Financial Crisis and the
Future of the P/C
Insurance Industry
Challenges Amid the
Global Economic Storm
Northwest Insurance Council
2009 Annual Luncheon
Seattle, WA
January 27, 2009
Robert P. Hartwig, Ph.D., CPCU, President
Insurance Information Institute  110 William Street  New York, NY 10038
Tel: (212) 346-5520  bobh@iii.org  www.iii.org
THE ECONOMIC
STORM
What a Weakening Economy and
Financial Crisis Mean for the
Insurance Industry
Exposure & Claim
Cost Effects
2.8%
1.2%
2.2%
2.6%
3.0%
3.3%
3.2%
2%
0.9%
4%
3.7%
6%
0.8%
1.6%
2.5%
3.6%
3.1%
2.9%
0.1%
4.8%
4.8%
Real GDP Growth*
0%
-0.8%
-3.3%
10:4Q
10:3Q
10:2Q
10:1Q
09:4Q
09:3Q
09:2Q
09:1Q
08:4Q
08:3Q
-5.2%
08:2Q
08:1Q
07:4Q
07:3Q
07:2Q
07:1Q
2006
2005
2004
2003
2000
-6%
2002
-4%
Recession began in
December 2007. Economic
toll of credit crunch, housing
slump, labor market
contraction is growing
2001
-2%
-0.5%
-0.2%
*Yellow bars are Estimates/Forecasts from Blue Chip Economic Indicators.
Source: US Department of Commerce, Blue Economic Indicators 1/09; Insurance Information Institute.
Real GDP By Market 2007-2010F
(% change from previous year)
2010F
0.8%
1.1%
3.0%
2.4%
2.0%
1.3%
1.2%
1.2%
2.6%
1.0%
6%
1.2%
8%
2.0%
0.4%
Steep declines in GDP will
negatively impact exposure
growth on a global scale
7.1%
7.9%
9.5%
10%
2%
2009F
All major economies except
China are in recession.
12%
4%
2008E
11.9%
2007
2.6%
1.4%
14%
Euro Area
Germany
Japan
Source: Blue Chip Economic Indicators, 1/10/09 edition.
US
-1.8%
-1.6%
-1.4%
-4%
-1.3%
-2%
-1.2%
0%
UK
China
Announced Economic Stimulus
Packages Worldwide ($ Billions)*
$600
$500
$400
$300
Governments around the world are
seeking to soften the economic blow
through spending. Deficits as a share of
GDP will mushroom leading to a
potential inflationary threat and higher
interest rates the future.
P/C insurers will provide insurance
necessary for stimulus projects and will
benefit from enhanced economic growth
U
M .S.
ex
ic
o
C
hi
le
$0
G
er
m
a
Fr n y
an
ce
U
.K
Sp .
ai
n
N
et Ita
he ly
rl
a
H nd
un s
g
Po a r
rt y
u
Sw gal
ed
en
C
hi
n
So J a a
ut pa
h
K n
o
A rea
us
tr
al
ia
In
di
D a
ub
ai
$100
$5.8
$2.0
$200
$105.0
$11.3
$7.4
$4.0
$36.8
$700
$825
$586.0
$800
U.S. stimulus comprises: $550 billion
spending and $275 billion tax relief
$69.0
$33.0
$29.7
$14.0
$8.0
$7.6
$6.9
$2.8
$1.8
$900
As of Dec. 18 except U.S. and Germany
Sources: Wall Street Journal, January 8, 2009; Institute of International Finance.
Length of US Recessions,
1929-Present*
Months in Duration
50
45
Current recession began in
Dec. 2007 and is already the
longest since 1981. If it
extends beyond April, it will
become the longest recession
since the Great Depression.
43
40
35
30
25
20
16
13
15
11
8
10
10
8
10
16
13
11
8
6
8
5
0
Aug.
1929
May
1937
Feb.
1945
Nov.
1948
July
1953
Aug.
1957
Apr.
1960
Dec.
1969
Nov.
1973
* As of January 2009
Sources: National Bureau of Economic Research; Insurance Information Institute.
Jan.
1980
Jul.
1981
Jul.
1990
Mar.
2001
Dec.
2007
Unemployment Rate:
On the Rise
January 2000 through December 2008
7.5
Previous Peak: 6.3% in
June 2003
7.0
6.5
Dec. 2008 unemployment jumped to
7.2%, exceeding the 6.3% peak
during the previous cycle
6.0
5.5
5.0
Trough: 4.4% in March 2007
Source: US Bureau of Labor Statistics; Insurance Information Institute.
Dec-08
Jan-08
Jan-07
Jan-06
Jan-03
Jan-02
Jan-00
3.0
Average unemployment
rate 2000-07 was 5.0%
Jan-01
3.5
Jan-05
Unemployment will likely peak above 8%
or 9% during this cycle, impacting payroll
sensitive p/c and non-life exposures
4.0
Jan-04
4.5
7.5%
7.0%
6.5%
Unemployment is
expected to peak
above 8% in the
second half of 2009.
4.5%
4.9%
4.6%
4.5%
5.0%
4.5%
5.5%
4.8%
6.0%
6.9%
8.0%
8.2%
8.3%
8.4%
8.4%
8.3%
7.9%
8.0%
6.1%
8.5%
Rising unemployment
will erode payrolls
and workers comp’s
exposure base.
5.4%
9.0%
7.4%
U.S. Unemployment Rate,
(2007:Q1 to 2010:Q4F)*
4.0%
07:Q1 07:Q2 07:Q3 07:Q4 08:Q1 08:Q2 08:Q3 08:Q4 09:Q1 09:Q2 09:Q3 09:Q4 10:Q1 10:Q2 10:Q3 10:Q4
* Blue bars are actual; Yellow bars are forecasts
Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (1/09); Insurance Info. Inst.
Monthly Change Employment*
(Thousands)
0
-100
-200
-300
-400
-500
-600
-700
-76
-83
-88
-67
-47
-100
-67
-127
Job losses in 2008 totaled 2.589
million, the highest since 1945 at
WW II’s end; 11.1 million people
are now defined as unemployed.
-403 -423
The Nov./Dec. 2008 losses were the largest
since May 1980 loss of 431,000, but less
than the Dec. 1974 loss of 602,000
-524
-584
Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08
Source: US Bureau of Labor Statistics: http://www.bls.gov/ces/home.htm; Insurance Info. Institute
91
92
2.07
1.80
1.85
93
94
95
96
97
New home
starts plunged
34% from
2005-2007;
Drop through
2009 trough is
65% (est.)—a
net annual
decline of
1.35 million
units
98
99
00
01
02
03
0.72
0.93
0.95
1.36
1.71
1.60
1.57
1.64
1.47
1.48
I.I.I. estimates that each incremental
100,000 decline in housing starts costs
home insurers $87.5 million in new
exposure (gross premium). The net
exposure loss in 2009 vs. 2005 is
estimated at about $1.2 billion.
1.01
90
1.35
1.29
1.20
1.46
1.62
Impacts also for comml. insurers
with construction risk exposure
1.19
2.1
2.0
1.9
1.8
1.7
1.6
1.5
1.4
1.3
1.2
1.1
1.0
0.9
0.8
0.7
Exposure growth forecast for HO
insurers is dim for 2009 with some
improvement in 2010.
1.96
New Private Housing Starts,
1990-2010F (Millions of Units)
04
05
06
07 08E 09F 10F
Source: US Department of Commerce; Blue Chip Economic Indicators (1/09); Insurance Information Inst.
Auto/Light Truck Sales,
1999-2010F (Millions of Units)
Weakening economy, credit
crunch are hurting auto sales;
Gas prices less of a factor now.
19
18
17.8
17.4
New auto/light trick sales are
expected to experience a net
drop of 5.7 million units
annually by 2009 compared
with 2005, a decline of 20.7%
17.5
17.1
17
16.6
16.9
16.9
16.5
16.1
16
15
Impacts of falling auto sales will
have a less pronounced effect on
auto insurance exposure growth
than problems in the housing
market will on home insurers
14
13
13.2
12
13.1
11.2
11
99
00
01
02
03
04
05
06
07F
08E
09F
10F
Source: US Department of Commerce; Blue Chip Economic Indicators (1/09); Insurance Information Inst.
Wage & Salary Disbursements
(Payroll Base) vs. Workers Comp
Net Written Premiums
Wage & Salary Disbursement (Private Employment) vs. WC NWP
$ Billions
7/90-3/91
$7,000
$6,000
3/01-11/01
$ Billions
12/07-?
Wage & Salary
Disbursements
WC NPW
$45
$40
$35
$5,000
$30
$4,000
$3,000
$2,000
Shaded areas indicate recessions
$1,000
Weakening wage
and salary
growth is
expected to cause
a deceleration in
workers comp
exposure growth
$0
$25
$20
$15
$10
$5
$0
89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08*
*9-month data for 2008
Source: US Bureau of Economic Analysis; Federal Reserve Bank of St. Louis at
http://research.stlouisfed.org/fred2/series/WASCUR; I.I.I. Fact Books
Total Industrial Production,
(2007:Q1 to 2010:Q4F)
Obama stimulus program is expected benefit
impact industrial production and therefore
insurance exposure both directly and indirectly
6.0%
3.2% 3.6%
4.0%
2.9% 3.3%
3.8% 3.7%
2.0%
2.0% 1.5%
0.5%
0.3% 0.4%
0.0%
-6.1%
Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (1/09); Insurance Info. Inst.
10:Q4
10:Q3
10:Q2
10:Q1
09:Q4
08:Q2
08:Q1
07:Q4
07:Q3
07:Q2
07:Q1
09:Q3
-8.9%-8.6%
-10.0%
09:Q2
-8.0%
-3.4%
09:Q1
-6.0%
Figures for H2:09
and 2010 revised
sharply upwards to
reflect expected
impact of Obama
stimulus program
-2.6%
08:Q4
-4.0%
Industrial
production began
to contract sharply
during H2 2008 and
is expected to
shrink through the
first half of 2009
08:Q3
-2.0%
U.S. $825B Economic Stimulus
Package, By Category
$300
$ Billions
Commercial insurance lines
that will benefit from the
Obama stimulus plan
include workers comp,
commercial property,
commercial auto, surety,
inland marine and others
$214.5
$200
$124.0
$100
$77.7
$68.4
$49.4
$26.8
$19.2
$0
Public sector
jobs and vital
services
Help workers Transportation,
hurt by the
Infrastructure
economy
Education
Energy
Lower
healthcare
costs
Sources: House Appropriations Committee; Wall Street Journal, January 16, 2009
Science,
technology
5%
0%
-5%
-10%
6%
4%
5.2%
78
-0.9%
79
80-7.4%
81 -6.5%
-1.5%
82
1.8%
83
4.3%
84
85
86
5.8%
87
0.3%
88
-1.6%
89
-1.0%
90
-1.8%
91
-1.0%
92
3.1%
93
1.1%
94
0.8%
95
0.4%
96
0.6%
97
-0.4%
98
-0.3%
99
1.6%
00
5.6%
01
02
7.7%
03
1.2%
04
-2.9%
05
-0.5%
06
-3.4%
07
-4.9%
08F
Real NWP Growth
15%
10%
8%
Real NWP Growth
Real GDP
2%
Real GDP Growth
20%
P/C insurance industry’s growth
is influenced modestly by growth
in the overall economy
13.7%
25%
18.6%
20.3%
Real GDP Growth vs. Real P/C
Premium Growth: Modest Association
0%
-2%
-4%
Sources: A.M. Best, US Bureau of Economic Analysis, Blue Chip Economic Indicators, 8/08; Insurance Information Inst.
FINANCIAL
STRENGTH &
RATINGS
Industry Has Weathered
the Storms Well
P/C Insurer Impairment Frequency
vs. Combined Ratio, 1969-2007
Combined Ratio
115
Combined Ratio after Div
P/C Impairment Frequency
2
1.8
1.6
1.4
110
1.2
105
1
0.8
100
95
0.4
2007 impairment rate was a record low 0.12%,
one-seventh the 0.8% average since 1969; Previous
record was 0.24% in 1972
69
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
06
07
90
0.6
Source: A.M. Best; Insurance Information Institute
0.2
0
Impairment Rate
120
Impairment rates
are highly
correlated
underwriting
performance and
could reached a
record low in 2007
Summary of A.M. Best’s P/C Insurer
Ratings Actions in 2008*
P/C insurance is by
design a resilient in
business. The dual
threat of financial
disasters and
catastrophic losses are
anticipated in the
industry’s risk
management strategy.
Upgraded, 59 , 4.0%
Downgraded, 55 ,
3.8%
Initial, 41 , 2.8%
Under Review, 63 ,
4.3%
Other, 59 , 4.0%
Despite financial market
turmoil, high cat losses
and a soft market in
2008, 81% of ratings
actions by A.M. Best
were affirmations; just
3.8% were downgrades
and 4.0% upgrades
Affirm, 1,183 , 81.0%
*Through December 19.
Source: A.M. Best.
21
Reasons for US P/C Insurer
Impairments, 1969-2005
2003-2005
Affiliate
Problems
8.6%
Catastrophe
Losses
8.6%
1969-2005
Deficient
Loss
Reserves/Inadequate
Pricing
62.8%
Reinsurance
Failure
3.5%
Deficient
Loss
Reserves/Inadequate
Pricing
38.2%
Investment
Problems*
7.3%
Alleged
Fraud
11.4%
Rapid
Growth
8.6%
Sig. Change
in Business
4.6%
Misc.
9.2%
Deficient
reserves,
CAT losses
are more
important
factors in
recent years
Affiliate
Problems
5.6%
Catastrophe
Losses
6.5%
Alleged
Fraud
8.6%
Rapid
Growth
16.5%
*Includes overstatement of assets.
Source: A.M. Best: P/C Impairments Hit Near-Term Lows Despite Surging Hurricane Activity, Special Report, Nov. 2005;
CONSUMER POLL:
2008 I.I.I. PULSE SURVEY
Q. DO YOU THINK THAT THESE PROBLEMS (THE MORTGAGE PROBLEMS SOME AMERICANS FACE,
THE DROP IN THE STOCK MARKET AND JOB LAYOFFS) AFFECT THE ABILITY OF INSURANCE
COMPANIES TO PAY THEIR CLAIMS, TO SELL MORE INSURANCE, BOTH, NONE OF THESE (DOESN’T
AFFECT ABILITY TO PAY CLAIMS OR SELL INSURANCE) OR DON’T KNOW?
95% Americans think
that the downturn in
the economy affects
the basic business of
the insurance
industry: the ability
to pay claims and/or
sell insurance
To pay
claims
7%
To sell
insurance Doesn't
affect ability
10%
to pay
claims or
sell
insurance
3%
Don't know
2%
To pay
claims AND
sell
insurance
78%
Source: Insurance Information Institute, 2008 Pulse Survey, November 2008.
Critical Differences
Between P/C
Insurers and Banks
Superior Risk Management Model
& Low Leverage Make
a Big Difference
How Insurance Industry Stability
Has Benefitted Consumers
BOTTOM LINE:
• Insurance Markets—Unlike Banking—Are Operating
Normally
• The Basic Function of Insurance—the Orderly Transfer
of Risk from Client to Insurer—Continues Uninterrupted
• This Means that Insurers Continue to:
 Pay claims (whereas 25 banks have gone under)
 The Promise is Being Fulfilled
 Renew existing policies (banks are reducing and eliminating
lines of credit)
 Write new policies (banks are turning away people who want
or need to borrow)
 Develop new products (banks are scaling back the products
they offer)
Source: Insurance Information Institute
25
Reasons Why P/C Insurers Have Fewer
Problems Than Banks:
A Superior Risk Management Model
•
Emphasis on Underwriting
 Matching of risk to price (via experience and modeling)
 Limiting of potential loss exposure
 Some banks sought to maximize volume and fees and disregarded risk
•
Strong Relationship Between Underwriting and Risk Bearing
 Insurers always maintain a stake in the business they underwrite, keeping “skin in the game”
at all times
 Banks and investment banks package up and securitize, severing the link between risk
underwriting and risk bearing, with (predictably) disastrous consequences—straightforward
moral hazard problem from Econ 101
•
Low Leverage
 Insurers do not rely on borrowed money to underwrite insurance or pay claimsThere is no
credit or liquidity crisis in the insurance industry
•
Conservative Investment Philosophy
 High quality portfolio that is relatively less volatile and more liquid
•
Comprehensive Regulation of Insurance Operations
 The business of insurance remained comprehensively regulated whereas a separate banking
system had evolved largely outside the auspices and understanding of regulators (e.g., hedge
funds, private equity, complex securitized instruments, credit derivatives—CDS’s)
•
Greater Transparency
 Insurance companies are an open book to regulators and the public
Source: Insurance Information Institute
26
The Financial Crisis
in Perspective
Bank vs. Insurer Impacts
Financial Institutions Globally Facing
Huge Losses from the Credit Crunch*
Billions
$800
$780
$700
$600
$500
$600
Losses as of Sept 2008
Total expected losses
The IMF estimates total “creditturmoil-related” losses will
eventually amount to $1.4 trillion
$205B or 20.8% of estimated total
(bank+insurer) losses will be
sustained by insurers worldwide
$400
$300
$200
$205
$100
$106
$0
Banks
Insurers
*Global losses since the beginning of 2007.
Source: IMF Global Financial Stability Report, October 2008, IIF, Bloomberg, cited in a presentation by
28Thomas
Hess (Chief Economist, Swiss Re) October 23, 2008, accessed via Geneva Association web site.
US Bank Failures:*
1995-2009**
30
25
20
15
Through January 23, 2009
Bank failures are up sharply. 27
banks (but no p/c or life
insurers) failed in 2008/09 due to
the financial crisis, including the
largest in history—Washington
Mutual with $307B in assets.
11
10
8
8
6
5
7
4
3
25
Remarkably, as recently
as 2005 and 2006, no
banks failed—the first
time this had happened in
FDIC history (dating
back to 1934)
3
4
1
3
0
0
05
06
2
0
95
96
97
98
99
00
01
02
03
04
07
*Includes all commercial banking and savings institutions. **Through Jan. 23.
Source: FDIC: http://www.fdic.gov/bank/historical/bank/index.html; Insurance Info. Institute
08
30
09**
Top 10 P/C Insolvencies, Based
Upon Guaranty Fund Payments*
$2,500
$ Millions
The 2001 bankruptcy
of Reliance Insurance
was the largest ever
among p/c insurers
$2,265.8
$2,000
$1,500
$1,272.7
$1,049.7
$1,000
$843.4
$699.4
$566.5
$555.8
$543.1
$531.6
$516.8
$500
dI
id
lan
M
In
s.
Fa
m
ily
bi
li
ia
ut
ua
lL
M
an
Am
er
ic
So
ut
he
rn
ns
ur
an
ce
In
s.
ty
In
s.
io
na
l
Su
pe
rio
rN
at
y
as
ua
lt
sit
C
Tr
an
PH
IC
O
In
s.
In
s.
In
s.
nd
em
Fr
em
on
tI
ns
ati
Co
m
pe
ni
ty
on
nc
e
Ca
lif
or
ni
a
Le
gi
on
In
su
ra
ce
eI
ns
ur
an
Re
lia
nc
In
s.
$0
* Disclaimer: This is not a complete picture. If anything the numbers are understated as some states have not reported in certain years.
Source: National Conference of Insurance Guaranty Funds, as of September 17, 2008.
32
Top 5 Threats
Facing P/C Insurers
Amid Financial
Crisis
Top 5 Threats Facing
P/C Insurers in 2009
1. Ability to Reload Capital




Continued asset price erosion coupled with major “capital event” could
lead to significant shortage of capital
P/C have come to assume that large amounts of capital can be raised
quickly and cheaply after major events (post-9/11, Katrina). This
assumption is probably incorrect in the current environment.
Cost of capital is much higher today
Implications: P/C insurers need to protect capital today and develop
detailed contingency plans to raise fresh capital & generate internally
2. Long-Term Loss of Investment Return






Low interest rates, risk aversion toward equities and many categories
of fixed income securities lock in a multi-year trajectory toward ever
lower investment gains
Insurers have not adjusted to this new investment paradigm
Regulators will not readily accept it; Many will reject it
Implication 1: Industry must be prepared to operate in environment
with investment earnings accounting for only small fraction of profits
Implication 2: Implies underwriting discipline of a magnitude not
witnessed in this industry in more than 30 years
Source: Insurance Information Inst.
Lessons from the period 1920-1975
Top 5 Threats Facing
P/C Insurers in 2009
3. Regulatory Overreach

P/C insurers get swept into vast federal regulatory overhaul and
subjected to inappropriate , duplicative and costly regulation
4. Tort Threat




No tort reform (or protection of recent reforms) is forthcoming from
the current Congress or Administration
Erosion of recent reforms is a certainty (already happening)
Innumerable legislative initiatives will create opportunities to
undermine existing reforms and develop new theories and channels of
liability
Historically extremely costly to p/c insurance industry
5. Disintermediation



Alternative forms of risk transfer are taking an ever-larger share of
the (commercial) p/c insurance pie
Soft market did not bring it back; Hard market could hasten trend
Trend toward state-sponsored insurance and reinsurance drains
premium out of private insurance markets
Source: Insurance Information Inst.
AFTERSHOCK:
Regulatory Response
Could Be Harsh
All Financial Segments
Including Insurers
Will Be Impacted
Post-Crunch: Fundamental
Issues To Be Examined Globally
•
•
Failure of Risk Management, Control & Supervision at
Financial Institutions Worldwide: Global Impact




Colossal failure of risk management (and regulation)
Counterparty risk and collateral management were systemic failure points
Implications for Enterprise Risk Management (ERM)?
Misalignment of management financial incentives
Focus Will Be on Risk Controls: Implies More Stringent Capital
& Liquidity Requirements; Prevention of Systemic Risks
 Data reporting requirements also likely to be expanded




•
•
Non-Depository Financial Institutions in for major regulation
Changes likely under US and European regulatory regimes
Will new regulations be globally consistent?
Can overreactions be avoided?
Accounting Rule Changes??



Problems arose under FAS, IAS
Asset Valuation, including Mark-to-Market
Structured Finance & Complex Derivatives
Ratings on Financial Instruments

New approaches to reflect type of asset, nature of risk
Source: Ins. Info. Inst.
Possible Regulatory Scenarios for
P/C Insurers as of Year-End 2009
•
Status Quo: P/C Insurers Remain Entirely Under
Regulatory Supervision of the States

•
•
Federal Regulation: Everything is Regulated by Feds

•
•
Unlikely that states will be left totally in the cold
Optional Federal Charter (OFC): Insurers Could Choose
Between Federal and State Regulation

•
Unlikely, but some segments of the industry might welcome this
outcome above all others
Unlikely to be implemented as envisioned for past several years by
OFC supporters
Dual Regulation: Federal Regulation Layer Above State

Feds assume solvency regulation, states retain rate/form regulation
Hybrid Regulation: Feds Assume Regulation of Large
Insurers at the Holding Company Level
Systemic Risk Regulator: Feds Focus on Regulation of
Systemic Risk Points in Financial Services Sector

What are these points for insurers? P/C vs. Life?
Source: Insurance Information Inst.
P/C INSURANCE
FINANCIAL
PERFORMANCE
A Resilient Industry in
Challenging Times
Profitability
Historically Volatile
$65,777
$61,940
07
$5,421
$44,155
$38,501
$30,029
$20,559
$21,865
$20,598
$10,870
$3,046
$10,000
$19,316
$20,000
$5,840
$30,000
$14,178
$40,000
$30,773
$50,000
$36,819
$60,000
Insurer profits
peaked in 2006.
$24,404
$70,000
2001 ROE = -1.2%
2002 ROE = 2.2%
2003 ROE = 8.9%
2004 ROE = 9.4%
2005 ROE= 9.4%
2006 ROE = 12.2%
2007 ROAS1 = 12.3%
2008 ROAS = 1.1%*
06
P/C Net Income After Taxes
1991-2009F ($ Millions)*
08F
05
04
03
01
-$6,970
00
99
98
97
96
95
94
93
92
91
-$10,000
02
$0
*ROE figures are GAAP; 1Return on avg. surplus. 2008 numbers are annualized based on 9-mos. Actual of
$4.066 billion.
45
Sources: A.M. Best, ISO, Insurance Information Inst.
P/C Insurance Industry ROEs,
1975 – 2010F*
1977:19.0%
1987:17.3%
25%
1997:11.6%
2006:12.2%
20%
15%
10%
2009F: 4.5%
5%
2008F: 1.1%
0%
1975: 2.4%
1984: 1.8%
1992: 4.5%
2001: -1.2%
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
06
06
08F
09F
10F
-5%
2010F: 6.0%
Note: 2009 figure is actual 9-month result.
Sources: ISO; Insurance Information Institute.
46
ROE vs. Equity Cost of Capital:
US P/C Insurance:1991-2008:Q3
18%
The p/c insurance industry fell well
short of is cost of capital in 2008
16%
+2.3 pts
14%
6%
4%
2%
0%
-2%
-4%
The cost of capital
is the rate of return
insurers need to
attract and retain
capital to the
business
US P/C insurers missed their
cost of capital by an average 6.7
points from 1991 to 2002, but on
target or better 2003-07
91
92
93
94
95
96
97
98
99
*Excludes mortgage and financial guarantee insurers.
Source: The Geneva Association, Ins. Information Inst.
00
-9.7 pts
-13.2 pts
8%
-9.0 pts
10%
-1.7 pts
12%
01
02
03
ROE
04
05
06
07 08*
47
Cost of Capital
Presidential Politics
& P/C Insurance
How is Profitability Affected by the
President’s Political Party?
P/C Insurance Industry ROE by
Presidential Administration,1950-2008*
16.43%
15.10%
Carter
Reagan II
10.13%
8.93%
OVERALL RECORD:
8.65%
1950-2008*
8.35%
7.98%
Democrats 8.05%
7.68%
6.98%
Republicans 8.02%
6.97%
Party of President has
5.43%
5.03%
marginal bearing on
4.83%
profitability of P/C
4.43%
insurance industry
3.55%
G.W. Bush II
Nixon
Clinton I
G.H.W. Bush
Clinton II
Reagan I
Nixon/Ford
Truman
Eisenhower I
Eisenhower II
G.W. Bush I
Johnson
Kennedy/Johnson
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
*ROE for 2008 based on H1 data. Truman administration ROE of 6.97% based on 3 years only, 1950-52.
Source: Insurance Information Institute
Profitability in
Washington State
Mixed Performance
Relative to US Overall
Rates of Return on Net Worth for
All Lines: US vs. WA, 1998–2007*
20%
15%
Washington State has
historically been somewhat
more profitable than the US
overall, due in part to lower
cat losses
18.0%
14.1%
8.4%
9.5%
5%
6.6%
5.0%
13.5%
11.9% 12.5%
10%
8.8%
14.4%
15.2%
10.0%
8.0%
7.3%
6.5%
5.3%
3.3%
-0.5%
-0.5%
0%
-5%
98
Source: NAIC.
99
00
01
02
03
US
WA
*Latest available.
04
05
06
07
Rates of Return on Net Worth for
PPA: US vs. WA, 1998–2007*
14%
13.3%
12.6%
12%
11.2%
10%
8%
10.1%
8.0%
9.4%
8.4%
7.7%
11.0%
9.8%
7.9%
9.3%
8.8%
7.0%
Washington State’s
auto insurance ROE
has been mixed
relative to the US
overall
6%
4.5%
4.1%
4%
3.3%
2.2%
2%
12.1%
2.0%
0%
98
Source: NAIC.
99
00
01
02
03
US
WA
*Latest available.
04
05
06
07
Rates of Return on Net Worth for
HO: US vs. WA, 1998–2007*
35%
30%
25%
20%
Until recently,
Washington State’s
homeowners insurance
ROE had been above
that of the US overall
31.2%
25.8%
21.2%
18.5%16.0%
15%
13.4%
10%
5%
5.4%
4.4%
7.6%
7.5%
3.8%
5.4%
3.9%
3.7%
1.4%
0.2%
0%
12.4%
9.7%
-2.8%
-5%
-7.2%
-10%
98
99
00
01
02
US
Source: NAIC.
03
WA
*Latest available.
04
05
06
07
Rates of Return on Net Worth for
Comm. M-P: US vs. WA, 1998–2007*
20%
17.9%
15%
11.2%
10.4%
10%
8.8%
6.2%
7.4%
6.7%
5%
3.5%
Washington State’s
commercial
multiperil ROE has
been mixed relative
to the US overall
-0.7%
-4.0%
-5%
5.7%
2.9%
1.6%
0%
15.6%15.1%
14.6%14.2%
-4.0%
-5.5%
-8.7%
-10%
-15%
98
99
00
01
02
US
Source: NAIC.
03
WA
*Latest available.
04
05
06
07
Investment
Performance
Investments are the Principle
Source of Declining
Profitability
Distribution of P/C Insurance
Industry’s Investment Portfolio
Portfolio Facts
•Invested assets totaled
$1.3 trillion as of
12/31/07
As of December 31, 2007
Bonds
66.7%
Common Stock
17.9%
•Insurers are generally
conservatively invested,
with 2/3 of assets
invested in bonds as of
12/31/07
Cash & ShortTerm Investments
7.2%
•Only about 18% of
assets were invested in
common stock as of
12/31/07
•Even the most
conservative of portfolios
was hit hard in 2008
Source: NAIC; Insurance Information Institute research;.
Real Estate
0.8%
Other
5.9%
Preferred Stock
1.5%
57
Property/Casualty Insurance Industry
Investment Gain:1994- 2008:Q3 1
$ Billions
$57.9
$60
$52.3
$51.9
$47.2
$50
$59.4
$56.9
$45.3
$44.4
$42.8
$63.6
$55.7
$48.9
$36.0
$40 $35.4
$28.3
$30
Investment gains are off sharply
in 2008 due to lower yields and
poor equity market conditions.
$20
$10
1Investment
08
:Q
3
07
06
05
*
04
03
02
01
00
99
98
97
96
95
94
$0
gains consist primarily of interest, stock dividends and realized capital gains and losses.
2006 figure consists of $52.3B net investment income and $3.4B realized investment gain.
*2005 figure includes special one-time dividend of $3.2B.
58
Sources: ISO; Insurance Information Institute.
P/C Insurer Net Realized
Capital Gains, 1990-2008:Q3
06
05
04
03
02
01
07
59
08:Q3
Sources: A.M. Best, ISO, Insurance Information Institute.
00
99
98
97
96
95
94
93
92
91
90
$ Billions
$20
$18.02
$18
$16.21
$16
$13.02
$14
$10.81
$12
$9.89 $9.82
$9.70
$9.24
$8.97
$9.13
$10
$8
$6.63
$6.61
$6.00
$4.81
$6
$3.52
$4 $2.88
$1.66
$2
$0
Realized capital gains exceeded $9
-$2
-$1.21
billion
in
2004/5
but
fell
sharply
in
-$4
2006 despite a strong stock market.
-$6
Nearly $9 billion again in 2007, but
-$8
$-9.7 billion in 2008 through Q3.
-$9.71
-$10
Underwriting
Trends
Financial Crisis Does Not Directly
Impact Underwriting
Performance: Cycle, Catastrophes
Were 2008’s Drivers
P/C Insurance Combined Ratio,
1970-2008F*
Combined Ratios
120
115
110
1970s: 100.3
1980s: 109.2
1990s: 107.8
2000s: 102.0*
105
100
95
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
06
07
08F
90
Sources: A.M. Best; ISO, III
65
*A.M. Best year end estimate of 103.2; Actual 9-mos. result was 105.6.
P/C Insurance Industry Combined
Ratio, 2001-2009E
120
115.8
As recently as 2001, insurers
paid out nearly $1.16 for every
$1 in earned premiums
Relatively
low CAT
losses,
reserve
releases
2005 ratio benefited from
heavy use of reinsurance
which lowered net losses
110
107.5
Best combined
ratio since 1949
(87.6)
100
Cyclical
Deterioration
103.3
101.2
100.8
100.1
Including
Mortgage
& Fin.
Guarantee
insurers
101
98.4
95.7
92.6
90
2001
2002
2003
2004
*Includes Mortgage & Financial Guarantee insurers.
2005
2006
2007
2008
Sources: A.M. Best.
2008*
2009F
66
35
30
25
20
15
10
5
0
-5
-10
-15
-20
-25
-30
-35
-40
-45
-50
-55
Insurers earned a record underwriting profit of
$31.7 billion in 2006, the largest ever but only the
second since 1978. Cumulative underwriting deficit
from 1975 through 2007 is $422 billion.
$19.877 Bill
underwriting
loss in 08:9M
incl. mort. &
FG insurers
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
06
07
08
$ Billions
Underwriting Gain (Loss)
1975-2008:Q3*
Source: A.M. Best, ISO; Insurance Information Institute
67insurers
* Includes mortgage & finl. guarantee
Number of Years With Underwriting
Profits by Decade, 1920s –2000s
Number of Years with Underwriting Profits
10
10
8
8
6
7
6
Underwriting profits were common
before the 1980s (40 of the 60 years
before 1980 had combined ratios
below 100)—but then they vanished.
Not a single underwriting profit was
recorded in the 25 years from 1979
through 2003.
5
4
4
3
2
0
1920s
1930s
1940s
1950s
1960s
Note: Data for 1920 – 1934 based on stock companies only.
Sources: Insurance Information Institute research from A.M. Best Data.
1970s
0
0
1980s
1990s
2000s*
68
*2000 through 2008.
90
103.3
97.6
97.6
93.9
96.4
98.4
105.3
104.5
102.7
104.9
103.5
Improvement in 2009 assumes
reasonable degree of underwriting
discipline and average CAT
activity ($10 B -$12B)
2008
deterioration
due to price
competition and
higher CAT
losses. Trends
reverse in 2009.
94.3
95
99.8
100
104.5
105
103.9
110
109.9
115
110.9
Personal Lines
Combined Ratio, 1993-2009F
85
93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08E 09F
Source: A.M. Best (historical and forecast).
2%
2%
1%
1%
0%
*Percentage change from same month in prior year.
Source: US Bureau of Labor Statistics
Dec-08
Nov-08
Oct-08
Sep-08
3%
Aug-08
4%
Jul-08
4%
2.6%
2.6%
2.7%
3.0%
3.1%
3.4%
3.7%
4.0%
Auto insurance
prices have clearly
begun to rise in
recent months
Jun-08
5%
May-08
0.8%
Feb-07
0.8%
Mar-07
0.5%
Apr-07
0.4%
May-07
0.3%
Jun-07
0.3%
Jul-07
0.5%
Aug-07
0.6%
Sep-07
0.5%
Oct-07 0.1%
Nov-07
0.2%
Dec-07
0.5%
Jan-08
0.9%
Feb-08
1.1%
Mar-08
1.3%
Apr-08
1.7%
Jan-07
Monthly Change in Auto
Insurance Prices*
3%
Commercial Lines Combined
Ratio, 1993-2009F
Mortgage and financial
guarantee may account for up
to 4 points on the commercial
combined ratio in 2008
122.3
125
Commercial coverages
have exhibited significant
variability over time.
90
105.1
106.5
102.5
102.0
110.2
111.1
112.3
109.7
107.6
105.4
95.1
95
2006/07 benefited from favorable loss cost
trends, improved tort environment, low CAT
losses, WC reforms and reserve releases.
Most of these trends reversed in 2008 and
mortgage and financial guarantee segments
have big influence. 2009 is transition year.
91.1
100
103.9
105
110.2
110
112.5
115
110.3
120
85
93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08E 09F
Sources: A.M. Best (historical and forecasts)
Average Commercial Rate Change,
All Lines, (1Q:2004 – 4Q:2008)
Source: Council of Insurance Agents & Brokers; Insurance Information Institute
-6.0%
4Q08
-11.0%
3Q08
2Q08 -12.9%
1Q08 -13.5%
-12.0%
4Q07
2Q07
1Q07
4Q06
3Q06
2Q06
1Q06
4Q05
3Q05
2Q05
1Q05
4Q04
3Q04
2Q04
1Q04
-16%
3Q07 -13.3%
KRW Effect
-11.8%
-5.3%
-3.0%
-2.7%
-4.6%
-14%
-11.3%
-12%
Magnitude of price
declines is now
shrinking. Reflects
shrinking capital,
reduced investment
gains, deteriorating
underwriting
performance and
costlier reinsurance
-9.6%
-10%
-8.2%
-8%
-9.7%
-5.9%
-6%
-9.4%
-4%
-7.0%
-3.2%
-2%
-0.1%
0%
Personal/Commercial Lines &
Reinsurance NPW Growth, 2006-2009F
Personal
Commercial
5.0%
7.6%
2009F
28.1%
-1.4%
2008E
-3.8%
3.5%
2007
-0.3%
2.5%
2006
1.0%
0.0%
2.0%
35%
30%
25%
20%
15%
10%
5%
0%
-5%
-10%
-15%
Declines in premium
growth began to stabilize
in later 2008 and are
firming to some extent as
we move into 2009
-11.9%
Reinsurance
Sources: A.M. Best Review & Preview (historical and revised year-end 2008 forecast as of 1/20/09
Advertising Expenditures by P/C
Insurance Industry, 1999-2007
$ Billions
$4.5
$4.0
Ad spending by P/C insurers
is at a record high, signaling
increased competition
$4.102
$3.426
$3.5
$2.975
$3.0
$2.5
$2.0
$1.736 $1.737 $1.803 $1.708
$1.882
$2.111
$1.5
99
00
01
02
03
04
05
06
Source: Insurance Information Institute from consolidated P/C Annual Statement data.
07
Catastrophe Losses
Impacting Underwriting
Results and the Bottom Line
$120
$100
$80
2008 CAT losses exceeded
2006/07 combined. 2005 was by
far the worst year ever for
insured catastrophe losses in the
US, but the worst has yet to come.
$100 Billion
CAT year is
coming soon
$61.9
$ Billions
$100.0
U.S. Insured Catastrophe Losses*
$20
$9.2
$6.7
$25.2
$40
$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
$27.5
$60
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08**
20??
$0
*Excludes $4B-$6b offshore energy losses from Hurricanes Katrina & Rita.
**Based on PCS data through Dec. 31. PCS $2.1B loss of for Gustav. $10.655B for Ike of 12/05/08.
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. Non-prop/BI losses = $12.2B. 80
Source: Property Claims Service/ISO; Insurance Information Institute
Capital/
Policyholder
Surplus
Shrinkage, but
Capital is Within
Historic Norms
U.S. Policyholder Surplus:
1975-2008*
$550
$500
$450
Actual capacity as of 9/30/08 was $478.5, down 7.6%
from 12/31/07 at $517.9B, but 68% above its 2002
trough. Recent peak was $521.8 as of 9/30/07. Estimate
as of 12/31/08 is $438B is 16% below 2007 peak.
$400
$ Billions
$350
$300
$250
$200
$150
The premium-to-surplus
ratio stood at $0.94:$1 at
year end 2008, up from
near record low of $0.85:$1
at year-end 2007
$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 05 06 07 08
Source: A.M. Best, ISO, Insurance Information Institute.
83
*Towers Perrin estimate as of 12/31/08
Policyholder Surplus,
2006:Q4 – 2008:Q4(Est.)
Capacity peaked at
$521.8 as of 9/30/07
$540
$521.8 $517.9 $515.6
$512.8
$520
$500
$ Billions
$487.1
$496.6
$505.0
$478.5
$480
$460
$440
$420
$400
Declines Since 2007:Q3 Peak
$438.0
Q2: -$16.6B (-3.2%)
Q3E: -$43.3B (-8.3%)
Q4E: -$84B (-16.1%)
$380
06:Q4 07:Q1 07:Q2 07:Q3 07:Q4 08:Q1 08:Q2 08:Q3 08:Q4
Source: ISO (historical); Towers Perrin (Oct. 21) estimates for Q4 2008. Q4 assumes no major 84
Investment market recovery before year-end 2008.
Historically, Hard Markets Follow
When Surplus “Growth” is Negative
30%
NWP % change
Surplus % change
25%
Sharp decline in capacity is a
necessary but not sufficient
condition for a true hard market
20%
15%
10%
5%
0%
-5%
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
2004
2005
2006
2007
2008*
-10%
*Actual 9-month 2008 result.
Sources: A.M. Best, ISO, Insurance Information Institute
P/C Premium
Growth
Primarily Driven by the
Industry’s Underwriting
Cycle, Not the Economy
Strength of Recent Hard Markets
by NWP Growth
24%
22%
20%
18%
1975-78
1984-87
2000-03
Shaded areas
denote “hard
market” periods
16%
14%
12%
10%
In 2007 net written
premiums fell
1.0%, the first
decline since 1943
Negative
growth in
2008 before
turning
positive in
2009
8%
6%
4%
2%
0%
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
2004
2005
2006
2007
2008F
2009F
2010F
-2%
Sources: A.M. Best, ISO, Insurance Information Institute
88
Year-to-Year Change in Net
Written Premium, 2000-2010F*
P/C insurers are
experiencing their
slowest growth rates
since 1943
15.3%
10.0%
Slow growth means
retention is critical
8.4%
5.0%
Protracted
period of
negative or
slow growth
is possible
due to soft
markets and
slow
economy
4.2%
3.9%
3.0%
1.0%
0.5%
-1.0% -0.4%
2000
2001
2002
2003
2004
2005
*2008 figure is 9-month actual result from ISO.
Source: A.M. Best (historical); I.I.I. estimates for 2009-2010.
2006
2007
2008F 2009F 2010F
89
Insurance Information
Institute On-Line
THANK YOU FOR YOUR TIME AND
YOUR ATTENTION!
90