the business of insurance

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The Griffith Insurance Education Foundation

The Business of Insurance

Robert E. Hoyt, Ph.D.

May 6, 2013

Overview Property and Casualty Insurance Insurance Operations

Investments Performance and Capacity

Reinsurance Principles Insurance Guaranty Funds Risk and Industry Trends to Watch


Premium Breakdown in the P/C Industry (2011)

Source: NAIC Data

Auto$190.5B/39%

Homeowners$73.7B/15%

Other P/C Lines$228.2B/46%

Property Exposures Types of property exposed to

loss Real property (buildings) Personal property (contents)

Causes of loss affecting property (perils)

Property loss consequences Direct loss Indirect loss

Major Property Insurance Policies

homeowners (HO) building and personal property

(BPP) business income (BIC) boiler & machinery inland marine (floaters) ocean marine crime (employee dishonesty) difference in conditions (DIC)

A World of Extremes(Attention on Risk)

Earthquake in Haiti (record death toll) Recent recession (deepest since the Great

Depression) BP Platform explosion Japanese Tsunami 1,000 all-time weather records set (most heat or rain) 10 U.S. weather cats costing over $1 billion each 99 federal disaster declarations (avg. 34 prev. 50 yrs) Boston bombings

U.S. Insured Catastrophe Losses

$7.5

$2.7 $4.7

$22.

9$5

.5$1

6.9

$8.3

$7.4

$2.6 $1

0.1

$8.3

$4.6

$26.

5$5

.9 $12.

9$2

7.5

$6.7

$27.

1$1

0.6

$13.

8$3

5.9

$35.

0

$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 10 11 12

Source: Property Claims Service/ISO; Insurance Information Institute

$ Billions

Sandy $18.8B


Top Most Costly Disasters in U.S.(Insured Losses, 2011 Dollars, $ Billions)

Sources: PCS; Insurance Information Institute inflation adjustments.

$9.0$11.9 $13.1

$19.1 $21.3$24.0 $25.0

$47.6

$8.5$7.7$6.5$5.5$4.4$4.3

$0$5

$10$15$20$25$30$35$40$45$50

Irene(2011)

Jeanne(2004)

Frances(2004)

Rita (2005)

Hugo (1989)

Ivan (2004)

Charley(2004)

Wilma(2005)

Ike (2008)

Northridge(1994)

SpringTornadoes& Storms*

(2011)

9/11 Attack(2001)

Andrew(1992)

Katrina(2005)

Taken as a single event, the Spring 2011 tornado and storm season is the 4th

costliest event in US insurance history


Hurricane/Superstorm Sandy

Estimated $19 billion insured losses Economic loss of nearly $80 billion Over $7 billion in NFIP flood claims Major infrastructure claims

Source of continued uncertainty in estimates


Sandy Lessons and Issues Flood risk remains a big issue

NFIP

Business interruption is one of the biggest issues facing businesses – and it is poorly assessed and addressed

Will insurers’ cat risk mitigation strategies work?

watch decisions on “hurricane” deductibles availability and pricing in cat-prone areas

Data Centers, utilities, supply chains …


Securitization of Property Risk (Catastrophe Bonds)

$1,729.8

$2,700.0$3,400.0

$4,800.0$4,300.0

$6,300.0

$966.9

$7,329.6

$4,693.4

$1,991.1

$1,142.8$1,219.5$846.1$984.8$1,139.0$633.0

$0$1,000$2,000$3,000$4,000$5,000$6,000$7,000$8,000

97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Ris

k C

apita

l Iss

ues

($ M

ill)

0

5

10

15

20

25

30

35

Num

ber o

f Iss

uanc

es

Risk Capital Issued Number of Issuances

Source: MMC Securities Guy Carpenter, A.M. Best; Insurance Information Institute.

Cincinnati Insurance in Jan. 2013 issued $61.2

million cat bonds for New Madrid earthquake and severe thunderstorms

protection.


Characteristics of Liability Risks Involvement of a third party Difficulty in defining the risk

measurement of the loss amount establishing fault identifying the scope of exposure

"Long-tail" problem


Major Liability Insurance Policies

homeowners personal auto policy (PAP) commercial general liability (CGL) business auto coverage (BAC) umbrella liability policies (commercial and personal) directors and officers liab. (D & O) environmental impair. liab. (EIL) workers comp. / employers liability employment practices liability (EPL) professional liability (malpractice)

Average Expenditures on Auto Insurance

$651$668

$691$705

$726

$786

$830$842$831$816

$795$789$785$808$816

$839

$690$685$703

$600

$650

$700

$750

$800

$850

$900

$950

94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10* 11* 12*

* Insurance Information Institute Estimates/ForecastsSource: NAIC, Insurance Information Institute estimates 2010-2013 based on CPI and other data.

Countrywide auto insurance expenditures are expected to increase about 3% in 2012


Average Auto Insurance Expenditure:Top/Bottom 5 vs. US (2010)

Source: NAIC; Insurance Information Institute.

NJ DC LA NY FL US ME ID IA ND SD$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

$1,157 $1,134 $1,121 $1,079 $1,037

$791

$582 $548 $547 $529 $525

Detroit ($5,941), Philadelphia ($4,071)

Cost of Insurance Fraud

Second largest economic crime Healthcare fraud $81 to $270

billion per year (Medicare, Medicaid and private insurance)

Property-casualty fraud $32 billion auto insurance fraud $6.8 billion workers’ compensation fraud $5 billion

$$$

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Insurance Operations

Structure of Insurance Market Types of insurers

property-liability insurers life insurers health insurers

Organizational form

Competitive market


Industry Size (L-H v. P-C)

0% 20% 40% 60% 80% 100%

Assets ($trillion)

Premiums ($billion)

Insurers

4.8

627

1106

1.49

481

2737

Life-HealthProperty-Liability

Source: III Insurance Fact Book 2011.

2,343 Life Insurers in 1988


Statutory Accounting Principles (SAP)(Insurance Accounting)

GAAP v. SAP going concern v. liquidation expenses recognized immediately while

revenues must be accrued admitted v. non-admitted assets conservative securities valuation

Insurance Market Direction

Assets – Liabilities = Net worth Policyholder Surplus = Capital

= Capacity = Supply Factors to consider

Underwriting (losses) Reserves Reinsurance Cats

Investments Regulation (e.g., Basel III)

Surplus

If domicile of parent considered, 83.4% of

reinsurance bought by U.S. insurers was from

foreign reinsurers

Reserves

Sources: NAIC & III.

Invested assets totaled $1.32 trillion

Generally, insurers invest conservatively, with over 2/3 of invested assets in bonds

Only 17% of invested assets were in common or preferred stock

66.4%

9.9%17.2%6.5%

Bonds

Common & Preferred Stock

As of December 31, 2010

Cash & Short-term

Investments

Other

Distribution of P/C Insurance Industry’s Investment Portfolio

-55-50-45-40-35-30-25-20-15-10-505

101520253035

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 10 11 12

Source: A.M. Best, ISO; Insurance Information Institute

$ B

illio

nsUnderwriting Gain (Loss)


P/C Insurer Investment Gains$ Billions

$35.4

$42.8$47.2

$52.3

$44.4

$36.0

$45.3$48.9

$59.4$55.7

$63.6

$51.5

$39.2

$53.4 $53.9$56.2$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 06 07 08 09 10 11 12Investment gains consist primarily of interest, stock dividends and realized capital gains and losses. Sources: ISO; Insurance Information Institute.


Policyholder Surplus$ Billions

$497

$513$522$518

$456

$437

$463

$491

$512

$541$531

$545$557

$565$559

$539$550

$568$570

$479

$505

$516

$420

$440

$460

$480

$500

$520

$540

$560

$580

07:Q

107

:Q2

07:Q

307

:Q4

08:Q

108

:Q2

08:Q

3

08:Q

409

:Q1

09:Q

209

:Q3

09:Q

410

:Q1

10:Q

210

:Q3

10:Q

411

:Q1

11:Q

211

:Q3

11:Q

4

12:Q

112

:Q2

12:Q

312

:Q4

Policyholder Surplus (Net Worth) = Assets – LiabilitiesSource: ISO (historical); Insurance Information Institute.

$584 $587


Average Commercial Insurance Rate Changes

3.9%4.7%

5.3%4.8%

5.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

Q4 2011 Q1 2012 Q2 2012 Q3 2012 Q4 2012

Average commercial insurance rate changes in that quarter. Source: Council of Insurance Agents and Brokers.


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Reinsurance Principles

Reinsurance Definition

Shifting of part or all of the insurance originally written by one insurer to another insurer

Customer other insurers ( primary insurer )


Reinsurers Professional

reinsurers direct broker market

Reinsurance departments

Terms Ceding Company ( primary insurer ) Reinsurer Net Retention Cession Retrocession

retrocessionnaire and retrocedent


Types of Reinsurance Contracts

Facultative Treaty

Coverage Proportional (quota and

surplus share) Excess

Functions of ReinsuranceBenefits for Insureds & Insurers

Benefits for Insureds

Benefits for Insurers

All coverage can be obtained from one insurer, reducing the chance of coverage gaps & problems in loss collection.

Reduces the chance of primary insurer insolvency.

Allows small insurers to compete with large insurers, which should increase availability & reduce price.

Stabilizes loss experience.

Increases large line capacity.

Provides surplus relief.

Protects against catastrophic losses.

Provides underwriting assistance.

Allows withdrawal from a territory or class of business.


Reinsurance Regulation Less stringent (little rate regulation) Domestic, foreign, alien Credit for reinsurance

(indirect regulation) effects primary insurer’s liabilities

and its surplus creates incentives to deal with

sound reinsurers

FIO has a monitoring role as well


Top three domiciles

are:• Germany

• Switzerla

nd• U.S.

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Guaranty Funds

Guaranty Funds Funds in all states (P-C and Life) Coverage limits vary across states Funded on a post-assessment

basis (except NY) Modest levels of insolvencies have

made this workable


P/C Insurer Impairments8

1512

711 9

349

13 1219

916 14 13

3649

3134

49 4954

60 5841

2915

1231

18 1949 50

4735

1813 15

719 21

34

4

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 07 08 09 10 11

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


Reasons for P/C Insurer Impairments(1969-2010)

Deficient Loss Reserves and Inadequate Pricing Are the Leading Cause of Insurer Impairments. Investment and Catastrophe Losses Play a Much Smaller Role

Deficient Loss Reserves/Inadequate Pricing

Reinsurance Failure

Rapid GrowthAlleged Fraud

Catastrophe Losses

Affiliate Impairment

Investment Problems

Misc.

Sig. Change in Business

Reason in 54.5% of insolvencies in

2010

3.6%4.0%

8.6%

7.3%

7.8%

7.1%

7.8% 13.6%

40.3%

Source: A.M. Best


Number of Impaired L/H Insurers6

1117

10 12 13 1232

16 16 1623

2755

4681

3824

12 1119 18

1226

10 8 105 5

103

8 9 126

2

0

10

20

30

40

50

60

70

80

9076 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 10 11

Source: A.M. Best Special Report “1969-2011 Impairment Review”; Insurance Information Institute.

The Number of Impairments Spiked in 1989-92. But in the Financial Crisis, When Large Numbers of Banks

Failed, Virtually No Life Insurers Failed.

Average number of impairments, 1976-2010: 18.2


Deficient Loss Reserves/Inadequate

Pricing, 27.5%

Affiliate Problems;

18.6%

Investment Problems; 15.4%

Rapid Growth, 14.5%

AllegedFraud, 9.1%

Other, 15.0%

Source: A.M. Best, 1976-2009 Impairment Review, Special Report

Leading Causes of Impairment

---Business Management (Rapid Growth, Investment Problems, Affiliate Problems)

---Deficient Loss Reserves/ Inadequate Pricing

Reasons for L-H Insurer Impairments(1976-2009)

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Trends to Watch

Interest and Concern in Risk Management Google Search

Risk Management – 2006 & 2007: 3.2 million 2008 & 2009: 27.2 million 2011 & 2012: 81.4 million

“Audit committee members rank risk management as top worry”

KPMG Survey of Corporate Directors


Risk Trends Reputation risks

80% chance of a company losing at least 20% of its value in any single month over a five-year period due to a reputation crisis (Aon, 2012)

Cyber-Liability Need to think about these risks outside of the IT

department Data loss, privacy, virus issues Need broad-based, disaster recovery plan (need

to test it!) Liability / Tort issues

Climate, energy, professional


Top Insurance Industry Trends Risk and Capital Management

Low interest rate environment Strategic risk management (ERM)

Financial Reporting Regulatory Compliance

Dodd-Frank (Thrift owners and SIFIs) ORSA and Solvency II

Catastrophe Risk Terrorism Risk (especially without TRIA)


Other Insurance Industry Trends Businesses opting for higher retentions

Especially in workers’ compensation Big data

Predictive modeling (underwriting and claims) Distribution issues (web and social media) Talent

The graying of the workforce Recruiting and retaining it


Contact Information for the Risk Management and Insurance Program at the University of Georgia

Department Head, Rob Hoyt Brooks Hall 206 [email protected]

Our web site www.terry.uga.edu/insurance


http://www.terry.uga.edu/insurance

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