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Trends in the Property Casualty Insurance Industry. Hankamer School of Business Baylor University October 2, 2003. Joan Lamm-Tennant, PhD Gen Re Capital Consultants. Trends In The Property Casualty Insurance Industry . Insurance Industry Financial Summary – Looking Good

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Trends in the property casualty insurance industry

Trends in the Property Casualty Insurance Industry

Hankamer School of Business

Baylor University

October 2, 2003

Joan Lamm-Tennant, PhD

Gen Re Capital Consultants


Trends in the property casualty insurance industry1
Trends In The Property Casualty Insurance Industry

  • Insurance Industry Financial Summary – Looking Good

  • Now Let’s Look Beyond The Financial Summary At Underlying Trends

  • Evolution in Risk Management

  • Summary and A Look Into The Future


Things are looking good you really like me
Things are looking goodYou really like me


Highlights property casualty 6 months 2003
Highlights: Property / Casualty 6 Months 2003

2003

2002

Change

Net Written Premium

$ 214.9

$ 182.4

+16.7%

Loss & LAE

150.3

134.3

+11.9%

Net UW Gain (Loss)

(2.1)

(11.9)

-82.3%

Net Inv. Income

20.7

17.8

+16.3%

Net Income (a.t.)

18.6

4.6

+300.4%

Surplus*

319.7

285.2

+12.2%

Combined Ratio**

99.3

107.2

-7.9 pts.

* Comparison with year-end 2002. Comparable 2nd quarter figure is 282.9

** Comparison is with full year 2002 combined ratio. Comparable quarter 2002 figure is 105.0

Source: Insurance Information Institute

(amounts in billions)


U s property casualty industry

World Trade Center Loss

U.S. Property / Casualty Industry

Combined Ratio 1955 to June 30, 2003

Average Combined Ratio

1955 - 2002 104.3%

1955 - 1979 100.1%

1980 - 2002 108.8%

116.0%

118.0%

116.3%

115.7%

As of June 2003 the industry reported a combined ratio of 99.3. This is the first time in the past five years that the industry reported a combined under 100 mid year.

* as of 6/30/03

Source: III


Property casualty net income after taxes
Property / Casualty Net Income After Taxes

1991 - 2003 *

* As of 6/30/03

Sources: A.M. Best, ISO, Insurance Information Institute.

(amounts in billions)


Policyholder surplus
Policyholder Surplus

1975 - 2003 *

Surplus (capacity) peaked at $336.3 billion in mid-1999 and then fell 15.2% ($51 billion) to $285.2 billion by 2002.

In 2003 surplus is $319.7 billion; an increase of $34.5 billion or (12.2%) over 2003.

*Second Quarter

Source: A.M. Best, Insurance Information Institute

(amounts in billions)


What is my point in this section
What Is My Point in this Section?

  • Premium is Up

  • Underwriting Result is Improved

  • Surplus is Growing

  • Look’s Like the Industry is Doing Well …


Summary numbers don t tell the whole story
Summary Numbers Don’t Tell the Whole Story

Risky Business

Are We Exposed or Are We Protected?


Now let s look beyond the financial summary
Now Let’s Look Beyond The Financial Summary

  • Economic Value Gap

  • Are Rates Holding?

  • Loss Trends

  • Emerging Exposures

  • Reserve Shortfall

  • Investment Results

  • Credit Quality – Insurers and Reinsurer

  • Insolvencies


Economic value gap roe vs cost of capital pc industry 1991 2003f
Economic Value GapROE vs. Cost of Capital: PC Industry 1991- 2003F*

There has been enormous gap between the industry’s cost of capital and its ROE. US P/C insurers have missed their cost of capital by an average 6.6 points from 1991 to 2002.

6.8. pts

14.6 pts

If we do end 2003 with 11.6% ROE, we will be breaking even but not yet creating economic value.

Source: The Geneva Association, Ins. Information Inst.


Are rates holding strength of recent hard markets by real nwp growth
Are Rates Holding?Strength of Recent Hard Markets by Real NWP Growth

1985-87

2001-03

1975-78

Real NWP Growth During Past 3 Hard Markets

1975-78: 8.6%

1985-87: 14.5%

2001-03: 9.1%

Note: Shaded areas denote hard market periods. Source: A.M. Best, Insurance Information Institute


Loss trends
Loss Trends

  • Four Problematic Lines of Business

    • Medical Malpractice

    • Product Liability

    • Workers’ Compensation

    • Homeowners


Loss trends line of business crs needed for profitability
Loss TrendsLine of Business CRs Needed for Profitability

Source: A.M. Best

* Reflects break-even accident year results including investment income on current writings.

Break-even figures are calculated using a 4% interest rate.


Loss trends average jury awards 1994 vs 2001
Loss TrendsAverage Jury Awards 1994 vs. 2001

*Figure is for 2000 (latest available)

Source: Jury Verdict Research; Insurance Information Institute.


Loss trends med mal losses exp paid vs premiums earned
Loss TrendsMed Mal: Losses & Exp Paid vs. Premiums Earned

Source: Computed from A.M. Best data by the Insurance Information Institute


Re emerging exposures
(Re)Emerging Exposures

  • Asbestos

  • “Toxic” Mold

  • Construction Defects

  • Obesity – Patron Suits


Obesity patron suits
Obesity – Patron Suits

  • Are the food service & manufacturing industry’s vulnerable to suits over obesity?

  • McDonald’s sued in late 2002 over allegations that their food makes people fat

  • Kraft sued earlier this year over trans fats in Oreo cookies


Takeaways at this points
Takeaways At This Points

  • ROEs might be at breakeven relative to cost of capital

    • BUT when will the PC industry become Economic Generators

  • What – you want more rate

  • Auto, package property, large account property look good but

    • Homeowners needs work

    • Workers compensation still has some problems

    • Medical utilization and inflation is a real concern

    • Then there is Property Liability and Tort



Yes there is more
YES, There Is More

  • Economic Value Gap

  • Are Rates Holding?

  • Loss Trends

  • Emerging Exposures

  • Reserve Shortfall

  • Investment Results

  • Credit Quality – Insurers and Reinsurer

  • Insolvencies


Reserve deficiency by line ay 1992 2001 as of 12 01
Reserve Deficiency, by Line(AY 1992-2001, as of 12/01)

*Occurrence and claims made

Source: Morgan Stanley


Reserve deficiencies adverse loss development
Reserve DeficienciesAdverse Loss Development

  • A number of companies reported reserve increases in excess of $1B

    • AIG – Q4 2002 $2.8B increase in excess casualty and D&O

    • Travelers – Q4 2002 $2B primarily for asbestos

    • Employers Re – Q4 2002 $2.5B in several liability segments, workers compensation and asbestos


Reserve deficiencies
Reserve Deficiencies

Nothing Good Happens When Reserves are Deficient

  • Profitability of Current Business Is Misleading

  • Continue to Underprice Risk

    • Target Rate Increases Are Too Low

    • Terms and Conditions Are Likely to Be Too Broad

  • Write More Unprofitable Business

    • True Adverse Selection

  • Losses Compound Across Accident Years Before Mistake Is Recognized

  • Lose Prestige and Respect in the Marketplace

  • Pay Too Much in Taxes

  • Very Painful to Fix


Investment results interest rates lower than they ve been in decades
Investment ResultsInterest Rates: Lower Than They’ve Been in Decades

  • While investment income is up in 2003 for the PC insurance industry it is due to the reinvestment of very strong cash flows from underwriting.

  • Rates remain relatively low.

*As of April 21, 2003.

Source: Board of Governors, Federal Reserve System; Insurance Information Institute


Investment results total investment returns of u s pc industry
Investment ResultsTotal Investment Returns of U.S. PC Industry

Total Investment Returns (1979 to 2002)

$81 billion

$17.8 billion

(amounts in billions)


Credit quality s p downgrades of pc insurers jan 03 to sept 03
Credit QualityS&P Downgrades of PC Insurers – Jan 03 to Sept 03

  • Of Of the 484 companies rated by S&P, 94 were downgraded (7 were upgraded)

  • For example, of the 94 companies downgraded, 17 were downgraded from AA+ to AA; 4 were downgraded from AA to AA- and 10 went from a AA- to A+ with another 5 going from AA- to A


Credit quality s p financial reinsurance downgrades
Credit QualityS&P Financial Reinsurance Downgrades

AAA AA+ AA AA- A+ A A- <BBB+ Outlook

General Re X Stable

Swiss Re |---------------------------------X Stable

Chubb Re |---------------------------------X Stable

Employers Re |----------------------------------------------------------------------X Negative

Munich Re |----------------------------------------------------------------------X Stable

- American Re |---------------------------------------------------------------------------------------X Stable

Hannover Re |-----------------------------------X Negative

Transatlantic Re X Stable

XL Re X Stable

Partner Re |-----------------X Stable

Hartford P/C Group |-----------------X Stable

AXA Re |-----------------X Stable

Converium Re |----------------------------------------------------X Stable

Everest Re X Stable

SCOR |--------------------------------------------------------------------X Watch / Dev

Gerling Global Re |--------------------------------------------------------------------X Withdrawn

ACE Tempest Re X Negative

IPC Holdings X Stable

W.R. Berkley X Negative

Lloyd’s |-------------X Stable

Trenwick Amer Re |------------------------------------------------X Withdrawn

Renaissance Re X--------------| Stable

PXRE Reins X Negative

Axis Re X Stable

Endurance Re X Stable

Montpelier Re X Stable

PMA Capital |------------------X Negative

CNA |------------------X Negative

As of September 2003




U s p c insolvencies vs combined ratio 1971 2002
U.S. P/C Insolvencies vs. Combined Ratio 1971-2002

10-yr failure rate is 0.72% but in 2002 the rate is 1.33%

30 companies went insolvent in 1992, peaked in 1992 with 63 insolvencies

Source: A.M.Best Co. Special Report “P/C Industry – 2001 Insolvencies”, June 18, 2002


Causes of insolvency
Causes of Insolvency

  • Deficient Loss Reserves

  • Inadequate Pricing

  • Rising Loss Cost Trends

  • Catastrophes

  • Cheap Reinsurance Protection

  • Cash Flow Underwriting

  • Aggressive Growth

  • Fraud

  • Overstated Assets


Bringing it all together
Bringing It All Together

  • Industry Results are Much, Much Better

    • We might breaking even in 2003 – no longer an economic detractor

    • Remember, not all lines are producing profits so we have work yet to do

  • Rates are still hardening

    • But can we hold them

  • Adverse reserve development continues to be a drag

  • Investments cannot support underwriting

  • (Re)emerging exposures—we must keep a watch on these!

  • Keep an eye on credit quality when placing your business

  • Focus and discipline are key


Trends in the property casualty insurance industry2
Trends In The Property Casualty Insurance Industry

  • Insurance Industry Financial Summary – Looking Good

  • Now Let’s Look Beyond The Financial Summary At Underlying Trends

  • Evolution in Risk Management

  • Summary and A Look Into The Future



Evolving disciplines in risk management
Evolving Disciplines in Risk Management

  • Managing for Profitability versus Growth

  • Advance Risk Metrics

  • Delaying Claims Payments – Market Consequences


Let s do the math

Managing Profitability versus Growth

Let’s Do the Math

Still looking for photo


Managing profitability versus growth
Managing Profitability versus Growth

What combined ratio is needed to provide a “fair” “risk-adjusted” return on capital given leverage and given investment income?


Underwriting profitability is critical
Underwriting Profitability Is Critical

Source: Dowling & Partners, “Underwriting Profit is Essential”


Ok so how do we change the culture to manage profitability as opposed to growth
OK … So How Do We Change The Culture To Manage Profitability as Opposed To Growth

  • Reward profitability not growth through compensation schemes

  • Build skills

  • Advance risk metrics

  • Improve both the quality and quantity of data


Evolving disciplines in risk management1
Evolving Disciplines in Risk Management Profitability as Opposed To Growth

  • Managing for Profitability versus Growth

  • Advance Risk Metrics

  • Delaying Claims Payments – Market Consequences


Realistic risk choices depend on our ability to see the complete range of outcomes
Realistic Risk Choices Depend On Our Ability To See The Complete Range of Outcomes

Stress testing may give you a false sense of confidence that you are seeing the complete range. Simulation may appear complex but it can be very insightful.

Mean

-70%

-30%

+25% (Mean)

+50%

% Change in Underwriting Profit


Simulation gives us a new measure of risk
Simulation Gives Us A New Measure Of Risk Complete Range of Outcomes

The probability of a decline in underwriting profits (Value-at-Risk) is a useful risk measure.

Mean

20% probability of a 30% or greater decline in underwriting profit

-70%

-30%

+25% (Mean)

+50%

% Change in Underwriting Profit


Simulation an insightful way to understand the drivers of unacceptable results
Simulation - An Insightful Way To Understand The Drivers of Unacceptable Results

“Bottom up” modeling allows us to explore in detail the root causes of risks.

Interest Rate

Spike

Probability

East Coast

Storm

Adverse Reserve

Development

Equity Market

Declines

-70%

-30%

% Change in Underwriting Profit


Taking it even further portfolio analytics
Taking It Even Further…… Portfolio Analytics of Unacceptable Results

Return on Surplus

Percentile Distribution

Combined Ratio

Percentile Distribution

This company did an in-depth simulation analysis the impact of 3 options for growth on the combined ratio and ROE of their company.

They were able to make a better-informed decision about the trade-offs presented to them.


So what is the point
So what is the point …… of Unacceptable Results

  • Know more than your expected outcome

    • A 25% increase in underwriting profit

  • Know the range around the expected

    • A 70% decline in underwriting profit to an 50% increase in underwriting profit

  • Focus on the tail – the “strike zone”

    • Know the “probability” of the downside

  • Be aware of the economics underlying the “strike zone”

  • Think about hedging the unthinkable


Evolving disciplines in risk management2
Evolving Disciplines in Risk Management of Unacceptable Results

  • Managing for Profitability versus Growth

  • Advance Risk Metrics

  • Delaying Claims Payments – Market Consequences


Delaying claims payment
Delaying Claims Payment of Unacceptable Results

What are the cause for the increase in unsettled claims?

  • Greater Fear

  • Greater Pressures on Profitability

    • Trading Reputation for Short-term Profitability

    • Willingness to Game Information Asymmetries

    • Imbalance in Risk Psychology – Fearing Losses More Than Loving Gains

  • More Litigious Society

  • More Uncertain World

    • Simply unclear because the contract was never written with these claims in mind


Delaying claims payment market consequences and solutions
Delaying Claims Payment – Market Consequences and Solutions

What might be the market consequences?

  • Loss of confidence in the insurance markets

  • Will have downward bias on price

    What might be a solution?

  • More disclosure of data

    • Is this even reasonable?

    • Does the data even exist?

  • Re-thinking the economics of contracts

    • Recognize that incomplete contracts may be optimal

    • Therefore, how might we design contracts on verifiable losses, given that non-verifiable losses will exist?


Summary an a look into the future
Summary An A Look Into The Future Solutions

  • Industry Results are Much, Much Better

    • We might breaking even in 2003 – no longer an economic detractor

  • Remember, not all lines are producing profits so we have work yet to do

    • Do we have the discipline to hold rates

    • Will adverse reserve development continue to be a drag

    • (Re)emerging exposures—we must keep a watch on these!

  • Keep an eye on credit quality

  • Evolving risk management disciplines are key



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