Crisis and Its Impacts on Energy Insurance Markets Trends & Challenges Robert P. Hartwig, Ph.D., CPCU, President Insurance Information Institute 110 William Street New York, NY 10038 Tel: (212) 346-5520 [email protected]www.iii.org Insurance Information Institute April 2, 2009
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The Global Financial Crisis and Its Impacts on Energy Insurance Markets Trends & Challenges
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The Global Financial Crisis and Its Impacts on Energy
Insurance Markets Trends & Challenges
Robert P. Hartwig, Ph.D., CPCU, PresidentInsurance Information Institute 110 William Street New York, NY 10038
• 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
THE GLOBAL ECONOMIC
STORMWhat Weakening Economies and the Financial Crisis Mean for the
Insurance Industry &Energy Concerns
Real GDP By Market 2007-2010F(% change from previous year)
2.6%
2.0%
2.0% 3.
0%
11.9
%
0.7% 1.0%
-0.7
%
1.3%
0.7%
9.0%
-2.1
%
-2.5
%
-4.1
% -2.6
%
-2.7
%
6.8%
0.9%
1.0%
0.9% 1.
9%
0.8%
8.0%
2.6%
-6%
-4%
-2%
0%
2%
4%
6%
8%
10%
12%
14%
Euro Area Germany Japan US UK China
2007 2008E 2009F 2010F
Source: Blue Chip Economic Indicators, 3/10/09 edition.
All major economies except China and Brazil are in recession.
Steep declines in GDP will negatively impact exposure growth on a global scale
Real GDP for Largest European Economies & Euro Area, 2007-2010F, (% change from prior yr.)
2.6% 3.
0%
2.1%
3.5%
2.8%
0.7% 1.
0%
0.7%
0.7%
2.1%
1.3%
-2.1
%
-2.5
%
-2.7
%
-1.8
% -1.4
%
-1.5
%
0.9% 1.0%
0.8% 1.
0%
0.9% 1.0%
2.6%
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
Euro Area Germany UK France Netherlands Belgium
2007 2008E 2009F 2010F
Source: Blue Chip Economic Indicators, 3/10/09 edition.
All European economies are in recession
3.7
%
0.8
% 1.6
% 2.5
% 3.6
%
3.1
%
2.9
%
0.1
%
4.8
%
4.8
%
0.9
%
2.8
%
-0.5
%
-2.0
%
0.5
% 1.8
%
2.3
%
2.8
%
2.9
%
3.1
%
-5.3%-6.2%
-0.2%
-8%
-6%
-4%
-2%
0%
2%
4%
6%
2
00
0
2
00
1
2
00
2
2
00
3
2
00
4
2
00
5
2
00
6
07
:1Q
07
:2Q
07
:3Q
07
:4Q
08
:1Q
08
:2Q
08
:3Q
08
:4Q
09
:1Q
09
:2Q
09
:3Q
09
:4Q
10
:1Q
10
:2Q
10
:3Q
10
:4Q
US Real GDP Growth*
*Yellow bars are Estimates/Forecasts from Blue Chip Economic Indicators.Source: US Department of Commerce, Blue Economic Indicators 3/09; Insurance Information Institute.
Recession began in December 2007. Economic toll of credit crunch, housing
slump, labor market contraction is growing
The Q4:2008 decline was the steepest since the
Q1:1982 drop of 6.4%
Length of US Recessions,1929-Present*
43
13
811 10
810 11
16
6
16
8 8
16
0
5
10
15
20
25
30
35
40
45
50
Aug.1929
May1937
Feb.1945
Nov.1948
July1953
Aug.1957
Apr.1960
Dec.1969
Nov.1973
Jan.1980
Jul.1981
Jul.1990
Mar.2001
Dec.2007
* As of April 2009
Sources: National Bureau of Economic Research; Insurance Information Institute.
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.
Months in Duration
“We will rebuild. We will recover.”
--President Barack Obama addressing a joint session
Source: International Monetary Fund, World Economic Outlook Update, Jan. 28, 2009; Ins. Info. Institute.
Global Industrial Production Is in a Tailspin, Reducing Energy Demand
Global industrial production was down 13% in late 2008, adversely
impacting energy demand
Industrial demand for energy has been particularly hard hit
16.916.916.6
17.117.5
17.817.4
16.516.1
13.1
10.9
12.7
10
11
12
13
14
15
16
17
18
19
99 00 01 02 03 04 05 06 07 08 09F 10F
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
Auto/Light Truck Sales,1999-2010F (Millions of Units)
Source: US Department of Commerce; Blue Chip Economic Indicators (2/09); Insurance Information Inst.
5.2%
-0.9
%-7
.4%
-6.5
%-1
.5%
1.8%
4.3%
18.6
%20
.3%
5.8%
0.3%
-1.6
%-1
.0%
-1.8
%-1
.0%
3.1%
1.1%
0.8%
0.4%
0.6%
-0.4
%-0
.3%
1.6%
5.6%
13.7
%7.
7%1.
2%-2
.9% -0
.5%
-3.8
%-4
.2%
1.7%
-10%
-5%
0%
5%
10%
15%
20%
25%7
87
98
08
18
28
38
48
58
68
78
88
99
09
19
29
39
49
59
69
79
89
90
00
10
20
30
40
50
60
70
8E
09
F
Rea
l N
WP
Gro
wth
-4%
-2%
0%
2%
4%
6%
8%
Rea
l G
DP
Gro
wth
Real NWP Growth Real GDP
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, 3/09; Insurance Information Inst.
Change in Producer Prices for Construction vs. Consumer Prices, 2003 - 2008
100
110
120
130
140
150
12/03 12/04 12/05 12/06 12/07
PPI for inputs to construction industries: 33%
Consumer price index: 14%
12/08
Source: Associated General Contractors from BLS (CPI, PPI)12
Dec. 2008
The inflationary spike of 2008 has been reversed—for now—easing concerns over claims severities
Inflation Rates for Largest European Economies & Euro Area, 2007-2010F, (% change from prior yr.)
2.3%
2.3%
1.5% 1.6% 1.
8%
3.3%
2.8%
3.7%
2.8%
2.6%
4.6%
0.6%
0.4% 0.
7%
0.5% 0.
8%
1.3%1.
5%
1.3%
1.8%
1.5% 1.6% 1.
9%2.1%
0%
1%
1%
2%
2%
3%
3%
4%
4%
5%
5%
Euro Area Germany UK France Netherlands Belgium
2007 2008E 2009F 2010F
Source: Blue Chip Economic Indicators, 3/10/09 edition.
Inflation is down sharply across Europe, reducing claim severity concerns
THE $2.75 TRILLION GLOBAL ECONOMIC
STIMULUS Countries Trying to Spend Their Way Out of Recession Will Need More Energy &
More Insurance
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
$5
.8
$2
.0
$1
30
.4
$3
3.0
$7
5.3
$8
.0
$7
.6
$6
.9
$2
.8
$1
.8
$5
86
.1
$4
85
.9
$11
.3
$2
8.0
$7
.4
$1
3.7
$3
6.8
$787
$4
0.8
$0
$100
$200
$300
$400
$500
$600
$700
$800
$900
Announced Economic Stimulus Packages Worldwide (US$ Bill)*
Sources: Wall Street Journal, January 8, 2009 with updates by I.I.I.; Institute of International Finance and Brookings Institute.
U.S. stimulus comprises a mix of spending, tax relief and aid to states
*As of March 2009.
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 US$2.3 trillion in stimulus spending
$ Billions
$221.3
$54.2
$94.1
$12.4
$0 $200 $400 $600 $800 $1,000
India
Japan
China
Europe
US $787B Total
Source: “Energy Sector Looks for Private, Public Help,” WSJ, 3/9/09, p. A2 from HSBC, New Energy Finance; Ins. Info. Inst.
Green Energy Spending: An Important Component of Some Stimulus Plans
European green energy stimulus spending = $54.2B
$634.1B Total
$586.1B Total
$485.9B Total
$13.7B Total
Green energy stimulus spending totals $382B in US, Japan and Europe, or 18.1% of their combined $2.1 trillion in stimulus spending
US Economic Stimulus Package: Where the $787B Goes—5% to Energy Projects
Tax Relief, $288 , 38%
State & Local Fiscal Relief, $144 , 18%
Infrastructure & Science, $111 , 14%
Protecting the Vulnerable, $81 , 10%
Health Care, $59 , 7% Education & Training, $53 , 7%
Energy, $43 , 5%
Other, 8, 1%
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.
$ Billions
US Economic Stimulus Package: $143.4 in Construction Spending—20% to Energy Projects
Transportation Infrastructure, 49.3, 32%
Water & Environmental Infrastructure, 21.4, 14%
Building Infrastructure, 29.6, 20%
Other, 0.2, 0%
Workforce Development & Safety, 4.3, 3%
Energy & Technology, 29.8, 20%
School Building, 9.2, 6%
Other, 8.0, 5%
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..
$ Billions
$542
$160$150$98
$60$33
$0
$100
$200
$300
$400
$500
$600
2004 2005 2006 2007 2008 2030
Current investment in green energy falls far short of what some believe is necessary to address climate change issue
Annual investment needed through 2030 in renewable energy and energy efficiency to keep atmospheric CO2 concentration below 450 parts per million—an amount many scientists claim is necessary to prevent serious
consequences from climate change
Global Green Energy Spending* ($ Billion)
*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.
Stimulus: Reading The Economic Tea Leaves for the Next 4 to 8 Years
Source: Insurance Information Institute
• 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 Administration’s 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
FINANCIAL STRENGTH &
RATINGS Industry Has Weathered
the Storms Well
US P/C Insurer Impairment Frequency vs. Combined Ratio, 1969-2007
90
95
100
105
110
115
120
69
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
Co
mb
ined
Ratio
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
2
Imp
air
men
t R
ate
Combined Ratio after DivP/C Impairment Frequency
Impairment rates are highly correlated
underwriting performance and could reached a
record low in 2007
Source: A.M. Best; Insurance Information Institute
2007 impairment rate was a record low 0.12%, one-seventh the 0.8% average since 1969;
Previous record was 0.24% in 1972
Summary of A.M. Best’s P/C Insurer Ratings Actions in 2008*
Under Review, 63 , 4.3%
Upgraded, 59 , 4.0%
Initial, 41 , 2.8%
Other, 59 , 4.0%
Affirm, 1,183 , 81.0%
Downgraded, 55 , 3.8%
*Through December 19.Source: A.M. Best.
24
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
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.
Historical Ratings Distribution,US P/C Insurers, 2008 vs. 2005 and 2000
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.
A/A-48.4%
D0.2%C++/C+
1.9%
E/F2.3% A++/A+
11.5%
C/C-0.6%
B++/B+28.3%
B/B-6.9%
2008 2005
P/C insurer financial strength has improved since 2005 despite financial crisis
A/A-52.3%
A++/A+9.2%
B++/B+26.4%
Vulnerable*12.1%
A/A-60.0%
A++/A+10.8%
B++/B+21.3%
Vulnerable*7.9%
2000A++/A+ and A/A- gains
Reasons for US P/C Insurer Impairments, 1969-2005
*Includes overstatement of assets.
Source: A.M. Best: P/C Impairments Hit Near-Term Lows Despite Surging Hurricane Activity, Special Report, Nov. 2005;
Catastrophe Losses8.6%
Alleged Fraud11.4%
Deficient Loss
Reserves/In-adequate Pricing62.8%
Affiliate Problems
8.6%
Rapid Growth
8.6%
2003-2005 1969-2005
Deficient reserves,
CAT losses are more important factors in
recent years
Reinsurance Failure3.5%
Rapid Growth16.5%
Misc.9.2%
Affiliate Problems
5.6%
Sig. Change in Business
4.6%
Deficient Loss
Reserves/In-adequate Pricing38.2%
Investment Problems*
7.3%
Alleged Fraud8.6%
Catastrophe Losses6.5%
Critical Differences Between P/C
Insurers and BanksSuperior Risk Management Model
& Low Leverage Makea Big Difference
$600
$106
$780
$205
$0
$100
$200
$300
$400
$500
$600
$700
$800
Banks Insurers
Losses as of Sept 2008
Total expected losses
Financial Institutions Globally FacingHuge Losses from the Credit Crunch*
*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.
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
28
How Insurance Industry Stability Has Benefitted Consumers
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 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 Institute29
• 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 Institute30
Reasons Why P/C Insurers Have Fewer Problems Than Banks:
A Superior Risk Management Model
ENERGY MARKET REVIEW
Global Energy Business Is Deeply Impacted by
Crisis, but Other Factors Matter Too
Key Trends
Capacity & RatingExposure
ProfitabilityReinsurance
Global Energy Insurance Markets: Key Trends
INSURANCE CAPACITYAggregate commercial property/casualty (nonlife) capacity fell sharply in
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
Upstream Capacities and Average Rating Levels, 1993-2009 (Excl. GOM)
Source: Willis Energy Market Review: March 2009
Onshore Capacities and Average Rating Levels, 1993-2009 (Excl. GOM)
Source: Willis Energy Market Review: March 2009
Total Theoretical Liability Capacity, 2000-09
Source: Willis Energy Market Review: March 2009
Global Energy Insurance Markets: Key Trends
INSURED EXPOSUREGlobal 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 demandCredit crisis impacting project viability as wellBOTTOM 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.
Global Energy Insurance Markets: Key Trends
PROFITABILITYSharp decline in investment returns in 2008, unlikely to
turnaround anytime soonLoss of investment return necessarily increases pressure on
(re)insurers to generate underwriting profitsMany insurers will also need to protect capital in 2009 via
increased reliance on reinsuranceHigher cost of capital could be a major issue if capital raises
are necessary among for insurers and reinsurersBOTTOM 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.
Energy Losses vs. Global Energy Premium Income 1990-2008*
*Figures include both insured and uninsured losses
Source: Willis Energy Market Review: March 2009
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)
Lloyd’s 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
Reinsurance & Alternative Risk
Transfer
Capacity is Down, Demand is Up
Reinsurance Market TrendsAmid 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 issuesBut 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.
Global Reinsurance Capacity Shrank in 2008, Mostly Due to Investments
$360
$300
$270
$280
$290
$300
$310
$320
$330
$340
$350
$360
$370
2007 2008
Global Reinsurance Capacity
Global reinsurance
capacity fell by an estimated 17% in 2008
45
Hurricanes14%
Change in Unrealized
Capital Losses55%
Realized Capital Losses31%
Source of Decline
Source: AonBenfield Reinsurance Market Outlook 2009; Insurance Information Institute.
Catastrophe Bond and Sidecar Issuance, 2004-2008
$1.14 $1.50
$4.69
$7.62
$2.73
$0.00
$2.33
$3.85
$1.75
$0.28$0
$2
$4
$6
$8
$10
2004 2005 2006 2007 2008
$ Billions
The credit crisis and decline in global capital have taken their
toll on alternative forms of catastrophe risk transfer
46Source: AonBenfield Reinsurance Market Outlook 2009; Insurance Information Institute.
The Global Financial Crisis Affects Energy Industry Supply and Demand & Insurance
Exposure
Severe Recession is Depressing US Energy Demand: Change 2009 vs. 2008
-2.2%
-1.3%-1.7% -1.7%
-6.4%-7%
-6%
-5%
-4%
-3%
-2%
-1%
0%
Oil Natural Gas Electricty(Industrial)
Electricty (All) Coal forElectricity
Sources: Energy Information Administration.
Industrial consumption of electricity has
experienced the most severe declines
Percentage Change in Consumption, 2009 vs. 2008
World Crude Oil Prices: 1997- March 2009
*All countries spot market price weighted by estimated export volume. Source: Energy Information Administration; http://tonto.eia.doe.gov/dnav/pet/hist/wtotworldw.htm
Source: Energy Information Administration, Short-Term Energy Outlook, March 10, 2009; Ins. Info. Inst.
US Energy Expenditures as a % of GDP Have Been Hurt by Recession
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.
Recession and 2008 energy price spike sharply
decreased energy demand
11.3
14.6
17.3
21.0
24.4
27.5
30.4
33.3
12.6
0
5
10
15
20
25
30
35
1990 1995 2000 2005 2010 2015 2020 2025 2030
World Net Effective Electric Power Generation, 1990-2030 (est.)
Source: Energy Information Administration, 2008 International Energy Outlook, Insurance Information Institute.
The current economic downturn will have little, if any, long-term impact on electric power generation
Source: International Atomic Energy Agency , World Outlook for Electricity Investment.
Investments in electricity supply infrastructure
globally are expected to total $9.841 trillion
between 2001 and 2030
European investment could total $1.351 trillion
52
World Energy Supply Infrastructure Investment by Category: 2001-2030 (Est.)
Generation-New, $4,080 , 42%
Generation-Refurbished, $439 , 4%
Transmission, $1,568 , 16%
Distribution, $3,755 , 38%
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
$ Billions
Source: International Atomic Energy Agency , World Outlook for Electricity Investment.
World Electricity Generation by Fuel 2005-2030F
2.63 3.
16 3.42
2
7.15
2
0.76
4
3.75
4 4.99
6
8.38
9
15.3
61
0.95
6
0
2
4
6
8
10
12
14
16
18
Liquids Nuclear Renewables Natural Gas Coal
2005 2010 2015 2020 2025 2030
Source: US Department of Energy Report #:DOE/EIA-0484 ( Sept. 2008); Insurance Information Institute
The sharp increase in generation and the
changing composition of fuel source will influence
insurance demand and the nature of products sold
Trillions of Kilowatt Hours
Natural Gas20%
Renewables18%
Liquids6%
Coal41%
Nuclear15%
2005 2030
World Electricity Generation by Fuel Source Share: 2005 vs. 2030F
Natural Gas25%
Renewables15%
Liquids2%
Coal47%
Nuclear11%
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).
European Electricity Generation,by Fuel: 2005-2030F
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
2005 2010 2015 2020 2025 2030
Liquids Coal Natural Gas Renewables Nuclear
Source: US Department of Energy Report #:DOE/EIA-0484 ( Sept. 2008); Insurance Information Institute
Gas, renewables grow, coal shrinks, implying
different insurance needs in Europe
Trillions of Kilowatt Hours
3.303.70
3.97 4.21 4.444.67
Avg. Annual Change in Consumption of Crude Oil in Major World Regions
171158
61531915
-21
3668
112
211
410
294242
169
905668
99
-3
-182
-349
86
162
276230
-400
-300
-200
-100
0
100
200
300
400
500
Can
ada,
Mex
ico
an
dth
e U
.S.
U.S
.
Dev
elo
pin
gA
sia,
exc
l.C
hin
a an
d
Lat
inA
mer
ica
Afr
ica
Au
stra
lia,
New
Zea
lan
d,
OE
CD
Eu
rop
e*
Jap
an
Ru
ssia
Fo
rmer
So
viet
an
dC
om
mu
nis
t
Ind
ia
Mid
dle
Eas
t
Ch
ina
2005-2015, projected 1990-2005
*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
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
Lessons from Energy Boom of 2008
Oil/Energy is a Chief Source of Global Economic Instability
LESSONS OF 2008 ENERGY PRICE BUBBLESteeply rising oil/energy prices lead to severe economic
dislocation and hardship on a global scaleReduced economic growth globally (except energy
exporting countries)Fuels InflationMakes investment decisions in exploration more
uncertain Encourages collateral boom in other commoditiesDisastrous 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
P/C INSURANCE FINANCIAL
PERFORMANCE
A Resilient Industry in Challenging Times
Profitability
Historically Volatile
P/C Net Income After Taxes1991-2009F ($ Millions)*
*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.
U.S. P/C Industry Premiums-to-Surplus Ratio: 1985-2008:Q3
Sources: A.M. Best, ISO, Insurance Information Institute.
19980.85:1–the lowest
(strongest) P:S ratio in recent history.
Premiums measure risk accepted; surplus is funds beyond reserves to pay unexpected losses. The larger
surplus is in relation to premiums—the lower the ratio of premiums to surplus—the greater the
industry’s capacity to handle the risk it has accepted.
0.92:1 as of
9/30/08
P/C insurers remain well capitalized despite recent
erosion of capital
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
19
78
19
79
19
80
19
81
19
82
19
83
19
84
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
*
NWP % changeSurplus % change
*Actual 9-month 2008 result.Sources: A.M. Best, ISO, Insurance Information Institute
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
Investment Performance
Investments are the Principle Source of Declining
Profitability
Distribution of P/C Insurance Industry’s Investment Portfolio
Cash & Short-Term Investments
7.2%
Common Stock17.9%
Bonds66.7%
Preferred Stock1.5%
Real Estate0.8%
Other5.9%
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;.
As of December 31, 2007
77
Property/Casualty Insurance Industry Investment Gain:1994- 2008:Q3 1
$ Billions
$35.4
$42.8$47.2
$52.3
$44.4
$36.0
$45.3$48.9
$59.4$55.7
$63.6
$28.3
$56.9$51.9
$57.9
$0
$10
$20
$30
$40
$50
$60
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.
Investment gains are off sharply in 2008 due to lower yields and poor equity market conditions.
78
P/C Insurer Net Realized Capital Gains, 1990-2008:Q3
*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
$ Billions2008 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.
$100 Billion CAT year is coming soon
96
Rising Number of U.S. Landfalling Tropical Cyclones Has Been Very Costly
for Energy Insurers
Source: Munich Re from NOAA
Six tropical cyclones made landfall in the
US in 2008
Key Issues & Threats Facing P/C
Insurers Amid Financial Crisis
Manageable Challenges
Important Issues & Threats Facing P/C Insurers in 2009
Source: Insurance Information Inst.
1. 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 internally2. 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.
3. Regulatory Overreach P/C insurers get swept into vast federal regulatory
overhaul and subjected to inappropriate , duplicative and costly regulation
4. 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
Important Issues & Threats Facing P/C Insurers in 2009 (cont’d)
AFTERSHOCK: Regulatory Response
Could Be Harsh
All Financial Segments Including InsurersWill Be Impacted
Post-Crunch: Fundamental Issues To Be Examined Globally
Source: Ins. Info. Inst.
• 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
Emerging Blueprint for Financial Services Regulatory Overhaul
Source: Wall Street Journal, “Frank Backs Regulator for Systemic Risk,” 2/4/09, p. C3; I.I.I. research.
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 can’t 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
Emerging Blueprint for Financial Services Regulatory Overhaul (cont’d)
Phase I: Systemic Risk Regulation/Regulator: OTHER (cont’d)
• 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.
Post-Crunch: Fundamental Regulatory Issues & Insurance
Source: Insurance Information Institute
• 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
Possible Regulatory Scenarios for P/C Insurers as of Year-End 2009
Source: Insurance Information Inst.
• 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?
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