Financial Crisis and the Future of the P/C Insurance Industry Challenges Amid theGlobal Economic Storm Northwest Insurance Council 2009 Annual Luncheon Seattle, WA January 27, 2009 Robert P. Hartwig, Ph.D., CPCU, President Insurance Information Institute 110 William Street New York, NY 10038 Tel: (212) 346-5520 firstname.lastname@example.org www.iii.org
THE ECONOMIC STORMWhat a Weakening Economy and Financial Crisis Mean for the Insurance IndustryExposure & Claim Cost Effects
Real GDP Growth* Recession began in December 2007. Economic toll of credit crunch, housing slump, labor market contraction is growing *Yellow bars are Estimates/Forecasts from Blue Chip Economic Indicators. Source: US Department of Commerce, Blue Economic Indicators 1/09; Insurance Information Institute.
Real GDP By Market 2007-2010F(% change from previous year) All major economies except China are in recession. Steep declines in GDP will negatively impact exposure growth on a global scale Source: Blue Chip Economic Indicators, 1/10/09 edition.
Announced Economic Stimulus Packages Worldwide ($ Billions)* U.S. stimulus comprises: $550 billion spending and $275 billion tax relief 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 Dec. 18 except U.S. and Germany Sources: Wall Street Journal, January 8, 2009; Institute of International Finance.
Length of US Recessions,1929-Present* Months in Duration Current recession began in Dec. 2007 and is already the longest since 1981. If it extends beyond April, it will become the longest recession since the Great Depression. * As of January 2009 Sources: National Bureau of Economic Research; Insurance Information Institute.
Unemployment Rate:On the Rise January 2000 through December 2008 Dec. 2008 unemployment jumped to 7.2%, exceeding the 6.3% peak during the previous cycle Previous Peak: 6.3% in June 2003 Trough: 4.4% in March 2007 Unemployment will likely peak above 8% or 9% during this cycle, impacting payroll sensitive p/c and non-life exposures Average unemployment rate 2000-07 was 5.0% Dec-08 Source: US Bureau of Labor Statistics; Insurance Information Institute.
U.S. Unemployment Rate,(2007:Q1 to 2010:Q4F)* Rising unemployment will erode payrolls and workers comp’s exposure base. Unemployment is expected to peak above 8% in the second half of 2009. * Blue bars are actual; Yellow bars are forecasts Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (1/09); Insurance Info. Inst.
Monthly Change Employment*(Thousands) Job losses in 2008 totaled 2.589 million, the highest since 1945 at WW II’s end; 11.1 million people are now defined as unemployed. The Nov./Dec. 2008 losses were the largest since May 1980 loss of 431,000, but less than the Dec. 1974 loss of 602,000 Source: US Bureau of Labor Statistics: http://www.bls.gov/ces/home.htm; Insurance Info. Institute
New Private Housing Starts,1990-2010F (Millions of Units) Exposure growth forecast for HO insurers is dim for 2009 with some improvement in 2010. Impacts also for comml. insurers with construction risk exposure New home starts plunged 34% from 2005-2007; Drop through 2009 trough is 65% (est.)—a net annual decline of 1.35 million units I.I.I. estimates that each incremental 100,000 decline in housing starts costs home insurers $87.5 million in new exposure (gross premium). The net exposure loss in 2009 vs. 2005 is estimated at about $1.2 billion. Source: US Department of Commerce; Blue Chip Economic Indicators (1/09); Insurance Information Inst.
Auto/Light Truck Sales,1999-2010F (Millions of Units) Weakening economy, credit crunch are hurting auto sales; Gas prices less of a factor now. New auto/light trick sales are expected to experience a net drop of 5.7 million units annually by 2009 compared with 2005, a decline of 20.7% 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 (1/09); Insurance Information Inst.
Wage & Salary Disbursements (Payroll Base) vs. Workers Comp Net Written Premiums Wage & Salary Disbursement (Private Employment) vs. WC NWP $ Billions $ Billions 12/07-? 7/90-3/91 3/01-11/01 Weakening wage and salary growth is expected to cause a deceleration in workers comp exposure growth Shaded areas indicate recessions *9-month data for 2008 Source: US Bureau of Economic Analysis; Federal Reserve Bank of St. Louis at http://research.stlouisfed.org/fred2/series/WASCUR; I.I.I. Fact Books
Total Industrial Production,(2007:Q1 to 2010:Q4F) Obama stimulus program is expected benefit impact industrial production and therefore insurance exposure both directly and indirectly Industrial production began to contract sharply during H2 2008 and is expected to shrink through the first half of 2009 Figures for H2:09 and 2010 revised sharply upwards to reflect expected impact of Obama stimulus program Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (1/09); Insurance Info. Inst.
U.S. $825B Economic Stimulus Package, By Category $ Billions Commercial insurance lines that will benefit from the Obama stimulus plan include workers comp, commercial property, commercial auto, surety, inland marine and others Sources: House Appropriations Committee; Wall Street Journal, January 16, 2009
Real GDP Growth vs. Real P/C Premium Growth: Modest Association P/C insurance industry’s growth is influenced modestly by growth in the overall economy Sources: A.M. Best, US Bureau of Economic Analysis, Blue Chip Economic Indicators, 8/08; Insurance Information Inst.
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
Summary of A.M. Best’s P/C Insurer Ratings Actions in 2008* P/C insurance is by design a resilient in business. The dual threat of financial disasters and catastrophic losses are anticipated in the industry’s risk management strategy. 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.
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;
CONSUMER POLL:2008 I.I.I. PULSE SURVEY Q. DO YOU THINK THAT THESE PROBLEMS (THE MORTGAGE PROBLEMS SOME AMERICANS FACE, THE DROP IN THE STOCK MARKET AND JOB LAYOFFS) AFFECT THE ABILITY OF INSURANCE COMPANIES TO PAY THEIR CLAIMS, TO SELL MORE INSURANCE, BOTH, NONE OF THESE (DOESN’T AFFECT ABILITY TO PAY CLAIMS OR SELL INSURANCE) OR DON’T KNOW? 95% Americans think that the downturn in the economy affects the basic business of the insurance industry: the ability to pay claims and/or sell insurance Source: Insurance Information Institute, 2008 Pulse Survey, November 2008.
Critical Differences Between P/C Insurers and BanksSuperior Risk Management Model & Low Leverage Makea Big Difference
How Insurance Industry Stability Has Benefitted Consumers • BOTTOM LINE: • Insurance Markets—Unlike Banking—Are Operating Normally • The Basic Function of Insurance—the Orderly Transfer of Risk from Client to Insurer—Continues Uninterrupted • This Means that Insurers Continue to: • Pay claims (whereas 25 banks have gone under) • The Promise is Being Fulfilled • Renew existing policies (banks are reducing and eliminating lines of credit) • Write new policies (banks are turning away people who want or need to borrow) • Develop new products (banks are scaling back the products they offer) Source: Insurance Information Institute
Reasons Why P/C Insurers Have Fewer Problems Than Banks: A Superior Risk Management Model • Emphasis on Underwriting • Matching of risk to price (via experience and modeling) • Limiting of potential loss exposure • Some banks sought to maximize volume and fees and disregarded risk • Strong Relationship Between Underwriting and Risk Bearing • Insurers always maintain a stake in the business they underwrite, keeping “skin in the game” at all times • Banks and investment banks package up and securitize, severing the link between risk underwriting and risk bearing, with (predictably) disastrous consequences—straightforward moral hazard problem from Econ 101 • Low Leverage • Insurers do not rely on borrowed money to underwrite insurance or pay claimsThere is no credit or liquidity crisis in the insurance industry • Conservative Investment Philosophy • High quality portfolio that is relatively less volatile and more liquid • Comprehensive Regulation of Insurance Operations • The business of insurance remained comprehensively regulated whereas a separate banking system had evolved largely outside the auspices and understanding of regulators (e.g., hedge funds, private equity, complex securitized instruments, credit derivatives—CDS’s) • Greater Transparency • Insurance companies are an open book to regulators and the public Source: Insurance Information Institute
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 (bank+insurer) 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.
US Bank Failures:* 1995-2009** Through January 23, 2009 Bank failures are up sharply. 27 banks (but no p/c or life insurers) failed in 2008/09 due to the financial crisis, including the largest in history—Washington Mutual with $307B in assets. Remarkably, as recently as 2005 and 2006, no banks failed—the first time this had happened in FDIC history (dating back to 1934) *Includes all commercial banking and savings institutions. **Through Jan. 23. Source: FDIC: http://www.fdic.gov/bank/historical/bank/index.html; Insurance Info. Institute
Top 10 P/C Insolvencies, Based Upon Guaranty Fund Payments* $ Millions The 2001 bankruptcy of Reliance Insurance was the largest ever among p/c insurers * Disclaimer: This is not a complete picture. If anything the numbers are understated as some states have not reported in certain years. Source: National Conference of Insurance Guaranty Funds, as of September 17, 2008.
Top 5 Threats Facing P/C Insurers in 2009 • Ability to Reload Capital • Continued asset price erosion coupled with major “capital event” could lead to significant shortage of capital • P/C have come to assume that large amounts of capital can be raised quickly and cheaply after major events (post-9/11, Katrina). This assumption is probably incorrect in the current environment. • Cost of capital is much higher today • Implications: P/C insurers need to protect capital today and develop detailed contingency plans to raise fresh capital & generate internally • Long-Term Loss of Investment Return • Low interest rates, risk aversion toward equities and many categories of fixed income securities lock in a multi-year trajectory toward ever lower investment gains • Insurers have not adjusted to this new investment paradigm • Regulators will not readily accept it; Many will reject it • Implication 1: Industry must be prepared to operate in environment with investment earnings accounting for only small fraction of profits • Implication 2: Implies underwriting discipline of a magnitude not witnessed in this industry in more than 30 years • Lessons from the period 1920-1975 Source: Insurance Information Inst.
Top 5 Threats Facing P/C Insurers in 2009 • 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 • Disintermediation • Alternative forms of risk transfer are taking an ever-larger share of the (commercial) p/c insurance pie • Soft market did not bring it back; Hard market could hasten trend • Trend toward state-sponsored insurance and reinsurance drains premium out of private insurance markets Source: Insurance Information Inst.
AFTERSHOCK: Regulatory Response Could Be HarshAll Financial Segments Including InsurersWill Be Impacted
Post-Crunch: Fundamental Issues To Be Examined Globally • Failure of Risk Management, Control & Supervision at Financial Institutions Worldwide: Global Impact • Colossal failure of risk management (and regulation) • Counterparty risk and collateral management were systemic failure points • Implications for Enterprise Risk Management (ERM)? • Misalignment of management financial incentives • Focus Will Be on Risk Controls: Implies More Stringent Capital & Liquidity Requirements; Prevention of Systemic Risks • Data reporting requirements also likely to be expanded • Non-Depository Financial Institutions in for major regulation • Changes likely under US and European regulatory regimes • Will new regulations be globally consistent? • Can overreactions be avoided? • Accounting Rule Changes?? • Problems arose under FAS, IAS • Asset Valuation, including Mark-to-Market • Structured Finance & Complex Derivatives • Ratings on Financial Instruments • New approaches to reflect type of asset, nature of risk Source: Ins. Info. Inst.
Possible Regulatory Scenarios for P/C Insurers as of Year-End 2009 • Status Quo: P/C Insurers Remain Entirely Under Regulatory Supervision of the States • 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.
P/C INSURANCE FINANCIAL PERFORMANCEA Resilient Industry in Challenging Times
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 peaked in 2006. *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.
P/C Insurance Industry ROEs,1975 – 2010F* 1977:19.0% 1987:17.3% 2006:12.2% 1997:11.6% 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.
ROE vs. Equity Cost of Capital:US P/C Insurance:1991-2008:Q3 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.
Presidential Politics & P/C InsuranceHow is Profitability Affected by the President’s Political Party?
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
Profitability in Washington State Mixed Performance Relative to US Overall
Rates of Return on Net Worth for All Lines: US vs. WA, 1998–2007* Washington State has historically been somewhat more profitable than the US overall, due in part to lower cat losses Source: NAIC. *Latest available.
Rates of Return on Net Worth for PPA: US vs. WA, 1998–2007* Washington State’s auto insurance ROE has been mixed relative to the US overall Source: NAIC. *Latest available.
Rates of Return on Net Worth for HO: US vs. WA, 1998–2007* Until recently, Washington State’s homeowners insurance ROE had been above that of the US overall Source: NAIC. *Latest available.
Rates of Return on Net Worth for Comm. M-P: US vs. WA, 1998–2007* Washington State’s commercial multiperil ROE has been mixed relative to the US overall Source: NAIC. *Latest available.
Investment Performance Investments are the Principle Source of Declining Profitability
Distribution of P/C Insurance Industry’s 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;.
Property/Casualty Insurance Industry Investment Gain:1994- 2008:Q3 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.
P/C Insurer Net Realized Capital Gains, 1990-2008:Q3 $ 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.
Underwriting TrendsFinancial Crisis Does Not Directly Impact Underwriting Performance: Cycle, Catastrophes Were 2008’s Drivers