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The Global Financial Crisis and Its Impacts on Energy Insurance Markets Trends

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Title: The Global Financial Crisis and Its Impacts on Energy Insurance Markets Trends


1
The Global Financial Crisis and Its Impacts on
Energy Insurance Markets Trends Challenges
  • Insurance Information Institute
  • April 2, 2009

Robert P. Hartwig, Ph.D., CPCU,
President Insurance Information Institute ? 110
William Street ? New York, NY 10038 Tel (212)
346-5520 ? bobh_at_iii.org ? www.iii.org
2
Presentation Outline
  • The Global Economic Storm What Weakening Economy
    and the Financial Crisis Mean for the P/C
    Insurance Industry and Energy Concerns
  • Recession, Growth Insurance
  • Economic Stimulus Package Worldwide Spending
    Programs
  • Impacts Implications for P/C Insurers and the
    Energy Sector
  • Insurer Financial Strength Ratings
  • Insurers vs. Banks A Difference of Approach to
    Risk Management
  • Energy Market Review
  • Capacity, Rating, Exposure, Profitability,
    Reinsurance, ART
  • The Financial Crisis Global Energy Supply,
    Demand and Investment
  • Insurance Industry Financial Performance
  • Capital Capacity
  • Regulatory Response to Crisis
  • Emerging Blueprint for Insurance Regulatory
    Overhaul

3
THE GLOBAL ECONOMIC STORMWhat Weakening
Economies and the Financial Crisis Mean for the
Insurance Industry Energy Concerns
4
Real GDP By Market 2007-2010F( change from
previous year)
All major economies except China and Brazil are
in recession. Steep declines in GDP will
negatively impact exposure growth on a global
scale
Source Blue Chip Economic Indicators, 3/10/09
edition.
5
Real GDP for Largest European Economies Euro
Area, 2007-2010F, ( change from prior yr.)
All European economies are in recession
Source Blue Chip Economic Indicators, 3/10/09
edition.
6
US Real GDP Growth
Recession began in December 2007. Economic toll
of credit crunch, housing slump, labor market
contraction is growing
The Q42008 decline was the steepest since the
Q11982 drop of 6.4
Yellow bars are Estimates/Forecasts from Blue
Chip Economic Indicators. Source US Department
of Commerce, Blue Economic Indicators 3/09
Insurance Information Institute.
7
Length of US Recessions,1929-Present
Months in Duration
Current recession began in Dec. 2007 and is
already the longest since 1981. If is now tied
for the longest recession since the Great
Depression.
We will rebuild. We will recover. --President
Barack Obama addressing a joint session of
Congress February 24, 2009
As of April 2009 Sources National Bureau of
Economic Research Insurance Information
Institute.
8
GDP Growth Advanced Emerging Economies vs.
World
1970-2010F
Emerging economies (led by China) are expected to
grow by 3.3 in 2009
The world economy is forecast to grow by 0.5 in
2009, but could shrink for the first time since
WW II by 1 to 2 according to the World Bank.
Advanced economies will shrink by 1.9 in 2009,
dampening energy demand
Source International Monetary Fund, World
Economic Outlook Update, Jan. 28, 2009 Ins.
Info. Institute.
9
Global Industrial Production Is in a Tailspin,
Reducing Energy Demand
Annualized 3-Month Percent Change
Industrial demand for energy has been
particularly hard hit
Global industrial production was down 13 in late
2008, adversely impacting energy demand
Source International Monetary Fund, World
Economic Outlook Update, Jan. 28, 2009 Ins.
Info. Institute.
10
Auto/Light Truck Sales,1999-2010F (Millions of
Units)
Weakening economy, credit crunch are hurting auto
sales Gas prices less of a factor now.
New auto/light truck sales are expected to
experience a net drop of 6.0 million units
annually by 2009 compared with 2005, a decline of
35.5 and the lowest level since the late 1960s
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
Source US Department of Commerce Blue Chip
Economic Indicators (2/09) Insurance Information
Inst.
11
Real GDP Growth vs. Real P/C Premium Growth
Modest Association
P/C insurance industrys growth is influenced
modestly by growth in the overall economy
Sources A.M. Best, US Bureau of Economic
Analysis, Blue Chip Economic Indicators, 3/09
Insurance Information Inst.
12
Change in Producer Prices for Construction vs.
Consumer Prices, 2003 - 2008
Dec. 2008
The inflationary spike of 2008 has been
reversedfor noweasing concerns over claims
severities
13
Inflation Rates for Largest European Economies
Euro Area, 2007-2010F, ( change from prior yr.)
Inflation is down sharply across Europe, reducing
claim severity concerns
Source Blue Chip Economic Indicators, 3/10/09
edition.
14
THE 2.75 TRILLION GLOBAL ECONOMIC STIMULUS
Countries Trying to Spend Their Way Out of
Recession Will Need More Energy More Insurance
15
Summary of Short-Run Impacts of Global Stimulus
Packages on P/C Insurance, Energy Sectors
  • No Stimulus Provisions Specifically Address P/C
    Insurance in US and Unaware of Provisions
    Elsewhere
  • Spending, Aid and Tax Reductions benefit other
    industries, state and local governments, as well
    as individual and some corporate taxpayers
  • Stimulus Package is Unlikely to Increase US Net
    Premiums Written by More Than 1 or Approximately
    4.5 Bill. in US by 2010
  • Little-to-modest impact in Europe and elsewhere
  • Several Stimulus Countries Plans Direct Spending
    Toward the Energy Sector
  • Stimulus Plans in US, Europe, China and Japan
    Have Numerous Green Provisions that Could
    Influence Supply and Demand for Energy

Source Insurance Information Institute
16
Announced Economic Stimulus Packages Worldwide
(US Bill)
U.S. stimulus comprises a mix of spending, tax
relief and aid to states
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
As of March 2009, these countries have approved
or proposed at least US2.3 trillion in stimulus
spending
As of March 2009.
Sources Wall Street Journal, January 8, 2009
with updates by I.I.I. Institute of
International Finance and Brookings Institute.
17
Green Energy Spending An Important Component of
Some Stimulus Plans
787B Total
European green energy stimulus spending 54.2B
634.1B Total
586.1B Total
485.9B Total
Green energy stimulus spending totals 382B in
US, Japan and Europe, or 18.1 of their combined
2.1 trillion in stimulus spending
13.7B Total
Source Energy Sector Looks for Private, Public
Help, WSJ, 3/9/09, p. A2 from HSBC, New Energy
Finance Ins. Info. Inst.
18
US Economic Stimulus Package Where the 787B
Goes5 to Energy Projects
Billions
US stimulus package allocates 43B or 5 or total
spending to energy programs
Source http//www.recovery.gov/ accessed
2/18/09 Insurance Information Institute.
19
US Economic Stimulus Package 143.4 in
Construction Spending20 to Energy Projects
Billions
Spending on energy-related construction projects
totals nearly 30B or 20 or all stimulus-related
construction spending
Source Associated General Contractors at
http//www.agc.org/cs/rebuild_americas_future
(2/18/09) Insurance Info. Inst..
20
Global Green Energy Spending ( Billion)
Annual investment needed through 2030 in
renewable energy and energy efficiency to keep
atmospheric CO2 concentration below 450 parts per
millionan amount many scientists claim is
necessary to prevent serious consequences from
climate change
Current investment in green energy falls far
short of what some believe is necessary to
address climate change issue
Estimated from source below. Source Energy
Sector Looks for Private, Public Help, WSJ,
3/9/09, p. A2 New Energy Finance interpretation
of International Energy Agency data Ins. Info.
Inst.
21
Stimulus Reading The Economic Tea Leaves for the
Next 4 to 8 Years
  • Growing Role of Government 2009 Stimulus
    Packages and Other Likely Spending Initiatives in
    US and Elsewhere Guarantee Government Will Play a
    Much Larger Role Than at Any Other Time in Recent
    History
  • Every industry, including insurance, will and
    must attempt to maximize direct and indirect
    benefits from this paradigm shift
  • Obama Administration Priorities Stimulus
    Package Acts as Economic Tea Leaf on the
    Administrations Fiscal Priorities for the Next
    Several Years
  • These Include
  • Alternative Energy
  • Environmental Spending
  • Health Care
  • Aging/New Infrastructure
  • Aid to States
  • Global Financial Services Regulatory Reform
  • Includes insurance

Source Insurance Information Institute
22
FINANCIAL STRENGTH RATINGS Industry Has
Weathered the Storms Well
23
US P/C Insurer Impairment Frequency vs. Combined
Ratio, 1969-2007
Impairment rates are highly correlated
underwriting performance and could reached a
record low in 2007
2007 impairment rate was a record low 0.12,
one-seventh the 0.8 average since 1969 Previous
record was 0.24 in 1972
Source A.M. Best Insurance Information
Institute
24
Summary of A.M. Bests 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
industrys risk management strategy.
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
Through December 19. Source A.M. Best.
25
Historical Ratings Distribution,US P/C Insurers,
2008 vs. 2005 and 2000
2000
2008
2005
A/A and A/A- gains
P/C insurer financial strength has improved since
2005 despite financial crisis
Source A.M. Best Rating Downgrades Slowed but
Outpaced Upgrades for Fourth Consecutive Year,
Special Report, November 8, 2004 for 2000 2006
and 2009 Review Preview. Ratings B and
lower.
26
Reasons for US P/C Insurer Impairments, 1969-2005
2003-2005
1969-2005
Deficient reserves, CAT losses are more important
factors in recent years
Includes overstatement of assets. Source
A.M. Best P/C Impairments Hit Near-Term Lows
Despite Surging Hurricane Activity, Special
Report, Nov. 2005
27
Critical Differences Between P/C Insurers and
BanksSuperior Risk Management Model Low
Leverage Makea Big Difference
28
Financial Institutions Globally FacingHuge
Losses from the Credit Crunch
Billions
The IMF estimates total credit- turmoil-related
losses will eventually amount to 1.4 trillion
205B or 20.8 of estimated total (bankinsurer)
losses will be sustained by insurers worldwide
Global losses since the beginning of
2007.Source IMF Global Financial Stability
Report, October 2008, IIF, Bloomberg, cited in a
presentation by Thomas Hess (Chief Economist,
Swiss Re) October 23, 2008, accessed via Geneva
Association web site.
29
How Insurance Industry Stability Has Benefitted
Consumers
  • BOTTOM LINE
  • Insurance MarketsUnlike BankingAre Operating
    Normally
  • The Basic Function of Insurancethe Orderly
    Transfer of Risk from Client to InsurerContinues
    Uninterrupted
  • This Means that Insurers Continue to
  • Pay claims (whereas 42 banks have gone under as
    of 3/13)
  • 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
30
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 consequencesstraightforward 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 derivativesCDSs)
  • Greater Transparency
  • Insurance companies are an open book to
    regulators and the public

Source Insurance Information Institute
31
ENERGY MARKET REVIEW Global Energy Business Is
Deeply Impacted by Crisis, but Other Factors
Matter Too
32
Key Trends Capacity Rating Exposure Profitabili
ty Reinsurance
33
Global Energy Insurance Markets Key Trends
  • INSURANCE CAPACITY
  • Aggregate commercial property/casualty (nonlife)
    capacity fell sharply in 2008 due to
  • Reduced Asset Values
  • Higher Underwriting Losses
  • Sharply Lower Investment Returns
  • Surprisingly, overall energy market capacity
    levels for 2009 have increased, despite start of
    early stage of market hardening, financial crisis
    and dislocations of key competitors
  • Higher capacity and basic laws of supply and
    demand temper extent of market hardening and
    limit price gains
  • Capacity freed up due in part to reduced
    construction activity and reduced business
    interruption levels
  • Fallout from Gulf of Mexico windstorm causes some
    supply issues for offshore and onshore risks

Source Willis Energy Market Review March 2009
34
Upstream Operating Underwriting Capacities,
2000-08 (Excl. GOM)
Source Willis Energy Market Review March 2009
35
Downstream Operating Underwriting Capacities,
2000-09 (Excl. GOM)
Source Willis Energy Market Review March 2009
36
Upstream Capacities and Average Rating Levels,
1993-2009 (Excl. GOM)
Source Willis Energy Market Review March 2009
37
Onshore Capacities and Average Rating Levels,
1993-2009 (Excl. GOM)
Source Willis Energy Market Review March 2009
38
Total Theoretical Liability Capacity, 2000-09
Source Willis Energy Market Review March 2009
39
Global Energy Insurance Markets Key Trends
  • INSURED EXPOSURE
  • Global economic downturn, reduced energy demand
    and collapse of oil prices hit energy industry
    project activity and asset values with negative
    impact on energy insurers exposure and therefore
    premium income levels
  • Impact is especially acute for industrial energy
    demand
  • Credit crisis impacting project viability as well
  • BOTTOM LINE IN 2009 Crisis will have little
    impact on long-run demand and supply for energy
    and energy assets
  • Global energy demand will begin to rebound in
    late 2009
  • Fuel prices are already beginning to rise
  • Insurance industry will be able to meet the
    short, intermediate and long-term demands despite
    current challenges

Source Willis Energy Market Review March 2009
Insurance Information Institute.
40
Global Energy Insurance Markets Key Trends
  • PROFITABILITY
  • Sharp decline in investment returns in 2008,
    unlikely to turnaround anytime soon
  • Loss of investment return necessarily increases
    pressure on (re)insurers to generate underwriting
    profits
  • Many insurers will also need to protect capital
    in 2009 via increased reliance on reinsurance
  • Higher cost of capital could be a major issue if
    capital raises are necessary among for insurers
    and reinsurers
  • BOTTOM LINE IN 2009 Stable and profitable
    energy sector (for the most part) particularly
    for low Nat Cat business
  • Movement toward disciplined underwriting is
    necessary

Source Willis Energy Market Review March 2009
Insurance Information Institute.
41
Energy Losses vs. Global Energy Premium Income
1990-2008
Figures include both insured and uninsured
losses Source Willis Energy Market Review March
2009
42
Gulf of Mexico Windstorm Still An Insoluble
Problem?
  • Gulf of Mexico windstorm (GOM) number one
    underwriting headache in the wake of Hurricane
    Ike
  • Long-term sustainability of Gulf wind insurance
    product in serious question by both the
    reinsurance and direct markets
  • Offshore energy losses spike in 2004, 2005 and
    2008 due to impact of Big Four (Hurricanes Ivan,
    Katrina, Rita and Ike)
  • Lloyds Franchise Performance Directorate (LFPD)
    taking keen interest in individual syndicates
    plans to write GOM wind in 2009. Significant
    product changes expected.
  • Market expected to offer 30 percent less capacity
    than in 2008
  • Catastrophe modeling and capital market
    parametric solutions expected to play a role.

Source Willis Energy Market Review March 2009
43
Reinsurance Alternative Risk Transfer
Capacity is Down, Demand is Up
44
Reinsurance Market Trends
  • Amid global capital markets turmoil and economic
    downturn global reinsurance industry has faired
    relatively well (with a small number of
    exceptions)
  • Capacity, however, is down due to investment
    issues
  • But reinsurers seeking price increases as of 1
    January and risk appetite more constrained (e.g.,
    U.S. catastrophe risk)
  • Primary insurers exploring lower retentions and
    other reinsurance mechanisms to protect and
    enhance their capital positions
  • Increasing syndication of risk as insurers seek
    to use portfolio diversification to mitigate
    counterparty exposure
  • Opportunity for traditional reinsurance market to
    win back market share as some alternative forms
    of risk transfer have dried up

Source Willis Energy Market Review March 2009
Insurance Information Institute.
45
Global Reinsurance Capacity Shrank in 2008,
Mostly Due to Investments
Source of Decline
Global Reinsurance Capacity
Global reinsurance capacity fell by an estimated
17 in 2008
Source AonBenfield Reinsurance Market Outlook
2009 Insurance Information Institute.
46
Catastrophe Bond and Sidecar Issuance, 2004-2008
Billions
The credit crisis and decline in global capital
have taken their toll on alternative forms of
catastrophe risk transfer
Source AonBenfield Reinsurance Market Outlook
2009 Insurance Information Institute.
47
The Global Financial Crisis Affects Energy
Industry Supply and Demand Insurance Exposure
48
Severe Recession is Depressing US Energy Demand
Change 2009 vs. 2008
Percentage Change in Consumption, 2009 vs. 2008
Industrial consumption of electricity has
experienced the most severe declines
Sources Energy Information Administration.
49
World Crude Oil Prices 1997- March 2009
Dollars per Barrel
PEAK Jul. 2008 145.29
Crude oil prices peaked at 145.29 in July 2008,
then fell 75 to 34.57 in Jan. 2009 but are
rising again to more than 47/bbl in mid-March
Jan. 1998 15.21
RECENT 16 Mar. 47.35
TROUGH Jan. 2009 34.57
All countries spot market price weighted by
estimated export volume. Source Energy
Information Administration http//tonto.eia.doe.
gov/dnav/pet/hist/wtotworldw.htm
50
US Energy Expenditures as a of GDP Have Been
Hurt by Recession
Percentage of GDP
Recession and 2008 energy price spike sharply
decreased energy demand
The energy price bubble pushed energy
expenditures to 9.9 of GDP in 2008. The
bursting of the bubble and recession pushed
expenditures down to 7.0 of GDP in 2009.
Source Energy Information Administration,
Short-Term Energy Outlook, March 10, 2009 Ins.
Info. Inst.
51
World Net Effective Electric Power Generation,
1990-2030 (est.)
Trillions of Kilowatt Hours
The current economic downturn will have little,
if any, long-term impact on electric power
generation
Source Energy Information Administration, 2008
International Energy Outlook, Insurance
Information Institute.
52
Electricity Supply Infrastructure Despite
Crisis, Huge Investments Needed Along With
Insurance 2001-2030 (Est.)
European investment could total 1.351 trillion
Investments in electricity supply infrastructure
globally are expected to total 9.841 trillion
between 2001 and 2030
Source International Atomic Energy Agency ,
World Outlook for Electricity Investment.
53
World Energy Supply Infrastructure Investment by
Category 2001-2030 (Est.)
Billions
Generation will account for 46 or 4.5 trillion
of all investment through 2030 to meet rising
demand. Current downturn will have no impact on
long-term global energy demand and the need to
develop supply infrastructure
Source International Atomic Energy Agency ,
World Outlook for Electricity Investment.
54
World Electricity Generation by Fuel 2005-2030F
Trillions of Kilowatt Hours
The sharp increase in generation and the changing
composition of fuel source will influence
insurance demand and the nature of products sold
Source US Department of Energy Report
DOE/EIA-0484 ( Sept. 2008) Insurance
Information Institute
55
World Electricity Generation by Fuel Source
Share 2005 vs. 2030F
2005
2030
Surprisingly, coal as a source of electricity
generation is expected rise through 2030. CO2,
pollution issues?
Source Insurance Information Institute from data
reported in US Department of Energy Report
DOE/EIA-0484 ( Sept. 2008).
56
European Electricity Generation,by Fuel
2005-2030F
Trillions of Kilowatt Hours
4.67
4.44
4.21
3.97
3.70
3.30
Gas, renewables grow, coal shrinks, implying
different insurance needs in Europe
Source US Department of Energy Report
DOE/EIA-0484 ( Sept. 2008) Insurance
Information Institute
57
Avg. Annual Change in Consumption of Crude Oil in
Major World Regions
000 barrels per day
Demand for oil will increase by a projected 49
in China, 30 in India and Middle East by 2015
but shrink in Europe
Austria, Belgium, the Czech Republic, Denmark,
Finland, France, Germany, Greece, Hungary,
Iceland, Ireland, Italy, Luxembourg, the
Netherlands, Norway, Poland, Portugal, the Slovak
Republic, Spain, Sweden, Switzerland, Turkey and
UK. Source Wall Street Journal, January 3, 2008
edition International Energy Agency
58
Lessons from Energy Boom of 2008
59
Oil/Energy is a Chief Source of Global Economic
Instability
  • LESSONS OF 2008 ENERGY PRICE BUBBLE
  • Steeply rising oil/energy prices lead to severe
    economic dislocation and hardship on a global
    scale
  • Reduced economic growth globally (except energy
    exporting countries)
  • Fuels Inflation
  • Makes investment decisions in exploration more
    uncertain
  • Encourages collateral boom in other commodities
  • Disastrous for transport sector (e.g., airlines)
  • Food, energy costs are acute problems in poorest
    parts of the world
  • Increases the power and wealth of certain
    unstable countries (e.g., Iran, Nigeria,
    Venezuela)
  • Influence on biofuels/alternative energy policies

60
P/C INSURANCE FINANCIAL PERFORMANCEA Resilient
Industry in Challenging Times
61
Profitability Historically Volatile
62
P/C Net Income After Taxes1991-2009F (
Millions)
  • 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

Insurer profits in US and globally peaked in
2006/2007
ROE figures are GAAP 1Return on avg. surplus.
2008 numbers are annualized based on 9-mos.
Actual of 4.066 billion. Sources A.M. Best,
ISO, Insurance Information Inst.
63
P/C Insurance Industry ROEs,1975 2010F
197719.0
198717.3
200612.2
199711.6
10 Years
10 Years
9 Years
2009F 4.5
2008F 1.1
2010F 6.0
1975 2.4
1984 1.8
1992 4.5
2001 -1.2
Note 2009 figure is actual 9-month
result. Sources ISO Insurance Information
Institute.
64
ROE vs. Equity Cost of CapitalUS P/C
Insurance1991-2008Q3
The p/c insurance industry fell well short of is
cost of capital in 2008
2.3 pts
-1.7 pts
-9.0 pts
-13.2 pts
-9.7 pts
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
The cost of capital is the rate of return
insurers need to attract and retain capital to
the business
Excludes mortgage and financial guarantee
insurers. Source The Geneva Association, Ins.
Information Inst.
65
Presidential Politics P/C InsuranceHow is
Profitability Affected by the Presidents
Political Party?
66
P/C Insurance Industry ROE byPresidential
Administration,1950-2008
OVERALL RECORD 1950-2008 Democrats
8.05 Republicans 8.02
Party of President has marginal bearing on
profitability of P/C insurance industry
ROE for 2008 based on H1 data. Truman
administration ROE of 6.97 based on 3 years
only, 1950-52. Source Insurance Information
Institute
67
P/C Insurance Industry ROE by Presidential Party
Affiliation,19502008
BLUE Democratic President RED
Republican President
Truman
Nixon/Ford
Kennedy/ Johnson
Eisenhower
Carter
Reagan/Bush
Clinton
Bush
Source Insurance Information Institute.
2008 based 9-month data.
68
P/C Premium Growth Primarily Driven by the
Industrys Underwriting Cycle, Not the Economy
69
Strength of Recent Hard Marketsby NWP Growth
1975-78
1984-87
2000-03
Shaded areas denote hard market periods
Net written premiums fell 1.0 in 2007 (first
decline since 1943) and by 0.4 in 2008, the
first back-to-back decline since 1930-33
69
Sources A.M. Best (historical and forecast),
ISO, Insurance Information Institute
70
Year-to-Year Change in Net Written Premium,
2000-2009F
P/C insurers are experiencing their slowest
growth rates since 1930-33 Slow growth means
retention is critical
Protracted period of negative or slow growth is
possible due to soft markets and slow economy
70
2008 figure is 9-month actual result from
ISO. Source A.M. Best (historical and forecast)
71
Capital/Policyholder Surplus Shrinkage, but
Capital is Within Historic Norms
72
U.S. Policyholder Surplus 1975-2008
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.
Billions
The premium-to-surplus ratio stood at 0.941 at
year end 2008, up from near record low of
0.851 at year-end 2007
Surplus is a measure of underwriting capacity.
It is analogous to Owners Equity or Net Worth
in non-insurance organizations
Source A.M. Best, ISO, Insurance Information
Institute. Towers Perrin estimate as of
12/31/08
73
Policyholder Surplus, 2006Q4 2008Q4(Est.)
Capacity peaked at 521.8 as of 9/30/07
Declines Since 2007Q3 Peak Q2 -16.6B (-3.2)
Q3E -43.3B (-8.3)
Q4E -84B (-16.1)
Source ISO (historical) Towers Perrin (Oct.
21) estimates for Q4 2008. Q4 assumes no major
Investment market recovery before year-end 2008.
74
U.S. P/C Industry Premiums-to-Surplus Ratio
1985-2008Q3
Premiums measure risk accepted surplus is funds
beyond reserves to pay unexpected losses. The
larger surplus is in relation to premiumsthe
lower the ratio of premiums to surplusthe
greater the industrys capacity to handle the
risk it has accepted.
P/C insurers remain well capitalized despite
recent erosion of capital
19980.851the lowest (strongest) PS ratio in
recent history.
0.921 as of 9/30/08
Sources A.M. Best, ISO, Insurance Information
Institute.
75
Historically, Hard Markets Follow When Surplus
Growth is Negative
Sharp decline in capacity is a necessary but not
sufficient condition for a true hard market
Actual 9-month 2008 result. Sources A.M. Best,
ISO, Insurance Information Institute
76
Investment Performance Investments are the
Principle Source of Declining Profitability
77
Distribution of P/C Insurance Industrys
Investment Portfolio
As of December 31, 2007
  • Portfolio Facts
  • Invested assets totaled 1.3 trillion as of
    12/31/07
  • Insurers are generally conservatively invested,
    with 2/3 of assets invested in bonds as of
    12/31/07
  • 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.
78
Property/Casualty Insurance Industry Investment
Gain1994- 2008Q3 1
Investment gains are off sharply in 2008 due to
lower yields and poor equity market conditions.
1Investment 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. Sources ISO Insurance
Information Institute.
79
P/C Insurer Net Realized Capital Gains,
1990-2008Q3
Billions
Realized capital gains exceeded 9 billion in
2004/5 but fell sharply in 2006 despite a strong
stock market. Nearly 9 billion again in 2007,
but -9.7 billion in 2008 through Q3.
Sources A.M. Best, ISO, Insurance Information
Institute.
80
Total Returns for Large Company Stocks 1970-2009
SP 500 is down 12.1 in 2009
The market crash of 2008 was the biggest since
1931
Source Ibbotson Associates, Insurance
Information Institute. Through
March 18, 2009.
81
Treasury Bond Yields HaveGenerally Been Falling
Forecast
July 1990-March 1991 recession
March 2001-November 2001 recession
Investment yields on the safest assets are near
multi-decade lows
December 2007 Present (Current Recession)
Sources US Bureau of Labor Statistics (history)
Blue Chip Economic Indicators, February 2009
issue (forecasts)
82
Treasury Yield Curves Pre-Crisis vs. Current
Treasury Yield Curve is at its most depressed
level in at least 45 years. Investment income
will fall significantly as a result.
Stock dividend cuts will further pressure
investment income
February 2009. Sources Federal Reserve
Insurance Information Institute.
83
Underwriting Trends Financial Crisis Does Not
Directly Impact Underwriting Performance Cycle,
Catastrophes Were 2008s Drivers
84
P/C Insurance Combined Ratio, 1970-2008F
Combined Ratios 1970s 100.3 1980s 109.2 1990s
107.8 2000s 102.0
Sources A.M. Best ISO, III
A.M. Best year end estimate of 103.2 Actual
9-mos. result was 105.6.
85
P/C Insurance Industry Combined Ratio, 2001-2009E
As recently as 2001, insurers paid out nearly
1.16 for every 1 in earned premiums
Relatively low CAT losses, reserve releases
Including Mortgage Fin. Guarantee insurers
2005 ratio benefited from heavy use of
reinsurance which lowered net losses
Cyclical Deterioration
Best combined ratio since 1949 (87.6)
Includes Mortgage Financial Guarantee
insurers. Sources
A.M. Best.
86
Underwriting Gain (Loss)1975-2008Q3
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.
Billions
19.877 Bill underwriting loss in 089M incl.
mort. FG insurers
Source A.M. Best, ISO Insurance Information
Institute Includes mortgage finl.
guarantee insurers
87
Number of Years With Underwriting Profits by
Decade, 1920s 2000s
Number of Years with Underwriting Profits
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.
Note Data for 1920 1934 based on stock
companies only. Sources Insurance Information
Institute research from A.M. Best Data.
2000 through 2008.
88
Commercial Lines
89
Commercial Lines Combined Ratio, 1993-2009F
Commercial coverages have exhibited significant
variability over time.
Mortgage and financial guarantee may account for
up to 4 points on the commercial combined ratio
in 2008
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.
Sources A.M. Best (historical and forecasts)
90
Average Commercial Rate Change,All Lines,
(1Q2004 4Q2008)
Magnitude of price declines is now shrinking.
Reflects shrinking capital, reduced investment
gains, deteriorating underwriting performance and
costlier reinsurance
-0.1
KRW Effect
Source Council of Insurance Agents Brokers
Insurance Information Institute
91
Catastrophe Losses The Energy Sector is
Vulnerable to a Increasing Natural Catastrophe
Activity
92
Natural Catastrophes in 2008 by Type and Location
Energy sector was impacted significantly by
catastrophes in 2008 Ike, European Wind/Winter
Storms, China Earthquake
Great natural catastrophes
Hurricane Ike ( Sept. 6-14, 2008) Caribbean,
USACyclone Nargis (May 2-5, 2008) Myanmar
Earthquake (May 12, 2008) China
Winter damage (Jan 10Feb 13, 2008) China
Source 2009 Münchener Rückversicherungs-Gesellsc
haft, Geo Risk Research, NatCatSERVICE
As of
January 2009
93
Some of the Costliest Natural Catastrophes in
2008 Impacted the Energy Business and Its
Insurers Significantly
Source 2009 Münchener Rückversicherungs-Gesellsc
haft, Geo Risk Research, NatCatSERVICE
As of
January 2009
94
The number of natural catastrophes is rising
globally. This has significant ramifications for
the energy sector and its insurers
Source 2009 Münchener Rückversicherungs-Gesellsc
haft, Geo Risk Research, NatCatSERVICE
As of
January 2009
95
Overall and Insured Losses from Natural
Catastrophes Worldwide, 1980 - 2008
The overall and insured costs from natural
catastrophes has been on the rise in recent year.
This has significant implications for the energy
sector and its insurers
Source 2009 Münchener Rückversicherungs-Gesellsc
haft, Geo Risk Research, NatCatSERVICE
As of
January 2009
96
U.S. Insured Catastrophe Losses
Billions
100 Billion CAT year is coming soon
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.
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. Source
Property Claims Service/ISO Insurance
Information Institute
97
Rising Number of U.S. Landfalling Tropical
Cyclones Has Been Very Costly for Energy Insurers
Six tropical cyclones made landfall in the US in
2008
Source Munich Re from NOAA
98
Key Issues Threats Facing P/C Insurers Amid
Financial CrisisManageable Challenges
99
Important Issues Threats Facing P/C Insurers
in 2009
  • Reloading Capital After Capital Event
  • Continued asset price erosion coupled with major
    capital event could lead to shortage of capital
    among some companies
  • P/C insurers have come to assume that large
    amounts of capital can be raised quickly and
    cheaply after major events (post-9/11, Katrina).
    This assumption may be incorrect in the current
    environment.
  • Cost of capital is much higher today, reflecting
    both scarcity risk
  • Implications P/C insurers need to protect
    capital today and develop detailed contingency
    plans to raise fresh capital generate
    internally
  • 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
  • Many 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 a smaller fraction of profits
  • Implication 2 Implies underwriting discipline of
    a magnitude not witnessed in this industry in
    more than 30 years
  • Lessons from the period 1920-1975

Source Insurance Information Inst.
100
Important Issues Threats Facing P/C Insurers
in 2009 (contd)
  • Regulatory Overreach
  • P/C insurers get swept into vast federal
    regulatory overhaul and subjected to
    inappropriate , duplicative and costly regulation
  • 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

Source Insurance Information Inst.
101
AFTERSHOCK Regulatory Response Could Be
HarshAll Financial Segments Including
InsurersWill Be Impacted
102
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.
103
Emerging Blueprint for Financial Services
Regulatory Overhaul
  • Phase I Systemic Risk Regulation/Regulator
  • Identification of systemic risk points in the
    financial system
  • Design of appropriate regulation to prevent
    future collapses
  • Will require international consultation (US cant
    manage systemic risk alone)
  • Oversight Responsibility Likely With Federal
    Reserve
  • Fed would have capacity and power to assess risk
    across financial markets regardless of corporate
    form and to intervene when appropriate
  • Fed could oversee (according to House FS
    Committee Chairman Barney Frank
  • Hedge funds (need to ensure complete
    transparency)
  • Credit ratings agencies
  • Executive compensation (to curb perverse risk
    incentives)
  • TIMELINE Frank wants general outline by April
    2 meeting of G20 industrialized and developing
    nations

http//financialservices.house.gov/press110/press
0320082.shtml Source Wall Street Journal,
Frank Backs Regulator for Systemic Risk,
2/4/09, p. C3 I.I.I. research.
104
Emerging Blueprint for Financial Services
Regulatory Overhaul (contd)
  • Phase I Systemic Risk Regulation/Regulator
    OTHER (contd)
  • Unification of federal bank regulatory agencies
  • Creation of a Financial Products Safety
    Commission to vet products before sold to
    investors
  • Creation of federal insurance program for muni
    bonds paid via premiums
  • Support for status quo on mark-to-market
  • Phase II Sectoral Reform/Overhaul
  • Each segment of the financial services industry
    will be examined and subject to regulation
    specific to its function, risks and other factors
  • TIMELINE August 2009 or later

Source Wall Street Journal, Frank Backs
Regulator for Systemic Risk, 2/4/09, p. C3
I.I.I. research.
105
Post-Crunch Fundamental Regulatory Issues
Insurance
  • Federal Encroachment on Regulation of Insurance
    in Certain Amid a Regulatory Tsunami
  • 150 billion in aid to AIG makes increased
    federal involvement in insurance regulation a
    certainty
  • States will lose some of their regulatory
    authority
  • What Feds get/what states lose is unclear
  • Removing the O from OFC?
  • Treasury in March proposed moving solvency and
    consumer protection authority to a federal
    Office of National Insurance
  • Moving toward more universal approach for
    regulation of financial services, perhaps under
    Fed/Treasury?
  • Is European (e.g., FSA) approach in store?
  • Treasury proposed assuming solvency and consumer
    protection roles while also eliminating rate
    regulation
  • Expect battle over federal regulatory role to
    continue to be a divisive issue within the
    industry
  • States will fight to maximize influence, arguing
    that segments of the financial services industry
    under their control had the least problems

Source Insurance Information Institute
106
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
  • Unlikely, but some segments of the industry might
    welcome this outcome above all others
  • 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 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.
107
Major Regulatory Considerations for Insurance
Regulation in 2009
  • Power Sharing Will Feds and States Divide
    Regulatory Authority How?
  • Holding company (federal) and operating
    company/insurer (state)?
  • Pre-Emption Will Congress Pass Legislation
    Pre-Empting State Authority?
  • Regulatory Consolidation Will Regulatory
    Authority (now spread over 4 agencies) be
    Consolidated Into One Entity? Will it Involve
    States?
  • Life vs. P/C Will Separate Regulatory Structures
    Emerge?
  • Guaranty Fund System FDIC has suggested
    federalization of system
  • State Run Insurers Who Would Regulate State-Run
    Insurers (Property, WC)?
  • Many coastal states have large state-run entities
  • About 25 states operate workers comp state funds
    or monopolistic insurers
  • Regulation of Credit Default Swaps as Insurance
    Will Feds take this up?
  • Insurer Divisiveness Industry is Not United on
    Many Key Issues

Source Insurance Information Institute research.
108
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