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The Price-Gouging Insurance Industry: Economic Windfall or Meltdown?

Debunking urban legends of the hard market in insurance industry, focusing on rising premiums due to various factors like investment losses and terrorism. Data analysis and insights provided.

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The Price-Gouging Insurance Industry: Economic Windfall or Meltdown?

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  1. Rising Premiums:Economic Windfall or Insurance Industry Meltdown?The Legend of the Price-Gouging Insurer Casualty Actuaries of Greater New York New York, NY June 11, 2003 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 • Overview • URBAN LEGENDS OF THE HARD MARKET • Insurers are Making a Killing • Commercial Insurance is More Expensive than Ever • Rate Hikes are to Make Up for 9/11 Losses • Rate Hikes are Mostly Due to Bad Investments • There’s No Connection Between Litigiousness & Rates • Insurers are Drowning in Capital • Insurers are “Redlining” Businesses post-9/11 • The Terrorism Problem is Fixed • Investors are Satisfied with P/C Stock Performance • Q&A

  3. PRICING:Past, Present & Future

  4. Average Price Change of Commercial Insurance Renewals (Pre-9/11) Source: Conning

  5. Council of Insurance Agents & Brokers Rate Survey First Quarter 2003 Rate Increases By Line of Business No Change Up 1-10% 10-20% 20-30% 30-50% 50%-100% >100% Comm. Auto 8% 23% 40% 19% 5% 0% 0% Workers Comp 7% 20% 35% 23% 7% 2% 0% General Liability 7% 23% 42% 20% 3% 0% 0% Comm. Umbrella 4% 12% 28% 27% 15% 8% 1% D&O 3% 6% 25% 28% 15% 8% 2% Comm. Property* 8% 24% 35% 17% 4% 0% 0% Construction Risk 7% 5% 27% 23% 16% 3% 0% Terrorism 13% 17% 19% 10% 2% 1% 1% Business Interr. 13% 33% 28% 7% 1% 0% 0% Surety Bonds 9% 14% 19% 10% 4% 0% 2% Med Mal 2% 2% 5% 8% 18% 14% 8% *9% of respondent reported a decline.

  6. DEBUNKING URBAN LEGENDS OF THE HARD MARKET

  7. Legend #1:Insurers are Exploiting the Current Hard Market and Making a Killing

  8. P/C Net Income After Taxes1991-2002 ($ Millions) • 2001 was the first year ever with a full year net loss • 2002 ROE = 1.0% Sources: A.M. Best, ISO, Insurance Information Institute.

  9. ROE: P/C vs. All Industries 1987–2003F There is an enormous gap between the p/c industry’s rate of return and that of most major industry groups Source: Insurance Information Institute; Fortune

  10. ROE vs. Cost of Capital: US P/C Insurance:1991 – 2002 There is an enormous gap between the industry’s cost of capital and its rate of return 14.6 pts 10.2. pts US P/C insurers have missed their cost of capital by an average 6.9 points since 1991 Source: The Geneva Association, Ins. Information Inst.

  11. Underexposed:The Economic Cycle Hurts Exposure Growth

  12. Real GDP Growth Economy continues to experience uneven growth following the recession of 2001 Source: US Department of Commerce, Blue Economic Indicators 6/03, Insurance Information Institute.

  13. Impact of Recession on P/C Premiums and Profitability (1970-2001) *GAAP return on equity, adjusted for inflation; Bank data 1952-2001; Div. Fin. 1987-2001 Source: Insurance Information Institute

  14. Unemployment Rate (%) Unemployment The unemployment rate is expected to rise slightly in 2003, harming WC exposure growth. Source: US Bureau of Labor Statistics; Blue Chip Economic Indicators (6/03), Insurance Info. Institute.

  15. Exposure: Employment, Wages & Salaries Disbursements ($Billions) Employment (Millions) Sources: Bureau of Labor Statistics, Bureau of Economic Analysis, Blue Chip Economic Indicators, Insurance Information Institute.

  16. Private Non-Residential Investment (Real, $1996) Commercial exposure growth is slowing as corporations cut back on capital spending Billions (US$) *Annualized based on first quarter data. Source: U.S. Bureau of Economic Analysis, Insurance Information Institute

  17. New Private Housing Starts(Millions of Units) New Private Housing Starts • Housing market remain strong. • Virtually no exposure impact for insurers Source: US Department of Commerce; Blue Chip Economic Indicators (5/03), Insurance Info. Institute

  18. Motor Vehicle Retail Sales (Millions of Units) New Motor Vehicle Sales Sales of automobiles remain relatively strong despite the weak economy. There is little adverse exposure impact on auto insurers. Source: US Department of Commerce; Insurance Information Institute; Blue Chip Economic Indicators as of May 2003.

  19. Legend #2:Insurance is More Expensive than Ever and is Squeezing Businesses and Families Alike

  20. Insurance is the Biggest Concern of Small Business Owners Source: National Federation of Independent Business (February 2003); Insurance Information Institute

  21. Commercial Lines Net Written Premium as % of GDP Commercial insurance premiums as a % of GDP fell 35% between 1988 and 2000 and remains far below late 1980’s levels More Cover for Less Money: Terms & conditions broadened significantly during the soft market, even as prices fell Sources: Insurance Information Institute, calculated from U.S. Bureau of Economic Analysis and A.M. Best data.

  22. Cost of Risk per $1,000 of Revenues: 1990-2002E • Cost of risk to corporations fell 42% between 1992 and 2000 • Estimated 15% increase in 2001, 25% in 2002 Cost of risk is still less than it was a decade ago! Source: 2001 RIMS Benchmark Survey; Insurance Information Institute estimates.

  23. Homeowners Insurance Expenditure as a % of Median Home Price The cost of homeowners insurance relative to the price of a typical home has fallen! HO Expenditure as % of Sales Price Median Home Sales Price *As of January 2003. Source: Insurance Information Institute calculations based on data from National Association of Realtors, NAIC.

  24. Legend #3:Insurers are Raising Rates to Make up for 9/11 Losses

  25. 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% 2001-03F: 9.2% Note: Shaded areas denote hard market periods. Source: A.M. Best, Insurance Information Institute

  26. Underwriting Gain (Loss)1975-2002 $ Billions P-C insurers paid $30.5 billion more in claims & expenses than they collected in premiums in 2002 Source: A.M. Best, Insurance Information Institute

  27. P/C Industry Combined Ratio Combined Ratios 1970s: 100.3 1980s: 109.2 1990s: 107.7 2000s: 111.0 2001 = 115.7 2002 = 107.2 2003F = 103.2* *Based on III Earlybird Survey, February 2003. Sources: A.M. Best; III

  28. Combined Ratio: Reinsurance vs. P/C Industry • 2001’s combined ratio was the worst-ever for reinsurers; 2003 was bad as well. • 2003: Big improvement in Q1 • Light weather helped Q1:03 *First quarter 2003 estimate from RAA. Source: A.M. Best, ISO, Reinsurance Association of America, Insurance Information Institute

  29. 12% After Tax ROE Requires Underwriting Profit Combined Ratio is 10-15 pts. too high Source: Dowling & Partners; Insurance Information Institute

  30. U.S. InsuredCatastrophe Losses $ Billions CAT losses continue to be a problem, though 2002 was much better than 2001 *Estimate through May 2003. 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. Source: Property Claims Service/ISO; Insurance Information Institute

  31. P/C Insurance Industry Prior Year Reserve Development* Adverse reserve development of about $23 billion accounted for most of the industry’s 2002 underwriting loss and “ate” much of the industry’s $37 billion increase in earned premiums *Negative numbers indicate favorable development; positive figures represent adverse development. Source: A.M. Best, Morgan Stanley, Dowling & Partners Securities

  32. Med Claim Costs Rising Sharply Health care inflation is affecting the cost of medical care, no matter what system it is delivered through Source: NCCI; William M. Mercer, Insurance Information Institute.

  33. Legend #4:Insurers’ Reckless Investment Strategies are the Primary Reason Why Rates are Rising Today

  34. Net Investment Income Investment income in 2002 fell 2.8% due primarily to historically low interest rates -$4.8 Billion Billions (US$) History 1997 Peak = $41.5B • = $40.7B • = $37.7B • = $36.7B Source: A.M. Best, Insurance Information Institute

  35. Interest Rates: Lower Than They’ve Been in Decades • Historically low interest rates are the primary driver behind lower investment yields. Nevertheless, overall insurer investment performance outpaces all major market indices and almost every major category of mutual fund. • 66% of the industry’s invested assets are in bonds *As of April 21, 2003. Source: Board of Governors, Federal Reserve System; Insurance Information Institute

  36. Total Returns for Large Company Stocks: 1970-2003* S&P 500 up 13.2% so far this year • 2002 was 3rd consecutive year of decline for stocks • Will it be the last? *As of June 6, 2003. Source: Ibbotson Associates, Insurance Information Institute

  37. P/C Industry Investments,by Type (as of Dec. 31, 2001) Common stock accounts for about 1/5 of invested assets Bond Holdings, by Type Industrial & Misc. 32.5% Special Revenue 30.5% Governments 18.0% States/Terr/Other 15.4% Public Utilities 3.1% Parents/Subs/Affiliates 0.5% Source: A.M. Best, Insurance Information Institute

  38. Property/Casualty Insurance Industry Investment Gain* Investment gains are simply returning to “pre-bubble” levels *Investment gains consists primarily of interest, stock dividends and realized capital gains and losses. Source: Insurance Services Office; Insurance Information Institute estimate annualized as of 9/30/02.

  39. Crisis in Corporate Governance Affecting Even Blue Chip Portfolios • Crisis has affected both equity and bond markets

  40. Legend #5:There is No Relationship Between Litigiousness and Rising Insurance Costs(A Trial Lawyer Favorite)

  41. TORT-ure • Asbestos • “Toxic” Mold • Medical Malpractice • Construction Defects • Lead • Fast/Fattening Foods & Obesity • Dietary Supplements (e.g., Ephedra) • Reality TV • Arsenic Treated Lumber • Guns • Genetically Modified Foods (Corn) • Pharmaceuticals & Medical Devices • Security exposures (workplace violence, post-9/11 issues) • Slavery • What’s Next? SARS?? New New

  42. Average Jury Awards1994 vs. 2001 *Figure is for 2000 (latest available) Source: Jury Verdict Research; Insurance Information Institute.

  43. Trends in Million Dollar Verdicts* Very sharp jumps in multi-million dollar awards in recent years across virtually all types of defendants *Verdicts of $1 million or more. Source: Jury Verdict Research; Insurance Information Institute.

  44. Cost of U.S. Tort System($ Billions) Tort costs consumed 2.0% of GDP annually on average since 1990, expected to rise to 2.4% of GDP by 2005! Per capita “tort tax” expected to rise to $1,000 by 2005, up from $721 in 2001 Even a modest reduction in tort costs would be more stimulative than the $674 billion Bush tax/spending plan Source: Tillinghast-Towers Perrin. 2005 forecasts from Tillinghast.

  45. Personal, Commercial & Self (Un) Insured Tort Costs* Total = $157.7 Billion Total = $120.2 Billion Billions Total = $39.5 Billion *Excludes medical malpractice Source: Tillinghast-Towers Perrin

  46. Who Will Pay for the US Asbestos Mess? Estimated Total US Settlements & Expenses = $200 billion $78 billion $60 billion $62 billion Source: Tillinghast-Towers Perrin; Insurance Information Institute

  47. Medical Malpractice: Tort Cost Growth is Skyrocketing • Over the period from 1990 through 2000, medical malpractice tort costs rose 140%, more than double the 60% increase in medical costs generally over the same period! • Over the period from 1975 through 2000, medical malpractice tort costs skyrocketed by 1,642% while medical costs generally rose 449%, nearly 4 times as fast! Sources: Tillinghast-Towers Perrin, US Bureau of Labor Statistics, Insurance Information Institute

  48. CALIFORNIA Alameda County Los Angeles County San Francisco County TEXAS Jefferson County Hidalgo County Starr County City of St. Louis, MO Mississippi’s 22nd Judicial District Madison County, IL MIAMI Orleans Parish, LA The Nation’s Judicial Hellholes:An International Embarrassment Source: American Tort Reform Association; Insurance Information Institute

  49. Average Cost per $1 Million Liability Coverage2001 vs. 2002 Excess litigiousness is raising the cost of liability coverage for businesses of all sizes Source: Marsh, 2002 Limits of Liability Report

  50. Average Total Limits Purchased by All Firms* ($ Millions) Limits purchased fell by 9.9% between 2000 and 2002. Price/capacity are issues. *Includes underlying primary limits Source: Limits of Liability 2002, Marsh, Inc.

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