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Insurance Information Institute March 2006

Personal Lines Insurance: Overview & Outlook Pillars of Profitability & Drivers of Revenue, Cost, Profit & Competition. Insurance Information Institute March 2006. Robert P. Hartwig, Ph.D., CPCU, Senior Vice President & Chief Economist

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Insurance Information Institute March 2006

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  1. Personal Lines Insurance:Overview & OutlookPillars of Profitability &Drivers of Revenue, Cost,Profit & Competition Insurance Information Institute March 2006 Robert P. Hartwig, Ph.D., CPCU, Senior Vice President & Chief Economist Insurance Information Institute 110 William Street New York, NY 10038 Tel: (212) 346-5520 Fax: (212) 732-1916 bobh@iii.org  www.iii.org

  2. Presentation Outline • P/C Profit Overview • Auto & Home • Public Perceptions of the P/C Insurance Industry • The Six Pillars of P/C Profitability • Underwriting • Pricing • Investments • Expenses • Leverage (Capacity) • P/C Operating Environment: Tort Focus • Catastrophe Loss Management • Auto Insurance: Drivers of Success • Homeowners Insurance: The Jury’s Still Out • Insurance-to-Value

  3. P/C PROFIT OVERVIEW2006 Outlook is Good

  4. Highlights: Property/Casualty,9-Mos. 2005 vs. 9-Mos. 2004 Growth rate barely 1/2 that of CY2004 Investment Income Rebound? Lowest in many years Source: ISO, Insurance Information Institute *Comparison is with year-end 2004 value.

  5. P/C Net Income After Taxes1991-2005:Q3 ($ Millions) • 2001 ROE = -1.2% • 2002 ROE = 2.2% • 2003 ROE = 8.9% • 2004 ROE = 9.4% • 2005E ROAS = 9.0%** 2005 NIAT will probably be on par with 2004 *ROE figures are GAAP; 2005 figure is annualized based on 9-month results. **Return on avg. surplus. Sources: A.M. Best, ISO, Insurance Information Institute.

  6. Strength of Recent Hard Markets by NWP Growth* 1975-78 1984-87 2001-04 2006-2010 (post-Katrina) period will resemble 1993-97 (post-Andrew) 2005: biggest real drop in premium since early 1980s Note: Shaded areas denote hard market periods. Source: A.M. Best, Insurance Information Institute *2005-10 figures are III forecasts/estimates.

  7. Advertising Expenditures by P/C Insurance Industry, 1999-2004 Ad spending by P/C insurers is at a record high, signaling increased competition Source: Insurance Information Institute from consolidated P/C Annual Statement data.

  8. ROE: P/C vs. All Industries 1987–2006F* 2006 Estimate = 13% 2005:H1 P/C ROAS = 15.3% 2005 P/C ROAS = 9% after adjusting for 2005 Hurricanes *GAAP ROEs except 2005 P/C figure = return on average surplus. 2005/6E figure is III full-year estimate. Source: Insurance Information Institute; Fortune for all industry figures

  9. ROE: P/C vs. All Industries 1987–2005E 2004/5 ROEs excl. hurricanes Sept. 11 Hugo Katrina, Rita, Wilma Lowest CAT losses in 15 years Andrew Northridge 4 Hurricanes Source: Insurance Information Institute; Fortune

  10. RETURN ON EQUITY (Fortune):Stock & Mutual vs. All Companies* Stock insurer ROEs consistently above mutuals Some mutual insurers sell/market the mutuality concept effectively *Fortune 1,000 group. Source: Fortune Magazine, Insurance Information Institute.

  11. RNW for Major P/C Lines,1994-2003 Average 10-Year returns for some major p/c lines surprisingly good, but HO is a major laggard Source: NAIC; Insurance Information Institute

  12. WALL STREET:GENERALLY STRONG GAINS

  13. P/C Insurers Stocks Up in 2005, Brokers Up Too, Reinsurers Down Total 2005 Returns P/C insurer stocks outperforming the market despite hurricanes Brokers up on tight market hopes Reinsurers lagging on record CAT losses Source: SNL Securities, Standard & Poor’s, Insurance Information Institute

  14. Change in YTD Stock Performance by Sector Pre- & Post-Katrina/Rita/Wilma P/C & reinsurer stocks hurt but now fully recovered. Brokers rose on expectation of tighter conditions and demand for broker services; closure of Spitzer issues. Katrina: Aug. 29 Rita comes ashore Sept. 24 Wilma landfall Oct. 24 Source: SNL Securities; Insurance Information Institute

  15. Insurance Stocks Off to a Slow Start in 2006 Total YTD Returns Through February 17, 2006 Source: SNL Securities, Standard & Poor’s, Insurance Information Institute

  16. PUBLIC PERCEPTIONS OF INSURANCE INDUSTRYHave Public Perceptions of the Industry Been Affected by Mega-Disasters and Scandals

  17. Percent of Public Rating Industry as Very or Mostly Favorable, 1968-2005 Favorable ratings of insurers dropped just 1 point after Katrina Source: Insurance Information Institute Pulse Survey, December 2005.

  18. Public Perceptions of Hurricane Katrina Response Adequacy Don’t Know Best Worst Source: Insurance Information Institute Pulse Survey, December 2005.

  19. Who Should be Responsible for Dealing With Katrina? House Special Committee: Chertoff performed his duties “late, inefficiently or not at all.” -2/15/05. Most people believe governments, not insurers, are primarily responsible for dealing with Katrina Source: Insurance Information Institute Pulse Survey, December 2005.

  20. Profit Pillar #1UNDERWRITINGSurprisingly Strong in 2005, Stage is Set for a Good 2006

  21. P/C Industry Combined Ratio January survey of analysts called for a 101.8 combined ratio in 2005, hurt by CATs and reserve charges. Actual 9-month results came in at 100.0. Expectation is for an underwriting profit in 2006 Sources: A.M. Best; ISO, III. *III estimate/forecast for 2005/6

  22. Personal LinesCombined Ratio, 1993-2006E A very strong 2006 is expected in personal lines assuming “normal” catastrophe loss activity Source: A.M. Best; Insurance Information Institute. 2006 forecast from Fitch Ratings as of 12/7/05.

  23. A 100 Combined Ratio Isn’t What it Used to Be: 95 is Where It’s At Combined ratios today must be below 95 to generate Fortune 500 ROEs * 2005 figure is return on average statutory surplus based in first 9 monhts data Source: Insurance Information Institute from A.M. Best and ISO data.

  24. Underwriting Gain (Loss)1975-2006F* $ Billions Before Katrina, p/c insurers were on track for only the second underwriting profit in 27 years; U/W profit in 2006 likely. *2005 estimate is III estimate. Source: A.M. Best, Insurance Information Institute

  25. Combined Ratio: Reinsurance vs. P/C Industry Sept. 11 2004/5 Hurricanes HurricaneAndrew * All lines figure is full-year III estimate. RAA figure for 2005:9 mos. Source: A.M. Best, ISO, Reinsurance Association of America, Insurance Information Institute

  26. UNDERWRITING AFFECTS FINANCIAL STRENGTHIs There Causefor Concern?

  27. P/C Company Insolvency Rates,1993 to 2004 • Insurer insolvencies are increasing • 12-yr industry failure rate: 0.71% • Failure rating for B+ or better rating: 0.49%* • Failure rate for D through B rating: 1.29%* 12-yr Failure Rate = 0.71% 30 30 38 21 10 Source: A.M. Best; Insurance Information Institute *1993-2003

  28. Reason for P/C Insolvencies(218 Insolvencies, 1993-2002) Reserve deficiencies account for more than half of all p/c insurers insolvencies So far, Katrina appears to have claimed just 1 victim—Rosemont Re—expected to go into run-off Source: A.M. Best, Insurance Information Institute

  29. 2006 SRQ CAT Model Reqs.* All Property Exposure Auto Physical Damage Reinsurance Assumed Pools & Assessments All Flood Exposure WC Losses from Quake Fire Following Storm Surge Demand Surge Secondary Uncertainty ALSO “A.M. Best will perform additional “stress-tested” risk-adjusted capital analysis for a second event in order to determine the potential financial condition of an entity post a severe event.” IMPLICATION: Some insurers may be required to carry more capital to maintain the same rating. Ratings Agencies Tightening Requirements for CATs Best currently estimates PML for 100-yr. wind & 250-yr. quake to determine capital adequacy *SRQ = Supplemental Rating Questionnaire Source: A.M. Best Review & Preview, January 2006.

  30. Historical Ratings Distribution,US P/C Insurers, 2000 vs. 2005 2000 2005 A++/A+ shrinkage Ratings agencies increasing emphasis on multiple eventsrequire more capital Source: A.M. Best: Rating Downgrades Slowed but Outpaced Upgrades for Fourth Consecutive Year, Special Report,November 8, 2004 for 2000; 2006 Review & Preview for 2005 distribution. *Ratings ‘B’ and lower.

  31. P/C Company AIU Insurance Co. Alfa Mutual Ins. Co. Amica Mutual Ins. Co. Church Mutual Ins. Co. Federal Insurance Co. General Reinsurance Corp. Great Northern Ins. Co. Lititz Mutual Ins. Co. Nationwide Mutual Fire Co. Otsego Mutual Fire Quincy Mutual Fire Ins. Co. State Automobile Mutual Ins. Co. State Farm Mutual Automobile Ins. Co. Vigilant Insurance Co. Group Affiliation American International Group Alfa Insurance Group Amica Mutual Group None Chubb Group of Ins Cos. Berkshire Hathaway Ins. Group Chubb Group of Ins Cos. Lititz Mutual Group Nationwide Mutual Group None Quincy Mutual Group State Auto Ins. Group State Farm Group Chubb Group of Ins Cos. P/C Insurers Maintaining Rating of A+ or Better Rating for 50+ Years Source: Best’s Review, January 1, 2004.

  32. Underwriting Matters Because Pricing is Often Undisciplined

  33. Private Passenger AutoCombined Ratios, 1993-2005E Somebody remembered Somebody forgot there’s a relationship between price and underwriting performance Sources: Insurance Information Institute from A.M. Best and NAIC data; 2004/5 expenditure estimates from III.

  34. CATASTROPHE LOSS MANAGEMENTFailure to Adequately Manage this Risk Has Been Devastating

  35. Most of US Population & Property Has Major CAT Exposure

  36. U.S. InsuredCatastrophe Losses ($ Billions) $ Billions $100 Billion CAT year is coming soon 2005 was by far the worst year ever for insured catastrophe losses in the US, but the worst has yet to come. 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

  37. Insured Property Catastrophe Losses as % Net Premiums Earned, 1983–2005E US CAT losses were a record 14.3% of net premiums earned in 2005 and were 4.3 times the 1984-2004 average of 3.3%* *Insurance Information Institute estimate of 14.3% for 2005 based estimated 2005 DPE of $418.8B and estimated insured CAT losses of $60B. Sources: ISO, A.M. Best, Swiss Re Economic Research & Consulting; Insurance Information Institute.

  38. 2005 Was a Busy, Destructive, Deadly & Expensive Hurricane Season All 21 names were used for the first time ever, so Greek letters were used for the final 6 storms: Alpha though Zeta 2005 set a new record for the number of hurricanes & tropical storms at 27, breaking the old record set in 1933. Source: WeatherUnderground.com, January 18, 2006.

  39. Number of Major (Category 3, 4, 5) Hurricanes Striking the US by Decade 1930s – mid-1960s: Period of Intense Tropical Cyclone Activity Mid-1990s – 2030s? New Period of Intense Tropical Cyclone Activity 10 Tropical cyclone activity in the mid-1990s entered the active phase of the “multi-decadal signal” that could last into the 2030s Already as many major storms in 2000-2005 as in all of the 1990s *Figure for 2000s is extrapolated based on data for 2000-2005 (6 major storms: Charley, Ivan, Jeanne (2004) & Katrina, Rita, Wilma (2005)). Source: Tillinghast from National Hurricane Center: http://www.nhc.noaa.gov/pastint.shtm.

  40. Top 10 U.S. Cities for Hurricane Risk Source: AIR Worldwide

  41. Number of Hurricanes Directly and Indirectly Affecting the Northeast United States Since 1900 Hurricanes affect Northeast more commonly than presumed Source: New Hampshire Office of Emergency Management

  42. Inflation-Adjusted U.S. Insured Catastrophe Losses By Cause of Loss, 1985-2004¹ Insured disaster losses totaled $221.3 billion from 1984-2004 (in 2004 dollars). After 2005 season, tropical cyclones will account for about 45% of the total. 1 Catastrophes are all events causing direct insured losses to property of $25 million or more in 2004 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. Source: Insurance Information Institute estimates based on ISO data.

  43. Number of Tornados & Associated Deaths, 1985-2005p There appears to be an upward trend in the number of tornados, though not deaths. Detection Increase? Source: III from National Weather Service data.

  44. Total Value of Insured Coastal Exposure (2004, $ Billions) Source: AIR Worldwide

  45. Value of Insured Residential Coastal Exposure (2004, $ Billions) Source: AIR

  46. Insured Coastal Exposure as a % of Statewide Insured Exposure (2004, $ Billions) Source: AIR Worldwide

  47. The 2006 Hurricane Season:Preview to Disaster?

  48. Outlook for 2006 Hurricane Season *Average over the period 1950-2000. **As of December 4, 2005. Source: Dr. William Gray, Colorado State University, December 6, 2005.

  49. Probability of Major Hurricane Landfall (CAT 3, 4, 5) in 2006 *Average over past century. Source: Dr. William Gray, Colorado State University, December 6, 2005.

  50. Hurricanes Katrina, Rita & Wilma:Their Place in History

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