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The Financial Crisisand
Its Effect onthe P/C Insurance Industry
48th Annual Insurance All-Industry DayIllinois State University
Bloomington, ILNovember 12, 2009
Steven N. Weisbart, Ph.D., CLU, Senior Vice President & Chief EconomistInsurance Information Institute 110 William Street New York, NY 10038
Office Tel: (212) 346-5540 Cell: (917) 494-5945 [email protected] www.iii.org
The Economy What It Means for the Industry’s
Exposure Base,Growth,
and Investments
Based on Recent History, the Recovery Is Likely to Last 5 Years, or Even More
43
138 11 10 8 10 11
166
168 8
22
50
80
37
45
39
24
106
36
58
12
92
120
73
0
10
20
30
40
50
60
70
80
90
100
110
120
Aug.1929
May1937
Feb.1945
Nov.1948
July1953
Aug.1957
Apr.1960
Dec.1969
Nov.1973
Jan.1980
Jul.1981
Jul.1990
Mar.2001
Dec.2007
Contraction Expansion following
Current contraction assumed to continue through September 2009Sources: National Bureau of Economic Research; Insurance Information Institute.
Duration (Months)
Month Recession Started
3.1%
2.1%
5.4%
1.4%
0.1%
3.0%
1.2%
3.2% 3.
6%
2.1%
1.5%
-5.4
%
-6.4
%
-0.7
%
3.5%
2.4% 2.6%
2.7%
2.8%
2.9%
-0.7
%
-2.7
%-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
05:3
Q
05:4
Q
06:1
Q
06:2
Q
06:3
Q
06:4
Q
07:1
Q
07:2
Q
07:3
Q
07:4
Q
08:1
Q
08:2
Q
08:3
Q
08:Q
4
09:1
Q
09:2
Q
09:3
Q
09:4
Q
10:1
Q
10:2
Q
10:3
Q
10:4
Q
Real Quarterly GDP Changes (annualized),
2005:Q3-2010:Q4F
Sources: US Department of Commerce, Bureau of Economic Analysis (actual) at http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm Blue Chip Economic Indicators 10/09 issue (forecasts).
Spike due almost entirely to the weak dollar (growing exports and slowing imports)
Red bars are actual; Yellowbars are forecasts/estimates
The Q1:2009 decline was the steepest since the
Q1:1982 drop of 6.4%
95
98
101
104
107
110
113
Mar 01
Jun 0
1
Sep 0
1
Dec 0
1
Mar 02
Jun 0
2
Sep 0
2
Dec 0
2
Mar 03
Jun 0
3
Sep 0
3
Dec 0
3
Mar 04
Jun 0
4
Sep 0
4
Dec 0
4
Mar 05
Jun 0
5
Sep 0
5
Dec 0
5
Mar 06
Jun 0
6
Sep 0
6
Dec 0
6
Mar 07
Jun 0
7
Sep 0
7
Dec 0
7
Mar 08
Jun 0
8
Sep 0
8
Dec 0
8
Mar 09
Jun 0
9
Total Industrial Production, monthly Mar 2001-Sept 2009 (Index 2002=100)*
Source: http://www.federalreserve.gov/releases/g17/ipdisk/ip_sa.txt. *seasonally adjusted5
Recession began December 2007
A bottom?
Index
Hurricane Katrina
March 2001-November 2001
recession
Near-Term Forecasts for QuarterlyIndustrial Production: A Wide Range
5.3%
9.6%
7.7%
6.6% 6.8% 7.1%
1.2%1.7% 1.7%
1.2%1.6%
2.0%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
09:Q3 09:Q4 10:Q1 10:Q2 10:Q3 10:Q4
Avg of 10 Most Optimistic Forecasts
Avg of 10 Most Pessimistic Forecasts
Source: Blue Chip Economic Indicators (10/09)
7
State Economic Growth Varied Tremendously in 2008
Lowest growth quintile
8
New Private Housing Starts,1990-2010F (Millions of Units)
2.07
1.80
1.36
0.90
0.58
0.81
1.48
1.351.
46
1.29
1.20
1.01
1.19
1.47
1.62 1.64
1.57 1.60 1.
71
1.85 1.
960.50.60.70.80.91.01.11.21.31.41.51.61.71.81.92.02.1
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09F 10F
Exposure growth due to home construction forecast for HO insurers is dim for 2009
with some improvement in 2010.
Impacts also for comml. insurers with construction risk exposure
New home starts plunged 34%
from 2005-2007; Drop through 2009 is 72% (est.)—a net
annual decline of 1.49 million
units, lowest since record
began in 1959
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 2009 vs. 2005 is estimated at about $1.3 billion.
Source: US Department of Commerce; Blue Chip Economic Indicators (10/09); Insurance Information Inst.
9
16.916.916.6
17.117.5
17.817.4
16.516.1
13.1
10.4
11.8
9
10
11
12
13
14
15
16
17
18
19
99 00 01 02 03 04 05 06 07 08 09F 10F
Low auto sales will have a less pronounced effect on auto insurance
exposure growth than problems in the housing market will on home insurers
Auto/Light Truck Sales,1999-2010F (Millions of Units)
Source: US Department of Commerce; Blue Chip Economic Indicators (10/09); Insurance Information Inst.
Labor Market Trends
Massive Job Losses Sap the Economy & Personal &
Commercial Lines Exposure
2
4
6
8
10
12
14
16
18
Jan-
00
Jan-
01
Jan-
02
Jan-
03
Jan-
04
Jan-
05
Jan-
06
Jan-
07
Jan-
08
Jan-
09
Traditional Unemployment Rate U-3Unemployment + Underemployment Rate U-6
January 2000 through September 2009, seasonally adjusted
U-6 went from 9.2% in April 2008 to
17.0% in Sept. 2009
Source: US Bureau of Labor Statistics; Insurance Information Institute.
9.8% Sept. 2009 unemployment rate (U-3) was the highest monthly rate since 1983. Peak rate in the last 30 years: 10.8% in
Nov-Dec 1982.
Unemployment and UnderemploymentRates: Rocketing Up in 2008-9
Percent
U.S. Unemployment Rate ForecastsQuarterly, 2009:Q3 to 2010:Q4
10.1%10.3%
10.4%10.3%
10.2%10.0%
10.1%10.0%
9.8%
9.5%
9.9%9.8%
9.6%
9.2%
8.9%
8.5%
9.0%
9.5%
10.0%
10.5%
11.0%
09:Q4 10:Q1 10:Q2 10:Q3 10:Q4
10 most pessimistic consensus/midpoint 10 most optimistic
Sources: Blue Chip Economic Indicators (10/09); Insurance Info. Inst.
Unemployment is expected to peak in late 2009:Q4 or 2010:Q2.
Rising unemployment will erode payrolls and workers comp’s exposure base.
Unemployment Rates* by State,September 2009: 15 Highest States
10.5
15.2
12.213
.012.7
11.5
11.1
10.8
10.8
10.712
.2
11.4
10.4
10.2
10.0
0
2
4
6
8
10
12
14
16
MI NV RI CA SC OR DC FL KY NC AL TN IL OH GA
Une
mpl
oym
ent R
ate
(%)
*Seasonally adjusted.
Sources: US Bureau of Labor Statistics at www.bls.gov/web/laumstrk.htm Insurance Information Institute.
The US average was 9.8%
14
% Change in Employment by Industry:All But Government/Health/Education Down
-18.3%
-12.6%
-7.4%-4.8%
1.4% 1.7% 2.2%
-0.4%
-3.4%-2.4%
-20%
-15%
-10%
-5%
0%
5%
Overall, private employment dropped by 5.4% from Sept 2008 to Sept 2009; total nonfarm employment dropped
4.5% in that span
Source: US Bureau of Labor Statistics http://www.bls.gov/news.release/empsit.t14.htm; Ins. Info. Institute.
PercentChange
Change: Sept 2009 vs. Sept 2008
Inflation Trends Pressures Claim Cost
Severities via Medical and Tort Channels
After Recent Recessions,the Annual Inflation Rate Dropped
4.9%5.1%
3.0%3.2%
2.6%
1.5%1.9%
3.3%3.4%
1.3%
2.5%2.3%
3.0%
3.8%
2.8%
3.8%
1.9%
-0.5%
2.8%2.9%2.4%
-1%
0%
1%
2%
3%
4%
5%
6%
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09F10F
Sources: US Bureau of Labor Statistics (actual, blue bars); Blue Chip Economic Indicators, 10/09 issue, (forecasts, yellow bars)
Average inflation rate, 1992-2007: 2.67% Post-
Recession Post-Recession
17
Insurers 5 Top Concerns/Risksif Inflation is Reignited
• Rising Claim Severities Cost of claims settlement rises across the board (property and
liability)
• Rate Inadequacy Rates inadequate due to low trend assumptions arising from use of
historical data
• Reserve Inadequacy Reserves may develop adversely and become inadequate (deficient)
• Burn Through on Retentions Retentions, deductibles burned through more quickly
• Reinsurance Penetration/Exhaustion Higher costsrisks burn through their retentions more quickly,
tapping into re-insurance more quickly and potential exhausting their reinsurance more quickly
P/C Premium Growth
Primarily Driven by the Industry’s Underwriting Cycle, Not the Economy
19
-6%
-4%-2%
0%
2%4%
6%
8%10%
12%
14%16%
18%
20%22%
24%
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
2007
2008
09:H
1
Sources: A.M. Best (historical and forecast), ISO, Insurance Information Institute
Strength of Recent Hard Marketsby NWP Growth
1975-78 1984-87 2000-03
19
Net written premiums fell 1.0%
in 2007 (first decline since 1943)
by 1.4% in 2008, and 4.2% in H1 2009, the first 3-
year decline since 1930-33
Shaded areas denote “hard
market” periods
Underwriting Trends
The Economy Doesn’t Directly Affect Underwriting Performance:
Cycle, Catastrophes Are Main Drivers
21
115.8
107.5
100.198.4
100.8
92.6
99.5101.0
95.7
90
100
110
120
2001 2002 2003 2004 2005 2006 2007 2008 2009:H1*
P/C Insurance Industry Combined Ratio, 2001-2009:H1*
*Excludes Mortgage & Financial Guaranty insurers in 2008. Including M&FG, 2008=105.1, 2009=100.9 Sources: A.M. Best, ISO.
Best combined ratio since 1949
(87.6)
As recently as 2001, insurers paid out nearly $1.16 for every
$1 in earned premiums
Relatively low CAT
losses, reserve releases
Cyclical Deterioration
21
2005 ratio benefited from heavy use of reinsurance which lowered net losses
Catastrophic Loss
Catastrophe Loss TrendsAre Getting Worse
Catastrophic Losses*: Was 2005an Outlier or a Harbinger?
$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
$6.7
$26.0
$6.9
$61.9
$9.2
$0
$10
$20
$30
$40
$50
$60
$70
89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
09**
*Excludes $4B-$6b offshore energy losses from Hurricanes Katrina & Rita. **2009:1HNote: 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
$ Billions
23
Is $25 billion the new level of expected
yearly CAT losses?Before 2001, CAT
losses averaged about $8-10 billion per year.
5.1 5.
3 5.4 5.
5 5.6 5.
7 5.8 5.
9 6.0 6.
2 6.3 6.
5 6.6 6.
8 7.0 7.
1
7.3 7.
4 7.5
7.5 7.5
7.6 7.6 7.
7 7.9 8.
0 8.1 8.
2 8.3 8.
5
5.0
5.5
6.0
6.5
7.0
7.5
8.0
8.5
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
09F
10F
11F
12F
13F
14F
15F
16F
17F
18F
19F
Source: http://edr.state.fl.us/conferences/population/demographic.htm
Data are from Feb. 18, 2009 Florida Demographic Estimating conference
A Million More Florida Resident Households in the Next Decade?
Millions of Households
The State of Florida now (Feb 09) forecasts nearly 1 million more
households by 2019 (up almost 13%). There will be more businesses, too.
Hurricane Andrew
Hurricane Wilma
Major (Category 3, 4, 5) Hurricanes Striking the US by Decade
3 10 10
76
5
4
6
88
5
8
6
9
1900s 1910s 1920s 1930s 1940s 1950s 1960s 1970s 1980s 1990s 2000s 2010s 2020s
*Figure for 2000s is extrapolated based on data for 2000-2008 (7 major storms: Charley, Ivan, Jeanne (2004), Katrina, Rita, Wilma (2005), Ike (2008)).Sources: Tillinghast from National Hurricane Center: http://www.nhc.noaa.gov/pastint.shtm.; I.I.I.
Mid 1920s – mid-1960s:AMO Warm Phase
Mid-1990s – 2030s?AMO Warm Phase
Colorado State team forecasts 3
more intense hurricanes in
2009
26
Inflation-Adjusted U.S. Insured Catastrophe Losses By Cause of Loss,
1989-2008¹
Wildland Fires, 2.4%
Tornadoes, 27.0%
All Tropical Cyclones, 46.9%
Other, 0.5%Wind/Hail/Flood,
2.9%
Earthquakes, 5.9%
Winter Storms, 7.6%
Terrorism, 6.9%
Source: Insurance Services Office (ISO)..
1 Catastrophes are all events causing direct insured losses to property of $25 million or more in 2007 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.
Top 10 Major Disaster Declaration Totals By State: 1953-2009*
83
74
63 6258 55
51 51 49 49 48 46 44 43 43
0
10
20
30
40
50
60
70
80
90
TX CA FL OK NY LA AL KY AR MO IL MS OH WA TN
Total Number
*Through November 2, 2009.Source: Federal Emergency Management Agency (FEMA) at www.fema.gov/news/disaster_totals_annual.fema
Illinois had almost as many disaster declarations as Louisiana or Alabama*
Government Aid After Major Disasters (Billions)*
$137.1
$48.4
$22.8 $19.5 $17.1 $16.5
$0
$20
$40
$60
$80
$100
$120
$140
$160
Hurricane Katrina(2005)*
Sept. 11 TerroristAttack (2001)
Hurricane Ike(2008)
Hurricane Andrew(1992)
NorthridgeEarthquake (1994)
HurricanesCharley, Frances,
Ivan & Jeanne(2004)
$ B
illio
ns
*Adjusted to 2008 dollars by the Insurance Information Institute.Source: United States Senate Budget Committee, Insurance Information Institute as of 12/31/05; Houston Chronicle, 09/24/08 for Ike.
The federal government poured an estimated
$22.8B into areas affected by Hurricane Ike
Does post-disaster government aid
create moral hazard?
P/C Insurance Financial
PerformanceA Resilient Industry in
Challenging Times
30
P/C Net Income After Taxes1991-2009:H1 ($ Millions)*
$14,
178
$5,8
40
$19,
316
$10,
870
$20,
598
$24,
404 $3
6,81
9
$30,
773
$21,
865
$3,0
46
$30,
029
$62,
496
$2,3
79
$5,7
57
-$6,970
$65,
777
$44,
155
$20,
559 $3
8,50
1
-$10,000
$0
$10,000
$20,000
$30,000
$40,000
$50,000
$60,000
$70,000
$80,00091 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
09:H
1
*ROE figures are GAAP; 1Return on avg. surplus. Excluding Mortgage & Financial Guaranty insurers yields an 4.5% ROAS for 2008 and 2.2%. 2009:Q1 net income was $10.0 billion excl. M&FG.Sources: A.M. Best, ISO, Insurance Information Inst.
2005 ROE= 9.4%2006 ROE = 12.2%2007 ROAS1 = 12.4%2008 ROAS = 0.5%*2009:H1 ROAS = 2.5%*
Insurer profits peaked in 2006 and 2007, but fell 96.2% during the economic
crisis in 2008
30
31
-5%
0%
5%
10%
15%
20%
25%
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 0809
H1
1975: 2.4%
1977:19.0% 1987:17.3% 1997:11.6% 2006:12.2%
1984: 1.8% 1992: 4.5% 2001: -1.2%
10 Years10 Years
9 Years
Note: 2008 result excluding Mortgage & Financial Guarantee insurers is 4.2% and 4.5% in H1 2009.Sources: ISO; A.M. Best; Insurance Information Institute.
2008: 0.5%
P/C Insurance Industry ROEs,1975 – 2009:H1*
09:H1: 2.5%
31
Investment Performance
Investments arethe Main Sourceof Lower Profits
Distribution of P/C Insurance Industry’s Investment Portfolio
Cash & Short-Term Investments
8.0%
Common Stock14.8%
Bonds68.4%
Preferred Stock1.8%
Real Estate0.9%
Other6.2%
Portfolio Facts
•Invested assets totaled $1.2 trillion as of 12/31/08, down from $1.3 trillion as of 12/31/07
•Insurers are generally conservatively invested, with 2/3+ of assets invested in bonds as of 12/31/08
•Only about 15% of assets were invested in common stock as of 12/31/08, down from 18% one year earlier
•Even the most conservative of portfolios were hit hard in 2008
Source: NAIC; Insurance Information Institute research;.
As of December 31, 2008
33
34
Property/Casualty Insurance Industry Investment Gain:1994- 2009:H11
$ Billions
$35.4
$42.8$47.2
$52.3
$44.4
$36.0
$45.3$48.9
$59.4$55.7
$64.0
$31.4
$12.4
$56.9$51.9
$57.9
$0
$10
$20
$30
$40
$50
$60
1Investment gains consist primarily of interest, stock dividends and realized capital gains and losses. 2006 figure consists of $52.3B net investment income and $3.4B realized investment gain. *2005 figure includes special one-time dividend of $3.2B.Sources: ISO; Insurance Information Institute.
Investment gains fell by 51% in 2008 due to lower yields, poor equity market
conditions. Falling again in 2009.
34
35
P/C Insurer Net Realized Capital Gains, 1990-2009:1H
$2.88$4.81
$9.89
$1.66
$6.00
$9.24$10.81
$13.02
$16.21
$6.63
-$1.21
$6.61$8.92
-$11.17
-$19.80
$18.02
$3.52
$9.70$9.13$9.82
-$20-$18-$16-$14-$12-$10-$8-$6-$4-$2$0$2$4$6$8
$10$12$14$16$18$20
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
09H
1
Sources: A.M. Best, ISO, Insurance Information Institute.
Realized capital losses hit a record $19.8 billion in 2008 due to financial market turmoil, a $27.7 billion swing from 2007, followed by an $11.2B
drop in H1 2009. This is a primary cause of 2008/2009’s large drop in profits and ROE.
$ Billions
35
Financial Strength/Capacity
Industry Has Weathered the Storms Well
37
$0
$50
$100
$150
$200
$250
$300
$350
$400
$450
$500
$550
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 0809*
U.S. Policyholder Surplus: 1975-2009:H1*
Source: A.M. Best, ISO, Insurance Information Institute. *As of 6/30/09
$ B
illi
ons
“Surplus” is a measure of underwriting capacity. It is analogous to “Owners Equity” or “Net Worth” in non-insurance organizations
Actual capacity as of 6/30/09 was $463.0B, up from $437.1B as of 3/31/09 Recent peak was $521.8 as of
9/30/07. Surplus as of 6/30/09 is 11.2% below 2007 peak; Crisis trough was as of 3/31/0916.2% below 2007 peak
The premium-to-surplus ratio stood at $0.92:$1 as of
6/30/09, up from near record low of $0.85:$1 at
year-end 2007
37
38
Policyholder Surplus, 2006:Q4 – 2009:H1
$ Billions
$487.1$496.6
$512.8$521.8
$478.5
$455.6
$437.1
$463.0
$505.0$515.6
$517.9
$380
$400
$420
$440
$460
$480
$500
$520
$540
06:Q4 07:Q1 07:Q2 07:Q3 07:Q4 08:Q1 08:Q2 08:Q3 08:Q4 09:Q1 09:Q2
Source: ISO, AM Best.
Declines Since 2007:Q3 Peak
08:Q2: -$16.6B (-3.2%) 08:Q3: -$43.3B (-8.3%) 08:Q4: -$66.2B (-12.9%) 09:Q1: -$84.7B (-16.2%)
09:Q2: -$58.8B (-11.2%)
Capacity peaked at $521.8 as of 9/30/07
38
39
Premium-to-Surplus Ratios Before Major Capital Events*
$1.65
$1.42 $1.40
$1.03 $1.03$0.92$0.88
$1.05$1.15
$0.5
$0.7
$0.9
$1.1
$1.3
$1.5
$1.7
$1.9
6/3
0/1
989
Hu
rric
an
eH
ug
o
6/3
0/1
992
Hu
rric
an
eA
nd
rew
12/3
1/9
3N
ort
hri
dg
eE
art
hq
uake
6/3
0/0
1S
ep
t. 1
1A
ttacks
6/3
0/0
4F
lori
da
Hu
rric
an
es
6/3
0/0
5H
urr
ican
eK
atr
ina
6/3
0/0
7F
inan
cia
lC
risis
As o
f3/3
1/0
9**
As o
f6/3
0/0
9**
*
*Ratio is for end of quarter immediately prior to event. Date shown is end of quarter prior to event. **Ratio at point of maximum capital erosion; ***Latest availableSource: PCS; Insurance Information Institute.
P/C insurance industry was better capitalized going into the
financial crisis than before any “capital event” in recent history
0.8
1.0
1.2
1.4
1.6
1.8
2.0
85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 0809:1H
U.S. P/C Industry Premiums-to-Surplus Ratio: 1985-2009:1H
Sources: A.M. Best, ISO, Insurance Information Institute.
19980.85:1–the lowest
(strongest) P:S ratio in recent history.
Premiums are a rough measure of risk accepted; surplus is funds beyond reserves to pay unexpected
losses. The larger surplus is in relation to premiums—the lower the ratio of premiums to surplus—the greater
the industry’s capacity to handle the risk it has accepted.
$0.92:1 as of
6/30/09
Ratio at year-end
41
Ratio of Insured Loss to Surplus for Largest Capital Events Since 1989*
3.3%
9.6%
6.9%
10.9%
16.2%
13.8%
6.2%
0%2%4%6%8%
10%12%14%16%18%
6/3
0/1
98
9H
urr
ica
ne
Hu
go
6/3
0/1
99
2H
urr
ica
ne
An
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w
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/31
/93
No
rth
rid
ge
Ea
rth
qu
ak
e
6/3
0/0
1S
ep
t. 1
1A
tta
ck
s
6/3
0/0
4F
lori
da
Hu
rric
an
es
6/3
0/0
5H
urr
ica
ne
Ka
trin
a
Fin
an
cia
lC
ris
is a
s o
f3
/31
/09
**
*Ratio is for end-of-quarter surplus immediately prior to event. Date shown is end of quarter prior to event. **Date of maximum capital erosion; As of 6/30/09 (latest available) ratio = 11.2%.Source: PCS; Insurance Information Institute.
The financial crisis now ranks as the largest
“capital event” over the past 20+ years
42
P/C Insurer Impairment Frequency vs. Combined Ratio, 1969-2008
90
95
100
105
110
115
120
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
Co
mb
ined
Rat
io
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.8
2.0
Imp
airm
ent R
ate
Combined Ratio after DivP/C Impairment Frequency
Impairment rates are highly
correlated with underwriting
performance and reached record lows in 2007/08
Source: A.M. Best; Insurance Information Institute
2008 impairment rate was a record low 0.23%, second only to the 0.17% record low in 2007 and barely one-fourth the 0.82% average since 1969
Number of Impairments by State, Top 10 States, 1969-2008
41
66
242533
63
9691
73
140
0
20
40
60
80
100
120
140
160
TX FL CA IL NY PA LA MO OK OH
No.
of I
mpa
irmen
ts
Catastrophe risk plays a big role. Other factors influencing
impairments include the political environment and business mix
Source: A.M. Best; Insurance Information Institute
Frequency of Impairments by State, 1969-2008
1.34
1.29
1.29
1.29
1.25
1.25
1.23
1.04
0.98
0.98
0.97
0.92
0.92
0.91
0.90
0.89
0.89
0.83
0.78
0.75
0.72
0.70
0.68
0.60
0.58
0.55
0.49
0.46
0.41
0.36
0.36
0.35
0.35
0.25
0.22
0.21
0.21
0.16
0.13
0.13
0.08
0.06
0.00
1.58
2.10
1.35
1.411.
531.571.
63
3.36
3.02
2.90
3.48
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
WY LA FL VI
MT
CA
WV AZ
TX PR UT RI
GA HI
DC
NM SC
OK
MO CO
MS NE
NV
GU
MD NJ
TN KY
OR IL NY
PA
AK
MA
WA IN AL
DE
VA
OH AR
KS
NC MI ID M
ES
D WI
NH IA CT
MN VT
ND
Impa
irmen
t Fre
quen
cy (%
)
WY, LA, FL have the highest impairment rates in the country
(Impairments per 100 Insurers Domiciled in State)
Source: A.M. Best; Insurance Information Institute
IL (0.78%) was slightly under the national
average 0.82%
In 2008, A.M. Best Affirmed or Upgraded 88% of P/C Insurers*
Upgraded, 59 , 4.2%
Other, 59 , 4.2%
Affirm, 1,183 , 83.4%
Downgraded, 55 , 3.9%
Under Review, 63 , 4.4%
*Through December 19.Source: A.M. Best.
45
In 2008, despite financial market turmoil, high cat losses and a soft
market, A.M. Best lowered ratings on just 3.9% of P-C insurers. It placed
another 4.4% under review
46
Reasons for US P/C Insurer Impairments, 1969-2008
Source: A.M. Best: 1969-2008 Impairment Review, Special Report, Apr. 6, 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.
Reinsurance Failure3.7%
Rapid Growth14.3%
Misc.9.1%
Affiliate Impairment
7.9%
Sig. Change in Business
4.2%
Deficient Loss
Reserves/In-adequate Pricing38.1%
Investment Problems
7.0%
Alleged Fraud8.1%
Catastrophe Losses7.6%
Critical Differences Between P/C Insurers
and Banks
Superior Risk Management Model & Low Leverage Make
a Big Difference
48
How Insurance Industry Stability Has Benefitted Consumers
BOTTOM LINE:• Insurance Markets—Unlike Banking—Are Operating
Normally• The Basic Function of Insurance—the Orderly Transfer
of Risk from Client to Insurer—Continues Uninterrupted• This Means that Insurers Continue to:
Pay claims (whereas 120 banks have gone under as of 9/25/09) The Promise is Being Fulfilled
Renew existing policies (banks are reducing and eliminating lines of credit) Write new policies (banks are turning away people and businesses who
want or need to borrow) Develop new products (banks are scaling back the products they offer) Compete Intensively (banks are consolidating, reducing consumer choice)
Source: Insurance Information Institute48
49
• Emphasis on Underwriting Matching of risk to price (via experience and modeling) Limiting of potential loss exposure Some banks sought to maximize volume and fees and disregarded risk
• Strong Relationship Between Underwriting and Risk Bearing Insurers always maintain a stake in the business they underwrite, keeping
“skin in the game” at all times Banks and investment banks package up and securitize, severing the link
between risk underwriting and risk bearing, with (predictably) disastrous consequences—straightforward moral hazard problem from Econ 101
• Low Leverage Insurers do not rely on borrowed money to underwrite insurance or pay
claimsThere is no credit or liquidity crisis in the insurance industry49
Why P/C Insurers HaveFewer Problems Than Banks
50
• Conservative Investment Philosophy High quality portfolio that is relatively less volatile and more
liquid
• Comprehensive Regulation of Insurance Operations The business of insurance remained comprehensively
regulated whereas a separate banking system had evolved largely outside the auspices and understanding of regulators (e.g., hedge funds, private equity, complex securitized instruments, credit derivatives—CDS’s)
• Greater Transparency Insurance companies are an open book to regulators and the
public 50
Why P/C Insurers HaveFewer Problems Than Banks (cont’d)
5 Challenges for Insurers in
the Next 5 Years
52
1. Further Erosion of, and“Reloading” of Capital
• Capital losses were the largest in a generation (a “Black Swan”?). It will take years to return to the 2007 peak.
• P/C insurers have come to expect that large amounts of capital can be raised quickly and cheaply after major events (9/11, Katrina). This assumption might be incorrect in the current environment
• The cost of capital is much higher today, reflecting both scarcity and risk
• Possible consequences of a failure to “reload”: insolvencies, forced mergers, calls for government aid, etc.
Implication: P/C (re)insurers need to protect capital and develop detailed contingency plans both to raise fresh capital and generate it internally.
53
2. Long-Term,Low Investment Earnings
• Low interest rates, risk aversion toward equities and many categories of fixed income securities lock in a multi-year trajectory toward ever lower investment gains• Fed actions in Treasury markets will keep yields
low• Implication 1: Industry must be prepared to
operate in environment with investment earnings accounting for a smaller fraction of profits
• Implication 2: Implies underwriting discipline of a magnitude not witnessed in this industry in more than 30 years. Yet to manifest itself.
• Lessons from the period 1920-1975 need to be relearned
• CAT risk and WC is, on net, now being socialized• via state-run insurance and reinsurance mechanisms or • via elaborate subsidy schemes involving assessments,
premium tax credits, etc.• Some (life) insurers sought/received TARP money• Efforts to expand flood program to include wind• Health insurance may be substantively socialized• Terrorism risk—already a major federal role backed by
insurers• Eventual takeover of other lines such as personal auto• Ownership stakes in some insurers via bailouts• States like FL will lean heavily on Washington in the
event of a mega-cat that threatens state finance
3. Socialization/Nationalizationof Insurance
55
• P/C insurers might get swept into vast federal regulatory overhaul and subjected to duplicative and costly regulation• Will some P/C insurers be considered systemically
important (i.e., “too big to fail”)?• Will personal lines insurance policies be regulated
by a new Consumer Financial Protection Agency?• What effect will repeal of McCarran-Ferguson have
on P/C insurers?• Will a new “Office of National Insurance” in the
Treasury Department speed adoption of new international regulatory rules?
4. Major New Layers/Typesof Regulation
56
Attacks on underwriting criteria such as credit, education, occupation, territory increasingView that these criteria are discriminatory and
create an adverse impact on certain populationsImpact will be to degrade the accuracy of rating
systems to increase subsidies Predictive modeling also at risk Danger that bans could be codified at federal level
during regulatory overhaul Bottom Line: Industry must be prepared to defend
existing and new criteria indefinitely
5. New Restrictions on Underwriting
57
Insurance Information Institute On-Line
THANK YOU FOR YOUR TIMEAND YOUR ATTENTION!
57