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
Insurance Information Institute  110 William Street  New York, NY 10038
Tel: (212) 346-5520  Fax: (212) 732-1916  bobh@iii.org  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
Growth rate less than half
2003
that of2004
a year earlier
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
NetRecord
Inv. Income
Surplus!
28,748
An underwriting
profit?
27,676
+3.9%
Net Income (a.t.)
26,707
20,819
+28.3%
Surplus*
369,018
346,987
+6.3%
97.9
100.3**
-2.4 pts.
Combined Ratio
*2003 surplus figure is as of 12/31/03
**The combined ratio for full-year 2003 was 100.1
What’s that?
Combined < 100
CYCLICAL EVIDENCE:
PREMIUMS
Strength of Recent Hard Markets
by NWP Growth*
25%
1975-78
1984-87
2001-04
Real NWP Growth During
Past 3 Hard Markets
20%
1975-78: 8.6%
15%
1984-87: 11.2%
10%
2001-04E: 6.8%
5%
0%
-5%
Premium growth is faltering. Real
growth in 2005 will approach ZERO.
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004F
2005
-10%
Note: Shaded areas denote hard market periods.
Source: A.M. Best, Insurance Information Institute
*2004 based on 1st half results from ISO.
2005 figure is III forecast.
CYCLICAL EVIDENCE:
UNDERWRITING
PERFORMANCE
P/C Industry Combined Ratio
120
110
2001 = 115.7
Combined Ratios
2002 = 107.2
1970s: 100.3
2003 = 100.1
1990s: 107.8
2004: 9 mos. = 97.9
2000-04E: 106.5
1980s: 109.2
2005F = 99
100
The industry has just
experienced its most
remarkable recovery in
recent history
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
90
Sources: A.M. Best; ISO, III
*9-month result.
Underwriting Gain (Loss)
1975-2004F
$25
$15
2004 is likely to produce the first
underwriting profit since 1978
$ Billions
$5
($5)
($15)
($25)
($35)
($45)
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
04*
04**
($55)
*Based on 9-month result.
Source: A.M. Best, Insurance Information Institute
Commercial vs. Personal Lines
Combined Ratios
100
98
97
98
101.9
110.2
105.3
111.5
109.9
112.3
104.5
Compression of results
is due to low interest.
Underwriting is now
more important in
long-tail commercial
lines
98.4
100
102.7
103.9
109.7
Personal: 104.4
99.8
104.9
107.6
112.5
110.2
103.5
105
104.5
110
103.9
115
Commercial: 109.9
110.3
120
10-Year Average Combined Ratios*
110.9
125
Personal--Net Basis
122.2
Commercial--Net Basis
95
90
93
94
95
96
97
Source: A.M. Best; Insurance Information Institute
98
99
00
01
02
*1994-2003 average
03
04E 05F
97.3
94.9
97.6
99.4
93.3
93.1
95
93.3
100
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
99
105
98.6
100.9
110
109.8
2005
110.5
2004
106.2
115
106.6
Combined Ratios:
2004 vs. 2005E
80
75
Commercial auto, CMP, Inland
Marine results remain reasonable,
but WC, GL still problematic
80.3
85
79.4
90
70
PP Auto
Homeowners
WC
GL &
Products
Comm Multi Comm Auto
Peril
Source: A.M. Best Review/Preview, January 2005; Insurance Information Institute.
Inland
Marine
ALL LINES
Combined Ratio:
Reinsurance vs. P/C Industry
170
All Lines Combined Ratio
2001’s combined ratio was the worstever for reinsurers; 2002 was bad as well.
160
162.5
Reinsurance
2003: Big improvement in primary and
reinsurer segments
150
100.3
100.1
102
97.9
121.3
00
115.7
99
107.2
98
106.5
110.0
100.5
105.6
97
100
114.3
107.7
100.8
101.6
104.8
105.8
119.2
106.5
113.6
108.5
110
105.0
106.9
120
110.5
108.8
130
115.8
126.5
140
03
04*
90
91
92
93
94
95
96
01
*Through 2004:Q3
Source: A.M. Best, ISO, Reinsurance Association of America, Insurance Information Institute
02
Underwriting Expense Ratio*
Insurers are keeping
expenses under control
29%
28.0%
28%
27.6%
27.5%
27.0%
27%
26%
25.9% 26.1%
26.5%
26.3%
25.3%
24.8%
24.6% 24.7%
25%
24%
23%
22%
94
95
96
97
98
99
00
*Ratio of expenses incurred to net premiums written.
Source: A.M. Best; Insurance Information Institute
01
02
03
04E
05F
CYCLICAL EVIDENCE:
PROFITABILITY
P/C Net Income After Taxes
1991-2004E* ($ Millions)
2001 ROE = -2.6%
$40,000
2002 ROE = 1.0%
$36,819
$36,000
2003 ROE = 9.4%
$30,000
$30,773
2004 ROE = 11.5%F
$24,404
$20,598
$19,316
$20,000
$29,877
$26,707
$21,865
$20,559
$14,178
$10,870
$10,000
$5,840
$3,046
$0
-$6,970
-$10,000
91
92
93
94
95
96
97
98
*9-Month results; F = Full Year forecast/estimate.
Sources: A.M. Best, ISO, Insurance Information Institute.
99
00
01
02
03
04* 04F
ROE: P/C vs. All Industries
1987–2004E
20%
15%
10%
5%
0%
-5%
87
88
89
90
91
92
93
94
95
US P/C Insurers
Source: Insurance Information Institute; Fortune
96
97
98
99
00
All US Industries
01
02
03 04E
ROE vs. Equity Cost of Capital:
US P/C Insurance: 1991 – 2004F
20%
The p/c insurance industry likely achieved its costs
of capital in 2004 for the first time in many years
-14.6 pts
5%
-1.2 pts
-10.2 pts
10%
+1.6 pts
15%
US P/C insurers missed their
cost of capital by an average
6.5 points from 1991 to 2003
0%
-5%
91
92
93
94
95
96
97
Source: The Geneva Association, Ins. Information Inst.
98
99
00
ROE
01
02
03
04F
Cost of Capital
THE CYCLE LIVES:
IT REALLY WILL BE
DIFFERENT THIS TIME
YES!
It Be Different This Time Around!
• New Management: Benefit of 20/20 Hindsight
 Most (re)insurer CEOs have been replaced over past 5 years
 New management teams not eager to repeat past mistakes
 Management 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 role
 Strict adherence to UW manual and pricing
• Sarbanes-Oxley
 CEO/CFO’s personal assets on the line
 Board of Directors quality enhanced; less chummy
 Reserves become more adequate
 Actuaries, UWs, accountants all on board & getting tough
YES!
It Be Different This Time Around!
• Ratings Agencies
 Have become de facto regulators
 Keeping 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!
It Won’t Be Different
This Time Around!
• Management Never Learns: Hindsight Means Nothing
 80 years of history show management repeats same mistakes
 Quarterly earnings and growth targets are still king
 Mantra 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 Fatigue
 Wall Street is fed up with low returns; no capital for you
 Capital is now highly opportunistic; not committed to long run
• Investments: Still Used to Paper Over Poor UW &
Pricing Decisions
 Cash flow underwriting is back in vogue (or soon will be)
NO!
It Won’t Be Different
This Time Around!
• Regulators Still Asleep at the Switch
 E.g., Piling on to Spitzer investigation
 Vehement defense on status quo regulatory environment
• Still do Bad Job Managing Variability/Volatility
 2004 hurricane season, D&O, Products Liability
 Constantly 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 Us
 Except CAFA, little success in Washington over past few years
 Spitzer 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
Downgrade/Upgrade Ratio*
4.93
1.79
1.92
1.99
1.56
1.1
0.83
0.44
0.58
0.82
0.99
1.05
1.12
1.71
1.22
2
1
1.78
3
1.08
0.8
0.51
0.41
0.96
4
3.3
Downgrade to upgrade ratio
is falling (primarily because
the number of downgrades is
falling; only a small increase
in upgrades)
0.45
0.41
0.43
0.42
0.68
Ratio of Downgrades to Upgrades
5
Sources: Impairment Rate and Rating Transition Study—
1977 to 2002, A.M. Best & Co.
03
04E
98
99
00
01
02
94
95
96
97
89
90
91
92
93
85
86
87
88
80
81
82
83
84
78
79
0
*U.S. property/casualty and life/health insurers before
2000; P/C only 2000-2004.
P/C Company Insolvency Rates,
1993 to 2002
•Insurer insolvencies are increasing
1.33%
•10-yr industry failure rate: 0.72%
1.20%
•Failure rating for B+ or better rating: 0.49%
•Failure rate for D through B rating: 1.29% 1.02% 1.03%
10-yr Failure Rate
0.79%
= 0.72%
0.60%
0.58%
0.21%
1993
1994
1995
0.28%
1996
30
30
38
2000
2001
2002
0.23%
1997
Source: A.M. Best; Insurance Information Institute
1998
1999
Reason for P/C Insolvencies
(218 Insolvencies, 1993-2002)
Impaired Affiliate
3%
Unidentified
17%
CAT Losses
3%
Reinsurer Failure
0%
Deficient Loss
Reserves
51%
Reserve
deficiencies
account for
more than half
of all p/c
insurers
insolvencies
Change in Business
3%
Discounted Ops
8%
Overstated Assets
2%
Alleged Fraud
3%
Rapid Growth
10% Source: A.M. Best, Insurance Information Institute
RESERVING
PROBLEMS:
ARE ACTUARIES TO
BLAME?
P/C Insurance Industry Reserve
Development from Prior Year*
$ Billions, Calendar Year Basis
$25
Adverse reserve development totaled
$47.8 billion from 2000 through 2003
$20
$13.7
Adverse reserve development is
the #1 killer of p/c insurance
companies: Strength Matters
$15
$10
$5
$22.7
$2.3
$0.3
$0
$2.2 $1.2
$0.4
($1.5)
($5)
($10)
$11.0
($3.7)
($7.5)($6.7)
($10.0)
($8.5)
($15)
90
91
92
93
94
95
96
97
98
99
00
01
02
03
*Negative numbers indicate favorable development; positive figures represent adverse development.
Source: A.M. Best, Morgan Stanley, Dowling & Partners Securities, Prudential Securities, Ins. Info. Inst.
CALENDAR Year Loss & ALAE
Reserve Development Through 2003*
$13.9
$40.9
$47.8
$14.1
($3.0)
($8.7)
($7.9)
($11.3)
($20)
($1.5)
NA
$0
($10)
$32.9
$33.6
$2.7
$10
$18.8
$20
$30.3
$30
$37.8
$40
$39.1
$50
Adverse reserve
development is a
perpetual problem
$53.6
$60
$58.7
$70
$ Billions, Calendar Year Basis
85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03
*Negative numbers indicate favorable development; positive figures represent adverse development.
Figures represent total development relative initial calendar year reserves
Source: A.M. Best; Ins. Info. Inst.
ACCIDENT Year Loss & ALAE
Reserve Development Through 2003*
$3.8
$8.4
$10
$7.8
AY1998-2001 claims
source of great pain
in the industry
$15
$13.6
$20
$13.0
$ Billions, Accident Year Basis
$5
NA
($4.8)
($1.9)
($9.8)
($6.7)
($10.4)
($15.5)
($11.3)
($3.9)
($15.2)
($20)
($14.1)
($15)
($7.3)
($10)
($8.2)
($5)
($4.5)
$0
85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03
*Negative numbers indicate favorable development; positive figures represent adverse development.
Figures represent total development relative initial accident year reserves
Source: A.M. Best; Ins. Info. Inst.
P/C Insurance Industry Prior Year
Reserve Development by Line, 2002-03*
$ Billions, Calendar Year Basis
$6
Why did most lines develop
so adversely in 2003?
Major adverse
development in
casualty segments
$5
$4
$3
$5.5
$2.9
$2.3
$2
$1
($1.5) ($0.9) ($0.8)
$0
$0.5
$1.1
$0.6
$1.7
$1.6
Who’s to blame?
($1)
b
Li
a
th
er
C
W
R
ei
ns
O
M
ed
M
al
P
C
M
uc
ts
Pr
od
Su
re
ty
ab
Fi
d/
Li
C
A
/F
O
H
O
A
PP
A
ut
o
PD
Li
ab
($2)
*Negative numbers indicate favorable development; positive figures represent adverse development.
Source: A.M. Best, Ins. Info. Inst.
Combined Ratio:
Impact of Reserve Changes (Points)
Points (Reduced)/Increased
7
6
5
4
3
2
1
0
-1
-2
-3
Prior-year adverse reserve
development totaling nearly
$14 billion in 2003 added 3.5
points to the p/c combined
ratio in 2002
6.3
5.2
3.5
0.5
(0.4)
(2.4)
1998
1999
2000
2001
Source: ISO, A.M. Best, MorganStanley, Prudential Securities.
2002
2003
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
Cost of Risk vs. Commercial
Lines Combined Ratio
$11.96
122.3
Commercial Operating Ratio
$6.40
$6.10
110.2
109.4
$10
$8.91
$8
$7.70
$8.30
115
110
Cost of Risk
118.8
120
$12
$7.30
112.5
$6.49
$5.70
110.2
109.5
$6.46
107.6
$5.71112.3
$6
111.5
110.3
109.7
$4.83
$5.25
$5.20
$4
103.9
105
101.9
100
$2
$0
90
91
92
93
94
95
96
Source: RIMS, A.M. Best; Insurance Information Institute
97
98
99
00
01
02
03
Cost of Risk/$1000 Revenue
Commercial Lines Operating Ratio
125
World Rate-On-Line Index
(1990 = 100)
400
372
337
350
288
283
300
Reinsurance prices rising, limits
falling: ROL up significantly,
though not as much as after
Hurricane Andrew in 1992
248
250
239
160
150
100
230
194
193
200
260
138 142
116
100
50
0
90
91
92
93
Source: Guy Carpenter
94
94
96
97
98
99
00
01
02
03
04
P/C Soft Spots: % Accounts With
Negative Price Change(4th Qtr. 2004)
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Casualty/Liability/Terrorism
86%
Propert
y
70%
62%
53%
53%
55%
35%
16%
Significant moderation now evident
in the commercial casualty lines
Comm Prop Biz
Terror Comm Auto WC
Interruption
GL
Source: Council of Insurance Agents & Brokers; Insurance Information Institute
EPL
Umbrella
P/C Soft Spots: % Accounts With
Negative Price Change(4th Qtr. 2003)
60%
55%
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
Propert
y
Casualty/Liability/Terrorism
42%
18%
13%
13%
12%
5%
Comm Prop Biz
Terror Comm Auto WC
Interruption
11%
2%
GL
Source: Council of Insurance Agents & Brokers; Insurance Information Institute
EPL
Umbrella
P/C Soft Spots: % Accounts With
Negative Price Change(4th Qtr. 2002)
60%
55%
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
Casualty/Liability/Terrorism
Propert
y
7%
2%
0%
0%
0%
1%
Comm Prop Biz
Terror Comm Auto WC
Interruption
GL
EPL
Umbrella
0%
1%
Source: Council of Insurance Agents & Brokers; Insurance Information Institute
35%
30%
25%
20%
15%
10%
5%
0%
Jul-01
14%
Aug-01
11%
Sep-01
13%
Oct-01
16%
Nov-01
19%
Dec-01
22%
Jan-02
28%
Feb-02
31%
Mar-02
31%
Apr-02
28%
May-02
30%
Jun-02
32%
Jul-02
33%
Aug-02
28%
Sep-02
29%
Oct-02
30%
Nov-02
32%
Dec-02
30%
Jan-03
27%
Feb-03
25%
Mar-03
28%
Apr-03
22%
May-03
18%
Jun-03
18%
Jul-03
17%
Aug-03
16%
Sep-03
12%
Oct-03
12%
Nov-03
10%
Dec-03
12%
Jan-04
11%
Feb-04
9%
Mar-04
9%
Apr-04
9%
May-04
7%
Jun-04
7%
Jul-04
5%
Aug-04
4%
Sep-04
4%
Oct-04
2%
Nov-04
2%
Dec-04
2%
Jan-05 1%
Feb-05 0%
Commercial Premium Rate
Changes Are Sharply Lower
Source: MarketScout.com
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 Story
WC: Slow Mo Train Wreck?
HO: Jury’s Out
Private Passenger Auto
Average Expenditures on
Auto Insurance
$950
$900
$850
Countrywide auto insurance
expenditures are expected to
rise 1.5% in 2005
$800
$834
$857
$870
$774
$750
$700 $668
$650
$706 $704
$691
$683 $687
$720
$600
95
96
97
98
99
*Insurance Information Institute Estimates/Forecasts
Source: NAIC, Insurance Information Institute
00
01
02
03* 04* 05*
Private Passenger Auto
Combined Ratio
109.5
PPA is the profit
juggernaut of the p/c
insurance industry today
110
105
107.9
104.2
103.5
101.7 101.3 101.3
101.1
101.0
99.5
100
98.4
Average Combined 1993 to 2004= 102.7
Many auto insurers have shown significant improvements in underwriting
performance since mid-2002
95
93.3 93.1
90
93
94
Sources: A.M. Best; III
95
96
97
98
99
00
01
02
03
04E
05F
Private Passenger Auto:
Incurred Loss Ratios, 1999-2004:Q3
Collision
Comprehensive
Liability (BI & PD)
110%
Loss ratios for all major
coverage are trending
downward
100%
90%
80%
70%
Source: ISO Fast Track; Insurance Information Institute.
04:Q3
04:Q1
03:Q3
03:Q1
02:Q3
02:Q1
01:Q3
01:Q1
00:Q3
00:Q1
99:Q3
50%
99:Q1
60%
Pure Premium Spread: Personal
Auto PD Liability, 2000-2004:Q3
Auto Insurance Component of CPI
Personal Auto-PD Pure Premium
12%
Margin necessary to
maintain PPA
profitability
10%
8%
6%
4%
2%
0%
Source: Insurance Information Institute calculations based ISO Fast Track and US BLS data.
04:Q3
04:Q2
04:Q1
03:Q4
03:Q3
03:Q2
03:Q1
02:Q4
02:Q3
02:Q2
02:Q1
01:Q4
01:Q3
01:Q2
01:Q1
00:Q4
00:Q3
00:Q2
-4%
2003 PPA
Combined = 98
2000 PPA
Combined = 110
00:Q1
-2%
RNW: Private Passenger Auto,
United States, 1992-2002
Segmentation
should help
profitability
16%
14%
14% 14%
12%
12%
11% 12%
10%
15%
15%
12%
10%
10%
8%
6%
4%
2%
Private passenger auto
profitability deteriorated
hroughout the 1990s but
has improved dramatically
8%
4%
2%
2%
0%
92
93
94
95
96
97
Source: NAIC; Insurance Information Institute
98
99
00
01
02 03E 04E 05F
Workers Compensation
Workers Comp Combined Ratios,
1994-2005F
Workers Comp Calendar Year vs. Ultimate Accident Year –
Private Carriers
Percent
138
140
133
129
130
125
122
119
118
120
115
111
108
108 107
110
106
106
101
101
101 100 101
97 97
100
106
90
1994
1995
1996
1997
1998
1999
Calendar Year
2000
2001
2002 2003p 2004E 2005F
Accident Year
p Preliminary AY figure.
Accident Year data is evaluated as of 12/31/2003 and developed to ultimate
Source: Calendar Years 1994-2002, A.M. Best Aggregates & Averages; Calendar Year 2003p and Accident Years 1994-2003p and 2004/5
estimate and forecast, NCCI
Includes dividends to policyholders
Workers Comp Medical Claims
Continue to Climb
Medical
Claim Cost ($000s)
$19
$17
Annual Change 1991–1995:
Annual Change 1996–2002:
$17.8
+3.9%
+9.0%
$16.3
$14.7
$15
$13.1
$13
$12.0
$11
$9
$7.9
$8.0
$7.8
1991
1992
1993
$8.5
$8.9
$9.6
$10.3
$11.1
$7
$5
1994
1995
1996
1997
Accident Year
2003p: Preliminary based on data valued as of 12/31/2003
1991-2002: Based on data through 12/31/2002, developed to ultimate
Based on the states where NCCI provides ratemaking services
Excludes the effects of deductible policies
1998
1999
2000
2001
2002 2003p
WC Medical Severity Rising Far
Faster than Medical CPI
14%
10%
8.7%
7.4%
8%
6%
4%
7.7%
12.0%
11.0%
9.0%
9.0%
7.3%
5.0 pts
12%
WC medical severity is rising
2.3 times faster than the
medical CPI
5.1%
4.5%
3.6%
2%
2.8%
3.2%
1996
1997
4.7%
4.0%
Change in Medical CPI
Change Med Cost per Lost Time Claim
0%
1995
3.5%
4.1%
4.6%
1998
1999
2000
2001
2002
2003
Sources: Med CPI from US Bureau of Labor Statistics, WC med severity from NCCI based on NCCI states.
Med Costs Share of Total
Costs is Increasing Steadily
2003p
1993
1983
Indemnity
56%
Indemnity
51%
Indemnity
45%
Medical
49%
Medical
44%
Source: NCCI (based on states where NCCI provides ratemaking services).
Medical
55%
Cost Drivers in Workers Comp
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
Source: Morgan Stanley
Other
25%
Physical
Medicine
20%
Diagnostic
Radiology
16%
Surgery/
Anesthesia
12%
Prescription
Drugs
14%
Hospital &
Facility
Charges
13%
Proportion of Workers Comp
Accounts Renewing With Increase of
20% or More
54%
38% 38%
32%
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
20%
12% 12%
3%
02:II 02:III 02:IV
03:I
03:II 03:III 03:IV
04:I
1%
1%
1%
04:II 04:III 04:IV
Source: Council of Insurance Agents and Brokers; Insurance Information Institute
Homeowners
Average Expenditures on
Homeowners Insurance
$700
$650
$600
Countrywide home
insurance expenditures
are expected to rise 2.5%
in 2005
$636
$660
$677
$593
$536
$550
$481 $488
$500
$450 $418 $440
$508
$455
$400
95
96
97
98
99
*Insurance Information Institute Estimates/Forecasts
Source: NAIC, Insurance Information Institute
00
01
02
03* 04* 05*
Homeowners Insurance
Combined Ratio
158.4
160
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
150
140
130
121.7
120
121.7
118.4
113.6
112.7
117.7
113.0
109.4 108.2111.4
110
109.3
101.0
98.2
100
100.9
98.6
90
90
91
Sources: A.M. Best; III
92
93
94
95
96
97
98
99
00
01
02
03 04E 05F
ROE for Homeowners Insurance in
Texas, 1992 - 2002
30%
20.7% 19.4%
20%
14.7%
11.9%
6.2%
10%
0%
-6.0%
-10%
-20%
-23.5%
-30%
-40%
States like TX &
FL make the
Homeowners
proposition more
difficult
-10.9%
-38.8%
-42.4%-41.9%
-50%
1992
Source: NAIC
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
WHY UNDERWRITING
DISCIPLINE MATTERS
A 100 Combined Ratio Isn’t What it
Used to Be: 95 is Where It’s At
Combined Ratio
105
Combined Ratio
14.3%
100
15.9%
100.6
100.1
85
15.0%
97.9
94.3
Combined ratios
today must be below
95 to generate
Fortune 500 ROEs
18%
16%
97.5
95
90
ROE*
9.4%
14%
12%
9.9% 10%
8%
80
6%
1978
1979
2003 Actual 2003 for 15%
ROE
* 2004 figure is return on average statutory surplus based in first 9 monhts data
Source: Insurance Information Institute from A.M. Best and ISO data.
2004F
Retrun on Equity*
110
INVESTMENT
INCOME:
THE SOLUTION TO
UNDERWRITING, PRICING
AND RESERVING BLUNDERS?
Net Investment Income
$45
Growth History
$36
2002: -1.3%
$ Billions
2003: +3.9%
$27
2004E: -1.0%
History
1997 Peak = $41.5B
2000= $40.7B
$18
2001 = $37.7B
2002 = $37.2B
$9
2003 = $38.7B
2004E = $38.3B
$0
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
Source: A.M. Best, ISO, Insurance Information Institute
Total Returns for Large Company
Stocks: 1970-2005*
S&P 500 was up 9% in 2004. Fears of higher interest rates, inflation,
the falling dollar, resurgent oil prices are concerns in 2005
40%
30%
20%
10%
0%
-10%
Source: Ibbotson Associates, Insurance Information Institute.
2005
*Through March 7, 2005
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1978
1976
1974
1972
-30%
1970
-20%
1980
2003/4 were the first
consecutive gains since 1999
Property/Casualty Insurance
Industry Investment Gain*
$ Billions
$60
$57.9
$52.3
$51.9
$47.2
$50
$40
$56.9
$45.6 $46.9
$44.4
$42.8
$36.0
$35.4
$30
Investment gains are
rising but are still
nearly 20% below
their 1998 peak
$20
$10
$0
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.
OTHER
POSSIBLE
FACTORS:
(Besides Actuaries)
9 Competing Hypotheses on
the Underwriting Cycle
Hypothesis 1:
Pt=f(Lt-j)
Past losses can explain
current premiums
Hypothesis 2:
Premiums are informationally efficient predictors of
P=PV E(L, LAE) future losses
Hypothesis 3:
dP/dSt-j<0
Inverse relationship between
current premiums and past
surplus changes
9 Competing Hypotheses on
the Underwriting Cycle
Hypothesis 4:
dP/di <0
Inverse relationship between
interest rates and premiums
Hypothesis 5:
dP/dU>0
Positive relationship between
underwriting expenses and
premiums
Hypothesis 6:
dP/ds>0
Positive relationship between
uncertainty and premiums
9 Competing Hypotheses on
the Underwriting Cycle
Hypothesis 7:
Hypothesis 8:
Impact of changes in interest
rates is more important to
premiums in long-tail lines
than those in short-tail lines
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?
Pt = a0 + a1Pt-1 + a2Pt-2 + et
Period (P) = 2p/cos-1(a1/2(-a2)-1/2)
Pt = underwriting profit
et = random error term
E. 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
Malaysia
France
United States
Japan
Canada
Spain
Australia
Italy
12.03
12.01
10.19
7.39
7.07
5.79
5.73
5.18
4.84
Austria
Denmark
S. Korea
Taiwan
None
None
None
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
Total Returns for Large Company
Stocks: 1970-2005*
S&P 500 was up 9% in 2004. Fears of higher interest rates, inflation,
the falling dollar, resurgent oil prices are concerns in 2005
40%
30%
20%
10%
0%
-10%
Source: Ibbotson Associates, Insurance Information Institute.
2005
*Through March 8, 2005
2004
2002
2000
1998
1996
1994
1992
1990
1988
1986
1984
1982
1978
1976
1974
1972
-30%
1970
-20%
1980
Do investment shocks cause
cycles or does management
overestimate future returns?
Interest Rates: Lower Than
They’ve Been in Decades, But…
16%
About 2/3 of invested assets
are in the form of bonds
14%
12%
Lower bond yields were the primary
driver behind declining investment
income in recent years, with the 10year 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
10%
8%
6%
4%
2%
3-Month T-Bill
1-Yr. T-Bill
10-Year T-Note
Source: Board of Governors, Federal Reserve System; Insurance Info. Institute
2005
*
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
0%
*As of 2/25/05.
US P/C Net Realized Capital Gains
1990-2004E ($ Millions)
Realized capital
gains rebounded
strongly in 2003/4
$20,000
$15,000
$16,205
$13,016
$10,808
$9,244
$9,893 $9,818
$10,000
$18,019
$8,724
$6,917
$6,631
$5,997
$4,806
$5,000
$2,880
$1,664
$0
-$1,214
-$5,000
90
91
92
93
94
95
96
97
*Annualized 9-month result.
Sources: A.M. Best, ISO, Insurance Information Institute.
98
99
00
01
02
03 04*
CAPACITY/SURPLUS
U.S. Policyholder Surplus:
1975-2004*
$400
$350
$300
$ Billions
$250
$200
$150
•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
Capacity TODAY is just 8.8%
above its mid-1999 peak
•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
$100
$50
“Surplus” is a measure of
underwriting capacity. It is
analogous to “Owners
Equity” or “Net Worth” in
non-insurance organizations
$0
75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04
Source: A.M. Best, ISO, Insurance Information Institute
*As of 9/30/04.
US Reinsurers: Change in
Policyholder Surplus ($ Billions)
Reinsurer PHS fell 20% from
1998-2002. Capacity today similar
to 1998. Same story globally.
$64.6
$70
$65
$60.9
$58.9
$ Billions
$60
$56.4
$55
$48.8
$50
$45.2
$45
$40
1998
1999
Source: A.M. Best; Insurance Information Institute
2000
2001
2002
2003E
CATASTROPHES
U.S. Insured
Catastrophe Losses ($ Billions)
2004 was the second$ worst
Billionsyear ever for natural
disaster losses in the US after adjusting for inflation.
About 79% of those losses originated in Florida.
$30
$22.9
$25
$20
$16.9
$12.9
$15
$10 $7.5
$5
$27.3
$26.5
$2.7
$4.7
$5.5
$8.3 $7.4
$10.1
$8.3
$2.6
$4.6
$5.9
$0
89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04
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
ROE: P/C vs. All Industries
1987–2004E*
20%
2004 ROE excl.
hurricanes
15%
10%
Sept. 11
5%
Hugo
0%
Lowest CAT
losses in 15 years
2004 ROE
reduced due to
hurricanes
Andrew
Northridge
-5%
87
88
89
90
91
US P/C Insurers
92
93
94
95
96
97
All US Industries
*2004 p/c estimate based on first 9 months data.
Source: Insurance Information Institute; Fortune
98
99
00
01
02
03
P/C excl. Hurricanes
FLORIDA HURRICANES
& UNDERWRITING
PERFORMANCE:
Homeowners Insurers
Have Lost Billions
in Florida
Underwriting Gain (Loss) in
Florida Homeowners Insurance,
1992-2004E*
$4
$2
$0.69 $0.43
$1.43 $1.16 $1.47
$0.86 $1.08 $1.23 $1.28
$1.88
$0
($0.21)
$ Billions
($2)
($4)
Florida’s homeowners
insurance market produces
small profits in most years and
enormous losses in others
($6)
($8)
($10)
($12)
($9.31)
($10.60)
92
93
94
95
96
97
98
99
00
01
02
03
04E
*2004 estimate by Insurance Information Institute based on historical loss and expense data for FL
adjusted for estimated 2004 residential windstorm losses of $11.2B; 2003 figure is also from III
estimates of loss and expense.
TORT SYSTEM
Cost of U.S. Tort System
($ Billions)
Tort costs will consume an estimated 2.24% of GDP in 2005
$350
$300
Per capita “tort tax” was $845
in 2003, up from $680 in 2000
$233
$250
$262
$246
$279
$297
$205
$200
$150
$129$130
$141 $144 $148
$159 $156$156
$167 $169
$180
Reducing tort costs relative to GDP by
just 0.25% (to about 2%) would
produce an economic stimulus of $27.5B
$100
$50
$0
90
91
92
93
Source: Tillinghast-Towers Perrin.
94
95
96
97
98
99
00
01
02
03 04E 05F 06F
Personal, Commercial &
Self (Un) Insured Tort Costs*
$250
Commercial Lines
Personal Lines
Self (Un)Insured
Total = $219.2 Billion
Billions
$200
$45.3
Total = $157.7 Billion
$150
Total = $120.2 Billion
$29.6
$20.1
$100
$70.9
Total = $39.5 Billion
$51.0
$50
$0
$82.5
$91.4
$5.4
$17.1
$17.0
$49.1
$57.2
1980
1990
2000
*Excludes medical malpractice
Source: Tillinghast-Towers Perrin
2003
Class Action Fairness Act of 2005:
Potential Hazards for Insurers
1. Overestimate Class Action Fairness Act’s Impact
1.
2.
3.
4.
Reduce rates too much
Reduce rates too quickly
Assume reserves are redundant when they’re not
Reserve inadequately
2. Rapid expansion into lines with little or no experience
to seize post-CAFA territory
3. Unwarranted broadening of terms and conditions
4. Commit too much capital to some casualty lines
5. Entry of new capital = accelerated casualty market
softening
6. Succumb to regulatory pressure to reduce rates when
reductions can’t be justified actuarially
Source: Insurance Information Institute
CONSOLIDATION/
M&A ACTIVITY
Private Passenger Auto:
Top 25 Writers Market Share
Substantial consolidation
81.4% evident over the past 25
years, suggesting:
85%
80%
75%
70%
•M&As more successful
74.2%
•Scale economies
68.8%
•Barriers to entry exist
66.3%
•Capital (esp. foreign
capital) cannot enter
easily
65%
60%
55%
50%
1977
1986
1997
2001
Sources: A.M. Best, Morgan Stanley, Insurance Information Institute.
Commercial Lines:
Top 25 Writers Market Share*
61.9%
62%
60%
61.3%
59.1%
Virtually no
consolidation in
commercial p/c
sector over the past
25 years, suggesting:
•M&As not generally
successful
58%
•Scale?
55.5%
56%
•Execution?
•Legacy
54%
•Distribution?
52%
•Deconsolidation
(asset sales, spinoffs, failures)
50%
1977
1986
1997
2002
* By direct premiums written.
Sources: A.M. Best, Morgan Stanley, Insurance Information Institute.
•Low barriers to
entry
NEW & EMERGING
RISKS
$250
30000
Paid Losses
20000
$150
15000
$100
10000
$50
5000
0
M
ar
-0
M 1
ay
-0
1
Ju
l-0
Se 1
p01
N
ov
-0
1
Ja
n02
M
ar
-0
M 2
ay
-0
2
Ju
l-0
Se 2
p02
N
ov
-0
2
Ja
n03
M
ar
-0
M 3
ay
-0
3
Ju
l-0
Se 3
p03
$0
Ja
Claim Count
25000
Claim Count
$200
n01
Water Damage Paid Losses * ($Millions)
Texas: Mold Losses/Claims
Continuing to Moderate*
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.
Sept. 11 Industry Loss Estimates
($ Billions)
Other
Liability
$4.0 (12.3%)
Property Life
WTC 1 & 2
$1.0 (3.1%)
$3.6 (11.1%)
Aviation
Liability
$3.5 (10.8%)
Event
Cancellation
$1.0 (3.1%)
Aviation Hull
$0.5 (1.5%)
Workers
Comp
$1.8 (5.8%)
Property Other
$6.0 (19.5%)
Biz
Interruption
$11.0 (33.8%)
Current Insured Losses Estimate: $32.5B
Source: Insurance Information Institute
Estimated Workers Comp Insured
Losses & Deaths for Terrorist Events
Fatalities
173,000
$100
$91.0
WC Losses ($ Billions)
$90
$80
12,300
$70
$60
$50
$40
1,300
1,000
$30
$15.4
$20
$10
$0.9
$1.1
Sears
Tower
Airplane
Attack
El Paso
Energy
Truck
Bomb
$1.8
$7.4
$0
Source: Eqecat, NCCI.
9/11 Attack Rockefeller
Ctr. Truck
Bomb
Nuclear
Power
Plant
Sabotage
New York
City
Anthrax
Release
D&O: Financial Restatements
Filed Continue to Grow
450
400
350
Restatements are fodder for
plaintiffs attorneys looking
to form class actions
300
330
323
270
250
216
200
150
414
158
233
Are the benefits of SarbanesOxley worth the cost? Many
business want S-O scaled back
and they may succeed.
116
100
50
0
1997
1998
1999
2000
2001
Sources: Huron Consulting Group; Insurance Information Institute
2002
2003
2004
Environmental Reserves:
3-Year Net Survival Ratios
10
9.4
9.3
7.7
Years
8
6.8
2
6.0
5.3
6
4
The current estimated industry
three year net survival ratio
of 5 years is low by recent
historical standards
5.6
5.2
5.0
2003
2004E
The survival ratio is the
number of years that current
reserves can support recent loss
payment activity.
0
1996
1997
Source: Morgan Stanley data
1998
1999
2000
2001
2002
Investigations: Do They
Threaten Industry Stability?
•Loss of incentive-based
compensation bodes ill
for control of
underwriting process
•Buyers/(re) insurers
back away from
legitimate products (e.g.,
finite)
Eliot Spitzer, NY State Attorney General
•Compliance costs will
raise expense ratio
Insurer/Broker Stocks:
Hammered by the Spitzer Suit*
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
S&P 500
-1.24%
P/C
-1.79%
-5.02%
Life/Health
-5.20%
All
-12.36%
Multiline
-26.73%
-30%
Brokers
-25%
-20%
-15%
-10%
-5%
*Percentage point change.
Source: SNL Securities, Standard & Poor’s, Insurance Information Institute
0%
SOLUTIONS
1.
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
Insurance Information
Institute On-Line
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