INFORM+INSPIRE The Griffith Insurance Education Foundation The Business of Insurance Robert E. Hoyt, Ph.D. May 6, 2013

Overview  Property and Casualty Insurance  Insurance Operations  Investments  Performance and Capacity  Reinsurance Principles  Insurance Guaranty Funds  Risk and Industry Trends to Watch The Griffith Insurance Education Foundation

Premium Breakdown in the P/C Industry (2011) Source: NAIC Data Auto $190.5B/39% Homeowners $73.7B/15% Other P/C Lines $228.2B/46%

Property Exposures  Types of property exposed to loss  Real property (buildings)  Personal property (contents)  Causes of loss affecting property (perils)  Property loss consequences  Direct loss  Indirect loss

Major Property Insurance Policies  homeowners (HO)  building and personal property (BPP)  business income (BIC)  boiler & machinery  inland marine (floaters)  ocean marine  crime (employee dishonesty)  difference in conditions (DIC)

A World of Extremes (Attention on Risk)  Earthquake in Haiti (record death toll)  Recent recession (deepest since the Great Depression)  BP Platform explosion  Japanese Tsunami  1,000 all-time weather records set (most heat or rain)  10 U.S. weather cats costing over $1 billion each  99 federal disaster declarations (avg. 34 prev. 50 yrs)  Boston bombings

U.S. Insured Catastrophe Losses Source: Property Claims Service/ISO; Insurance Information Institute $ Billions Sandy $18.8B The Griffith Insurance Education Foundation

12/01/ pm Top Most Costly Disasters in U.S. (Insured Losses, 2011 Dollars, $ Billions) Sources: PCS; Insurance Information Institute inflation adjustments. Taken as a single event, the Spring 2011 tornado and storm season is the 4 th costliest event in US insurance history The Griffith Insurance Education Foundation

Hurricane/Superstorm Sandy  Estimated $19 billion insured losses  Economic loss of nearly $80 billion  Over $7 billion in NFIP flood claims  Major infrastructure claims  Source of continued uncertainty in estimates The Griffith Insurance Education Foundation

Sandy Lessons and Issues  Flood risk remains a big issue  NFIP  Business interruption is one of the biggest issues facing businesses – and it is poorly assessed and addressed  Will insurers’ cat risk mitigation strategies work?  watch decisions on “hurricane” deductibles  availability and pricing in cat-prone areas  Data Centers, utilities, supply chains … The Griffith Insurance Education Foundation

Securitization of Property Risk (Catastrophe Bonds) Source: MMC Securities Guy Carpenter, A.M. Best; Insurance Information Institute. Cincinnati Insurance in Jan issued $61.2 million cat bonds for New Madrid earthquake and severe thunderstorms protection. The Griffith Insurance Education Foundation

Characteristics of Liability Risks  Involvement of a third party  Difficulty in defining the risk  measurement of the loss amount  establishing fault  identifying the scope of exposure  "Long-tail" problem The Griffith Insurance Education Foundation

Major Liability Insurance Policies  homeowners  personal auto policy (PAP)  commercial general liability (CGL)  business auto coverage (BAC)  umbrella liability policies (commercial and personal)  directors and officers liab. (D & O)  environmental impair. liab. (EIL)  workers comp. / employers liability  employment practices liability (EPL)  professional liability (malpractice)

Average Expenditures on Auto Insurance * Insurance Information Institute Estimates/Forecasts Source: NAIC, Insurance Information Institute estimates based on CPI and other data. Countrywide auto insurance expenditures are expected to increase about 3% in 2012 The Griffith Insurance Education Foundation

Average Auto Insurance Expenditure: Top/Bottom 5 vs. US (2010) Source: NAIC; Insurance Information Institute. Detroit ($5,941), Philadelphia ($4,071)

Cost of Insurance Fraud  Second largest economic crime  Healthcare fraud $81 to $270 billion per year (Medicare, Medicaid and private insurance)  Property-casualty fraud $32 billion  auto insurance fraud $6.8 billion  workers’ compensation fraud $5 billion $$$$$$$$$$$$

INFORM+INSPIRE The Griffith Insurance Education Foundation Insurance Operations

Structure of Insurance Market  Types of insurers  property-liability insurers  life insurers  health insurers  Organizational form  Competitive market The Griffith Insurance Education Foundation

Industry Size (L-H v. P-C) Source: III Insurance Fact Book ,343 Life Insurers in 1988 The Griffith Insurance Education Foundation

Statutory Accounting Principles (SAP) (Insurance Accounting)  GAAP v. SAP  going concern v. liquidation  expenses recognized immediately while revenues must be accrued  admitted v. non-admitted assets  conservative securities valuation

Insurance Market Direction  Assets – Liabilities = Net worth  Policyholder Surplus = Capital = Capacity = Supply  Factors to consider  Underwriting (losses)  Reserves  Reinsurance  Cats  Investments  Regulation (e.g., Basel III) Surplus If domicile of parent considered, 83.4% of reinsurance bought by U.S. insurers was from foreign reinsurers Reserves

Sources: NAIC & III. Invested assets totaled $1.32 trillion Generally, insurers invest conservatively, with over 2/3 of invested assets in bonds Only 17% of invested assets were in common or preferred stock Bonds Common & Preferred Stock As of December 31, 2010 Cash & Short-term Investments Other Distribution of P/C Insurance Industry’s Investment Portfolio

Source: A.M. Best, ISO; Insurance Information Institute $ Billions Underwriting Gain (Loss) The Griffith Insurance Education Foundation

P/C Insurer Investment Gains Investment gains consist primarily of interest, stock dividends and realized capital gains and losses. Sources: ISO; Insurance Information Institute. The Griffith Insurance Education Foundation

Policyholder Surplus Policyholder Surplus (Net Worth) = Assets – Liabilities Source: ISO (historical); Insurance Information Institute. $584 $587 The Griffith Insurance Education Foundation

Average Commercial Insurance Rate Changes Average commercial insurance rate changes in that quarter. Source: Council of Insurance Agents and Brokers. The Griffith Insurance Education Foundation

INFORM+INSPIRE The Griffith Insurance Education Foundation Reinsurance Principles

Reinsurance  Definition  Shifting of part or all of the insurance originally written by one insurer to another insurer  Customer  other insurers ( primary insurer ) The Griffith Insurance Education Foundation

Reinsurers  Professional reinsurers  direct  broker market  Reinsurance departments

Terms  Ceding Company ( primary insurer )  Reinsurer  Net Retention  Cession  Retrocession  retrocessionnaire and retrocedent The Griffith Insurance Education Foundation

Types of Reinsurance  Contracts  Facultative  Treaty  Coverage  Proportional (quota and surplus share)  Excess

Functions of Reinsurance Benefits for Insureds & Insurers Benefits for Insureds Benefits for Insurers All coverage can be obtained from one insurer, reducing the chance of coverage gaps & problems in loss collection. Reduces the chance of primary insurer insolvency. Allows small insurers to compete with large insurers, which should increase availability & reduce price. Stabilizes loss experience. Increases large line capacity. Provides surplus relief. Protects against catastrophic losses. Provides underwriting assistance. Allows withdrawal from a territory or class of business. The Griffith Insurance Education Foundation

Reinsurance Regulation  Less stringent (little rate regulation)  Domestic, foreign, alien  Credit for reinsurance (indirect regulation)  effects primary insurer’s liabilities and its surplus  creates incentives to deal with sound reinsurers  FIO has a monitoring role as well The Griffith Insurance Education Foundation Top three domiciles are: Germany Switzerland U.S.

INFORM+INSPIRE The Griffith Insurance Education Foundation Guaranty Funds

 Funds in all states (P-C and Life)  Coverage limits vary across states  Funded on a post-assessment basis (except NY)  Modest levels of insolvencies have made this workable The Griffith Insurance Education Foundation

P/C Insurer Impairments The number of impairments varies significantly over the p/c insurance cycle, with peaks occurring well into hard markets Source: A.M. Best; Insurance Information Institute The Griffith Insurance Education Foundation

Reasons for P/C Insurer Impairments ( ) Deficient Loss Reserves and Inadequate Pricing Are the Leading Cause of Insurer Impairments. Investment and Catastrophe Losses Play a Much Smaller Role Deficient Loss Reserves/ Inadequate Pricing Reinsurance Failure Rapid Growth Alleged Fraud Catastrophe Losses Affiliate Impairment Investment Problems Misc. Sig. Change in Business Reason in 54.5% of insolvencies in 2010 Source: A.M. Best The Griffith Insurance Education Foundation

Number of Impaired L/H Insurers Source: A.M. Best Special Report “ Impairment Review”; Insurance Information Institute. The Number of Impairments Spiked in But in the Financial Crisis, When Large Numbers of Banks Failed, Virtually No Life Insurers Failed. Average number of impairments, : 18.2 The Griffith Insurance Education Foundation

Source: A.M. Best, Impairment Review, Special Report Leading Causes of Impairment ---Business Management (Rapid Growth, Investment Problems, Affiliate Problems) ---Deficient Loss Reserves/ Inadequate Pricing Reasons for L-H Insurer Impairments ( )

INFORM+INSPIRE The Griffith Insurance Education Foundation Trends to Watch

Interest and Concern in Risk Management  Google Search  Risk Management –  2006 & 2007: 3.2 million  2008 & 2009: 27.2 million  2011 & 2012: 81.4 million  “Audit committee members rank risk management as top worry”  KPMG Survey of Corporate Directors The Griffith Insurance Education Foundation

Risk Trends  Reputation risks  80% chance of a company losing at least 20% of its value in any single month over a five-year period due to a reputation crisis (Aon, 2012)  Cyber-Liability  Need to think about these risks outside of the IT department  Data loss, privacy, virus issues  Need broad-based, disaster recovery plan (need to test it!)  Liability / Tort issues  Climate, energy, professional The Griffith Insurance Education Foundation

Top Insurance Industry Trends  Risk and Capital Management  Low interest rate environment  Strategic risk management (ERM)  Financial Reporting  Regulatory Compliance  Dodd-Frank (Thrift owners and SIFIs)  ORSA and Solvency II  Catastrophe Risk  Terrorism Risk (especially without TRIA) The Griffith Insurance Education Foundation

Other Insurance Industry Trend s  Businesses opting for higher retentions  Especially in workers’ compensation  Big data  Predictive modeling (underwriting and claims)  Distribution issues (web and social media)  Talent  The graying of the workforce  Recruiting and retaining it The Griffith Insurance Education Foundation

Contact Information for the Risk Management and Insurance Program at the University of Georgia  Department Head, Rob Hoyt  Brooks Hall 206   Our web site  The Griffith Insurance Education Foundation