Market Cycle UpdatePersonal Lines

Greg Ciezadlo, FCAS, MAAA

Farmers Insurance Group

Casualty Actuarial Society

Spring Meeting 2002 – San Diego, California

Today’s Topics

• Historical Overview– Past cycles– The current downturn– Why cycles?

• Insurer reaction to the current cycle– Pricing– Product– Market availability– Segmentation

• Future outlook for personal lines insurers

…worst year ever in 2001 as the industry recorded an after-tax loss for the first time

in history.

P/C Net Income After Taxes1993-2001 ($ Millions)

$19,316

$10,870

$20,598

$24,404

$36,819

$30,773

$21,865$20,223

-$7,921-$10,000

-$5,000

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

$40,000

1993 1994 1995 1996 1997 1998 1999 2000 2001

Sources: A.M. Best, ISO, Insurance Information Institute.

2001 was the first year ever with a full year net loss

Key Drivers

• Confluence of events

– Insurance cycles

– Capital markets

– Investment yields

– TORTure

– Mold

– WTC/Catastrophes

0%

5%

10%

15%

20%

25%

19

70

19

72

19

74

19

76

19

78

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

U.S.

*Estimate from I.I.I. Groundhog Survey.Source: A.M. Best, Insurance Information Institute

Growth in Net Premiums Written (All P/C Lines)

2000: 5.1%

2001: 8.1%

2002 Forecast: 14.7%*

The underwriting cycle went AWOL in the 1990s.

It’s Back!

Auto Repair Costs

0%

10%

20%

30%

40%

50%

60%

95 96 97 98 99 '00 '01

Pe

rce

nta

ge

gro

wth

Cost of repairing vehicles Inflation rate

Construction Material Costs

0%

10%

20%

30%

40%

50%

60%

95 96 97 98 99 '00 '01

Per

cen

tag

e g

row

th

Cost of Housing Construction Material Inflation Rate

HO insurance costs & cost of home repairs

2.20%

5.30%

1.50%

3.4%4.1%

2.4%

3.20%

7.20%

6.00%

Overall CPI (Inflation) Home Repairs HO Insurance

1999 2000 2001* *2001 Estimate

Investment environment

-35%

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

DJIA S&P 500

-19%

-31%

March 2000 – December 2001

$0

$9

$18

$27

$36

$45

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

Net Investment Income

Facts

1997 Peak = $41.5B

1998 = $39.9B

1999 = $38.9B

2000= $40.7B

2001 = $37.1E

Source: A.M. Best, Insurance Information Institute

Bil

lion

s

(US

$)

Pricing & underwriting problems were exacerbated by declining investment income

Short-term interest rates are under 2%!

TORT-ure• Asbestos• “Toxic” Mold• Aftermarket Parts• Lead• Arsenic Treated Lumber• Construction Defects• Guns• What’s Next?• September 11!!!

Average Jury Awards1994 vs. 2000

419759

187 333

1,140 1,185

1,744

1,168

1,727

269698

3,482 3,566

6,817

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

Overall BusinessNegligence

VehicularLiability*

PremisesLiability

MedicalMalpractice

WrongfulDeath

ProductsLiability

($00

0)

1994 2000

Source: Jury Verdict Research; Insurance Information Institute.

Stachybotrys

$0

$200

$400

$600

$800

$1,000

$1,200

1997 1998 1999 2000 2001*

Source: Texas Department of Insurance * 2001 (estimate based on Jan. - Mar. data)

Texas: Paid Losses for Water Damage Claims

In M

illi

ons

9/11/2001

U.S. insured catastrophe losses

0

10

20

30

40

50

89 90 91 92 93 94 95 96 97 98 99 00 01*

$ Billions

95

100

105

110

115

120

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00

02**

P/C Industry Combined Ratio2000 = 110.1

2001 Estimate = 116.0

2002 Forecast* = 108.0

Combined Ratios

1970s: 100.3

1980s: 109.2

1990s: 107.7

Sources: A.M. Best; III

* Based on III 2002 Groundhog Forecast

Personal Lines Combined Ratios

99.5101.0101.1

109.4

103.5

108.2109.5

111.4

107.0

126.0

105103

90

95

100

105

110

115

120

125

130

*Breakeven Ratio: Reflects AY results, includes investment income; assumes 4% interest rate.Source: A.M. Best

97 98 99 00 01E BE*

97 98 99 00 01E BE*

PERSONAL AUTO HOMEOWNERS

$0

$50

$100

$150

$200

$250

$300

$350

75 77 79 81 83 85 87 89 91 93 95 97 99 01

Policyholder Surplus: 1975-2001

Source: A.M. Best, Insurance Information Institute

Bil

lion

s

(US

$)

Surplus Peaked at $336.3 Billion in 1999

•Surplus decreased 8.7% in 2001 to $289.6 Billion.

•Surplus is now lower than at year-end 1997.

Why do we still have cycles?

• Lag between emerging trends and insurers’ ability to react in the market

• Continued reliance on investment income to offset underwriting losses

• Reluctance to lead the pack• Incentives in place based on the past, not on the future • New and unusual events or coverage

– Tort liability crises in the 70’s and 80’s– High inflation in the 70’s– Mold

• Catastrophes

The Industry’s Reaction

• Price increases• New business limitations• Coverage modifications and/or exclusions• More sophisticated segmentation systems

– Insurance scoring using credit information

– Complex tiering plans using scoring plus other variables

– Introduction of rating plans in HO focused on the individual not the property

Average Price Change of Personal Lines Renewals

6%

7%

6%

6%3%

4%

1%

5%

4%

1%-1%

2%

0%

2%

-2% -1% 0% 1% 2% 3% 4% 5% 6% 7%

Homeowners

Personal Auto

2002* 2001* Fall 2000 Spring 2000 Fall 99 Spring 99 Fall 98*III estimatesSource: Conning, III

The Texas Result: A Lesson to be Learned4 out of the 5 top insurers stopped writing homeowners

HOB insurance policies due to the mold impact on business

Market Restrictions

• Tighter new business underwriting rules

• New business quotas

• Highly segmented rate changes

• Weaker nonstandard auto market

• Stop writing new business

• Withdrawal from the line

• Mold exclusions and water damage limitations

• Use of insurance scoring models for acceptance or retention

PERSONAL AUTO HOMEOWNERS

Mold-Induced Rate Increases Will Impact Affordability in

TX*

1.72%

2.40%2.60%

0.86%

$879 $1,230 $1,319

$481

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

TX TX--40% Hike TX--50% Hike US

Pre

miu

m a

s %

of

Inco

me

*As a % of the median family of 4’s income. Source: NAIC, Insurance Information Institute

In summary:

Reasons Why Market Will Remain Hard

• Price increases by market leaders• The Homeowners line has a long, tough road ahead to return to

profitability– Large price increases– Catastrophes remain problematic– Will product suffer from affordability or availability issues?

• Auto is in better shape, but …– Cost pressures from Diminished Value, OEM, etc.– Influence of legislation and court decisions on liability cases

• Uncertain investment future• Wall Street pressure for short-term profits

Where we are heading…

…conditions are set for improved results in 2002 as: •pricing environment continues

to harden appreciably

•policy coverage terms and conditions become more restrictive.

Outlook for 2002: Personal Lines

99.5101.0101.1

109.4

103.5

108.2109.5

111.4

107.0

126.0

106.3

117.5

105103

90

95

100

105

110

115

120

125

130

*Breakeven Ratio: Reflects AY results, includes investment income; assumes 4% interest rate.Source: A.M. Best

97 98 99 00 01E 02E BE*

97 98 99 00 01E 02E BE*

PERSONAL AUTO HOMEOWNERS

Market Cycle UpdatePersonal Lines

Greg Ciezadlo, FCAS, MAAA

Farmers Insurance Group

Casualty Actuarial Society

Spring Meeting 2002 – San Diego, California