The Commercial PropertyCasualty Insurance Industry Today Overview

1
The Commercial Property/Casualty Insurance
Industry TodayOverview Outlook

• November 5, 2003
• Boston, MA

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

• P/C Insurance Overview
• Ratings, Solvency Reinsurance Issues
• P/C Macro Cost Drivers
• Investment Perfromance
• Capacity
• Pricing
• Economic Environment Commercial Exposure
• Workers Comp Overview
• Issue Potpourri
• QA

3
P/C FINANCIAL OVERVIEW
4
Highlights Property/Casualty First Half 2003
Comparison with year-end 2002
5
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
8.8
Note Shaded areas denote hard market
periods. Source A.M. Best, Insurance
Information Institute
2003 figure is estimate on first half result.
6
Commercial Insurance Share of P/C Market is Rising
Commercial Market Share 1993 52.7 1998
48.0 2002 52.9
Source A.M. Best Insurance Information Institute
7
P/C Net Income After Taxes1991-2003 ( Millions)

• 2001 was the first year ever with a full year net
  loss
• 2002 ROE 1.0
• 2003 ROE 9.7

First half 2003 Sources A.M. Best, ISO,
Insurance Information Institute.
8
ROE P/C vs. All Industries 19872003E
2003 p/c estimate based on first half
data. Source Insurance Information Institute
Fortune
9
ROE vs. Cost of Capital US P/C Insurance 1991
2003E
The gap between the industrys cost of capital
and its rate of return is narrowing
1.8 pts
14.6 pts
10.2 pts
US P/C insurers missed their cost of capital by
an average 6.9 points from 1991 to 2002
Source The Geneva Association, Ins. Information
Inst.
10
ROE Financial Services Industry Segments,
19872002
Source Insurance Information Institute,
Fortune, Value Line.
11
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 2003First Half 99.8
Based on First Half 2003 results.
Sources A.M. Best ISO, III
12
Underwriting Gain (Loss)1975-2003
Billions
Based on first half results, 2003 will likely be
a much better year in terms of underwriting
losses. First half losses totaled 2.71 billion
or 5.42 billion on an annualized basis
2003 figure of 5.42 billion is annualized based
on first quarter underwriting loss of 2.71
billion Source A.M. Best, Insurance Information
Institute
13
After-Tax ROE for Selected AY Combined Ratios
Assumes 4 tax-equivalent yield, 28 expense
ratio and 140 premium/surplus ratio Source
Dowling Partners Securities
14
Combined Ratio Reinsurance vs. P/C Industry

• 2001s combined ratio was the worst-ever for
  reinsurers 2003 was bad as well.
• 2003 Big improvement in first half

First half 2003 figures for full industry from
ISO 1st half reinsurance figures from
RAA. Source A.M. Best, ISO, Reinsurance
Association of America, Insurance Information
Institute
15
Commercial vs. Personal Lines Combined Ratios
10-Year Average Combined Ratios Commercial 111.1
Personal 105.2
Source A.M. Best Insurance Information Institute
16
Commercial Auto, CMP Workers Comp Combined
Ratios
10-Year Avg. Combineds Commercial Auto
110.3 CMP-Liability 118.1 WC 109.8
Includes State Funds. Source A.M. Best
Insurance Information Institute
17
WALL STREETHIGH EXPECTATIONS
18
Insurer Stocks Underperforming the SP 500
Total Return 2003 YTD Through October 31, 2003
Source SNL Securities, Insurance Information
Institute
19
RATINGS,SOLVENCY REINSURANCE ISSUES
20
Number of Insurer Upgrades vs. Downgrades, 1993
to 2003

• Downgrades have outpaced upgrades by nearly 41
  since 2000
• Are we at a peak?

North American insurance holding companies
through October 17, 2003 Source Standard Poors
21
North American Insurance Holding Company Rating
Distribution (as of Oct. 17, 2003)

• SP Outlooks
• Commercial Negative Sustain pricing? Reserves?
• Personal Stable Insufficient pricing
  momentum
• Reinsurance Negative Qty./Quality. of capital?
  Recoverables? Asbestos other prior-year
  liabilities?

Shift from AA and A to BBB and BB is
notable
Source Standard Poors
22
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
23
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
24
P/C Insurance Industry Prior Year Reserve
Development
Adverse reserve development of about 23 billion
accounted for most of the industrys 2002
underwriting loss and ate much of the
industrys 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
25
Combined RatioImpact of Reserve Changes (Points)
Adverse reserve development totaling an estimated
23 billion added more than 6 points to the p/c
combines ratio in 2002
Source ISO, A.M. Best, MorganStanley.
26
US P/C Net Net Reinsurance Recoverables as of
Adjusted PHS
Alarm over sharp increase in reinsurance
recoverables in 2002 to 41.5 of adjusted PHS
Source Reinsurance Association of America from
Thompson Financial OneSource database.
27
Percentage of Premiums Reinsured US All Lines
Slow but steady increase in cession rates
Source Reinsurance Association of America
28
Size Growth of Global Reinsurance Market vs.
US P/C
9.3
Global reinsurance premiums written is rising
faster than overall (US) market
14.3
17.9
34.0
2001 2002 2003E
2001 2002 2003E
Top 40 groups Note 2003 figures are III
estimates based on first half RAA results for
reinsurers and ISO figures for P/C. Source
Global Reinsurance Highlights 2003, ISO ,
Insurance Information Institute
29
PRICING IN COMMERCIAL MARKETS
30
Insurance is the Biggest Concern of Small
Business Owners
Source National Federation of Independent
Business (June 2003) Insurance Information
Institute
31
PRICINGCommercial Premium Rate Changes Highly
Cyclical

• Pricing power is ebbing
• Is moderation due to realization of performance
  and profit goals, increasing capacity/capital, or
  market share strategies?

Source MarketScout.com
32
Council of Insurance Agents Brokers Rate Survey
Third Quarter 2003
Premium Rate Changes By Line of Business
Down
1-10 No Change Up 1-10 10-20 20-30
30-50 50-100 Comm. Auto
12 14 42 30
0 0 0 Workers
Comp 10 17 31
21 8 2 2 General
Liability 9 21
39 24 4 1
1 Comm. Umbrella 6 17
27 33 11 4
0 DO 0
10 22 34 16
7 2 Comm. Property 24
26 28 9 2
1 0 Construction Risk 3
16 26 23 13
2 2 Terrorism 6
48 15 5
1 1 0 Business Interr.
11 33 34
8 2 0 0 Surety
Bonds 28 18
9 9 4 2
0 Med Mal 0
2 7 9 19
10 2
Source Council of Insurance Agents Brokers.
33
P/C Soft Spots Accounts With Negative Price
Change(2nd Qtr 2003)
Property
Casualty/Liability
Commercial property-related coverages are clearly
the softest segment of the p/c market today.
Source Council of Insurance Agents Brokers
Insurance Information Institute
34
P/C Soft Spots Accounts With Negative Price
Change(3rd Qtr 2003)
Property
Casualty/Liability
Some softness creeping into commercial casualty
segments
Source Council of Insurance Agents Brokers
Insurance Information Institute
35
Proportion of Accounts Renewing With Increase of
20 or More,(Select Lines)
Source Council of Insurance Agents and Brokers
Insurance Information Institute
36
Rate On Line Index(1989100)
Prices rising, limits falling ROL up
significantly
Source Guy Carpenter III Estimate
37
P/C COST DRIVERSMacro Factors
38
U.S. Policyholder Surplus 1975-2003

• Surplus (capacity) peaked at 336.3 Billion in
  mid-1999 and fell by 15.5 (52 billion) to
  284.3 billion at year-end 2002 (a trough?)
• Surplus during the first half of 2003 rose by
  28.2B or 9.9 to 312.5B

47 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 First Half
39
Shareholders FundsTop 40 Reinsurance Groups
Capital at Top 40 reinsurance groups fell 2.26
billion or 1.3 from 2001 to 2002
By net reinsurance premiums written. Source
Global Reinsurance Highlights 2003, Standard
Poors
40
Capacity of Lloyds Market

• After remaining stable at around GBP10bn, Lloyds
  capacity has increased by over 40 in the last
  three years.
• 2003 capacity is GBP14.4bn, 18 higher than 2002.

Source Lloyds
41
Number of Captive Formations Liquidations 1993
to 2002

• Hard market fueling captive formation
• Corporate collapses and captive consolidations
  fueled the upward trend in captive liquidations
  in 2002.

Source AM Best, Tillinghast-Towers Perrin
42
Net Investment Income
Investment income fell 2.8in 2002 but rose 2.1
in first half of 2003
-5.6 Billion
Billions (US)

• History
• 1997 Peak 41.5B
• 40.7B
• 37.7B
• 36.7B
• E 36.5B

Note 2003 estimate is based on annualized first
half investment income of 18.268
billion. Source A.M. Best, Insurance
Information Institute
43
Total Returns for Large Company Stocks 1970-2003
SP 500 up 19.4 so far this year

• 2002 was 3rd consecutive year of decline for
  stocks
• Will it be the last?

As of October 31 , 2003. Source Ibbotson
Associates, Insurance Information Institute
44
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 6/30/03.
45
U.S. InsuredCatastrophe Losses
Billions
Through October 2003, including 2B III estimate
for California wildfires. 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
46
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.
47
THE ECONOMIC ENVIRONMENTWEAK JOBLESS
RECOVERY IS (WAS?) BAD NEWS FOR COMMERCIAL
INSURERS
48
Real GDP Growth
Economy experienced weak growth following the
recession of 2001, strengthening now with
eventual positive impact on commercial exposure
growth.
Estimate/Forecast Source US Department of
Commerce, Blue Economic Indicators 10/03
Insurance Information Institute.
49
Change in Selected Componentsof GDP Growth (3rd
Qtr 2003)
Strong growth in durable goods fixed capital
investment should bode well for commercial
insurers
Source Bureau of Eocnomic Analysis, Third
quarter 2003.
50
Number of Employed Workers(Millions)
Employment rose by 57,000 in September 2003
2.76 Million Jobs Lost from Feb. 2001 Aug. 2003
Employment peaked at 132. 56 million in February
2001.
By August 2003, employment stood at 129.81
million, its lowest level since October 1999. Is
it a trough?
Source U.S. Bureau of Labor Statistics
Insurance Information Institute
51
Jobless Recovery of 2001-2003 Hurting Workers
Comp Exposure
Wage Salary Disbursement (Private Employment,
Billions)
1/80-7/80
7/81-11/82
7/90-3/91
3/01-11/01
Shaded areas represent recessions
III estimate based in data through September
2003. Source US Bureau of Economic Analysis
Insurance Information Institute.
52
Workers Comp Claim Frequency Costs vs. Real GDP
1/80-7/80
7/81-11/82
3/01-11/01
7/90-3/91
Shaded areas represent recessions
Source Insurance Information Institute, US
Department of Commerce, NCCI.
53
WORKERS COMPENSATION OPERATING ENVIRONMENT(full
presentation availableupon request)
54
WC Combined Ratios
2.9 pts due to 9/11
Includes dividends to policyholders Accident
year is developed to ultimate as 12/31/02 Note
CY figures from AM Best AY figures from NCCI
Source A.M. Best, NCCI
55
WC Net Premiums Written
Billions
III Estimate Source A.M. Best
56
WC Indemnity Claim Costs Has Accelerated Since
1995
Indemnity Claim Cost (000s)
Annual Change 1991-1995 0.3 Annual Change
1996-2002p 6.8
Based on data through 12/31/2001, developed to
ultimate, as of 12/2/2002 2002 data are
preliminary. Based on the states where NCCI
provides ratemaking services Excludes the effects
of deductible policies Source NCCI
57
WC Medical Claim Costs Accelerating Too
Medical Claim Cost (000s)
Annual Change 1991-1995 4.0 Annual Change
1996-2001 8.1
Based on data through 12/31/2001, developed to
ultimate, as of 12/2/2002 Based on the states
where NCCI provides ratemaking services Excludes
the effects of deductible policies Source NCCI
58
WC Medical Severity Rising Far Faster than
Medical CPI
WC medical severity is rising 2.7 times faster
than the medical CPI
7.3 pts
Sources Med CPI from US Bureau of Labor
Statistics, WC med severity from NCCI based on
NCCI states.
59
Med Costs Share of Total Costs is Increasing
Steadily
2002p
1992
1982
Source NCCI (based on states where NCCI
provides ratemaking services).
60
WC Residual Market Shares
Residual market plans/pools are nowhere near
where they were a decade ago
Source NCCI
61
Lost Time Claim Frequency Continues to Fall
Cumulative change since 1990 -38.8
Note NCCI states only Source NCCI
62
Workers Comp Indemnity (Wage Replacement) Costs
Higher in CA

• Wage replacement costs in California are 41.6
  above the US average

Source NCCI, WCIRB
63
Workers Comp Medical Costs are Much Higher in
California

• Medical costs in California are 129.8 above the
  US average

Source NCCI, WCIRB
64
LEGAL LIABILITY TORT ENVIRONMENT(full
presentation available upon request)
65
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.
66
Where the Tort Dollar Goes(2000)

• Tort System is extremely inefficient
• Only 20 of the tort dollar compensates victims
  for economic losses
• At least 58 of every tort dollar never reaches
  the victim

Source Tillinghast-Towers Perrin
67
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
68
THE U.S. LEGAL SYSTEMIS IT OUT OF
CONTROL?TRENDS, CONDITIONS OUTLOOK
69
TORT-ure

• Asbestos
• Silicosis
• Toxic Mold
• Medical Malpractice
• Construction Defects
• Lead
• Fast/Fattening Foods Obesity
• Reality TV
• Arsenic Treated Lumber
• Guns
• Genetically Modified Foods Labeling
• Generic Drugs, Pharmaceuticals Medical Devices
• Security exposures (workplace violence, post-9/11
  issues)
• Slavery

New
New
New
70
Business Leaders Ranking of Liability Systems for
2003

• Best States
• Delaware
• Nebraska
• Iowa
• South Dakota
• Indiana
• North Dakota
• Utah
• Virginia
• Minnesota
• New Hampshire

• Worst States
• New Mexico
• South Carolina
• Hawaii
• California
• Arkansas
• Texas
• Louisiana
• Alabama
• West Virginia
• Mississippi

Source US Chamber of Commerce States Liability
Systems Ranking Study Insurance Info. Institute.
71
The Nations Judicial Hellholes
Source American Tort Reform Association
Insurance Information Institute
72
Average Jury Awards1994 vs. 2001
Figure is for 2000 (latest available) Source
Jury Verdict Research Insurance Information
Institute.
73
Probability of Plaintiff Verdict is Rising
Source Jury Verdict Research, 2002 Current
Award Trends
74
There is Was a Glimmer of Hope for Tort Reform

• Best Chance for Tort Reform in Years
• Medical Malpractice
• Statesalready happening 20 states have caps
• Federal reform discussed in Congress but bill
  failed in Senate
• Class Action Reform
• Class Action Fairness Act
• Presently 2 or 3 votes short in the Senate.
  Failed by 1 Vote 10/22
• Asbestos Reform
• Fairness in Asbestos Injury Resolution of 2003
  Failed! 2004??
• Punitive DamagesWhats Reasonable
• Supreme Court ruled favorably in Campbell v.
  State Farm

75
ISSUES POTPOURRI
76
Claims Filed Against U.S. Silica By Claimant
(1997-2003)

• Leading industrial sand producer U.S. Silica
  today faces more than 22,000 silica claims!
• Some 15,342 plaintiffs have named the company in
  lawsuits so far in 2003 - triple the number seen
  in 2002!

Some 87 of the lawsuits filed are from
Mississippi and Texas!
Source Coalition for Litigation Justice (
through 6/30/03)
77
Texas Mold Losses/Claims Are Finally Moderating
Data are for TDI Cause 61 Discharge Other
Damage. Not all claims in cause 61 are mold and
mold claims may also arise from other (non-water)
causes of loss.
Source Texas Department of Insurance Insurance
Information Institute
78
Prevalence of Overweight and Obesity among US
Adults (aged 20-74 years)
31
23
15
Nearly 2/3 of US adults are overweight or obese,
up from 47 in the late 1970s
Source Centers of Disease Control and Prevention
(CDC), National Center for Health Statistics
(NCHS), National Health and Nutrition Examination
Survey (NHANES) Insurance Information Institute
79
Dram Shop/VicariousLiquor Liability

• NFL is Sued Over Crash That Left a Child
  Paralyzed,
• New York Times, October 11, 2003
• Perry Mason Moment, A 39 Million Verdict
  Outback Restaurant Loses Dram Shop Action
• National Law Journal, July 7, 2003
• Eatery Pays Millions For Drunk Driver
• The Guardian (Charlottetown), June 21, 2003
• DUI Suit Settled For 21 million Man in Crash
  That Killed 3 Drank at TGI Fridays"
• The Courier-Journal (Louisville, KY), June 20,
  2003
• Bar Ordered to Pay 1 million in Death of
  Patron Denim Diamonds Plans to Appeal Verdict
  in Lawsuit"
• Kansas City Star, April 15, 2003

80
Cyber-Risk Gaps in Insurance Coverage
Few actually have policies to cover cyber risk,
many mistakenly believe cyber risks covered by
general policies
Source Ernst Young 2003 Global Information
Security Survey of 1,400 organizations from 66
countries
81
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.
82
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