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Insurance Industry Insights: Challenges & Opportunities

Dive into the concerns keeping insurance CEOs awake at night, from underwriting dilemmas to terrorism threats. Gain valuable outlook on profitability, pricing, and more. Presented by Robert P. Hartwig, Ph.D., at the Midwest Actuarial Forum in 2003.

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Insurance Industry Insights: Challenges & Opportunities

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  1. What Keeps Insurance CEOs Awake at Night?Overview & Outlook for the P/C Insurance Industry Midwest Actuarial Forum Casualty Actuaries of the Midwest Schaumburg, IL March 12, 2003 Robert P. Hartwig, Ph.D., CPCU, Senior Vice President & Chief Economist Insurance Information Institute 110 William Street New York, NY 10038 Tel: (212) 346-5520 Fax: (212) 732-1916 bobh@iii.org  www.iii.org

  2. Presentation Outline • Improve Profitability • Improve Underwriting • Reserving Issues • Improve Pricing • Restore Destroyed Capacity • Improve Investment Performance • The Challenge of Terrorism • The Tragedy of Corporate Governance • Courts & Torts: Abuse of the Civil Justice System • Mold • Insurance Scoring • Q & A

  3. IMPROVE PROFITABILITY

  4. P/C Net Income After Taxes1991-2002E ($ Millions) • 2001 was the first year ever with a full year net loss • 2002 9-Month ROE = 4.4% *I.I.I. estimate based on first 9 months of 2002 data. Sources: A.M. Best, ISO, Insurance Information Institute.

  5. ROE: P/C vs. All Industries 1987–2003F* Source: Insurance Information Institute; Fortune

  6. ROE vs. Cost of Capital: US P/C Insurance:1991 – 2002 There is an enormous gap between the industry’s cost of capital and its rate of return 6.8. pts 14.6 pts US P/C insurers have missed their cost of capital by an average 6.6 points since 1991 Source: The Geneva Association, Ins. Information Inst.

  7. IMPROVE UNDERWRITING

  8. Underwriting Gain (Loss)1975-2002* $ Billions P-C insurers paid $22 billion more in claims & expenses than they collected in premiums in 2002 *Annualized estimate based on first 9 months of 2002 data. Source: A.M. Best, Insurance Information Institute

  9. P/C Industry Combined Ratio Combined Ratios 1970s: 100.3 1980s: 109.2 1990s: 107.7 2000s: 110.4 2001 = 115.7 2002E = 106.3* 2003F = 103.2* *Based on January 2003 III survey of industry analysts. Sources: A.M. Best; III

  10. Combined Ratio: Reinsurance vs. P/C Industry 2001’s combined ratio was the worst-ever for reinsurers *Reinsurance figure for first 9 months of 2002. Source: A.M. Best, ISO, Reinsurance Association of America, Insurance Information Institute

  11. U.S. InsuredCatastrophe Losses $ Billions CAT losses continue to be a problem, though 2002 was much better than 2001 *Estimate. 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. Source: Property Claims Service/ISO; Insurance Information Institute

  12. Med Claim Costs Rising Sharply Health care inflation is affecting the cost of medical care, no matter what system it is delivered through Source: NCCI; William M. Mercer, Insurance Information Institute.

  13. Outlook for Personal Lines:2002-2003 PERSONAL AUTO HOMEOWNERS 979899 00 0102E 03F 979899 00 0102E 03F Source: A.M. Best

  14. Outlook for Commercial Lines:2002 - 2004 Sources: A.M. Best, Conning & Co.

  15. HOW DOES THIS HARD MARKET STACK UP TO PREVIOUS HARD MARKETS?

  16. Hard Markets Since 1970 1985-87 1975-78 2001-03 There have been 3 hard markets since 1970: 1975-1978 1985-1987 2001-200? Source: A.M. Best, Insurance Information Institute

  17. Strength of Recent Hard Markets by Real NWP Growth 1985-87 2001-03 1975-78 Real NWP Growth During Past 3 Hard Markets 1975-78: 8.6% 1985-87: 14.5% 2001-03: 9.1% Note: Shaded areas denote hard market periods. Source: A.M. Best, Insurance Information Institute

  18. GDP Growth vs. Net Written Premium Growth (1987=100) Hard Market The gap between cumulative GDP and Net Written Premium growth hit a maximum of 52.5 pts or 33.7% in 2000. In 2003, the estimated gap is 29.0 pts or 15.2%. 29.0 pts 52.5 pts Note: Shaded area denotes hard market. Source: Insurance Information Institute

  19. RESERVING ISSUES

  20. Reserve Deficiency, by Line(AY 1992-2001, as of 12/01) Estimated Deficiency Total Excluding A&E: $64 Billion A&E Deficiency: $55 Billion Total Including A&E: $120 Billion *Occurrence and claims made Source: Morgan Stanley

  21. IMPROVE PRICING

  22. Growth in Net Premiums Written (All P/C Lines) 2001: 8.1% 2002: 14.2% (est.)* 2003: 12.7% (forecast)* The underwriting cycle went AWOL in the 1990s. It’s Back! *Estimate/forecast based on January 2003 III survey of industry analysts. Source: A.M. Best, Insurance Information Institute

  23. Council of Insurance Agents & Brokers Rate Survey Fourth Quarter 2002 Rate Increases By Line of Business No Change Up 1-10% 10-20% 20-30% 30-50% 50%-100% >100% Comm. Auto 6% 14% 42% 25% 8% 1% 0% Workers Comp 8% 17% 25% 24% 10% 2% 2% General Liability 7% 13% 29% 37% 11% 0% 0% Comm. Umbrella 8% 3% 21% 21% 26% 10% 5% D&O 6% 4% 22% 23% 18% 9% 3% Comm. Property 8% 16% 25% 25% 18% 3% 0% Construction Risk 4% 8% 17% 18% 23% 9% 4% Terrorism 12% 5% 8% 12% 5% 0% 6% Business Interr. 13% 19% 36% 14% 4% 0% 0% Surety Bonds 8% 16% 16% 15% 6% 1% 1% Med Mal 1% 5% 6% 6% 12% 12% 16%

  24. Rate On Line Index(1989=100) Prices rising, limits falling: ROL up significantly Source: Guy Carpenter * III Estimate

  25. Cost of Risk per $1,000 of Revenues: 1990-2002E • Cost of risk to corporations fell 42% between 1992 and 2000 • Estimated 15% increase in 2001, 25% in 2002 • About half of 2002 increase due to 9/11 Source: 2001 RIMS Benchmark Survey; Insurance Information Institute estimates.

  26. Average Price Change of Personal Lines Renewals *III estimates Source: Conning, III

  27. *Insurance Information Institute Estimates/Forecasts Source: NAIC, Insurance Information Institute Average Expenditures on Auto Insurance: US Countrywide auto insurance expenditures are expected to rise 8-10% in 2003

  28. *III Estimates Source: NAIC, Insurance Information Institute Average Expenditures on Homeowners Ins.: US Average HO expenditures are expected to rise by 8-10% in 2003

  29. Urban LegendInsurance is More Expensive than Ever and is Squeezing Families and Businesses Alike

  30. Commercial Lines Net Written Premium as % of GDP Commercial insurance premiums as a % of GDP fell 35% between 1988 and 2000 and remains far below late 1980’s levels More Cover for Less Money: Terms & conditions broadened significantly during the soft market, even as prices fell Sources: Insurance Information Institute, calculated from U.S. Bureau of Economic Analysis and A.M. Best data.

  31. Cost of Risk per $1,000 of Revenues: 1990-2002E • Cost of risk to corporations fell 42% between 1992 and 2000 • Estimated 15% increase in 2001, 25% in 2002 Cost of risk is still less than it was a decade ago! Source: 2001 RIMS Benchmark Survey; Insurance Information Institute estimates.

  32. Homeowners Insurance Expenditure as a % of Median Home Price The cost of homeowners insurance relative to the price of a typical home has fallen! HO Expenditure as % of Sales Price Median Home Sales Price *As of January 2003. Source: Insurance Information Institute calculations based on data from National Association of Realtors, NAIC.

  33. Change in Cost of Homes vs. Change in Cost of Homeowners Insurance Recent increases in the cost of homeowners insurance are miniscule in comparison to the soaring cost of homes *August 2002 Source: Insurance Info. Inst. calculations based on data from Natl. Association of Realtors, NAIC.

  34. RESTORE DESTROYED CAPACITY

  35. Policyholder Surplus: 1975-2002* Surplus (capacity) peaked at $336.3 Billion in mid-1999 and has fallen by 18.7% ($63 billion) to $273.3 billion since then. • Surplus fell 5.6% during first 9 months of 2002 • Surplus is now lower than at year-end 1997. Billions (US$) “Surplus” is a measure of underwriting capacity. It is analogous to “Owners Equity” or “Net Worth” in non-insurance organizations *As of September 30, 2002 Source: A.M. Best, Insurance Information Institute

  36. Global P/C Insurance Capacity is Falling Dramatically Global non-life capacity is down 25% over the past 2 years Sources: Insurance Information Institute, Swiss Re

  37. Capital Raising by P/C Insurers Since September 11, 2001* Capital Raising by P/C Insurers Since 9/11 Totals $53.2B $27.9 Billion $25.4 Billion 14 Pending 38 Pending 40 Completed 33 Completed *As of September 13, 2002. Source: Morgan Stanley, Insurance Information Institute.

  38. Capital Myth: US P/C Insurers Have $300 Billion to Pay Terrorism Claims Total PHS = $298.2 B as of 6/30/01 = $273.3 B as of 9/30/02 Only 33% of industry surplus backs up “target” lines *”Target” Commercial includes: Comm property, liability and workers comp; Surplus must also back-up on non-terrorist related property/liability and WC claims Source: Insurance Information Institute

  39. IMPROVE INVESTMENT PERFORMANCE

  40. Net Investment Income Investment income in 2002 is expected to fall 5 to 6% due primarily to historically low interest rates Billions (US$) Facts 1997 Peak = $41.5B • = $40.7B • = $37.7B • E* = $35.2B *Annualized estimate based on first 9 months of 2002 data. Source: A.M. Best, Insurance Information Institute

  41. Interest Rates: Lower Than They’ve Been in Decades • Historically low interest rates are the primary driver behind lower investment yields. Nevertheless, overall insurer investment performance outpaces all major market indices and almost every major category of mutual fund. • 66% of the industry’s invested assets are in bonds *As of February 2003. Source: Board of Governors, Federal Reserve System; Insurance Information Institute

  42. Total Returns for Large Company Stocks: 1970-2003* • 2002 was 3rd consecutive year of decline for stocks • Will 2003 be the 4th? *As of March 7, 2003. Source: Ibbotson Associates, Insurance Information Institute

  43. P/C Industry Investments,by Type (as of Dec. 31, 2001) Common stock accounts for about 1/5 of invested assets Bond Holdings, by Type Industrial & Misc. 32.5% Special Revenue 30.5% Governments 18.0% States/Terr/Other 15.4% Public Utilities 3.1% Parents/Subs/Affiliates 0.5% Source: A.M. Best, Insurance Information Institute

  44. Property/Casualty Insurance Industry Investment Gain* Investment gains are simply returning to “pre-bubble” levels *Investment gains consists primarily of interest, stock dividends and realized capital gains and losses. Source: Insurance Services Office; Insurance Information Institute estimate annualized as of 9/30/02.

  45. Geopolitical Instability Increased in 2002, Boiling Over in 2003 Terrorists & Terrorism War on Terrorism North Korea: Nukes & Kooks Iraq: War Jitters

  46. THE CHALLENGE OF TERRORISM

  47. Sept. 11 Industry Loss Estimates($ Billions) Consensus Insured Losses Estimate: $40.2B Source: Insurance Information Institute

  48. Industry Losses Under Proposed Federal Backstop Using 9/11 Scenario(as interpreted on date of enactment, Nov. 26, 2002) Total Ind. Loss: $14.25B $19.675B $10.875B $0.925B Industry Co-Share $1.75B Industry Co-Share $2.0B Industry Co-Share $0.125B Industry Co-Share Assumes $30B Commercial Prop & WC Loss, $125B “At Risk” Commercial DPE Source: Insurance Information Institute.

  49. Terrorism Act Summary • Terrorism Risk Insurance Act signed into law Nov. 26, 2002 • Capping of risk allows insurers to estimate PMLs • Enhances ability to price • Industry maintains significant retentions & FF exposure • Company: 7%, 10%, 15% Comm. DPE in Years 1, 2, 3 • Aggregate industry cap of $10B, $12.5, 15B in those years • 10% co-reinsurance above industry aggregate • Government liability capped at $100B • Legislation requires mandatory offer of terror coverage • Reinsurers/Life insurers NOT eligible under the program • UPSHOT: • Bill will help a bit (expectation may be too high) • Laws of insurance economics are not suspended • Price/availability still a function of risk and capital available

  50. Terrorism Act Summary • Mechanics of the Bill: • Bill immediately creates/reinstates coverage for all commercial policyholders (even those that declined or purchased sub-limited coverage) • Mandatory offer of coverage within 90 days (Feb. 24, 2003) • Policyholder has 30 days to accept/reject (can negotiate after rejection) • Charge for terrorism must now appear as a line item • Claims must be processed in accordance with “appropriate business practices” • Law Sunsets in 3 years (12/31/05) • State authority to disapprove rates if excessive, inadequate or unfairly discriminatory retained • Civil liability can exist as federal cause of action • Federal definition of terrorism applies

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