What Keeps Insurance CEOs Awake at Night? An Overview and Outlook for the P/C Insurance Industry May 2002 Robert P. Hartwig, Ph.D., Senior Vice President

What Keeps Insurance CEOsAwake at Night?

An Overview and Outlook for the P/C Insurance Industry

May 2002

Robert P. Hartwig, Ph.D., Senior Vice President & Chief EconomistInsurance Information Institute 110 William Street New York, NY 10038

Tel: (212) 346-5520 Fax: (212) 732-1916 [email protected] www.iii.org

Presentation OutlineTough Mission for CEOs but Not Mission Impossible

• Restore Profitability >Restore & Rebuild Capacity• Rationalize Pricing>Focus on the Fundamentals• Improve Investment Returns• Accelerate Consolidation• Add Value through Technology—Insurance Scoring• Restore Order in the Courts• Keep Wall Street Happy• The Challenge of Corporate Governance• The Challenge of Terrorism

RESTOREPROFITABILITY

P/C Net Income After Taxes1993-2001 ($ Millions)

$19,316

$10,870

$20,598

$24,404

$36,819

$30,773

$21,865$20,223

-$7,921-$10,000

-$5,000

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

$40,000

1993 1994 1995 1996 1997 1998 1999 2000 2001

Sources: A.M. Best, ISO, Insurance Information Institute.

2001 was the first year ever with a full year net loss

Highlights: Property/Casualty Full-Year 2001 ($ Millions)

2001 2000 Change

Net Written Prem. 323,977 299,652 +8.1%

Loss & LAE 276,120 238,781 +15.6%

Net UW Gain (Loss) (52,990) (31,220) +69.7%

Net Inv. Income 37,066 40,704 -8.9%

Net Income (a.t.) (7,921) 20,559 N/A

Surplus* 289,649 317,361 -8.7%

Combined Ratio** 116.0 110.1 +5.9 pts.*Comparison with year-end 2000;

**Comparison with full-year 2000; 2001 figure excl. 9/11 losses is 111.8.

-5%

0%

5%

10%

15%

20%

25%

US P/C Insurers All US Industries LifeDiversified Finl. Comm. Banks

ROE: Financial Services Industry Segments, 1987–2001

Source: Insurance Information Institute; Fortune

2000 Return on Equity: US (Profitability)

1.3%

2.9%

3.6%

5.4%

5.7%

7.0%

14.2%

0% 2% 4% 6% 8% 10% 12% 14% 16%

Fortune 500

Workers Comp

Med Mal

Comm Multi Peril

PP Auto

Comm Auto

Homeowners

Source: NAIC, Insurance Information Institute

2000

2000 Return on Equity: Mid-Atlantic States PP Auto

2.2%

2.2%

2.9%

6.1%

6.7%

9.7%

0% 2% 4% 6% 8% 10% 12%

Dist. Of Columbia

Virginia

New Jersey

Maryland

Delaware

US


2000

2000 Return on Equity: Mid-Atlantic States HO

-8.6%

0.9%

2.5%

3.8%

16.1%

16.3%

-10% -5% 0% 5% 10% 15% 20%

New Jersey

Dist. of Columbia

US

Delaware

Maryland

Virginia


2000

12% After Tax ROE Requires Underwriting Profit

Source: Dowling & Partners

Accident Year Combined Ratio

P : S 90.0% 92.5 % 95.0 % 97.5 % 100.0 % 102.5 % 105.0 % 107.5 % 110.0 % 112.5 %

100 % 13.0 % 11.5 % 10.1 % 8.6 % 7.1 % 5.6 % 4.1 % 2.6 % 1.1 % -0.4 %

110 % 14.0 % 12.4 % 10.7 % 9.1 % 7.5 % 5.8 % 4.2 % 2..5 % 0.9 % -0.7 %

120 % 15.0 % 13.2 % 11.4 % 9.6 % 7.8 % 6.1 % 4.3 % 2.5 % 0.7 % -1.1 %

130 % 16.0% 14.0 % 12.1 % 10.2 % 8.2 % 6.3 % 4.4 % 2..4 % 0.5 % -1.5 %

140 % 16.9 % 14.9 % 12.8 % 10.7 % 8.6 % 6.5 % 4.4 % 2.4 % 0.3 % -1.8 %

150 % 17.9 % 15.7 % 13.5 % 11.2 % 9.0 % 6.8 % 4.5 % 2.3 % 0.1 % -2.2 %

160 % 18.9 % 16.5 % 14.1 % 11.8 % 9.4 % 7.0 % 4.6 % 2.2 % -0.2 % -2.5 %

170 % 19.9 % 17.3 % 14.8 % 12.3 % 9.8 % 7.2 % 4.7 % 2.2 % -0.4 % -2.9 %

180 % 20.9 % 18.2 % 15.5 % 12.8 % 10.1 % 7.5 % 4.8 % 2.1 % -0.6 % -3.3 %

190 % 21.8 % 19.0 % 16.2 % 13.3 % 10.5 % 7.7 % 4.9 % 2.0 % -0.8 % -3.6 %

200 % 22.8 % 19.8 % 16.9 % 13.9 % 10.9 % 7.9 % 4.9 % 2.0 % -1.0 % -4.0 %

225 % 25.3 % 21.9 % 18.6 % 15.2 % 11.9 % 8.5 % 5.2 % 1.8 % -1.5 % -4.9 %

250 % 27.7 % 24.0 % 20.3 % 16.5 % 12.8 % 9.1 % 5.4 % 1.7 % -2.1 % -5.8 %

RESTORE & REBUILD

DESTROYEDCAPACITY

$0

$50

$100

$150

$200

$250

$300

$350

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

Policyholder Surplus: 1975-2001

Source: A.M. Best, Insurance Information Institute

Bil

lion

s

(US

$)

Surplus Peaked at $336.3 Billion in 1999

•Surplus decreased 8.7% in 2001 to $289.6 Billion.

•Surplus is now lower than at year-end 1997.

“Surplus” is a measure of underwriting capacity. It is analogous to “Owners Equity” or “Net Worth” in non-insurance organizations

Capital Myth 1: Insurers Have $4 Trillion in Assets to Pay Terrorism Claims

$3,139 (77%)

$931 (23%)

Source: Insurance Insurance Information Institute

The Facts

P/C insurers have $931 billion in assets compared to $3.1 trillion for life insurers

Total = $4.1 Trillion (as of 12/31/00)

P/C

LIFE

Capital Myth 2: P/C Insurers Have Nearly$1 Trillion in Assets to Pay Terrorism Claims

Liabilities ($594.6B)

64%

PH Surplus ($317.4B)

34%

Non-Admitted

Assets ($19B)2%

Source: Insurance Information Institute; A.M. Best

The Facts

66% of Assets are offset by liabilities

(mostly reserves) or are non-admitted

Assets = Liabilities + Policyholder Surplus

Capital Myth 3: P/C Insurers Have $300 Billion to Pay Terrorism Claims

"Target" Commercial*$100 billion

33%

Other Commercial$50 billion

17%

Personal$150 billion

50%

Total PHS = $298.2 B as of 6/30/01

*”Target” Commercial includes: Comm property, liability and workers comp; Surplus must also back-up on non-terrorist related property/liability and WC claimsSource: Insurance Information Institute

Only 33% of industry surplus backs up “target” lines

Fresh Capital: Top 15 Deals(as of April 12, 2002)

CGNU $1,700DSwiss Re 1,600VAxis (Marsh) 1,600SAce Ltd. 1,150SAIG 1,000CDMontpelier 1,000PEConverium 985SAllied World 959SXL Capital 819SEndurance 800V

Arch Capital 763SXL Capital 600DChubb 600DSt. Paul 575TPWellington 564SALL OTHERS 7,281 Total Completed = $24,584

Pending = $8,889GRAND TOTAL = $33,473

Will they shorten the hard market?Type of Issuance: CD=Convertible Debt; D= Debt; PE=Private Equity;S=Stock;TP=Trust Preferred;V=Various Source: Morgan Stanley

RATIONALIZE PRICING

Average Price Change of Commercial Insurance Renewals

9.5%

13.5%

8.8%

10.0%

12.0%

11.0%

8.9%

6.1%

9.5%

8.0%

8.3%

7.9%

9.0%

-1.6%

-1.2%

-0.4%

-7.0%

-6.0%

-11.0%

-6.0%

-10.0%

-7.0%

-3.0%

1.4%

0.8%

3.5%

3.2%

3.2%

2.8%

4.1%

-2.1%

-2.8%

-1.8%

0.2%

-5.0%

-4.4%

-3.5%

-4.3%

-6.6%

-4.1%

-2.0%

-13%

-11%

-9% -7% -5% -3% -1% 1% 3% 5% 7% 9% 11%

13%

E&S

Umbrella

Workers' Comp

Commercial Property

CMP

General Liability

Commercial Auto

Spring 2001 Fall 2000 Spring 2000 Fall 99 Spring 99 Fall 98Source: Conning

CIAB Rate SurveyFirst Quarter 2002

Rate Increases By Line of BusinessRate Increases By Line of Business NoNo

Change Up 1-10%Change Up 1-10% Up 10-30% Up 30-50% Up 10-30% Up 30-50% Up>50%Up>50% Up>100%Up>100%

Commercial Auto 3% 19% 55% 13% 4% 1%

Workers Comp 7% 20% 45% 17% 3% 1%

General Liability 1% 13% 62% 17% 3% 1%

Commercial Umbrella 1% 4% 29% 32% 18% 11%

Commercial Property 1% 5% 39% 34% 13% 3%

Business Interruption 3% 10% 47% 22% 7% 2%

Surety Bonds 8% 20% 28% 7% 3% 1%

Source: Council of Insurance Agents and Brokers

CIAB Rate SurveyFirst Quarter 2002

Rate Increases By Size of AccountRate Increases By Size of Account NoNo

Change Up 1-10%Change Up 1-10% Up 10-30% Up 30-50% Up 10-30% Up 30-50% Up>50%Up>50% Up>100%Up>100%

Small (<$25K) 3% 16% 61% 10% 1% 0%

Medium ($25K - $100K) 2% 4% 60% 25% 3% 1%

Large (>$100K) 1% 6% 45% 27% 6% 1%

Source: Council of Insurance Agents and Brokers

100110

120130140

150160

170180190

200210220

230240

250260

89 90 91 92 93 94 95 96 97 98 99 00 01 02*

Rate On Line Index(1989=100)

Source: Guy Carpenter * III Estimate

Prices rising, limits falling: ROL up significantly

Cost of Risk per $1,000 of Revenues: 1990-2002E

$6.10

$6.40

$8.30$7.70

$7.30

$6.49

$5.70$5.25

$5.71

$5.20$4.83

$5.55

$7.22

$4

$5

$6

$7

$8

$9

$10

90 91 92 93 94 95 96 97 98 99 00 01E 02E

Source: 2001 RIMS Benchmark Survey; Insurance Information Institute estimates.

Cost of risk to corporations could rise sharply in 2002; About half of increase due to 9/11

0.9%

-5.9%

-16.9%

-27.3%

-35.6%-37.6%

-35.4%

-22.0%

-40%

-35%

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

Workers Comp: Impact of Loss Cost/Rate &

Discounting

Source: NCCI, Insurance Information InstituteP=preliminary*Insurance Information Institute estimates.

2000 AY Combined Ratio: 136

2000 Reserve Deficiency: $20B

Average Price Change of Personal Lines Renewals

6%

7%

6%

6%3%

4%

1%

5%

4%

1%-1%

2%

0%

2%

-2% -1% 0% 1% 2% 3% 4% 5% 6% 7%

Homeowners

Personal Auto

2002* 2001* Fall 2000 Spring 2000 Fall 99 Spring 99 Fall 98*III estimatesSource: Conning, III

Average Expenditures on Auto Insurance: US

668

691

706

704

683 69

3

735

793

$600

$620

$640

$660

$680

$700

$720

$740

$760

$780

$800

1995

1996

1997

1998

1999

2000

*

2001

*

2002

*

*Insurance Information Institute Estimates/ForecastsSource: NAIC, Insurance Information Institute

Countrywide rates were up 1.5% in 2000 and up est. 6% in 2001, 8% in 2002

Mid-Atlantic AutoInsurance Expenditures vs. US

$1034 $988

$824

$757 $683

$567$469

$0

$200

$400

$600

$800

$1,000

$1,200

NJ DC DE MD US VA ND

Source: Insurance Information Institute from NAIC Data, 1999.

2 5 3912

Highest in US

Lowest in US

1

Average Expenditures on Homeowners Ins.: US

418

440

455

481 48

8 500

530

567

$400

$450

$500

$550

$600

1995

1996

1997

1998

1999

2000

*

2001

*

2002

*

*III EstimatesSource: NAIC, Insurance Information Institute

Average HO expenditures rose by 1.5% in 2000;

Up 6.0% in 2001; 7.0% in 2002

Average HO Premium by Region, 2000

Source: Conning & Co.

$859

$713

$623$565

$506 $495 $482$418 $392

WestSouth

Central

Pacific NewEngland

Mountain WestNorth

Central

Mid-Atlantic

EastSouth

Central

SouthAtlantic

EastNorth

Central

Mid-Atlantic HO-3Insurance Premiums vs. US

$861

$617

$497$487

$372$345 $317

$266

$0

$200

$400

$600

$800

$1,000

TX DC NJ US MD VA DE WI

Source: Insurance Information Institute from NAIC Data, 1999.

4 184942 45

Highest in USLowest in US

Health Plan Costs per Employee

*EstimateSource: Hewitt Associates LLC.

15.6%

10.1% 9.4%7.8%

0.0%

5.0%

10.0%

15.0%

20.0%

2002* 2001 2000 1999

Annual % Increase

Tremendous cost pressure

Employers want help managing costs

Phamaceutical costs

What is managed care?

Most layoffs in this sector (e.g., Aetna announced Dec. 13 the layoff of 6,000)

Still LT growth industry

Reasons Why Market Will Remain Hard

• Total capital raised less than what was lost from 9/11• Capacity lost is greater than dollar losses from attack

suggestMore caution on the part of insurers/reinsurers means more

capital needed per dollar of risk assumed

• Demand up (we’re more at risk as a nation now)• Reserve shortfalls (e.g, asbestos, WC)• Poor results in many important lines for reason other

than 9/11• Poor investment results• Wall Street pressure

FOCUS ON FUNDAMENTALS

0%

5%

10%

15%

20%

25%

19

70

19

72

19

74

19

76

19

78

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

U.S.

*Estimate from I.I.I. Groundhog Survey.Source: A.M. Best, Insurance Information Institute

Growth in Net Premiums Written (All P/C Lines)

2000: 5.1%

2001: 8.1%

2002 Forecast: 14.7%*

The underwriting cycle went AWOL in the 1990s.

It’s Back!

95

100

105

110

115

120

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00

02**

P/C Industry Combined Ratio

2000 = 110.1

2001 Estimate = 116.0

2002 Forecast* = 108.0

Combined Ratios

1970s: 100.3

1980s: 109.2

1990s: 107.7

Sources: A.M. Best; III

* Based on III 2002 Groundhog Forecast

Combined Ratio Components

108.1 106.8103.1

1.57.8

3.0

0.6

1.4

1.5

100

105

110

115

120

2000 2001E 2002E

"Normalized" Losses Catastrophe Losses Asbestos & Environmental

116.0

110.1 107.5

WTC losses accounted for 4.8 pts. on the 2001

combined ratio

Source: A.M. Best.; ISO.

Kitchen Sink Quarter:2001:Q4

$1,794

$801 $702 $653$388 $267 $175 $109 $69 $40

$0

$500

$1,000

$1,500

$2,000

P/C insurers took $5 billion in miscellaneous

charges against their 2001:Q4 results

Source: Morgan Stanley as of February 8, 2002.

Combined Ratios

Source: A.M. Best, NCCI; Insurance Information Institute

*A.M. Best estimate;**ForecastIncludes dividends to policyholdersAccident year is developed to ultimate

Calendar Year vs. Ultimate Accident Year Countrywide—Private Carrier

123 122

109

10197

99

122

108

121

101

107

120

129

137

129

101

108

115117 118

9695

100

112

133

90

95

100

105

110

115

120

125

130

135

140

90 91 92 93 94 95 96 97 98 99 00 01* 02**

Pe

rce

nt

Calendar YearAccident Year

110.

5

105.

0

113.

6 119.

2

104.

8

100.

8

100.

5

114.

3

107.

2

142.

9

108.

8 115.

8

106.

9

108.

5

106.

5

105.

8

101.

6

105.

6

107.

7

110.

1 116.

0

126.

5

90

100

110

120

130

140

150

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Reinsurance All Lines Combined Ratio

Combined Ratio: Reinsurance vs. P/C Industry

Source: A.M. Best, ISO, Reinsurance Association of America, Insurance Information Institute

2001’s combined ratio was the worst-ever for reinsurers & the 3rd worst ever for p/c insurers in aggregate.

U.S. InsuredCatastrophe Losses

$7.5

$2.7$4.7

$22.9

$5.5

$16.9

$8.3 $7.3

$2.6

$10.1$8.3

$4.3

$24.1

$0.60

5

10

15

20

25

89 90 91 92 93 94 95 96 97 98 99 00 01 02**

•Includes $16.6B for 9/11 losses reported through 12/31/01. Includes only business and personal property claims, business interruption and auto claims.**First Quarter 2002.Source: Property Claims Service, Insurance Information Institute

$ BillionsCAT Losses for 2001 Set a Record

•20 events (lowest since 1969)•1.5 million claims

•9/11: $16.6B = 74,000 claims

($60)

($50)

($40)

($30)

($20)

($10)

$0

$101

97

51

97

61

97

71

97

81

97

91

98

01

98

11

98

21

98

31

98

41

98

51

98

61

98

71

98

81

98

91

99

01

99

11

99

21

99

31

99

41

99

51

99

61

99

71

99

81

99

92

00

02

00

1

Underwriting Gain (Loss)1975-2001


$ B

illi

ons

P-C insurers paid $53 billion more in claims & expenses than they collected in premiums

in 2001

-$2.2-$2.8

-$4.0

-$2.9

-$5.4

-$0.3

-$2.6 -$2.4

-$3.6

-$8.9

-$6.5

-$11.5($12)

($10)

($8)

($6)

($4)

($2)

$01

99

1

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

E

20

02

F

Underwriting Loss in HO Insurance, 1991-2002F


$ B

illi

ons

Underwriting losses in homeowners insurance from 2000 to 2002 alone are

estimated at $19.0 billion, 14.5% above the $16.6 billion in 9/11 property losses.

Outlook for 2002: Personal Lines

99.5101.0101.1

109.4

103.5

108.2109.5

111.4

107.0

126.0

106.3

117.5

105103

90

95

100

105

110

115

120

125

130

*Breakeven Ratio: Reflects AY results, includes investment income; assumes 4% interest rate.Source: A.M. Best

97 98 99 00 01E 02E BE*

97 98 99 00 01E 02E BE*

PERSONAL AUTO HOMEOWNERS

Outlook for 2002: Commercial Lines12

9.0 13

5.5

114.

5

132.

0

143.

0

102.

5107.

8 117.

0

110.

0 116.

5 122.

0

95.0

112

113

107

107

115

107

90

100

110

120

130

140

150

WorkersComp

GL & Prod.Liab

CommercialAuto

CommercialPackage

Med Mal InlandMarine

01E 02E Breakeven*

*Breakeven Ratio: Reflects AY results, includes investment income; assumes 4% interest rate.Source: A.M. Best

IMPROVEINVESTMENT

RETURNS

$0

$9

$18

$27

$36

$45

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

Net Investment Income

Facts

1997 Peak = $41.5B

1998 = $39.9B

1999 = $38.9B

2000= $40.7B

2001 = $37.1E


Bil

lion

s

(US

$)

Pricing & underwriting problems were exacerbated by declining investment incomeShort-term interest rates

are under 2%!

Markets Down Considerably in 2001

-7.10%

-13.04%

-21.05%

-25% -20% -15% -10% -5% 0%

Nasdaq

S&P 500

DJIA

Source: Insurance Information Institute

2001 Change in Major Market Indexes

P/C Insurer Portfolio:

64% Bonds

23% Stocks

5% Cash & ST Sec.

8% Other

2002: Not Off to a Great Start

2.76%

-4.42%

-11.86%

-15% -10% -5% 0% 5%

Nasdaq

S&P 500

DJIA


YTD Change Through May 14, 2002

P/C Insurer Portfolio:

64% Bonds

23% Stocks

5% Cash & ST Sec.

8% Other

-30%

-20%

-10%

0%

10%

20%

30%

40%

19

70

19

72

19

74

19

76

19

78

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

*

Large Company Stocks*As of May 14, 2002.Source: Ibbotson Associates, Insurance Information Institute

Total Returns for Large Company Stocks: 1970-2002*

Could be headed for 3rd consecutive year of decline for stocks

Last happened 1939-1941 (years straddling Great Depression & WW II)

4.4%3.5%

2.5%

5.7%

8.3%

4.8%5.6%

2.2%

1.0%1.3%

0.3%

-1.3%

5.8%

4.0%3.5%

1.7%

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

Real GDP Growth

Source: US Department of Commerce, Blue Economic Indicators, Insurance Information Institute.

Economy is recovering quickly from the recession of 2001

(first recession since 1990/91)

New Private Housing Starts(Millions of Units)

1.19

1.01

1.20

1.29

1.461.35

1.48 1.47

1.62 1.67 1.591.60 1.61 1.58

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 1 02* 03*

Source: US Department of Commerce; Insurance Information Institute*Projections from Blue Chip Economic Indicators.

New Private Housing Starts Annualized starts in early 2001 were

surprisingly strong: Virtually no exposure impact for insurers

Motor Vehicle Retail Sales (Millions of Units)

15.515.5

16.0

17.417.8

17.1

16.2

16.5

15.0

15.5

16.0

16.5

17.0

17.5

18.0

18.5

19.0

19.5

20.0

96 97 98 99 00 01 02* 03*

Source: US Department of Commerce; Insurance Information Institute*Projections from Blue Chip Economic Indicators.

New Motor Vehicle Sales

Sales so far in 2001 are surprisingly strong—up from from 2000’s record pace.

Despite slowing economy, no adverse exposure impact on auto insurers.

ACCELERATE CONSOLIDATION

Insurance Mergers and Acquisitions

7.1 6.9 8.6 5 8.5 12.527

40.856.2

41.755.7

41.5

243 246

171 188149

221

349382

433

300295

468

$0

$20

$40

$60

$80

$100

$120

$140

$160

$180

89 90 91 92 93 94 95 96 97 98 99 00 01

Val

ue o

f M

& A

s ($

Bil

lion

s)

0

100

200

300

400

500

600

Num

ber

of M

& A

s

Value of Deals Number of Deals

Source: Compiled from Conning & Company reports.

1998: 565 deals valued at $165.4 B

8 of the 10 top deals in 2001 were in the Life sector; 2 were Health/Mgd. Care

None of the top10 deals were in the P/C sector

Competition—Still Intense: Number of Insurers: 1970-2000

1095 1059

15751702

2406 2430 2485 2480 2455

1802 17461958

2261 2195

17151563

0

500

1,000

1,500

2,000

2,500

3,000

1970 1975 1980 1985 1990 1995 1998 1999 2000

Property/Casualty

Life/Health

Sources: P/C: A.M. Best; L/H: NAIC.

ADD VALUE THROUGH

TECHNOLOGY

Application of Technology in Underwriting:

Insurance Scoring

Insurance Scoring• What is “Insurance Scoring”?

Insurers use credit information as way of determining individual’s financial stability and responsibility. Not being assessed for ability to repay a loan.

Insurance scores are HIGHLY accurate predictors of future loss in auto and homeowners insurance

Produces more fair, more equitable rating structure Those most likely to impose costs on system pay more Those least likely to impose costs on the system pay less

Does not discriminate by income, location, gender,marital status, etc.

In use by 85% - 90+% of the market (roots back to 1970s)

FICO Scores

Source: Fair, Isaac

1%

5%7%

11%

16%

20%

29%

11%

<= 499 500-549 550-599 600-649 650-699 700-749 750-799 800+

Distribution of Borrower Credit Scores by Risk Tier

Risk TierCredit Score –

Banking% of Borrowers

A (prine) – Good 660+ 70%

A – Fair 620 – 659 18%

B 580 – 619 9%

C 550 – 579 2.7%

D 520 – 549 0.3%

Source: HSH Associates, National Home Equity Assoc.

142

118

100

99

93

83

80

75

71

155

127

118

104

97

92

82 80

72 70

121

60

70

80

90

100

110

120

130

140

150

160

Score Range

Rel

ativ

e P

erfo

rman

ce

Loss Ratio Claims Frequency

Performance by Score

Interpretation:

As score improves (gets larger), performance in terms of loss ratio and

frequency of claims improves

CAS Credit StudyPersonal Automobile Loss Ratio by Credit Categoty

CategoryEarned

PremiumIncurred

LossLoss Ratio

Loss Ratio Relativity

A $74,279 $75,333 101.4% 133

B 158,922 124,723 78.5% 103

C 69,043 47,681 69.1% 91

D 91,746 52,688 57.4% 75

Total $393,990 $300,425 76.3%

Category A – Unacceptable Credit Rating

Category B – No established credit history (or does not meet the definition of A, C or D)

Category C – Good Credit Rating

Category D – Excellent Credit Rating

Source: Casualty Actuarial Society

Fraud & Credit

Source: Conning & Company

49%38%

33%

24% 23%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

300-399 400-499 500-599 600-699 700 +

Percentage of People Saying It Is Acceptable to Increase the Amount of the Claim to Make Up for the Deductible by Insurance Score

Insurance Scoring*• What information is used?

Adverse public recordsCollectionsTypes of accountsPayment timingUtilization of balance relative to limitsAge of accountsNumber of accounts opened recentlyInquiries

*Practices vary by insurer and state

1000

1804

1293

0

200

400

600

800

1000

1200

1400

1600

1800

2000

Zero One Two or More

Number of 60+ Day Delinquencies

Los

s R

atio

Rel

ativ

ity

Delinquencies & Loss Ratio*(Homeowners HO-3)

Interpretation:

Higher number of delinquencies correlated with higher loss ratios

733 723 711 708 711 716 721 722733

200

300

400

500

600

700

800

<$15 $15-19 $20-29 $30-39 $40-49 $50-74 $75-99 $100-124

>=$125

Income ($000)

Cre

dit

Sco

reAverage Credit Score by

Income Group

Interpretation:

Credit score is not significantly correlated with income

Source: American Insurance Association

Insurance Scoring: Is it Fair?• Scoring Models Exclude Factors Such As:

GenderRace IncomeLocationNet WorthMarital StatusAge

• Always used in conjunction with other factors (e.g., driving record, type of car…)

Insurance Scoring: Is it Fair?

• Insurers comply with Fair Credit Reporting Act of 1970 (& subsequent amendments)Firms must have permissable purpose to access

(underwriting of insurance is explicitly listed as a permissable purpose)

Consumer must notified of adverse actionConsumer may obtain free copy of reportConsumer may request full reinvestigationConsumer may dispute reinvestigation results

RESTORE ORDER TO THE

COURTS

TORT-ure

• Asbestos• “Toxic” Mold• Aftermarket Parts• Lead• Arsenic Treated Lumber• Construction Defects• Guns• Genetically Modified Foods (Corn)• Nursing Homes/Med Mal• What’s Next?• Sept. 11??

Average Jury Awards1994 vs. 2000

419759

187 333

1,140 1,185

1,744

1,168

1,727

269698

3,482 3,566

6,817

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

Overall BusinessNegligence

VehicularLiability*

PremisesLiability

MedicalMalpractice

WrongfulDeath

ProductsLiability

($00

0)

1994 2000

Source: Jury Verdict Research; Insurance Information Institute.

Rising Jury Awards

Source: Jury Verdict Research

LESS THAN$100,000

$100,000 -$249,999

$250,000 -$499,999

$450,000 -$999,999

$1 MILLIONAND OVER

1994 2000

52%30%

20%7%

Percentage of Awards at $1 Million and Above (2000)

Source: Jury Verdict Research; Insurance Information Institute

25.0% 24.0%

20.0%18.0%

16.0% 15.0% 15.0% 15.0% 15.0% 14.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

Top 10 States

Cost of U.S. Tort System($ Billions)

Source: Tillinghast-Towers Perrin; Insurance Information Institute estimates for 2001/2002 assume tort costs equal to 2% of GDP.

$128.9$129.8$140.8$144.1$148.3

$159.3$155.6$156.0$166.8$168.8

$178.6$197.5$204.2

$0

$50

$100

$150

$200

$250

90 91 92 93 94 95 96 97 98 99 00 01* 02E*

Tort costs consumed 2.0% of GDP annually on average since 1990

Tort costs equaled $636 per person in 2000!

Source: New York Daily News, September 10, 2001

Source: New York Times Magazine, August 12, 2001

Source: New York Daily News, September 10, 2001

232615471722

3413

5722

883

0

1000

2000

3000

4000

5000

6000

7000

2000 Q1 2000 Q2 2000 Q3 2000 Q4 2001 Q1 2001 Q2

Texas:Estimated Total # of Mold

Claims

Note: Data are not developedSource: Texas Department of Insurance Special Call for Homeowners mold experience issued July 30, 2001; Insurance Information Institute.

The number of mold claims increased

548% between early 2000:I and 2001:II

Asbestos: Reserve Deficiency and Ultimate Costs Growing

23.9 26.0

31.9

16.1 14.0

33.1

40.0 40.0

65.0

$0

$10

$20

$30

$40

$50

$60

$70

1996 1997 2001

($ B

illio

ns)

Incurred Losses to Date Unfunded Future Liabilities Ultimate Costs

Source: A.M. Best.

Reserve Deficiency = $33.1 Billion

KEEP WALL STREET

HAPPY

Insurer Stock Performance:It Could Have a Lot Worse

39.8%

-21.1%

-10.9%

1.8%

-7.0%

-7.6%

-1.2%

-39.3%

-9.1%

18.1%

34.5%

43.4%

-60% -40% -20% 0% 20% 40% 60%

Nasdaq

S&P 500

Banks

Life/Health

All Insurers

Property/Casualty

Percentage Change

2001

2000

Source: SNL Securities; Insurance Information Institute

Insurer Stock Price Performance: Before & After 9/11

Source: SNL Securities, Insurance Information Institute

-21

.6

-9.7 -8

.2

-20

.0 -16

.5

-23.

0

-21.

7 -18.

3

-21.

1

-26.

2

-7.6

-10

.9

-13

.2

-29.

5

1.2

-1.2

-7.0

-15

.9

-35.0

-30.0

-25.0

-20.0

-15.0

-10.0

-5.0

0.0

5.0

All Multi L/H P/C Broker S&P500

Per

cent

10-Sep 21-Sep 2001

Total Return

Insurer Stocks: Outperforming the S&P 500

-10.57%

1.55%

4.14%

-1.07%

3.53%

3.36%

-17.90%

-7.70%

-20% -15% -10% -5% 0% 5% 10%

S&P 500

Nasdaq

Banks

Life/Health

Brokers

P/C

All

Multiline

Source: SNL Securities, Insurance Information Institute

Total Return 2002 YTD Through May 10, 2002

THE CHALLENGE OF CORPORATE GOVERNANCE

CORPORATE GOVERNANCE:

New & Difficult Risk for Financial Institutions

Accounting Problems are Getting Many Companies into Trouble

•Enron fallout much worse than anticipated

•Many companies restating earnings

Corporate Governance: Expensive and Hard-Learned Lessons

• Crisis of Confidence—skepticism is on the rise

Ratings agencies Analysts Regulators

Investors/Creditors Employees Lawmakers

• Regulatory/Legislative Fallout Unclear

SEC opened record 49 financial cases opened in first 2 months of 2002 compared to

18 during same period of 2001

Most new SEC cases are against large companies

• SEC, Administration & Congressional proposals vary

• Surge in shareholder suits has already begun

Breach of Faith

Cover of BusinessWeek,

May 13, 2002

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;Woodruff-Sawyer & Co.; Insurance Information Institute

164202

163

231188

110

178

236209 216

487

0

100

200

300

400

500

600

Shareholders typically recover just 2.56% of amount lost; 1/3 of that

goes to lawyers & expenses**

Serious Implications for Financial Institutions

• FIs exposed to wide variety of risks:

Investment risk (as institutional investors)

Insurance risk (surety, credit guarantees, D&O)

Professional liability (investment banks advisory role)

Reputation risk

• FIs will be targets of regulatory/legal action

Most large FIs are organizationally complex

GLB necessarily increases complexity (BHC tent is big)

As principals go bankrupt, shareholders go in search of deep pockets (Read: Wall Street)

Houston…We Have a Problem

Source: Loss estimates from Morgan Stanley as Feb. 8, 2002; Insurance Information Institute.

Surety26%

Multiple7%

D&O1%

Fin. Guarantee

2%Investment

64%

Total Exposure (Life & Non-Life): $3.796 BillionEnron is the biggest bankruptcy in US history ($31B+)

Equity/debt widely-held as S&P 500 company

Biggest impact in institutional investors/creditors

11 Congressional investigations

56 suits against officers & directors

Will spark similar suits

THE CHALLENGE OF TERRORISM

TERRORIST ATTACKS OF SEPTEMBER 11, 2001

What’s this Going to Cost & Who’s Going to Pay for It?

Sept. 11 Insured Loss Estimates

• Biggest insured CAT is US and world history ($40B)Hurricane Andrew: $15.5B (1992$); $20B (2000$)

• 100+ insurers worldwide have made announcements accounting for about $22B in insured losses

• Industry loss estimates range from low of $30 billion to $70 billion (consensus = low $40Bs)First WC disaster ($3.5B); 8,000 physically injured First life disaster ($2.7B); 3,000+ killedAnthrax Issue? WC exposure if out of course of employment

• Estimated NYC economic losses are $83 billion• Insurance will pay biggest share by far

Fed. Govt. promised $20B, excluding Victims Comp. Fund• Where would NY be today if terror exclusions were adopted after

1993 WTC bombing?


Sept. 11 Industry Loss Estimates($ Billions)

Life$2.7 (7%)

Aviation Liability$3.5 (9%)

Other Liability

$10.0 (26%)

Biz Interruption$10.0 (26%)

Property -WTC 1 & 2$3.5 (9%)

Property - Other

$5.0 (13%)

Aviation Hull$0.5 (1%)

Event Cancellation

$1.0 (3%)

Workers Comp

$2.0 (5%)

Consensus Insured Losses Estimate: $38.2B

9/11 Gross vs. Net Losses*(Life & Non-Life)

Primary62%

Reinsurance38%

*Gross: before adjusting for reinsurance recoverables;Net: After adjusting for reinsurance recoverables.Source: Insurance Information Institute, as of February 2002.

Implies $27B in reinsurance involved. System worked because of spread of risk and reinsurance. What about the next attack?

Primary48%Reinsurance

52%

GROSS LOSSES = $49.3 B NET LOSSES = $22.2 B

$10.6B$11.6B$30.4B$18.8B

Insured Loss Estimates* (updated through Dec. 31, 2001)

2,800

2,3682,280

1,740

1,3001,070

820 800 769 700 606 550 450 420 400

0

500

1000

1500

2000

2500

3000

Mill

ion

s

*Midpoint if company has announced range.

**Includes $289MM for ConveriumSource: AM Best, III

Top 15 Groups (pre-tax, net of reinsurance, $ millions)

World: Top 10 Biggest Catastrophes (by insured loss)

$40

$19.6$16.3

$7.1 $6.1 $6.0 $5.8 $4.6 $4.2 $4.2

$0$5

$10$15$20$25$30$35$40 $ Billions, in 2000 $

*III Estimate; Includes life, liability and workers compensation losses.Source: Swiss Re, Insurance Information Institute.

What About the Next Attack?

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Nov. 0

1

Dec. 0

1

Jan-

02

Feb-0

2

Mar

-02

Apr-0

2

May

-02

Jun-

02

Jul-0

2

Aug-0

2

Sep-0

2

Oct-02

Nov-0

2

Dec-0

2

Insurers Overexposed to Terror Risk in 2002

Source: Insurance Information Institute* Excludes workers comp, which will carry no terrorism exclusion.

%

Insurer Exposure to Terrorism

•+/- 70% reinsurance treaties expired 12/31/01

•+/- 30% expire 6/30/02

•Underlying policies renewed w/terror exclusion gradually as they expire

+/-70% Reinsurance Treaties Expired 12/31/01

+/-30% Reinsurance Treaty Coverage 1/1/02 – 6/30/02

0% Thereafter

100%

Rei

nsu

ran

ce T

reat

y C

over

age

Pri

or t

o Ja

n. 1

, 200

2

Proportion of Commercial Risks

With Terrorism Coverage Included in Basic Coverage

UNREINSURED EXPOSURE

UNREINSURED EXPOSURE

GAO Report: Highlights Economic Vulnerabilities

• GAO Report Released February 27, 2002• Major Findings:www.house.gov/financialservices/022702t2.htm

1. Insurers Shifting Terrorism Risk to Property Owners/Businesses Reinsurers withdrawing from market for terrorism Primary insurers excluding coverage as their exposure increases

2. As Business Exposure to Uninsured Risks Rise, so do Potential Economic Consequences Economic consequences from next attack could be more severe

3. Potential Economic Consequences of Not Having Terrorism Insurance are Cause for Concern

• Conclusions Congressional action is “properly a matter of public policy” Consequences of inaction are “may be real and potentially large”

“A decision not to act could have debilitating financial consequences for for businesses…their employees, lenders, suppliers, and customers.”

Government will face difficulties if it waits to act after an attack: “difficult to implements quickly—and extremely expensive.”

Commercial Real Estate: Value at Risk*

Replacement Cost of

Structures52%

Inventory 13%

Equipment & Software

35%

*As of 12/31/2000; Excludes residential real estate.Source: Morgan Stanley, FDIC, Federal Reserve; Insurance Information Institute.

TOTAL = $10.6 Trillion

Without terror bill more of this risk will be shifted to business/property owners

$1.40 Trillion

$3.70 Trillion

$5.53 Trillion

Commercial Real Estate Debt: Debt at Risk*

Real Estate/ Mortagage

Loans85%

Lease Receivables ($0.17 Tr)

2%

Industrial Loans13%

*As of 12/31/2000; Excludes residential real estate.Source: Morgan Stanley, FDIC, Federal Reserve; Insurance Information Institute.

TOTAL = $8.2 Trillion

Without terror bill more of this risk will be shifted to

commercial lenders/landlords

$1.08 Trillion

$6.94 Trillion

A Federal Backstop for Insuring the Peril of Terrorism

• Industry Proposal: Pool (similar to Pool Re in U.K.)Called for creation of pool that would receive premiums for

terrorist act coverage and pay lossesFed steps in only as pool becomes depletedSTATUS = DEAD

• Administration Proposal: Quota Share3-yr plan (then sunsets)

2002: 80% Fed, 20% Private; ret./sharing above $10B…– $12B max industry exposure

2003: $10B insurer retention; 50/50 sharing… ($23B max) 2004: $20 B insurer retention; 50/50 sharing… ($36B max)

Attacked by critics on left and rightSTATUS = DEAD


A Federal Backstop for Insuring the Peril of Terrorism

• Capitol Hill—SENATE (Banking Committee) 2-yr plan (White House approval for 1-year extension) Industry retains first $10 billion in terror losses 90% fed share above $10B, 10% industryNO BILL PASSED IN 2001

• Capitol Hill—HOUSE (H.R. 3210, passed Nov. 29) 3-year loan guarantee program

Industrywide losses must exceed $1B, or industrywide losses exceed $100 million and those losses exceed 10% of

surplus and 10% of net premium written of an individual commercial carrier.

Criticized by industry for complexity of loan repayment/ assessment formula; some view triggers as too high. Congress recessed Dec. 21 w/o bill for President.

• President spoke on issue April 8 w/business, labor leaders; Cited construction slowdown

• Possible bill by Memorial Day??

Insurance Information Institute On-Line

If you would like a copy of this presentation, please give me your business card with e-mail address

Documents

What Keeps Insurance CEOs Awake at Night? An Overview and Outlook for the P/C Insurance Industry May 2002 Robert P. Hartwig, Ph.D., Senior Vice President