Alabama Affordable Homeowners Insurance Commission

Presentation ofJ. Robert Hunter, FCAS, MAAA

Director of Insurance

April 11, 2012

2

Bob Hunter’s CV• Federal insurance Administrator under Presidents Ford and Carter (ran the

National Flood Insurance Program among other duties)• Also served FIA as Chief Actuary• Texas Insurance Commissioner• Executive committee Member NAIC, Vice Chair Western Zone• Advisor to the state of Florida after Hurricane Andrew and after 2004/5

hurricanes• Advisor to the California Earthquake Authority• Fellow of the Casualty Actuarial Society (by examination) and Member of the

American Academy of Actuaries• Actuarial Supervisor: Insurance Services Office• Schraeder-Nelson Publications Award; article of the year for Enron’s Impact

on State Insurance Regulation, Regulator Magazine, Insurance Regulatory Examiner’s Society 2002; Same award in 2007 for How Regulators can Return P/C Insurance Industry Profits to Reasonable Levels.

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A BRIEF LOOK AT CFA’s STUDY

“THE INSURANCE INDUSTRY’S INCREDIBLE DISAPPEARING WEATHER CATASTROPHE RISK”

(How Insurers have Shifted Risk and Costs to Consumers and Taxpayers)

4

19671969

19711973

19751977

19791981

19831985

19871989

19911993

19951997

19992001

20032005

20072009

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

P/C INSURANCE ECONOMIC CYCLE

Op.

Inco

me

as %

of P

rem

ium

5

19811982

19831984

19851986

19871988

19891990

19911992

19931994

19951996

19971998

19992000

20012002

20032004

20052006

20072008

20092010

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

PURE NET LOSS RATIOS

P/C L/RHO L/R

6

YEAR

19681970

19721974

19761978

19801982

19841986

19881990

19921994

19961998

20002002

20042006

20082010

$0

$100

$200

$300

$400

$500

$600

$700

SSURPLUS

7

LEVERAGE RATIO

YEAR

19681970

19721974

19761978

19801982

19841986

19881990

19921994

19961998

20002002

20042006

20082010

0.00

0.50

1.00

1.50

2.00

2.50

3.00

NPW/SURP

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“Review and Outlook for the P/C Industry.” August 10, 2011, Presentation given by III President Robert Hartwig to the Vermont Captive Insurance Association (Slide 73)

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HOW DID P/C INSURERS ELIMINATE HURRICANE RISK?

1. Reinsurance and risk diversification.2. Hollowing out of coverage in the homeowners insurance policy.

*Hurricane Deductibles of 2%, 5% and even more*Caps on replacement cost (even if demand surge takes place)*Eliminate coverage for certain items (such as if a home becomesa non-conforming use; mold)*Anti-concurrent causation clause

3. Move to models for pricing with astonishing rate increases at coasts4. Shifted high risk properties to pools

These steps shift risk either back to people or to taxpayers. For example a 5%deductible instead of a $1,000 deductible on a $200,000 home would mean $9,000 more front-end cost to a homeowner, which could be part of a disasterRelief claim.

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TOP CATASTROPHES IN USA PRE-TAX POST TAXEVENT 2010 DOLLAR LOSS

1. Hurricane Katrina, August 2005 $45.5 billion $29.62. World Trade Center, Pentagon terrorist attacks, September 2001 22.9 14.93. Hurricane Andrew, August 1992 22.4 14.64. Northridge, California earthquake, January 1994 17.3 11.25. Hurricane Ike, September 2008 12.7 8.36. Hurricane Wilma, October 2005 11.4 7.47. Hurricane Charley, August 2004 8.5 5.58. Hurricane Ivan, September 2004 8.1 5.39. Hurricane Hugo, September 1989 6.7 4.410. Hurricane Rita, September 2005 6.2 4.0 The catastrophes were ranked by III based on size of loss in 2005 dollars, which we do not display here. What is displayed is the actual dollars in the year of the event. We calculate the post-tax figure by deducting the corporate tax rate of 35 percent.

Source: Insurance Services Office (ISO); Insurance Information Institute (See http://www.iii.org/facts_statistics/catastrophes-us.html). (Ranked on constant dollar cost to insurers)

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INDUSTRY ULTRA SAFE

Even if all of these top ten catastrophic events, including the September 11, 2001 attack, the Northridge Earthquake, and the top eight hurricanes, had occurred in the last year and had been paid for last week (a total of $162 billion in 2010 dollars after tax), the property-casualty industry surplus would still be at $418 billion and the leverage ratio would still be at an ultra safe ratio 1.0.

[The ratio 1.0 is calculated as follows: $430 million in premium divided by ($580 million in surplus less $162 million in assumed after-tax loss) Data on Net Premiums Written and Surplus for all insurers is from A. M. Best Aggregates and Averages, 2011 Edition, Page 369.]

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WHO PAYS WHEN INSURERS DO NOT?

Consider a hypothetical $100,000 home that incurred different levels of wind damage under the Hurricane Andrew compared to Hurricane Katrina. Assume the home had a $500 deductible under Andrew and a 5 percent deductible under Katrina. If the home was in a flood plain and not elevated, damages that totaled 50 percent of the home’s value would trigger a “non-conforming use” under the National Flood Insurance Program and the home would have to be upgraded to withstand a “100-year” flood. If such an improvement costs $10,000, the damage situation with $50,000 in losses would be: Benefit after Deductible Katrina as a % of AndrewDamage Andrew Katrina $10,000 $ 9,500 + $1,000 + $10,000 $ 5,000 24.4%(Consumer pays $500 in Andrew; $6,000 in Katrina) $50,000 $49,500 + $1,000 + $10,000 $45,000 74.4%(Consumer pays $500 in Andrew; $16,000 in Katrina)

How much of this would end up being paid by taxpayers is unclear, but some would.

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SOME OTHER SLIDES TO CONSIDER

1. III Presentation

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FIRST NINE MONTHS OF 2011 FINANCIAL RESULTS($ Billions)

Net Earned Premiums $323.8

Incurred Losses (Including loss adjustment expenses) 264

Expenses 93.6

Policyholder Dividends 1.1

Net Underwriting Gain (Loss) -34.9

Investment Income 36.5

Other Items 1.7

Pre-Tax Operating Gain 3.3

Realized Capital Gains (Losses) 5.5

Pre-Tax Income 8.8

Taxes 0.8

Net After-Tax Income $8.0

Surplus (End of Period) $538.6

Combined Ratio 109.9

Source III @ http://www.iii.org/articles/2011-first-nine-months-results.html

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Average Premiums For Home InsuranceBy State, 2009* (1)

*Latest available.(1) Based on the HO-3 homeowner package policy for owner-occupied dwellings, 1 to 4 family units. Provides “all risks” coverage (except those specifically excluded in the policy) on buildings and broad named-peril coverage on personal property, and is the most common package written.Note: Average premium=Premiums/exposure per house years. A house year is equal to 365 days insured coverage for a single dwelling.

Source: NAIC; Insurance Information Institute. III Slide

Top 25 States

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Average Expenditures For Auto InsuranceBy State, 2009

Note: Average expenditure=Total written premium/liability car years. A car year is equal to 365 days of insured coverage for a single vehicle. Source: © 2010 National Association of Insurance Commissioners.  III Slide

Top 25 States

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Average Expenditures For Auto InsuranceBy State, 2009

Note: Average expenditure=Total written premium/liability car years. A car year is equal to 365 days of insured coverage for a single vehicle. Source: © 2010 National Association of Insurance Commissioners.  III Slide

Bottom 25 States

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ALABAMA PERSONAL LINES PREMIUM BELOW NATIONAL AVERAGE

NAIC data shows total 2009 premiums as follows:

Line USA AL

Auto $785 $652Home $880 $987Total $1,665 $1,639

The home and auto combined premium is lower in Alabama than USA.

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SOME OTHER SLIDES TO CONSIDER

1. III Presentation2. DOI Presentation

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INSURANCE INDUSTRY RESULTS

• Return on Net Worth for 2000-2009:

– Property/Casualty Industry = 6.3%– Avg. of 301 other industries = 9.4%– P/C Industry ranked 200 out of 302* industries– P/C Industry ROE was lower than the 301- industry

average for all 10 years

* # of industries in S&P’s COMPUSTAT database for which 10 years of data was available.

AL DOI Slide 13

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P/C Insurance Below Average Risk and Requires Lower Returns on Equity

Beta – sensitivity of stock price to market = 0.97 when 1.00 is average. P/C Insurance Industry risk below average

Financial Safety Index– = 1 when 1 is lowest risk on scale of 1 to 5. P/C Insurance Industry risk below average

Stock Price Stability – = 83 when 50 is average and 100 is safest. P/C Insurance Industry risk below average

Industry should have lower ROE than Fortune 500 because it is lower risk. Also, it is not a selected group of top performers like the 500 is. Also, the data include large mutuals like State Farm who have lower returns because they do not service stockholders. Also, the base for measurement of ROE, equity, is excessive for P/C insurers.

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No wonder then, when Investment Advisor Seeking Alpha “used Morningstar Direct to create an equal-weighted P&C insurance index (of) the largest and highest-quality P&C insurance names and those with a long trading history” they found the P/C industry “a 12.4% annualized total return from 1973 to 2010, compared with a 9.8% annualized total return for the S&P 500 during the same time frame” Apples to apples, P/C insurers make more than S&P 500 even though they have less risk! EVEN SHOWING NO UNDERWRITING PROFIT!

It’s also no wonder that Warren Buffet reported this in his 2011 letter to shareholders: “I believe it likely that we will continue to underwrite profitably in most – though certainly not all – future years. If we accomplish that, our float will be better than cost-free. We will profit just as we would if some party deposited $70.6 billion with us, paid us a fee for holding its money and then let us invest its funds for our own benefit.”

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INDUSTRY HOMEOWNERS RESULTSHomeowners Return on Net Worth: 2000-2009

Louisiana -32% Mississippi -29% Missouri -12% Kentucky -9% Alabama -8% Arkansas -7% Georgia -7% Nebraska -7% Tennessee -5%

Texas -2% Oklahoma -2% Florida 0% W. Virginia +5% Virginia +10% N. Carolina +15% S. Carolina +21%

Countrywide +5%

AL DOI Slide 14

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INDUSTRY HOMEOWNERS RESULTS• Alabama’s -8% average Homeowners ROE over the last 10 years means that if a company had

started with $1 billion in net worth 10 years ago, today the company would only have $434 million net worth remaining.

• Companies must deploy their capital / net worth where they can achieve a reasonable return for their investors. Clearly a -8% average ROE does not make Alabama an attractive investment for companies.

• On the Coast, approximately 70% - 80% of the Homeowners policy premium is required to cover wind losses. Upstate it is only about 20% - 35%.

• A company’s Homeowners ROE can be improved in several ways:– Raise rates– Reduce the company’s exposure to loss by raising deductibles or excluding wind coverage– Shift to writing more policies Upstate and fewer policies on the Coast– Focus their coastal writings on homes that have been fortified; Improve building codes to

lower the damageability of houses; retrofit homes to higher building standards

DOI Slide

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Home Ins. COASTAL 2001/10 STATE Return NW Maine 12.7% New Hampshire 9.2% Massachusetts 17.6% Rhode Island 20.6% Connecticut 20.2% New Jersey 12.5% New York 18.1% Delaware 18.4% Maryland 9.4% Virginia 12.2% North Carolina 15.4% South Carolina 22.3% Would you say the SC profits are excessive?Georgia -7.1% Florida -13.1% Alabama -7.2% Would you say the AL profits are inadequate?Mississippi -29.2% Louisiana -25.4% Texas 0.4% Average Coastal 5.9% Are Coastal profits near right, even in a decade with Katrina?

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Question for DOI • The Alabama DOI claims that the April 27 tragedy was a 1-in-250 year

is based on tornado models run on a “countrywide basis,” according to AON slide #5. Is the AON statement correct? If so, why did DOI run tornado models on a countrywide basis, and does it require hurricane modeling to be run on a countrywide basis?

• News articles suggested that the April tornadoes represented a 1-in-20 year event. Aon explained to the DOI that this was based on the probability of another similar event happening somewhere in the country. When the DOI asked what the probability would be of the April tornadoes re-occurring in Alabama, Aon told the DOI that the AIR tornado model suggested it was a 1-in-250 year event, and the RMS model suggested it was a 1-in-10,000 year event. So the DOI result was based on the Alabama model, not the countrywide model. Aon has acknowledged that their slide was incorrect regarding this issue.

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Question for DOI:• Accuracy of premium rates being used is questionable since they

were developed based upon modeled projected hurricane costs which the modelers have admitted are erroneous and overstated by over 40% for coastal Alabama.

• The DOI doesn’t believe modelers have said the models are erroneous…..they have said that based on new data they have revised their models, which, in the case of RMS, has lowered the estimated losses on the coast. In the past, RMS estimates on the coast have been substantially higher than the AIR estimates; now they are lower than AIR estimates. Each insurer must decide whether the AIR or RMS models better reflect their exposure to loss. Some insurers use an average of the two models since they are not sure which model is better, while some insurers only use one model.

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Question for DOI:• Public has little access to insurer data in order

to make a meaningful appeal to a rate increase.

• Current statute maintains that all actuarial data, projections, estimates, etc. are proprietary trade secrets.

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Rate for $150,000 home -- HO-3 AL Market

Company Birmingham Mobile w/ wind Tuscaloosa Share

35216 36608 35401

State FarmF&C $917 $2,079 $1,206 30.2%

Alfa Mut Ins $1,043 $4,169 $1,047 15.6%

Allstate Ind $1,026 $1,193 $994 6.4%

Travelers Home $473 $2,766 $545 3.4%

Cotton States $734 NA $772 3.0%

Unt Serv Auto A $498 $1,837 $450 2.9%

Allstate Ins NA NA NA 2.6%

Fire Ins Exch 1177 $2,282 $1,372 2.6%

Foremost NA NA NA 2.4%

Farmers Ins Exch $529 $1,061 $614 2.3%

Alfa Mut Gen $1,838 $5,211 $1,845 2.2%

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From DOI Homeowners Insurance Rate Comparison Page

Homeowners Premium Comparisons

The Alabama Department of Insurance now offers consumers the opportunity to compare homeowners rates of insurance companies. The information provided is for comparison purposes only. Even though these are real rates, rates vary considerably depending on the circumstances. At this time we do not have every insurance company's rates, just a few.

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SOME OTHER SLIDES TO CONSIDER

1. III Presentation2. DOI Presentation3. Raymond James Presentation

FINANCIAL MARKET UPDATETHE FLORIDA HURRICANE CATASTROPHE FUND

• The FHCF is not primarily intended to be a rate-reducing entity, but its structure (even with actuarially sound rates) saves Florida policyholders several billion dollars annually, and has a high ROI

Fiscal Year

(06/30)

FHCF Reimbursement

Premiums

Savings to Florida

Policyholders

FHCF Hurricane

Losses

Total FHCF Emergency

Assessments 2000 $438 $876 $02001 $439 $878 $02002 $478 $956 $02003 $498 $996 $02004 $488 $976 $3,950 $02005 $617 $1,234 $5,700 $02006 $735 $1,470 $1,3502007 $1,189 $2,378 $02008 $1,320 $2,641 $02009 $1,276 $2,553 $6252010 $1,440 $2,880 $6752011 $1,388 $2,775 $0Total $10,306 $20,613 $9,650 $2,650

678%100%

Actual Return on Investment (2000-2011)Projected Long-Term Return on Investment

The FHCF provides significant economic benefits to Florida, and has been exceptionally reliable

The FHCF has a projected 2011 year-end fund balance of over $7 billion

Raymond James Slide

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Overall Return Homeowners Return USA

USA AL USA AL HO Net ROE

1985 2.4% -1.1% 0.0% -22.9% 4.4%

1986 13.7% 15.3% 12.6% 8.2% 11.6%

1987 16.0% 22.6% 20.2% 20.9% 18.7%

1988 13.5% 9.2% 15.3% -5.2% 14.1%

1989 6.0% 3.4% -9.6% -22.4% -2.0%

1990 7.7% -2.9% -0.9% -18.1% -0.7%

1991 8.8% 11.0% -6.6% -9.9% -5.3%

1992 5.6% 15.7% -54.3% 17.8% -44.5%

1993 11.8% 13.1% 2.5% 7.5% -0.7%

1994 7.8% 12.0% -1.7% 6.4% -7.1%

1995 9.8% -1.0% 3.7% -45.0% -90.0%

1996 9.9% 7.7% -4.2% 3.6% -8.1%

1997 12.6% 5.8% 12.4% 3.7% 8.9%

1998 8.8% 0.1% 5.4% -10.1% 3.1%

1999 6.6% 3.9% 5.4% 11.3% 3.1%

2000 6.5% 4.6% 3.8% -2.0% 1.3%

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Overall Return Homeowners Return USA

USA AL USA AL HO Net ROE

2001 -0.5% 1.0% -7.2% -2.3% -9.5%

2002 3.3% 3.9% 1.4% 5.8% -2.2%

2003 9.5% 6.5% 9.7% 4.5% 7.8%

2004 10.0% -7.3% 3.7% -67.1% 7.2%

2005 5.3% -7.0% -2.8% 16.0% 6.5%

2006 14.4% 13.6% 18.5% 7.0% 13.9%

2007 12.5% 12.2% 16.0% 11.5% 9.0%

2008 2.4% 3.9% -2.6% 4.2% -7.3%

2009 6.3% 1.2% 6.2% -24.1% 0.7%

2010 8.0% 7.5% 7.2% 4.6% 1.3%

26-year Average 8.4% 6.0% 2.1% -3.7% -2.5%

Source: NAIC Profitability Report By Line By State, various Editions.

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SOME OTHER SLIDES TO CONSIDER

1. III Presentation2. DOI Presentation3. Raymond James Presentation4. RMS Presentation

Absolute Loss Cost Changes vs. Percent Differences

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• Percent change can demonstrate different message than absolute changes.

• Even after inland increases, risk is still far greater for coastal counties than inland counties.

State County v10 v11 $ Difference % Change

AL Baldwin 4.43 2.31 -2.12 -48%

AL Franklin 0.00 0.03 0.03 15,627

AL Crenshaw 0.17 0.25 0.08 48%

Loss Cost ($ / $1000 exposure)

Losses based on Gross average annual loss, historical event rates; include loss amplifi cati onRMS Slide

Hypothetical Total Premium Impact

Premium Component v10 v11 Absolute Difference

Percent Difference

Baldwin CountyHurricane 4.43 2.31 -2.12 -48%

Other Pricing 1.80 1.80 0.00Total 6.23 4.11 -2.12 -34%

Franklin CountyHurricane 0.00 0.03 0.03 15627%

Other Pricing 1.80 1.80 0.00Total 1.80 1.83 0.03 2%

Crenshaw CountyHurricane 0.17 0.25 0.08 48%

Other Pricing 1.80 1.80 0.00Total 1.97 2.05 0.08 4%

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If model results are used for direct pricing, change in modeled hurricane loss is muted by degree to which hurricane losses contribute to total premium.

Hypotheti cal rate example: Losses based on Gross average annual loss, historical event rates; include loss amplifi cati on

RMS Slide

WHY COMPETITION FAILS TO CONTROL P/C PRICES ADEQUATELY

Why Regulation is required.

41

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WHY COMPETITION FAILS TO CONTROL HOME INSURANCE PRICES

1. Complex Legal Documents – customers can’t understand (post Katrina proves it)2. Comparison Shopping is Difficult Price complex (tiers, classes, running mates) Service Quality hard to determine Solvency requires research3. People rarely shop and rarely change carriers – Inertia in the market. (Especially in a stressed market like home insurance in Alabama)4. Lenders Require Insurance – inelastic demand5. Underwriters free to refuse client – totally elastic supply6. Antitrust exemption – insurers collude on aspects of pricing

1. and 2. above show lack of informed consumer. 3. shows market stagnation. 4. and 5. show lack of normal free market conditions. 6. Is not compatable with a free market.And, the homeowners insurance market in Alabama is also moderately concentrated, with an HHI of 1,472. Surely, the Baldwin and Mobile areas are even more concentrated with many homes insured in the AIUA.

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CONSUMERS FARE BETTER UNDER STRICTER REGULATION

PRIVATE PASSENGER AUTO INSURANCE

89/05 97/05

Regulatory# of States Change in Return on HHI

System Expenditure Net Worth Index

State Set 1 52.8% 6.4% 1,371

Prior Approval 15 54.0% 8.6% 984

File & Use 23 68.1% 9.0% 1,016

Use & File 8 70.0% 9.7% 935

Flex 2 70.8% 7.0% 1,292

Competitive 2 73.9% 9.6% 1,111

Report available at:

http://www.consumerfed.org/elements/www.consumerfed.org/file/finance/state_auto_insurance_report.pdf

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RECOMMENDATIONS

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The Al legislature should:*join together to form an interstate compact to deal with common

issues stemming from their shared hurricane risk (such as resisting jointlycoercive efforts by insurers to weaken consumer protections; spread

riskacross the entire coast; create Florida-like reinsurance mechanism –

which might open the door to federal assistance; develop a regulatory

model fordetermining CAT risk to test insurer assumptions; develop model

language that would be required as a minimum homeowners insurance policy

sold in the coastal regions) THIS IS THE MOST IMPORTANT IDEA TO

PURSUE!*make all filings public and post them on the web. Many states make

rate filings public. Rate filings are simply not trade secrets. *adopt the California approach to consumer participation in

regulatory proceedings, where consumers can receive reimbursement from the

filing insurer to hire experts (like actuaries, lawyers and economists) if they make a “substantial contribution” to a case

Note: The stand-by reinsurance mechanism we envision would sell reinsurance to insurers at 50 percent more than actuarial rates developed by the model, which would keep premiums in check during the non-competitive phase of the insurer cycle or after hurricane events when reinsurers often gouge. When private reinsurance is reasonably priced at or near the actuarial level, the state back-up would not kick in.

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The AL Insurance Department should:*carefully examine national data on limited catastrophe losses and excessive surplus before approving any insurer requested rate increases*revisit hurricane pricing in recognition of the fact that the industry has mastered hurricanes * review the reasons why insurers are dumping risks into state pools and take action to stop insurers from unjustifiably refusing to cover qualified homeowners *ban use of anti-concurrent causation clauses and any other attempt by insurers to build a “trap-door” hidden in the policy, through which coverage can unexpectedly fall when policyholders most need help *not allow hurricane deductibles to apply unless a storm is classified as a hurricane throughout its journey through the state, from entry to exit *make sure that AL has all the data they need to monitor the home insurance market, including data by census track on who is writing and where, non-renewal patterns, etc.

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The AL Insurance Department also should:*every insurer should be required to have home insurance price info on the DOI web site.*require every insurer to use the average of all available models in pricing (some modelers compete for market share by offering high price answers)*require insurers to reveal things they select rather than the modeler selectsfor use in the model, such as demand surge*every home insurance policy sold should be accompanied by a written bill of rights. I suggest the Texas bill of rights as a model.

48

Ideas for a possible federal role:

The federal government is not going to move to help the coastal states, asEvidenced by failed attempts for decades to get wind and earthquakeInsurance as part of the federal insurance approach. States like Iowa will never support these proposals.

But innovative thinking might move the federal government to help. For example, the new Federal Insurance Office has a data collection authority. FIO mightUndertake research on why certain markets are stressed, which insurers are doing their best to serve markets in stressed areas and which are causing problems.

CFA has suggested that the federal government take steps such as:*Offering the expertise of the federal government (entities like FEMA, NOAA, etc.) to the group of coastal states. These experts could help develop the regulatory hurricane model for states to use in regulating insurance and in developing stand-by reinsurance pricing. Offering bridge loans at low-interest when stand-by reinsurance is used, if such use suffers losses due to timing risk (such as a large storm in the early years of the development of reserves.) These loans would be required to be fully repaid over reasonable time periods.

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OTHER THOUGHTS

• Do NOT move regulation of home insurance in Alabama’s non-competitive market away from prior approval. AL must control Prices with thoughtful regulation that is fair to insurers and consumers.

• Mitigation is critical. Building and land use codes are vital and need tough enforcement. Finding ways to match mitigation with insurance discounts that are a real incentive is an important effort that should be undertaken.