the insurance cycle is alive and well and ready to kill your company: are actuaries to blame?
DESCRIPTION
The Insurance Cycle is Alive and Well and Ready to Kill Your Company: Are Actuaries to Blame?. Casualty Actuarial Society Ratemaking Seminar New Orleans, LA March 10, 2005. Robert P. Hartwig, Ph.D., CPCU, Senior Vice President & Chief Economist - PowerPoint PPT PresentationTRANSCRIPT
The Insurance Cycle is Alive and Well and Ready
to Kill Your Company:
Are Actuaries to Blame?Casualty Actuarial Society
Ratemaking SeminarNew Orleans, LA
March 10, 2005
Robert P. Hartwig, Ph.D., CPCU, Senior Vice President & Chief EconomistInsurance Information Institute 110 William Street New York, NY 10038
Tel: (212) 346-5520 Fax: (212) 732-1916 [email protected] www.iii.org
Presentation Outline
• P/C Financial Overview & Outlook: The Cycle Returns Premiums Underwriting Performance Pricing, Profits Capital/Capacity Investments Financial Strength/Ratings
• Will it Be Different This Time Around?• Actuaries: Are They to Blame?• 3 Case Studies: PPA, Homeowners & WC• Investment Income Influence Considerations• Exogenous Influences• Possible Solutions• Summary• Q & A
P/C FINANCIAL OVERVIEW
Highlights: Property/Casualty,9-Months 2004 vs. 9-Months 2003
2004 2003 Change
Net Written Prem. 321,225 307,472 +4.5%
Loss & LAE 223,687 216,796 +3.2%
Net UW Gain (Loss) 2,848 (5,854) N/A
Net Inv. Income 28,748 27,676 +3.9%
Net Income (a.t.) 26,707 20,819 +28.3%
Surplus* 369,018 346,987 +6.3%
Combined Ratio 97.9 100.3** -2.4 pts.*2003 surplus figure is as of 12/31/03**The combined ratio for full-year 2003 was 100.1
Growth rate less than half that of a year earlier
An underwriting profit? What’s that?
Record Surplus!
Combined < 100
CYCLICAL EVIDENCE:
PREMIUMS
-10%
-5%
0%
5%
10%
15%
20%
25%
19
70
19
71
19
72
19
73
19
74
19
75
19
76
19
77
19
78
19
79
19
80
19
81
19
82
19
83
19
84
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
F2
00
5
Note: Shaded areas denote hard market periods.Source: A.M. Best, Insurance Information Institute
Strength of Recent Hard Markets by NWP Growth*
Real NWP Growth During Past 3 Hard Markets
1975-78: 8.6%
1984-87: 11.2%
2001-04E: 6.8%
1975-78 1984-87 2001-04
*2004 based on 1st half results from ISO.2005 figure is III forecast.
Premium growth is faltering. Real growth in 2005 will approach ZERO.
CYCLICAL EVIDENCE:
UNDERWRITING PERFORMANCE
90
100
110
120
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
*0
5
P/C Industry Combined Ratio2001 = 115.7
2002 = 107.2
2003 = 100.1
2004: 9 mos. = 97.9
2005F = 99
Combined Ratios
1970s: 100.3
1980s: 109.2
1990s: 107.8
2000-04E: 106.5
Sources: A.M. Best; ISO, III *9-month result.
The industry has just experienced its most
remarkable recovery in recent history
($55)
($45)
($35)
($25)
($15)
($5)
$5
$15
$25
19
75
19
76
19
77
19
78
19
79
19
80
19
81
19
82
19
83
19
84
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
04
*0
4**
Underwriting Gain (Loss)1975-2004F
*Based on 9-month result. Source: A.M. Best, Insurance Information Institute
$ B
illi
ons
2004 is likely to produce the first underwriting profit since 1978
110.
3
110.
2
107.
6
103.
9
109.
7
112.
3
111.
5
122.
2
110.
2
98
100
103.
9
104.
5
103.
5
104.
9
99.8 10
2.7
104.
5 109.
9
110.
9
105.
3
98.4
97 98
112.
5
101.
9
90
95
100
105
110
115
120
125
93 94 95 96 97 98 99 00 01 02 03 04E 05F
Commercial--Net Basis Personal--Net Basis
Commercial vs. Personal Lines Combined Ratios
Source: A.M. Best; Insurance Information Institute *1994-2003 average
10-Year Average Combined Ratios*
Commercial: 109.9 Personal: 104.4
Compression of results is due to low interest. Underwriting is now more important in
long-tail commercial lines
Combined Ratios:2004 vs. 2005E
93.3
100.
9 106.
6 110.
5
99
93.3
79.4
97.6
93.1
98.6
106.
2 109.
8
99.4
80.3
97.3
94.9
70
75
80
85
90
95
100
105
110
115
PP Auto Homeowners WC GL &Products
Comm MultiPeril
Comm Auto InlandMarine
ALL LINES
2004 2005
Source: A.M. Best Review/Preview, January 2005; Insurance Information Institute.
Combined ratios are expected to change very little in 2005, masking
a deterioration of about 2 to 3 points associated with 2004’s catastrophe impacted results
Commercial auto, CMP, Inland Marine results remain reasonable,
but WC, GL still problematic
110
.5
10
5.0 11
3.6 11
9.2
10
4.8
10
0.8
10
0.5
114
.3
10
6.5
12
1.3
10
0.3
10
210
8.8 11
5.8
10
6.9
10
8.5
10
6.5
10
5.8
10
1.6
10
5.6
10
7.7
110
.0 115
.7
10
7.2
10
0.1
97
.9
16
2.5
12
6.5
90
100
110
120
130
140
150
160
170
91 92 93 94 95 96 97 98 99 00 01 02 03 04*
Reinsurance All Lines Combined Ratio
Combined Ratio: Reinsurance vs. P/C Industry
*Through 2004:Q3
Source: A.M. Best, ISO, Reinsurance Association of America, Insurance Information Institute
2001’s combined ratio was the worst-ever for reinsurers; 2002 was bad as well.
2003: Big improvement in primary and reinsurer segments
Underwriting Expense Ratio*
25.9% 26.1% 26.3%
27.0%
27.6%28.0%
27.5%
26.5%
25.3%
24.6% 24.7% 24.8%
22%
23%
24%
25%
26%
27%
28%
29%
94 95 96 97 98 99 00 01 02 03 04E 05F
*Ratio of expenses incurred to net premiums written.Source: A.M. Best; Insurance Information Institute
Insurers are keeping expenses under control
CYCLICAL EVIDENCE:
PROFITABILITY
P/C Net Income After Taxes1991-2004E* ($ Millions)
$14,178
$5,840
$19,316
$10,870
$20,598
$24,404
$36,819
$30,773
$21,865
-$6,970
$3,046
$29,877
$36,000
$20,559
$26,707
-$10,000
$0
$10,000
$20,000
$30,000
$40,000
91 92 93 94 95 96 97 98 99 00 01 02 03 04* 04F*9-Month results; F = Full Year forecast/estimate.Sources: A.M. Best, ISO, Insurance Information Institute.
2001 ROE = -2.6%
2002 ROE = 1.0%
2003 ROE = 9.4%
2004 ROE = 11.5%F
-5%
0%
5%
10%
15%
20%
87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04E
US P/C Insurers All US Industries
ROE: P/C vs. All Industries 1987–2004E
Source: Insurance Information Institute; Fortune
-5%
0%
5%
10%
15%
20%
91 92 93 94 95 96 97 98 99 00 01 02 03 04F
ROE Cost of Capital
ROE vs. Equity Cost of Capital: US P/C Insurance: 1991 – 2004F
Source: The Geneva Association, Ins. Information Inst.
The p/c insurance industry likely achieved its costs of capital in 2004 for the first time in many years
-14.
6 p
ts -10.
2 p
ts
US P/C insurers missed their cost of capital by an average 6.5 points from 1991 to 2003
-1.2
p
ts
+1.
6 p
ts
THE CYCLE LIVES:
IT REALLY WILL BE DIFFERENT THIS TIME
YES!
YES!It Be Different This Time Around!
• New Management: Benefit of 20/20 HindsightMost (re)insurer CEOs have been replaced over past 5 yearsNew management teams not eager to repeat past mistakesManagement Mantra: Preaching Disciplined UW & Pricing
• Information Flow: Many insurers have now implemented MIS systems that reduce
recognition lags & reaction times and increase info flow• Compensation Structure: Not Just Volume Based
Stock incentives playing a lesser roleStrict adherence to UW manual and pricing
• Sarbanes-OxleyCEO/CFO’s personal assets on the lineBoard of Directors quality enhanced; less chummyReserves become more adequateActuaries, UWs, accountants all on board & getting tough
YES!It Be Different This Time Around!
• Ratings AgenciesHave become de facto regulatorsKeeping a tight leash on upgrades and paying a lot of attention to
capital/reserve adequacy & profitability-industry disciplined• Investment Analysts
Subject insurers to greater scrutiny• Regulators
Finally waking up• Quasi-Regulators
Spitzer, other AGs, SEC will keep industry on its toes• Tort reform is finally happening• Republican Domination of Congress/White House Good for
Industry• We’re Better at Anticipating New/Emerging Risks• Better at Managing Existing Risks/Reducing Volatility
NO!
NO!It Won’t Be DifferentThis Time Around!
• Management Never Learns: Hindsight Means Nothing80 years of history show management repeats same mistakesQuarterly earnings and growth targets are still kingMantra of UW & Pricing discipline is just lip service
• P/C Insurance Will Always Be an Impossible Business Impossible to use past information to determine prices today for a
product sold tomorrow for claims that may arise in the distant future AND expect to be right
• Investor FatigueWall Street is fed up with low returns; no capital for youCapital is now highly opportunistic; not committed to long run
• Investments: Still Used to Paper Over Poor UW & Pricing DecisionsCash flow underwriting is back in vogue (or soon will be)
NO!It Won’t Be DifferentThis Time Around!
• Regulators Still Asleep at the SwitchE.g., Piling on to Spitzer investigationVehement defense on status quo regulatory environment
• Still do Bad Job Managing Variability/Volatility 2004 hurricane season, D&O, Products LiabilityConstantly blindsided
• Tort Reform: Keep on Dreamin’Big loopholes in Class Action Fairness Act Act was watered down (no atty. fee limits or damage caps)Forum shopping at the federal level still possible
• Republican Congress/White House Don’t Care About UsExcept CAFA, little success in Washington over past few yearsSpitzer investigation = opportunity to heap scorn on industry
What Wall Street Thinks
• *The commercial insurance market is softening as prices decline, particularly in short tail lines, and competition increases.
•Company X [name omitted] said that it would reduce pricing for its best customers in what we view as a potentially troubling trend because it’s a slippery slope.
•Falling pricing, less restrictive terms and conditions, and a shift in negotiating leverage away from the insurers to the commercial insurance buyers should result in a challenging operating environment for the commercial insurers in 2005, as well as lower premium growth and deteriorating margins
•Demand for reinsurance is flat, while supply has increased.
Source: Prudential Securities’ P/C insurance analyst, Jay Gelb, March 9, 2005
CAUSE FOR CONCERN?
THE CYCLE IS A NATURAL BORN KILLER
FINANCIAL STRENGTH, SOLVENCY &
SECURITY
0.4
5
0.4
1
0.4
3
0.4
2 0.6
8
1.2
2
1.7
1
1.1
2
0.4
4
0.5
8 0.8
2
0.9
9
1.0
5
1.7
8
1.1
0.8
3
1.5
6
1.0
8
0.8
0.5
1
0.4
1
0.9
6
1.9
2
1.9
9
3.3
1.7
9
4.93
0
1
2
3
4
5
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
E
Ra
tio
of
Do
wn
gra
des
to
Up
gra
des
Downgrade/Upgrade Ratio*
Sources: Impairment Rate and Rating Transition Study—1977 to 2002, A.M. Best & Co.
*U.S. property/casualty and life/health insurers before 2000; P/C only 2000-2004.
Downgrade to upgrade ratio is falling (primarily because the number of downgrades is falling; only a small increase
in upgrades)
P/C Company Insolvency Rates,1993 to 2002
Source: A.M. Best; Insurance Information Institute
1.20%
0.58%
0.21%0.28%
0.79%
0.60%
0.23%
1.02% 1.03%
1.33%
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
•Insurer insolvencies are increasing•10-yr industry failure rate: 0.72%
•Failure rating for B+ or better rating: 0.49%•Failure rate for D through B rating: 1.29%
383030
10-yr Failure Rate
= 0.72%
Reason for P/C Insolvencies(218 Insolvencies, 1993-2002)
Unidentified17%
Impaired Affiliate3%
Overstated Assets2%
Change in Business3%
CAT Losses3%
Reinsurer Failure0%
Rapid Growth10%
Discounted Ops8%
Alleged Fraud3%
Deficient Loss Reserves
51%
Source: A.M. Best, Insurance Information Institute
Reserve deficiencies account for
more than half of all p/c insurers
insolvencies
RESERVING PROBLEMS:
ARE ACTUARIES TO BLAME?
$ Billions, Calendar Year Basis
$2.3 $2.2 $1.2
($8.5)
($1.5)
($7.5)($6.7)($10.0)
$22.7
$13.7
$0.3
($3.7)
$0.4
$11.0
($15)
($10)
($5)
$0
$5
$10
$15
$20
$25
90 91 92 93 94 95 96 97 98 99 00 01 02 03
P/C Insurance Industry Reserve Development from Prior Year*
*Negative numbers indicate favorable development; positive figures represent adverse development.Source: A.M. Best, Morgan Stanley, Dowling & Partners Securities, Prudential Securities, Ins. Info. Inst.
Adverse reserve development totaled $47.8 billion from 2000 through 2003
Adverse reserve development is the #1 killer of p/c insurance companies: Strength Matters
$ Billions, Calendar Year Basis
$58.
7
$39.
1
$37.
8
$33.
6
$30.
3
$18.
8
$2.7
($11
.3) ($3.
0)
$14.
1
$32.
9
$47.
8
$40.
9
$13.
9
$53.
6
($1.
5)
($8.
7)
($7.
9)($20)
($10)
$0
$10
$20
$30
$40
$50
$60
$70
85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03
CALENDAR Year Loss & ALAE Reserve Development Through 2003*
*Negative numbers indicate favorable development; positive figures represent adverse development.Figures represent total development relative initial calendar year reservesSource: A.M. Best; Ins. Info. Inst.
Adverse reserve development is a
perpetual problem
NA
$ Billions, Accident Year Basis$8
.4
($8.
2)
($7.
3) ($3.
9)
($14
.1)
($11
.3)
($15
.2)
($15
.5)
($1.
9)
$7.8
$13.
0
$13.
6
$3.8
($4.
8)
($4.
5)
($10
.4)
($9.
8) ($6.
7)($20)
($15)
($10)
($5)
$0
$5
$10
$15
$20
85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03
ACCIDENT Year Loss & ALAE Reserve Development Through 2003*
*Negative numbers indicate favorable development; positive figures represent adverse development.Figures represent total development relative initial accident year reservesSource: A.M. Best; Ins. Info. Inst.
AY1998-2001 claims source of great pain
in the industry
NA
$ Billions, Calendar Year Basis
$0.5 $0.6$1.1
$1.6 $1.7$2.3
$5.5
$2.9
($0.9)($1.5) ($0.8)
($2)
($1)
$0
$1
$2
$3
$4
$5
$6
P/C Insurance Industry Prior Year Reserve Development by Line, 2002-03*
*Negative numbers indicate favorable development; positive figures represent adverse development.Source: A.M. Best, Ins. Info. Inst.
Major adverse development in
casualty segments
Why did most lines develop so adversely in 2003?
Who’s to blame?
Points (Reduced)/Increased
0.5
(2.4)
5.2
6.3
3.5
(0.4)
-3
-2
-10
1
2
3
45
6
7
1998 1999 2000 2001 2002 2003
Combined Ratio:Impact of Reserve Changes (Points)
Source: ISO, A.M. Best, MorganStanley, Prudential Securities.
Prior-year adverse reserve development totaling nearly $14 billion in 2003 added 3.5 points to the p/c combined
ratio in 2002
PRICING PROBLEMS:
ARE ACTUARIES TO BLAME?
POLL: Who’s to Blame for Problem Pricing? (by Applause)
1. Actuaries
2. Senior Management of Company
3. Your Underwriting Department
4. Your Marketing Department
5. Regulators
109.4110.2
118.8
109.5
112.5
110.2
107.6
103.9
109.7
122.3
110.3
101.9
111.5112.3
$7.30$6.49
$8.91
$8.30
$11.96
$6.46
$4.83$5.20
$5.71
$5.25
$5.70
$7.70
$6.40$6.10
100
105
110
115
120
125
90 91 92 93 94 95 96 97 98 99 00 01 02 03
Co
mm
erc
ial L
ine
s O
pe
rati
ng
Ra
tio
$0
$2
$4
$6
$8
$10
$12
Co
st
of
Ris
k/$
10
00
Re
ve
nu
e
Commercial Operating Ratio
Cost of Risk
Source: RIMS, A.M. Best; Insurance Information Institute
Cost of Risk vs. Commercial Lines Combined Ratio
World Rate-On-Line Index(1990 = 100)
100116
283
372
337
288
248
193
160138 142
194
239260
230
0
50
100
150
200
250
300
350
400
90 91 92 93 94 94 96 97 98 99 00 01 02 03 04
Source: Guy Carpenter
Reinsurance prices rising, limits falling: ROL up significantly, though not as much as after Hurricane Andrew in 1992
P/C Soft Spots: % Accounts With Negative Price Change(4th Qtr. 2004)
86%
53% 53% 55%
70%62%
16%
35%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Comm Prop BizInterruption
Terror Comm Auto WC GL EPL Umbrella
Source: Council of Insurance Agents & Brokers; Insurance Information Institute
Significant moderation now evident in the commercial casualty lines
Property
Casualty/Liability/Terrorism
P/C Soft Spots: % Accounts With Negative Price Change(4th Qtr. 2003)
42%
18%
5%
13% 12% 11%13%
2%0%5%
10%15%20%25%30%35%40%45%50%55%60%
Comm Prop BizInterruption
Terror Comm Auto WC GL EPL Umbrella
Source: Council of Insurance Agents & Brokers; Insurance Information Institute
Property
Casualty/Liability/Terrorism
P/C Soft Spots: % Accounts With Negative Price Change(4th Qtr. 2002)
2% 0% 1% 0% 0% 1%
7%
0%0%5%
10%15%20%25%30%35%40%45%50%55%60%
Comm Prop BizInterruption
Terror Comm Auto WC GL EPL Umbrella
Source: Council of Insurance Agents & Brokers; Insurance Information Institute
Property
Casualty/Liability/Terrorism
14
%11
% 13
%1
6%
19
%2
2%
28
%3
1%
31
%2
8% 3
0% 3
2%
33
%2
8%
29
%3
0% 3
2%
30
%2
7%
25
%2
8%
22
%1
8%
18
%1
7%
16
%1
2%
12
%1
0% 12
%11
%9
%
7%
7%
5%
4%
4%
2%
2%
2%
1%
0%
9%
9%
0%
5%
10%
15%
20%
25%
30%
35%
Ju
l-0
1A
ug
-01
Sep
-01
Oct
-01
No
v-0
1D
ec-0
1J
an
-02
Feb
-02
Ma
r-0
2A
pr-
02
Ma
y-0
2J
un
-02
Ju
l-0
2A
ug
-02
Sep
-02
Oct
-02
No
v-0
2D
ec-0
2J
an
-03
Feb
-03
Ma
r-0
3A
pr-
03
Ma
y-0
3J
un
-03
Ju
l-0
3A
ug
-03
Sep
-03
Oct
-03
No
v-0
3D
ec-0
3J
an
-04
Feb
-04
Ma
r-0
4A
pr-
04
Ma
y-0
4J
un
-04
Ju
l-0
4A
ug
-04
Sep
-04
Oct
-04
No
v-0
4D
ec-0
4J
an
-05
Feb
-05
Source: MarketScout.com
Commercial Premium Rate Changes Are Sharply Lower
Is moderation due to realization of performance and profit goals, increasing capacity/ capital, or market- share strategies?
A TALE OF THREE PRICING STRATEGIES
PPA: Pricing Success StoryWC: Slow Mo Train Wreck?
HO: Jury’s Out
Private Passenger Auto
$668$691
$706 $704$683 $687
$720
$774
$834$857 $870
$600
$650
$700
$750
$800
$850
$900
$950
95 96 97 98 99 00 01 02 03* 04* 05*
Average Expenditures on Auto Insurance
*Insurance Information Institute Estimates/ForecastsSource: NAIC, Insurance Information Institute
Countrywide auto insurance expenditures are expected to
rise 1.5% in 2005
101.7 101.3 101.3 101.0
99.5
101.1
103.5
109.5
107.9
104.2
98.4
93.3 93.1
90
95
100
105
110
93 94 95 96 97 98 99 00 01 02 03 04E 05F
Private Passenger Auto Combined Ratio
Average Combined 1993 to 2004= 102.7
Many 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
50%
60%
70%
80%
90%
100%
110%
99
:Q1
99
:Q3
00
:Q1
00
:Q3
01
:Q1
01
:Q3
02
:Q1
02
:Q3
03
:Q1
03
:Q3
04
:Q1
04
:Q3
Collision Comprehensive Liability (BI & PD)
Source: ISO Fast Track; Insurance Information Institute.
Private Passenger Auto:Incurred Loss Ratios, 1999-2004:Q3
Loss ratios for all major coverage are trending
downward
-4%
-2%
0%
2%
4%
6%
8%
10%
12%
00
:Q1
00
:Q2
00
:Q3
00
:Q4
01
:Q1
01
:Q2
01
:Q3
01
:Q4
02
:Q1
02
:Q2
02
:Q3
02
:Q4
03
:Q1
03
:Q2
03
:Q3
03
:Q4
04
:Q1
04
:Q2
04
:Q3
Auto Insurance Component of CPI Personal Auto-PD Pure Premium
Source: Insurance Information Institute calculations based ISO Fast Track and US BLS data.
Pure Premium Spread: Personal Auto PD Liability, 2000-2004:Q3
Margin necessary to maintain PPA profitability
2000 PPA Combined = 110
2003 PPA Combined = 98
10%
15%15%
12%14%14%
11% 12%12%
10%
8%
2% 2%
4%
0%
2%
4%
6%
8%
10%
12%
14%
16%
92 93 94 95 96 97 98 99 00 01 02 03E 04E 05F
RNW: Private Passenger Auto, United States, 1992-2002
Source: NAIC; Insurance Information Institute
Private passenger auto profitability deteriorated hroughout the 1990s but
has improved dramatically
Segmentation should help profitability
Workers Compensation
Workers Comp Calendar Year vs. Ultimate Accident Year – Private Carriers
10197
111108 107 106
101106
119
129
138133
125
100 101
108
115118
122
97
106101
90
100
110
120
130
140
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003p 2004E 2005F
Calendar Year Accident Year
Percent
p Preliminary AY figure. Accident Year data is evaluated as of 12/31/2003 and developed to ultimateSource: Calendar Years 1994-2002, A.M. Best Aggregates & Averages; Calendar Year 2003p and Accident Years 1994-2003p and 2004/5 estimate and forecast, NCCIIncludes dividends to policyholders
Workers Comp Combined Ratios, 1994-2005F
$7.9 $8.0 $7.8$8.5 $8.9
$9.6$10.3
$11.1$12.0
$13.1
$14.7
$16.3
$17.8
$5
$7
$9
$11
$13
$15
$17
$19
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003p
Annual Change 1991–1995: +3.9%Annual Change 1996–2002: +9.0%
Accident Year
MedicalClaim Cost ($000s)
2003p: Preliminary based on data valued as of 12/31/20031991-2002: Based on data through 12/31/2002, developed to ultimateBased on the states where NCCI provides ratemaking servicesExcludes the effects of deductible policies
Workers Comp Medical Claims Continue to Climb
4.5%3.6%
2.8% 3.2% 3.5%4.1%
4.6% 4.7%4.0%
5.1%
7.4% 7.7% 7.3%
8.7% 9.0%
12.0%11.0%
9.0%
0%
2%
4%
6%
8%
10%
12%
14%
1995 1996 1997 1998 1999 2000 2001 2002 2003
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.
5.0
pts
WC medical severity is rising 2.3 times faster than the
medical CPI
Med Costs Share of Total Costs is Increasing Steadily
Indemnity56%
Medical44%
Source: NCCI (based on states where NCCI provides ratemaking services).
Indemnity51%
Medical49%
Indemnity45% Medical
55%
1983
1993
2003p
Cost Drivers in Workers Comp
Source: Morgan Stanley
Prescription Drugs14%
Surgery/ Anesthesia
12%
Other25%
Physical Medicine
20%
Hospital & Facility Charges
13%
Diagnostic Radiology
16%
Average rate if inflation in the 5 specific areas is
likely to continue at 5%-6%for the indefinite future, which bodes ill
given current WC rate environment
Proportion of Workers Comp Accounts Renewing With Increase of
20% or More
Source: Council of Insurance Agents and Brokers; Insurance Information Institute
54%
38% 38%
32%
20%
12% 12%
3% 1% 1% 1%
02:II 02:III 02:IV 03:I 03:II 03:III 03:IV 04:I 04:II 04:III 04:IV
More than half of all WC accounts
renewed up at least 20% in mid-2002,
two years later virtually none did.
55% of WC accounts renewed negative during the 4th quarter of 2004
Homeowners
$418$440
$455$481 $488
$508$536
$593
$636$660
$677
$400
$450
$500
$550
$600
$650
$700
95 96 97 98 99 00 01 02 03* 04* 05*
Average Expenditures on Homeowners Insurance
*Insurance Information Institute Estimates/ForecastsSource: NAIC, Insurance Information Institute
Countrywide home insurance expenditures
are expected to rise 2.5% in 2005
117.7
158.4
113.6118.4
112.7
121.7
101.0
108.2111.4
121.7
109.3
98.2100.9
98.6
113.0109.4
90
100
110
120
130
140
150
160
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04E 05F
Homeowners Insurance Combined Ratio
Average 1990 to 2004E= 114
Insurers have paid out an average of $1.15 in losses for every dollar earned
in premiums over the past 14 years
Sources: A.M. Best; III
ROE for Homeowners Insurance in Texas, 1992 - 2002
-38.8%
14.7%
-42.4%-41.9%
11.9%
-10.9%
19.4%20.7%
-23.5%
6.2%
-6.0%
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
30%
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
Source: NAIC
States like TX & FL make the Homeowners
proposition more difficult
WHY UNDERWRITING DISCIPLINE MATTERS
97.5
100.6 100.1
94.3
97.9
9.4%9.9%
14.3%
15.9%15.0%
80
85
90
95
100
105
110
1978 1979 2003 Actual 2003 for 15%ROE
2004F
Co
mb
ine
d R
ati
o
6%
8%
10%
12%
14%
16%
18%
Re
tru
n o
n E
qu
ity
*
Combined Ratio ROE*
* 2004 figure is return on average statutory surplus based in first 9 monhts dataSource: Insurance Information Institute from A.M. Best and ISO data.
A 100 Combined Ratio Isn’t What it Used to Be: 95 is Where It’s At
Combined ratios today must be below
95 to generate Fortune 500 ROEs
INVESTMENT INCOME:
THE SOLUTION TO UNDERWRITING, PRICING
AND RESERVING BLUNDERS?
$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 02 03 04
Net Investment Income
History
1997 Peak = $41.5B
2000= $40.7B
2001 = $37.7B
2002 = $37.2B
2003 = $38.7B
2004E = $38.3B
$ B
illi
ons
Growth History
2002: -1.3%
2003: +3.9%
2004E: -1.0%
Source: A.M. Best, ISO, Insurance Information Institute
-30%
-20%
-10%
0%
10%
20%
30%
40%
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
20
04
Source: Ibbotson Associates, Insurance Information Institute. *Through March 7, 2005
Total Returns for Large Company Stocks: 1970-2005*
2003/4 were the first consecutive gains since 1999
S&P 500 was up 9% in 2004. Fears of higher interest rates, inflation, the falling dollar, resurgent oil prices are concerns in 2005
2005
Property/Casualty Insurance Industry Investment Gain*
$ Billions
$35.4
$42.8$47.2
$52.3
$44.4
$36.0
$45.6 $46.9
$56.9$51.9
$57.9
$0
$10
$20
$30
$40
$50
$60
94 95 96 97 98 99 00 01 02 03 04E*Investment gains consist primarily of interest, stock dividends and realized capital gains and losses.2004 estimate is annualized figure based on first 9-months results.Source: Insurance Services Office; Insurance Information Institute.
Investment gains are rising but are still nearly 20% below
their 1998 peak
OTHER POSSIBLE FACTORS:
(Besides Actuaries)
9 Competing Hypotheses on the Underwriting Cycle
Hypothesis 1: Past losses can explain
Pt=f(Lt-j) current premiums
Hypothesis 2: Premiums are information-ally efficient predictors of
P=PV E(L, LAE) future losses
Hypothesis 3: Inverse relationship between
dP/dSt-j<0 current premiums and past surplus changes
9 Competing Hypotheses on the Underwriting Cycle
Hypothesis 4: Inverse relationship between dP/di <0 interest rates and premiums
Hypothesis 5: Positive relationship between dP/dU>0 underwriting expenses and premiums
Hypothesis 6: Positive relationship between dP/d>0 uncertainty and premiums
9 Competing Hypotheses on the Underwriting Cycle
Hypothesis 7: Impact of changes in interest rates is more important to premiums in long-tail lines than those in short-tail lines
Hypothesis 8: Response of premiums to shock in variables (such as loss or interest rates) is more volatile in long-tail lines and highly regulated lines than short-tail lines
9 Competing Hypotheses on the Underwriting Cycle
Hypothesis 9: Regulatory lags lead to underwriting cycle
(e.g., rate surpression, delays in form filings, licensing).
The Holy Grail? Rosetta Stone?
t = a0 + a1t-1 + a2t-2 + et
Period (P) = 2cos-1(a1/2(-a2)-1/2)
t = underwriting profit
et = random error term
Venezian, “Ratemaking Methods and Profit Cycles in Property and Liability Insurance,” Journal of Risk and Insurance, v. 52, 1985.
Cycles, Cycles Everywhere (Cycle Periods in Years)
Netherlands 12.03
Malaysia 12.01
France 10.19
United States 7.39
Japan 7.07
Canada 5.79
Spain 5.73
Australia 5.18
Italy 4.84
Austria None
Denmark None
S. Korea None
Taiwan None
Sources: J. Lamm-Tenant and M. Weiss, “International Insurance Cycles” Rational Expectations/Institutional Intervention, Journal of Risk and Insurance, September 1997; R. Chen, K. Wong and H. Lee, “Underwriting Cycles in Asia,”, ibid, March 1999.
EXOGENOUS INFLUENCES
INVESTMENT SHOCKS
-30%
-20%
-10%
0%
10%
20%
30%
40%
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
20
04
Source: Ibbotson Associates, Insurance Information Institute. *Through March 8, 2005
Total Returns for Large Company Stocks: 1970-2005*
Do investment shocks cause cycles or does management overestimate future returns?
S&P 500 was up 9% in 2004. Fears of higher interest rates, inflation, the falling dollar, resurgent oil prices are concerns in 2005
2005
0%
2%
4%
6%
8%
10%
12%
14%
16%
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
*
3-Month T-Bill 1-Yr. T-Bill 10-Year T-Note
Interest Rates: Lower Than They’ve Been in Decades, But…
Source: Board of Governors, Federal Reserve System; Insurance Info. Institute *As of 2/25/05.
Lower bond yields were the primary driver behind declining investment income in recent years, with the 10-year note reaching a 45-year low in 2003
Higher ST rates as Fed tightens. In long run budget & current account deficits may force rates higher
About 2/3 of invested assets are in the form of bonds
US P/C Net Realized Capital Gains1990-2004E ($ Millions)
$2,880
$4,806
$9,893
$1,664
$5,997
$9,244$10,808
$18,019
$13,016
$16,205
$6,631
-$1,214
$6,917
$8,724$9,818
-$5,000
$0
$5,000
$10,000
$15,000
$20,000
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04*
*Annualized 9-month result.Sources: A.M. Best, ISO, Insurance Information Institute.
Realized capital gains rebounded
strongly in 2003/4
CAPACITY/SURPLUS
$0
$50
$100
$150
$200
$250
$300
$350
$400
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
U.S. Policyholder Surplus: 1975-2004*
Source: A.M. Best, ISO, Insurance Information Institute *As of 9/30/04.
$ B
illi
ons
•Surplus (capacity) peaked at $339.3 Billion in mid-1999 and fell by 15.9% ($53.9 billion) to $285.4 billion at year-end 2002
•Surplus is up $83.6B or 29.3% since year-end 2002
•Surplus increased by $22B or 6.3% to $369B by 2004:Q3 from $347B at year-end 2003 “Surplus” is a measure of
underwriting capacity. It is analogous to “Owners Equity” or “Net Worth” in non-insurance organizations
$53.9 Billion
Capacity TODAY is just 8.8% above its mid-1999 peak
US Reinsurers: Change in Policyholder Surplus ($ Billions)
$60.9$58.9
$56.4
$45.2
$48.8
$64.6
$40
$45
$50
$55
$60
$65
$70
1998 1999 2000 2001 2002 2003E
$ B
illi
ons
Source: A.M. Best; Insurance Information Institute
Reinsurer PHS fell 20% from 1998-2002. Capacity today similar to 1998. Same story
globally.
CATASTROPHES
U.S. InsuredCatastrophe Losses ($ Billions)
$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
$27.3
$0
$5
$10
$15
$20
$25
$30
89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04Note: 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.Source: Property Claims Service/ISO; Insurance Information Institute
$ Billions2004 was the second worst year ever for natural disaster losses in the US after adjusting for inflation.
About 79% of those losses originated in Florida.
-5%
0%
5%
10%
15%
20%
87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03
US P/C Insurers All US Industries P/C excl. Hurricanes
ROE: P/C vs. All Industries 1987–2004E*
*2004 p/c estimate based on first 9 months data.Source: Insurance Information Institute; Fortune
AndrewNorthridge
Hugo Lowest CAT losses in 15 years
Sept. 11
2004 ROE excl. hurricanes
2004 ROE reduced due to
hurricanes
FLORIDA HURRICANES & UNDERWRITING PERFORMANCE:
Homeowners Insurers Have Lost Billions
in Florida
($10.60)
($0.21)
$0.69 $0.43 $0.86 $1.08 $1.23 $1.28 $1.43 $1.16 $1.47 $1.88
($9.31)
($12)
($10)
($8)
($6)
($4)
($2)
$0
$2
$4
92 93 94 95 96 97 98 99 00 01 02 03 04E
Underwriting Gain (Loss) in Florida Homeowners Insurance,
1992-2004E*
*2004 estimate by Insurance Information Institute based on historical loss and expense data for FL adjusted for estimated 2004 residential windstorm losses of $11.2B; 2003 figure is also from IIIestimates of loss and expense.
$ B
illi
ons
Florida’s homeowners insurance market produces
small profits in most years and enormous losses in others
TORT SYSTEM
Cost of U.S. Tort System($ Billions)
Source: Tillinghast-Towers Perrin.
$129$130$141$144 $148
$159 $156$156$167$169 $180
$205
$233$246
$262$279
$297
$0
$50
$100
$150
$200
$250
$300
$350
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04E 05F 06F
Tort costs will consume an estimated 2.24% of GDP in 2005
Per capita “tort tax” was $845 in 2003, up from $680 in 2000
Reducing tort costs relative to GDP by just 0.25% (to about 2%) would
produce an economic stimulus of $27.5B
Personal, Commercial & Self (Un) Insured Tort Costs*
$17.0$49.1 $57.2
$91.4
$17.1
$51.0$70.9
$82.5
$5.4
$20.1
$29.6
$45.3
$0
$50
$100
$150
$200
$250
1980 1990 2000 2003
Commercial Lines Personal Lines Self (Un)Insured
Bil
lion
s
Total = $39.5 Billion
*Excludes medical malpracticeSource: Tillinghast-Towers Perrin
Total = $120.2 Billion
Total = $157.7 Billion
Total = $219.2 Billion
Class Action Fairness Act of 2005:Potential Hazards for Insurers
1. Overestimate Class Action Fairness Act’s Impact1. Reduce rates too much2. Reduce rates too quickly3. Assume reserves are redundant when they’re not 4. Reserve inadequately
2. Rapid expansion into lines with little or no experience to seize post-CAFA territory
3. Unwarranted broadening of terms and conditions4. Commit too much capital to some casualty lines5. Entry of new capital = accelerated casualty market softening6. Succumb to regulatory pressure to reduce rates when
reductions can’t be justified actuarially
Source: Insurance Information Institute
CONSOLIDATION/
M&A ACTIVITY
66.3%68.8%
74.2%
81.4%
50%
55%
60%
65%
70%
75%
80%
85%
1977 1986 1997 2001
Sources: A.M. Best, Morgan Stanley, Insurance Information Institute.
Substantial consolidation evident over the past 25 years, suggesting:
•M&As more successful
•Scale economies
•Barriers to entry exist
•Capital (esp. foreign capital) cannot enter easily
Private Passenger Auto:Top 25 Writers Market Share
Commercial Lines:Top 25 Writers Market Share*
59.1%
61.9%
55.5%
61.3%
50%
52%
54%
56%
58%
60%
62%
1977 1986 1997 2002
* By direct premiums written.Sources: A.M. Best, Morgan Stanley, Insurance Information Institute.
Virtually no consolidation in commercial p/c sector over the past 25 years, suggesting:
•M&As not generally successful
•Scale?
•Execution?
•Legacy
•Distribution?
•Deconsolidation (asset sales, spin-offs, failures)
•Low barriers to entry
NEW & EMERGING RISKS
$0
$50
$100
$150
$200
$250
Wa
ter
Da
ma
ge
Pa
id L
os
se
s* ($
Mill
ion
s)
0
5000
10000
15000
20000
25000
30000
Cla
im C
ou
nt
Paid Losses
Claim Count
Source: Texas Department of Insurance; Insurance Information Institute
* Data are for TDI Cause 61: Discharge – Other Damage. Not all claims in cause 61 are mold and mold claims may also arise from other (non-water) causes of loss.
Texas: Mold Losses/Claims Continuing to Moderate*
Sept. 11 Industry Loss Estimates($ Billions)
Life$1.0 (3.1%)
Aviation Liability
$3.5 (10.8%)
Other Liability
$4.0 (12.3%)
Biz Interruption
$11.0 (33.8%)
Property -WTC 1 & 2
$3.6 (11.1%) Property - Other
$6.0 (19.5%)
Aviation Hull$0.5 (1.5%)
Event Cancellation$1.0 (3.1%)
Workers Comp
$1.8 (5.8%)
Current Insured Losses Estimate: $32.5BSource: Insurance Information Institute
$0.9 $1.1 $1.8$7.4
$15.4
$91.0
$0
$10
$20
$30
$40
$50
$60
$70
$80
$90
$100
SearsTower
AirplaneAttack
El PasoEnergyTruckBomb
9/11 Attack RockefellerCtr. Truck
Bomb
NuclearPowerPlant
Sabotage
New YorkCity
AnthraxRelease
WC
Lo
ss
es
($
Bill
ion
s)
Source: Eqecat, NCCI.
Estimated Workers Comp Insured Losses & Deaths for Terrorist Events
1,000
12,300
173,000
1,300
Fatalities
D&O: Financial RestatementsFiled Continue to Grow
116158
216 233270
330 323
414
0
50
100
150
200
250
300
350
400
450
1997 1998 1999 2000 2001 2002 2003 2004
Sources: Huron Consulting Group; Insurance Information Institute
Restatements are fodder for plaintiffs attorneys looking
to form class actions
Are the benefits of Sarbanes-Oxley worth the cost? Many
business want S-O scaled back and they may succeed.
Environmental Reserves:3-Year Net Survival Ratios
5.05.25.66.05.3
6.87.7
9.39.4
0
2
4
6
8
10
1996 1997 1998 1999 2000 2001 2002 2003 2004E
Yea
rs
The current estimated industry three year net survival ratio of 5 years is low by recent
historical standards
Source: Morgan Stanley data
The survival ratio is the number of years that current reserves can support recent
loss payment activity.
Investigations: Do They Threaten Industry Stability?
Eliot Spitzer, NY State Attorney General
•Loss of incentive-based compensation bodes ill for control of underwriting process
•Buyers/(re) insurers back away from legitimate products (e.g., finite)
•Compliance costs will raise expense ratio
Insurer/Broker Stocks: Hammered by the Spitzer Suit*
-26.73%
-12.36%
-5.20%
-5.02%
-1.79%
-1.24%
-30% -25% -20% -15% -10% -5% 0%
S&P 500
P/C
Life/Health
All
Multiline
Brokers
*Percentage point change.Source: SNL Securities, Standard & Poor’s, Insurance Information Institute
Change in YTD Total Return from October 8 to October 15, 2004
Spitzer suit announced Oct. 14 produced huge hit on all insurance sectors,
especially brokers
SOLUTIONS1. Shorten information lags: Invest in MIS systems
2. Shift basis of competition to emphasize underwriting Pure price/market share competition eventually destructive
Competition based extensively on terms & conditions can be fatal
3. Maintain underwriting & pricing discipline
4. Get your CEOs ear (and hold on to it) [pricing, reserving]
5. Grab CFO’s ear with the other hand (S-O helps grip)
6. Align management incentives with long-term performance based on AY results
7. Remove regulatory barriers an inefficiencies that contribute to cyclicality
8. Rein-in Marketing Dept. if necessary
Summary• Cycle is by now means dead
• Not at all obvious that cycle will be more tame in the future
• Personal lines better behaved than commercial
• Rising investment returns insufficient to support deep soft market in terms of price,
terms & conditions
• Exogenous Factors: Some getting better (tort environment)
Others unclear (terrorism)
• Major Challenges:
Maintaining price/underwriting discipline
Managing variability/volatility of results
New/emerging/re-emerging risks
Insurance Information Institute On-Line
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