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“A Plague on Your Houses”
What’s Wrong With Homeowners Insurance Markets
National Conference of State Legislators CouncilSan Francisco, CA
July 24, 2003
Robert P. Hartwig, Ph.D., CPCU, Senior Vice President & Chief EconomistInsurance Information Institute 110 William Street New York, NY 10038
Tel: (212) 346-5520 Fax: (212) 732-1916 bobh@iii.org www.iii.org
Presentation Outline
• Homeowners Insurance Market Financial Performance
• P/C Insurance Industry Financial OverviewThe truth about insurer investment performance
• Impact of Rising HO Insurance Costs and Tighter Underwriting on Real Estate Industry & Homebuyers
• Use of Credit Information in Underwriting Homeowners Insurance
• C.L.U.E. Reports
HOMEOWNERS INSURANCE:
Recent Financial Performance
Industry Net Premiums Written by Product Lines
Source: A.M. Best
1960NPW=$14.7 Billion
2001NPW=$369.1 Billion
Fire2%
A&H4%
ComIMP7%
Allied2%
WC8%
Other Lines19%
OtherLiab7%
HomeMP11%
AutoPhys17%
AutoLiab23%
Fire12% A&H
9%
ComIMP0%
Allied5%
WC8% Other
Lines9%
OtherLiab7%
HomeMP5%
AutoPhys15%
AutoLiab28%
2.9 3.4 3.8 4.2 4.7 5.7 6.8 7.8 8.8 9.8 10
.811
.71
2.5
13
.21
4.1
15
.21
6.7
17
.11
7.7
18
.61
9.3
20
.52
1.5
22
.62
4.0
25
.42
6.9 29
.0 30
.6 32
.4 35
.14
0.0
$0
$5
$10
$15
$20
$25
$30
$35
$40
$45
19
71
19
72
19
73
19
74
19
75
19
76
19
77
19
78
19
79
19
80
19
81
19
82
19
83
19
84
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
($ B
illi
on
s) .
Homeowners Multi-Peril InsuranceNet Premiums Written
Source: Best’s Aggregates & Averages - Property/Casualty
Revenue Growth Drivers:•New home construction•Trend toward larger, more expensive homes•Home price inflation•Home improvements•Rates
113117.7
158.4
113.6118.4
112.7
121.7
101
109.4 108.2111.4
121.7
113
95
100
105
110
115
120
125
130
135
140
145
150
155
160
165
90
91
92
93
94
95
96
97
98
99
00
01
02
Homeowners Insurance Combined Ratio
Average 1990 to 2002= 116.0
Insurers have paid out an average of $1.16 in losses for every dollar earned
in premiums over the past 13 years
2002 Loss: $4.7 Billion
2001 Loss: $7.4 Billion
Sources: A.M. Best; III
Rates of Return on Net Worth
Source: NAIC, Insurance Information Institute
* Average is 0.71% if excluding 1992 (year of Hurricanes Andrew and Iniki.
Note: 2002 Homeowners figure is III estimate.
-0.9%-6.6%
-54.3%
2.5%-1.7% -4.2%
3.8%
-7.2%-4.0%
12.2% 10.8% 10.1%13.7% 14.0% 14.1% 13.9% 13.4% 15.2% 14.6%
10.4%
3.6%
12.4%
5.4%5.4%
10.0%11.9%
-60%
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
NAIC HomeownerMulti-Peril
Fortune All-Industry*
Averages: 1990 to 2002
HO Insurance = -3.52%*
Fortune 500 = 12.64%
$0
$50
$100
$150
$200
$250
Wa
ter
Da
ma
ge
Pa
id L
os
se
s*
($M
illio
ns
)
0
5000
10000
15000
20000
25000
30000
Cla
im C
ou
nt
Paid Losses
Claim Count
Source: Texas Department of Insurance; Insurance Information Institute
* 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.
Texas: Mold Losses/Claims Are Finally Moderating*
California: Surging Water Claim Frequency and Costs:
Symptom of Growing Mold Problem
$224.1
$298.9$316.5
$441.6
$496.3
$562.4
24%
36%
27%
32%33%
31%
$100
$150
$200
$250
$300
$350
$400
$450
$500
$550
$600
1997 1998 1999 2000 2001 2002
20%
22%
24%
26%
28%
30%
32%
34%
36%
38%
Paid Water Losses ($ Mill) Water Claims as % of All Homeowners Claims
Source: Insurance Information Network of California; Insurance Information Institute
•Water losses paid rose 151% from 1997 to 2002 and 77% since 1999
•Water claims accounted for less than 1/4 of all HO claims in 1997, now they for 1/3.
California may be in a drought, but homeowners say they’re drowning
Average Expenditures on Homeowners Insurance: US
$418$440
$455$481 $488
$508$520
$532
$569
$615
$400
$500
$600
$700
95 96 97 98 99 00 01* 02* 03* 04*
*III Estimates; Estimates for 2001-2003 based on BLS CPI data for tenants and household insurance.Source: NAIC, Insurance Information Institute
Average US HO expenditures are expected to rise by 7% in
2003, 8% in 2004
Reasons for Rising HO Insurance Prices
• Enormous underwriting losses are the primary reason for rising homeowners insurance rates today Function of frequency/severity of claims and events
• Home price/repair inflation• Constant threats:
CAT losses (>$100B since 1990); Not just hurricanes/earthquakes, but also major hail/wind events
• New issues such as “toxic” mold cost billions; no prior premium collected
• Litigation is a problem (property & liability related)• Falling capacity; Rising reinsurance costs• Attempts to weaken insurers ability to underwrite
Credit restrictions raise costs for millions (WA, MD & others) CA “emergency” reg. preventing insurers from using claims history in coverage decisions
(Safeco moratorium on new HO policies)
PROPERTY/CASUALTY INSURANCE INDUSTRY:
Recent Financial Performance
P/C Net Income After Taxes1991-2002 ($ Millions)
$14,178
$5,840
$19,316
$10,870
$20,598
$24,404
$36,819
$30,773
$21,865$20,559
-$6,970
$2,903
-$10,000
$0
$10,000
$20,000
$30,000
$40,000
91 92 93 94 95 96 97 98 99 00 01 02
Sources: A.M. Best, ISO, Insurance Information Institute.
2001 was the first year ever with a full year net loss
2002 ROE = 1.0%
-5%
0%
5%
10%
15%
20%
87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03F
US P/C Insurers All US Industries
ROE: P/C vs. All Industries 1987–2003F
Source: Insurance Information Institute; Fortune
There is an enormous gap between the p/c industry’s rate of return and that of most major industry groups
2001 Return on Equity (Profitability)
-7.2%
-5.5%
-0.5%
0.2%
1.0%
2.0%
10.4%
-10% -5% 0% 5% 10% 15%
Fortune 500
PP Auto
Comm Auto
Workers Comp
All P/C
Comm Multi Peril
Homeowners
Source: National Association of Insurance Commissioners, Insurance Information Institute
2001 (Selected Lines)
Investment Issues:
The Truth About P/C Insurer Investment Performance
$0
$9
$18
$27
$36
$45
75 77 79 81 83 85 87 89 91 93 95 97 99 01 03E
Net Investment Income
History
1997 Peak = $41.5B
2000= $40.7B
2001 = $37.7B
2002 = $36.7B
2003E = $35.9B
Bil
lion
s
(US
$)
Investment income fell 2.8%in 2002 and 0.3% in Q1 of 2003 (v. Q1:2002) due primarily to historically low interest rates
Note: 2003 estimate is based on annualized first quarter investment income of $8.984 billion.Source: A.M. Best, Insurance Information Institute
-$5.6 Billion
-30%
-20%
-10%
0%
10%
20%
30%
40%
19
70
19
71
19
72
19
73
19
74
19
75
19
76
19
77
19
78
19
79
19
80
19
81
19
82
19
83
19
84
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
*As of July 23, 2003.Source: Ibbotson Associates, Insurance Information Institute
Total Returns for Large Company Stocks: 1970-2003*
2002 was 3rd consecutive year of decline for stocks
Will it be the last?
S&P 500 up 12.4% so
far this year
P/C Industry Investments,by Type (as of Dec. 31, 2001)
Other5%
Bonds66%
Real Est. & Mortgages
1%
Common Stock21%
Cash & ST Secs.6%
Preferred Stock1%
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
Common stock accounts for about 1/5 of invested
assets
Property/Casualty Insurance Industry Investment Gain*
$ Billions
$35.4
$42.8$47.2
$52.3
$44.4
$36.6
$57.9
$51.9
$56.9
$0
$10
$20
$30
$40
$50
$60
94 95 96 97 98 99 00 01 02
*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.
Investment gains are simply returning to “pre-bubble” levels
HOUSING MARKETS:
Recent Performance &
Insurance Impact
Difficult to See Where Insurance Issues Significantly Harming Residential
Real Estate Markets• “Record for Home Sales Likely in 2003”
“Record low mortgage interest rates, a growing number of households, rising consumer confidence and an improving economy mean probably will set a third consecutive record for both existing- and new-home sales this year.”
David Lereah, NAR Chief Economist, June 3, 2003
• “Existing Home Sales Still on a Roll in April” “Sales of existing homes single-family homes rose in April 2003 and are at
the fifth highest level of activity ever recorded.” As reported on www.realtor.org on June 13, 2003
• “Most Metro Area Home Prices Rising Above Norms” “…short supply is continuing to put pressure on home prices in many
areas, with more buyers than sellers…” David Lereah, NAR Chief Economist, February 12, 2002
New Private Housing Starts(Millions of Units)
1.19
1.01
1.20
1.29
1.461.35
1.48 1.47
1.62 1.64 1.57 1.60
1.71 1.681.62
1.0
1.1
1.2
1.3
1.4
1.5
1.6
1.7
1.8
1.9
2.0
90 91 92 93 94 95 96 97 98 99 00 01 02 03E 04F
Source: US Department of Commerce; Blue Chip Economic Indicators (5/03), Insurance Info. Institute
New Private Housing Starts
•Housing market remain strong.
•Virtually no exposure impact for insurers
Homeownership Rates,1990 to 2003*
* First QuarterSource: U.S. Census Bureau
63.9%64.1%64.5%
64.0%
64.7%
65.4%65.7%
66.3%66.8%
67.4%67.8%67.9%68.0%
90 92 93 94 95 96 97 98 99 00 01 02 03*
Homeownership is at a record high. Because you can’t buy a home without
insurance, insurance is clearly available and affordable, including to
millions of Americans of modest means and all ethnic groups.
Homeownership Rates in Central Cities, 1990 to 2003*
*First quarter 2003.Source: U.S. Census Bureau
48.7%
49.2%
48.6%48.5%
49.5%49.7%
49.9%50.0%50.4%
51.4%51.9%51.8%51.9%
48.7%
90 91 92 93 94 95 96 97 98 99 00 01 02 03*
Homeownership rates in central cities is rising to record/near record levels Because you can’t
buy a home without insurance, insurance is clearly available and affordable, including to
millions of Americans of modest means and all ethnic groups.
Homeowners Insurance Expenditure as a % of Median Home Price
$107
,200
$115
,800
$121
,800
$128
,400
$133
,300
$139
,000
$147
,800
$158
,300
$110
,500
0.39%
0.38% 0.38%
0.37% 0.37% 0.37%
0.36%
0.35% 0.35%
$100,000
$125,000
$150,000
$175,000
$200,000
94 95 96 97 98 99 00 01 02
0.30%
0.33%
0.35%
0.38%
0.40%Median Sales Price of Existing HomesHO Insurance Expenditure as a % of Sales Price
Source: Insurance Information Institute calculations based on data from National Association of Realtors, NAIC.
HO
Exp
end
iture as %
of Sales P
riceMed
ian
Hom
e S
ales
Pri
ce
The cost of homeowners
insurance relative to the
price of a typical home has fallen!
Change in Cost of Homes vs. Change in Cost of Homeowners Insurance
$3,300
-$2
$5,300
$22
$6,000
$15
$6,600
$26
$4,900
$7
$5,700
$12
$8,800
$12
$10,500
$41
$8,500
$50
-$2,000
$0
$2,000
$4,000
$6,000
$8,000
$10,000
$12,000
1995 1996 1997 1998 1999 2000 2001 2002 2003E
Change in Cost of Median Existing Home
Change in Average Homeowners Insurance Expenditure
Recent increases in the cost of homeowners insurance
are miniscule in comparison to the soaring cost of homes
Note: 2003 home price increase based on NAR’s est. of $166,900 median home for 2003.Source: Insurance Info. Inst. calculations based on data from Natl. Association of Realtors, NAIC.
Cumulative Change in the Price of Homes & Homeowners Insurance
$3,300
-$2
$8,600
$20
$14,600
$35
$21,200
$61
$26,100
$68
$31,800
$80
$40,600
$92
$51,100
$133
$59,600
$183
-$10,000
$0
$10,000
$20,000
$30,000
$40,000
$50,000
$60,000
1995 1996 1997 1998 1999 2000 2001 2002 2003E
Cumulative Change in Cost of Median Existing Home
Cumulative Change in Average HO Insurance Expenditure
Increases in the price of homes has outstripped the increase in HO insurance
costs by more than $59,400, a factor of 326 to 1!
Note: 2003 home price increase based on NAR’s est. of $166,900 median home for 2003.Source: Insurance Info. Inst. calculations based on data from Natl. Association of Realtors, NAIC.
Property Taxes12%
Principal & Interest
84%
Homeowners Insurance
4%
Composition of Monthly Homeowners Payments
Sources: Mortgage interest rates: Freddie Mac; Median Home Price (existing homes): National Associationof Home Builders; Property Taxes: US Census Bureau; Homeowners Insurance: III and NAIC.
Property Taxes13%
Principal & Interest
83%
Homeowners Insurance
4%
2002 Total Monthly Payment: $1,0941997 Total Monthly Payment: $945
$791
$116
$38
$46
$144
$904
2002
Median Home Price
$158,300
Mortgage Rate (30-yr)
6.54%
Principal & Interest*,1
$10,851
Property Taxes*
$1,726
Homeowners Insurance*
$553 (est.)
1997 $121,800 7.83% $7,495 $1,390 $455
*Annual basis. 1Assues 90% of purchase price is financed (i.e., 10% down payment).
THE USE OF CREDIT INFORMATION IN
HOMEOWNERS INSURANCE UNDERWRITING
Why Do Insurers Use Credit Information?
Why Insurers Use Credit Information in Insurance Underwriting
1. There is a strong correlation between credit standing and loss ratios in both auto and homeowners insurance.
2. There is a distinct and consistent decline in relative loss ratios (which are a function of both claim frequency and cost) as credit standing improves.
3. The relationship between credit standing and relative loss ratios is statistically irrefutable.
4. The odds that such a relationship does not exist in a given random sample of policyholders are usually between 500, 1,000 or even 10,000 to one.
Source: Insurance Information Institute.
1.593
0.9110.795
0.656
1.066
0.0
0.5
1.0
1.5
2.0
Score Range
Rel
ativ
e P
erfo
rman
ce
Homeowners Company A
Source: Tillinghast Towers-Perrin
Interpretation:
Those with scores under 645 had losses that were 59.3% above average; those with best scores had losses 34.4% below average
1.2001.083
0.9000.783
1.150
0.0
0.5
1.0
1.5
2.0
Score Range
Rel
ativ
e P
erfo
rman
ce
Homeowners Company B
Source: Tillinghast Towers-Perrin
Interpretation:
Those with scores under 560 had losses that were 20% above average; those with best scores had losses 21.7% below average
2.533
1.241
0.9090.807 0.734 0.715 0.637
1.357
0.0
0.5
1.0
1.5
2.0
2.5
3.0
Score Range
Rel
ativ
e P
erfo
rman
ce
Homeowners Company C
Source: Tillinghast Towers-Perrin
Interpretation:
Those with scores under 530 had losses that were 153% above average; those with best
scores had losses 36.3% below average.
Statistical CorrelationHomeowners HO - 3
Number of Adverse Public Records
1000
1540
0200400600800
1000120014001600
zero one or more
96%
Lo
ss R
atio
Re
lativ
ity
Source: Fair, Isaac
Interpretation:
Existence of adverse public records correlated with higher loss ratios
Statistical CorrelationHomeowners HO - 3
Number of Trade Lines 60+ Days Delinquent inLast 24 Months
10001293
1804
0200400600800
100012001400160018002000
Zero One 2+
89%
Lo
ss R
atio
Re
lativ
ity
Source: Fair, Isaac
Interpretation:
Higher number of delinquencies correlated with higher loss ratios
Statistical CorrelationHomeowners HO - 3
Number of Trade Lines Open in Last 12 Months
10001147 1220
15031658
0200400600800
10001200140016001800
Zero One Two Three 4+
60%
Lo
ss R
atio
Re
lativ
ity
Source: Fair, Isaac
Interpretation:
Higher number of trade credit lines opened correlated with higher loss ratios
Intuition Behind Insurance Scoring*
1. Personal Responsibility Responsibility is a personality trait that carries over into many
aspects of a person’s life It is intuitive and reasonable to believe that the responsibility
required to prudently manage one’s finances is associated with other types of responsible and prudent behaviors, for example: Proper maintenance of homes and automobiles Safe operation of cars
2. Stability It is intuitive and reasonable to believe that financially stable
individuals are likely to exhibit stability in many other aspects of their lives.
3. Stress/Distraction Financial stress could lead to stress, distractions or other
behaviors that produce more losses (e.g., deferral of car/home maintenance).
*This list is neither exhaustive nor is it intended to characterize the behavior of any specific individual.
Source: Insurance Information Institute
The Controversy Over C.L.U.E. Reports
Comprehensive Loss Underwriting Exchange Reports (CLUE)
Why Insurers Use CLUE:• Enormous informational asymmetry between homeowner and
insurer Reduction of that asymmetry means that policyholder pays a price
more closely associated with the risk assumed Overall pricing system is more fair, equitable Claim frequency depends on property AND owner
Consumers Who Learn About CLUE, Like It!• Majority of Americans, when CLUE is explained to them,
believe CLUE is a good idea• Most buyers would want to see seller’s CLUE report• Most sellers want buyers to see their CLUE report• Why do some realtors want to hide info from buyers?
Some Groups Want to Ban C.L.U.E. Reports
Ad run by realtors in AZ in January 2003: But how would homeowners be
helped if CLUE is banned?
CLUE helps protect homebuyers by letting them see what problems a house has had before they buy it
A house without problems or that has been properly repaired will command a
premium, benefiting sellers
A house can be made safer and less expensive to insure if repairs have
been made properly
Don’t YOU want to know what you’re buying before you make the biggest investment of your life???
Comprehensive Loss Underwriting Exchange Reports (CLUE)
CLUE is:• Available to homeowner for just $12.95• Can be shared online by property owner• Can help a homeowner sell a home at a premium
No claims Claim properly addressed (e.g., new roof, plumbing
upgraded)
Realtors who oppose CLUE are on the wrong side of this issue
Insurance Information Institute On-Line
If you would like a copy of this presentation, please give me your business card with e-mail address
10
0.1
10
4.6 1
06
.5
10
4.8
10
7.7
11
1.1
10
8.3
10
6.1
10
6.8 1
08
.9
10
9
10
4.7
10
2
10
1.7
10
1.3
10
1.3
10
1
99
.5 10
1.1
10
3.5
10
9.5
10
8
10
3
90
95
100
105
110
115
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
Auto Combined Ratio(1980-2002E)
Sources: A.M. Best; III
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