Market Cycle Update Personal Lines Greg Ciezadlo, FCAS, MAAA Farmers Insurance Group Casualty Actuarial Society Spring Meeting 2002 – San Diego, California

Today’s Topics Historical Overview –Past cycles –The current downturn –Why cycles? Insurer reaction to the current cycle –Pricing –Product –Market availability –Segmentation Future outlook for personal lines insurers

…worst year ever in 2001 as the industry recorded an after-tax loss for the first time in history.

P/C Net Income After Taxes ($ Millions) Sources: A.M. Best, ISO, Insurance Information Institute was the first year ever with a full year net loss

Key Drivers Confluence of events – Insurance cycles – Capital markets – Investment yields – TORTure – Mold – WTC/Catastrophes

*Estimate from I.I.I. Groundhog Survey. Source: A.M. Best, Insurance Information Institute Growth in Net Premiums Written (All P/C Lines) 2000: 5.1% 2001: 8.1% 2002 Forecast: 14.7%* The underwriting cycle went AWOL in the 1990s. It’s Back!

Auto Repair Costs

Construction Material Costs

HO insurance costs & cost of home repairs *2001 Estimate

Investment environment -19% -31% March 2000 – December 2001

Net Investment Income Facts 1997 Peak = $41.5B 1998 = $39.9B 1999 = $38.9B 2000= $40.7B 2001 = $37.1E Source: A.M. Best, Insurance Information Institute Billions (US$) Pricing & underwriting problems were exacerbated by declining investment income Short-term interest rates are under 2%!

TORT-ure Asbestos “Toxic” Mold Aftermarket Parts Lead Arsenic Treated Lumber Construction Defects Guns What’s Next? September 11!!!

Average Jury Awards 1994 vs Source: Jury Verdict Research; Insurance Information Institute.

Stachybotrys

Source: Texas Department of Insurance * 2001 (estimate based on Jan. - Mar. data) Texas: Paid Losses for Water Damage Claims In Millions

9/11/2001

U.S. insured catastrophe losses $ Billions

P/C Industry Combined Ratio 2000 = Estimate = Forecast* = Combined Ratios 1970s: s: s: Sources: A.M. Best; III * Based on III 2002 Groundhog Forecast

Personal Lines Combined Ratios *Breakeven Ratio: Reflects AY results, includes investment income; assumes 4% interest rate. Source: A.M. Best E BE* PERSONAL AUTOHOMEOWNERS

Policyholder Surplus: Source: A.M. Best, Insurance Information Institute Billions (US$) Surplus Peaked at $336.3 Billion in 1999 Surplus decreased 8.7% in 2001 to $289.6 Billion. Surplus is now lower than at year-end 1997.

Why do we still have cycles? Lag between emerging trends and insurers’ ability to react in the market Continued reliance on investment income to offset underwriting losses Reluctance to lead the pack Incentives in place based on the past, not on the future New and unusual events or coverage –Tort liability crises in the 70’s and 80’s –High inflation in the 70’s –Mold Catastrophes

The Industry’s Reaction Price increases New business limitations Coverage modifications and/or exclusions More sophisticated segmentation systems –Insurance scoring using credit information –Complex tiering plans using scoring plus other variables –Introduction of rating plans in HO focused on the individual not the property

Average Price Change of Personal Lines Renewals *III estimates Source: Conning, III

The Texas Result: A Lesson to be Learned 4 out of the 5 top insurers stopped writing homeowners HOB insurance policies due to the mold impact on business

Market Restrictions Tighter new business underwriting rules New business quotas Highly segmented rate changes Weaker nonstandard auto market Stop writing new business Withdrawal from the line Mold exclusions and water damage limitations Use of insurance scoring models for acceptance or retention PERSONAL AUTOHOMEOWNERS

Mold-Induced Rate Increases Will Impact Affordability in TX* *As a % of the median family of 4’s income. Source: NAIC, Insurance Information Institute

In summary:

Reasons Why Market Will Remain Hard Price increases by market leaders The Homeowners line has a long, tough road ahead to return to profitability –Large price increases –Catastrophes remain problematic –Will product suffer from affordability or availability issues? Auto is in better shape, but … –Cost pressures from Diminished Value, OEM, etc. –Influence of legislation and court decisions on liability cases Uncertain investment future Wall Street pressure for short-term profits

Where we are heading… …conditions are set for improved results in 2002 as: pricing environment continues to harden appreciably policy coverage terms and conditions become more restrictive.

Outlook for 2002: Personal Lines *Breakeven Ratio: Reflects AY results, includes investment income; assumes 4% interest rate. Source: A.M. Best E 02E BE* PERSONAL AUTOHOMEOWNERS

Market Cycle Update Personal Lines Greg Ciezadlo, FCAS, MAAA Farmers Insurance Group Casualty Actuarial Society Spring Meeting 2002 – San Diego, California