Rising Premiums: Economic Windfall or Insurance Industry Meltdown? The Legend of the Price-Gouging Insurer

1
Rising PremiumsEconomic Windfall or Insurance
Industry Meltdown?The Legend of the
Price-Gouging Insurer

• Casualty Actuaries of Greater New York
• New York, NY
• June 11, 2003

Robert P. Hartwig, Ph.D., CPCU, Senior Vice
President Chief Economist Insurance Information
Institute ? 110 William Street ? New York, NY
10038 Tel [phone] ? Fax [phone]
? bobh_at_iii.org ? www.iii.org
2
Presentation Outline

• Overview
• URBAN LEGENDS OF THE HARD MARKET
• Insurers are Making a Killing
• Commercial Insurance is More Expensive than Ever
• Rate Hikes are to Make Up for 9/11 Losses
• Rate Hikes are Mostly Due to Bad Investments
• Theres No Connection Between Litigiousness
  Rates
• Insurers are Drowning in Capital
• Insurers are Redlining Businesses post-9/11
• The Terrorism Problem is Fixed
• Investors are Satisfied with P/C Stock
  Performance
• QA

3
PRICINGPast, Present Future
4
Average Price Change of Commercial Insurance
Renewals (Pre-9/11)
Source Conning
5
Council of Insurance Agents Brokers Rate Survey
First Quarter 2003
Rate Increases By Line of Business
No Change
Up 1-10 10-20 20-30 30-50
50-100 gt100 Comm. Auto 8
23 40 19
5 0 0 Workers Comp
7 20 35 23
7 2 0 General
Liability 7 23 42
20 3 0
0 Comm. Umbrella 4 12
28 27 15 8
1 DO 3
6 25 28 15
8 2 Comm. Property 8
24 35 17
4 0 0 Construction Risk
7 5 27 23
16 3 0 Terrorism
13 17 19
10 2 1
1 Business Interr. 13 33
28 7 1
0 0 Surety Bonds 9
14 19 10 4
0 2 Med Mal
2 2 5
8 18 14
8
9 of respondent reported a decline.
6
DEBUNKING URBAN LEGENDS OF THE HARD MARKET
7
Legend 1 Insurers are Exploiting the Current
Hard Market and Making a Killing
8
P/C Net Income After Taxes1991-2002 ( Millions)

• 2001 was the first year ever with a full year net
  loss
• 2002 ROE 1.0

Sources A.M. Best, ISO, Insurance Information
Institute.
9
ROE P/C vs. All Industries 19872003F
There is an enormous gap between the p/c
industrys rate of return and that of most major
industry groups
Source Insurance Information Institute Fortune
10
ROE vs. Cost of Capital US P/C Insurance 1991
2002
There is an enormous gap between the industrys
cost of capital and its rate of return
14.6 pts
10.2. pts
US P/C insurers have missed their cost of capital
by an average 6.9 points since 1991
Source The Geneva Association, Ins. Information
Inst.
11
Underexposed The Economic Cycle Hurts Exposure
Growth
12
Real GDP Growth
Economy continues to experience uneven growth
following the recession of 2001
Source US Department of Commerce, Blue Economic
Indicators 6/03, Insurance Information Institute.
13
Impact of Recession on P/C Premiums and
Profitability (1970-2001)
GAAP return on equity, adjusted for inflation
Bank data 1952-2001 Div. Fin. 1987-2001 Source
Insurance Information Institute
14
Unemployment Rate ()
Unemployment The unemployment rate is expected
to rise slightly in 2003, harming WC exposure
growth.
Source US Bureau of Labor Statistics Blue Chip
Economic Indicators (6/03), Insurance Info.
Institute.
15
Exposure Employment, Wages Salaries
Disbursements (Billions)
Employment (Millions)
Sources Bureau of Labor Statistics, Bureau of
Economic Analysis, Blue Chip Economic
Indicators, Insurance Information Institute.
16
Private Non-Residential Investment (Real, 1996)
Commercial exposure growth is slowing as
corporations cut back on capital spending
Billions (US)
Annualized based on first quarter data. Source
U.S. Bureau of Economic Analysis, Insurance
Information Institute
17
New Private Housing Starts(Millions of Units)

• New Private Housing Starts
• Housing market remain strong.
• Virtually no exposure impact for insurers

Source US Department of Commerce Blue Chip
Economic Indicators (5/03), Insurance Info.
Institute
18
Motor Vehicle Retail Sales (Millions of Units)
New Motor Vehicle Sales Sales of automobiles
remain relatively strong despite the weak
economy. There is little adverse exposure impact
on auto insurers.
Source US Department of Commerce Insurance
Information Institute Blue Chip Economic
Indicators as of May 2003.
19
Legend 2 Insurance is More Expensive than Ever
and is Squeezing Businesses and Families Alike
20
Insurance is the Biggest Concern of Small
Business Owners
Source National Federation of Independent
Business (February 2003) Insurance Information
Institute
21
Commercial Lines Net Written Premium as of GDP
Commercial insurance premiums as a of GDP fell
35 between 1988 and 2000 and remains far below
late 1980s levels
More Cover for Less Money Terms conditions
broadened significantly during the soft market,
even as prices fell
Sources Insurance Information Institute,
calculated from U.S. Bureau of Economic Analysis
and A.M. Best data.
22
Cost of Risk per 1,000 of Revenues 1990-2002E

• Cost of risk to corporations fell 42 between
  1992 and 2000
• Estimated 15 increase in 2001, 25 in 2002

Cost of risk is still less than it was a decade
ago!
Source 2001 RIMS Benchmark Survey Insurance
Information Institute estimates.
23
Homeowners Insurance Expenditure as a of Median
Home Price
The cost of homeowners insurance relative to the
price of a typical home has fallen!
HO Expenditure as of Sales Price
Median Home Sales Price
As of January 2003. Source Insurance
Information Institute calculations based on data
from National Association of Realtors, NAIC.
24
Legend 3 Insurers are Raising Rates to Make up
for 9/11 Losses
25
Strength of Recent Hard Markets by Real NWP Growth
1975-78
1985-87
2001-03
Real NWP Growth During Past 3 Hard
Markets 1975-78 8.6 1985-87 14.5 2001-03F
9.2
Note Shaded areas denote hard market
periods. Source A.M. Best, Insurance
Information Institute
26
Underwriting Gain (Loss)1975-2002
Billions
P-C insurers paid 30.5 billion more in claims
expenses than they collected in premiums in 2002
Source A.M. Best, Insurance Information
Institute
27
P/C Industry Combined Ratio
Combined Ratios 1970s 100.3 1980s 109.2 1990s
107.7 2000s 111.0
2001 115.7 2002 107.2 2003F 103.2
Based on III Earlybird Survey, February 2003.
Sources A.M. Best III
28
Combined Ratio Reinsurance vs. P/C Industry

• 2001s combined ratio was the worst-ever for
  reinsurers 2003 was bad as well.
• 2003 Big improvement in Q1
• Light weather helped Q103

First quarter 2003 estimate from RAA. Source
A.M. Best, ISO, Reinsurance Association of
America, Insurance Information Institute
29
12 After Tax ROE Requires Underwriting Profit
Accident Year Combined Ratio Accident Year Combined Ratio Accident Year Combined Ratio Accident Year Combined Ratio Accident Year Combined Ratio Accident Year Combined Ratio Accident Year Combined Ratio Accident Year Combined Ratio Accident Year Combined Ratio Accident Year Combined Ratio
P S 90.0 92.5 95.0 97.5 100.0 102.5 105.0 107.5 110.0 112.5
100 13.0 11.5 10.1 8.6 7.1 5.6 4.1 2.6 1.1 -0.4
110 14.0 12.4 10.7 9.1 7.5 5.8 4.2 2..5 0.9 -0.7
120 15.0 13.2 11.4 9.6 7.8 6.1 4.3 2.5 0.7 -1.1
130 16.0 14.0 12.1 10.2 8.2 6.3 4.4 2..4 0.5 -1.5
140 16.9 14.9 12.8 10.7 8.6 6.5 4.4 2.4 0.3 -1.8
150 17.9 15.7 13.5 11.2 9.0 6.8 4.5 2.3 0.1 -2.2
160 18.9 16.5 14.1 11.8 9.4 7.0 4.6 2.2 -0.2 -2.5
170 19.9 17.3 14.8 12.3 9.8 7.2 4.7 2.2 -0.4 -2.9
180 20.9 18.2 15.5 12.8 10.1 7.5 4.8 2.1 -0.6 -3.3
190 21.8 19.0 16.2 13.3 10.5 7.7 4.9 2.0 -0.8 -3.6
200 22.8 19.8 16.9 13.9 10.9 7.9 4.9 2.0 -1.0 -4.0
225 25.3 21.9 18.6 15.2 11.9 8.5 5.2 1.8 -1.5 -4.9
250 27.7 24.0 20.3 16.5 12.8 9.1 5.4 1.7 -2.1 -5.8
Combined Ratio is 10-15 pts. too high
Source Dowling Partners Insurance Information
Institute
30
U.S. InsuredCatastrophe Losses
Billions
CAT losses continue to be a problem, though 2002
was much better than 2001
Estimate through May 2003. Note 2001 figure
includes 20.3B for 9/11 losses reported through
12/31/01. Includes only business and personal
property claims, business interruption and auto
claims. Source Property Claims Service/ISO
Insurance Information Institute
31
P/C Insurance Industry Prior Year Reserve
Development
Adverse reserve development of about 23 billion
accounted for most of the industrys 2002
underwriting loss and ate much of the
industrys 37 billion increase in earned premiums
Negative numbers indicate favorable development
positive figures represent adverse
development. Source A.M. Best, Morgan Stanley,
Dowling Partners Securities
32
Med Claim Costs Rising Sharply
Health care inflation is affecting the cost of
medical care, no matter what system it is
delivered through
Source NCCI William M. Mercer, Insurance
Information Institute.
33
Legend 4 Insurers Reckless Investment
Strategies are the Primary Reason Why Rates are
Rising Today
34
Net Investment Income
Investment income in 2002 fell 2.8 due
primarily to historically low interest rates
-4.8 Billion
Billions (US)

• History
• 1997 Peak 41.5B
• 40.7B
• 37.7B
• 36.7B

Source A.M. Best, Insurance Information
Institute
35
Interest Rates Lower Than Theyve Been in Decades

1. Historically low interest rates are the primary
   driver behind lower investment yields.
   Nevertheless, overall insurer investment
   performance outpaces all major market indices and
   almost every major category of mutual fund.
2. 66 of the industrys invested assets are in bonds

As of April 21, 2003. Source Board of
Governors, Federal Reserve System Insurance
Information Institute
36
Total Returns for Large Company Stocks 1970-2003
SP 500 up 13.2 so far this year

• 2002 was 3rd consecutive year of decline for
  stocks
• Will it be the last?

As of June 6, 2003. Source Ibbotson
Associates, Insurance Information Institute
37
P/C Industry Investments,by Type (as of Dec. 31,
2001)
Common stock accounts for about 1/5 of invested
assets
Bond Holdings, by Type Industrial Misc.
32.5 Special Revenue 30.5 Governments
18.0 States/Terr/Other
15.4 Public Utilities
3.1 Parents/Subs/Affiliates 0.5
Source A.M. Best, Insurance Information
Institute
38
Property/Casualty Insurance Industry Investment
Gain
Investment gains are simply returning to
pre-bubble levels
Investment gains consists primarily of interest,
stock dividends and realized capital gains and
losses. Source Insurance Services Office
Insurance Information Institute estimate
annualized as of 9/30/02.
39
Crisis in Corporate Governance Affecting Even
Blue Chip Portfolios

• Crisis has affected both equity and bond markets

40
Legend 5There is No Relationship Between
Litigiousness and Rising Insurance Costs(A
Trial Lawyer Favorite)
41
TORT-ure

• Asbestos
• Toxic Mold
• Medical Malpractice
• Construction Defects
• Lead
• Fast/Fattening Foods Obesity
• Dietary Supplements (e.g., Ephedra)
• Reality TV
• Arsenic Treated Lumber
• Guns
• Genetically Modified Foods (Corn)
• Pharmaceuticals Medical Devices
• Security exposures (workplace violence, post-9/11
  issues)
• Slavery
• Whats Next? SARS??

New
New
42
Average Jury Awards1994 vs. 2001
Figure is for 2000 (latest available) Source
Jury Verdict Research Insurance Information
Institute.
43
Trends in Million Dollar Verdicts
Very sharp jumps in multi-million dollar awards
in recent years across virtually all types of
defendants
Verdicts of 1 million or more. Source Jury
Verdict Research Insurance Information Institute.
44
Cost of U.S. Tort System( Billions)
Tort costs consumed 2.0 of GDP annually on
average since 1990, expected to rise to 2.4 of
GDP by 2005!
Per capita tort tax expected to rise to 1,000
by 2005, up from 721 in 2001 Even a modest
reduction in tort costs would be more stimulative
than the 674 billion Bush tax/spending plan
Source Tillinghast-Towers Perrin. 2005
forecasts from Tillinghast.
45
Personal, Commercial Self (Un) Insured Tort
Costs
Total 157.7 Billion
Total 120.2 Billion
Billions
Total 39.5 Billion
Excludes medical malpractice Source
Tillinghast-Towers Perrin
46
Who Will Pay for the US Asbestos Mess?
Estimated Total US Settlements Expenses 200
billion
78 billion
60 billion
62 billion
Source Tillinghast-Towers Perrin Insurance
Information Institute
47
Medical Malpractice Tort Cost Growth is
Skyrocketing

• Over the period from 1990 through 2000, medical
  malpractice tort costs rose 140, more than
  double the 60 increase in medical costs
  generally over the same period!
• Over the period from 1975 through 2000, medical
  malpractice tort costs skyrocketed by 1,642
  while medical costs generally rose 449, nearly 4
  times as fast!

Sources Tillinghast-Towers Perrin, US Bureau of
Labor Statistics, Insurance Information Institute
48
The Nations Judicial HellholesAn International
Embarrassment
Source American Tort Reform Association
Insurance Information Institute
49
Average Cost per 1 Million Liability
Coverage2001 vs. 2002
Excess litigiousness is raising the cost of
liability coverage for businesses of all sizes
Source Marsh, 2002 Limits of Liability Report
50
Average Total Limits Purchased by All Firms (
Millions)
Limits purchased fell by 9.9 between 2000 and
2002. Price/capacity are issues.
Includes underlying primary limits Source
Limits of Liability 2002, Marsh, Inc.
51
EXAMPLES Medical Malpractice AsbestosToxic
MoldObesitySARS
52
Medical Malpractice
53
Medical Crises across the US
Figure 1
AMA Crises reached in at least 18 states !
AK
AL
MT
VT
NY
WI
SD
WY
DC
OH
IN
NV
UT
CO
KY
MO
KS
CA
TN
SC
AR
NM
AL
GA
MS
Crisis states Crisis looming
FL
PR
Source American Medical Association, March 2003
54
Medical Malpractice Combined Ratio

• Trial lawyers have destroyed commercial viability
  of med mal. The future holds
• Increased mutualization
• Local market collapses
• HC Providers seeking govt. protection

Insurers in 2001 paid out an estimated 1.65 for
every 1 they earned in premiums!
Source AM Best, Conning, Insurance Information
Institute
55
Asbestos
56
Who Will Pay for the US Asbestos Mess?
Estimated Total US Settlements Expenses 200
billion
78 billion
60 billion
62 billion
Source Tillinghast-Towers Perrin Insurance
Information Institute
57
Toxic Mold
58
Litigiousness in US Society Compounded the
ProblemDocumented Toxic Mold Suits
1,000 Cases
5,000 Cases
2,000 Cases
2,000 Cases
Source www.toxlaw.com Guy Carpenter
59
TX Mold Claim Frequency( claims per 1,000
policyholders)
The frequency of mold claims rose 1,286 between
2000I and 2001IV
Source Texas Department of Insurance Insurance
Information Institute estimates.
60
Texas Mold Losses/Claims Are Finally Moderating
Data are for TDI Cause 61 Discharge Other
Damage. Not all claims in cause 61 are mold and
mold claims may also arise from other (non-water)
causes of loss.
Source Texas Department of Insurance Insurance
Information Institute
61
Sharply Rising Average Water Claim Cost in CA
Mold Symptom
The cost of the average water loss in CA surged
27 in 2001 and 80 since 1998
Source Insurance Information Institute based on
data from the Insurance Information Network of
California
62
Construction Defect Litigation Destroying CA
Condo Market
Ratio of Losses Paid Out to Premiums Taken In
Condo construction in parts of CA has come to a
virtual stop. Insurer costs rose 58 in just 2
years!
Right-to-Cure laws now in 5 states AZ, CA, NV,
TX, WA 16 considering such laws.
Source ISO, Insurance Information Institute
63
Where are the Next Battlefields for Mold?

• Homeowners issue probably crested in 2002
• Migration to commercial area affects many lines
• Commercial Property Commercial Liability
• Products Liability Builders Risk/Construction
  Defects
• Workers Comp(very little)
• Hot Spots
• Apartments/Condos/Co-ops Office Structures
• Schools Municipal Buildings
• Cars? (GM case in NC)
• Trend toward class actions since science doesnt
  support massive individual non-economic damages
• Much more lucrative for trial lawyers to form
  class

Source Insurance Information Institute.
64
Obesity
65
Fast Food/Junk ScienceEdible Asbestos?

• Are the food service manufacturing industrys
  vulnerable to suits over obesity?
• McDonalds sued in late 2002 over allegations
  that their food makes people fat
• Kraft sued earlier this year over trans fats in
  Oreo cookies

66
Fast Food Junk ScienceThe Case Against Pizza

• Premise Cheese makes you fat
• Why? Cheese is addictive!!
• Digestion breaks down milk protein called casein,
  into components called casomorphins which are
  opiates like morphine codeine, which are
  addictive
• Caseins are concentrated in cheeses
• Manipulation of cheese content in productsor
  sale of cheese itselfknowing its addictive
  qualitiesis theoretically a scientific basis
  to file suit on behalf of the pizza-addicted
  obese.
• ADAs Cheese Logo ?

67
SARSA Threat to the P/C Insurance Industry?
68
SARS Limited P/C Insurance Industry Exposure

• Are there any potential SARS-related p/c
  insurance exposures?
• Workers comp? Mostly health care workers
• Event cancellation? Fear of SARS insufficient,
  but legitimate claims possible
• CGL? Several courts have ruled that
  viruses/bacteria (e.g., E. Coli, Legionnaires
  disease) not covered
• EIL? Court decisions fact that at least half of
  EILs have naturally occurring substance
  exclusions preclude coverage.

69
Legend 6Insurers are Awash in Cash and Have
More Money than They Know What to Do With
70
Capital Raising by P/C Insurers Since September
11, 2001
Capital Raising by P/C Insurers Since 9/11 Totals
53.2B
27.9 Billion
25.4 Billion
14 Pending
38 Pending
40 Completed
33 Completed
As of September 13, 2002. Source Morgan
Stanley, Insurance Information Institute.
71
Policyholder Surplus 1975-2002

• Surplus (capacity) peaked at 336.3 Billion in
  mid-1999 and fell by 15.2 (51 billion) to
  285.2 billion since then.
• Surplus is now lower than at year-end 1997.

51 Billion
Billions
Surplus is a measure of underwriting capacity.
It is analogous to Owners Equity or Net Worth
in non-insurance organizations
Source A.M. Best, Insurance Information
Institute
72
Global P/C Insurance Capacity is Falling
Dramatically
Global non-life capacity is down 25 over the
past 2 years
Sources Insurance Information Institute, Swiss Re
73
Capital Myth P/C Insurers Have 300 Billion to
Pay Terrorism Claims
Total PHS 298.2 B as of 6/30/01 285.2 B
as of 12/31/02
Only 33 of industry surplus backs up target
lines
Target Commercial includes Comm property,
liability and workers comp Surplus must also
back-up on non-terrorist related
property/liability and WC claims Source
Insurance Information Institute
74
Legend 7 Insurers are Redlining Businesses
in the Wake of 9/11
75
Insurance Coverage in Lower Manhattan
Over 95 of businesses in Downtown were able to
continue coverage in the wake of 9/11
Source Downtown Alliance
76
WC Residual Market Shares

• The vast majority of employers are finding
  coverage in the private market
• Residual market share is growing but is less than
  1/6 of the share in 1993.

Source NCCI
77
Legend 8TRIA Has Solved the Industrys
Terrorism Exposure Problems
78
Sept. 11 Industry Loss Estimates( Billions)
Consensus Insured Losses Estimate 40.2B Source
Insurance Information Institute
79
Industry Losses Under Proposed Federal Backstop
Using 9/11 Scenario(as proposed/interpreted as
of 10/18/02)
Total Ind. Loss
14.25B
19.675B
10.875B
0.925B Industry Co-Share
1.75B Industry Co-Share
2.0B Industry Co-Share
0.125B Industry Co-Share
Assumes 30B Commercial Prop WC Loss, 125B At
Risk Commercial DPW
Source Insurance Information Institute.
80
Legend 9 Wall Street Investors Should be
Satisfied With Insurer Stock Performance
81
Insurer Stocks Underperforming the SP 500
Total Return 2003 YTD Through June 6, 2002
Source SNL Securities, Insurance Information
Institute
82
Insurance Mergers and Acquisitions
1998 565 deals valued at 165.4 B

• Number of MAs was down 39.4 during the first
  half of 2002 vs. first half 2001.
• Value of deals was down 80.8.
• None of the top deals were in the P/C sector

Source Compiled from Conning Company reports.
83
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