The State of theInsurance Market

Kevin M. Bingham – Deloitte & Touche

2002 Casualty Actuarial Society Annual MeetingBoston, MassachusettsNovember 10, 20021:45 – 3:15pm

INTRODUCTION

• Hardening Market Drivers – The answers for your insurance consumers

• Historical Perspective• Insurance Layering

° Perception Change

° Impact on Consumer

• Market Examples• Closing Thoughts

Hardening Market Drivers

Hardening Market Drivers

• Deteriorating industry results• September 11th • Reduced capacity• “Enronitis”• Asbestos• Litigation/Regulatory• Rating agency pressure

Deteriorating Industry Results• Intense price competition during the 1990s soft market

° Rate decreases° Pricing Spiral

• Declining investment returns° Low interest rates° Declining equity markets

• Catastrophes on the rise • Favorable impact on calendar year financials from workers compensation

reserve takedowns have been fully reflected by companies. Accident year combined ratios are rising significantly.

• Rising medical inflation• Medical Malpractice crisis

•

Worst possible combination

September 11th • Insured losses ranging from $30 to $50 billion dollars

• Rethinking of insurance industry’s determination/quantification of probable maximum loss (PML) – “Actuarial pricing for the WTC reflected a PML of 4 floors”

• Force insurers and reinsurers to step back and re-evaluate their exposures to:° Concentration risk

• Marquee properties in the same city

• Multi-line exposure (e.g., WC, property and business interruption)

° Layer risk• Attritional

• Severity

° Policy language (e.g., WilProp form, terrorism exclusions)

Reduced Capacity• St. Paul exiting medical malpractice• Collapse of Fortress Re aviation underwriting pool• State specific capacity issues

° Texas homeowners’ and mold impact° N.J. automobile° Pennsylvania medical malpractice° California homeowners’ (State Farm policy freeze)° Florida nursing homes

• Workers compensation° Reliance° Frontier° Fremont° Collapse of Unicover and other WC carve-out pools eliminating cheap

“working layer” protection

Litigation/Regulatory

• Jury Verdict Research (www.juryverdictresearch.com) /Insurance Information Institute (www.iii.org)

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

($000)

1994 2000

Average Jury Awards (000s)

Litigation/Regulatory• Massive individual awards

° Texas $313 million dollar award to a plaintiff alleging negligence against a nursing home

° Numerous asbestos awards

° Mold (www.moldupdate.com) • Texas $32.1 million dollar award against Farmers

• California $18.5 million dollar award against Allstate (judge reduced to $3 million, case under appeal)

• Class action lawsuits

• Bursting of internet bubble and rising D&O losses

• State elimination of credit scoring in rating personal lines products

“Enronitis”• Enron “double hit” for insurers ($3.8 billion in exposure)

° 64% Investment Exposure• Common Stock, Preferred Stock, Corporate Bonds• John Hancock $320 million invested in Enron• After-tax write downs

° 36% Insurance Exposure• Surety • Directors and Officers• Financial Guarantee

• Worldcom ($5.7 billion in exposure – 94% investment related)

• Global Crossing• Tyco• Adelphia• Quest

And the list goes on and on and…

Asbestos• A.M. Best industry estimates

° $65 billion as of May 2001° $25 billion increase from prior estimate of $40 billion

• Key drivers° Rising jury awards

• 2002 $53 million dollar jury verdict to a family of a man who died of lung cancer caused by asbestos

° Asbestos related bankruptcies and push by lawyers for accessing deep pocketed insurers

° Shift from product coverage (limited) to premises/operations (unlimited)° Claimants without manifestation° Reserve strengthening impacting financials

• CNA $1.2 billion in reserve strengthening• Allianz/Fireman’s Fund $750 million in reserve strengthening• Chubb $625 million in reserve strengthening

Rating Agency Pressure

ANNUAL RATING ACTIVITY - P/C INDUSTRY

2000 2001 2002CATEGORY # % # % # %

Superior A++, A+ 120 11.5% 107 10.5% 93 9.6%Excellent A, A- 507 48.4% 499 49.0% 499 51.5%Very Good B++, B+, FPR 6,5 297 28.3% 266 26.1% 225 23.2% SECURE

RATINGS Total 924 88.2% 872 85.6% 817 84.3%

Fair B, B-, FPR 4 72 6.9% 76 7.5% 74 7.6%Marginal C++, C+, FPR 3 20 1.9% 18 1.8% 21 2.2%Week C, C- 6 0.6% 4 0.4% 3 0.3%Poor D 2 0.2% 4 0.4% 6 0.6% VULNERABLEState Sup/ RATINGSLiquidation E, F 24 2.3% 45 4.4% 48 5.0%

Total 124 11.8% 147 14.4% 152 15.7%

Total Letter Ratings 1,048 100.0% 1,019 100.0% 969 100.0%

Upgrades 80 77 76 Downgrades 77 148 151 Downgrades/Upgrades 1.0x 1.9x 2.0x

SOURCE: A.M. BEST SPECIAL REPORT, OCTOBER 2, 2002RATING DOWNGRADES OUTPACE UPGRADES DESPITE IMPROVED PRICING

Historical Perspective

Effective Rate Level – The StoryXYZ MANUFACTURING COMPANY

SIR DROPPED FROM $250,000 TO $150,000 SIR DROPPED FROM

$150,000 TO $100,000

RATE LEVEL: INCLUDES MANUAL RATE CHANGE, EXPERIENCE MOD, SCHEDULE RATING & TIER IMPACTSIR LEVEL: RATE IMPACT OF REDUCTION IN LOSSES FROM LOWER SELF-INSURED RETENTION (SIR)

0.000

0.200

0.400

0.600

0.800

1.000

1.200

CALENDAR YEAR

RA

TE

IND

EX

(199

2 =

1.00

0)

RATE LEVEL 1.000 0.769 0.552 0.481 0.443 0.454 0.449 0.449 0.456

SIR LEVEL 1.000 1.000 1.000 0.796 0.796 0.667 0.667 0.667 0.667

EFFECTIVE RATE LEVEL 1.000 0.769 0.552 0.383 0.353 0.303 0.300 0.299 0.304

1992 1993 1994 1995 1996 1997 1998 1999 2000

Effective Rate Level – Insurance Consumer Perspective• Risk manager (RM)

° Budgetary focus• Pro formas usually only include one or two historical years

° RM likely doesn’t know true cumulative “effective rate level”• RM may track audited premium

• Audited premium doesn’t include

Soft market SIR/large deductible “give aways”

Broker driven coverage expansions

Exposure shift

° RM likely attributes some (if not all) of the decreasing premiums to proactive risk management and EH&S department involvement

“99.9% of companies are better than average”

Effective Rate Level – Insurance Consumer Perspective• Thought process:

° Focus on rate level only

° Missing SIR changes

° Missing long term pricing and concept of “rate adequacy”

INSURANCE CONSUMER PERSPECTIVE

EFFECTIVE 1998 RMCALENDAR RATE SIR RATE RATE "PERCIEVED"

YEAR LEVEL LEVEL LEVEL LEVEL BASE BENEFIT

1992 1.000 1.000 1.0001993 0.769 1.000 0.7691994 0.552 1.000 0.5521995 0.481 0.796 0.3831996 0.443 0.796 0.3531997 0.454 0.667 0.3031998 0.447 0.667 0.298 1.0001999 0.422 0.667 0.281 0.9432000 0.428 0.667 0.285 0.957 4.5%

Effective Rate Level – Insurance Company Perspective• Thought process:

° Focus on effective rate level° Focus on “rate adequacy”

• If we assume 1992 rate levels are adequate, then the insurance company would need a 250% increase to break even

INSURANCE COMPANY PERSPECTIVE

EFFECTIVE REQUIRED EFFECTIVECALENDAR RATE RATE RATE

YEAR LEVEL CHANGE LEVEL

1992 1.000 25.0% 0.3571993 0.769 50.0% 0.4281994 0.552 75.0% 0.4991995 0.383 100.0% 0.5701996 0.353 150.0% 0.7131997 0.303 200.0% 0.8561998 0.298 250.5% 1.0001999 0.281 275.0% 1.0702000 0.285 300.0% 1.141

Effective Rate Level – Message

• Communication of rate change° +25% rate change

• 36% of 1992 rate level

° +75% rate change• 50% of 1992 rate level (still need to double rates)

• Tough sell to RMRM – “Poor insurance company pricing decisions of the past should be borne by the Insurer, not the buyer.”

VersusInsurer – “Cannot continue to operate at a loss. Current environment doesn’t allow for policy subsidation.”

Insurance Layering: Insurers’ Perceptions Change and Impact on

Insurance Consumers

Insurance Layering: Insurers’ Perceptions Change

RetentionRetention

Working Layer(s)Working Layer(s)

Excess LayersExcess Layers

RetentionRetention

Working Layer(s)Working Layer(s)

Excess LayersExcess Layers

Pre-9/11 Post-9/11

Statutory Limits?Statutory Limits?

TerrorismExcluded

By Reinsurers

Impact on Insurance Consumer

• Increased SIRs/decreased large deductibles° Reversal of 90s trend° Little or no premium credit

• Primary insurers forced to provide protection against terrorism° Shift of highly concentrated risk into

state funds (e.g., N.Y. City financial service firms and WC)

• Significant rate increases° Property° WC

• Lack of coverageRetentionRetention

Working Layer(s)Working Layer(s)

Excess LayersExcess Layers

Post-9/11

Statutory Limits?Statutory Limits?

Impact on Insurance Consumer

• Rising attachment points• “Actuarial Pricing” with U/W flair• Terrorism excluded

° Must purchase separately• Limits range from $25-$50 million• Significant additional cost

• Policy forms tightening° WilProp Form – occurrence defined° Coverage decreasing

• D&O• WC

• Significant rate on line increases • Fewer market players

RetentionRetention

WorkingWorkingLayer(s)Layer(s)

Excess LayersExcess Layers

Post-9/11

Statutory Limits?Statutory Limits?

Impact on Insurance Consumer

• “Best Terms”

• “Actuarial Pricing” with U/W flair° Significant ROL increases

• Minimum premiums • More creative “PMLs”

° No credits for raising attachments° Willing to walk away from deal

• Terrorism excludedRetentionRetention

Working Layer(s)Working Layer(s)

Excess LayersExcess Layers

Post-9/11

Statutory Limits?Statutory Limits?

=$3M

$6M

$9M

Impact on Insurance Consumer

• Safety push from insurers/reinsurers° Return to work focus (a/k/a integrated disability

management)

° Employee training (e.g., officer training, EH&S involvement)

° Demand for quicker claim notification

° More detailed underwriting information

° Review of business continuity plan

° Increased audits (e.g., payroll, property, etc.)

Market Examples

Market Examples

• Major state fund unable to purchase unlimited excess WC coverage. Drastically reduced coverage with significant price increases.

• Governments and cities having difficulty obtaining insurance for their high profile buildings and land marks

• Lack of coverage for major events (e.g., sports, fairs, concerts, etc.)° New Jersey Sports and Exposition Authority insurance

costs more than tripled to $2.4 million.

Market Examples

• A hospital institution obtained 1/5th the property coverage for three times the prior year’s cost, with terrorism coverage excluded. It took 23 insurers to replace the coverage offered by a single insurer last year.

• A steel merchant and fabricator’s general liability premiums increased from $8,000 last year to $75,000 upon renewal. As an added bonus, auto premiums jumped from $31,000 to $56,000 while umbrella premiums jumped from $6,000 to $34,000. A 267% increase in total.

• Southwest Airlines’ liability insurance for their 364-plane fleet soared from $20 million to $100 million, a 400% increase.

Market Examples

• George Washington University’s insurers have cut the school’s former $1 billion policy in half, raised its premiums 160% and advised that renewing terrorism coverage would cost 15 times more.

• Before September 11th, the MTA’s property insurance absorbed up to $1.5 billion in property damages, minus a $15 million deductible, at a cost of $6.4 million. Now the agency has two property insurance policies, one providing $500 million of plain property coverage with a $30 million deductible for $18.6 million, the other offering $100 million in terrorism coverage with a $30 million deductible for $7.5 million. A total increase of 308%, for less than 1/3rd of the original protection.

Closing Thoughts

Closing Thoughts

• Self-insured clients developing “story board” for next round of renewals° Proactively address concentration risk° Perform independent actuarial analyses

• Confidence levels• Worst case scenario testing

° Put on “road show” including following professionals• Risk management• Legal• Claims• Safety

• Flight to quality taking hold

Closing Thoughts• Duration of hard market in question

° Statutory limits becoming available° New Bermuda capital needs to find a home

• Hard to deliver on 20% promised returns when holding free capital in 3% risk free investments

• Federal back stop important° Passage critical° BUT CONSUMERS - will remember the insurers/reinsurers who

abandoned ship

• Clients are upset° What happened to long-term relationships?° “Best Terms” = Insurance Industry Collusion?

• Captive boom° Majority of premium may never return to market

Closing Thoughts

• The insurance transaction will no longer be viewed simply as the insurer selling insurance and the insured paying a premium. Instead, the insurer/reinsurer will view themselves as “investing” in a portfolio of risks composed of the best prepared insurance consumers in the industry.