Insurance Markets in a Turbulent Economy Trends & Challenges Robert P. Hartwig, Ph.D., CPCU, President Insurance Information Institute ♦ 110 William Street ♦ New York, NY 10038 Tel: (212) 346-5520 ♦ Fax: (212) 732-1916 ♦ [email protected]♦ www.iii.org Association of Insurance Financial Analysts 33 rd Annual Conference Naples, FL March 4, 2008
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Insurance Markets in a Turbulent Economy · 2014. 5. 8. · Insurance Markets in a Turbulent Economy Trends & Challenges Robert P. Hartwig, Ph.D., CPCU, President Insurance Information
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Insurance Markets in a Turbulent Economy
Trends & Challenges
Robert P. Hartwig, Ph.D., CPCU, PresidentInsurance Information Institute ♦ 110 William Street ♦ New York, NY 10038
Fundamental Factors Affecting US Economy in 2008• Puncture of Two Bubbles: Credit and Housing• Credit Crunch: Credit is the lifeblood of the US economy, but
some markets have effectively seized (at least to some degree)Problem originated with interest rates being left too low for too long in the early 2000sSubprime mortgage market first part of credit bubble to burst; Spread via securitization and amplified via leverage and concentration of riskAs lenders tighten standards, credit issues have spread to primeborrowers, commercial mortgages, munis, credit cards, student loans
• General Economic Impacts: Burst Bubble Asset DeflationHome price bubble is bursting: Loss of value in most valuable asset impacts wealth via loss of home equity Negative “wealth effect” implies consumers (2/3 of spending) become more cautiousBusiness scale back as prospects diminish in classic economic slowdownJob growth stagnating (-17,000 in Jan. 2008, first decline since Aug. 2003)
Source: Insurance Information Institute.
3.7%
0.8%
1.6%
2.5%
3.6%
3.1%
2.9%
0.6%
3.8%
4.9%
0.5%
2.3% 2.
5% 2.7% 2.8% 2.9%
2.9%
0.6%
1.1%
0%
1%
2%
3%
4%
5%
6%
20
00
20
01
20
02
20
03
20
04
20
05
20
06
07:1
Q
07:2
Q
07:3
Q
07:4
Q
08:1
Q
08:2
Q
08:3
Q
08:4
Q
09:1
Q
09:2
Q
09:3
Q
09:4
Q
Real GDP Growth*
*Yellow bars are Estimates/Forecasts.Source: US Department of Commerce, Blue Economic Indicators 2/08; Insurance Information Institute.
Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (2/08); Insurance Info. Inst.
Rising unemployment rate negative impacts workers comp exposure and could signal a temporary claim
frequency surge
Toward a New WorldEconomic Order
Source: Insurance Information Institute
1. Credit Crunch (incl. Subprime) Issue Will Ultimately Cost Hundreds of Billions Globally
• Problem exacerbated by leveraged bets taken by some financial institutions therefore its reach extends beyond simple defaults
2. Heavy Toll on Capital Base of Some Large Financial Institutions Worldwide; US Bond Insurers
• Cash infusions necessary; Sovereign Wealth Funds important source3. Most Significant Economic Event in a Generation
• US economy will recover, but will take 18-24 months 4. Shuffling of Global Economic Deck; Economic
Pecking Order Shifting• China, oil producing countries hold the upper hand
5. IOUs are Being Redeemed• Stakes in hard assets/institutions demanded
6. Good News: No Shortage of Available Capital• Central banks are (generally) making right decisions; Dollar sinks
What’s Being Done to Fix the Economy? Impacts on Insurers
•Nothing solid proposed but in the wake of subprimecrisis and credit crunch, actions seem inevitable•Will actions be directed primarily toward banks or broadly affecting all financial institutions
Regulatory/ Legislative Action (?)
•Keeps more people in their homes and hopefully paying HO insurance premiums•Abandoned and neglected homes have demonstrably worse loss performance
Housing Bailout (?)
•Hope is that $168B plan boosts overall economic activity and employment (by 500,000 jobs) and therefore p/c personal and commercial exposures•Contributes to already exploding budget deficits—Washington may expand its search for people and industries to tax
Stimulus Package
•Reduces bond yields (65% - 80% of portfolio)•Potentially contributes to inflation longer run
Fed Rate Cuts
Impacts on InsurersEconomic Fix
Post-Crunch: Fundamental Issues To Be Examined Globally
Source: Insurance Information Institute
• Adequacy of Risk Management, Control & Supervision at Financial Institutions Worldwide
Implications for ERM?Includes review of incentives
• Effectiveness and Nature of RegulationWhat sort of oversite is optimal given recent experience?Credit problems arose under US and European (Basel) regulatory regimesWill new regulations be globally consistent? Can overreactions be avoided?Capital adequacy & liquidity
• Accounting RulesProblems arose under FAS, IASAsset Valuation, including Mark-to-MarketStructured Finance & Complex Derivatives
• Ratings on Financial InstrumentsNew approaches to reflect type of asset, nature of risk
Insurance &The Economy
Important but Somewhat Muted Impacts
A Few Facts About the Relationship Between Insurance & Economy
• Vast Majority of Insurance Business is Tied to RenewalsApproximately 98+% of P/C business (units) is linked to renewalsA very large share of p/c insurance premiums are statutorily or de facto compulsory (e.g., WC, auto liability, surety, usually HO…)P/C insurers have marginal exposure impact due to economyMost life revenues and units are renewals, but some products (e.g., variable annuities are sensitive to market volatility)Life insurers who manage 401(k) assets seeing more loans and hardship withdrawals;
• Insurers are Sensitive to Interest RatesAbout 2/3 of P/C invested assets and 75% if Life assets are fixed incomeHistorically, yield on industry portfolios has tracked 10-year note closelyAll else equal, lower total investment gain implies greater emphasis on underwritingHistorically, industry’s best underwriting performances are rooted in periods when interests rates were low and/or equity market performance poor (1930s – 1950s, early 2000s gave rise to strong 2006/07)
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, 2/08; Insurance Information Inst.
Summary of Economic Risks and Implications for Insurers
•Reduced commercial lines exposure growth•Surety slump•Increased workers comp frequency
General Economic Slowdown/Recession
•Decreased capital gains (which are usually relied upon more heavily as a source of earnings as underwriting results deteriorate)
Stock Market Slump
•Lower investment income Lower Interest Rates
•Reduced exposure growth•Deteriorating loss performance on neglected, abandoned and foreclosed properties
Housing Slump
•Some insurers have some asset risk•D&O/E&O exposure for some insurers•Client asset management liability for some•Bond insurer problems; Muni credit quality
Credit Crunch/ Subprime Meltdown
Risks to InsurersEconomic Concern
New Private Housing Starts,1990-2013F (Millions of Units)
*Nonresidential fixed investment consists of structures, equipment and software.Sources: US Bureau of Economic Analysis (Historical), Value Line (2/22/08) estimates/forecasts for 2008-2012.
Non
resi
dent
ial F
ixed
Inve
stm
ent (
$ B
ill)
Total Industrial Production,(2007:Q1 to 2009:Q4F)
1.1%
3.5% 3.6%
-1.0%
0.2%0.7%
1.8%2.4%
2.7% 2.7% 2.6% 2.6%
-2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
07:Q1 07:Q2 07:Q3 07:Q4 08:Q1 08:Q2 08:Q3 08:Q4 09:Q1 09:Q2 09:Q3 09:Q4Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (2/08); Insurance Info. Inst.
Industrial production shrank during the final quarter of 2007 and is expected to grow only very slowly
during the first half of 2008
Industrial production affects exposure both directly and indirectly
Employment Change by Industry
(27,000)(28,000)
11,000
(11,000)
47,000
19,000
(18,000)(40,000)(30,000)(20,000)(10,000)
010,00020,00030,00040,00050,00060,000
Construction Manuf. Retail Trade Professional& Biz
Services
Education &Health
Leisure &Hospitality
Government
Sources: US Bureau of Labor Statistics; Insurance Information Institute.
Employment fell by 17,000 in January, the first decline since Aug. 2003.
Manufacturing and Construction are always the hardest hit in an economic slowdown, with each losing more than 150,000 jobs over the past 12 months.
*As of 7/1/07 (latest available).Source: US Bureau of Economic Analysis; Federal Reserve Bank of St. Louis at http://research.stlouisfed.org/fred2/series/WASCUR; I.I.I. Fact Books
Wage & Salary Disbursements (Payroll Base) vs. Workers Comp
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08* 08F 09F*12-month change Jan. 2008 vs. Jan. 2007; CPI rose at 6.8% pace NSource: US Bureau of Labor Statistics; Blue Chip Economic Indicators, Feb. 10, 2008; Ins. Info. Institute.
Inflation is Accelerating
Inflation often amplified in casualty lines (e.g, WC)Rising inflation can also lead to rate inadequacyAdverse reserve development
Favored Industry Groups for Insurer Exposure Growth
•Solar, Wind, Bio-Fuels, Hydro & OtherAlternative Energy
•Strong global demand, •Supplies remain tight…but beware of bubbles•Significant investments in R&D, plant & equip required
Natural Resources & Commodities
•Weak dollar, globalization persist; Cuba angle?Export Driven
•Consumer Staple Recession Resistant•Grain and land prices high due to global demand, weak dollar (exports)•Ethanol/Bio-Fuel Source•Acreage Growing Farm Equipment, Transport•Benefits many other industries
*Securities fraud suits filed in U.S. federal courts; 2008 figure is current through February 29.Source: Stanford University School of Law (securities.stanford.edu); Insurance Information Institute
Median Investor Losses Median Rate of Settlement to Investor Losses (%)
Source: NERA Economic Consulting, Recent Trends in Shareholder Class Actions, Dec. 2007. *Refers to settlement year.
As losses rise, ratio of settlement
to loss has been falling.
Shareholders recovered 2.4% of losses in 2007
PROFITABILITY & PERFORMANCE
Profits in 2006/07 ReachedTheir Cyclical Peak
P/C Net Income After Taxes1991-2008F ($ Millions)*$1
4,17
8
$5,8
40
$19,
316
$10,
870
$20,
598
$24,
404 $3
6,81
9
$30,
773
$21,
865
$3,0
46
$30,
029
$59,
200
$46,
300
-$6,970
$63,
695
$44,
155
$20,
559
$38,
501
-$10,000
$0
$10,000
$20,000
$30,000
$40,000
$50,000
$60,000
$70,000
91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06
07E
08F
*ROE figures are GAAP; 1Return on avg. surplus. **Return on Average Surplus; Actual 9-month 2007 result.Sources: A.M. Best, ISO, Insurance Information Inst.
Profitability Peaks & Troughs in the P/C Insurance Industry,1975 – 2008F*
1975: 2.4%
1977:19.0% 1987:17.3%
1997:11.6%
2006:12.2%
1984: 1.8% 1992: 4.5% 2001: -1.2%
10 Years
10 Years 9 Years
*GAAP ROE for all years except 2007 which is actual 9-month ROAS of 13.1%. 2008 P/C insurer ROE is I.I.I. estimate.Source: Insurance Information Institute; Fortune
*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
$ Billions
2006/07 were welcome respites. 2005 was by far the worst year ever for insured catastrophe losses in the US, but the worst has yet to come.
$100 Billion CAT year is coming soon
Inflation-Adjusted U.S. Insured Catastrophe Losses By Cause of Loss,
1987-2006¹Fire, $6.6 , 2.2%
Tornadoes, $77.3 , 26.0%
All Tropical Cyclones, $137.7 ,
46.3%
Civil Disorders, $1.1 , 0.4%
Utility Disruption, $0.2 , 0.1%
Water Damage, $0.4 , 0.1%Wind/Hail/Flood,
$9.3 , 3.1%
Earthquakes, $19.1 , 6.4%
Winter Storms, $23.1 , 7.8%
Terrorism, $22.3 , 7.5%
Source: Insurance Services Office (ISO)..
1 Catastrophes are all events causing direct insured losses to property of $25 million or more in 2006 dollars. Catastrophe threshold changed from $5 million to $25 million beginning in 1997. Adjusted for inflation by the III.2 Excludes snow. 3 Includes hurricanes and tropical storms. 4 Includes other geologic events such as volcanic eruptions and other earth movement. 5 Does not include flood damage covered by the federally administered National Flood Insurance Program. 6 Includes wildland fires.
Insured disaster losses totaled $297.3 billion from
1987-2006 (in 2006 dollars). Wildfires accounted for
approximately $6.6 billion of these—2.2% of the total.
Annual Catastrophe Bond Transactions Volume, 1997-2007
$1,729.8
$966.9
$7,329.6
$4,693.4
$1,991.1
$1,142.8$1,219.5$846.1$984.8$1,139.0
$633.0
$0
$1,000$2,000
$3,000
$4,000
$5,000$6,000
$7,000
$8,000
97 98 99 00 01 02 03 04 05 06 07
Ris
k C
apita
l Iss
ues
($ M
ill)
0
5
10
15
20
25
30
35
Num
ber o
f Iss
uanc
es
Risk Capital Issued Number of Issuances
Source: MMC Securities Guy Carpenter, A.M. Best; Insurance Information Institute.
Catastrophe bond issuance has soared in the wake of
Hurricanes Katrina and the hurricane seasons of 2004/2005,
despite two quiet CAT years
The 2008 Hurricane Season:
Less Activity Predicted
Outlook for 2008 Hurricane Season: 25% Worse Than Average
115NA96.2Accumulated Cyclone Energy675Intense Hurricane Days
Source: A.M. Best, ISO, Insurance Information Institute;*Includes special dividend of $3.2B. Increase is 15.7% excluding dividend. **Based on annualized 9M result of $39.515B.
Investment income posted modest
gains in 2006, but ran flat in 2007
-30%
-20%
-10%
0%
10%
20%
30%
40%
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
*
Source: Ibbotson Associates, Insurance Information Institute. *Through March 3, 2008.
Total Returns for Large Company Stocks: 1970-2008*
S&P 500 was up 3.53% in 2007, but down -9.38% so far in 2008*
Markets were up in 2007 for the 5th consecutive
year; 2008 off to a rough start
Property/Casualty Insurance Industry Investment Gain1
$ Billions
$35.4$42.8
$47.2$52.3
$44.4
$36.0
$45.3$48.9
$59.4$55.7
$61.9$56.9
$51.9
$57.9
$0
$10
$20
$30
$40
$50
$60
94 95 96 97 98 99 00 01 02 03 04 05* 06 07**
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 $3.2B. **A.M. Best estimate
Sources: ISO; Insurance Information Institute.
Investment rose in 2007 but are marginally higher than what they
were nearly a decade earlier in 1998
Investment Gain on Funds & Other Income, 1997-2006
10.9% 10.6%
9.4%10.3%
8.9%
6.4% 6.3% 6.4%7.1% 7.1%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
11.0%
12.0%
97 98 99 00 01 02 03 04 05 06
Sources: A.M. Best; Insurance Info. Inst.
Invest gains have been trending
generally downward over the past decade
US P/C Net Realized Capital Gains,1990-2007:9 Months ($ Millions)
$2,8
80 $4,8
06
$9,8
93
$1,6
64
$5,9
97
$9,2
44 $10,
808
$13,
016 $1
6,20
5
$6,6
31
-$1,
214
$6,6
10 $8,2
04
$18,019
$3,3
59
$9,7
01
$9,1
25
$9,8
18
-$5,000
$0
$5,000
$10,000
$15,000
$20,000
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07*Sources: A.M. Best, ISO, Insurance Information Institute. *As of September 30, 2007.
Realized capital gains rebounded strongly in 2004/5
but fell sharply in 2006 despite strong stock market as insurers “banked” their
gains. Rising again in 2007.
Realized capital gains rose during the last soft
market as they are now, as underwriting
results deteriorate
0%
1%
2%
3%
4%
5%
6%
11/0
412
/04
1/05
2/05
3/05
4/05
5/05
6/05
7/05
8/05
9/05
10/0
511
/05
12/0
51/
062/
063/
064/
065/
066/
067/
068/
069/
0610
/06
11/0
612
/06
01/0
702
/07
03/0
704
/07
5/07
6/07
7/07
8/07
9/07
10/0
711
/07
12/0
71/
082/
08
The “Fed” is Now Aggressively Pushing the “Fed Funds” Rate Down
Source: Federal Reserve Bank of New York.
Cuts in the “Fed Funds” rate—for very short-term loans—has so far not brought down longer-term yields as
inflationary expectations build
The Fed has cut rates by 2.25 points since Aug. 2007. More cuts likely by end of March
Yield Curves for Last Week of February 2008, 2007, 1978*
0%1%2%3%4%5%6%7%8%9%
1m 3m 6m 1y 2y 3y 5y 7y 10y 20y 30y
Feb. 1978 Feb. 2007 Feb. 2008
*Constant maturities for last week of February each year. No data for 1m, 3m or 6m available for 1978. 20-yr 1978 figures is III interpolated value.Sources: Federal Reserve; Insurance Information Institute.
2008: Fed action pushed ST yields down, LT little changed
Tort costs moderated beginning in 2003 as many improvements in the tort system began to bear fruit
Asbestos-related and other costs drove tort growth sharply upward in 2001 and 2002
2001-2005: 7.8%
2006-2009F: 1.6%
Tort System Costs, 1950-2009E
$1.8 $5.4 $7.9$13.9$20.0
$83.7
$130.2
$179.2
$246.0$265
$277
$158.5
$247.0
$42.7
$3.4
0.62%0.82%
1.03%
1.34%1.22%
1.98%2.14%
1.82% 1.83%1.83%1.87%
2.24%2.24%
1.53%
1.11%
$0
$50
$100
$150
$200
$250
$300
50 55 60 65 70 75 80 85 90 95 00 03 06 08E 09E
Tor
t Sys
tem
Cos
ts
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
Tor
t Cos
ts a
s % o
f GD
P
Tort Sytem Costs Tort Costs as % of GDP
Source: Tillinghast-Towers Perrin, 2007 Update on U.S. Tort Costs as % of GDP
After a period of rapid escalation,
tort system costs as a % of GDP are
now falling
The Nation’s Judicial Hellholes (2007)
Source: American Tort Reform Association; Insurance Information Institute
TEXASRio Grande Valley and Gulf Coast
South Florida
ILLINOISCook County West Virginia
Some improvement in “Judicial
Hellholes” in 2007
Watch ListMadison County, ILSt. Clair County, IL
Northern New Mexico
Hillsborough County, FLDelawareCalifornia
Dishonorable MentionsDistrict of Columbia
MO Supreme CourtMI Legislature
GA Supreme CourtOklahoma
NEVADAClark County (Las Vegas)
NEW JERSEYAtlantic County (Atlantic City)
Sum of Top 10 Jury Awards
$ Millions
$615.0$815.0
$2,953.7
$5,158.8
$0
$1,000
$2,000
$3,000
$4,000
$5,000
$6,000
2004 2005 2006 2007Source: Insurance Information Institute from LawyersWeekly USA, January 2005, 2006, 2007 and 2008.
Total of Top 10 awards in 2007 was 25% lower than in 2006
Excess Liability Market Capacity –North America
Source: Marsh, 2007 Limits of Liability Report
$1.660$1.645
$1.570$1.535$1.425
$1.575$1.710
$2.045$1.941
$2.011
$1.721
$1.405$1.334
$1.432
$1.0
$1.2
$1.4
$1.6
$1.8
$2.0
$2.2
$2.4
$2.6
$2.8
94 95 96 97 98 99 00 01 02 03 04 05 06 07
Bill
ions
Capacity is up 16.5% since its 2003 trough
Summary• Economy will provide muted bumps for insurers• Results were very good in 2006/07; Overall profitability reached
its highest level (est. 12-13%) since 1988• Underwriting results were aided by lack of CATs & favorable
underlying loss trends, including tort system improvements• Property cat reinsurance markets past peak & more competitive• Premium growth rates are slowing to their levels since WW II;
Commercial leads decreases.• Rising investment returns insufficient to support deep soft
market in terms of price, terms & conditions as in 1990s• How/where to deploy/redeploy capital??• Major Challenges: