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The View From The Top Union League Club of Chicago February 26, 2013

The View From The Top Union League Club of Chicago February 26, 2013. J. Patrick Gallagher Chairman, President and CEO Arthur J. Gallagher & Co. Agenda. Insurance market – what is happening and why? What you, your broker and your carrier should be doing

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The View From The Top Union League Club of Chicago February 26, 2013

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  1. The View From The TopUnion League Club of ChicagoFebruary 26, 2013 J. Patrick Gallagher Chairman, President and CEO Arthur J. Gallagher & Co.

  2. Agenda • Insurance market – what is happening and why? • What you, your broker and your carrier should be doing • Greatest business on earth – let’s recruit like it!

  3. IRMI Brochure

  4. Agenda • Insurance market – what is happening and why • Hurricane Sandy

  5. Hurricane Sandy est. $10-20B Top Ten Most Costly Hurricanes in the U.S.(1)In Millions • Includes hurricanes occurring through 2011. • Property coverage only. Does not include flood damage covered by the federally administered National Flood Insurance Program. • Adjusted for inflation through 2011 by ISO using the GDP implicit price deflator. • Source: The Property Claim Services (PCS) unit of ISO, a Verisk Analytics company.

  6. Estimate Value of Insured Coastal Properties Vulnerable to Hurricanes - 2012 (1) • Includes residential and commercial properties. Ranked by value of insured coastal property. • Total exposure is an estimate of the actual total value of all property in the state that is insured or can be insured, including • the full replacement value of structures and their contents, additional living expenses and the time value of business interruption coverage. • Source: AIR Worldwide

  7. New England Hurricanes • Hurricane Irene – August, 2011 • Total $5.6 billion in damages • 10th most costly U.S. hurricane • $4.3 billion in insured property damage • $1.3 billion insured flood damage • The Great New England Hurricane of 1938 (The Long Island Express) • $400 million in damages – today would be $35 billion • Category 3 at landfall along Long Island, New York, and the Connecticut coast • 600 deaths, 1,700 injuries • Hurricane Gloria – 1985 • $900 million in damages along New England Coast • Hurricane Bob – 1991 • $1 billion in damages in Southern New England

  8. Criteria Necessary for a “Market Turn”: All Four Criteria Must Be Met Sources: Barclays Capital; Insurance Information Institute. 8

  9. Profitability Peaks & Troughs in the P/C Insurance Industry, 1975 – 2011* History suggests next ROE peak will be in 2016-2017 ROE 1977:19.0% 1987:17.3% 2007:12.3% 10 Years 1997:11.6% 2011:6.1%* 10 Years 10 Years 1975: 2.4% 2001: -1.2% 1992: 4.5% 1984: 1.8% *Profitability = P/C insurer ROEs are I.I.I. estimates. 2011 figure is an estimate based on annualized ROAS for Q1 data. Note: Data for 2008-2011 exclude mortgage and financial guaranty insurers. Source: Insurance Information Institute; NAIC, ISO, A.M. Best.

  10. Average Commercial Rate Change,All Lines, (1Q:2004–2Q:2011) (Percent) Pricing is flat for the first time in more than 7 years Q2 2011 decreases were the smallest since 2004, perhaps signaling a market firming KRW Effect Source: Council of Insurance Agents & Brokers; Insurance Information Institute 10

  11. Change in Commercial Rate Renewals, by Account Size: 1999:Q4 to 2011:Q1 Percentage Change (%) Market has Been Soft for 7 years and Remains Soft as Capital Hits Record Levels; But Is Softness Moderating? Peak = 2001:Q4 +28.5% Pricing Turned Negative in Early 2004 and Has Been Negative Ever Since KRW Effect: No Lasting Impact Trough = 2007:Q3 -13.6% 11 Source: Council of Insurance Agents and Brokers; Insurance Information Institute.

  12. Cumulative Qtrly. Commercial Rate Changes, by Account Size: 1999:Q4 to 2011:Q1 1999:Q4 = 100 Pricing today is where is was in Q3:2000 (pre-9/11) Downward pricing pressure is most pronounced for larger risks Source: Council of Insurance Agents and Brokers; Insurance Information Institute. 12

  13. Policyholder Surplus, 2006:Q4–2011:Q1 Quarterly Surplus Changes Since 2007:Q3 Peak 09:Q1: -$84.7B (-16.2%) 09:Q2: -$58.8B (-11.2%) 09:Q3: -$31.0B (-5.9%) 09:Q4: -$10.3B (-2.0%) 10:Q1: +$18.9B (+3.6%) 10:Q2: +$8.7B (+1.7%) 10:Q3: +$23.0B (+4.4%) 10:Q4: +$35.1B (+6.7%) 11:Q4: +$42.9B (+8.2%) Surplus set a new record in 2011:Q1* 2007:Q3Previous Surplus Peak ($ Billions) The Industry now has $1 of surplus for every $0.77 of NPW—the strongest claims-paying status in its history. *Includes $22.5B of paid-in capital from a holding company parent for one insurer’s investment in a non-insurance business in early 2010. Sources: ISO, A.M .Best. 13

  14. Soft Market Persisted in 2010 but Growth Returned: More in 2011? 1975-78 1984-87 2000-03 (Percent) Net Written Premiums Fell 0.7% in 2007 (First Decline Since 1943) by 2.0% in 2008, and 4.2% in 2009, the First 3-Year Decline Since 1930-33. 2011:Q1 growth was +3.5%; First Q1 growth since 2007 NWP was up 0.9% in 2010 *2011 figure is an estimate based on Q1 data. Shaded areas denote “hard market” periods Sources: A.M. Best (historical and forecast), ISO, Insurance Information Institute. 14

  15. Medical Cost Inflation Has Outpaced Overall Inflation Over 50 Years A claim that cost $1,000 in 1961 would cost nearly $16,000 based on medical cost inflation trends over the past 50 years. *Based on change from Feb. 2011 to Feb. 2010 (latest available) Source: Department of Labor (Bureau of Labor Statistics)

  16. Workers Comp Medical Claim Costs Continue to Rise Average Medical Cost per Lost-Time Claim Medical Claim Cost ($000s) Does smaller pace of increase suggest that small med-only claims are becoming lost-time claims? Annual Change 1991–1993: +1.9% Annual Change 1994–2001: +8.9% Annual Change 2002-2009: +6.6% +2.0% +5.4% +5.0% +6.1% +6.1% +9.1% Cumulative Change = 238% (1991-2010p) +5.4% +7.7% +8.8% +13.5% +7.3% +10.6% +8.3% +10.1% +7.4% +5.1% +9.0% +1.3% -2.1% +6.8% Accident Year 2010p: Preliminary based on data valued as of 12/31/2010 1991-2008: Based on data through 12/31/2008, developed to ultimate Based on the states where NCCI provides ratemaking services; Excludes the effects of deductible policies

  17. P/C Insurance Claim Cost Drivers Grow Faster than even the Medical CPI Suggests Price Changes in 2010 Inpatient Services Rose 8.8%; Outpatient Services Rose 6.1% Excludes Food and Energy Healthcare costs are a major claim cost driver in WC. They are likely to grow faster than the CPI in most years. Source: Bureau of Labor Statistics; Insurance Information Institute. 17

  18. Property/Casualty Insurance Industry Investment Gain: 1994–2011:Q11 ($ Billions) Investment gains in 2010 were the best since 2007 Investment Gains Recovered Significantly in 2010 Due to Realized Investment Gains; The Financial Crisis Caused Investment Gains to Fall by 50% in 2008 1 Investment gains consist primarily of interest, stock dividends and realized capital gains and losses. * 2005 figure includes special one-time dividend of $3.2B. Sources: ISO; Insurance Information Institute.

  19. A 100 Combined Ratio Isn’t What ItOnce Was: Investment Impact on ROEs Combined Ratio / ROE A combined ratio of about 100 generated ~7.5% ROE in 2009/10,10% in 2005 and 16% in 1979 Combined Ratios Must Be Lower in Today’s DepressedInvestment Environment to Generate Risk Appropriate ROEs * 2009 and 2010 figures are return on average statutory surplus. 2008 -2011 figures exclude mortgage and financial guaranty insurers Source: Insurance Information Institute from A.M. Best and ISO data.

  20. P/C Net Income After Taxes1991–2011:Q1 ($ Millions) P-C Industry 2011:Q1 profits were down 12.2% to $7.8B vs. $8.9B in 2010:Q1, as underwriting results deteriorated • 2005 ROE*= 9.6% • 2006 ROE = 12.7% • 2007 ROE = 10.9% • 2008 ROE = 0.3% • 2009 ROAS1 = 5.9% • 2010 ROAS = 6.5% • 2011:Q1 ROAS = 5.6% * ROE figures are GAAP; 1Return on avg. surplus. Excluding Mortgage & Financial Guaranty insurers yields a 6.5% ROAS for 2011:Q1, 7.5% for 2010 and 7.4% for 2009. Sources: A.M. Best, ISO, Insurance Information Institute

  21. Workers Compensation Combined Ratio: 1973–2012P WC was the worst performing of the major commercial lines in 2010. Workers Comp Underwriting Results Are Deteriorating Markedly Sources: A.M. Best; Insurance Information Institute. 2010 is NCCI figure for private carriers.

  22. Reduction in Combined Ratio Necessary to Offset 1% Decline in Investment Yield to Maintain Constant ROE, by Line* Lower Investment Earnings Place a Greater Burden on Underwriting and Pricing Discipline *Based on 2008 Invested Assets and Earned Premiums **US domestic reinsurance only Source: A.M. Best; Insurance Information Institute. 23

  23. WC Combined Ratio Necessary to Achieve Cost of Capital (Percent) WC combined ratios need to improve substantially (115 in 2010) in order generate a risk appropriate rate of return. Assumptions: 3.8% Pre-Tax Investment Yield; 2.8% Post-Tax Investment Yield; WC R/S ratio = 2.07; Based on NCCI’s 2011 Internal Rate of Return Model Source: NCCI. 24

  24. A 100 Combined Ratio Isn’t What ItOnce Was: Investment Impact on ROEs Combined Ratio / ROE A combined ratio of about 100 generated ~7.5% ROE in 2009/10,10% in 2005 and 16% in 1979 Combined Ratios Must Be Lower in Today’s DepressedInvestment Environment to Generate Risk Appropriate ROEs * 2009 and 2010 figures are return on average statutory surplus. 2008 -2011 figures exclude mortgage and financial guaranty insurers Source: Insurance Information Institute from A.M. Best and ISO data.

  25. P/C Net Premiums Written: % Change, Quarter vs. Year-Prior Quarter The long-awaited uptick. In 2011:Q1 occurring in personal lines predominating cos. (+3.8%) and commercial lines predominating cos. (+3.5%) Finally! Back-to-back quarters of net written premium growth(vs. the same quarter, prior year) Sources: ISO, Insurance Information Institute. 26

  26. Average 2nd Quarter 2012 Commercial Rate Increases Continued Source: The Council of Insurance Agents and Brokers Chart prepared by Barclays Research

  27. This Cycle – Change is Different • Income statement driven • Balance sheets are strong • Loss costs escalating “A flat renewal equals a decrease”

  28. Is this like Benefits circa 1980??

  29. Criteria Necessary for a “Market Turn”: All Four Criteria Must Be Met Sources: Barclays Capital; Insurance Information Institute. 30

  30. Agenda • Insurance market – what is happening and why • What you, your broker and carrier should be doing

  31. What You Should Be Doing • Get a clear picture of your account • Have a planning meeting . . . early • Involve carriers . . . early

  32. Decision – Shop or Not • Shop • Stay involved • Loss control – essential • Finances – strong • Backlog manageable • Differentiate your firm • Expect an increase

  33. Decision – Shop or Not • Not • Stay involved • Get a strong feel of incumbent’s commitment • Get an early firm quote . . . in writing • Expect to pay more

  34. Agenda • Insurance market – what is happening and why? • What you, your broker and your carrier should be doing? • Greatest business on earth – let’s recruit like it!

  35. The Greatest Business on Earth!

  36. The Greatest Business on Earth • Oxygen • Competitive • Creative – Dream It! • Huge -- $1.5 Trillion P/C Market Globally • Growing • Lucrative

  37. We Put Peoples’ Lives Back Together

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