Liability Trends, Issues and Jury Verdicts: Impact on Insurance Liability and Excess Casualty Markets Insurance Information Institute October 2003 Robert P. Hartwig, Ph.D., CPCU, Senior Vice President & Chief Economist Insurance Information Institute ♦ 110 William Street ♦ New York, NY 10038 Tel: (212) 346-5520 ♦ Fax: (212) 732-1916 ♦ [email protected] ♦ www.iii.org Presentation Outline • P/C Insurance Overview • Liability Issues • P/C Macro Cost Drivers • US Legal System: Is it Out of Control • Case Studies • Overview of Primary & Excess Liability Markets • Pricing & Profitability Considerations • Corporate Governance •Q&A P/C FINANCIAL OVERVIEW Highlights: Property/Casualty First Half 2003 2003 2002 Change Net Written Prem. 202,828 182,760 +11.0% Loss & LAE 142,129 134,897 +5.4% Net UW Gain (Loss) (2,070) (11,422) -81.9% Net Inv. Income 18,268 17,894 +2.1% Net Income (a.t.) 14,496 4,371 +231.6% Surplus* 312,455 284,300 +9.9% Combined Ratio 99.8 105.1 -5.3 pts. *Comparison with year-end 2002 Source: A.M. Best, Insurance Information Institute Information Source: A.M. Best, Insurance Note: Shaded areas denote -10% 10% 15% 20% 25% -5% 0% 5% 1970 1971 Strength ofRecent HardMarkets 1972 1973 1974 1975 1975-78 hard market periods. 1976 1977 by RealNWP Growth 1978 1979 1980 1981 1982 1983 1984 1985 1985-87 2001-03 1986 *2003 figure is estimate 1987 1988 Real NWPGrowthDuring 1989 Past 3HardMarkets Current $ Current 1990 2001-03F: 8.8% 1985-87: 14.5% 1991 1975-78: 8.6% 1992 1993 1994 on first half result. 1995 1996 Real $ Real 1997 1998 1999 2000 2001 2002 2003 P/C Net Income After Taxes 1991-2003* ($ Millions) y2001 was the first year ever $40,000 with a full year net loss $36,819 y2002 ROE = 1.0% $30,773 $30,000 y2003 ROE = 9.7%* $24,404 $21,865 $19,316 $20,598 $20,559 $20,000 $14,178 $14,496 $10,870 $10,000 $5,840 $2,903 $0 -$10,000 -$6,970 91 92 93 94 95 96 97 98 99 00 01 02 03* *First half 2003 Sources: A.M. Best, ISO, Insurance Information Institute. ROE: P/C vs. All Industries 1987–2003E* 20% 15% 10% 5% 0% -5% 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03F US P/C Insurers All US Industries *2003 p/c estimate based on first half data. Source: Insurance Information Institute; Fortune ROE vs. Cost of Capital: US P/C Insurance: 1991 – 2003E 20% The gap between the industry’s cost of capital and 15% its rate of return is narrowing 10% 1.8 pts 5% 14.6 pts 10.2 pts US P/C insurers missed their 0% cost of capital by an average 6.9 points from 1991 to 2002 -5% 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003E Source: The Geneva Association, Ins. Information Inst. ROE Cost of Capital Sources: A.M. Best; ISO, III 100 105 110 115 120 95 70 71 72 2003First Half=99.8 73 P/C Industry Combined Ratio 74 2002 =107.2 2001 =115.7 75 76 77 78 79 80 81 82 83 84 85 86 87 *Based on First Half 2003 results. 88 89 90 91 92 93 2000s: 111.0 1990s: 107.7 1980s: 109.2 1970s: 100.3 94 Combined 95 Ratios 96 97 98 99 00 01 02 03 *First half 2003 figures fo *First half 2003 figures Source: A.M. Best, ISO, Reinsurance Associati 100 110 120 130 140 150 160 170 90 9 1 110.5 108.8 9 2 126.5 Reinsurance vs. P/CIndustry 115.8 9 r full industry from ISO; 1 from industry r full 3 Reinsurance 105.0 y well. ever forreinsurers;2003was badas y 106.9 in firsthalf 2003: Bigimprovement 2001’s combinedratiowasthe worst- 9 4 113.6 108.5 Combined Ratio: 9 5 119.2 106.5 on of America, Insurance Information Institute on of America, Insurance Information 9 6 All Lines Combined Ratio Combined Lines All st 104.8 half reinsusrance 105.8 9 7 100.8 101.6 9 8 100.5 figures from RAA. 105.6 9 9 114.3 107.7 0 0 106.5 110.0 0 1 162.5 115.7 0 2 121.3 107.2 0 3* 97.9 99.8 *2003 figure of$5.42 billi Source: A.M. Best, Insurance Information Institute Information Source: A.M. Best, Insurance $ Billions ($60) ($50) ($40) ($30) ($20) ($10) $10 $0 1975 much betteryear intermsofunderwritinglosses. Based onfirsthalf results,2003willlikelybea 1976 First halflosses totaled$2.71billionor$5.42 1977 Underwriting Gain(Loss) 1978 on isannualized based 1979 billion on anannualized basis 1980 1981 1982 1983 1975-2003* 1984 1985 1986 on first quarter underwriti 1987 1988 1989 1990 1991 1992 1993 1994 1995 ng loss of$2.71 billion 1996 1997 1998 1999 2000 2001 2002 2003 Source: NCCI; William M. Mercer 10% 15% -5% 0% 5% 92 93 94 95 96 97 9810.1% 99 00 01 02 03p 1.3% Med ClaimCosts RisingSharply 8.0% -2.1% -1.1% 9.0% Health careinflationisaffecting the , Insurance Information Institute. Information , Insurance what systemitisdeliveredthrough Health Benefit CostsHealth 2.1% cost ofmedicalcare,nomatter 5.1% 2.5% 6.4% 0.2% 7.3% 6.1% WC 5.7% 7.3% 7.4% 8.1% 7.6% 11.2% 10.7% 14.7% 12.0% 14.0% World’s Most Dangerous Lines of Insurance (Combined Ratio + 1 Std. Deviation) Earthquake 407.3 Med Mal 135.6 Other Liability 135.1 Reinsurance 133.9 Homeowners 133.3 Allied Lines 131.6 Aircraft 129.3 Comm. M ulti Peril 121.8 Comm. Auto Liab. 119.3 Workers Comp 118.7 F arm M ulti Peril 117.1 Commercial--All 116.3 Ocean Marine 115.1 Fire 114.6 All Lines 112.9 PP Auto Liab 111 Personal--All Lines 109.7 Comm Auto PD 109.1 Boiler & M achine 107 Group A&H 106.6 Other A&H 103.4 Priv Pass PD 102.9 Inland Marine 101.7 Fidelity 101.3 Other 100 Surety 84.1 Burglary & Theft 73.3 70 80 90 100 110 120 130 140 150 Source: Insurance Information Institute, calculated from A.M. Best combined ratio data 1992-2001. (IN)SOLVENCY ISSUES Seismic Shift in P/C Insurer Ratings Shift in IFS Ratings Distribution (by Group) Aa3 30 Decline in Average Rating 25 A1 20 1998 2003 15 A2 10 5 A3 0 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Aaa Aa A Baa <Baa 10 Upgrades / Downgrades: North America • Ratings in persistent, accelerating decline. 5 0 • Aaa ratings appear an endangered species. -5 • Mainly commercial insurers and reinsurers. -10 -15 -20 ¾ Is 2003 the trough? -25 -30 1998 1999 2000 2001 2002 Source: Moody’s P/C Company Insolvency Rates, 1993 to 2002 •Insurer insolvencies are increasing 1.33% •10-yr industry failure rate: 0.72% 1.20% •Failure rating for B+ or better rating: 0.49% •Failure rate for D through B rating: 1.29% 1.02% 1.03% 10-yr Failure Rate 0.79% = 0.72% 0.58% 0.60% 30 30 38 0.28% 0.21% 0.23% 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Source: A.M. Best; Insurance Information Institute Reason for P/C Insolvencies (218 Insolvencies, 1993-2002) Impaired Affiliate Deficient Loss 3% Unidentified Reserves 17% 51% Reserve CAT Losses deficiencies 3% account for more than half Reinsurer Failure of all p/c 0% insurers insolvencies Change in Business 3% Discounted Ops 8% Overstated Assets 2% Alleged Fraud Rapid Growth 3% 10% Source: A.M. Best, Insurance Information Institute P/C Insurance Industry Prior Year Reserve Development* $ Billions, Calendar Year Basis $25 $22.7 $20 Adverse reserve development of about $23 billion accounted for most of the $15 industry’s 2002 underwriting loss and “ate” much of the industry’s $37 billion $9.9 $10 increase in earned premiums $5 $2.3 $2.2 $1.2 $0.3 $0 ($1.5) ($0.3) ($5) ($3.7) ($6.7) ($10) ($8.5) ($7.5) ($10.0) ($15) 90 91 92 93 94 95 96 97 98 99 00 01 02 *Negative numbers indicate favorable development; positive figures represent adverse development. Source: A.M. Best, Morgan Stanley, Dowling & Partners Securities Combined Ratio: Impact of Reserve Changes (Points) Points (Reduced)/Increased 7 6.3 6 Adverse reserve development 5.2 5 totaling an estimated $23 billion added more than 6 points to the p/c 4 combines ratio in 2002 3 2 1 0.5 0 -1 (0.4) -2 -3 (2.4) 1998 1999 2000 2001 2002 Source: ISO, A.M. Best, MorganStanley. LIABILITY ISSUES: Dollars and $ense Cost of U.S. Tort System ($ Billions) Tort costs consumed 2.0% of GDP annually on average since 1990, $350 expected to rise to 2.4% of GDP by 2005! $298 $300 Per capita “tort tax” expected to rise to $1,000 by 2005, up from $721 in 2001 $250 Even a modest reduction in tort costs would be more $205 stimulative than the $674 billion Bush tax/spending plan $180 $200 $167 $169 $159 $156 $156 $141 $144 $148 $150 $129 $130 $100 $50 $0 90 91 92 93 94 95 96 97 98 99 00 01 05F Source: Tillinghast-Towers Perrin. 2005 forecasts from Tillinghast. Tort Costs as a % of GDP* Denmark 0.4% High tort costs put the U.S. economy at U.K.