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The Business of Insurance

INFORM+INSPIRE. 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.

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The Business of Insurance

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  1. INFORM+INSPIRE The Business of Insurance Robert E. Hoyt, Ph.D. May 6, 2013 The Griffith Insurance Education Foundation

  2. Overview • Property and Casualty Insurance • Insurance Operations • Investments • Performance and Capacity • Reinsurance Principles • Insurance Guaranty Funds • Risk and Industry Trends to Watch The Griffith Insurance Education Foundation

  3. Premium Breakdown in the P/C Industry (2011) Other P/C Lines $228.2B/46% Homeowners $73.7B/15% Source: NAIC Data Auto $190.5B/39%

  4. 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

  5. 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)

  6. 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

  7. U.S. Insured Catastrophe Losses Sandy $18.8B $ Billions Source: Property Claims Service/ISO; Insurance Information Institute The Griffith Insurance Education Foundation

  8. Top Most Costly Disasters in U.S. (Insured Losses, 2011 Dollars, $ Billions) Taken as a single event, the Spring 2011 tornado and storm season is the 4th costliest event in US insurance history Sources: PCS; Insurance Information Institute inflation adjustments. The Griffith Insurance Education Foundation

  9. 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 The Griffith Insurance Education Foundation

  10. 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 … The Griffith Insurance Education Foundation

  11. Securitization of Property Risk (Catastrophe Bonds) Cincinnati Insurance in Jan. 2013 issued $61.2 million cat bonds for New Madrid earthquake and severe thunderstorms protection. Source: MMC Securities Guy Carpenter, A.M. Best; Insurance Information Institute. The Griffith Insurance Education Foundation

  12. 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 The Griffith Insurance Education Foundation

  13. 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)

  14. Average Expenditures on Auto Insurance Countrywide auto insurance expenditures are expected to increase about 3% in 2012 * Insurance Information Institute Estimates/Forecasts Source: NAIC, Insurance Information Institute estimates 2010-2013 based on CPI and other data. The Griffith Insurance Education Foundation

  15. Average Auto Insurance Expenditure:Top/Bottom 5 vs. US (2010) Detroit ($5,941), Philadelphia ($4,071) Source: NAIC; Insurance Information Institute.

  16. 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 $$$

  17. INFORM+INSPIRE Insurance Operations The Griffith Insurance Education Foundation

  18. Structure of Insurance Market • Types of insurers • property-liability insurers • life insurers • health insurers • Organizational form • Competitive market The Griffith Insurance Education Foundation

  19. Industry Size (L-H v. P-C) 2,343 Life Insurers in 1988 Source: III Insurance Fact Book 2011. The Griffith Insurance Education Foundation

  20. 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

  21. 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) Reserves Surplus If domicile of parent considered, 83.4% of reinsurance bought by U.S. insurers was from foreign reinsurers

  22. Distribution of P/C Insurance Industry’s Investment Portfolio As of December 31, 2010 • 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 Bonds Common & Preferred Stock Other Cash & Short-term Investments Sources: NAIC & III.

  23. Underwriting Gain (Loss) $ Billions Source: A.M. Best, ISO; Insurance Information Institute The Griffith Insurance Education Foundation

  24. P/C Insurer Investment Gains Investment gains consist primarily of interest, stock dividends and realized capital gains and losses. Sources: ISO; Insurance Information Institute. The Griffith Insurance Education Foundation

  25. Policyholder Surplus $587 $584 Policyholder Surplus (Net Worth) = Assets – Liabilities Source: ISO (historical); Insurance Information Institute. The Griffith Insurance Education Foundation

  26. Average Commercial Insurance Rate Changes Average commercial insurance rate changes in that quarter. Source: Council of Insurance Agents and Brokers. The Griffith Insurance Education Foundation

  27. INFORM+INSPIRE Reinsurance Principles The Griffith Insurance Education Foundation

  28. Reinsurance • Definition • Shifting of part or all of the insurance originally written by one insurer to another insurer • Customer • other insurers ( primary insurer ) The Griffith Insurance Education Foundation

  29. Reinsurers • Professional reinsurers • direct • broker market • Reinsurance departments

  30. Terms • Ceding Company ( primary insurer ) • Reinsurer • Net Retention • Cession • Retrocession • retrocessionnaire and retrocedent The Griffith Insurance Education Foundation

  31. Types of Reinsurance • Contracts • Facultative • Treaty • Coverage • Proportional (quota and surplus share) • Excess

  32. Functions of ReinsuranceBenefits for Insureds & Insurers Benefits for Insureds Benefits for Insurers Stabilizes loss experience. All coverage can be obtained from one insurer, reducing the chance of coverage gaps & problems in loss collection. Increases large line capacity. Provides surplus relief. Reduces the chance of primary insurer insolvency. Protects against catastrophic losses. Allows small insurers to compete with large insurers, which should increase availability & reduce price. Provides underwriting assistance. Allows withdrawal from a territory or class of business. The Griffith Insurance Education Foundation

  33. 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 • Switzerland • U.S. The Griffith Insurance Education Foundation

  34. INFORM+INSPIRE Guaranty Funds The Griffith Insurance Education Foundation

  35. 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 The Griffith Insurance Education Foundation

  36. P/C Insurer Impairments 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 The Griffith Insurance Education Foundation

  37. 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 Reinsurance Failure Sig. Change in Business Misc. Deficient Loss Reserves/Inadequate Pricing Investment Problems Affiliate Impairment Reason in 54.5% of insolvencies in 2010 Source: A.M. Best Catastrophe Losses Alleged Fraud Rapid Growth The Griffith Insurance Education Foundation

  38. Number of Impaired L/H Insurers Average number of impairments, 1976-2010: 18.2 The Number of Impairments Spiked in 1989-92. But in the Financial Crisis, When Large Numbers of Banks Failed, Virtually No Life Insurers Failed. Source: A.M. Best Special Report “1969-2011 Impairment Review”; Insurance Information Institute. The Griffith Insurance Education Foundation

  39. Reasons for L-H Insurer Impairments(1976-2009) Leading Causes of Impairment ---Business Management (Rapid Growth, Investment Problems, Affiliate Problems) ---Deficient Loss Reserves/ Inadequate Pricing Source: A.M. Best, 1976-2009 Impairment Review, Special Report

  40. INFORM+INSPIRE Trends to Watch The Griffith Insurance Education Foundation

  41. 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 The Griffith Insurance Education Foundation

  42. 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 The Griffith Insurance Education Foundation

  43. 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) The Griffith Insurance Education Foundation

  44. 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 The Griffith Insurance Education Foundation

  45. Contact Information for the Risk Management and Insurance Program at the University of Georgia • Department Head, Rob Hoyt • Brooks Hall 206 • rhoyt@uga.edu • Our web site • www.terry.uga.edu/insurance The Griffith Insurance Education Foundation

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