How to Live to Be 100:In the Property/Casualty
Insurance IndustryInsurance Industry
January 20, 2010
Robert P. Hartwig, Ph.D., CPCU, President & EconomistInsurance Information Institute ♦ 110 William Street ♦ New York, NY 10038
Tel: 212.346.5520 ♦ Cell: 917.453.1885 ♦ [email protected] ♦ www.iii.org
Presentation Outline
The Life Cycle of Businesses: Lessons from the Natural WorldCharacteristics of the World’s Oldest BusinessesP/C Centenarians: Who Lives to Be 100+ and Why?yWhy Do Insurers Fail?Secrets of the Ancients: Leadership AttributesSecrets of the Ancients: Leadership Attributes of 100+ Year Old InsurersLesson from the Financial Crisis
2
Lesson from the Financial CrisisQ&A
Lessons from Nature: What Would Darwin Would Say?
Longevity in the Business World Has Parallels in the Natural WorldHas Parallels in the Natural World
3
On the Life Cycle of Businesses: Lessons from Nature
Most Businesses, Like Living Species, Eventually Become Extinct99 5% of all living species to ever exist on Earth are now extinct; The99.5% of all living species to ever exist on Earth are now extinct; The proportion is higher for business and extinctions occur over a much compressed timespan.Changes in the natural environment (not external forces like humans) were responsible for almost all e tinctionsresponsible for almost all extinctionsThis means that despite millions of years of evolution and adaptation, virtually every species eventually confronts a change in its environment to which it cannot adaptIt is the same in business; Wall Street models likely offer less assurance than millions of years of evolution
Business Cycle Gives Rise to “Creative Destruction”Business Cycle Gives Rise to Creative DestructionMass extinctions in business are commonEconomy is constantly reinventing itselfNew industries and businesses spring from the ashes of the previous generation, fill voids and occupy niches
Mass Extinction: Surge in Business Bankruptcy Filings Amid Crisis Since 2007
00 277 81
,235
82,4
46
3 549
643
80 000
90,000
% Change Surrounding Recessions
1980-82 58.6%1980-87 88.7%
94 125
69,3
062
,436
64,0
04 71,2
63,8
5363
,235
64,8
53 71,5
70,6
62,3
042,
374
1,95
953
,549
54,0
2767 9 46
60,0
00
60,000
70,000
80,000 %1990-91 10.3%2000-01 13.0%2006-09 204.2%*
43,6
948
, 5 5 5 544
,36
37,8
8435
,472
40,0
9938
,540
35,0
3734
,317
39,2
0195 28
,322
43,5
4
30 000
40,000
50,000
19,6
9 2
10,000
20,000
30,000There were 45,510 business bankruptcies during the first
three quarters of 2009, up 52% from 2008:Q3 and on track for about 60,000 for all of 2009, the most since 1993. Current recession will generate 200%+ surge
0
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
The Crisis Will Destroy Hundreds of Thousands of Businesses
1993. Current recession will generate 200%+ surge
5
*2009 is annualized estimate based on actual business bankruptcies in first three quarters of 2009Source: American Bankruptcy Institute,http://www.abiworld.org/AM/Template.cfm?Section=Business_Bankruptcy_Filings1&Template=/TaggedPage/TaggedPageDisplay.cfm&TPLID=59&ContentID=36301.
y
Lessons from History: What Types of Business Live a VeryWhat Types of Business Live a Very Long Time (500+ Years) and Why?
Longevity in the Business World Requires Focus, Long-Term ObjectivesRequires Focus, Long Term Objectives
6
Number of Firms More than 500 Years Old, by Industry*
Total NumberThe brewery
industry appears to have
BENEATH THE SURFACEM t f th i
3535
40
appears to have the greatest
longevity with 35 firms 500+
Most of these companies are:
1. Family Owned2 Hi hl f d28
1925
30
35 35 firms 500+ years old. 2. Highly focused on one
specific business3. Have some geographic 19
7 5 410
15
20g g p
focus (product or client)
5 4 2 2 2 2 10
5
wery otel
rant
Wine
acy ary
Glass
per
Sake
port
hers
Brewe
HotRest
aura W
iPharm
aCon
fectio
na Gla
Pap SakTra
nspo Othe
Source: http://en.wikipedia.org/wiki/List_of_oldest_companies
Characteristics of Firms That Stand the Test of Time
1. Business Model: Highly FocusedFirms tend to remain true to core businessAvoid businesses you don’t understandSome diversification is usually good, but leads to an exponential increase in complexity and unforeseen interactions across units
2. Ownership Structure: There Exists Some Concept of MutualitySome of the world’s oldest firms are family owned (artisans, craftsman)Others have some form of cooperative arrangement (agricultural)Such organizations also exhibit altruistic behavior, a proven survival trait
3. Communal Interest: A Concern for the Greater Common GoodPerpetuation of the species (i e the industry) is evident in behaviorsPerpetuation of the species (i.e., the industry) is evident in behaviorsConcept of mutuality extends beyond organization to communal interestA strong willingness to work for the common good
Characteristics of Firms That Stand the Test of Time (cont’d)
4. Growth: Tend to Grow SlowlyAs with living species, the longest lived businesses in the world tend to grow only slowly, if at all
5 Size: Tend to Be Small Relative to Competition5. Size: Tend to Be Small Relative to CompetitionSize seems to matter when it comes to species longevity: smaller = longerAlso true among living species (e.g., bacteria, insects)
6. Profitability: Tend Not to Be the Most ProfitableObject of continuous profit maximization is not consistent with longevityA “will to survive” is still necessaryA “will to survive” is still necessary
World’s Oldest Insurance Companies
Who Has Truly Endured?
10
Sampling of World’s Oldest Insurance Companies, by Age and Country*
322368Bilsener (Germany)
Lloyd's (UK) 322321
300266
258
y ( )Gjensidige (Norway)
Royal & SunAlliance (UK)Dolleruper (Germany)
Philadelphia Contributionship (USA) 258254
243222
218
Philadelphia Contributionship (USA)Möreler Brandgilde (Germany)
Storebrand (Norway)Ostangler (Germany)
CIGNA (USA) 218216216
200
CIGNA (USA)Baltimore Equitable (USA)
Mutual Assurance (USA)The Hartford (USA)
197191189186
Neuendorfer (Germany)Gilmore & Associates (USA)Hickok & Boardman (USA)Clerical Medical (Germany)
0 50 100 150 200 250 300 350 400*Insurers’ age calculated as number of years from inception date to 2010Source: http://en.wikipedia.org/wiki/List_of_oldest_companies
# of Years Old
Sampling of World’s Oldest Insurance Companies, by Age and Country* (cont’d)
184185Standard Life (UK)
Ci i ti E it bl (USA) 184184184
182
Cincinnati Equitable (USA)HEK (Germany)
Schweizerische Mobiliar (Switzerland)Vermont Mutual (USA) 182
171170
169
Vermont Mutual (USA)Lakeland Insurance
HüttenerNew York Life (USA) 169
168167167
New York Life (USA)Atlantic Mutual
Frederick MutualHolyoke Mutual (USA) 167
163162
160
o yo e utua (US )Southern Mutual
Macomber, Farr and Whitten (USA)Aetna
145 150 155 160 165 170 175 180 185 190*Insurers’ age calculated as number of years from inception date to 2010. Source: http://en.wikipedia.org/wiki/List_of_oldest_companies
# of Years Old
The Centenarians: Who Lives to Be 100+ in the P/C Insurance World?
Characteristics of An Exclusive C fClub of Insurers
13
100+ Year Old Insurers as a Share of All P/C Insurers
Nearly 13% of P/C insurance companies (1-in-8) today is 100+ years old. This is a surprisingly high percentage.
Insurers at Least 100 Years Old, 12.7%(287)
Insurers Less than12.7%
Insurers Less than 100 Years Old,
87.3%(1,979)
87.3%
Odds of a Human Living to 100Born 1900: ~0 25% (1-in-400)
14Source: National Association of Insurance Commissioners (NAIC) Annual Statement Database, via Highline Data LLC; CDC
Born 1900: 0.25% (1 in 400)Born Today: ~2% (1-in-50)
Decade of Formation for P/C Insurers at Least 100 Years Old in 2010
Of the Centenarian p/c insurers in existence today, 70% were formed since 1870. There is post-Civil war spike in the
1870s and another in the 1890s
6065
60
70
80 1870s and another in the 1890s
As of Jan. 1, 2010 there were 287 P/C that were at least 100 years old.
37 3840
50
9 10
22 2016
10
20
30
31 0 0 04 2
0
10
1750-59
1760-69
1770-79
1780-89
1790-99
1800-09
1810-19
1820-29
1830-39
1840-49
1850-59
1860-69
1870-79
1880-89
1890-99
1900-09
15
Decade Of Formation
Source: National Association of Insurance Commissioners (NAIC) Annual Statement Database, via Highline Data LLC.
100-year-old Insurers: Independent vs. Part of Group/Holding Company
The number of 100-year-old insurers that are independent vs. part of a more diversified group structure is split almost evenly.
Independent, 48.8%(140)
51.2% 48.8%Part of Holding
Company, 51.2%(147)
16Source: National Association of Insurance Commissioners (NAIC) Annual Statement Database, via Highline Data LLC.
100-year-old Insurers: Some Are Shell Companies or Are in Runoff
Approximately 12% of “existing” 100-year old insurers had net written premiums less than or equal to zero, suggesting they were either unused
shell companies or in runoff and not actively writing new business.shell companies or in runoff and not actively writing new business.
NPW Equal or Less Than Zero, 12.2%(35)
12.2%
NPW Greater than Zero, 87.8%(252)
87.8%
17Source: National Association of Insurance Commissioners (NAIC) Annual Statement Database, via Highline Data LLC.
100-year-old Insurers: Mutual vs. Stock vs. Reciprocal
The vast majority (62.4%) of 100-year-old insurers are mutual insurers, while stock insurers account for 35.9% of the total.
1 4%0.3%
Reciprocal, 1.4%,(4)
Other, 0.3%,(1)
35 9%
1.4%
Mutual, 62.4%,(179)
62 4%
35.9% ( )
Stock, 35.9%,(103)
62.4%
18Source: National Association of Insurance Commissioners (NAIC) Annual Statement Database, via Highline Data LLC.
100-Year Old Insurers: Share of Total Industry NWP 1998 vs. 2008
19982008100-yr insurer
NWP
15.6%
NWP$44.33 Billion
16.5%
100-yr insurer NWP
$73.14 Billion
28.3%
6.9%
48.4%Total P/C industry NWP
$283.91 Billion
Total P/C industry NWP
$444.10 Billion
The market share of 100-year-old insurers as a % of total P/C industry NWP remained stable over the decade ending in 2008 (latest available)
19
Source: National Association of Insurance Commissioners (NAIC) Annual Statement Database, via Highline Data LLC; A.M. Best
remained stable over the decade ending in 2008 (latest available)
100-year-old Insurers: Share of Total Industry Admitted Assets 1998 vs. 2008
19982008100-yr insurer
assets
17.5%
assets$183.74 Billion
19.0%
100-yr insurer assets
$306.65 Billion
28.3%
6.9%
48.4%Total P/C industry assets
$1,048.62 Billion
Total P/C industry assets
$1,617.31 Billion
The market share of 100-year-old insurers as a % of total P/C industry assets has increased slightly over the years
20Source: National Association of Insurance Commissioners (NAIC) Annual Statement Database, via Highline Data LLC; A.M. Best
has increased slightly over the years.
Distribution of 2008 NWP by Decile
21.7"Centenarians" All P-C companies
Median NWP ($Million)
$1,3
2
$1,200
$1,500 There are a small number of large Centenarian insurers, mostly part of larger groups, that
make the median NWP size of this group larger
5
$690
.7
$600
$900for the top 50% of companies by size;
Centenarians tend to be somewhat larger among the smaller-sized firms.
51.5
$102
.1
$248
.5
0.2 .2 3.3
6.4
12.8
23.4
41.4
$80.
1
$164
.6
0.1 .0 2.7
4.9
11.4
23.0$300
$600
$$0 $1 $3 $6 $1 $2 $ $$0 $1 $2 $4 $1 $2$0
Lowest 2d 3d 4th 5th 5th 4th 3d 2d Highest
21
Note: 25 companies per decile for centenarians; 227 per decile for all p/c industrySource: NAIC Annual Statement data, via Highline
lowest lowest lowest lowest highest highest Highest Highest
Distribution of 2008 Surplus by Decile
1,90
9.6
$2,000
"Centenarians" All P/C IndustryMedian Surplus ($Million)
There are a small number of large Centenarian $15.
3
$1,500
There are a small number of large Centenarian insurers, mostly part of larger groups, that make the median size of this group by PHS larger for the top 50% of companies by size;
6 6.8
277.
6
3 4 3 4 .1 209.
6
$78 5
0 3$500
$1,000 Centenarians tend to be somewhat larger among the smaller-sized firms.
$59.
$11 $
$1.4
$3.8
$7.4
$12.
3
$20.
4
$32.
3
$57.
$98 $ 2
$1.4
$2.4
$5.0
$8.5
$16.
0
$32.
3
$0
Lowest 2d 3d 4th 5th 5th 4th 3d 2d HighestLowest 2dlowest
3dlowest
4thlowest
5thlowest
5thhighest
4thhighest
3dHighest
2dHighest
Highest
22
Note: 25 companies per decile for centenarians; 225 per decile for all P-CSource: NAIC Annual Statement data, via Highline
Distribution of 1998-2008 NWPChange, by Decile
.8%"Centenarians" All P-C
Median Rate of Change
1918
1400%1600%1800%2000%
% 483%
% 9% 60.6
%
600%800%
1000%1200%1400%
107%
138% 20
4%
4
% %
10.7
%
38.4
%
62.9
%
90.6
%
138.
0%
220.
9 4
%
-9%
18%
46%
61%
82%
-200%0%
200%400%600%
-91.
1%
-29.
2
-50200%
Lowest 2dlowest
3dlowest
4thlowest
5thlowest
5thhighest
4thhighest
3dHighest
2dHighest
Highest
23
Note: 24 companies per decile for centenarians’ 163 per decile for all P-C industry 1998-2008Source: NAIC Annual Statement data, via Highline
Distribution of 1998-2008 SurplusChange, by Decile
.0%
900%1000%
Centenarians All P-C
Median Rate of Change
%4%
722.
500%600%700%800%900%
92%
124% 16
6% 291 %
9.7%
40.4
%
62.9
%
91.8
%
130.
0%
186.
4% 288.
4
3% 32%
50%
65%
100%200%300%400%500%
-45.
8% -6.9
%
1 4
-42% -11%
1 3 5-100%
0%100%
Lowest 2d 3d 4th 5th 5th 4th 3d 2d Highestlowest lowest lowest lowest highest highest Highest Highest
24
Note: 24 companies per decile for centenarians; 163 per decile for all p-c 1998-2008Source: NAIC Annual Statement data, via Highline
Premium to Surplus Ratios, “Centenarians” vs. Current P-C Industry, 1998 and 2008
$0.95$1.00"Centenarians" Current P-C Industry
NWP/Surplus
$0.85
$0.72 $0.69
$0 60
$0.70
$0.80
$0.90
$0.30
$0.40
$0.50
$0.60
$0.00
$0.10
$0.20
1998 20081998 2008
Premiums are a rough measure of risk accepted; surplus is funds beyond reserves to pay unexpected losses. The larger surplus is in relation to premiums—the lower the ratio of premiums to surplus—the greater the
25
“Centurians” are companies at least 100 years old with positive NWP in 2008 Sources: National Association of Insurance Commissioners’ Annual Statements, via Highline; I.I.I. calculations
p e u s t e o e t e at o o p e u s to su p us t e g eate t ecapacity to handle the risk it has accepted.
Asset Class Distribution of Admitted Assets,“Centenarians” vs. All P/C Insurers, 2008
Bonds Stocks Cash Other
20.9%
5.9% 20.6%52.6%All P/C Insurers
%20.8%
3.2% 21.3%53.7%Centenarians
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
26
Note: 25 companies per decileSource: NAIC Annual Statement data, via Highline
Why Do Insurers Fail?Why Do Insurers Fail?
Leading Reasons Why Most Insurers Don’t Make it to 100
27
P/C Insurer Impairments, 1969–2009p
70
5 of the 11 are Florida companies (1 of these
5 is a title insurer)
Since most failures are due to inadequate pricing, underreserving
and excessive growth (factors under management control) the leading
49 50 4855
60 58
49 504750
60
70 management control), the leading cause of death in the p/c insurance
industry amounts to suicide
34 36
3134
4129 31
435
30
40
50
815
127
11 9 913 12
199
16 14 13
1612
18 19 1814 15
711
10
20
7 75
0
69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09p
Source: A.M. Best; Insurance Information Institute.
The Number of Impairments Varies Significantly Over the P/C Insurance Cycle, With Peaks Occurring Well into Hard Markets
P/C Insurer Impairment Frequency vs. Combined Ratio, 1969-2009p
115
120
1.8
2.0Combined Ratio after Div P/C Impairment Frequency
110
115
Rat
io
1.2
1.4
1.6
Impair
100
105
Com
bine
d
0.6
0.8
1.0
rment R
ate
90
95
0 0
0.2
0.4
0.6
2009 estimated impairment rate rose to 0.36% up from a near record low of 0.23% in 2008 and the 0.17% record low in 2007; Rate is still less than one-half the 0.79% average since 1969
90
69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09* 0.0
g
Impairment Rates Are Highly Correlated With Underwriting Performance
29*Combined ratio of 101.7 is through Q3:09; 0.36% 2009 impairment rate is III estimate based on preliminary A.M. Best data.Source: A.M. Best; Insurance Information Institute
p g y gand Reached Record Lows in 2007/08
Five Deadliest Sins for P/C Insurance Companies
OPERATIONAL ISSUES
1. Underpricing/Underreserving (~38% of failures)p g g ( )Leading cause of p/c insurer death according to A.M. Best
2. Excessive Growth (~14%)( )Too much growth too fast (organically or via M&A) can be fatal
3. Excessive Catastrophe Exposure (~8%)( )Too much underpriced exposure, too little reinsurance, insufficient diversification
4 I t t P bl ( 7%)4. Investment Problems (~7%)Investments are too risky, too illiquid or insufficiently understood
5 Affiliate Problems ( 8%)5. Affiliate Problems (~8%)Non-core operations can cause problems for parent (e.g., AIG)
Source: I.I.I. research.
Reasons for US P/C Insurer Impairments, 1969–2008
Deficient Loss Reserves and Inadequate Pricing Are the Leading Cause of Insurer Impairments, Underscoring the Importance of Discipline.
Investment Catastrophe Losses Play a Much Smaller Role
3.7%4 2%
Investment Catastrophe Losses Play a Much Smaller Role
Reinsurance Failure
Mi
Sig. Change in Business
4.2%9.1%
7.0% 38.1% Deficient Loss Reserves/In adequate Pricing
Investment Problems
Misc.
7.9%
38.1% In-adequate Pricing
Affiliate Impairment
7.6%
8.1% 14.3%Catastrophe Losses
31Source: A.M. Best: 1969-2008 Impairment Review, Special Report, Apr. 6, 2008
Rapid GrowthAlleged Fraud
Leadership Attributes Found in pInsurers that Reach 100+ Years
Secrets of the Ancients
32
Leadership Attributes Inherent in Long-Lived Insurance Companies1. Management Acts as a Steward of the Enterprise
Objective is to pass a healthy firm safely and securely to the next generation of management and policyholders
2. Management Financial IncentivesIn line with the goal of providing the protection purchasedTh i t i ll 3rd t ( h h ld ) t t (60% t l )There is typically no 3rd party (shareholders) to compensate (60%+ mutuals)
Objective if public company is to maximize profits
CEO (total) comp is a smaller multiple relative to average employee
3. Nimble: Environment for Small Insurers Can & Does ChangeNot always first to change, but adaptation occurs within reasonable timefram
4. Customer Focus & Relationship DrivenCustomer is the #1 priorityCommitted to agency form of distribution, with 21st century enhancementg y y
5. RegulationIn favor of comprehensive but local regulation (contrast with banks)
Traits to Admire in an Insurer and Its Management?1. A Firm Whose Management’s Incentives are Strictly
Aligned With the Insurer’s Principal StakeholdersCustomers agents employees shareholders communityCustomers, agents, employees, shareholders, communityThese include financial and operational objectives
2 M t I K l d bl2. Management Is KnowledgeableManagement of small, long-lived insurer is no less knowledgeable about industry trends, opportunities and threats than larger competitorscompetitors
3. Intuitive and Comprehensive Understanding of Enterprise Risk ManagementRisk Management
Much is made of ERM today, but long-lived insurers practiced it well before it had a name
What Do I Admire in an Insurer and Its Management?4. CEO is Willing to Seek Advice and Counsel
No imperial CEOs; Self-aggrandizement is rareCEO is a listener and consensus builder
5. Commitment to Core ConstituenciesCustomer is the #1 priorityCommitted to agency form of distribution, with 21st century enhancement
6. Lack of a “Wandering Eye”Disciplined enough to stick with the business you know, but also adapting to changing business conditions and seizing opportunities as necessary
Lessons from the Financial CrisisLessons from the Financial Crisis
What Have the Past Two Years Taught /C ?the P/C Insurance Industry?
36
Lessons All Financial Industries Must Learn from the Recent Financial Crisis1. Risk Management Matters
2 Getting Involved in Businesses You Don’t Understand2. Getting Involved in Businesses You Don t Understand Can Be Fatal
3. Too Rapid Growth Can Kill Quickly3. Too Rapid Growth Can Kill Quickly
4. Management Financial Incentives Can Pervert Risk Management Controlsg
5. Support of Comprehensive and Appropriate Regulation is Vital to Longevity of Financial Services Enterprisesg y p
6. Keeping “Skin in the Game” is Critical
7. Never Lose Sight of What is in the Best Interest of the Customer
What Some Insurers Learned From the Financial Crisis
Bottom Line:
Adherence to Sound Risk Management Makes a Big Difference
Keeping Skin in the Game Matters
Taking Inordinate Risk on the Investment Portfolio Can Be Dangerous
Involvement in Non-Core Business Can Cause Serious Problems
Tail Probabilities Matter and May Often Be Underestimated
Can’t Substitute Liquidity for Capital
Regulatory Vacuums and Regulatory Arbitrage are Dangerous
Government Money Comes With Many Strings Attached
38Source: Insurance Information Institute
Insurance Information Institute Online:
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