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Insurance Markets in a Turbulent Economy Trends & Challenges Association of Insurance Financial Analysts 33rd Annual Conference Naples, FL March 4, 2008 Robert P. Hartwig, Ph.D., CPCU, President Insurance Information Institute 110 William Street New York, NY 10038 Tel: (212) 346-5520 Fax: (212) 732-1916 [email protected] www.iii.org Presentation Outline • The Economic Storm What it Means for the Insurance Industry • • • • • • Financial & Underwriting Performance Ratings & Financial Strength Premium Growth Capacity Investment Overview Shifting Legal Liability & Tort Environment Q&A A STORMY ECONOMIC FORECAST What a Weakening Economy & Credit Crunch Mean for the Insurance Industry What’s Going On With the US Economy Today? Fundamental Factors Affecting US Economy in 2008 • Puncture of Two Bubbles: Credit and Housing • Credit Crunch: Credit is the lifeblood of the US economy, but some markets have effectively seized (at least to some degree) Problem originated with interest rates being left too low for too long in the early 2000s Subprime mortgage market first part of credit bubble to burst; Spread via securitization and amplified via leverage and concentration of risk As lenders tighten standards, credit issues have spread to prime borrowers, commercial mortgages, munis, credit cards, student loans • General Economic Impacts: Burst BubbleAsset Deflation Home price bubble is bursting: Loss of value in most valuable asset impacts wealth via loss of home equity Negative “wealth effect” implies consumers (2/3 of spending) become more cautious Business scale back as prospects diminish in classic economic slowdown Job growth stagnating (-17,000 in Jan. 2008, first decline since Aug. 2003) Source: Insurance Information Institute. Real GDP Growth* 2.7% 2.8% 2.9% 2.9% 09:2Q 09:3Q 09:4Q 2.3% 0.5% 08:1Q 1.1% 0.6% 07:4Q 1% 0.6% 0.8% 2% 09:1Q 4.9% 3.8% 2.9% 1.6% 3% 3.1% 3.6% 2.5% 4% 3.7% 5% 2.5% Economic growth is expected to slow dramatically in the year ahead 6% 08:4Q 08:3Q 08:2Q 07:3Q 07:2Q 07:1Q 2006 2005 2004 2003 2002 2001 2000 0% *Yellow bars are Estimates/Forecasts. Source: US Department of Commerce, Blue Economic Indicators 2/08; Insurance Information Institute. Unemployment Rate, (2007:Q1 to 2009:Q4F) 6.0% 5.5% 5.2% 5.3% 5.4% 5.3% 5.3% 5.2% 5.2% 5.0% 5.0% 4.8% 4.5% 4.5% 4.5% 4.0% 3.5% 4.6% Rising unemployment rate negative impacts workers comp exposure and could signal a temporary claim frequency surge 3.0% 07:Q1 07:Q2 07:Q3 07:Q4 08:Q1 08:Q2 08:Q3 08:Q4 09:Q1 09:Q2 09:Q3 09:Q4 Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (2/08); Insurance Info. Inst. Toward a New World Economic Order 1. Credit Crunch (incl. Subprime) Issue Will Ultimately Cost Hundreds of Billions Globally • Problem exacerbated by leveraged bets taken by some financial institutions therefore its reach extends beyond simple defaults 2. Heavy Toll on Capital Base of Some Large Financial Institutions Worldwide; US Bond Insurers • Cash infusions necessary; Sovereign Wealth Funds important source 3. Most Significant Economic Event in a Generation • US economy will recover, but will take 18-24 months 4. Shuffling of Global Economic Deck; Economic Pecking Order Shifting • China, oil producing countries hold the upper hand 5. IOUs are Being Redeemed • Stakes in hard assets/institutions demanded 6. Good News: No Shortage of Available Capital • Central banks are (generally) making right decisions; Dollar sinks Source: Insurance Information Institute What’s Being Done to Fix the Economy?Impacts on Insurers Economic Fix Fed Rate Cuts Stimulus Package Housing Bailout (?) Regulatory/ Legislative Action (?) Impacts on Insurers •Reduces bond yields (65% - 80% of portfolio) •Potentially contributes to inflation longer run •Hope is that $168B plan boosts overall economic activity and employment (by 500,000 jobs) and therefore p/c personal and commercial exposures •Contributes to already exploding budget deficits— Washington may expand its search for people and industries to tax •Keeps more people in their homes and hopefully paying HO insurance premiums •Abandoned and neglected homes have demonstrably worse loss performance •Nothing solid proposed but in the wake of subprime crisis and credit crunch, actions seem inevitable •Will actions be directed primarily toward banks or broadly affecting all financial institutions Post-Crunch: Fundamental Issues To Be Examined Globally • • • • Adequacy of Risk Management, Control & Supervision at Financial Institutions Worldwide Implications for ERM? Includes review of incentives Effectiveness and Nature of Regulation What sort of oversite is optimal given recent experience? Credit problems arose under US and European (Basel) regulatory regimes Will new regulations be globally consistent? Can overreactions be avoided? Capital adequacy & liquidity Accounting Rules 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: Insurance Information Institute Insurance & The Economy Important but Somewhat Muted Impacts A Few Facts About the Relationship Between Insurance & Economy • Vast Majority of Insurance Business is Tied to Renewals Approximately 98+% of P/C business (units) is linked to renewals A very large share of p/c insurance premiums are statutorily or de facto compulsory (e.g., WC, auto liability, surety, usually HO…) P/C insurers have marginal exposure impact due to economy Most life revenues and units are renewals, but some products (e.g., variable annuities are sensitive to market volatility) Life insurers who manage 401(k) assets seeing more loans and hardship withdrawals; • Insurers are Sensitive to Interest Rates About 2/3 of P/C invested assets and 75% if Life assets are fixed income Historically, yield on industry portfolios has tracked 10-year note closely All else equal, lower total investment gain implies greater emphasis on underwriting Historically, industry’s best underwriting performances are rooted in periods when interests rates were low and/or equity market performance poor (1930s – 1950s, early 2000s gave rise to strong 2006/07) Source: Insurance Information Institute. 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 -2.9% 07 -2.7% 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, 2/08; Insurance Information Inst. Summary of Economic Risks and Implications for Insurers Economic Concern Credit Crunch/ Subprime Meltdown Housing Slump Lower Interest Rates Stock Market Slump General Economic Slowdown/Recession Risks to Insurers •Some insurers have some asset risk •D&O/E&O exposure for some insurers •Client asset management liability for some •Bond insurer problems; Muni credit quality •Reduced exposure growth •Deteriorating loss performance on neglected, abandoned and foreclosed properties •Lower investment income •Decreased capital gains (which are usually relied upon more heavily as a source of earnings as underwriting results deteriorate) •Reduced commercial lines exposure growth •Surety slump •Increased workers comp frequency 1.0 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 2008 vs. 2005 is estimated at $920 million. 1.65 1.62 1.58 1.54 1.17 1.35 1.80 1.36 1.60 1.57 1.47 New home starts plunged 34% from 2005-2007; Drop through 2008 trough is 51% (est.)—a net annual decline of 1.05 million units 1.02 1.01 1.2 1.1 1.19 1.3 1.20 1.4 1.29 1.46 1.6 1.5 1.48 1.7 1.64 1.62 1.8 2.07 Impacts also for comml. insurers with construction risk exposure 1.85 2.0 1.9 1.71 2.1 Exposure growth forecast for HO insurers is dim for 2008/09 1.96 New Private Housing Starts, 1990-2013F (Millions of Units) 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07F 08F 09F 10F 11F 12F 13F Source: US Department of Commerce; Blue Chip Economic Indicators (10/07), except 2008/09 figures from 2/08 edition of BCEF; Insurance Info. Institute $1,641 $1,563 $1,438 $1,396 $1,370 $1,307 8% 7% 6% 5% $1,000 Sharp dip in business investment in 2007/2008 will slow commercial exposure growth $800 $600 $400 $200 4% 3% 2% 1% Nonresidential Fixed Investment % Change Nonresidential Fixed Investment 12F 11F 10F 09F 08F 07E 06 05 04 0% 03 $0 *Nonresidential fixed investment consists of structures, equipment and software. Sources: US Bureau of Economic Analysis (Historical), Value Line (2/22/08) estimates/forecasts for 2008-2012. % Change $1,200 $1,226 $1,400 $1,144 $1,600 $1,082 Nonresidential Fixed Investment ($ Bill) $1,800 $1,495 Nonresidential Fixed Investment,* 2003 – 2012F Total Industrial Production, (2007:Q1 to 2009:Q4F) 4.0% 3.5% 3.6% Industrial production affects exposure both directly and indirectly 3.0% 2.4% 2.7% 2.7% 2.6% 2.6% 1.8% 2.0% 1.1% 0.7% 1.0% 0.2% 0.0% -1.0% -1.0% Industrial production shrank during the final quarter of 2007 and is expected to grow only very slowly during the first half of 2008 -2.0% 07:Q1 07:Q2 07:Q3 07:Q4 08:Q1 08:Q2 08:Q3 08:Q4 09:Q1 09:Q2 09:Q3 09:Q4 Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (2/08); Insurance Info. Inst. Employment Change by Industry Dec. 2007 to Jan. 2008p 60,000 50,000 40,000 30,000 Employment fell by 17,000 in January, the first decline since Aug. 2003. Manufacturing and Construction are always the hardest hit in an economic slowdown, with each losing more than 150,000 jobs over the past 12 months. 47,000 19,000 20,000 11,000 10,000 0 (10,000) (11,000) (20,000) (30,000) (40,000) (18,000) (27,000) (28,000) Construction Manuf. Retail Trade Professional Education & Leisure & & Biz Health Hospitality Services Sources: US Bureau of Labor Statistics; Insurance Information Institute. Government Wage & Salary Disbursements (Payroll Base) vs. Workers Comp Net Written Premiums Wage & Salary Disbursement (Private Employment) vs. WC NWP $ Billions $ Billions 7/90-3/91 $7,000 $6,000 3/01-11/01 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 $25 $20 $15 $10 $5 $0 $0 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07* *As of 7/1/07 (latest available). 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 Inflation Rate (CPI-U, %), 1990 – 2009F Inflation is Accelerating 6 5 4.9 5.1 Inflation often amplified in casualty lines (e.g, WC) Rising inflation can also lead to rate inadequacy Adverse reserve development 4 3.0 3.2 3 2 3.8 3.3 3.4 3.0 2.9 2.8 2.6 2.4 2.5 2.3 1.9 1.5 4.3 2.9 2.2 2.3 1.3 1 0 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08* 08F 09F *12-month change Jan. 2008 vs. Jan. 2007; CPI rose at 6.8% pace N Source: US Bureau of Labor Statistics; Blue Chip Economic Indicators, Feb. 10, 2008; Ins. Info. Institute. Favored Industry Groups for Insurer Exposure Growth Industry Health Care Alternative Energy Agriculture & Food Processing & Manufacturing Export Driven Natural Resources & Commodities Sources: Insurance Information Institute Rationale •Economic NecessityRecession Resistant •Demographics: aging/immigrationGrowth •Solar, Wind, Bio-Fuels, Hydro & Other •Consumer StapleRecession Resistant •Grain and land prices high due to global demand, weak dollar (exports) •Ethanol/Bio-Fuel Source •Acreage GrowingFarm Equipment, Transport •Benefits many other industries •Weak dollar, globalization persist; Cuba angle? •Strong global demand, •Supplies remain tight…but beware of bubbles •Significant investments in R&D, plant & equip required Shareholder Class Action Lawsuits* 600 500 400 A credit crunch creating a “contagion” effect resulting in significant financial distress and bankruptcies in other sectors could breed more securities litigation 300 202 200 164 163 242 231 188 173 497 Pace of suits is up due in part to subprime issues, housing collapse and market volatility. Defendants include banks, investment banks, builders, lenders, bond and mortgage insurers 267 210215 226237 182 118 111 100 176 Includes 44 suits related to subprime in 2007/08 24 0 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08* *Securities fraud suits filed in U.S. federal courts; 2008 figure is current through February 29. Source: Stanford University School of Law (securities.stanford.edu); Insurance Information Institute Origin of D&O Claims for Public Companies, 2006 40% of D&O suits originate with shareholders Competitors, 6% Customers & Clients, 4% Shareholders, 40% Employees, 25% Government, 2% Other 3rd Party, 22% Source: Tillinghast Towers-Perrin, 2006 Directors and Officers Liability Survey. PROFITABILITY & PERFORMANCE Profits in 2006/07 Reached Their Cyclical Peak $46,300 $63,695 $44,155 $38,501 $30,029 $20,559 $30,773 $21,865 $10,870 $3,046 $10,000 $19,316 $20,000 $5,840 $30,000 $14,178 $40,000 Insurer profits peaked in 2006 $36,819 $50,000 $24,404 $60,000 $20,598 $70,000 2001 ROE = -1.2% 2002 ROE = 2.2% 2003 ROE = 8.9% 2004 ROE = 9.4% 2005 ROE= 9.6% 2006 ROE = 12.2% 2007E ROAS1 = 13.1%** $59,200 P/C Net Income After Taxes 1991-2008F ($ Millions)* *ROE figures are GAAP; 1Return on avg. surplus. **Return on Average Surplus; Actual 9-month 2007 result. Sources: A.M. Best, ISO, Insurance Information Inst. 08F 07E 06 05 04 03 01 -$6,970 00 99 98 97 96 95 94 93 92 91 -$10,000 02 $0 ROE: P/C vs. All Industries 1987–2008E 20% P/C profitability is cyclical, volatile and vulnerable 15% 10% Sept. 11 5% US P/C Insurers All US Industries *2007 is actual 9-month ROAS of 13.1%. 2008 P/C insurer ROE is I.I.I. estimate. Source: Insurance Information Institute; Fortune 07 F 08 F 06 04 03 02 01 00 99 98 4 Hurricanes 97 96 93 92 91 90 89 88 95 Northridge -5% 05 Andrew 87 Katrina, Rita, Wilma Lowest CAT losses in 15 years 94 0% Hugo Profitability Peaks & Troughs in the P/C Insurance Industry,1975 – 2008F* 25% 1977:19.0% 1987:17.3% 2006:12.2% 20% 1997:11.6% 15% 10% 5% 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 07E 08F -5% *GAAP ROE for all years except 2007 which is actual 9-month ROAS of 13.1%. 2008 P/C insurer ROE is I.I.I. estimate. Source: Insurance Information Institute; Fortune ROE vs. Equity Cost of Capital: US P/C Insurance:1991-2007E 18% The p/c insurance industry achieved its cost of capital in 2005/6 for the first time in many years 16% 12% 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 Source: The Geneva Association, Ins. Information Inst. -0.1 pts 6% +0.2 pts -13.2 pts 8% -9.0 pts 10% +3.1 pts +1.7 pts 14% 00 01 02 ROE 03 04 05 06 07E Cost of Capital P/C, L/H Stocks: Ahead of the S&P 500 Index in 2008 Total YTD Returns Through February 29, 2008 P/C insurance stocks not affected as much as the overall market by credit, subprime concerns Mortgage & Financial Guarantee insurers were -18.90% down 69% in 2008 S&P 500 -9.38% All Insurers -11.49% -5.08% P/C -9.59% Life/Health Multiline -9.68% Reinsurance -36.25% Mortgage* -11.76% -40.0% -30.0% -20.0% Brokers -10.0% *Includes Financial Guarantee. Source: SNL Securities, Standard & Poor’s, Insurance Information Inst. 0.0% FINANCIAL STRENGTH & RATINGS Financially Fit P/C Insurer Impairment Frequency vs. Combined Ratio, 1969-2007E Combined Ratio 115 Combined Ratio after Div P/C Impairment Frequency 2 1.8 1.6 110 1.4 1.2 105 1 100 0.8 0.6 95 0.4 0.2 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 07E 90 2006 impairment rate was 0.43%, or 1-in-233 companies, half the 0.86% average since 1969; 2007 will be lower; Record is 0.24% in 1972 Source: A.M. Best; Insurance Information Institute 0 Impairment Rate 120 Impairment rates are highly correlated underwriting performance and could reach nearrecord low in 2007 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% Deficient Loss Reserves/Inadequate Pricing 38.2% Investment Problems* 7.3% Alleged Fraud 11.4% Rapid Growth 8.6% Reinsurance Sig. Change Failure in Business 3.5% 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; Cumulative Average Impairment Rates by Best Financial Strength Rating* 60% 50% Insurers with strong ratings are far less likely to become impaired over long periods of time. Especially important in long-tailed lines. D C/C- 40% C++/C+ 30% B/BB++/B+ 20% A/A- 10% A++/A+ 0% 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Average Years to Impairment *US P/C and L/H companies, 1977-2002 Sources: A.M. Best: Best’s Impairment Rate and Rating Transition Study—1977-2002, March 1, 2004. UNDERWRITING TRENDS Extremely Strong 2006/07 P/C Insurance Combined Ratio, 1970-2008F* Combined Ratios 120 115 110 1970s: 100.3 1980s: 109.2 1990s: 107.8 2000s: 101.8* 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 *2007 is actual 9-month result; 2008F from A.M. Best. P/C Insurance Combined Ratio, 2001-2008F 120 115.8 110 As recently as 2001, insurers were paying out nearly $1.16 for every dollar they earned in premiums 107.4 2006 produced the best underwriting result since the 87.6 combined ratio in 1949 100.7 100.1 100 2007/8 deterioration due primarily to falling rates, but results still strong assuming normal CAT activity 98.6 98.3 2005 figure benefited from heavy use of reinsurance which lowered net losses 92.4 93.8 90 01 02 03 04 05 06 Sources: A.M. Best; ISO, III. *2007 is actual 2007 9-monoth result; 2008 is from A.M. Best. 07F 08F Ten Lowest P/C Insurance Combined Ratios Since 1920 vs. 2007E 95 94 92.4 92.5 92.1 92.3 93 92 91.2 91 93.3 93.0 93.1 93.1 93.8 2007 was one of the Top 12 best since 1920 90 The industry’s best underwriting years are associated with periods of low interest rates 89 88 87.6 The 2006 combined ratio of 92.5 was the best since the 87.6 combined in 1949 1949 1948 87 86 85 1943 1937 1935 2006 1950 1939 1953 1936 2007E Sources: Insurance Information Institute research from A.M. Best data. *2007: Actual 9-mo. result. 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. Expected gain for 2007 is approximately $20 billion. Cumulative underwriting deficit since 1975 is $421 billion. 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 07E 08F $ Billions Underwriting Gain (Loss) 1975-2008F* Source: A.M. Best. *Actual 2007:9M underwriting profit = $18.146B Commercial Lines Combined Ratio, 1993-2008F 04 90 91.2 Recent results benefited from favorable loss cost trends, improved tort environment, low CAT losses, WC reforms and reserve releases 95 97.5 102.5 03 100 94.0 111.1 112.3 109.7 110.2 102.0 105 103.9 107.6 110 110.2 112.5 115 110.3 120 105.4 125 Outside CAT-affected lines, commercial insurance is doing fairly well. Caution is required in underwriting long-tail commercial lines. 122.3 Commercial coverages have exhibited significant variability over time. 85 93 94 95 96 97 Sources: A.M. Best (historical and forecasts) 98 99 00 01 02 05 06 07E 08F 90 98.6 95.6 94.3 96.4 105.3 104.5 Recent strong results attributable favorable frequency trends and low CAT activity 94.3 95 98.4 100 102.7 99.8 104.9 103.5 104.5 105 103.9 110 109.9 115 110.9 Personal Lines Combined Ratio, 1993-2007E 85 93 94 95 96 97 98 99 Source: A.M. Best; Insurance Information Institute. 00 01 02 03 04 05 06 07E 08F CATASTROPHIC LOSS What Will 2008 Bring? U.S. Insured Catastrophe Losses* $8.3 $7.4 $2.6 $10.1 $8.3 $4.6 95 96 97 98 99 00 01 02 $100.0 $6.5 $5.5 $16.9 $9.2 $61.9 $4.7 91 92 93 94 $5.9 $7.5 $2.7 $20 89 90 $40 $26.5 $60 $22.9 $80 2006/07 were welcome respites. 2005 was by far the worst year ever for insured catastrophe losses in the US, but the worst has yet to come. $12.9 $27.5 $120 $100 $100 Billion CAT year is coming soon $ Billions 07 20?? 03 04 05 06 $0 *Excludes $4B-$6b offshore energy losses from Hurricanes Katrina & Rita. 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. Source: Property Claims Service/ISO; Insurance Information Institute Inflation-Adjusted U.S. Insured Catastrophe Losses By Cause of Loss, 1987-2006¹ Fire, $6.6 , 2.2% Civil Disorders, $1.1 , 0.4% Wind/Hail/Flood, $9.3 , 3.1% Earthquakes, $19.1 , 6.4% Winter Storms, $23.1 , 7.8% Terrorism, $22.3 , 7.5% Water Damage, $0.4 , 0.1% Utility Disruption, $0.2 , 0.1% Tornadoes, $77.3 , 26.0% Insured disaster losses totaled $297.3 billion from 1987-2006 (in 2006 dollars). Wildfires accounted for approximately $6.6 billion of these—2.2% of the total. All Tropical Cyclones, $137.7 , 46.3% 1 Catastrophes are all events causing direct insured losses to property of $25 million or more in 2006 dollars. Catastrophe threshold changed from $5 million to $25 million beginning in 1997. Adjusted for inflation by the III. 2 Excludes snow. 3 Includes hurricanes and tropical storms. 4 Includes other geologic events such as volcanic eruptions and other earth movement. 5 Does not include flood damage covered by the federally administered National Flood Insurance Program. 6 Includes wildland fires. Source: Insurance Services Office (ISO).. Annual Catastrophe Bond Transactions Volume, 1997-2007 Risk Capital Issues ($ Mill) $8,000 Number of Issuances Catastrophe bond issuance has soared in the wake of Hurricanes Katrina and the hurricane seasons of 2004/2005, despite two quiet CAT years $7,000 $6,000 $5,000 $7,329.6 35 30 25 $4,693.4 20 $4,000 15 $3,000 $1,000 $633.0 $846.1$984.8 $1,139.0 $1,219.5 $966.9 10 $1,991.1 $1,729.8 $2,000 $1,142.8 5 $0 0 97 98 99 00 01 02 03 04 Source: MMC Securities Guy Carpenter, A.M. Best; Insurance Information Institute. 05 06 07 Number of Issuances Risk Capital Issued The 2008 Hurricane Season: Less Activity Predicted Outlook for 2008 Hurricane Season: 25% Worse Than Average Average* 2005 2008F 9.6 49.1 5.9 24.5 2.3 28 115.5 14 47.5 7 13 60 7 30 3 5 7 6 Accumulated Cyclone Energy 96.2 NA 115 Net Tropical Cyclone Activity 100% 275% 125% Named Storms Named Storm Days Hurricanes Hurricane Days Intense Hurricanes Intense Hurricane Days *Average over the period 1950-2000. Source: Philip Klotzbach and Dr. William Gray, Colorado State University, December 7, 2007. Landfall Probabilities for 2008 Hurricane Season: Above Average Entire US East Coast US East Coast Including Florida Peninsula Gulf Coast from Florida Panhandle to Brownsville Caribbean Average* 2008F 52% 31% 60% 37% 30% 36% NA Above Average *Average over the past century. Source: Philip Klotzbach and Dr. William Gray, Colorado State University, December 7, 2007. PREMIUM GROWTH At a Virtual Standstill in 2007/08 Strength of Recent Hard Markets by NWP Growth* 25% 1975-78 1984-87 2001-04 Post-Katrina period resembles 1993-97 (post-Andrew) 20% 15% 10% 5% 0% -5% 2007/2008: Premium growth of 0% or less would be slowest since a decline in 1943 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 2004 2005 2006 2007F 2008F -10% Note: Shaded areas denote hard market periods. Source: A.M. Best, Insurance Information Institute *2007 figure is actual 9-month figure. Cost of Risk vs. Commercial Lines Combined Ratio $8.42 110.2 $11 $9 $7 105.4 102.5 102.0 $5 $3 95 $1 90.5 90 ($1) 90 91 92 93 94 95 96 97 98 99 00 01 02 03 Source: RIMS, A.M. Best 2007 Aggregates & Averages; Insurance Information Institute 04 05 06 Cost of Risk/$1000 Revenue $11.94 $13.15 $13.91 $13.50 $13 $4.83 $5.20 $5.25 104.1 $6.49 $7.30 107.6 $7.70 $11.95 112.3 111.1 109.7 $5.70 100 $8.30 105 110.2 109.4 $6.40 110 112.5 110.2 109.5 $5.71 115 $15 122.3 Commercial Combined Ratio Cost of Risk 118.8 120 $6.10 Commercial Lines Combined Ratio 125 CAPACITY/ SURPLUS Accumulation Continues U.S. Policyholder Surplus: 1975-2007* $550 $500 $450 Capacity as of 9/30/07 was $521.8B, 5.3% above year-end 2006, 80% above its 2002 trough and 54% above its 1999 peak. $400 $ Billions $350 $300 $250 $200 Premium-to-surplus ratio neared a record low of $0.84:$1 at year end 2007, suggesting excess capital $150 $100 $50 Capacity exceeded a half trillion dollars for the first time during the 2nd quarter of 2007 “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* Source: A.M. Best, ISO, Insurance Information Institute. *As of September 30, 2007 P/C Industry Premium-to-Surplus Ratio, 1985-2007:Q3 Private Carriers $ Billions P:S Ratio At 0.86:1 as of 9/30/07, now approaching all-time record premium-to-surplus ratio of 0.84:1 in 1998 600 1.92:1 $521.8B 500 2.5 2.0 400 $450 B 300 1.0 $145 B Low P:S Ratio 0.84:1 in 1998 100 NWP 0.86:1 P:S Ratio Q 3 07 05 04 03 02 01 00 99 98 97 96 95 94 93 92 91 90 0.0 89 88 87 85 86 $76 B 0 Surplus 0.5 06 200 1.5 Calendar Year Q3 = First 3 quarters as of 9/30/07 Source: Insurance Information Institute; 1985–2006, A.M. Best Aggregates & Averages;; 2007 ISO P/C Insurer Share Repurchases, 1987- Through Q3:2007 ($ Mill) Reasons Behind Capital BuildUp & Repurchase Surge •Strong underwriting results •Moderate catastrophe losses $566.8 $310.1 $658.8 $769.2 92 93 94 95 $7,094.1 $5,242.3 $763.7 $418.1 91 $311.0 89 $952.4 $646.9 88 90 $564.0 $2,000 87 $6,000 $1,539.9 $8,000 $2,764.2 Returning capital owners (shareholders) is one of the few options available $10,000 $4,297.3 $12,000 $5,266.0 $14,000 2007 repurchases to date equate to 4.4% of industry surplus, the highest in 20 years $4,586.5 •Reasonable investment performance •Lack of strategic alternatives (M&A, large-scale expansion) $16,000 $17,412.7 $2,385.6 $4,497.5 $18,000 $4,370.0 $20,000 $4,000 First 9-months 2007 share buybacks are already 133% of the 2006 record 06 05 04 03 02 01 07Q3 Sources: Credit Suisse, Company Reports; Insurance Information Inst. 00 99 98 97 96 $0 INVESTMENT OVERVIEW More Pain, Little Gain Property/Casualty Insurance Industry Investment Gain1 $ Billions $57.9 $60 $52.3 $56.9 $51.9 $47.2 $50 $59.4 $44.4 $42.8 $55.7 $48.9 $36.0 $40 $35.4 $30 $45.3 $61.9 Investment rose in 2007 but are marginally higher than what they were nearly a decade earlier in 1998 $20 $10 1Investment 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. **A.M. Best estimate Sources: ISO; Insurance Information Institute. Investment Gain on Funds & Other Income, 1997-2006 12.0% 11.0% 10.9% 10.6% 10.0% 10.3% 9.4% 8.9% 9.0% Invest gains have been trending generally downward over the past decade 8.0% 7.1% 7.1% 7.0% 6.4% 6.3% 6.4% 6.0% 5.0% 4.0% 3.0% 97 98 99 Sources: A.M. Best; Insurance Info. Inst. 00 01 02 03 04 05 06 $8,204 $3,359 $13,016 $9,701 $9,125 $6,610 $6,631 $9,244 $5,997 Realized capital gains rebounded strongly in 2004/5 but fell sharply in 2006 despite strong stock market as insurers “banked” their gains. Rising again in 2007. $1,664 $4,806 $5,000 $2,880 $10,000 $9,818 $9,893 $15,000 $18,019 $10,808 $20,000 Realized capital gains rose during the last soft market as they are now, as underwriting results deteriorate $16,205 US P/C Net Realized Capital Gains, 1990-2007:9 Months ($ Millions) -$1,214 $0 -$5,000 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07* Sources: A.M. Best, ISO, Insurance Information Institute. *As of September 30, 2007. The “Fed” is Now Aggressively Pushing the “Fed Funds” Rate Down 6% 5% The Fed has cut rates by 2.25 points since Aug. 2007. More cuts likely by end of March 4% 3% 2% 1% Cuts in the “Fed Funds” rate—for very short-term loans—has so far not brought down longer-term yields as inflationary expectations build 11/04 12/04 1/05 2/05 3/05 4/05 5/05 6/05 7/05 8/05 9/05 10/05 11/05 12/05 1/06 2/06 3/06 4/06 5/06 6/06 7/06 8/06 9/06 10/06 11/06 12/06 01/07 02/07 03/07 04/07 5/07 6/07 7/07 8/07 9/07 10/07 11/07 12/07 1/08 2/08 0% Source: Federal Reserve Bank of New York. Yield Curves for Last Week of February 2008, 2007, 1978* 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% 1978: Stagflation yield curve built in LT inflationary expectations. Are they building again? Feb. 1978 Feb. 2007 Feb. 2008 2007: Pre-credit crunch flat/inverted yield curve 2008: Fed action pushed ST yields down, LT little changed and reflect inflation fears 1m 3m 6m 1y 2y 3y 5y 7y 10y 20y 30y *Constant maturities for last week of February each year. No data for 1m, 3m or 6m available for 1978. 20-yr 1978 figures is III interpolated value. Sources: Federal Reserve; Insurance Information Institute. Shifting Legal Liability & Tort Environment Will the Pendulum Swing Against Insurers? Personal, Commercial & Self (Un) Insured Tort Costs* $250 Commercial Lines Personal Lines Self (Un)Insured Total = $216.7 Billion Billions $200 $45.5 Total = $159.6 Billion $150 Total = $121.0 Billion $30.0 $85.6 $20.4 $100 $70.9 Total = $39.3 Billion $51.0 $50 $0 $85.6 $5.2 $17.1 $17.0 $49.6 $58.7 1980 1990 2000 *Excludes medical malpractice Source: Tillinghast-Towers Perrin, 2007 Update on US Tort Cost Trends. 2006 $300 Tort System Costs $250 $200 $150 $100 $50 After a period of rapid escalation, tort system costs as a % of GDP are now falling 2.24% $277 2.24% $265 2.14% $246.0 1.98% $247.0 1.82% 1.83% 1.83% 1.53% 1.87% $179.2 1.34% $158.5 1.22% 1.11% $130.2 1.03% 0.82% $83.7 0.62% 2.5% $42.7 $13.9$20.0 $7.9 $5.4 $1.8 $3.4 0.5% $0 2.0% 1.5% 1.0% 0.0% 50 55 60 65 70 75 80 Tort Sytem Costs 85 90 95 00 03 06 08E 09E Tort Costs as % of GDP Source: Tillinghast-Towers Perrin, 2007 Update on U.S. Tort Costs as % of GDP Tort Costs as % of GDP Tort System Costs, 1950-2009E The Nation’s Judicial Hellholes (2007) Watch List Madison County, IL St. Clair County, IL Northern New Mexico Hillsborough County, FL Delaware California Some improvement in “Judicial Hellholes” in 2007 NEVADA Clark County (Las Vegas) ILLINOIS Cook County NEW JERSEY Atlantic County (Atlantic City) West Virginia Dishonorable Mentions District of Columbia MO Supreme Court MI Legislature GA Supreme Court Oklahoma TEXAS Rio Grande Valley and Gulf Coast Source: American Tort Reform Association; Insurance Information Institute South Florida Sum of Top 10 Jury Awards $6,000 $ Millions $5,158.8 $5,000 $4,000 $2,953.7 $3,000 Total of Top 10 awards in 2007 was 25% lower than in 2006 $2,000 $1,000 $815.0 $615.0 2006 2007 $0 2004 2005 Source: Insurance Information Institute from LawyersWeekly USA, January 2005, 2006, 2007 and 2008. Excess Liability Market Capacity – North America Billions Capacity is up 16.5% since its 2003 trough $2.8 $2.045 $2.011 $1.941 $2.6 $2.4 $1.721 $2.2 $2.0 $1.660 $1.645 $1.535$1.570 $1.710 $1.575 $1.425 $1.432 $1.405 $1.334 $1.8 $1.6 $1.4 $1.2 $1.0 94 95 96 97 Source: Marsh, 2007 Limits of Liability Report 98 99 00 01 02 03 04 05 06 07 Insurance Information Institute On-Line If you would like a copy of this presentation, please give me your business card with e-mail address