Property/Casualty Insurancein a Post-Katrina WorldAn Industry at the Crossroads Insurance Information Institute May 9, 2007 Robert P. Hartwig, Ph.D., CPCU, President & Chief Economist Insurance Information Institute 110 William Street New York, NY 10038 Tel: (212) 346-5520 Fax: (212) 732-1916 firstname.lastname@example.org www.iii.org
Presentation Outline • P/C Profit Overview—2006, A Cyclical Peak • Underwriting Trends: Unsustainable? • Premium Growth: Approaching a Standstill • Pricing: Competitive Pressures Mounting • Expenses: Will Ratios Rise a Growth Slows? • Capital & Capacity: UnderleveragedROE Pressure • Catastrophe Loss Management • What is the Appropriate Role for Government? • Reinsurance Summary • Financial Strength & Ratings • Investments: Less Bang for the Buck • Tort System: Great News for a Change (Mostly) • Legislative & Regulatory Update • Q&A
P/C PROFIT:An Historical PerspectiveProfits in 2006 ReachedTheir Cyclical Peak
P/C Net Income After Taxes1991-2006 ($ Millions)* Though up in 2006, insurer profits are highly volatile (2001 was the industry’s worst year ever). ROEs generally fall below that of most other industries. • 2001 ROE = -1.2% • 2002 ROE = 2.2% • 2003 ROE = 8.9% • 2004 ROE = 9.4% • 2005 ROE= 10.5% • 2006 ROAS1 = 14.0% *ROE figures are GAAP; 1Return on avg. Surplus. Sources: A.M. Best, ISO, Insurance Information Inst.
ROE: P/C vs. All Industries 1987–2008E P/C profitability is cyclical, volatile and vulnerable Sept. 11 Hugo Katrina, Rita, Wilma Lowest CAT losses in 15 years Andrew Northridge 4 Hurricanes *2007-08 P/C insurer ROEs are I.I.I. estimates. Source: Insurance Information Institute; Fortune
RETURN ON EQUITY (Fortune):Stock & Mutual vs. All Companies* Mutual insurer ROEs are typically lower than for stock companies, but gap has narrowed. All are cyclical. *Fortune 1,000 group. Source: Fortune Magazine, Insurance Information Institute.
Profitability Peaks & Troughs in the P/C Insurance Industry, 1975 – 2008F 1977:19.0% 1987:17.3% 2006:14.0% 10 Years 1997:11.6% 9 Years 10 Years 1975: 2.4% 1984: 1.8% 1992: 4.5% 2001: -1.2% *2007-08 P/C insurer ROEs are I.I.I. estimates. Source: Insurance Information Institute; ISO, A.M. Best.
ROE vs. Equity Cost of Capital:US P/C Insurance:1991-2007E The p/c insurance industry achieved its cost of capital in 2005/6 for the first time in many years +3.0 pts +2.0 pts -9.0 pts +1.0 pts +0.2 pts -13.2 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 Source: The Geneva Association, Ins. Information Inst.
ROE vs. Equity Cost of Capital:US P/C Insurance:1991-2006 The p/c insurance industry achieved its cost of capital in 2005/6 for the first time in many years +5.5 pts -9.0 pts +0.2 pts +1.0 pts -13.2 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 2003-06 The cost of capital is the rate of return insurers need to attract and retain capital to the business Source: The Geneva Association, Ins. Information Inst.
Insurance & Reinsurance Stocks:Strong Finish in 2006 Total Returns for 2006 P/C insurer & reinsurer stocks rallied in late 2006 as hurricane fears dissipated and insurers turned in strong results Broker stocks held back by weak earnings Source: SNL Securities, Standard & Poor’s, Insurance Information Institute
Insurance & Reinsurance Stocks: Slow Start in 2007 in P/C, Reins Total YTD Returns Through May 4, 2007 P/C insurance, reinsurance stocks lagging on soft market concerns and worries over 2007 hurricane season Source: SNL Securities, Standard & Poor’s, Insurance Information Institute
Top 10 Most Profitable P/C InsurersRanked by 2006 ROE *Not a stock company, but reported results under GAAP. Source: Fortune, April 30, 2007 edition; Insurance Information Institute
Top Industries by ROE: P/C Insurers Still Underperformed in 2006* P/C insurer profitability in 2006 ranked 30th out of 50 industry groups despite renewed profitability P/C insurers underperformed the All Industry median for the 19th consecutive year *Excludes #1 ranked Airline category at 65.1% due to special one-time bankruptcy-related factors. Source: Fortune, April 30, 2007 edition; Insurance Information Institute
Advertising Expenditures by P/C Insurance Industry, 1999-2005 Ad spending by P/C insurers is at a record high, signaling increased competition Source: Insurance Information Institute from consolidated P/C Annual Statement data.
P/C Industry Combined Ratio 2007/8 deterioration due primarily to falling rates, but results still strong assuming normal CAT activity As recently as 2001, insurers were paying out nearly $1.16 for every dollar they earned in premiums 2006 produced the best underwriting result since the 91.2 combined ratio in 1949 2005 figure benefited from heavy use of reinsurance which lowered net losses Sources: A.M. Best; ISO, III. *Estimates/forecasts based on III’s 2007 Early Bird survey.
Ten Lowest P/C Insurance Combined Ratios Since 1920 The industry’s best underwriting years are associated with periods of low interest rates The 2006 combined ratio of 92.4 was the best since the 87.6 combined in 1949 Sources: Insurance Information Institute research from A.M. Best data.
Underwriting Gain (Loss)1975-2006 Insurers earned an underwriting profit of $31.2 billion in 2006, the largest ever but only the second since 1978. Despite the 2006 underwriting profit, the cumulative underwriting deficit since 1975 is $419 billion. $ Billions Source: A.M. Best, Insurance Information Institute
Commercial Lines Combined Ratio, 1993-2006E* Commercial coverages have exhibited extreme variability. Are current results anomalous? Outside CAT-affected lines, commercial insurance is doing fairly well. Caution is required in underwriting long-tail commercial lines. 2006 results will benefited from relatively disciplined underwriting and low CAT losses Source: A.M. Best; Insurance Information Institute .
Personal LinesCombined Ratio, 1993-2006E A very strong 2006 resulted from favorable frequency & severity trends and low CAT activity Source: A.M. Best; Insurance Information Institute.
Impact of Reserve Changes on Combined Ratio Reserve adequacy has improved substantially Source: A.M. Best, Lehman Brothers for years 2005E-2007F
The Big Question: Is the Industry More Disciplined Today? • Signs suggest that the answer is yes • Current period of sustained underwriting profitability is the first since the 1950s • While prices are falling, underlying lost cost trends (frequency and severity trends) are generally favorable to benign • Suggest impact of falling prices will be less pronounced than late 1990s • Reserve situation appears much improved an under control • Management Information Systems: Much More Sophisticated • Insurers can monitor and make adjustments much more quickly • Adjustments made quickly by line, geographic area, producer, etc. • Investment Income • Relative to late 1990s, interest rates and stock markets returns are lower • Has effect of imposing (some) discipline • Ratings Agencies • More stringent capital requirements • Quicker to downgrade
Strength of Recent Hard Markets by NWP Growth* 1975-78 1984-87 2001-04 2006-2010 (post-Katrina) period could resemble 1993-97 (post-Andrew) 2005: biggest real drop in premium since early 1980s *2007-10 figures are III forecasts/estimates. 2005 growth of 0.4% equates to 1.8% after adjustment for a special one-time transaction between one company and its foreign parent. 2006-2008 figures from III Groundhog Survey. Note: Shaded areas denote hard market periods. Source: A.M. Best, Insurance Information Institute
Growth in Net Written Premium, 2000-2008F P/C insurers will experience their slowest growth rates since the late 1990s…but underwriting results are expected to remain healthy Source: A.M. Best; Forecasts from the Insurance Information Institute’s Groundhog survey: http://www.iii.org/media/industry/financials/groundhog2007/.
*Insurance Information Institute Estimates/Forecasts Source: NAIC, Insurance Information Institute Average Expenditures on Auto Insurance Countrywide auto insurance expenditures are expected to fall 0.5% in 2007, the first drop since 1999 Lower underlying frequency and modest severity are keeping auto insurance costs in check
*Insurance Information Institute Estimates/Forecasts **Excludes cost of flood and earthquake coverage. Source: NAIC, Insurance Information Institute Average Expenditures on Homeowners Insurance** Countrywide home insurance expenditures rose an estimated 6% in 2006 Homeowners in non-CAT zones will see smaller increases, but larger in CAT zones
Average Commercial Rate Change,All Lines, (1Q:2004 – 1Q:2007) Magnitude of rate decreases diminished greatly after Katrina but have grown again KRW Effect Source: Council of Insurance Agents & Brokers; Insurance Information Institute
Personal vs. Commercial Lines Underwriting Expense Ratio* Expenses ratios will likely rise as premium growth slows *Ratio of expenses incurred to net premiums written. Source: A.M. Best; Insurance Information Institute
Underwriting Expense Ratio, P/C Insurance, 1930-2005 The cost of selling p/c insurance has barely moved in 35 years…Why? TRANSFORMATIONAL CHANGE: Taking down the cost of selling insurance to 20% or premium or less by 2017 Source: A.M. Best; Insurance Information Institute.
U.S. Policyholder Surplus: 1975-2006 Capacity as of 12/31/06 was $487.1B (est.), 14.4% above year-end 2005, 71% above its 2002 trough and 46% above its 1999 peak. $ Billions Foreign reinsurance and residual market mechanisms absorbed 45% of 2005 CAT losses of $62.1B “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.
Capital Raising by Class Within 15 Months of KRW $ Billions Insurers & Reinsurers raised $33.7 billion in the wake of Katrina, Rita, Wilma Source: Lane Financial Trade Notes, January 31, 2007.
Annual Catastrophe Bond Transactions Volume, 1997-2006 Catastrophe bond issuance has soared in the wake of Hurricanes Katrina and the hurricane seasons of 2004/2005 Source: MMC Securities and Guy Carpenter; Insurance Information Institute.
MERGER & ACQUISITIONMore Catalysts for Major P/C Consolidation?
P/C Insurance-Related M&A Activity, 1988-2006 2006 surge due mostly to 2 deals. No trend started. Liberty Mutual acquired Ohio Casualty for $2.7B* No model for successful consolidation has emerged *Announced May 7, 2007. Source: Conning Research & Consulting.
Life Insurance-Related M&A Activity, 1988-2006 Source: Conning Research & Consulting.
Distribution Sector: Insurance-Related M&A Activity, 1988-2006 No extraordinary trends evident Source: Conning Research & Consulting.
Distribution Sector M&A Activity, 2005 vs. 2006 2005 2006 Number of bank acquisitions is falling years Source: Conning Research & Consulting
Motivating Factors for Increased P/C Insurer Consolidation in 2007 • Motivating Factors for P/C M&As • Slow Growth: Growth is at its lowest levels since the late 1990s • NWP growth is forecast at 1.8% in 2007 and 1.9% in 2008 • Prices are falling or flat in most non-coastal markets • Accumulation of Capital: Excess capital depresses ROEs • Policyholder Surplus up 14.4% in 2006 and up 71% since 2002 • Insurers hard pressed to maintain earnings momentum • Options: Share Buybacks, Boost Dividends, Invest in Operation, Acquire • Option B: Engage in destructive price war and destroy capital • Reserve Adequacy: No longer a drag on earnings • Favorable development in recent years offsets pre-2002 adverse develop. • Favorable Fundamentals/Drop-Off in CAT Activity • Underlying claims inflation (frequency and severity trends) are benign • Lower CAT activity took some pressure of capital base Source: Insurance Information Institute.
Limiting Factors for Increased P/C Insurer Consolidation in 2007 • Limiting Factors for P/C M&As • Ownership Structure • Mutuals are generally not targets (but can be buyers: Liberty & OCAS) • P/C demutualizations are very difficult • Inside Ownership: e.g., family involvement or entrenched management could make deal unwieldy, complex • Size • Larger Insurer = Fewer Buyers • Price • More Expensive Share Price = Fewer Buyers, all else equal (but rising share price for acquiring company can serve as currency for acquisitions) • Growth Opportunities • Better Growth Opportunities = Less Likely Management Will Sell • Culture • Unique/distinct culture makes sale less likely • Fear • Many M&As in the 1990s went badly Source: Insurance Information Institute; Lehman Borthers.
Property/Casualty Insurance Industry Investment Gain* Investment gains fell in 2006 and are now only comparable to gains seen in the late 1990s *Investment 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. Source: ISO; Insurance Information Institute.
U.S. Insured Catastrophe Losses* $ Billions $100 Billion CAT year is coming soon 2006 was a welcome respite. 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. 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 = $12.2B. Source: Property Claims Service/ISO; Insurance Information Institute
U.S. Catastrophe Losses 2006: States With Largest Losses ($ Millions) Some 33 catastrophe events* in 34 states cost insurers an estimated $8.8bn in 2006, compared with $61.9bn in 2005. Cat losses in the following five states -- totaling $4.5bn -- represent half the total catastrophe losses for the year. SURPRISE!! Indiana led the US with $1.5 billion in insured CAT losses in 2006 *ISO defines a catastrophe event as an event causing $25 million or more in insured property losses. Source: ISO; Insurance Information Institute
Number of Tornadoes,1985 – 2006p There are usually more than 1,000 confirmed tornadoes each year in the US. They accounted for about 25% of catastrophe losses since 1985 Source: US Dept. of Commerce, Storm Prediction Center, National Weather Service; Ins. Info. Inst.
Insured Losses from Top 10 Earthquakes Adjusted to 2005 Exposure Levels (Billions of 2005 Dollars) With development along major fault lines, the threat of $25B+ quakes looms large 3 of the Top 10 are not West Coast events Source: AIR Worldwide