Insurance Institute of London London Institute Centenary Lecture London, UK. 6 March 2007

Transcription

1 State-Backed Insurance Schemes The Role of Insurers Insurance Institute of London London Institute Centenary Lecture London, UK 6 March 2007 Robert P. Hartwig, Ph.D., CPCU, President & Chief Economist Insurance Information Institute 110 William Street New York, NY Tel: (212) Fax: (212) bobh@iii.org

2 Presentation Outline Historical Role of the State in (Re) Insurance Markets The Case of Terrorism The Case of Natural Disaster Risk Public Policy Remedies: Recent Trends & Developments in the United States The Case of Florida Re Could United States Re be Far Behind? Outlook for State-Backed Insurance Schemes Summary Q&A

3 Historical Role of the State in Insurance Markets 1. Solvency 2. Rate and Form Regulation 3. Consumer Protection 4. (Re) Insurer of Last (or Only) Resort 5. (Re) Insurer of First Resort

4 SOLVENCY REGULATION Government Wants to Insure CATs, but How Well Do They Regulate that Risk Now?

5 Reasons for US P/C Insurer Impairments, Catastrophe Losses 8.6% Affiliate Problems 8.6% Deficient Loss Reserves/Inadequate Pricing 62.8% Sig. Change in Business 4.6% Misc. 9.2% Reinsurance Failure 3.5% Deficient Loss Reserves/Inadequate Pricing 38.2% Alleged Fraud 11.4% Rapid Growth 8.6% More insurer impairments due to CATs recently Investment Problems* 7.3% Affiliate Problems 5.6% Catastrophe Losses 6.5% Alleged Rapid Fraud Growth 8.6% 16.5% *Includes overstatement of assets. Source: A.M. Best: P/C Impairments Hit Near-Term Lows Despite Surging Hurricane Activity, Special Report, Nov. 2005;

6 Major Residual Market Plan Estimated Deficits 2004/2005 (Millions of Dollars) $0 -$200 -$400 -$600 -$800 -$1,000 -$1,200 -$1,400 -$1,600 -$1,800 -$2,000 -$1,425 -$516 -$1, Florida Hurricane Catastrophe Fund (FHCF) Florida Citizens Louisiana Citizens -$954 Mississippi Windstorm Underwriting Association (MWUA) -$595 * Hurricane Katrina pushed all of the residual market property plans in affected states into deficits for 2005, following an already record hurricane loss year in 2004 * MWUA est. deficit for 2005 comprises $545m in assessments plus $50m in Federal Aid. Source: Insurance Information Institute

7 NFIP: Loss Dollars Paid by Calendar Year $1,400 $1,200 $1,000 $800 $600 $400 $200 $0 The NFIP paid an estimated $20 billion in flood claims in 2005, indicating a need for a taxpayer-financed bailout of at least $18 billion $ Millions $147.7 $483.3 $230.4 $127.1 $198.3 $439.5 $254.6 $368.2 $126.4 $105.4 $51.0 $661.7 $167.9 $353.7 $710.2 $659.1 $411.1 $1,295.5 $828.0 $519.5 $886.0 $754.8 $ $1,276.4 $432.5 $759.8 $1,207.2 Source: FEMA, National Flood Insurance Program (NFIP)

8 RATE REGULATION Government Wants to Insure CATs, but Do They Know What to Charge?

9 $ Billions $4 $2 $0 ($2) ($4) ($6) ($8) ($10) ($10.60) ($12) Underwriting Gain (Loss) in Florida Homeowners Insurance, E* ($0.21) $0.69 $0.43 $0.86 $1.08 $1.23 $1.28 $1.43 $1.16 $1.47 $1.88 Florida s homeowners insurance market produces small profits in most years and enormous losses in others ($10.39) ($3.73) $ E 06F *2005 estimate by Insurance Information Institute based on historical loss and expense data for FL adjusted for estimated 2005 residential windstorm losses of $7.35B estimate from Ins. Info. Inst.

10 $ Billions $2 $0 ($2) ($4) ($6) ($8) ($10) ($12) ($14) ($16) Cumulative Underwriting Gain (Loss) in Florida Homeowners Insurance, E* Regulator under US law has duty to allow rates that are fair, not excessive and not unduly discriminatory. Reality is that regulators in CAT-prone states suppress rates. -$6.5 -$7.7 -$1.2 -$2.7 -$3.8 -$5.2 -$10.6-$10.8 -$10.1-$9.7-$8.8 It took insurers 11 years ( ) to erase the UW loss associated with Andrew, but the 4 hurricanes of 2004 erased the prior 7 years of profits & 2005 deepened the hole. $0.7 -$9.7 -$13.4 -$ E 06F *2005 estimate by Insurance Information Institute based on historical loss and expense data for FL adjusted for estimated 2005 residential windstorm losses of $7.35B estimate from Ins. Info. Inst.

11 Rates of Return on Net Worth for Homeowners Ins: US vs. Florida 100% 0% US Florida 0.0% 36.0% -100% -200% -54.3% Averages: 1990 to 2006E US HO Insurance = -0.7% % -80.0% -300% FL HO Average = -38.1% -400% -500% -600% -700% -800% 4 Hurricanes % Andrew Wilma, Dennis, Katrina E 06E Source: NAIC; 2005/6 US and FL estimates from the Insurance Information Institute.

12 RATIONALE FOR GREATER GOVERNMENT INVOLVEMENT Insurability, Magnitude of Loss, Price, Availability

13 Commonly Cited Rationale for Greater State Role in Insurance 1. Insurability Questions of insurability of some risks 2. Magnitude of Loss (Severity) Losses so large only the state can manage? 3. Price Concerns over price charged by private (re)insurers 4. Availability Concerns over availability at affordable prices (or any price at all) 5. Government Participation via Aid State already provides economic relief

14 Terrorism The Classic Example for a State Role in (Re) Insurance Markets

15 Cost of Largest Terrorist Attacks (Millions of 2006 Dollars) $ Millions $40,000 $35,000 $30,000 $25,000 $20,000 $15,000 $10,000 $35,600 September 11 terrorist attacks dwarf all other events Hurricane Katrina aid will dwarf aid following all other disasters. Congress may authorize $150-$200 billion ultimately (about $400,000 for each of the 500,000 displaced families). Is the incentive to buy insurance and insure to value diminished? $5,000 $0 Sept. 11 Terrorist Attack (2001) $1,000 $825 $803 $744 $237 $166 Nat West Bombing, London (1993) IRA Car Bombing, Manchester, (1996) World Trade Center Bombing (1993) London Financial District (1992) Anthrax Attacks (2001)* Oklahoma City Bombing (1995) Source: Insurance Information Institute research, GAO. *Clean-Up Expenses: $130M Brentwood Postal; $80M Trenton Postal; $27 Hart Senate Office Bldg.

16 Sept. 11 Industry Loss Estimates ($ Billions) Life Other $1.0 (3.1%) Liability $4.0 (12.3%) Property - WTC 1 & 2 $3.6 (11.1%) Property - Other $6.0 (19.5%) Aviation Liability $3.5 (10.8%) Event Cancellation $1.0 (3.1%) Aviation Hull $0.5 (1.5%) Workers Comp $1.8 (5.8%) Insured Losses Estimate: $32.5B Source: Insurance Information Institute Biz Interruption $11.0 (33.8%)

17 TRIA s Extension Modified Industry Retention Limits, but Remains Vital Allocation of P/C Underwriting Loss Original vs. Extension U/W Loss ($B) $250 $200 $150 $100 $50 $0 Original Extension The long return period for major terrorism events suggests great difficulty estimating frequency, making expected loss calculations difficult. Classic insurability problem arises. 2% 2% 4% Total Loss as % of P/C Surplus 6% 12% 20% 68% 9/10 3/4 1/2 1/4 1/20 1/25 3/100 1/50 1/100 1/200 1/1000 Chance of an Event Industry Loss With TRIA Federal Contribution Excess of TRIA Limit Source: EQECAT, NCCI

18 Insurance Industry Retention Under TRIA ($ Billions) $ Billions $35 $30 $25 $20 $15 $10 Individual company retentions rise to 17.5% in 2006, 20% in 2007 Above the retention, federal govt. pays 90% in 2006, 85% in 2007 $10.0 $12.5 $15.0 $25.0 Extension $27.5 $5 $0 Year 1 (2003) Year 2 (2004) Year 3 (2005) Year 4 (2006) Year 5 (2007) Source: Insurance Information Institute

19 Insured Terrorism Loss as a % of TRIEA-Exposure Industry Surplus* 600% 500% 400% 300% 200% 100% 0% Large CNBR Attack Medium CNBR Attack Conventional Truck Bomb 515% 296% New York City Some terror attack scenarios consume several times the industry s estimated TRIEA-exposed 2005 surplus of $151 billion. 130% 113% 70% 61% 8% 28% 4% 6% 18% 2% Washington San Francisco Des Moines *Insurance Information Institute preliminary estimate of 2006 TRIEA-exposed surplus of $151 billion. Source: Insurance Information Institute preliminary estimate of TRIEA exposed p/c insurance industry surplus and calculations using American Academy of Actuaries modeled scenarios, Response to President s Working Group, Appendix II, April 26, 2006.

20 Insured Loss Estimates: Large CNBR Terrorist Attack ($ Bill) Type of Coverage New York Washington San Francisco Des Moines Group Life $82.0 $22.5 $21.5 $3.4 General Liability Workers Comp Residential Prop Commercial Prop Auto TOTAL $778.1 $196.8 $171.2 $42.3 Source: American Academy of Actuaries, Response to President s Working Group, Appendix II, April 26, 2006.

21 Insured Loss Estimates: Medium CNBR Terrorist Attack ($ Bill) Type of Coverage New York Washington San Francisco Des Moines Group Life $37.7 $22.5 $21.5 $3.4 General Liability Workers Comp Residential Prop Commercial Prop Auto TOTAL $446.5 $106.2 $92.2 $27.3 Source: American Academy of Actuaries, Response to President s Working Group, Appendix II, April 26, 2006.

22 Insured Loss Estimates: Truck Bomb Terrorist Attack ($ Bill) Type of Coverage New York Washington San Francisco Des Moines Group Life $0.3 $0.2 $0.3 $0.1 General Liability Workers Comp Residential Prop Commercial Prop Auto TOTAL $11.8 $5.5 $8.8 $3.0 Source: American Academy of Actuaries, Response to President s Working Group, Appendix II, April 26, 2006.

23 Terrorism Coverage Take-Up Rate Continues to Rise Terrorism take-up rate for non-wc risk rose steadily through 2003, 2004 and % 46% 44% 48% 47% 54% 59% 64% 24% 26% 33% TAKE UP RATE FOR WC COMP TERROR COVERAGE IS 100%!! 03Q2 03Q3 03Q4 04Q1 04Q2 04Q3 04Q4 05Q1 05Q2 05Q3 05Q4 Source: Narketwatch: Terrorism Insurance 2006, Marsh, Inc.; Insurance Information Institute

24 Outlook for Terrorism Risk Insurance Democratic Control in Congress Implies Less Resistance to Government Involvement in Insurance Markets Many key Democrats are from terrorism exposed states: NY, MA, CA Senate Banking Cmte. chaired by Christopher Dodd (D-CT); House Financial Services Cmte. by Barney Frank (D-MA) Hearings Held Feb. 28 (DC) and March 5 (NYC) Indicating Little Opposition Possible Bill Could Emerge by Late April May Propose Long-Term Solution: yrs.

25 Natural Catastrophes View by Some that Government Must Play a Larger Role

26 U.S. Insured Catastrophe Losses* $120 $100 $80 $60 $ Billions 2006 was a welcome respite was by far the worst year ever for insured catastrophe losses in the US, but the worst has yet to come. $100 Billion CAT year is coming soon $61.9 $100.0 $40 $20 $0 $ $ $ $ $ $ $ $ $ *Excludes $4B-$6b offshore energy losses from Hurricanes Katrina & Rita. Note: 2001 figure includes $20.3B for 9/11 losses reported through 12/31/01. Includes only business and personal property claims, business interruption and auto claims. Non-prop/BI losses = $12.2B. Source: Property Claims Service/ISO; Insurance Information Institute $ $ $ $ $ $ $ $ ??

27 Insured Loss & Claim Count for Major Storms of 2005* Insured Loss Claims Insured Loss ($ Billions) $45 $40 $35 $30 $25 $20 $15 $10 $5 $0 Hurricanes Katrina, Rita, Wilma & Dennis produced a record 3.3 million claims 104 $ $5.0 1,047 $10.3 1,744 $40.6 2,000 1,800 1,600 1,400 1,200 1, Claims (thousands) Dennis Rita Wilma Katrina Size of Industry Loss ($ Billions) *Property and business interruption losses only. Excludes offshore energy & marine losses. Source: ISO/PCS as of June 8, 2006; Insurance Information Institute.

28 Top 10 Most Costly Hurricanes in US History, (Insured Losses, $2005) $45 $40 $35 $30 Seven of the 10 most expensive hurricanes in US history occurred in the 14 months from Aug Oct. 2005: $40.6 $ Billions $25 $20 $15 $10 $5 Katrina, Rita, Wilma, Charley, Ivan, Frances & Jeanne $3.5 $3.8 $4.8 $5.0 $6.6 $7.4 $7.7 $10.3 $21.6 $0 Georges (1998) Jeanne (2004) Frances (2004) Rita (2005) Hugo (1989) Ivan (2004) Charley (2004) Wilma (2005) Andrew (1992) Katrina (2005) Sources: ISO/PCS; Insurance Information Institute.

29 Insured Losses from Top 10 Hurricanes Adjusted to 2005 Exposure Levels $90 $80 $70 $60 $50 $40 $30 $20 $10 $0 $20.0 $24.0 $26.0 (Billions of 2005 Dollars) Plurality of worst-case scenarios involve Florida With rapid coastal development, $40B+ storms will be more common $33.0 $33.0 $34.0 $35.0 $41.0 $42.0 $80.0 $ Billions Homestead Hurr (1945, FL) Ft. Lauderdale Hurr (1947, FL) Donna (1960, FL) Okeechobee Hurr (1928, FL) Galveston (1900, TX) Bestsy (1965, LA) LI Express (1938, NY) Katrina (2005, LA)* Andrew (1992, FL)* Miami Hurr (1926, FL) Source: AIR Worldwide **ISO/PCS estimate as of June 8, 2006

30 Nightmare Scenario: Insured Property Losses for NJ/NY CAT 3/4 Storm Insured Losses: $110B Economic Losses: $200B+ Distribution of Insured Property Losses, by State, ($ Billions) $80 $60 $40 $20 $0 $70 $30 Total Insured Property Losses = $110B, nearly 3 times that of Hurricane Katrina $5 $4 $1 NY NJ PA CT Other Source: AIR Worldwide

31 Inflation-Adjusted U.S. Insured Catastrophe Losses By Cause of Loss, ¹ Earthquakes 4 6.7% Winter Storms 7.8% Wind/Hail/Flood 5 Terrorism 7.7% 2.8% Civil Disorders 0.4% Fire 6 2.3% Water Damage 0.1% Utility Disruption 0.1% Tornadoes % Insured disaster losses totaled $289.1 billion from (in 2005 dollars). Tropical systems accounted for nearly half of all CAT losses from , up from 27.1% from All Tropical Cyclones % 1 Catastrophes are all events causing direct insured losses to property of $25 million or more in 2005 dollars. Catastrophe threshold changed from $5 million to $25 million beginning in Adjusted for inflation by the III. 2 Excludes snow. 3 Includes hurricanes and tropical storms. 4 Includes other geologic events such as volcanic eruptions and other earth movement. 5 Does not include flood damage covered by the federally administered National Flood Insurance Program. 6 Includes wildland fires. Source: Insurance Services Office (ISO)..

32 Total Value of Insured Coastal Exposure (2004, $ Billions) Florida New York Texas Massachusetts New Jersey Connecticut Louisiana S. Carolina Virginia Maine North Carolina Alabama Georgia Delaware New Hampshire Mississippi Rhode Island Maryland $740.0 $662.4 $505.8 $404.9 $209.3 $148.8 $129.7 $117.2 $105.3 $75.9 $73.0 $46.4 $45.6 $44.7 $43.8 $12.1 $1,937.3 $1,901.6 Florida & New York lead the way for insured coastal property at more than $1.9 trillion each. Texas has $740B. Source: AIR Worldwide $0 $500 $1,000 $1,500 $2,000 $2,500

33 Insured Coastal Exposure as a % of Statewide Insured Exposure (2004, $ Billions) Florida Connecticut New York Maine Massachusetts Louisiana New Jersey Delaware Rhode Island S. Carolina Texas NH Mississippi Alabama Virginia NC Georgia Maryland 13.5% 12.0% 11.4% 8.9% 5.9% 1.4% 37.9% 33.6% 33.2% 28.0% 25.6% 25.6% 23.3% 63.1% 60.9% 57.9% 54.2% 79.3% Who s to Blame* 1. State & local zoning, land use and building code officials 2. State & local legislators 3. State-run property insurers, pools & plans 4. Washington, DC 5. Property owners *III list Source: AIR Worldwide 0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

34 Value of Insured Commercial Coastal Exposure (2004, $ Billions) New York Florida Texas Massachusetts New Jersey Connecticut Louisiana S. Carolina Virginia Maine North Carolina Georgia Alabama Mississippi New Hampshire Delaware Rhode Island Maryland $437.8 $355.8 $258.4 $199.4 $121.3 $83.7 $69.7 $52.6 $45.3 $43.3 $39.4 $23.8 $20.9 $19.9 $17.9 $6.7 $994.8 $1,389.6 Source: AIR $0 $200 $400 $600 $800 $1,000 $1,200 $1,400 $1,600

35 Value of Insured Residential Coastal Exposure (2004, $ Billions) Florida New York Massachusetts Texas New Jersey Connecticut Louisiana S. Carolina Maine Virginia North Carolina Alabama Georgia Delaware Rhode Island New Mississippi Maryland $88.0 $65.1 $64.5 $60.0 $60.0 $36.5 $29.7 $26.6 $25.9 $24.8 $20.9 $5.4 $306.6 $302.2 $247.4 $205.5 $512.1 $942.5 Source: AIR $0 $200 $400 $600 $800 $1,000

36 Insured Losses from Top 10 Earthquakes Adjusted to 2005 Exposure Levels $120 $100 $80 $60 $40 $20 $9 $11 $11 $12 (Billions of 2005 Dollars) With development along major fault lines, the threat of $25B+ quakes looms large $16 3 of the Top 10 are not West Coast events $25 $27 $38 $88 $108 $ Billions $0 San Jose, CA ( ; 6.6) Portland, OR ( ; 6.3) San Francisco ( ; 7.2) Marked Tree, AR ( ; 6.5) Northridge, CA ( ; 6.7) Hayward, CA ( ; 6.8) Ft. Tejon, CA ( ; 7.9) Charleston, SC ( ; 7.3)* New Madrid, MO ( ; 7.7)* San Francisco ( ; 7.9) Source: AIR Worldwide

37 ARE COASTAL DEVELOPMENT PATTERNS RATIONAL? The Answer May Surprise You

38 Excessive Catastrophe Exposure: Outcome of Economically & Politically Rational Decision Process? Property Owners Make economically rational decision to live in disaster-prone areas Low cost of living, low real estate prices & rapid appreciation, low/no income tax, low property tax, rapid job growth Government-run insurers (e.g., CPIC, NFIP) provide implicit subsidies by selling insurance at below-market prices with few underwriting restrictions Government aid, tax deductions, litigation recovery for uninsured losses No fear of death and injury Local Zoning/Permitting Authorities Allowing development is economically & politically rational & fiscally sound Residential construction creates jobs, attracts wealth, increases tax receipts, stimulates commercial construction & permanent jobs, develops infrastructure Increases local representation in state legislature & political influence Property and infrastructure damage costs shifted to others (state and federal taxpayers, policyholders in unaffected areas) Developers Coastal development is a high-margin business Financial interest reduced to zero after sale Source: Insurance Information Institute.

39 Excessive Catastrophe Exposure: Outcome of Economically & Politically Rational Decision Process? State Legislators Loathe to pass laws negatively impacting development in home districts Local development benefits local economy and enhances political influence Rapid development lessens need for higher income and property taxes Can redistribute CAT losses to unaffected policyholders and taxpayers Can suppress insurance prices via state insurance regulator, suppress pricing and weaken underwriting standards in state-run insurer & redistribute losses Congressional Delegation Home state development increases influence in Washington Political representation, share of federal expenditures Loathe to pass laws harming development in home state/district Tax law promotes homeownership and actually produces supplemental benefits for property owners in disaster-prone areas Large amounts of unbudgeted disaster aid easily authorized Tax burden largely borne by those outside CAT zone & those with no representation (children & unborn) President Presidential disaster declarations and associated aid are increasing Political benefits to making declarations and distributing large amounts of aid Direct impact on favorability ratings & election outcomes Losses can be distributed to other areas and the unrepresented Source: Insurance Information Institute.

40 UNDERWRITING CAPACITY Are the Industry s Claims Paying Resources are Adequate?

41 U.S. Policyholder Surplus: E* ($ Billions) $ Billions $550 $500 $450 $400 $350 $300 $250 $200 $150 $100 $50 $0 Capacity as of 12/31/06 is $481.5B (est.), 13.1% above year-end 2005, 69% above its 2002 trough and 44% above its 1999 peak. Foreign reinsurance and residual market mechanisms absorbed 45% of 2005 CAT losses of $62.1B Surplus is a measure of underwriting capacity. It is analogous to Owners Equity or Net Worth in non-insurance organizations Source: A.M. Best, ISO, Insurance Information Institute *III estimate for 2006.

42 Announced Insurer Capital Raising* ($ Millions, as of December 1, 2005) $ Millions $3,500 $3,000 $2,500 $2,000 $1,500 $1,000 $500 $0 $1,500 As of Dec. 1, 19 insurers announced plans to raise $10.35 billion in new capital. Fourteen start-ups plan to raise as much as $10 billion more for a total of $20.4 billion. Actual total higher as Lloyd s syndicates have added capacity for $400 $450$600$710 $600 $620 $490 $300 $38 $100 $140 $129 $297 $124 $202 $150 $299 *Existing (re) insurers. Announced amounts may differ from sums actually raised. Sources: Morgan Stanley, Lehman Brothers, Company Reports; Insurance Information Institute. $3,200 Ace Ltd. Argonaut Aspen Axis Endurance Everest Re Fairfax Finl. Glacier Re HCC Insurance IPC Hldgs Kiln PLC Max Re Montpelier Re Navigators Odyssey Re Partner Re Platinum PXRE XL Capital

43 Announced Capital Raising by Insurance Start-Ups ($ Millions, as of April 15, 2006) $ Millions $1,600 $1,400 $1,200 $1,000 $800 $600 $1,500 $1,000$1,000$1,000$1,000$1,000$1,000 As of April 15, 14 startups plan to raise as much as $10 billion. $500 $500 $500 $500 $400 $200 $220 $180 $100 $0 Harbor Point* Amlin Bermuda Flagstone Re Validus Holdings Lancashire Re** Augsburg Re Ariel Re Hiscox Bermuda New Castle Re Arrow Capital XL/Highfields Greenlight Re Omega Specialty Ascendent Re *Chubb, Trident are funding Harbor Point. Announced amounts may differ from sums actually raised. **Stated amount is $750 million to $1 billion. ***XL Capital/Hedge Fund venture. Arrow Capital formed by Goldman Sachs. Sources: Investment Bank Reports; Insurance Information Institute.

44 Capital Raising by Class Within 15 Months of KRW $ Billions Insurers & Reinsurers raised $33.7 billion in the wake of Katrina, Rita, Wilma Insurance Linked Securities, $6.253, 19% New Cos., $8.898, 26% Sidecars, $6.359, 19% Existing Cos., $12.145, 36% Source: Lane Financial Trade Notes, January 31, 2007.

45 Capital Market Participation Post-KRW Reaches Record Highs Source: Lane Financial Trade Notes, January 31, 2007.

46 P/C Industry Combined Ratio As recently as 2001, insurers were paying out nearly $1.16 for every dollar they earned in premiums /8 deterioration due primarily to falling rates, but results still strong assuming normal CAT activity 2006 could produce the best underwriting result since the 93.3 combined ratio in figure benefited from heavy use of reinsurance which lowered net losses E 07F 08F Sources: A.M. Best; ISO, III. *Estimates/forecasts based on III s 2007 Early Bird survey.

47 Ten Lowest P/C Insurance Combined Ratios Since The projected 2006 combined ratio of 93.2 would be the best since 1936, a span of 70 years E 1936 Sources: A.M. Best; Insurance Information Institute. *III Groundhog Survey forecast, Feb

48 PRICING Are Low and Stable Prices Valid Arguments for an Expanded Role of the State?

49 Percent of Commercial Accounts Renewing w/positive Rate Changes, 2 nd Qtr % 70% 60% 50% 40% 30% 20% 10% 0% Commercial Property Business Interruption 71% 63% Largest increases for Commercial Property & Business Interruption are 48% in the Southeast, smallest in Midwest 32% 35% 21% 28% 21% 12% 10% Southeast Southwest Pacific NW Northeast Midwest Source: Council of Insurance Agents and Brokers

50 Average Commercial Rate Change, All Lines, (1Q:2004 4Q:2006) 0% -2% -4% -0.1% -3.2% Magnitude of rate decreases has diminished greatly since mid-2005 but is growing again -2.7% -3.0% -6% -8% -10% -4.6% -5.9% -7.0% -8.2% -9.4% -9.7% KRW Effect -5.3% -9.6% -12% 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 3Q06 Source: Council of Insurance Agents & Brokers; Insurance Information Institute

51 REINSURANCE MARKETS View Among Some that Reinsurance Markets Failed Post-Katrina

52 Share of Losses Paid by Reinsurers, by Disaster* 70% 60% 50% 40% 30% 20% Reinsurance is playing an increasingly important role in the financing of mega- CATs; Reins. Costs are skyrocketing 30% 25% 60% 20% 45% 10% 0% Hurricane Hugo (1989) Hurricane Andrew (1992) Sept. 11 Terror Attack (2001) 2004 Hurricane Losses 2005 Hurricane Losses *Excludes losses paid by the Florida Hurricane Catastrophe Fund, a FL-only windstorm reinsurer, which was established in 1994 after Hurricane Andrew. FHCF payments to insurers are estimated at $3.85 billion for 2004 and $4.5 billion for Sources: Wharton Risk Center, Disaster Insurance Project; Insurance Information Institute.

53 Loss Distribution of 2005 CAT Losses Reinsurers and Retro market absorbed nearly half of 2005 CAT losses Source: Lane Financial Trade Notes, January 31, 2007.

54 Transmission of Shock Through Insurance/Reinsurance Markets Primary Insurer Loss of Capacity Higher Re Prices Higher Retentions Reinsurer Loss of Capacity Retrocessional Loss of Capacity Higher Retail Price/Less Capacity for Insurance

55 Reinsurers Net Written Premiums, US Business, $ Billions Premiums Written $35 $30 $25 $20 $15 $10 Premiums written are actually falling despite higher prices $19.93 $19.44 $21.21 ($ Billions) $24.85 $26.69 $29.50 $30.63 $28.76 US reinsurance premiums written grew 54% between 1997 and 2003, but fell 17% from 2003 through 2005 $ Source: Reinsurance Association of America; Insurance Information Institute Fact Book 2007, p. 38.

56 Reinsurance Markets are Globally Linked Global Premiums Ceded Reinsurance Market Losses Paid States like LA, MS paid little into the global reinsurance pool but got a lot in return, shrinking global claims paying resources and pushing up reinsurance costs for all

57 Debate Over Reinsurance Market Performance & Government Reinsurance markets typically suffer large shocks, followed by a period of higher prices and transient capacity constraints A new equilibrium between Supply and Demand is typically found within 18 months, commensurate with changes in the risk landscape. This is Economics 101 and is a textbook illustration of how capitalism works. A competing hypothesis suggests that reinsurance markets fail because they do not provide a stable price or quantity of protection as is required in an economy with continuously exposed fixed assets, especially one that is growth oriented Public Policy Solution: Acting on this hypothesis generally results in displacement of private (re)insurance capital by government intermediaries Open Question: Are policyholders and the economy better served through free markets, government or some hybrid? Sources: Insurance Information Institute

58 What Role Should the Federal Government Play in Insuring Against Natural Disaster Risks?

59 PUBLIC POLICY REMEDIES Helpful or Harmful?

60 Public Policy: The Role of the State Government Disaster Aid State-Run Residual Markets (Markets of Last Resort) Federal Natural Catastrophe Plan Socialization of the (Re) Insurance Markets

61 GOVERNMENT AID Helpful but Inefficient & Not a Solution

62 Top 10 Major Disaster Declaration Totals By State: * Total Number Texas California Florida 57 Louisiana *Through July 12, Source: Federal Emergency Management Agency (FEMA) Federal aid is routinely authorized after even very modest-sized disasters in the US New York Oklahoma Alabama Kentucky Mississippi Pennsylvania

63 Government Aid After Major Disasters (Billions)* $ Billions $120 $100 $80 $60 $40 $110.0 Within 3 weeks of Katrina s LA landfall, the federal government had authorized $75B in aid more than all the federal aid for the 9/11 terrorist attacks, 2004 s 4 hurricanes and Hurricane Andrew combined! $29B more was authorized in Dec At least $80B more is sought. $43.9 Hurricane Katrina aid will dwarf aid following all other disasters. Congress may authorize $150-$200 billion ultimately (about $400,000 for each of the 500,000 displaced families). Is the incentive to buy insurance and insure to value diminished? $20 $17.7 $15.5 $15.0 $0 Hurricane Katrina (2005) Sept. 11 Terrorist Attack (2001) Hurricane Andrew (1992) Northridge Earthquake (1994) Hurricanes Charley, Frances, Ivan & Jeanne (2004) *In 2005 dollars. Source: United States Senate Budget Committee, Insurance Information Institute as of 12/31/05.

64 Spending on Hurricane Katrina Reconstruction (Through Dec. 2006) $45 $40 $35 $30 $25 $20 $15 $10 $5 $0 $1.7 $17.0 Spent Allocation $25.4 $42.0 $1.3 $5.8 HUD FEMA US Army Corps of Engineers Source: Wall Street Journal, January 27, 2007, p. A1. Only a fraction of promised government relief has reached the hands of those affected

65 STATE RESIDUAL MARKETS How Big is Too Big?

66 US FAIR Plans Exposure to Loss* (Billions of Dollars) $450 $400 $350 $300 $250 $200 $150 $100 $50 $0 Total exposure to loss in the residual market (FAIR & Beach/Windstorm) Plans has surged from $54.7bn in 1990 to $419.5 billion in In the 15-year period between 1990 and 2005, total exposure to loss in the FAIR plans has surged by a massive 965 percent, from $40.2bn in 1990 to $387.8bn in 2005! $170.1 $140.7 $113.3 $96.5 $40.2 $269.6 $345.9 $400.4 $ Source: PIPSO; Insurance Information Institute *Hurricane exposed states only.

67 US Beach and Windstorm Plans Exposure to Loss (Bill. of Dollars) In 2002 Florida combined its Windstorm and Joint Underwriting Association to create Florida Citizens, so Florida data shifted to the FAIR plans from this date. $120 $100 $80 $111.8 $108.0 $103.5 In the 15-year period between 1990 and 2005, total exposure to loss in the Beach and Windstorm plans has more than doubled, from $14.5bn in 1990 to $31.7bn in $60 $53.5 $40 $20 $14.5 $22.4 $26.4 $30.0 $31.7 $ Source: PIPSO; Insurance Information Institute. *Hurricane exposed states only.

68 Florida Citizens Exposure to Loss (Billions of Dollars) $450 $400 $350 $300 $250 $200 $150 $100 $50 $0 Exposure to loss in Florida Citizens nearly doubled in 2006 $154.6 $195.5 Source: PIPSO; Insurance Information Institute $206.7 $

69 MS Windstorm Plan: Exposure to Loss (Millions of Dollars) $2,000 $1,800 $1,600 $1,400 $1,200 $1,000 $800 $600 $400 $200 $0 Total exposure to loss in the Mississippi Windstorm Underwriting Association (MWUA) has surged by 431 percent, from $352.9m in 1990 to $1.9bn in $352.9 $637.1 $917.9 $864.9 $848.6 $1,121.7 $1,344.3 $1,631.8 $1, Source: PIPSO; Insurance Information Institute

70 Texas: TWIA Growth In Exposure to Loss (Building & Contents Only, $ Bill) Exposure to Loss (Building & Contents Only) $40 $35 $30 $25 $20 $15 TWIA s liability in-force for building & contents has surged by nearly 200 percent in the last six years from $12.1bn in 2000 to $35.9bn in 2006 $12.1 $13.2 $16.0 $18.8 $20.8 $23.3 $35.9 $10 $5 $ * Source: TWIA (as of 11/30/06); Insurance Information Institute

71 Overview of Plans for a National Catastrophe Insurance Plan

72 NAIC s Comprehensive National Catastrophe Plan Proposes Layered Approach to Risk Layer 1: Maximize resources of private insurance & reinsurance industry Includes All Perils Residential Policy Encourage Mitigation Create Meaningful, Forward-Looking Reserves Layer 2: Establishes system of state catastrophe funds (like FHCF) Layer 3: Federal Catastrophe Reinsurance Mechanism Source: Insurance Information Institute

73 Guiding Principles of NAIC s National Catastrophe Plan National program should promote personal responsibility among policyholders National program should support reasonable building codes, development plans & mitigation tools National program should maximize riskbearing capacity of private markets, and National plan should provide quantifiable risk management to the federal government Source: Insurance Information Institute from NAIC, Natural Catastrophe Risk: Creating a Comprehensive National Plan, Dec. 1, 2005.

74 Comprehensive National Catastrophe Plan Schematic 1:500 Event National Catastrophe Contract Program 1:50 Event State Regional Catastrophe Fund State Attachment Personal Disaster Account Private Insurance Source: NAIC, Natural Catastrophe Risk: Creating a Comprehensive National Plan, Dec. 1, 2005; Insurance Information. Inst.

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77 Legislation: Comprehensive National Catastrophe Plan H.R. 846: Homeowners Insurance Availability Act of 2005 Introduced by Representative Ginny Brown-Waite (R-FL) Requires Treasury to implement a reinsurance program offering contracts sold at regional auctions H.R. 4366: Homeowners Insurance Protection Act of 2005 Also worked on by Rep. Brown-Waite Establishes national commission on catastrophe preparation and protection Authorizes sale of federally-backed reinsurance contracts to state catastrophe funds H.R. 2668: Policyholder Disaster Protection Act of 2005 Backed by Rep. Mark Foley (R-FL) Amends IRS code to permit insurers to establish tax-deductible reserve funds for catastrophic events 20-year phase-in for maximum reserve Use limited to declared disasters Source: NAIC, Insurance Information Institute

78 Layer 1: The Insurance Contract, Enhancing Capacity & Shaping the Risk All Perils Policy No exclusion except acts of war Contains standard deductibles of $500 - $1000 but requires separate CAT deductible of 2% 10% of insured value; Consumer could buy down the deductible to non-cat fixed dollar amount Encouraging Mitigation Policy will provide meaningful discounts for effective mitigation measures Creating Meaningful, Forward-Looking Reserves Change tax law to allow insurers to set aside a share of premiums paid by policyholders as a reserve for future events Amount set aside would be actuarially based Phased-in to maximum reserve over 20 years Use limited to declared disasters Source: NAIC, Natural Catastrophe Risk: Creating a Comprehensive National Plan, Dec. 1, 2005; Insurance Information. Inst.

79 Layer 2: State Level Public/Private Partnership (State CAT Fund) Requirement to Create Fund To participate in national fund, states must establish state CAT fund or participate in regional CAT fund Funds responsible for managing capacity of their funds up to costs expected for combined 1-in-50 year CAT loss level Operation of State/Regional CAT Funds Operating structures left to states discretion, including Financing mechanism (e.g., debt, pool etc.) Trigger point for qualifying loss (if any) Amount of retention between private insurers & state fund Participation by surplus lines & residual markets Requirement that rates are actuarially sound Requirement that fund will finance a level of mitigation education and implementation Source: NAIC, Natural Catastrophe Risk: Creating a Comprehensive National Plan, Dec. 1, 2005; Insurance Information. Inst.

80 Layer 2: State Level Public/Private Partnership (State CAT Fund) [Cont d] Building Codes Participating states expected to establish effective (enforced) building codes that properly reflect their CAT exposures as well as the latest in accepted science and engineering States also required to develop high land use plans where appropriate Anti-Fraud Measures State funds and DOIs maintain rigorous anti-fraud programs to ensure losses paid actaully due to insured CAT loss Mitigation DOIs required to establish & implement effective mitigation plans Review of mitigation plans will be considered as part of an NAIC certification process Source: NAIC, Natural Catastrophe Risk: Creating a Comprehensive National Plan, Dec. 1, 2005; Insurance Information. Inst.

81 Layer 3: The Role of a National Mechanism The National Catastrophe Plan Mechanism Federal legislation is needed to create a National Catastrophe Insurance Commission (NCIC) NCIC purpose is to serve as conduit between state funds and US Treasury for purpose of providing reinsurance to state funds for insured losses resulting from catastrophic events beyind the statemandated 1-in-50 year exposure States & NCIC will enter into National Catastrophe Financing Contracts Reinsurance will attach at 1-in-50 year level and provide protection through the 1-in-500 year level event Source: NAIC, Natural Catastrophe Risk: Creating a Comprehensive National Plan, Dec. 1, 2005; Insurance Information. Inst.

82 Layer 3: [Cont d] The Role of a National Mechanism The National Catastrophe Insurance Commission Structure & Duties NCIC would annually establish actuarially sound rates, with no profit factor, for each state s aggregate catastrophic exposure State fund responsible for collecting premium and remitting to NCIC. NCIC remits premiums to US Treasury general revenues No separate fund is created, nor are any funds accumulated In the event of a loss, US Treasury provides funds pursuant to catastrophe financing contract NCIC will consist of 11 members serving 6-year terms 1 member from each of 4 NAIC zones, 1 US Treasury rep., remainder are to be experts in actuarial science, engineering, meteorological/seismic science, consumer affairs & p/c insurance Members are selected by the President & confirmed by the Senate with chair appointed by the President Source: NAIC, Natural Catastrophe Risk: Creating a Comprehensive National Plan, Dec. 1, 2005; Insurance Information. Inst.

83 Interaction of State Funds, National Commission & US Treasury US Treasury Reimbusements Under the Catastrophe Contract $$$ to General Revenue $ National Commission $ State Fund A $ State Fund B State Fund C StateFunds Pay Premium to the Commission Source: NAIC, Natural Catastrophe Risk: Creating a Comprehensive National Plan, Dec. 1, 2005; Insurance Information. Inst.

84 Pros/Cons of Federal CAT (Re) Insurance Facility Rationale FOR Federal Involvement Insurance was not meant to handle mega-catastrophes Such risks are fundamentally uninsurable Federal government already heavily involved in insuring against weather-related mega-catastrophes (e.g., flood, crop) Insurers are not allowed to charge risk appropriate rates (including rising reinsurance costs) Price/availability of private reinsurance is volatile Rationale AGAINST Federal Involvement Crowds-out pvt. insurance/reinsurance markets; stifles innovation Relationship between price and risk assumed is diminished since fed insurance programs are seldom actuarially sound Increases federal involvement and regulatory authority in p/c insurance (not a negative for some market participants) Cost to US Treasury (esp. taxpayers in less disaster prone states) Diminishes incentives for mitigation, tougher building codes and wiser land use policies if Fed rate are politically influenced

85 Proponents/Opponents of National Catastrophe Plan Proponents of a National Catastrophe Plan Some major personal lines insurers: Allstate, State Farm Insurance regulators from some CAT-prone states: FL, CA, NY as well as NY (but not TX) Some elected officials in state legislatures & Congress, esp. from disaster-prone states like FL Coalition building on-going (ProtectingAmerica.org) Opponents of a National Catastrophe Plan Reinsurers, American Insurance Association, numerous large insurers both domestic and foreign Many smaller insurers concerned about federal intrusion into the p/c regulatory arena Many insurers operating outside areas prone to major CAT risk Some regulators in states not prone to major catastrophic risk Likely opposition among legislators and policymakers in Washington opposed to deeper involvement of government in p/c insurance sector

86 Regional Natural Disaster Pool(s) KEY ELEMENTS Share of property premiums in certain states (homeowners, commercial property) premiums collected would be ceded to pool and used to finance mega-catastrophes in participating states Funds would earn investment income tax-free to speed accumulation Federal government would provide a backstop to the pool as: Reinsurance purchased by pool from the government Line of credit offset by assessing authority KEY CHALLENGES Is participation by insureds mandatory or optional? If optional, significant adverse selection problem Determination of actuarially sound rates Maintaining role for private reinsurance Keeping rates free of political influence and manipulation Formula for assessing shortfalls in pool (including taxpayer share) Attracting support of states not prone to mega-catastrophes Appeasing deficit hawks, advocates of small government

87 Federal Reinsurance Program KEY ELEMENTS Insurers purchase CAT reinsurance from federal government KEY CHALLENGES Determination of actuarially sound rates Maintaining significant role for private reinsurers Maintaining significant role for ART and risk securitization Keeping rates free of political influence and manipulation Appeasing advocates of small government Keeping natural disaster risk programs separate and distinct from terrorism risk

88 Tax-Preferred Treatment of Pre-Event Catastrophe Reserving KEY ELEMENTS Insurers would be allowed to deduct from their taxable income amounts set aside in reserve for natural disaster risks in advance of the occurrence of the actual event Presently, US tax law does not allow for such treatment Most other countries already permit pre-event reserving KEY CHALLENGES Determination of appropriate reserve levels Overcoming criticism of impact on US Treasury receipts Note that impact on Treasury is limited to time value of tax receipts

89 FLORIDA SPECIAL SESSION LEGISLATIVE CHANGES Insurer, Policyholder & State Impacts

90 Summary: Florida Legislature Special Session (January 2007) 1. Exponential Expansion of the Role of the State in Insuring Homes & In Reinsurance Markets Doubles exposure of Florida Hurricane Catastrophe Fund to $32 billion from $16 billion (FHCF only has $1B cash), greatly displacing private reinsurers Allows Florida Citizens to compete with private insurers by lowering rates and lowering eligibility standards Allows Florida Citizens to displace private insurers by expanding into non-wind coastal business Disbands disciplined, small and adequately priced Commercial JUA and transfers business to poorly run, underpriced, Citizens Commercial Account Sources: Zurich Insurance Technical Center; Insurance Information Institute.

91 Summary: Florida Legislature Special Session (January 2007) 2. Dramatically Increases Exposure of Florida Policyholders to Post-Catastrophe Taxes Expands the Citizens assessment base more than 4 fold Increases maximum annual assessment facing Florida policyholders from $9.2 billion to $25 billion Increases maximum general liability and commercial auto assessment exposure from 14% to 74% (These are 2 types of insurance that having nothing to do with hurricane risk) Accelerates growth of Citizens, already the largest home insurers in the state and which doubled in size in 2006, by lowering rates and making access easier Sources: Zurich Insurance Technical Center; Insurance Information Institute.

92 Summary: Florida Legislature Special Session (January 2007) 3. Disincentives for Insurers to Offer Policies in Florida Introduces excess profits law (a virtual oxymoron in FL) Requires Executive Officer review on routine rate filings Threatens perjury charges and administrative penalties Increases cost of processing and maintaining policies Requires premium discounts even if not actuarially justified 4. Threatens State of Florida s Credit Rating Major event could result in simultaneous issuance of $40+ billion in debt from Cat Fund, Citizens and Guarantee Fund Governor s promise to cut property taxes could compound state s fiscal problems after an event Sources: Zurich Insurance Technical Center; Insurance Information Institute.

93 Florida Hurricane Assessment Base, 2006 vs. 2007* ($ Bill) $40 $35 $30 $25 $20 $15 $10 $5 $0 $35.0 $35.0 $35.0 $8.3 $8.3 FL Citizens Personal Lines Acct FL Citizens Commercial Lines Acct. $8.3 FL High Risk Acct. $35.0 $35.0 FL Hurricane Cat Fund $1.3 The FL legislature quadrupled the assessment base for Citizens FL PCJUA $11.2 $11.2 FL Guarantee Assoc. Sources: Zurich Insurance Technical Center; Ins. Info. Inst. *Per special legislative session, Jan

94 Florida Hurricane Max. Policyholder Annual Burden, 2006 vs. 2007* ($ Bill) $8 $7 $6 $5 $4 $3 $2 $1 $0 $1.660 $7.0 FL Citizens Personal Lines Acct. $ $7.0 FL Citizens Commercial Lines Acct. $1.660 $7.0 FL High Risk Acct. $3.500 $3.5 FL Hurricane Cat Fund The FL legislature nearly tripled state insurers assessment base from $9.2B to $25B, an increase of $15.8B or 174% $0.260 FL PCJUA $0.448 $0.448 FL Guarantee Assoc. Sources: Zurich Insurance Technical Center; Ins. Info. Inst. *Per special legislative session, Jan

95 Why There is Concern Over the Florida Legislature s & Governor s Changes Risk is Now Almost Entirely Borne Within State Virtually Nothing Done to Reduce Actual Vulnerability Creates Likelihood of Very Large Future Assessments Potentially Crushing Debt Load State May be Forced to Raise/Levy Taxes to Avoid Credit Downgrades Many Policyholder Will See Minimal Price Drop Savings came from canceling recent/planned rate hikes Residents in Lower-Risk Areas, Drivers, Business Liability Policyholders Will Come to Resent Subsidies to Coastal Dwellers Governor s Emergency Order for Rate Freezes & Rollbacks Viewed as Unfair & Capricious Sources: Insurance Information Institute.

96 WHAT REALLY HAPPENED? Florida Re

97 What Really Happened in Florida? Problems Began in 1992 with Hurricane Andrew Continuous escalation in home and commercial property insurance prices; $21.6B insured losses ($2005); 700K+ claims Issue Ignited in 2004: Charlie, Frances, Ivan & Jeanne $23B in insured catastrophe losses; 2.3 million claims Large rate increases requested; Wind deductibles triggered 100,000+ homeowners non-renewals issued Channeling of policies into expensive market of last resort Issue Exploded in 2005: Dennis, Katrina, Wilma $12B in insured losses; 1.2 million claims More large rate requests 125,000+ non-renewals Several insurers announce moratoria on new policies Sharply higher commercial property prices Failure of Poe Financial Group

98 What Really Happened in Florida? (Cont d) Florida Elections of 2006: Populist Issues Dominant #1 Campaign Issue: Lowering insurance costs Populist tide was unstoppable Promises made by all political candidates, new governor on down Republicans completely abandoned free market principles Insurers Offered No Cohesive Plan of Their Own Reflects disunity about how to approach natural cat exposure in the US; Some support state s expansion, others do not Industry misjudged populist groundswell Opportunist politicians filled the void Record Profits of 2006 Spawned Resentment & Made Insurers Easy Political/Media Targets Calm Storm Season of 2006 Allowed Politicians and Media to Assert that Insurers Were Gouging Public Inability/No Willingness of Public to Understand Potential Post- CAT Assessments; Debt Load Impacts

99 FUTURE CASE STUDY? United States Re???

100 Could the Florida Model be Adopted in Other State or Federal Level? (Re) Insurers Fear Export of Florida Model Louisiana is a concern Several States Considering State/Regional CAT Funds Louisiana, South Carolina, Massachusetts & others Would be a major negative for private reinsurers Federal Level Several bills introduced to facilitate Natl. CAT Plan concept Would be a negative development for private reinsurers New Federal Bill: Multiple Peril Insurance Act of 2007 HR 920: Would further expand federal role by requiring government to provide flood and wind coverage Theoretically coverage offered on actuarial basis but given history of National Flood Insurance Program is unlikely

101 CONCLUSIONS Are State-Backed Insurance Schemes the Wave of the Future?

102 Conclusions: Role of the State in Insurance Markets Government s Role as Provider of Re/Insurance Grows Federal and State Level Democratic Congress less opposed to state involvement Significant Displacement of Private Insurance Markets Reinsurer displacement supported by some insurers As much as 15-20% percent of US property-cat reinsurance market displaced by FL; If other states follow, up to 30-35% Government Programs Tend to Become Entrenched Displacement could become permanent Political determination of rates could cause further displace of private capacity in the future Opportunity: State s May Look to Offload Risk to Avoid Fiscal Crisis and Debt Downgrades States will quietly look for ways to offload risk Private reinsurance, ILS offer solutions

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