capital punishment: why earning a fair rate of return is tougher than ever in the p/c insurance...
TRANSCRIPT
Capital Punishment:Why Earning a Fair Rate of Return
is Tougher than Ever in the P/C Insurance Business
International Union of Marine InsurersNew York, NY
September 16, 2002
Robert P. Hartwig, Ph.D., CPCU, Senior Vice President & Chief EconomistInsurance Information Institute 110 William Street New York, NY 10038Tel: (212) 346-5520 Fax: (212) 732-1916 [email protected] www.iii.org
Presentation Outline
• Profitability in the P/C insurance industry• Insurer Cost of Capital: A Global Perspective• Supply of Capital in P/C Insurance Industry• Cost of Capital: How is it Computed?• Factors Influencing Cost of Capital
Special factors affecting p/c insurance• Summary
Profitability in the P/C Insurance Industry
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$20,223
-$7,921
$20,420
-$10,000
-$5,000
$0
$5,000
$10,000
$15,000
$20,000
$25,000
$30,000
$35,000
$40,000
91 92 93 94 95 96 97 98 99 00 01 02*
*I.I.I. estimate based on first quarter 2002 data.Sources: A.M. Best, ISO, Insurance Information Institute.
2001 was the first year ever with a full year net loss
2002 Q1 ROE = 1.7%
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
2001 = 115.7
2002 Forecast* = 108.0
2002 Q1: 102.3
Combined Ratios
1970s: 100.3
1980s: 109.2
1990s: 107.7
2000s: 112.9
Sources: A.M. Best; III
* Based on III 2002 Groundhog Forecast
110.
5
105.
0
113.
6 119.
2
104.
8
100.
8
100.
5
114.
3
107.
2
142.
9
117.
4
108.
8 115.
8
106.
9
108.
5
106.
5
105.
8
101.
6
105.
6
107.
7
110.
1 116.
0
101.
6
126.
5
90
100
110
120
130
140
150
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002*
Reinsurance All Lines Combined Ratio
Combined Ratio: Reinsurance vs. P/C Industry
*First Quarter 2002 for all p/c; first half for reinsurance.
Source: A.M. Best, ISO, Reinsurance Association of America, Insurance Information Institute
2001’s combined ratio was the worst-ever for reinsurers
($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
12
00
2
Underwriting Gain (Loss)1975-2002*
*Annualized estimate based on first quarter 2002 data.Source: A.M. Best, Insurance Information Institute
$ B
illi
ons
P-C insurers paid $53 billion more in claims & expenses than they collected in premiums
in 2001
-5%
0%
5%
10%
15%
20%
US P/C Insurers All US Industries
ROE: P/C vs. All Industries 1987–2002*
*First QuarterSource: Insurance Information Institute; Fortune
-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
20.5%
13.2% 12.8%
10.5%
25.9% 25.1%23.5%
17.5%
11.8%
22.0%
0%
5%
10%
15%
20%
25%
30%
US P/C Insurers All US Industries Inland Marine
ROE: Inland Marine vs. Overall P/C & Fortune 500, 1991–2000
Source: NAIC, Insurance Information Institute; Fortune
Inland marine profitability consistently above P/C & Fortune 500
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 %
Insurer Cost of Capital
A Global Perspective
Cost of Capital: A Definition
• Cost of Capital:Rate of return that can be earned by investors in
industries offering comparable degree of risk Must be sufficient to maintain & attract capital
• Insurance Cost of Capital:Will vary substantially by line
-5%
0%
5%
10%
15%
20%
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
ROE Cost of Capital
ROE vs. Cost of Capital: US Non-Life 1991 – 2002*
Source: The Geneva Association, Insurance Information Institute.
There is an enormous gap between the industry’s cost of capital and its rate of return
14.6
pts
9.5.
pts
US P/C insurers have missed their cost of capital by an
average 6.7 points since 1991
0%
5%
10%
15%
20%
25%
30%
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
UK Switzerland France Germany
Cost of Capital: Non-Life Insurers:1978 – 1998
*
Source: Kielholz, Walter, “The Cost of Capital for Insurance Companies,” The Geneva Papers on Economic Activity, v 25, no. 1, January 2000.
Supply of Capital in the P/C Insurance Industry
How Much is There?
$0
$50
$100
$150
$200
$250
$300
$350
75 77 79 81 83 85 87 89 91 93 95 97 99 01
Policyholder Surplus: 1975-2002*
*As of 1st quarter 2002Source: 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 rose 1.9% in the 1st quarter of 2002
•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
0.5
1.3
2.0
2.8
Net Premiums Written to Policyholder Surplus Ratio
Source: A.M. Best, Insurance Information Institute
2000: 0.95
2001: 1.16
2002 (Forecast): 1.33
Capital Raising by P/C Insurers Since September 11, 2001*
$20,492
$11,442
$16,437
$4,872
$0
$5,000
$10,000
$15,000
$20,000
$25,000
$30,000
2001 2002*
($ M
illi
on
s)
Completed Pending
$25.4 Billion$27.9 Billion
*As of September 13, 2002.
Source: Morgan Stanley, Insurance Information Institute.
14 Pending 38 Pending
40 Completed 33 Completed
Capital Raising by P/C Insurers Since 9/11 Totals $44.5B
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
Price Increases Needed to Achieve Cost of Capital
Second Quarter 2002
Rate Increases By Line of BusinessRate Increases By Line of Business NoNo
Change Up 1-10% 10-20% 20-30% 30-50% 50%-100% >100%Change Up 1-10% 10-20% 20-30% 30-50% 50%-100% >100%
Comm. Auto 2% 6% 28% 39% 21% 1% 1%
Workers Comp 5% 13% 19% 32% 15% 5% 2%
General Liability 2% 9% 24% 45% 15% 2% 1%
Comm. Umbrella 2% 4% 10% 20% 27% 17% 16%
Comm. Property 3% 4% 16% 30% 31% 13% 1%
Business Interr. 3% 8% 32% 33% 10% 1% 0%
Surety Bonds 10% 13% 16% 14% 6% 0% 1%
Source: Council of Insurance Agents and Brokers
100110
120130
140150
160170
180190
200210
220230
240250
260
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%
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
*Estimate based on first quarter 2002Source: A.M. Best, Insurance Information Institute
Growth in Net Premiums Written (All P/C Lines)
2000: 5.1%
2001: 8.1%
2002: 10.3%*
The underwriting cycle went AWOL in the 1990s.
It’s Back!
Cost of Capital:
How is it Computed?
Cost of Capital: Methods
• 2 Commonly Used MethodsDiscounted Cash Flow (DCF)
Uses current dividend yield & dividend (or earnings) growth rateCapital Asset Pricing Model (CAPM)
Uses risk-free interest rate, risk premium & measure of relative risk, Beta (• Factors currently affecting costs of capital
Dividend yields very low (1.39% mid-2002), little growth expected; Recent earnings performance poor
Interest rates very low (short-term rates < 1.8% mid-2002)Risk premium shrinking (return on alternatives to risk-free return
are shrinking)Beta (low relative to overall stock market (stock price volatility
slightly less than overall market: • CURRENT P/C COST OF CAPITAL IS: 11% - 12%
Factors Influencing the Cost of Capital
4.4%3.5%
2.5%
5.7%
8.3%
4.8%5.6%
2.2%
1.0%
-0.6%
-1.6%
-0.3%
5.0%
1.1%
2.3%3.2%2.7%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
Real GDP Growth
Source: US Department of Commerce, Blue Economic Indicators 9/02, Insurance Information Institute.
Economy is experiencing sluggish growth following the
recession of 2001
(first recession since 1990/91)
Economic Outlook for Major US Trading Partners (Real GDP Growth, %)
1.5
-0.3
2.2 3.
0
1.5
7.3
1.5
3.0
1.9
1.8
5.6
1.2
3.0
7.2
1.5
3.5 3.9
0.9
2.9
5.4
2.7
3.9
7.3
3.1
-0.2
-1.9-0
.5
-2
0
2
4
6
8
Real
GDP
Gro
wth
(%)
2001 2002E 2003F
Source: Blue Chip Economic Indicators, September 2002.
Economies of most major trading partners expected to
improve in 2002/2003
Does US have a trade policy?
0%
2%
4%
6%
8%
10%
12%
14%
16%
3-Month T-Bill 1-Yr. T-Bill 10-Year T-Note
Interest Rates: Lower Than They’ve Been in Decades
*Average for week ending September 6, 2002.Source: Board of Governors, Federal Reserve System; Insurance Information Institute
Interest Rates Low for 2 Reasons
1. Weak Economy (= low inflation, less demand for cap)
2. Perception that federal budget will return to surplus
If either of these changes, interest rates and CoC up
0.00
0.50
1.00
1.50
2.00
2.50
3.00
Yie
ld S
pread
(p
oin
ts)
Risky Business: Yield Spread Rising with Corporate Scandals*
*January 1990 through August 2002Source: Board of Governors, Federal Reserve System; Insurance Information Institute
Risk premium (2.46 points) reached all time high in Oct. 2001 (Enron problem surfaced)
Yield Spread Between Long-Term ‘aaa’ Corporates and 10-Year US Treasury Securities
0%
1%
2%
3%
4%
5%
6%
7%
6-Sep-02 7-Sep-01 10-Sep-99
Treasury Yield Curve: Rates Down Across Every Maturity, esp. Short-Term
*Data are averages for all trading days for the week on the indicated date.Source: Board of Governors, Federal Reserve System; Insurance Information Institute
Yield Curve for the week before September 11 terrorist attack
Yield Curve 2 years before attack
Yield Curve: Most Recent (1st anniversary of 9/11 attack)
$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 02
Net Investment Income
Facts
1997 Peak = $41.5B
2000= $40.7B
2001 = $37.1B
2002E = $35.8B
Source: A.M. Best, Insurance Information Institute
Bil
lion
s
(US
$)
Investment income in 2002 could fall 5% to 6%
Realized capital gains in the 1st quarter of 2002 were
down 89%
-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 September 13, 2002.Source: Ibbotson Associates, Insurance Information Institute
Total Returns for Large Company Stocks: 1970-2002*
Headed for 3rd consecutive year of decline for stocks
Last happened 1939-1941
0.50
0.60
0.70
0.80
0.90
1.00
1.10
1.20
1.30
1.40
1.50
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
UK Switzerland
Average Betas: Non-Life Insurers:1978 – 1998
Source: Kielholz, Walter, “The Cost of Capital for Insurance Companies,” The Geneva Papers on Economic Activity, v 25, no. 1, January 2000.
0.75
0.85
0.95
1.05
1.15
1.25
1.35
1.45
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
UK France
Average Betas: Non-Life Insurers:1978 – 1998
Source: Kielholz, Walter, “The Cost of Capital for Insurance Companies,” The Geneva Papers on Economic Activity, v 25, no. 1, January 2000.
0.50
0.60
0.70
0.80
0.90
1.00
1.10
1.20
1.30
1.40
1.50
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
UK Germany
Average Betas: Non-Life Insurers:1978 – 1998
Source: Kielholz, Walter, “The Cost of Capital for Insurance Companies,” The Geneva Papers on Economic Activity, v 25, no. 1, January 2000.
0.75
0.85
0.95
1.05
1.15
1.25
1.35
1.45
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
US UK Switzerland France Germany
Average Betas: Non-Life Insurers:1978 – 1998
Source: Kielholz, Walter, “The Cost of Capital for Insurance Companies,” The Geneva Papers on Economic Activity, v 25, no. 1, January 2000.
World’s Most Dangerous Lines of Insurance(Combined Ratio + 1 Std. Deviation)
135.6135.1
133.9133.3
131.6129.3
121.8119.3
118.7117.1
116.3115.1114.6
112.9111
109.7109.1
107106.6
103.4102.9
101.7101.3
10084.1
80 90 100 110 120 130 140 150
EarthquakeMed Mal
Other LiabilityReinsurance
HomeownersAllied Lines
AircraftComm. Multi PerilComm. Auto Liab.
Workers CompFarm Multi PerilCommercial--All
Ocean MarineFire
All LinesPP Auto Liab
Personal--All LinesComm Auto PD
Boiler & MachineGroup A&HOther A&H
Priv Pass PDInland Marine
FidelityOther
SuretyBurglary & Theft
Source: Insurance Information Institute, calculated from A.M. Best combined ratio data.
407.3
Cost of capital will vary significantly by
line and mix of business, according
to risk assumed
P/C Performance Volatile, but Better than S&P 500 Lately
-25.7%
43.4%
-1.2% -3.7%
21.0%
-9.1% -10.9%
-21.7%
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
1999 2000 2001 2002*
P/C S&P 500
*Through September 13, 2002.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
-10.
2
-25.
5
-11.
2
-3.7 -2.6
-21.
7
-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
Pe
rce
nt
10-Sep-01 21-Sep-0128-Dec-02 1 Jan - 13 Sep '02
Total Return
Special Factors Influencing Insurers’ Cost of Capital
TerroristsTrial Lawyers
TycoonsTempests
Sept. 11 Industry Loss Estimates($ Billions)
Life$2.7 (7%)
Aviation Liability$3.5 (9%)
Other Liability
$10.0 (25%)
Biz Interruption$11.0 (27%)
Property -WTC 1 & 2$3.5 (9%)
Property - Other
$6.0 (15%)
Aviation Hull$0.5 (1%)
Event Cancellation
$1.0 (2%)
Workers Comp
$2.0 (5%)
Insured Losses Estimate: $40.2BSource: Insurance Information Institute, July 2002
Accounting Problems are Getting Many Companies into Trouble
•Enron fallout much worse than anticipated
•Many companies restating earnings
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.
Who Will Pay for the US Asbestos Mess?
Source: Tillinghast-Towers Perrin; Insurance Information Institute
US Insurers30%Asbestos
Defendants39%
Foreign Insurers
31%
Estimated Total US Settlements & Expenses = $200 billion
$78 billion $60 billion
$62 billion
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
$28.1
0
5
10
15
20
25
30
89 90 91 92 93 94 95 96 97 98 99 00 01
* Includes $20.3B for 9/11 losses reported through 12/31/01. Includes only business and personal property claims, business interruption and auto claims.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: $20.3B = 51,000 claims
Insurance Mergers and Acquisitions
7.1 6.9 8.6 5.0 8.5 12.527.0
40.856.2
41.755.7
6.6
41.5
243 246
171 188149
221
349382
433
109
300
295
468
$0
$20
$40
$60
$80
$100
$120
$140
$160
$180
89 90 91 92 93 94 95 96 97 98 99 00 01 02*
Val
ue o
f M
& A
s ($
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
Number of M&As was down 39.4% during the first half of 2002 vs. first half 2001.
Value of deals was down 80.8%.
None of the top deals were in the P/C sector
Summary
• Industry not even close to earnings its cost of capital
• Hard market must continue for it to be earned• Lots of new capital seeking high rate of return• Not all companies will be able to meet investor
expectations• Shareholders like to be more impatient (have give
p/c stocks benefit of the doubt)• Increase in M&A activity possible to squeeze
excess capacity from industry, but not anytime soon.
Insurance Information Institute On-Line
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