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Capital Punishment?The Challenge of Profitability and
Growth in an Industry and World Awash in Capital
Geneva Association10th Annual Insurance and Finance Seminar
London, UK4 November 2014
Download at: www.iii.org/presentationsRobert P. Hartwig, Ph.D., CPCU, President & Economist
Insurance Information Institute 110 William Street New York, NY 10038Tel: 212.346.5520 Cell: 917.453.1885 [email protected] www.iii.org
2
A World Awash in Capital
2
Too Much of a Good Thing?The Global Glut of Capital is Not
Unique to (Re)Insurance
S&P 500 (Excl. Financials):Cash & Short-Term Investments
3Source: Fact Set Fundamentals.
Holdings of Cash and Liquid Asset Holdings Have Soared Across Virtually All Industries Since the Financial Crisis
Cash and ST investments holdings have nearly doubled since 2007
Hedge Fund Industry: Assets Under Management: 1997–2014:Q21
$118
.2
$143
.1
$188
.9
$236
.6
$1,2
29.0
$1,3
60.7
$1,7
13.1 $2
,136
.8
$1,4
57.9
$1,5
54.1
$1,6
93.9
$1,7
10.0
$1,7
98.7
$2,1
56.7
$2,3
52.6
$321
.9
$505
.5 $825
.6
$0
$500
$1,000
$1,500
$2,000
$2,500
$3,000
97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14:Q2
Yield Hungry Pension Funds Have Grown Rapidly Since the Financial Crisis, Deploying Oceans of Capital in Industries Across the Globe—
Including the Global Reinsurance Industry
1 Figures for 2011-2013 are as of Q4 for each year.Sources: BarclayHedge: http://www.barclayhedge.com/research/indices/ghs/mum/Hedge_Fund.html; Insurance Information Institute.
($ Billions)
Assets managed by hedge funds are up 63% or $894.7 billion since 2008 to $2.35 trillion
5
8.6% 8.4% 8.0%6.4%
5.5%4.4%
2.3%
9.9%10.1%10.6%11.4%13.3%
14.9%
0%2%4%6%8%
10%12%14%16%
Compound Annual Growth Rate (%)
5
Global Pension Assets Growth,2008 – 2013*
Global pension assets for the top 13 pension
markets reached $31.98 trillion in 2013 (+9.5% from 2012), an
amount equal to 83.4% of these economies
CAGR of pension fund assets in most major pension markets has
been quite strong since the financial crisis
*As of year-end. Source: Towers Watson Global Pensions Asset Study 2014 at: http://www.towerswatson.com/en-US/Insights/IC-Types/Survey-Research-Results/2014/02/Global-Pensions-Asset-Study-2014
Pension Asset Allocation(World’s 7 Largest Pension Markets)
6
Holdings of Cash and Liquid Asset Holdings Have Soared Across Virtually All Industries Since the Financial Crisis
Alternative investment’s
share of assets is up +15 points since 2001 from 5% to
18%
*Australia, Canada, Japan, Netherlands, Switzerland, UK, US. Source: Towers Watson Global Pensions Asset Study 2014 at: http://www.towerswatson.com/en-US/Insights/IC-Types/Survey-Research-Results/2014/02/Global-Pensions-Asset-Study-2014
$0$50
$100$150$200$250$300$350$400$450$500$550$600$650$700$750
75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13
U.S. Policyholder Surplus:1975–2014*
* As of 6/30/14.Source: A.M. Best, ISO, Insurance Information Institute.
“Surplus” is a measure of underwriting capacity. It is analogous to “Owners
Equity” or “Net Worth” in non-insurance organizations
($ Billions)
The Premium-to-Surplus Ratio Stood at $0.73:$1 as of6/30/14, a Near Record Low (at Least in Recent History)
Surplus as of 6/30/14 was a record $671.6, up 2.8% from $653.3 of 12/31/13, and up 53.6% ($234.5B)
from the crisis trough of $437.1B at 3/31/09
$0.50
$0.60
$0.70
$0.80
$0.90
$1.00
$1.10
$1.20
$1.30
$1.40
$1.50
$1.60
$1.70
$1.80
$1.90
$2.00
85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14*
Premium-to-Surplus Ratio:1985–2014*
* As of 6/30/14.Source: A.M. Best, ISO, Insurance Information Institute.
The larger surplus is in relation to premiums—the lower the P:S ratio—
and the great the industry’s capacity to handle the risk it has accepted
(Ratio of NWP to PHS)
The Premium-to-Surplus Ratio Stood at $0.73:$1 as of6/30/14, a Record Low (at Least in Recent History)
Surplus as of 6/30/14 was $0.73:$1, a
record low (at least in modern
history)
9/11, Recession & Hard Market
Financial crisis had virtually no effect on the capital adequacy of the US nonlife insurance sector
11
U.S. Treasury Security Yields:A Long Downward Trend, 1990–2014*
*Monthly, constant maturity, nominal rates, through September 2014.Sources: Federal Reserve Bank at http://www.federalreserve.gov/releases/h15/data.htm. National Bureau of Economic Research (recession dates); Insurance Information Institute.
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
'90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14
Recession2-Yr Yield10-Yr Yield
Yields on 10-Year U.S. Treasury Notes have been essentially below 5% for a full decade.
Since roughly 80% of P/C bond/cash investments are in 10-year or shorter durations, most P/C insurer portfolios will have low-yielding bonds for years to come.
U.S. Treasury yields plunged to historic lows in 2013. Longer-
term yields have rebounded a bit.
11
Key European Central Bank Interest Rates, 2000 - 2014
12Source: European Central Bank from www.cbrates.com; Insurance Information Institute.
Interest Rates Have Been Slashed by Most Major Central Banks, Igniting a Global Quest for Yield. Reinsurance Is Just One of
Many New Areas “Discovered” by Large Institutional Investors
ECB’s cut its key rate to 0.05% on 4 Sept. 2014
13
Alternative Capital in Global Reinsurance Markets
13
The Global Hunt for Yield Pushed Institutional Investors Into
Countless New Areas—(Re)Insurance Being One of Them
14
Mentions of the Term “Alternative Capital” with “Insurance” or “Reinsurance”
* Estimate is annualized figure based on actual data through September 30, 2014.Source: Insurance Information Institute search of Factiva database.
11 9 20 21 35 52 29 4379 83
55 59116
409
712
0
100
200
300
400
500
600
700
800
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14*
Should the Increased Use of Terms Such as “Alternative Capital,” “Hedge Fund” and “Pension Fund” in Conjunction with a (Re)Insurance Be a Concern
Global Reinsurance Capital (Traditional and Alternative), 2006 - 2014
2014 data is as of June 30, 2014.Source: Aon Benfield Analytics; Insurance Information Institute.
Total reinsurance capital reached a record $570B in 2013, up 68% from
2008.
2006 2007 2008 2009 2010 2011 2012 2013 2014$0
$100
$200
$300
$400
$500
$600
17 22 19 22 24 28 39 50 59
368 388321
378447 428
466 490 511
385410
340400
470 455505
540570
Alternative Capital Traditional Capital Total
(Billions of USD)
But alternative capacity has grown 210% since 2008, to $50B. It has more than doubled in the past three years.
Global Reinsurance Capital Share (Traditional and Alternative), 2006 - 2014
2014 data is as of June 30, 2014.Source: Aon Benfield Analytics; Insurance Information Institute.
2006 2007 2008 2009 2010 2011 2012 2013 2014
-2%
0%
2%
4%
6%
8%
10%
12%
4.6%5.7% 5.9% 5.8% 5.4%
6.5%
8.4%
10.2%
11.5%
Alternative Capital’s Share of Global Reinsurance Capital Has More Than Doubled Since 2010.
Growth in Traditional and Alternative Capital, 2007-2014
2014 reflects growth through June 30 from prior year end.Source: Aon Benfield Analytics; Insurance Information Institute.
Post 2011, alternative capital is
growing four and five times
faster than traditional capital.
2007 2008 2009 2010 2011 2012 2013 2014-20%
-10%
0%
10%
20%
30%
40%
29%
-14%
16%
9%
17%
39%
28%
18%
5%
-17%
18% 18%
-4%
9%5% 4%
Alternative Capital Traditional Capital
(Change from Previous Year)
Japan, NZ quakes, US tornadoes drove
traditional capital slightly lower.
Economic meltdown depleted all forms of capital.
2009-10: Low cat losses, recovering markets fueled tra-
ditional capital growth.
Alternative capital has grown 247% since 2006, vs. 39% growth in traditional capital.
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014$0
$5
$10
$15
$20
$25
$30
Cat Bonds Sidecars ILWs Collateralized Re
(Billions of USD)
Growth of Alternative Capital Structures, 2002 - 2014
2014 data is as of June 30, 2014.Source: Aon Benfield Analytics; Insurance Information Institute.
Collateralize Re’s Growth Has Accelerated in the Past Three Years.
Collateralized Reinsurance and Catastrophe Bonds Currently Dominate the Alternative Capital Market.
ILS: Issuance and Outstanding, 1997- 2014:Q2Risk Capital Amount ($ Millions)
Sources: Artemis.bm, Insurance Information Institute.
71
4.0
74
2.2
82
4.8
1,1
25
.0
96
6.9 2,9
79
.9
3,4
79
.8
5,0
24
.8
4,5
80
.3
6,2
79
.2
7,6
41
.7
6,6
32
.7
2,500.0
1,142.82,388.2
8,2
41
.6
5,6
95
.7
989.5
4,5
94
.5
4,6
44
.5
6,4
41
.5 10
,11
4.5
17
,04
2.9
15
,67
6.8
14
,86
5.5
14
,04
3.6
13
,69
1.1
2,3
78
.9
1,8
84
.1
1,0
04
.8
89
5.6
22
,92
0.6
16
,47
9.2
20
,53
2.4
2,8
01
.4
$0
$4,000
$8,000
$12,000
$16,000
$20,000
$24,000
97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14:Q2Risk Capital IssuedRisk Capital Outstandng at Year End
2014 Has Seen the Largest Cat Bond Ever - $1.5 Billion (Florida Citizens). Bond Issuance Will Set a Record.
Model Uncertainty, Concerns on Economy Pushed Issuance Lower.
Risk Capital Outstanding Is at
a Record
Financial Crisis Depressed Issuance
Cat Bond:Investor by Category
Years ended June 30.Source: Aon Benfield Securities; Insurance Information Institute.
Catas-trophe Fund46%
Insti-tu-
tional32%
Mutual Fund11%
Hedge Fund5%
Reinsurer6%
2014
Mutual Funds Share of Cat Bond Purchases is Growing; Most Hedge
Funds Participate Via Collateralized Reinsurance.
Catas-trophe Fund51%
Insti-tu-
tional34%
Mutual Fund5%
Hedge Fund5%
Reinsurer5%
2012
U.S. Wind and Quake36%
U.S. Wind26%
Other (incl. U.S. Wind)11%
Euro Wind9%
U.S. Quake7%
Other (ex. U.S. Wind)
8%
Japanese Perils4%
21
Catastrophe Bonds Outstanding, Q2 2014
Source: Willis Capital Markets, Insurance Information Institute.
Catastrophe Bonds Are Heavily
Concentrated in U.S. Hurricane
Exposures. More Than 70 Percent of Catastrophe Risks Outstanding Cover U.S. Wind Risks.
22
Alternative Capital Is Impacting the Reinsurance
Pricing Environment
22
Traditional and Alternative Returns Are Under Pressure
U.S. Wind-Exposed Risk Premium* 2010:Q1 to 2014: Q1
Q1-10
Q2-10
Q3-10
Q4-10
Q1-11
Q2-11
Q3-11
Q4-11
Q1-12
Q2-12
Q3-12
Q4-12
Q1-13
Q2-13
Q3-13
Q4-13
Q1-14
Q2-14
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
11.0%
12.0%
13.0%
10.9%
8.2% 8.0%
8.0%
7.9%8.2%
8.2%
10.1%
10.9%
12.0%
12.0%
11.6%
11.0%
7.6%
7.4% 7.2%
6.4%6.2%
Ris
k S
pre
ad
(c
ou
po
n –
ris
k-f
ree
ra
te)
23
* Trailing 12-month averageSOURCE: Willis Capital Markets, Insurance Information Institute.
Risk spreads dropped –
equivalent to lower rates –
low cat losses, capital entering
market.
Risk spreads rose in 2011-2012 from cat activity and changes to catastrophe
models.
Non-U.S. Wind-Exposed Risk Premium* 2010:Q1-2014: Q1
Q1-10
Q2-10
Q3-10
Q4-10
Q1-11
Q2-11
Q3-11
Q4-11
Q1-12
Q2-12
Q3-12
Q4-12
Q1-13
Q2-13
Q3-13
Q4-13
Q1-14
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
8.5%
7.2%
6.9%
4.2%
4.2%4.5%
5.7% 5.7%5.7%
5.6%
4.9%
5.4%
4.8%
4.2%
3.6%
2.7%2.6%
Wtd. Avg. Risk Spread
Ris
k S
pre
ad
(c
ou
po
n –
ris
k-f
ree
ra
te)
24
* Trailing 12-month average.SOURCE: Willis Capital Markets, Insurance Information Institute.
Spreads are also falling in non-U.S. wind exposures, but
less sharply and in line with
expected losses
Reinsurance Pricing: Change in Rate on Line for U.S. CAT Business
2014 reflects growth through June 30 from prior year end.Source: Guy Carpenter; Insurance Information Institute.
Alternative Capital, Low
Levels of Catastrophe Drive Rates
Down.
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014-20%
-10%
0%
10%
20%
30%
40%
14% 14%
-11%
-6%
76%
-9%
-16%
10%
-12%
-3%
7%
-7%
-17%
(Change from Previous Year)
Japan, NZ Quakes, US Tornadoes.
2001-02: WTC Losses, Falling
Stock, Bond Prices Dry Up Capital.
2006: Higher Rates After Record Hurri-
canes.
Some Observers Predict Catastrophe Prices Will Fall Another 10 Percent in 2015, Driven by Emergence of New Capital.
76%
What Is Happening to Insurer Profitability?
27
Has Capital Accumulation Impacted Profitability?
Déjà Vu: Does History Suggest Cycles or Super-Cycles in Insurance?
27
-5%
0%
5%
10%
15%
20%
25%
75
76
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
07
08
09
10
11
12
13
14
Profitability Peaks & Troughs in the P/C Insurance Industry, 1975 – 2014:H1*
*Profitability = P/C insurer ROEs. 2011-14 figures are estimates based on ROAS data. Note: Data for 2008-2014 exclude mortgage and financial guaranty insurers.Source: Insurance Information Institute; NAIC, ISO, A.M. Best.
1977:19.0%1987:17.3%
1997:11.6% 2006:12.7%
1984: 1.8% 1992: 4.5% 2001: -1.2%
10 Years
10 Years9 Years
History suggests next ROE peak will be in 2015-2016
ROE
1975: 2.4%
2013 10.4%
2014:H1 7.7%
30
P/C Insurance ROE as 5-Year Moving Average
Source: Jessica Weinkle, Insurance Journal, “An Average Perspective Based Insurance Profitability Cycles,” October 6, 2014, based om I.I.I. data, http://www.insurancejournal.com/magazines/closingquote/2014/10/06/342096.htm.
After smoothing, there is a more evident trend over the past 40 years toward lower peak profitability
The Tradeoff:
Impairment rates have plunged
31
P/C Insurance ROE Index(1974-2014:Q1 = 100)
Source: Jessica Weinkle, Insurance Journal, “An Average Perspective Based Insurance Profitability Cycles,” October 6, 2014, based om I.I.I. data, http://www.insurancejournal.com/magazines/closingquote/2014/10/06/342096.htm.
Lower peak profitability seems to be the norm after
1994. Is RBC a cause? Greater use of modeling?
Lower interest rates?
The Tradeoff:
Industry impairment rates have plunged
-5%
0%
5%
10%
15%
20%
25%
50 52 54 56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12
14:H
1
*Profitability = P/C insurer ROEs. 2011-14 figures are estimates based on ROAS data. Note: Data for 2008-2014 exclude mortgage and financial guaranty insurers. 2014 figure is through Q2.Source: Insurance Information Institute; NAIC, ISO, A.M. Best.
1977:19.0%
1987:17.3%
1997:11.6%
2006:12.7%
1984: 1.8%
1992: 4.5%2001: -1.2%
ROE
1975: 2.4%
2013 10.4%
2014:H1 7.7%
Back to the Future: Profitability Peaks & Troughs in the P/C Insurance Industry, 1950 – 2014*
1969: 3.9%
1965: 2.2%1957: 1.8%
1972:13.7%
1966-67: 5.5%1959:6.8%
1950:8.0%
1950-70: ROEs were lower in this period. Low interest rates,
low inflation, “Bureau” rate regulation all played a role
1970-90: Peak ROEs were much higher in this period while troughs
were comparable. High interest rates, rapid inflation, economic
volatility all played roles
1990-2010s: Déjà vu. Excluding mega-
CATs, this period is very similar to the 1950-1970 period
33
7.3%7.0%8.4%
11.5%11.2%
4.2%5.7%
0%
2%
4%
6%
8%
10%
12%
14%
1950-59 1960-69 1970-79 1980-89 1990-99 2000-09 2010-14*
Average Annual Percent Change (%)
Profitability in the current low yield, low Inflation environment has declined since the highs of the 1970s and
1980s, but is above that of the 1950s and 1960s and the industry’s impairment rates have dropped since the 1980s
33Sources: Insurance Information Institute research.
Average ROE for the P/C Insurance Industry by Decade, 1950s – 2010s
Profitability peaked in the 1970s and 1980s but has tapered off
since thenP/C profitability was much lower in the 1960s and
1970s
35
BANK LESSON: Profitability, Capital and Systemically Important Banks
Source: The Economist, “No Respite,” September 27, 2014.
Global Systemically Important bank Tier-1
capital ratios are up since the global financial crisis,
but ROEs are lower
The Message from Bank Regulators:
Get used to it!
P/C Insurer Impairments, 1969–20137
07
17
27
37
47
57
67
77
87
98
08
18
28
38
48
58
68
78
88
99
09
19
29
39
49
59
69
79
89
90
00
10
20
30
40
50
60
70
80
91
01
11
21
3
0
10
20
30
40
50
60
70
15
12
71
19
34
91
31
21
99
16
14
13
36
49
31 3
45
04
85
56
05
84
12
91
61
23
11
8 19
49 50
47
35
18
14 15
51
6 19 2
13
42
51
4
Source: A.M. Best Special Report “U.S. P/C Impairments Down Sharply in 2013; Alternative Risk Players Faltered,” June 23, 2014; Insurance Information Institute.
The Number of Impairments Varies Significantly Over the P/C Insurance Cycle, With Peaks Occurring Well into Hard Markets
36
Impairments among P/C insurers remain infrequent
37
P/C Insurer Impairment Frequency vs. Combined Ratio, 1969-2013
90
95
100
105
110
115
1206
97
07
17
27
37
47
57
67
77
87
98
08
18
28
38
48
58
68
78
88
99
09
19
29
39
49
59
69
79
89
90
00
10
20
30
40
50
60
70
80
91
01
11
21
3
Co
mb
ine
d R
ati
o
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.8
2.0
Imp
airm
en
t Ra
te
Combined Ratio after Div P/C Impairment Frequency
Source: A.M. Best; Insurance Information Institute
2013 impairment rate was 0.43%, down from 0.76% in 2012; the rate is lower than the 0.81% average since 1969
Impairment Rates Are Highly Correlated With Underwriting Performance and Reached Record Lows in 2007; Recent Increase Was Associated
Primarily With Mortgage and Financial Guaranty Insurers and Not Representative of the Industry Overall
39
Summary
Capital Accumulation is Not Unique to (Re)InsuranceLarge corporations, institutional investors (e.g.,
pension funds), hedge funds, sovereign wealth funds have experienced rapid cash (or equivalent) accumulation
All Are Chasing Yield—Globally
Capital Has Generally Been Accumulating on the Balance Sheets of Nonlife (Re)Insurers for YearsEra of rapid accumulation pre-dates financial crisisPace has accelerated post-financial crisisProfits, capital gains and “alternative capital” all
contribute
40
Summary (Continued) Nonlife ROEs Have Trended Downward
Downward trend pre-dates financial crisis Capital accumulation, RBC requirements are factors; Low yields Tradeoff: Impairment rates have trended downward
Quantum Shift or Evidence of a Super-Cycle? Profitability patterns today are more reminiscent of the pre-1970
era (and in the US back to WW II and even pre-war)
Capital Allocation Challenges: Excess capital seemingly “stuck” in the industry Sluggish economy diminishes rate of exposure growth Insurance penetration lags economic growth in emerging markets Changes in the nature of insurable exposures (e.g., cyber, IP, etc.) Share repurchases preferred over long-term investments or
acquisitions (situation is not unique to insurance) Tax and regulatory obstacles
www.iii.org
Thank you for your timeand your attention!
Twitter: twitter.com/bob_hartwigDownload at www.iii.org/presentations
Insurance Information Institute Online:
41