NCCI PY2015 Florida Rate Hearing. Financial Analysis. October 14, Harry Shuford Chief Economist
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1 NCCI PY2015 Florida Rate Hearing Financial Analysis October 14, 2014 Harry Shuford Chief Economist
2 NCCI PY2015 Florida WC Rate Hearing Financial Analysis Methodology Models Unchanged DCF CAPM IRR Inputs Updated Value Line Projected Dividend Growth Up 0.01% Provision for Share Buy-backs Lower Current Effective Dividend Yield Lower Beta Lower Cost of Capital Lower Financial Markets Improved Interest Rates Are Now Just Above Recent Historic Lows Stock Market Gained 2
3 Cost of Capital Overall Result Cost of Capital (DCF) 10.42% Cost of Capital (CAPM) 10.67% Estimated Cost of Capital (DCF & CAPM) 10.53% 3
4 What Contributed to the Change in the Indicated PY 2015 P&C for Florida FLORIDA - VOLUNTARY INTERNAL RATE OF RETURN MODEL RECONCILIATION EXHIBIT 1/1/15 vs 1/1/14 Change From To P&C Change in P&C % Change in P&C Last Year's Starting Value Cost of Capital (6/27/2014) % Post Tax Return on Assets % Overall Total Expenses % Reserve to Surplus Ratio % Written Premium Pattern % Collected Premium Pattern % IRS Discount Factors % Loss Payout Pattern % Overall Change TRUE 100.0%
5 What Contributed to the Change in the Indicated PY 2015 P&C for Florida FLORIDA - VOLUNTARY INTERNAL RATE OF RETURN MODEL RECONCILIATION EXHIBIT 1/1/15 vs 1/1/14 Change From To P&C Change in P&C % Change in P&C Last Year's Starting Value Cost of Capital (6/27/2014) % Post Tax Return on Assets % Overall Total Expenses % Reserve to Surplus Ratio % Written Premium Pattern % Collected Premium Pattern % IRS Discount Factors % Loss Payout Pattern % Overall Change TRUE 100.0%
6 What Contributed to the Change in the Indicated PY 2015 P&C for Florida FLORIDA - VOLUNTARY INTERNAL RATE OF RETURN MODEL RECONCILIATION EXHIBIT 1/1/15 vs 1/1/14 Change From To P&C Change in P&C % Change in P&C Last Year's Starting Value Cost of Capital (6/27/2014) % Post Tax Return on Assets % Overall Total Expenses % Reserve to Surplus Ratio % Written Premium Pattern % Collected Premium Pattern % IRS Discount Factors % Loss Payout Pattern % Overall Change TRUE 100.0%
7 What Contributed to the Change in the Indicated PY 2015 P&C for Florida FLORIDA - VOLUNTARY INTERNAL RATE OF RETURN MODEL RECONCILIATION EXHIBIT 1/1/15 vs 1/1/14 Change From To P&C Change in P&C % Change in P&C Last Year's Starting Value Cost of Capital (6/27/2014) % Post Tax Return on Assets % Overall Total Expenses % Reserve to Surplus Ratio % Written Premium Pattern % Collected Premium Pattern % IRS Discount Factors % Loss Payout Pattern % Overall Change TRUE 100.0%
8 What Contributed to the Change in the Indicated PY 2015 P&C for Florida FLORIDA - VOLUNTARY INTERNAL RATE OF RETURN MODEL RECONCILIATION EXHIBIT 1/1/15 vs 1/1/14 Change From To P&C Change in P&C % Change in P&C Last Year's Starting Value Cost of Capital (6/27/2014) % Post Tax Return on Assets % Overall Total Expenses % Reserve to Surplus Ratio % Written Premium Pattern % Collected Premium Pattern % IRS Discount Factors % Loss Payout Pattern % Overall Change TRUE 100.0%
9 What Contributed to the Change in the Indicated PY 2015 P&C for Florida FLORIDA - VOLUNTARY INTERNAL RATE OF RETURN MODEL RECONCILIATION EXHIBIT 1/1/15 vs 1/1/14 Change From To P&C Change in P&C % Change in P&C Last Year's Starting Value Cost of Capital (6/27/2014) % Post Tax Return on Assets % Overall Total Expenses % Reserve to Surplus Ratio % Written Premium Pattern % Collected Premium Pattern % IRS Discount Factors % Loss Payout Pattern % Overall Change TRUE 100.0%
10 What Contributed to the Change in the Indicated PY 2015 P&C for Florida FLORIDA - VOLUNTARY INTERNAL RATE OF RETURN MODEL RECONCILIATION EXHIBIT 1/1/15 vs 1/1/14 Change From To P&C Change in P&C % Change in P&C Last Year's Starting Value Cost of Capital (6/27/2014) % Post Tax Return on Assets % Overall Total Expenses % Reserve to Surplus Ratio % Written Premium Pattern % Collected Premium Pattern % IRS Discount Factors % Loss Payout Pattern % Overall Change TRUE 100.0%
11 What Contributed to the Change in the Indicated PY 2015 P&C for Florida FLORIDA - VOLUNTARY INTERNAL RATE OF RETURN MODEL RECONCILIATION EXHIBIT 1/1/15 vs 1/1/14 Change From To P&C Change in P&C % Change in P&C Last Year's Starting Value Cost of Capital (6/27/2014) % Post Tax Return on Assets % Overall Total Expenses % Reserve to Surplus Ratio % Written Premium Pattern % Collected Premium Pattern % IRS Discount Factors % Loss Payout Pattern % Overall Change TRUE 100.0%
12 What Contributed to the Change in the Indicated PY 2015 P&C for Florida FLORIDA - VOLUNTARY INTERNAL RATE OF RETURN MODEL RECONCILIATION EXHIBIT 1/1/15 vs 1/1/14 Change From To P&C Change in P&C % Change in P&C Last Year's Starting Value Cost of Capital (6/27/2014) % Post Tax Return on Assets % Overall Total Expenses % Reserve to Surplus Ratio % Written Premium Pattern % Collected Premium Pattern % IRS Discount Factors % Loss Payout Pattern % Overall Change TRUE 100.0%
13 What Contributed to the Change in the Indicated PY 2015 P&C for Florida FLORIDA - VOLUNTARY INTERNAL RATE OF RETURN MODEL RECONCILIATION EXHIBIT 1/1/15 vs 1/1/14 Change From To P&C Change in P&C % Change in P&C Last Year's Starting Value Cost of Capital (6/27/2014) % Post Tax Return on Assets % Overall Total Expenses % Reserve to Surplus Ratio % Written Premium Pattern % Collected Premium Pattern % IRS Discount Factors % Loss Payout Pattern % Overall Change TRUE 100.0%
14 What Contributed to the Change in the Indicated PY 2015 P&C for Florida FLORIDA - VOLUNTARY INTERNAL RATE OF RETURN MODEL RECONCILIATION EXHIBIT 1/1/15 vs 1/1/14 Change From To P&C Change in P&C % Change in P&C Last Year's Starting Value Cost of Capital (6/27/2014) % Post Tax Return on Assets % Overall Total Expenses % Reserve to Surplus Ratio % Written Premium Pattern % Collected Premium Pattern % IRS Discount Factors % Loss Payout Pattern % Overall Change TRUE 100.0%
15 NCCI PY2015 Florida WC Rate Hearing Financial Analysis Interest Rates, Investment Income, and the Underwriting Cycle 15
16 NCCI PY2015 Florida WC Rate Hearing Financial Analysis Over the Past Quarter Century Every Hard Market Has Followed a Recession Every Recession Has Been Followed by a Hard Market 16
17 NCCI PY2015 Florida WC Rate Hearing Financial Analysis Why? Interest Rates Fall During and Following Recessions 17
18 NCCI PY2015 Florida WC Rate Hearing Financial Analysis This Reflects the Fundamental Challenge in Managing the Financial Performance in Property and Casualty Insurance Trying to Maintain an Appropriate Balance between Underwriting and Investment Returns 18
19 NCCI PY2015 Florida WC Rate Hearing Financial Analysis Interest Rates Are at or Near Their Historic Lows 19
20 The Federal Reserve Typically Reduces Short-Term Interest Rates Before the Start of a Recession, With Declines Continuing After the Economy Begins to Expand - Other Interest Rates Follow Percent 20 Effective Federal Funds Rate Year Treasury Constant Maturity Rate Shaded areas indicate U.S. economic recessions Source: Board of Governors of the Federal Reserve System
21 The Federal Reserve Typically Reduces Short-Term Interest Rates Before the Start of a Recession, With Declines Continuing After the Economy Begins to Expand - Other Interest Rates Follow Percent 20 Effective Federal Funds Rate Year Treasury Constant Maturity Rate Shaded areas indicate U.S. economic recessions Source: Board of Governors of the Federal Reserve System
22 The Federal Reserve Typically Reduces Short-Term Interest Rates Before the Start of a Recession, With Declines Continuing After the Economy Begins to Expand - Other Interest Rates Follow Percent 20 Effective Federal Funds Rate Year Treasury Constant Maturity Rate Shaded areas indicate U.S. economic recessions Source: Board of Governors of the Federal Reserve System
23 The Federal Reserve Typically Reduces Short-Term Interest Rates Before the Start of a Recession, With Declines Continuing After the Economy Begins to Expand - Other Interest Rates Follow Percent 20 Effective Federal Funds Rate Year Treasury Constant Maturity Rate Shaded areas indicate U.S. economic recessions Source: Board of Governors of the Federal Reserve System
24 The Federal Reserve Typically Reduces Short-Term Interest Rates Before the Start of a Recession, With Declines Continuing After the Economy Begins to Expand - Other Interest Rates Follow Percent 20 Effective Federal Funds Rate Year Treasury Constant Maturity Rate Shaded areas indicate U.S. economic recessions Source: Board of Governors of the Federal Reserve System
25 Long-term Interest Rates Have Been Trending Downward for More than a Quarter Century and Are Currently Near Historic Lows Percent Year Treasury Constant Maturity Rate Shaded areas indicate U.S. economic recessions Source: Board of Governors of the Federal Reserve System
26 Long-term Interest Rates Have Been Trending Downward for More than a Quarter Century and Are Currently Near Historic Lows Percent Year Treasury Constant Maturity Rate 60 per. Mov. Avg. (10-Year Treasury Constant Maturity Rate) Shaded areas indicate U.S. economic recessions Source: Board of Governors of the Federal Reserve System
27 Long-term Interest Rates Have Been Trending Downward for More than a Quarter Century and Are Currently Near Historic Lows Percent Year Treasury Constant Maturity Rate 60 per. Mov. Avg. (10-Year Treasury Constant Maturity Rate) Shaded areas indicate U.S. economic recessions Source: Board of Governors of the Federal Reserve System
28 NCCI PY2015 Florida WC Rate Hearing Financial Analysis Interest Rates Are at or Near Their Historic Lows Why Does This Matter? It Means that Expected Investment Income Is Low 28
29 Changes in the Post-tax Yield Are a Key Driver of Changes in the P&C 12.00% Indicated P&C - Std w/o dividends (left) Post tax yield (right) Post-tax Return 6.000% 10.00% 5.04% 5.000% 8.00% 4.32% 6.00% 4.000% 4.00% 2.00% 3.07% 3.000% 0.00% 2.31% 2.000% -2.00% -4.00% Effective Date 1.000% -6.00% 0.000% Source: NCCI
30 NCCI PY2015 Florida WC Rate Hearing Financial Analysis When Expected Investment Income Is Low The Indicated P&C Is High 30
31 Changes in the Post-tax Yield Are a Key Driver of Changes in the P&C P&C 12.00% 10.00% 8.00% Indicated P&C - Std w/o dividends (left) Post tax yield (right) Post-tax Return 6.000% 10.47% 5.000% 6.00% 4.69% 6.63% 4.000% 4.00% 3.000% 2.00% 0.00% -0.75% 2.000% -2.00% -4.00% -3.01% Effective Date 1.000% -6.00% 0.000% Source: NCCI
32 Changes in the Post-tax Yield Are a Key Driver of Changes in the P&C P&C 12.00% 10.00% 8.00% Indicated P&C - Std w/o dividends (left) Post tax yield (right) Post-tax Return 6.000% 10.47% 5.000% 6.00% 4.69% 6.63% 4.000% 4.00% 3.000% 2.00% 0.00% -0.75% 2.000% -2.00% -4.00% -3.01% Effective Date 1.000% -6.00% 0.000% Source: NCCI
33 NCCI PY2015 Florida WC Rate Hearing Financial Analysis Underwriting Results Must Improve to Offset the Projected Decline in Investment Income 33
34 NCCI PY2015 Florida WC Rate Hearing Financial Analysis Over the Past Five Years the Filed and Approved P&Cs Have Been Significantly Lower than the P&Cs Indicated by NCCI s Financial Analysis 34
35 The Approved P&C Has Been Significantly Lower than the Indicated for the Past Five Years P&C 12.00% 10.00% Approved P&C Factor (left) Proposed P&C Factor (left) Indicated P&C - Std w/o dividends (left) 8.00% 6.00% 4.00% 2.00% 0.00% -2.00% -4.00% Effective Date -6.00% Source: NCCI
36 The Approved P&C Has Been Significantly Lower than the Indicated for the Past Five Years P&C 12.00% 10.00% Approved P&C Factor (left) Proposed P&C Factor (left) Indicated P&C - Std w/o dividends (left) 8.00% 6.00% 4.00% 2.00% 0.00% -2.00% -4.00% Effective Date -6.00% Source: NCCI
37 The Approved P&C Has Been Significantly Lower than the Indicated for the Past Five Years P&C 12.00% 10.00% Approved P&C Factor (left) Proposed P&C Factor (left) Indicated P&C - Std w/o dividends (left) 8.00% 6.00% 4.00% 2.00% 0.00% -2.00% -4.00% Effective Date -6.00% Source: NCCI
38 NCCI PY2015 Florida WC Rate Hearing Financial Analysis Why Should the Selected and Approved P&Cs Be Closer to the Value Indicated by this Financial Analysis. The Impact on the Florida Workers Compensation Market of Capping the P&C at 2.5% Has Been Increasing Steadily for Several Years 38
39 Percent of Premium Policyholder Dividends & Rate Departures The Increasing Gap between the Indicated and Approved P&C Has Impacted the Workers Compensation Market in Florida 8% 4% As the Gap Has Increased Since 2008 there Has Been a Sharp Decline in Policyholder Dividends and a Marked Increase in Departures from Approved Rates. 2.9% 4.7% 3.5% 3.2% 3.7% 4.9% 6.2% 8.0% 5.8% 0% 0.9% -0.8% 0.6% -4% -8% p Policy Year Consent to Rate Dividends Gap -Indicated vs Approved p Preliminary Based on data through 12/31/2013 Dividend ratios are based on calendar year statistics 39
40 Percent of Premium Policyholder Dividends & Rate Departures The Increasing Gap between the Indicated and Approved P&C Has Impacted the Workers Compensation Market in Florida 8% 4% As the Gap Has Increased Since 2008 there Has Been a Sharp Decline in Policyholder Dividends and a Marked Increase in Departures from Approved Rates. 2.9% 4.7% 3.5% 3.2% 3.7% 4.9% 6.2% 8.0% 5.8% 0% 0.9% -0.8% 0.6% -4% -8% p Policy Year Consent to Rate Dividends Gap -Indicated vs Approved p Preliminary Based on data through 12/31/2013 Dividend ratios are based on calendar year statistics 40
41 Percent of Premium Policyholder Dividends & Rate Departures The Increasing Gap between the Indicated and Approved P&C Has Impacted the Workers Compensation Market in Florida 8% 4% As the Gap Has Increased Since 2008 there Has Been a Sharp Decline in Policyholder Dividends and a Marked Increase in Departures from Approved Rates. 2.9% 4.7% 3.5% 3.2% 3.7% 4.9% 6.2% 8.0% 5.8% 0% 0.9% -0.8% 0.6% -4% -8% p Policy Year Consent to Rate Dividends Gap -Indicated vs Approved p Preliminary Based on data through 12/31/2013 Dividend ratios are based on calendar year statistics 41
42 Percent of Premium Policyholder Dividends & Rate Departures The Increasing Gap between the Indicated and Approved P&C Has Impacted the Workers Compensation Market in Florida 8% 4% As the Gap Has Increased Since 2008 there Has Been a Sharp Decline in Policyholder Dividends and a Marked Increase in Departures from Approved Rates. 2.9% 4.7% 3.5% 3.2% 3.7% 4.9% 6.2% 8.0% 5.8% 0% 0.9% -0.8% 0.6% -4% -8% p Policy Year Consent to Rate Dividends Gap -Indicated vs Approved p Preliminary Based on data through 12/31/2013 Dividend ratios are based on calendar year statistics 42
43 NCCI PY2015 Florida WC Rate Hearing Financial Analysis Why Should the Selected and Approved P&Cs Be Closer to the Value Indicated by this Financial Analysis? To Ease the Financial Pressures that Have Been Growing in the Workers Compensation Market in Florida 43
44 NCCI PY2015 Florida WC Rate Hearing Financial Analysis Questions and Comments 44
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