Catastrophic Risk: Impacts

1
Catastrophic Risk Impacts Implications for
the P/C Insurance Industry

• Houston Marine Insurance Seminar
• Houston, TX
• September 18, 2006

Robert P. Hartwig, Ph.D., CPCU, Executive 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 Profit Overview
• Underwriting Trends
• Primary Reinsurance
• Competitive Pressures Mounting Pricing Trends
• Financial Strength Ratings
• Investments
• Capital Capacity
• Catastrophe Loss Management
• Terrorism Are TRIAs Days Numbered?
• Q A

3
P/C PROFIT OVERVIEW2006 Outlook is Good
4
P/C Net Income After Taxes1991-2006E (
Millions)

• 2001 ROE -1.2
• 2002 ROE 2.2
• 2003 ROE 8.9
• 2004 ROE 9.4
• 2005 ROAS1 10.5
• 2006 ROAS2 15.4

2006 Net Income may shatter previous records
ROE figures are GAAP 1Return on avg. surplus.
2005 ROAS 9.8 after adj. for one-time special
dividend paid by the investment subsidiary of one
company. 2Based on Q1 results For 12 months
ending 3/31/06, ROAS10.1.
Sources A.M. Best,
ISO, Insurance Information Inst.
5
ROE vs. Equity Cost of CapitalUS P/C
Insurance1991-2006E
The p/c insurance industry achieved its cost of
capital in 2005
5.9 pts
-9.0 pts
0.2 pts
1.0 pts
-13.2 pts
US P/C insurers missed their cost of capital by
an average 6.7 points from 1991 to 2002, but on
target 2003-05
Based on 2006Q1E ROAS of 15.4 Source The
Geneva Association, Ins. Information Inst.
6
ROE P/C vs. All Industries 19872006Q1
Insurers will outperform only if CAT losses are
normal
2004/5 ROEs excl. hurricanes
Sept. 11
Hugo
Katrina, Rita, Wilma
Lowest CAT losses in 15 years
Andrew
Northridge
4 Hurricanes
2006 P/C insurer ROE based on annualized Q1
results. Source Insurance Information
Institute Fortune
7
WALL STREETMAINTAINING THE CONFIDENCE OF WALL
STREET IS CRITICAL FOR MANY INSURERS
8
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
9
P/C Insurance Stocks Off to a Slow Start in 2006
Total YTD Returns Through September 8, 2006
P/C insurer stocks now up in 2006. Investors
less worried about potential hurricane losses,
but price weakness looms.
Broker stocks hurt by weak earnings
Source SNL Securities, Standard Poors,
Insurance Information Institute
10
UNDERWRITING Surprisingly Strong in 2005,
Stage is Set for a Good 2006!
11
P/C Industry Combined Ratio
2005 figure reflects heavy use of reinsurance
which lowered net losses, but still a substantial
deterioration from first half 2005
2006 is Off to a Strong Start Expectation is for
an underwriting profit
Sources A.M. Best ISO, III. III
forecasts/estimates for 2006 first half and full
year.
12
Underwriting Gain (Loss)1975-2006F
Insurers sustained a 5.9 billion underwriting
loss in 2005. 2006 could become only the second
underwriting profit in 28 years, assuming
normal CAT losses. 06Q1 U/W profit was 8.4B.
Billions
Source A.M. Best, Insurance Information
Institute
13
A 100 Combined Ratio Isnt What it Used to Be 95
is Where Its At
Combined ratios today must be below 95 to
generate Fortune 500 ROEs
2005/6 figures are return on average statutory
surplus. Source Insurance Information Institute
from A.M. Best and ISO data.
14
Commercial Lines Combined Ratio, 1993-2006E
Outside CAT-affected lines, commercial insurance
is doing fairly well. Caution is required in
underwriting long-tail commercial lines.
2006 results dependent on a return to normal
catastrophe loss levels
Source A.M. Best Insurance Information
Institute Fitch estimate for 2005. Actual
1H05 combined ratio all lines was 92.7.
15
REINSURANCE MARKETSHigher Reinsurance Costs
Squeezing Insurers, Pushing Property CAT Prices
Upward
16
Global Number of Catastrophic Events, 19702005
The number of natural and man-made catastrophes
has been increasing on a global scale for 20 years
Record 248 man-made CATs record 149 natural
CATs in 2005
Man-made disasters without road disasters.
Source Swiss Re, sigma No. 1/2005 and 2/2006.
17
Combined Ratio Reinsurance vs. P/C Industry
Sept. 11
2004/5 Hurricanes
HurricaneAndrew
Source A.M. Best, ISO, Reinsurance Association
of America, Insurance Information Institute
18
Share of Losses Paid by Reinsurers, by Disaster
Reinsurance is playing an increasingly important
role in the financing of mega-CATs Reins. Costs
are skyrocketing
Excludes losses paid by the Florida Hurricane
Catastrophe Fund, a FL-only windstorm reinsurer,
which was established in 1994 after Hurricane
Andrew. FHCF payments to insurers are estimated
at 3.85 billion for 2004 and 4.5 billion for
2005. Sources Wharton Risk Center, Disaster
Insurance Project Insurance Information
Institute.
19
Property Catastrophe Price Index 1994 - 2006
US CAT prices are continue to rise faster than
anywhere else in the world
Insurance Information Institute figure of 13.8
for 2005 based estimated 2005 DPE of 417.7B and
insured CAT losses of 57.7B. Includes primary
and reinsurance coverage. Sources ISO, A.M.
Best, Swiss Re Economic Research Consulting
Insurance Information Institute.
20
Reinsurance Prices Surged in 2006 Following
Record CATs in 2005
In hurricane-prone areas, property CAT
reinsurance prices are up 100-300
US cat reinsurance price index 1994 100
Sources Swiss Re, Cat Market Research Insurance
Information Institute estimate for 2006.
21
Changes in the 2006 Reinsurance Markets

• Property CAT reins. rates up 20 - 30 nationally
• Property CAT coverage in hurricane exposed areas
  up 100-300
• Marine/Energy Reinsurance? Up 300
• Most challenging markets for reinsurers today
• Aggregate reinsurer exposure is down 20-30
• Cedants retaining more risk, often by 50-100 or
  more (higher attachment pts.)
• Increased demand for Excess of Loss cover
• XoL is potentially more volatile for reinsurers
• Some supply issues as a few small players enter
  run-off
• Retrocessional market is much tighter

Sources Morgan Stanley, Lehman Brothers, III
22
A Look Ahead to Reinsurance Markets for 2007

• Despite lack of major hurricane in 2006,
  reinsurance pricing strong in US for 2007
• New capital entry not sufficient to fully meet
  demand
• Reinsurance prices flat at best outside peak CAT
  zones
• Retrocessional market still tight
• Softening in European p/c reinsurance markets
• Softening in US casualty reinsurance markets
• More pronounced if property cat reinsurers shift
  emphasis
• Capital market role expanding
• Hedge funds, private equity
• Securitization Insurance Linked Securities
• Some concern over staying power, (lack of)
  regulation
• Complement or competitor to traditional
  reinsurance?

Sources Insurance Information Institute.
23
UNDERWRITING AFFECTS FINANCIAL STRENGTHIs There
Causefor Concern?
24
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
25
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.
26
Ratings Agencies Tightening Requirements for CATs

• 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.

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.
27
COMPETITIVE PRESSURENon-CAT Pricing Momentum
Slows
28
Strength of Recent Hard Markets by NWP Growth
1975-78
1984-87
2001-04
2006-2010 (post-Katrina) period could resemble
1993-97 (post-Andrew)
2005 biggest real drop in premium since early
1980s
2006-10 figures are III forecasts/estimates.
2005 growth of 0.4 equates to 1.8 after
adjustment for a special one-time transaction
between one company and its foreign parent. 2006
figure of 1.9 is based on 2006Q1 data.
Note Shaded areas denote hard market
periods. Source A.M. Best, Insurance
Information Institute
29
Average Commercial Rate Change,All Lines,
(1Q2004 2Q2006)
Magnitude of rate decreases has diminished
greatly since mid-2005
Source Council of Insurance Agents Brokers
Insurance Information Institute
30
Average Commercial Rate Change by Account Size
Commercial accounts trended downward from early
2004 to mid-2005 but now that trend is shrinking
post-Katrina
Source Council of Insurance Agents Brokers
31
Average Commercial Rate Change by Line
Commercial property accounts are renewing sharply
upward (9.3) in 2Q06. All other lines are
renewing down.
Source Council of Insurance Agents Brokers
32
Percent of Commercial Accounts Renewing
w/Positive Rate Changes, 2nd Qtr. 2006
Largest increases for Commercial Property
Business Interruption are in the Southeast,
smallest in Midwest
Source Council of Insurance Agents and Brokers
33
Commercial Accounts Rate Changes,2nd Qtr. 2005
vs. 2nd Qtr. 2006
Only commercial property is renewing up in 2006
Source Council of Insurance Agents and Brokers
34
UNDERWRITING CAPACITYCan the Industry
Efficiently Employ Its Increasing Capital?
35
U.S. Policyholder Surplus 1975-2006
Capacity TODAY is 440.1B, 10.1 above year-end
2005, 54 above its 2002 trough and 30 above its
1999 peak.
Billions
Foreign reinsurance and residual market
mechanisms absorbed 50 of 2005 CAT losses of
62.1B
Surplus is a measure of underwriting capacity.
It is analogous to Owners Equity or Net Worth
in non-insurance organizations
Source A.M. Best, ISO, Insurance Information
Institute As of 3/31/06.
36
Announced Insurer Capital Raising( Millions,
as of December 1, 2005)
As of Dec. 1, 19 insurers announced plans to
raise 10.35 billion in new capital. Twelve
start-ups plan to raise as much as 8.75 billion
more for a total of 19.1 billion. Actual total
higher as Lloyds syndicates have added capacity
for 2006.
Existing (re) insurers. Announced amounts may
differ from sums actually raised. Sources
Morgan Stanley, Lehman Brothers, Company Reports
Insurance Information Institute.
37
Announced Capital Raising by Insurance
Start-Ups( Millions, as of April 15, 2006)
As of April 15, 14 start-ups plan to raise as
much as 10 billion.
Chubb, Trident are funding Harbor Point.
Announced amounts may differ from sums actually
raised. Stated amount is 750 million to 1
billion. XL Capital/Hedge Fund venture. Arrow
Capital formed by Goldman Sachs. Sources
Investment Bank Reports Insurance Information
Institute.
38
INVESTMENTSDoes Investment Performance Affect
Discipline?
39
Property/Casualty Insurance Industry Investment
Gain
Investment gains are up but are only now
comparable to gains seen in the late 1990s
Investment gains consist primarily of interest,
stock dividends and realized capital gains and
losses. 2006 estimate based on actual annualized
2006Q1 results. 2005 figure includes special
one-time dividend of 3.2B. Source ISO
Insurance Information Institute.
40
CATASTROPHE LOSS MANAGEMENTInsurers Have Done a
Better Jobat Managing CAT Risk
41
Most of US Population Property Has Major CAT
Exposure
Is Anyplace Safe?
42
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 storms
2005 set a new record for the number of
hurricanes tropical storms at 28, breaking the
old record set in 1933.
Source WeatherUnderground.com, January 18, 2006.
43
2005 Was a Busy, Destructive, Deadly Expensive
Hurricane Season
What a difference a year makes! Just 8 named
storms through Sept. 18, 2006 vs. 17 as of same
date in 2005!
Source WeatherUnderground.com, September 17,
2006.
44
2006 Hurricane Season Forecasts Repeatedly
Scaled Back
2006 hurricane seasons has turned out to be far
less severe than anticipated
Average over the period 1950-2000. Source
Insurance Information Institute compilation of
forecasts by Dr. William Gray, Colorado State
University.
45
U.S. InsuredCatastrophe Losses ( Billions)
100 Billion CAT year is coming soon
Billions
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. As of June 30,
2006. 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
46
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.
47
Top 10 Most Costly Hurricanes in US History,
(Insured Losses, 2005)
Seven of the 10 most expensive hurricanes in US
history occurred in the 14 months from Aug. 2004
Oct. 2005 Katrina, Rita, Wilma, Charley, Ivan,
Frances Jeanne
Sources ISO/PCS Insurance Information
Institute.
48
Insured Loss Claim Count for Major Storms of
2005
Hurricanes Katrina, Rita, Wilma Dennis produced
a record 3.3 million claims
Property and business interruption losses only.
Excludes offshore energy marine losses. Source
ISO/PCS as of June 8, 2006 Insurance Information
Institute.
49
Hurricane Katrina Insured Loss Distribution by
State ( Millions)
Louisiana accounted for 62 of the insured losses
paid and 56 of the claims filed
Total Insured Losses 40.579 Billion
As of June 8, 2006 Source PCS division of ISO.
50
Hurricane Katrina Loss Distribution by Line (
Billions)
Total insured losses are estimated at 40.579
billion from 1.7438 million claims. Excludes
2-3B in offshore energy losses
As of June 8, 2006 Source PCS division of ISO.
51
Hurricane Rita Claim Count Distribution by State
Louisiana accounted for 48.3 of the insured
losses, Texas 44.6. Excludes offshore energy
losses of 2-3B
Total Claims 383,000
As of June 8, 2006 Source PCS division of ISO.
52
Hurricane Rita Loss Distribution, by Line (
Millions)
Total insured losses are estimated at 5.0
billion (excl. offshore energy of 2-3B) from
383,000 claims.
As of June 8, 2006 Source PCS division of ISO.
53
Hurricane Wilma Loss Distribution by Line (
Millions)
Total insured losses are estimated at 10.3
billion from 1.047 million claims
As of June 8, 2006. All losses are in
FL. Source PCS division of ISO.
54
2005 Storms Have Developed Adversely
18.0
Are the models inaccurate?
Wilma is the storm with the most extraordinary
adverse development
54.0
6.3
Source Insurance Information Institute from PCS
survey data.
55
Inflation-Adjusted U.S. Insured Catastrophe
Losses By Cause of Loss, 1986-2005¹
Insured disaster losses totaled 289.1 billion
from 1984-2005 (in 2005 dollars). Tropical
systems accounted for nearly half of all CAT
losses from 1986-2005, up from 27.1 from
1984-2003.
1 Catastrophes are all events causing direct
insured losses to property of 25 million or more
in 2005 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 Services Office (ISO)..
56
Total Value of Insured Coastal Exposure (2004,
Billions)
Florida New York lead the way for insured
coastal property at more than 1.9 trillion each.
Texas has 740B.
Source AIR Worldwide
57
Insured Coastal Exposure as a of Statewide
Insured Exposure (2004, Billions)
After FL, many Northeast states have among the
highest coastal exposure as a share of all
insured exposure in the state.
Source AIR Worldwide
58
Value of Insured Commercial Coastal Exposure
(2004, Billions)
Commercial property exposure also implies
significant business interruption losses.
Source AIR
59
Percentage of California Homeowners with
Earthquake Insurance, 1994-2004
The vast majority of California homeowners forego
earthquake coverage play Russian Roulette with
their most valuable asset.
Includes CEA policies beginning in 1996. Source
California Department of Insurance Insurance
Information Institute.
60
The 2006 Hurricane SeasonLowering Expectations
61
Outlook for 2006 Hurricane Season
Average 2005 2006F
Named Storms 9.6 28 13
Named Storm Days 49.1 115.5 50
Hurricanes 5.9 14 5
Hurricane Days 24.5 47.5 13
Intense Hurricanes 2.3 7 2
Intense Hurricane Days 13 7 4
Net Tropical Cyclone Activity 100 275 90
Average over the period 1950-2000. Source Dr.
William Gray, Colorado State University,
September 1, 2006.
62
Probability of Major Hurricane Landfall (CAT
3,4,5) in Sept/Oct 2006
9/06F Avg. 10/06F Avg.
Named Storms 74 67 22 29
Hurricanes 59 48 14 15
Intense Hurricanes 35 27 4 6
Average over past 52 years. Source Dr. William
Gray, Colorado State University, September 1,
2006.
63
CAT Models for 2006 Show Increase in Hurricane
Frequency Severity
Expected frequency and severity are up in every
region
Frequency in the Northeast is up 30 and severity
10-15
Source EQECAT
64
ENERGY MARKET OVERVIEWThe Biggest Casualtyof
2004/5
65
Katrinas Path of Destruction Through the
Offshore Energy Industry
Katrina ( Rita) tore through offshore facilities
Source Hurricane Katrina Profile of a Super
Cat, RMS, October 2005.
66
Hurricane Ritas Path Was at Least as Devastating
for Energy Concerns
Rita did significant damage to onshore facilities
too
Source Energy Information Administration
iMapData Inc.
67
Hurricanes Katrina/Rita Initial Damage to Oil
Platforms Rigs in Gulf of Mexico
No. of Platforms/Rigs Destroyed, Damaged or
Adrift, as of October 4, 2005.
Totals Destroyed 114 Damaged 69 Adrift
19 Missing 3
About 75 (3,050 out of roughly 4,000 GOM
platforms were in the path of Katrina Rita
Source Minerals Management Service (MMS), US
Department of the Interior.
68
Katrina and Rita Total Energy Sector Estimated
Losses
Total 9.149 Billion
Total 5.880 Billion
Millions
Source Willis, Energy Market Review, May 2006.
Loss estimates are total losses,
not just insured losses.
69
Katrina and Rita Total Energy Sector Losses, by
Type
Total 9.149 Billion
Total 5.880 Billion
Millions
Source Willis, Energy Market Review, May 2006.
Loss estimates are total losses,
not just insured losses.
70
Katrina Rita Total Energy Losses, Onshore vs.
Offshore
Total 9.15 Billion
Total 5.89 Billion
Billions
Source Willis, Energy Market Review, May 2006.
Loss estimates are total losses,
not just insured losses.
71
Insured Offshore Energy Losses for Recent Major
Gulf Storms
Hurricanes Katrina, Rita and Ivan cost energy
insurers at least 7 billion
Sources Insurance Information Institute research
estimates. Midpoint of estimated range for
2.0 to 2.5 billion)
72
Insured Offshore Energy Losses as a of All
Offshore Losses
Katrina
Rita
Insured share of losses for Rita much higher
Source Insurance Information Institute Willis,
Energy Market Review, May 2006.
73
2005 North American Energy Losses a of
Worldwide Losses
Millions
North American losses accounted for 96 of all
energy sector losses (insured insured) in 2005
Source Willis, Energy Market Review, May 2006.
Loss estimates are total losses,
not just insured losses.
74
LITIGATION UPDATEInsurers Are Ahead
75
Post-Katrina Litigation Update

• 95 of HO claims settled as of One-Year
  Anniversary
• About 2 in dispute (mediation/litigation) in
  LA/MS
• Insurers have won several major decisions
• Leonard v. Nationwide
• Class Actions Contained in MS Each case tried on
  its merits
• Most cases no longer economical to pursue
• A.G. Hood Case Still Outstanding
• Case substantially weakened, though not bound by
  Fed court decisions
• Trial Lawyers will Try to Try Better Cases,
  Refine Classes
• Misc. commercial litigation coverage disputes,
  pollution

76
TRIA EXTENSIONThe Burden Grows, and the Clock
is Ticking
77
Terrorism Coverage Take-Up Rate Continues to Rise
Terrorism take-up rate for non-WC risk rose
steadily through 2003, 2004 and 2005
TAKE UP RATE FOR WC COMP TERROR COVERAGE IS 100!!
Source Narketwatch Terrorism Insurance 2006,
Marsh, Inc. Insurance Information Institute
78
Insurance Industry Retention Under TRIA (
Billions)
Extension

• Individual company retentions rise to 17.5 in
  2006, 20 in 2007
• Above the retention, federal govt. pays 90 in
  2006, 85 in 2007

Congress Administration want TRIA dead
Source Insurance Information Institute
79
Insured Loss Estimates Large CNBR Terrorist
Attack ( Bill)
Type of Coverage New York Washington San Francisco Des Moines
Group Life 82.0 22.5 21.5 3.4
General Liability 14.4 2.9 3.2 0.4
Workers Comp 483.7 126.7 87.5 31.4
Residential Prop. 38.7 12.7 22.6 2.6
Commercial Prop. 158.3 31.5 35.5 4.1
Auto 1.0 0.6 0.8 0.4
TOTAL 778.1 196.8 171.2 42.3
Source American Academy of Actuaries, Response
to Presidents Working Group, Appendix II, April
26, 2006.
80
Surplus Under TRIA/TRIEA Covered Lines
(Billions of Dollars)
Shrinkage in 2006 (-11) surplus is due to
elimination of several lines covered under TRIA
though 2005 but dropped under the Acts extension
effective 1/1/06
2006 figure uses 2005 estimated year-end surplus
and premiums by line as basis for
calculations. Source Insurance Information
Institute.
81
Summary

• Commercial/Personal lines picture is bright for
  2006, assuming normal CAT loss activity
• Concern about pricing discipline in some some
  commercial lines, including casualty segments
• Rising investment returns insufficient to support
  deep soft market in terms of price, terms
  conditions
• Clear need to remain underwriting focused
• How/where to deploy/redeploy capital??
• Major Challenges
• Slow Growth Environment Ahead
• Maintaining price/underwriting discipline
• Managing variability/volatility of results

82
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