it difficult to earn their equityprofits, making it difficult to earn their equity cost of capital
Investments and InflationInvestments and Inflation
Interest-Based InvestmentsBenefit from Higher Inflationg
63
Distribution of P/C InsuranceIndustry’s Invested Assets
Portfolio Facts As of September 30, 2009
Invested assets totaled $1.245 trillion as of 9/30/09 68.7%
Bonds
Insurers are generally conservatively invested, with more than 2/3 of assets invested in bonds as of 9/30/09
Only about 17% of assets were invested in common and preferred stock as of 9/30/09 7 3%
17.0%5 7%
Other
Even the most conservative of portfolios was hit hard in 2008
7.3%1.2%
5.7%
StockMortgages & Real Estate
Cash and Short-term
Investments
64Sources: NAIC, via SNL Financial; Insurance Information Institute calculations.
Bond Yields Tend to Follow Inflation,but the Relationship is a Loose One
10%CPI-U % Change U.S. Treasury 10-Year Note Yield
8%
10%Forecast
6%
2%
4%
0%
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10F
11F
12F
13F
14F
-2%Sources: US Bureau of Labor Statistics (history); Blue Chip Economic Indicators, 10/09 and 2/10 issues (forecast)
P/C Investment Income* as a % ofInvested Assets Follows 10-Year U.S. T-Note
9%P-C Inv Income/Inv Assets 10-Year Treasury Note
7%
8%The midpoint of the Blue Chip forecasts indicates that T-note
yields might spike in 2012.
5%
6%
7%
4%
5%
P-C investment yield historically tracks
2%
3%
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 0F 1F 2F 3F 4F
P C investment yield historically tracks 10-year Treasury note quite closely
1 1 1 1 1
*Not including realized capital gains/lossesSources: history: Board of Governors, Federal Reserve System; A.M.Best; Insurance Information Institute.forecasts: Blue Chip Economic Indicators, 10/2009 issue
Inflation’s Effect onP C Cl i RP-C Claim Reserves
Will I i t RiWill Impairments RiseIf Reserves Are Deficient?
67
Strengthening and Releasing P/C Reserves Appears Unrelated to Inflation
$23.2
$20
$25
$30
e ($
B
3 0%
3.5%
4.0%Prior Yr. ReserveDevelopment ($B)Inflation
$2.3 $1 0
$11.7 $13.7$9.9
$7.3$5
$10
$15
$
erve
Rel
eas
1 5%
2.0%
2.5%
3.0%
Inflation
-$2.1
-$8.3
-$2.6-$6.6
-$9 9-$9 8
-$4.1
$1.0
-$6.7-$9 5
-$5.0-$10
-$5
$0
rior Y
r. R
ese
0.5%
1.0%
1.5%
(CPI-U
)
-$9.9-$9.8 -$9.5-$14.6-$16.0-$15.0
-$20
-$15
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10F
11F
P r
-0.5%
0.0%
1 1
Reserve Releases Are Expected to Taper Off in 2010 and Drop Significantly in 2011
68
Note: 2005 reserve development excludes a $6 billion loss portfolio transfer between American Re and Munich Re. Including this transaction, total prior year adverse development in 2005 was $7 billion. The data from 2000 and subsequent years excludes development from financial guaranty and mortgage insurance. Sources: Barclay’s Capital; A.M. Best, BLS
Reasons for US P/C Insurer Impairments, 1969–2008
Deficient Loss Reserves and Inadequate Pricing Are the Leading Cause of Insurer Impairments, Underscoring the Importance of Discipline.
Investment Catastrophe Losses Play a Much Smaller Role
3.7%4 2%
Investment Catastrophe Losses Play a Much Smaller Role
Reinsurance Failure
Mi
Sig. Change in Business
4.2%9.1%
7.0% 38.1% Deficient Loss Reserves/Inadequate Pricing
Investment Problems
Misc.
7.9%
38.1% Inadequate Pricing
Affiliate Impairment
7.6%
8.1% 14.3%Catastrophe Losses
69Source: A.M. Best: 1969-2008 Impairment Review, Special Report, Apr. 6, 2008
Rapid GrowthAlleged Fraud
P/C Insurer Impairments, 1969–2009p
60 5860
70 5 of the 11 are Florida companies (1 of these
5 is a title insurer)
649 50 48
55
541
49 5047
40
50
6034
19 6
36
3134
296
3118 19
351820
30
40
815
127
11 9 913 12
19
16 14 13
1 612
1 1 114 15
711
5
0
10
20
0
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 07 08 09p
The Number of Impairments Varies Significantly Over the P/C Insurance
Source: A.M. Best; Insurance Information Institute.
p g yCycle, With Peaks Occurring Well into Hard Markets
P/C Insurer Impairment Frequencyvs. Inflation, 1970-2009p
12%
14%
1.8
2.0Inflation P/C Impairment Frequency
8%
10%
CPI
)
1.2
1.4
1.6
Impa
4%
6%
Infla
tion
(
0 6
0.8
1.0
irment R
ate
0%
2%
0.2
0.4
0.6
-2%
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 08 09
0.0
The Highest Impairment Rates Appear Affected by Inflation,
710.36% 2009 impairment rate is III estimate based on preliminary A.M. Best data.Sources: BLS, A.M. Best, Insurance Information Institute
g p pp y ,But the Correlation Isn’t a Strong One
Re-Ignited Inflation is An Economic Catastrophe (Like a Major Hurricane?)( j )
Hold more capital to cover the uncertainty of re emergent inflationof re-emergent inflationGo more heavily into inflation-indexed investmentsinvestmentsImprove the quality of data used for reserving
Underlying trends & elasticitiesTailored inflation inde es?Tailored inflation indexes?
Regulators Must Be Part of the Discussion