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Commercial Lines Underwriting Seminar National Association of Mutual Insurance Companies

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  1. Crisis, Stimulus and the Future of the P/C Insurance Industry Challenges Amid theGlobal Economic Storm Commercial Lines Underwriting Seminar National Association of Mutual Insurance Companies Chicago, IL February 24, 2009 Robert P. Hartwig, Ph.D., CPCU, President Insurance Information Institute 110 William Street New York, NY 10038 Tel: (212) 346-5520  bobh@iii.org  www.iii.org

  2. Presentation Outline • Financial Crisis & The Weakening Global Economy: Insurance Impacts • Recession, Growth & Insurance • Economic Stimulus Package • Impacts & Implications for P/C Insurers • Financial Strength & Ratings • P/C Insurance Industry Overview & Outlook • Profitability • Premium Growth • Underwriting Performance • Financial Market Impacts • Capital & Capacity • Regulatory Response to Crisis • Emerging Blueprint of Regulatory Overhaul • Important Threats Facing P/C Insurers in 2009 • Q & A

  3. THE ECONOMIC STORMWhat a Weakening Economy and Financial Crisis Mean for the Insurance IndustryExposure & Claim Cost Effects

  4. Real GDP Growth* 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% *Yellow bars are Estimates/Forecasts from Blue Chip Economic Indicators. Source: US Department of Commerce, Blue Economic Indicators 2/09; Insurance Information Institute.

  5. 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 February 2009 Sources: National Bureau of Economic Research; Insurance Information Institute.

  6. Unemployment Rate:On the Rise January 2000 through January 2009 Jan. 2009 unemployment jumped to 7.6%, exceeding the 6.3% peak during the previous cycle, and is now at it highest level since Sept. 1992 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% Jan-09 Source: US Bureau of Labor Statistics; Insurance Information Institute.

  7. Unemployment Rate:A Volatile History January 1948 through January 2009 May 1975 9.0% Nov/Dec 1982: 10.8% Jul. 1958 7.5% Aug. 1949 7.9% May 1961 7.1% Jan. 2009 7.6% Jun. 1992 7.8% Sep. 1954 6.1% Aug. 1971 6.1% Jun. 2003 6.3% Source: US Bureau of Labor Statistics; Insurance Information Institute.

  8. 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 at nearly 9% in late 2009 into 2010. * Blue bars are actual; Yellow bars are forecasts Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (2/09); Insurance Info. Inst.

  9. Monthly Change Employment*(Thousands) January 2008 through January 2009 Job losses since the recession began in Dec. 2007 total 3.572 million; 11.6 million people are now defined as unemployed. The Jan. 2009 losses were the largest since than the Dec. 1974 loss of 602,000 Source: US Bureau of Labor Statistics: http://www.bls.gov/ces/home.htm; Insurance Info. Institute

  10. New Private Housing Starts,1990-2010F (Millions of Units) New home starts plunged 34% from 2005-2007; Drop through 2009 trough is 68% (est.)—a net annual decline of 1.41 million units, lowest since record began in 1959 Exposure growth forecast for HO insurers is dim for 2009 with some improvement in 2010. Impacts also for comml. insurers with construction risk exposure 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 (2/09); Insurance Information Inst.

  11. State Construction Employment, Dec. 2007 – Dec. 2008 WA NH MT ND ME VT MN OR ID MA WI NY SD WY MI RI CT PA NV IA NE NJ OH IL UT IN DE Construction employment declined in 47 of 50 states in 2008 CO WV VA CA KS MO KY MD NC TN AZ DC OK NM AR SC AL GA MS LA AK AK TX FL HI 14 Sources: Associated General Contractors of America from Bureau of Labor Statistics; Insurance Information Institute.

  12. 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 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 Source: US Department of Commerce; Blue Chip Economic Indicators (2/09); Insurance Information Inst.

  13. 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 2010 revised upwards to reflect expected impact of Obama stimulus program Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (2/09); Insurance Info. Inst.

  14. 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

  15. 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, 2/09; Insurance Information Inst.

  16. Change in Producer Prices for Construction vs. Consumer Prices, 2003 - 2008 Dec. 2008 The inflationary spike of 2008 has been reversed—for now Source: Associated General Contractors from BLS (CPI, PPI)

  17. THE $787 BILLION ECONOMIC STIMULUSSectoral Impacts & Implications for P/C Insurance

  18. Economic Stimulus Package: Where the $787B Goes Less than ¼ of the stimulus package is direct spending on infrastructure How much “stimulus” is actually in the stimulus package is open to debate and dispute Sources: Wall Street Journal , 2/13/09; House Ways and Means Committee; Senate Finance Committee.

  19. Economic Stimulus Package: Where the $787B Goes $ Billions Objective is to create or preserve 3.5 million jobs Tax relief and aid to state and local government account for 56% of stimulus. Actual spending accounts for only about 25% Source: http://www.recovery.gov/ accessed 2/18/09; Insurance Information Institute.

  20. Economic Stimulus Package: Where the $787B Goes After Tax Reallocations $123B of the original $288B in Tax Relief can be allocated back to 3 categories of investment and/or relief $142B Total $126B Total $68B Total Source: From http://www.recovery.gov/ accessed 2/18/09; Insurance Information Institute.

  21. U.S. Economic $787B Stimulus Package: Major Spending Components $ Billions Objective is to create or preserve 3.5 million jobs 24.1% or $132.2B of the stimulus package is allocated toward direct spending. This is the component that will most directly benefit p/c insurers. Lines Most Likely to Benefit: Workers Comp Commercial Auto Inland Marine Commercial Property & Liability Surety Sources: Wall Street Journal , 2/13/09; House Ways and Means Committee; Senate Finance Committee; Ins. Info. Inst.

  22. Economic Stimulus Package: $143.4 in Construction Spending $ Billions There is approximately $140B in new construction spending in the stimulus package, about 1/3 of it for transportation. Source: Associated General Contractors at http://www.agc.org/cs/rebuild_americas_future (2/18/09); Insurance Info. Inst..

  23. U.S. Economic $787B Stimulus Package: Major Tax Cut Components $ Billions 38% or $288 of the stimulus package is earmarked for tax relief. There are virtually no direct impacts for insurers. Secondary impacts could benefit auto and home insurers if consumer spending rises and real estate markets and residential construction improve. Business tax deductions geared toward firms with physical capital Sources: The Wall Street Journal 2/13/09; Speaker of the House; House Ways and Means Committee; Senate Finance Committee; Insurance Information Institute.

  24. U.S. Economic $787B Stimulus Package: Major Aid Components $ Billions 38% or $288B of the stimulus package is earmarked for aid, mostly to the states. It is the largest component of the package and the least likely to have any stimulus impact. There is virtually no direct or indirect benefit to p/c insurers, other than making ongoing funding available for public works projects. Most of the dollars will plug state budget gaps. Sources: The Wall Street Journal 2/13/09; Speaker of the House; House Ways and Means Committee; Senate Finance Committee; Insurance Information Institute.

  25. U.S. Economic $787B Stimulus Package: Major Aid Components $ Billions 38% or $XXX.X of the stimulus package is earmarked for aid, mostly to the states. It is the largest component of the package and the least likely to have any stimulus impact. There is virtually no direct or indirect benefit to p/c insurers, other than making ongoing funding available for public works projects. Most of the dollars will plug state budget gaps. Sources: The Wall Street Journal 2/13/09; Speaker of the House; House Ways and Means Committee; Senate Finance Committee; Insurance Information Institute.

  26. State-by-State Infrastructure SpendingBigger States Get More, Should Benefit Commercial Insurer Exposure

  27. Infrastructure Stimulus Spending by State (Total = $38.1B) Sources: USA Today, 2/17/09; House Transportation and Infrastructure Committee; the Associated Press.

  28. Infrastructure Stimulus Spending By State: Top 25 States ($ Millions) Infrastructure spending is in the stimulus package total $38.1B, allocated largely by population size Sources: USA Today 2/19/09; House Transportation and Infrastructure Committee; the Associated Press.

  29. Infrastructure Stimulus Spending By State: Bottom 25 States ($ Millions) Infrastructure spending is in the stimulus package total $38.1B, allocated largely by population size Sources: USA Today 2/19/09; House Transportation and Infrastructure Committee; the Associated Press.

  30. Expected Number of Jobs Gained or Preserved by Stimulus SpendingLarger States = More JobsWorkers Comp Benefits

  31. Estimated Job Effect of Stimulus: Jobs Created/Saved By State = 3.5 Mill Total Sources: http://www.recovery.gov/; Council of Economic Advisers; Insurance Information Institute.

  32. Estimated Job Effect of Stimulus Spending By State: Top 25 States (Thousands) The economic stimulus plan calls for the creation or preservation of 3.5 million jobs, allocated roughly in proportion to the size of the state’s labor force Sources: http://www.recovery.gov/; Council of Economic Advisers Insurance Information Institute.

  33. Estimated Job Effect of Stimulus Spending By State: Bottom 25 States (Thousands) The economic stimulus plan calls for the creation or preservation of 3.5 million jobs, allocated roughly in proportion to the size of the state’s labor force Sources: http://www.recovery.gov/; Council of Economic Advisers Insurance Information Institute.

  34. Stimulus: Reading The Economic Tea Leaves for the Next 4 to 8 Years • Growing Role of Government: 2009 Stimulus Package and Other Likely Spending Initiatives Guarantee that 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 • Health Care • Education • Aging/New Infrastructure • Aid to States • Stimulus is Only One Leg of the Stool • (1) Stimulus; (2) Housing, and (3) Financial Services Reform Source: Insurance Information Institute

  35. FINANCIAL STRENGTH & RATINGSIndustry Has Weathered the Storms Well

  36. 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

  37. 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.

  38. 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;

  39. Critical Differences Between P/C Insurers and BanksSuperior Risk Management Model & Low Leverage Makea Big Difference

  40. 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 38 banks have gone under as of 2/13) • 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 Institute

  41. 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 claimsThere 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

  42. The Financial Crisis in PerspectiveBank vs. Insurer Impacts

  43. 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.

  44. US Bank Failures:* 1995-2009** Through February 20, 2009 Bank failures are up sharply. 39 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 Feb. 20. Source: FDIC: http://www.fdic.gov/bank/historical/bank/index.html; Insurance Info. Institute

  45. 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.

  46. P/C INSURANCE FINANCIAL PERFORMANCEA Resilient Industry in Challenging Times

  47. ProfitabilityHistorically Volatile

  48. 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.

  49. 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.

  50. 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.