Overview

1
Overview Outlook for the P/C and Ocean Marine
Insurance Markets

• American Institute of Marine Underwriters
• New York, NY
• April 28, 2003

Robert P. Hartwig, Ph.D., CPCU, Senior Vice
President Chief Economist Insurance Information
Institute ? 110 William Street ? New York, NY
10038 Tel [phone] ? Fax [phone]
? bobh_at_iii.org ? www.iii.org
2
Presentation Outline

• Profit Woes
• Underwriting Performance
• Reserving Issues
• (In)Solvency Issue Reinsurance Concerns
• Pricing Discipline
• Scarcity of Capital
• Nightmare on Wall Street
• Abuse of the Civil Justice System
• (Dis)Honorable Mentions

3
IMPROVING PROFITABILITY
4
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.
5
ROE P/C vs. All Industries 19872003F
There is an enormous gap between the p/c
industrys rate of return and that of most major
industry groups
Source Insurance Information Institute Fortune
6
ROE vs. Cost of Capital US P/C Insurance 1991
2002
There is an enormous gap between the industrys
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.
7
IMPROVING UNDERWRITING
8
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
9
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
10
Combined Ratio Reinsurance vs. P/C Industry

• 2001s combined ratio was the worst-ever for
  reinsurers
• 2002 was bad as well
• Clearly pressure on reinsurers to improve
  performance

Source A.M. Best, ISO, Reinsurance Association
of America, Insurance Information Institute
11
HOW DOES THIS HARD MARKET STACK UP TO PREVIOUS
HARD MARKETS?
12
Strength of Recent Hard Markets by Real NWP Growth
1975-78
1985-87
2001-03
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
13
GDP Growth vs. Net Written Premium Growth
(1987100)
Hard Market
17.6 pts
The gap between cumulative GDP and Net Written
Premium growth hit a maximum of 52.5 pts or 33.7
in 2000. In 2003, the estimated gap is 17.4 pts
or 8.1.
52.5 pts
Note Shaded area denotes hard market. Source
Insurance Information Institute
14
OCEAN MARINE
15
Combined RatioOcean Marine vs. Commercial Lines
Source A.M. Best, American Inst. Of Marine
Underwriters, Insurance Information Institute
16
Change in Net Premiums WrittenOcean Marine vs.
Commercial Lines
Source A.M. Best, American Inst. Of Marine
Underwriters, Insurance Information Institute
17
Real GDP Growth
Economy continues to experience uneven growth
following the recession of 2001 (first recession
since 1990/91)
Source US Department of Commerce, Blue Economic
Indicators 4/03, Insurance Information Institute.
18
Are Ports Vulnerable to Terrorist Attack?

• Top 3 US Ports
• Port of Long Beach
• Port of Los Angeles
• Port of New York/NJ
• 361 coastal inland ports in U.S.
• 5.7 million containers passed through US ports
  in2001, compared to 2.7 in 1989
• Fewer than 2 of containers inspected
• More than 500,000 container packers around world
• GAO Cargo volume doubled but no increase in
  inspection staff
• Multi-agency oversight Coast Guard, Dept. of
  Agriculture, FDA, INS

Source Newsday Jan. 15, 2002 Insurance
Information Institute, from US Customs Service,
Port of NY/NJ, American Association of Port
Authorities.
19
Some Ports are Adopting Security Improvements

• Many people seem to fear port exposure
• New York, Norfolk, Charleston, Ft. Lauderdale,
  Los Angeles, Seattle all cited as making progress
• Canadian Exposure 3 million containers travel
  in/out of Canada each year valued at C70 billion
• 27 of the 1.5 million containers imported into
  Canada wind up in the US

Source Wall Street Journal April 21, 2003
Insurance Information Institute, from US Coast
Guard
20
DEALING WITHRESERVING ISSUES
21
Reserve Deficiency, by Line(AY 1992-2001, as of
12/01)
Estimated Deficiency Total Excluding AE 64
Billion AE Deficiency 55 Billion Total
Including AE 120 Billion
Occurrence and claims made Source Morgan Stanley
22
Combined RatioImpact of Reserve Changes (Points)
Adverse reserve development of nearly 30 billion
accounted for most of the industrys 2002
underwriting loss and ate about 80 of the
industrys 37 billion increase in earned premiums
Source ISO, A.M. Best, MorganStanley.
23
(IN)SOLVENCY CONCERNS
24
P/C Company Insolvency Rates,1993 to 2002

• Insurer insolvencies are increasing
• 10-yr industry failure rate 0.72
• Failure rating for B or better rating 0.49
• Failure rate for D through B rating 1.29

10-yr Failure Rate 0.72
38
30
30
Source A.M. Best Insurance Information
Institute
25
Reason for P/C Insolvencies(218 Insolvencies,
1993-2002)
Reserve deficiencies account for more than half
of all p/c insurers insolvencies
Source A.M. Best, Insurance Information
Institute
26
Reinsurance Recoverables as of Total Assets are
Rising
Top 20 cedents to 2 of the most troubled
reinsurers had 4.7B in exposure as of 12/31/01
Source Company data, Williams Capital
27
Ratings Downgrades Swarms of Downgrades
Stinging Insurers

• Reasons for Recent Downgrades
• of Insurers Worldwide
• Asbestos
• Reserve Deficiencies
• Management Issues (e.g., transitions)
• Reinsurance Uncollectibles
• Investment Write-Downs
• Adverse Development
• Missed/Shifting Earnings Targets

28
ACHIEVING MAINTAINING PRICE DISCIPLINE
29
Growth in Net Premiums Written (All P/C Lines)
2001 8.1 2002 14.1 2003 12.2 (forecast)
The underwriting cycle went AWOL in the
1990s. Its Back!
Estimate/forecast based on January 2003 III
survey of industry analysts. Source A.M. Best,
Insurance Information Institute
30
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 gt100 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 DO 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.
31
Rate On Line Index(1989100)
Prices rising, limits falling ROL up
significantly
Source Guy Carpenter III Estimate
32
Urban Legend Insurance is More Expensive than
Ever and is Putting Companies Out of Businesses
33
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 1980s 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.
34
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.
35
ATTRACTING AND RETAINING SCARCE CAPITAL
36
Policyholder Surplus 1975-2002

• Surplus (capacity) peaked at 336.3 Billion in
  mid-1999 and fell by 15.2 (51 billion) to
  285.2 billion since then.
• Surplus is now lower than at year-end 1997.

51 Billion
Billions
Surplus is a measure of underwriting capacity.
It is analogous to Owners Equity or Net Worth
in non-insurance organizations
Source A.M. Best, Insurance Information
Institute
37
Global P/C Insurance Capacity is Falling
Dramatically
Global non-life capacity is down 25 over the
past 2 years
Sources Insurance Information Institute, Swiss Re
38
THE NIGHTMARE ON WALL STREET
39
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
40
Interest Rates Lower Than Theyve 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 industrys invested assets are in bonds

As of April 21, 2003. Source Board of
Governors, Federal Reserve System Insurance
Information Institute
41
Total Returns for Large Company Stocks 1970-2003

• 2002 was 3rd consecutive year of decline for
  stocks
• Will 2003 be the 4th?

As of April 22, 2003. Source Ibbotson
Associates, Insurance Information Institute
42
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
43
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.
44
TORT-ureABUSE OF THE U.S. CIVIL JUSTICE SYSTEM
45
Average Jury Awards1994 vs. 2001
Figure is for 2000 (latest available) Source
Jury Verdict Research Insurance Information
Institute.
46
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.
47
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.
48
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
49
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
50
Glimmer of Hope?Reigning-In Punitives
In BMW of North America v. Gore (1996)the Supreme
Court ruled in an Alabama case that punitive
awards that were 500 to 1 were excessive (actual
damages in the case, which involved the
repainting of a car, were 4,000 but the jury
awarded the plaintiff 2 million)
In Campbell v. State Farm (2003) the Supreme
Court ruled in a 22-year old Utah case that
punitive awards that were 145 to 1 were excessive
(actual damages in the case, which involved
insurer bad faith were 1 million)
In Campbell v. State Farm the Court added that
few awards exceeding a single- digit ratio
between punitive and compensatory damages will
satisfy due processSingle digit multipliers are
more likely to comport with due process, still
achieving the States deterrence and retribution
goals
Sources Insurance Information Institute
51
(DIS)HONORABLE MENTIONS
AsbestosTerrorismCrisis in Corporate
GovernanceToxic Mold
52
AsbestosWho Will Pay for the Asbestos Mess?
Estimated Total US Settlements Expenses 200
billion
78 billion
60 billion
62 billion
Source Tillinghast-Towers Perrin Insurance
Information Institute
53
TerrorismSept. 11 Industry Loss Estimates(
Billions)
Consensus Insured Losses Estimate 40.2B Source
Insurance Information Institute
54
Industry Losses Under Proposed Federal Backstop
Using 9/11 Scenario(as interpreted on date of
enactment, Nov. 26, 2002)
Total Ind. Loss
14.25B
19.675B
10.875B
0.925B Industry Co-Share
1.75B Industry Co-Share
2.0B Industry Co-Share
0.125B Industry Co-Share
Assumes 30B Commercial Prop WC Loss, 125B At
Risk Commercial DPE
Source Insurance Information Institute.
55
Crisis in Corporate Governance When Will it All
End?

• Enron was tip of an iceberg
• Insurance and Investment Risk

56
Shareholder Class Action Lawsuits
Securities fraud suits filed in U.S. federal
courts. Suits of 100 million or more. Source
Stanford University School of Law Insurance
Information Institute
57
Financial Restatements Filed
The number of financial restatements is rising
even thought the number of publicly traded
companies is falling.
Sources Huron Consulting Group insurance
Information Institute
58
MoldDocumented Toxic Mold Suits
1,000 Cases
5,000 Cases
2,000 Cases
2,000 Cases
Source www.toxlaw.com Guy Carpenter
59
MOLDAnnual Losses from Mold Claims in TX
Millions
Mold claim costs rose 612 between 1999 and 2002
Source Texas Department of Insurance 2002 III
estimate is annualized figure based on data
through September 2002.
60
Summary

• No cure for CEO insomnia in sight
• Economics of the industry suggest hard market
  should continue into 2004
• If it doesnt, it will end badly for some
  insurers
• Combined ratio remains unacceptably high given
  current investment environment
• Profit Troll Eats virtually entire top line
  improvement, eviscerating the bottom line
• Reserve hangover still enormous
• US courts still out of control
• Hopes for significant tort reform probably too
  high
• 2003 is do or die year for some companies

61
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62
Combined RatioInland Marine vs. Commercial Lines
Source A.M. Best, Insurance Information
Institute
63
Change in Net Premiums WrittenInland Marine vs.
Commercial Lines
Source A.M. Best, Insurance Information
Institute
64
Inland Marine Better Than Most, but Challenges
Remain

• Trucking Market Bad Results ? Reduced Capacity
• Weak economy ? Low or negative exposure growth
• 2002 renewal up 15 30 for many trucking cos.
• Cargo Theft Cost 3.5B to 12B annually
  (American Trucking Association/Natl. Cargo
  Security Council)
• Cargo Very vulnerable to terrorism threat
• Hundreds of thousands of points of entry to
  system globally
• Fine Art/Collectibles
• Market hardening pre-9/11
• Post-9/11 even more difficult