Top 10 Challenges Facing the P/C Insurance Industry
Insurers at the Crossroads
Katie School of InsuranceCatastrophe Management Symposium
Bloomington-Normal, ILApril 17, 2007
Robert P. Hartwig, Ph.D., CPCU, President & Chief Economist
Insurance Information Institute 110 William Street New York, NY 10038
Tel: (212) 346-5520 Fax: (212) 732-1916 [email protected] www.iii.org
Top 10 Challenges:
Presentation Outline
• #1: Maintaining Profitability: 2006, A Cyclical Peak
• #2: Maintaining Underwriting Discipline
• #3: Managing a Slow Growth Environment: Premium Plunge
• #4: Capital Management: Capacity & Capital Allocation
• #5: Managing Investment Volatility: Rollercoaster Returns
• #6: Catastrophe Loss Management: Is the Worst Yet to Come?
• #7: Financial Strength & Ratings: Ready for the Big One?
• #8: Legal Liability & Tort System: Not Quite Out of the Woods
• #9: Defining the Role of Government in Insurance Markets
• #10: Containing Legislative & Regulatory Zealotry
• Q&A
#1. Maintaining Profitability
Profits in 2006 ReachedTheir Cyclical Peak
P/C Net Income After Taxes
1991-2006 ($ Millions)*
$14,178
$5,840
$19,316
$10,870
$20,598$24,404
$36,819
$30,773
$21,865
-$6,970
$3,046
$30,029
$63,695
$44,155
$20,559
$38,501
-$10,000
$0
$10,000
$20,000
$30,000
$40,000
$50,000
$60,000
$70,000
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
*ROE figures are GAAP; 1Return on avg. Surplus.
Sources: A.M. Best, ISO, Insurance Information Inst.
2001 ROE = -1.2%
2002 ROE = 2.2%
2003 ROE = 8.9%
2004 ROE = 9.4%
2005 ROE= 10.5%
2006 ROAS1 = 14.0%
Though up in 2006, insurer profits are highly volatile (2001 was the industry’s worst year ever). ROEs
generally fall below that of most other industries.
-5%
0%
5%
10%
15%
20%
87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07F
08F
US P/C Insurers All US Industries
ROE: P/C vs. All Industries
1987–2008E
*2007-08 P/C insurer ROEs are I.I.I. estimates.
Source: Insurance Information Institute; Fortune
AndrewNorthridge
Hugo Lowest CAT
losses in 15 years
Sept. 11
4 Hurricanes
Katrina, Rita, Wilma
P/C profitability is cyclical, volatile and vulnerable
RETURN ON EQUITY (Fortune):Stock & Mutual vs. All Companies*
*Fortune 1,000 group.
Source: Fortune Magazine, Insurance Information Institute.
13%
13.4%14.6%
10.0%
14.9%
13.0%
11%
13%
15%14%
13%
7%6%
11%12%
8%
11%12%
10%9%
-2%
8%7%
2%
10%
10.4%
15.0%14.0%
13.9%
12.6%
-4%
-2%
0%
2%
4%
6%
8%
10%
12%
14%
16%
1998 2000 2001 2002 2003 2004 2005 2006E 2007F 2008F
Stock
Mutual
All Cos.*
Mutual insurer ROEs are typically lower than for stock
companies, but gap has narrowed. All are cyclical.
-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
F
08
F
Profitability Peaks & Troughs in the
P/C Insurance Industry, 1975 – 2008F
*2007-08 P/C insurer ROEs are I.I.I. estimates.
Source: Insurance Information Institute; ISO, A.M. Best.
1975: 2.4%
1977:19.0% 1987:17.3%
1997:11.6%
2006E:14.0%
1984: 1.8% 1992: 4.5% 2001: -1.2%
-4%
-2%
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06E
ROE Cost of Capital
ROE vs. Equity Cost of Capital:
US P/C Insurance:1991-2006
Source: The Geneva Association, Ins. Information Inst.
The p/c insurance industry achieved its cost of capital in 2005/6 for the first time in many years
-13
.2 p
ts
+0
.2 p
ts
US P/C insurers missed their
cost of capital by an average 6.7
points from 1991 to 2002, but on
target or better 2003-06
+1
.0 p
ts
+5
.5 p
ts
-9.0
pts
The cost of capitalis the rate of return
insurers need to attract and retain
capital to the business
Insurance & Reinsurance Stocks:Strong Finish in 2006
0.61%
9.53%
10.33%
16.57%
19.95%
16.24%
13.62%
0.0% 5.0% 10.0% 15.0% 20.0% 25.0%
S&P 500
Life/Health
Reinsurers
P/C
All Insurers
Multiine
Brokers
Source: SNL Securities, Standard & Poor’s, Insurance Information Institute
Total Returns for 2006
P/C insurer & reinsurer stocks rallied in late 2006
as hurricane fears dissipated and insurers turned in strong resultsBroker stocks held back
by weak earnings
Insurance & Reinsurance Stocks: Slow Start in 2007 in P/C, Reins
4.09%
-2.22%
0.85%
-0.89%
-3.30%
5.32%
2.44%
-4.0% -2.0% 0.0% 2.0% 4.0% 6.0%
S&P 500
Life/Health
Reinsurers
P/C
All Insurers
Multiine
Brokers
Source: SNL Securities, Standard & Poor’s, Insurance Information Institute
Total YTD Returns Through April 13, 2007
P/C insurance, reinsurance stocks slipping on soft market
concerns and worries over 2007 hurricane season
#2. Maintaining Underwriting
Discipline
Extremely Strong 2006, Momentum for 2007
115.8
107.4
100.198.3
100.7
92.4
98.6
96.6
90
100
110
120
01 02 03 04 05 06 07F 08F
P/C Industry Combined Ratio
Sources: A.M. Best; ISO, III. *Estimates/forecasts based on III’s 2007 Early Bird survey.
2005 figure benefited from heavy use of reinsurance which lowered net losses
2006 produced the best underwriting result
since the 92.4 combined ratio in 1935
As recently as 2001, insurers were paying out nearly $1.16 for
every dollar they earned in premiums
2007/8 deterioration due primarily to falling rates, but results still strong assuming
normal CAT activity
87.6
91.2
92.1 92.3 92.4 92.4
93.1 93.1 93.393.0
85
86
87
88
89
90
91
92
93
94
1949 1948 1943 1937 1935 2006 1950 1939 1953 1936
Ten Lowest P/C Insurance
Combined Ratios Since 1920
Sources: Insurance Information Institute research from A.M. Best data.
The 2006 combined ratio of 92.4 was the
best since 1935, a span of 71 years
The industry’s best underwriting years are associated with
periods of low interest rates
110.3
110.2
107.6
103.9
109.7
112.3
111.1
122.3
110.2
102.5
105.1
94
102.0
112.5
85
90
95
100
105
110
115
120
125
93 94 95 96 97 98 99 00 01 02 03 04 05 06F
Commercial Lines Combined
Ratio, 1993-2006E*
Source: A.M. Best; Insurance Information Institute .
Outside CAT-affected lines, commercial
insurance is doing fairly well. Caution is
required in underwriting long-
tail commercial lines.
2006 results will benefited from
relatively disciplined underwriting
and low CAT losses
Commercial coverages have exhibited extreme variability. Are current
results anomalous?
10
3.9
10
4.5
10
3.5
10
4.9
99
.8 10
2.7
10
4.5
10
9.9
11
0.9
10
5.3
98
.4
94
.3 96
.4
91
.0
85
90
95
100
105
110
115
93 94 95 96 97 98 99 00 01 02 03 04 05 06F
Personal Lines
Combined Ratio, 1993-2006E
Source: A.M. Best; Insurance Information Institute.
A very strong 2006 resulted from favorable frequency & severity
trends and low CAT activity
$10.8
$22.7
$13.9
$9.9
$8.0
$5.0
$2.0$0.4
2.41.9
1.1
0.4
6.5
3.63.5
0.1
$0
$5
$10
$15
$20
$25
2000 2001 2002 2003 2004 2005E 2006E 2007E
Reserv
e D
evelo
pm
en
t ($
B)
0
1
2
3
4
5
6
7
Co
mb
ined
Rati
o P
oin
ts
PY Reserve Development Combined Ratio Points
Impact of Reserve Changes on
Combined Ratio
Source: A.M. Best, Lehman Brothers for years 2005E-2007F
Reserve adequacy has improved substantially
Private Passenger Auto
101.7101.3101.3101.0
99.5
101.1
103.5
109.5
107.9
104.2
98.4
94.395.1
93.0
90
95
100
105
110
93 94 95 96 97 98 99 00 01 02 03 04 05 06F
Private Passenger Auto
Combined Ratio
Average Combined 1993 to 2005= 101.4
Most auto insurers have shown sig-
nificant improvements in underwriting
performance since mid-2002
Sources: A.M. Best; III
PPA is the profit
juggernaut of the p/c
insurance industry today
9%
17%
13%
15%
12%14%14%
11% 12%12%
10%
8%
2%2%
4%
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
92 93 94 95 96 97 98 99 00 01 02 03 04 05E 06F
RNW: Private Passenger Auto,
United States, 1992-2006E
Source: NAIC; Insurance Information Institute
Private passenger auto profitability deteriorated throughout the 1990s but
has improved dramatically
Segmentation should help profitability
-2.2%
-5.3%
-4.0%-3.3%
-0.9%
-2.6%
-5.4%
-3.8%
3.0%3.6% 3.8%
3.4%2.8%
4.8%
-0.3%
4.7%
-6%
-4%
-2%
0%
2%
4%
6%
99 00 01 02 03 04 05 06*
Frequency Severity
Bodily Injury: Severity Trend
Running Ahead of Frequency
*Average of 4 quarters ending with 4th quarter 2006.
Source: ISO Fast Track data.
Medical inflation
is a powerful
cost driver
Workers Compensation
Workers Comp Calendar Year vs. Ultimate Accident Year –
Private Carriers
10197
111 110107
102100 101
107
115118
122
80
90
100
110
120
130
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005p
Calendar Year
Percent
p Preliminary AY figure.
Accident Year data is evaluated as of 12/31/2005 and developed to ultimate
Source: Calendar Years 1994-2004, A.M. Best Aggregates & Averages; Calendar Year 2005p and Accident Years 1994-2005pbased on NCCI
Annual Statement Analysis.
Includes dividends to policyholders
Workers Comp Combined Ratios, 1994-2005P
Lost-Time Claims
-4.2 -4.4
-9.2
-6.9
-5.7
-4.3-3.9
0.3
-6.5
-4.5
0.5
-3.9
-2.3
-4.5 -4.5
-10
-8
-6
-4
-2
0
2
91 92 93 94 95 96 97 98 99 00 01 02 03 04 05p
Cumulative Change of –45.8%
(1991-2004)
Accident Year
Percent
Change
Workers Comp Lost-TimeClaim Frequency (% Change)
2003p: Preliminary based on data valued as of 12/31/2005
1991-2003: Based on data through 12/31/2004, developed to ultimate
Based on the states where NCCI provides ratemaking services
Excludes the effects of deductible policies
Source: NCCI
Indemnity
Claim Cost (000s)
Lost-Time Claims
$9.9 $9.6 $9.4 $9.8 $10.0$10.6
$11.4$12.4
$13.6
$15.1
$16.5 $16.9$17.7
$18.6$19.1
$5
$7
$9
$11
$13
$15
$17
$19
91 92 93 94 95 96 97 98 99 00 01 02 03 04 05p
Annual Change 1992–1996: +1.3%
Annual Change 1997–2004: +7.4%
2005p: Preliminary based on data valued as of 12/31/2005
1991-2004: Based on data through 12/31/2004, developed to ultimate
Based on the states where NCCI provides ratemaking services
Excludes the effects of deductible policies
Source: NCCI
Accident Year
Workers Comp Indemnity Claims Costs Have Accelerated, 1993-2005p
Cumulative Change = +103.2%
(1993-2005p)
$8.3 $8.4 $8.2$8.9 $9.4
$10.1$11.1
$12.0$13.2
$14.2
$16.0
$17.4
$19.0
$20.9
$22.7
$5
$7
$9
$11
$13
$15
$17
$19
$21
$23
91 92 93 94 95 96 97 98 99 00 01 02 03 04 05p
Annual Change 1992–1996: +4.1%
Annual Change 1997–2005: +9.5%
Accident Year
Medical
Claim Cost ($000s)
2005p: Preliminary based on data valued as of 12/31/2005
1991-2004: Based on data through 12/31/2004, developed to ultimate
Based on the states where NCCI provides ratemaking services; Excludes the effects of deductible policies
Workers Comp Medical Claims Continue to Climb
Cumulative Change = +176.8%
(1993-2005p)
4.5%
3.6%2.8%
3.2% 3.5%4.1%
4.6% 4.7%4.0%
4.4% 4.2%
5.1%
7.4%
10.1%
8.3%
9.5%
8.1%
12.3%
8.7%9.1%
10.3%
8.5%
0%
2%
4%
6%
8%
10%
12%
14%
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Change in Medical CPIChange Med Cost per Lost Time Claim
WC Medical Severity Rising Far
Faster than Medical CPI
Sources: Med CPI from US Bureau of Labor Statistics, WC med severity from NCCI based on NCCI states.
4.3
pts
WC medical severity is
rising twice as fast as the
medical CPI
#3. Slow Premium Growth
Managing the Slow Part of the Cycle
-10%
-5%
0%
5%
10%
15%
20%
25%
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
2007
F20
08F
2009
F20
10F
Note: Shaded areas denote hard market periods.
Source: A.M. Best, Insurance Information Institute
Strength of Recent Hard Markets by NWP Growth*
1975-78 1984-87 2001-04
*2007-10 figures are III forecasts/estimates. 2005 growth of 0.4% equates to 1.8% after adjustment for a special one-time transaction between one company and its foreign parent. 2006-2008 figures from III Groundhog Survey.
2006-2010 (post-Katrina) period could resemble 1993-97
(post-Andrew)
2005: biggest real drop in premium since early 1980s
Growth in Net Written Premium, 2000-2008F
Source: A.M. Best; Forecasts from the Insurance Information Institute’s Groundhogsurvey: http://www.iii.org/media/industry/financials/groundhog2007/.
5.1%
8.1%
14.1%
9.8%
4.7%
0.3%
4.3%
1.8% 1.9%
2000 2001 2002 2003 2004 2005 2006 2007F 2008F
P/C insurers will experience their slowest growth rates since the late 1990s…but underwriting results are
expected to remain healthy
PRICING
Under Pressure in 2007
$6
51
$6
68
$6
91
$7
05
$7
03
$6
85
$6
90 $7
24
$7
80 $8
23
$8
51
$8
47
$8
38
$8
47
$600
$650
$700
$750
$800
$850
$900
$950
94 95 96 97 98 99 00 01 02 03 04 05* 06* 07*
Average Expenditures on Auto Insurance
*Insurance Information Institute Estimates/Forecasts
Source: NAIC, Insurance Information Institute
Countrywide auto insurance expenditures are expected to fall 0.5%
in 2007, the first drop since 1999
Lower underlying frequency and modest
severity are keeping auto insurance costs in check
$418$440
$455$481 $488
$508$536
$593
$668$693
$776
$711$739
$400
$450
$500
$550
$600
$650
$700
$750
$800
95 96 97 98 99 00 01 02 03 04* 05* 06* 07*
Average Expenditures on Homeowners Insurance
*Insurance Information Institute Estimates/Forecasts
Source: NAIC, Insurance Information Institute
Countrywide home insurance expenditures are expected to rise 4% in 2007, but much more
in hurricane zones
Hurricane zone residents can
expect increases in the 20%-
100% range, especially if
insured by a state entity
Average Commercial Rate Change,
All Lines, (1Q:2004 – 4Q:2006)
-0.1%
-3.2%
-7.0%
-9.4%-9.7%
-4.6%
-2.7%-3.0%
-5.3%
-9.6%
-5.9%
-8.2%
-12%
-10%
-8%
-6%
-4%
-2%
0%
1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06
Source: Council of Insurance Agents & Brokers; Insurance Information Institute
Magnitude of rate decreases has diminished greatly since
mid-2005 but is growing again
KRW Effect
EXPENSES
Will Expense Ratio Rise as Premium Growth Slows?
Personal vs. Commercial Lines
Underwriting Expense Ratio*
23.4%
24.3%25.0%
30.8%
24.4%
24.5%24.8%25.6%
24.6%
25.6%24.7%
26.6%25.6%
30.0%
31.1%
29.4%29.9%
29.1%
26.6%
25.0%
20%
22%
24%
26%
28%
30%
32%
96 97 98 99 00 01 02 03 04 05
Personal Commercial
*Ratio of expenses incurred to net premiums written.
Source: A.M. Best; Insurance Information Institute
Expenses ratios will likely rise as premium
growth slows
#4. Capital Management
Capital Allocation & Leverage
$0
$50
$100
$150
$200
$250
$300
$350
$400
$450
$500
$550
7576777879808182838485868788899091929394959697989900010203040506
U.S. Policyholder Surplus: 1975-2006
Source: A.M. Best, ISO, Insurance Information Institute.
$ B
illi
on
s
“Surplus” is a measure of
underwriting capacity. It is
analogous to “Owners
Equity” or “Net Worth” in
non-insurance organizations
Capacity as of 12/31/06 was
$487.1B (est.), 14.4% above year-
end 2005, 71% above its 2002
trough and 46% above its 1999
peak.Foreign reinsurance
and residual market
mechanisms absorbed
45% of 2005 CAT
losses of $62.1B
Capital Raising by Class Within
15 Months of KRW
Existing Cos.,
$12.145 , 36%
New Cos., $8.898 ,
26%
Sidecars, $6.359 ,
19%Insurance Linked
Securities, $6.253 ,
19%
Insurers & Reinsurers raised $33.7 billion in the wake of Katrina,
Rita, Wilma
Source: Lane Financial Trade Notes, January 31, 2007.
$ Billions
Annual Catastrophe Bond
Transactions Volume, 1997-2006
$966.9
$1,729.8
$4,693.4
$1,991.1
$1,142.8$1,219.5$846.1$984.8
$1,139.0
$633.0
$0
$500
$1,000
$1,500
$2,000
$2,500
$3,000
$3,500
$4,000
$4,500
$5,000
97 98 99 00 01 02 03 04 05 06
Ris
k C
ap
ita
l Is
su
es
($
Mill)
0
2
4
6
8
10
12
14
16
18
20
Nu
mb
er
of
Iss
ua
nc
es
Risk Capital Issued Number of Issuances
Source: MMC Securities and Guy Carpenter; Insurance Information Institute.
Catastrophe bond issuance has soared in the wake of Hurricanes
Katrina and the hurricane seasons of 2004/2005
#5. Managing the Investment
Portfolio Volatility
RollercoasterReturns
Property/Casualty Insurance Industry Investment Gain*
$ Billions
$35.4
$42.8$47.2
$52.3
$44.4
$36.0
$45.3$48.9
$59.4$55.7$56.9
$51.9
$57.9
$0
$10
$20
$30
$40
$50
$60
94 95 96 97 98 99 00 01 02 03 04 05** 06E*Investment 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. Source: ISO; Insurance Information Institute.
Investment gains fell in 2006 and are now only comparable to gains seen in the late 1990s
#6.Catastrophe Loss
ManagementIs the Worst
Yet to Come?
U.S. Insured Catastrophe Losses*$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
$100.0
$61.9
$9.2
$0
$20
$40
$60
$80
$100
$120
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
20??
*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
$ Billions
2006 was a welcome respite. 2005 was by far the worst
year ever for insured catastrophe losses in the US, but the worst has yet to come.
$100 Billion CAT year is coming soon
U.S. Catastrophe Losses 2006: States
With Largest Losses ($ Millions)
*ISO defines a catastrophe event as an event causing $25 million or more in insured property losses.
Source: ISO; Insurance Information Institute
$601$688
$873$878
$1,500
$0
$200
$400
$600
$800
$1,000
$1,200
$1,400
$1,600
Indiana Missouri Tennessee Texas Kansas
SURPRISE!! Indiana led the US with $1.5 billion in
insured CAT losses in 2006
Some 33 catastrophe events* in 34 states cost
insurers an estimated $8.8bn in 2006, compared
with $61.9bn in 2005. Cat losses in the following
five states -- totaling $4.5bn -- represent half the
total catastrophe losses for the year.
Number of Tornadoes,1985 – 2006p
1071 1216
941
1376
1819
1254
1333
1132
1133
856
702
656765
684
1297
1173
1082 1234
1173
1148
1424
1345
0
200
400
600
800
1,000
1,200
1,400
1,600
1,800
2,000
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06p
Source: US Dept. of Commerce, Storm Prediction Center, National Weather Service; Ins. Info. Inst.
There are usually more than 1,000 confirmed tornadoes each year in the US. They
accounted for about 25% of catastrophe losses since 1985
Inflation-Adjusted U.S. Insured Catastrophe Losses By Cause of Loss,
1986-2005¹
Utility Disruption
0.1%
Terrorism
7.7%
All Tropical
Cyclones3
47.5%
Tornadoes2
24.5%
Water Damage
0.1%Civil Disorders
0.4%Fire
6
2.3%
Wind/Hail/Flood5
2.8%
Earthquakes4
6.7%
Winter Storms
7.8%
Source: Insurance Services Office (ISO)..
1 Catastrophes are all events causing direct insured losses to property of $25 million or more in 2005 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.
Insured disaster losses totaled $289.1 billion from
1984-2005 (in 2005 dollars). Tropical systems accounted for nearly half of all CAT losses from 1986-2005, up
from 27.1% from 1984-2003.
Total Value of Insured Coastal Exposure (2004, $ Billions)
$1,901.6
$740.0
$662.4
$505.8
$404.9
$209.3
$148.8
$129.7
$117.2
$105.3
$75.9
$73.0
$46.4
$45.6
$44.7
$43.8
$12.1
$1,937.3
$0 $500 $1,000 $1,500 $2,000 $2,500
Florida
New York
Texas
Massachusetts
New Jersey
Connecticut
Louisiana
S. Carolina
Virginia
Maine
North Carolina
Alabama
Georgia
Delaware
New Hampshire
Mississippi
Rhode Island
Maryland
Source: AIR Worldwide
Florida & New York lead the way for insured coastal property at more than $1.9 trillion each.
Northeast state insured coastal exposure totals
$3.73 trillion.
Source: AIR Worldwide
Insured Losses: $110B
Economic Losses: $200B+
$70
$30
$5 $4 $1$0
$20
$40
$60
$80
NY NJ PA CT Other
Nightmare Scenario: Insured Property Losses for NJ/NY CAT 3/4 Storm
Total Insured Property Losses =
$110B, nearly 3 times that of
Hurricane Katrina
Distribution of Insured Property Losses,
by State, ($ Billions)
Percentage of California Homeowners with Earthquake
Insurance, 1994-2004*
32.9%33.2%
19.5%17.4%
14.6%13.3%13.8%
12.0%
15.8%15.7%16.8%
0%
5%
10%
15%
20%
25%
30%
35%
94 96 97 98 99 00 01 02 03 04 06**
*Includes CEA policies beginning in 1996. **2006 estimate from Insurance Information Network of CA.
Source: California Department of Insurance; Insurance Information Institute.
The vast majority of California homeowners forego earthquake
coverage & play Russian Roulette with their most valuable asset.
The 2007 Hurricane Season:
Preview to Disaster?
Outlook for 2007 Hurricane
Season: 85% Worse Than Average
Average* 2005 2007F
Named Storms 9.6 28 17
Named Storm Days 49.1 115.5 85
Hurricanes 5.9 14 9
Hurricane Days 24.5 47.5 40
Intense Hurricanes 2.3 7 5
Intense Hurricane Days 5 7 11
Accumulated Cyclone Energy 96.2 NA 170
Net Tropical Cyclone Activity 100% 275% 185%
*Average over the period 1950-2000.
Source: Philip Klotzbach and Dr. William Gray, Colorado State University, April 3, 2007.
Probability of Major Hurricane
Landfall (CAT 3, 4, 5) in 2007
Average* 2007F
Entire US Coast 52% 74%
US East Coast Including
Florida Peninsula
31% 50%
Gulf Coast from FL Panhandle
to Brownsville, TX
30% 49%
ALSO…Above-Average Major Hurricane
Landfall Risk in Caribbean for 2007
*Average over the period 1950-2000.
Source: Philip Klotzbach and Dr. William Gray, Colorado State University, April 3, 2007.
REINSURANCE MARKETS
Big Risk, Big Reward orBig Government?
Share of Losses Paid by Reinsurers, by Disaster*
30%25%
60%
20%
45%
0%
10%
20%
30%
40%
50%
60%
70%
Hurricane Hugo
(1989)
Hurricane Andrew
(1992)
Sept. 11 Terror
Attack (2001)
2004 Hurricane
Losses
2005 Hurricane
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.
Reinsurance is playing an increasingly
important role in the financing of mega-
CATs; Reins. Costs are skyrocketing
Debate Over Reinsurance Market
Performance & Government• Reinsurance markets typically suffer large shocks, followed by a
period of higher prices and transient capacity constraints
• A new equilibrium between Supply and Demand is typically found within 18 months, commensurate with changes in the risk landscape. This is Economics 101 and is a textbook illustration of how capitalism works.
• A competing hypothesis suggests that reinsurance markets “fail” because they do not provide a stable price or quantity of protection as is required in an economy with continuously exposed fixed assets, especially one that is growth oriented
• Public Policy Solution: Acting on this hypothesis generally results in displacement of private (re)insurance capital by government intermediaries
• Question Asked: Are policyholders and the economy better served through free markets, government or some hybrid?
Sources: Insurance Information Institute
#7. Maintaining Financial Strength
& RatingsWeathering the Storms
Reasons for US P/C Insurer
Impairments, 1969-2005
*Includes overstatement of assets.
Source: A.M. Best: P/C Impairments Hit Near-Term Lows Despite Surging Hurricane Activity, Special Report, Nov. 2005;
Catastrophe
Losses
8.6%
Alleged
Fraud
11.4%
Deficient
Loss
Reserves/In-
adequate
Pricing
62.8%
Affiliate
Problems
8.6%
Rapid
Growth
8.6%
2003-2005 1969-2005
Deficient reserves,
CAT losses are more
important factors in
recent years
Reinsurance
Failure
3.5%
Rapid
Growth
16.5%
Misc.
9.2%
Affiliate
Problems
5.6%
Sig. Change
in Business
4.6%
Deficient
Loss
Reserves/In-
adequate
Pricing
38.2%
Investment
Problems*
7.3%
Alleged
Fraud
8.6%
Catastrophe
Losses
6.5%
P/C Insurer Impairments,
1969-20068
15
12
71
19
34
91
31
21
99
16
14
13
36
49
31 3
44
94
95
46
05
84
12
91
51
23
11
8 19
49 50
47
35
18
13 15
0
10
20
30
40
50
60
70
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
The number of impairments varies significantly over the p/c insurance cycle,
with peaks occurring well into hard markets
Source: A.M. Best; Insurance Information Institute
P/C Insurer Impairment Frequency
vs. Combined Ratio, 1969-2006
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
Co
mb
ine
d R
ati
o
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
2
Imp
air
me
nt
Ra
te
Combined Ratio after Div
P/C Impairment FrequencyImpairment
rates are highly correlated
underwriting performance
Source: A.M. Best; Insurance Information Institute
2006 impairment rate was 0.43%, or 1-in-233 companies, half the 0.86% average since 1969
#8. Legal Liability & Tort
Environment
Definitely Improving ButNot Out of the Woods
Personal, Commercial &
Self (Un) Insured Tort Costs*
$17.0
$49.6 $58.7
$95.2
$17.1
$51.0
$70.9
$86.7
$5.2
$20.4
$30.0
$49.4
$0
$50
$100
$150
$200
$250
1980 1990 2000 2005
Commercial Lines Personal Lines Self (Un)Insured
Bil
lion
s
Total = $39.3 Billion
*Excludes medical malpracticeSource: Tillinghast-Towers Perrin, 2006 Update on US Tort Cost Trends.
Total = $121.0 Billion
Total = $159.6 Billion
Total = $231.3 Billion
Tort System Costs,2000-2006E
$179
$233$246
$260
$261
$261
$205
1.82%
2.03%
2.22% 2.22%2.09%
2.00%
2.24%
$100
$120
$140
$160
$180
$200
$220
$240
$260
$280
$300
00 01 02 03 04 05 06E
To
rt S
yst
em C
ost
s
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
To
rt C
ost
s a
s %
of
GD
P
Tort Sytem Costs Tort Costs as % of GDP
After a period of rapid
escalation, tort system costs
as % of GDP are now fallin
Source: Tillinghast-Towers Perrin, 2006 Update on US Tort Cost Trends;2006 is III estimate.
KATRINA TORT UPDATE
Suits Add to Uncertainty, Expense
Likely Market Impacts of Post-
Katrina Litigation• Litigation Creates an Additional Layer of Uncertainty
in What is Already a Very Difficulty Market Ultimate Thrust of Litigation is to Compel Insurers to Pay
Water Damage (Flood/Surge) Losses for Which They Have Never Received A Penny in Premium
• Some Courts’ Apparent Willingness to Retroactively Rewrite Long-Standing, Regulator Approved Terms & Conditions of Insurance Contracts Creates an Unpriceable Risk Compounded by juries willing to award millions in punitives
• People Discouraged from Buying Flood Coverage
• BOTTOM LINE: Weather, Courts, Juries Together Create Nearly Impossible Operating Environment
• Coverage Under These Circumstances Will Necessarily Become More Expensive, Less Available
#9. Defining the Role of Government
in Insurance Markets
How Big is Too Big?
NAIC’s Comprehensive
National Catastrophe Plan
• Proposes Layered Approach to Risk
• Layer 1: Maximize resources of private insurance & reinsurance industry
Includes “All Perils” Residential Policy
Encourage Mitigation
Create Meaningful, Forward-Looking Reserves
• Layer 2: Establishes system of state catastrophe funds (like FHCF)
• Layer 3: Federal Catastrophe Reinsurance Mechanism
Source: Insurance Information Institute
Comprehensive National
Catastrophe Plan Schematic
Personal
Disaster
Account
Private Insurance
State Regional Catastrophe Fund
National Catastrophe Contract Program
Source: NAIC, Natural Catastrophe Risk: Creating a Comprehensive National Plan, Dec. 1, 2005; Insurance Information. Inst.
State Attachment
1:50 Event
1:500 Event
Legislation has been introduced and ideas
espoused by ProtectingAmerica.org will likely get a more
thorough airing in 2007/8
STATE RESIDUAL MARKETS
How Big is Too Big?
Florida Citizens Exposure to
Loss (Billions of Dollars)
Source: PIPSO; Insurance Information Institute
408.8
$210.6$206.7$195.5
$154.6
$0
$50
$100
$150
$200
$250
$300
$350
$400
$450
2002 2003 2004 2005 2006
Exposure to loss in Florida Citizens nearly doubled in 2006
Major Residual Market Plan Estimated
Deficits 2004/2005 (Millions of Dollars)
* MWUA est. deficit for 2005 comprises $545m in assessments plus $50m in Federal Aid.
Source: Insurance Information Institute
-$516
-$1,425
-$1,770
-$954
-$595 *
-$2,000
-$1,800
-$1,600
-$1,400
-$1,200
-$1,000
-$800
-$600
-$400
-$200
$0
Florida Hurricane
Catastrophe Fund
(FHCF) Florida Citizens Louisiana Citizens
Mississippi Windstorm
Underwriting
Association (MWUA)
2004 2005
Hurricane Katrina pushed all of the residual market property plans in
affected states into deficits for 2005, following an already record hurricane loss year in 2004
#10. Containing Regulatory &
Legislative Zealotry
Busy Year for Insurersin Washington & States
Federal Legislative Update
Federal Terrorism Reinsurance (TRIA)• TRIA expires 12/31/07. The current federal program offers $100 billion of
coverage subject to a $27.5B industry aggregate retention.
• New Democratic Congress (with Committee chairs from urban Northeast states) predisposed to extend. Despite resistance/lackluster Administration support TRIA will likely extended for a multi-year period, perhaps 6-8 but potentially as long as 15 years (last extension in 2005 was for 2 years)
• Potential changes include extensions of coverage for domestic terrorism losses (not included currently), and a lower industry retention for nuclear, biological, chemical, or radiological (NBCR) attacks. There could possibly be a modestly higher industry retention for non-NBCR losses, and it needs to be resolved whether liability and group life losses will be covered.
• Original hope for first-half 2007 extension have faded. Now looking at fall or even 11th-hour extension at year’s end, as in 2005.
Sources: Lehman Brothers, Insurance Information Institute
Federal Legislative Update
Natural Disaster Coverage• Some insurers are pushing for federal catastrophic risk fund coverage in the
wake of billions of dollars of losses suffered by insurers from the 2004-2005
hurricane seasons.
• Legislative relief addressing property/casualty insurers’ exposure to natural
catastrophes, such as the creation of state and federal catastrophe funds, has
been advocated by insurers include Allstate and State Farm
recently. However, there is active opposition many other insurers and all
reinsurers.
• There are supporters in Congress, mostly from CAT-prone states. Skeptics in
Congress believe such a plan would be a burden on taxpayers like the NFIP
and that the private sector can do a better job. Unlike TRIA, the industry is
not unified on this issue.
• Allowing insurers to establish tax free reserves for future catastrophe losses
has also been proposed, but Congress has not yet indicated much support.
Sources: Lehman Brothers, Insurance Information Institute
Federal Legislative Update
Optional Federal Charter (OFC)• Large P&C and life insurers are the major supporters of OFC.
Supporters argue that the current patchwork of 50 state regulators reduces competition, redundant, slows new product introductions and adds cost to the system.
• In general, global P/C insurers , reinsurers and large brokers mostly support the concept, while regulators (state insurance commissioners), small single-state and regional insurers, and independent agency groups largely oppose the idea. An optional federal charter is more favorable for global P&C insurers, because an insurer that operates in multiple states could opt to be regulated under federal rules rather than multiple state regulations. As a result, this could increase innovation in the industry.
• A new bill should be introduced in May or June. Currently appears to be more momentum for OFC for life than for P&C insurers based on the homogeneous nature of many life products. The debate should intensify and although passage may not occur in the current session of Congress, it may lay the groundwork for passage in the 2009-2010 session.
Sources: Lehman Brothers, Insurance Information Institute
Federal Legislative Update
McCarran-Ferguson Insurance Antitrust Exemption
• Under McCarran-Ferguson Act of 1945, insurers have limited immunity
under federal anti-trust laws allowing insurers to pool past claims
information to develop accurate (actuarially credible) rates.
• Very low level of understanding of M-F in Washington
• Certain legislators threaten to revoke McCarran-Ferguson because of
alleged collusion in the wake of Hurricane Katrina. However, the view
among some Washington insiders is that such a move would hurt small
insurers with less resources rather than the large insurers perhaps being
targeted. The current bills designed to revoke McCarran-Ferguson are
S.618 and H.R. 1081.
• The government appointed Antitrust Modernization Commission in an
April 2007 report strongly encouraged Congress to re-examine the
McCarran-Ferguson Act. Notably, 4 of the commissions 12 members
called for a full repeal of the law. Sources: Lehman Brothers, Insurance Info. Institute
TRIA EXTENSION
The Burden Grows, and the Clock is Ticking
Terrorism Coverage Take-Up Rate Continues to Rise
Source: Narketwatch: Terrorism Insurance 2006, Marsh, Inc.; Insurance Information Institute
24%26%
33%
44% 46%44%
48% 47%
54%59%
64%
03Q2 03Q3 03Q4 04Q1 04Q2 04Q3 04Q4 05Q1 05Q2 05Q3 05Q4
Terrorism take-up rate for non-WC risk rose steadily
through 2003, 2004 and 2005
TAKE UP RATE FOR WC COMP TERROR
COVERAGE IS 100%!!
Insurance Industry Retention
Under TRIA ($ Billions)
$10.0$12.5
$15.0
$25.0$27.5
$0
$5
$10
$15
$20
$25
$30
$35
Year 1
(2003)
Year 2
(2004)
Year 3
(2005)
Year 4
(2006)
Year 5
(2007)
$ B
illi
on
s
Source: Insurance Information Institute
•Individual company retentions rise to 17.5%
in 2006, 20% in 2007
•Above the retention, federal govt. pays 90% in
2006, 85% in 2007
Extension
Insured Loss Estimates:
Large CNBR Terrorist Attack ($ Bill)
Type of Coverage New York Washington
San
Francisco
Des
Moines
Group Life $82.0 $22.5 $21.5 $3.4
General Liability 14.4 2.9 3.2 0.4
Workers Comp 483.7 126.7 87.5 31.4
Residential Prop. 38.7 12.7 22.6 2.6
Commercial Prop. 158.3 31.5 35.5 4.1
Auto 1.0 0.6 0.8 0.4
TOTAL $778.1 $196.8 $171.2 $42.3
Source: American Academy of Actuaries, Response to President’s Working Group, Appendix II, April
26, 2006.
FLORIDA SPECIAL SESSION
LEGISLATIVE CHANGES
Insurer, Policyholder & State Impacts
Why There is Concern Over the Florida
Legislature’s & Governor’s Changes
• Risk is Now Almost Entirely Borne Within State
• Virtually Nothing Done to Reduce Actual Vulnerability
• Creates Likelihood of Very Large Future Assessments
• Potentially Crushing Debt Load
• State May be Forced to Raise/Levy Taxes to Avoid Credit Downgrades
• Many Policyholder Will See Minimal Price Drop “Savings” came from canceling recent/planned rate hikes
• Residents in Lower-Risk Areas, Drivers, Business Liability Policyholders Will Come to Resent Subsidies to Coastal Dwellers
• Governor’s Emergency Order for Rate Freezes & Rollbacks Viewed as Unfair & Capricious
Sources: Insurance Information Institute.
Summary• Industry results were unsustainably good 2006; Overall
profitability reached its highest level (14%) since 1988
• Many factors will prevent repeat of 2006
• Underwriting results were aided by lack of mega-CATs & favorable underlying loss trends, including tort system improvements
• Premium growth rates are slowing to their levels since the late 1990s; No obvious/easy opportunities for growth
• Rising investment returns insufficient to support deep soft market in terms of price, terms & conditions
• Clear need to remain underwriting focused
• How/where to deploy/redeploy capital??
• Major Challenges:
Maintaining price/underwriting discipline
Managing variability/volatility of results
Managing new/emerging risks
Insurance Information
Institute On-Line
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