economic trends, challenges, and opportunities for insurers

Economic Trends, Challenges, and

Opportunities for InsurersNU’s Annual Executive Conferences

New York, NYNovember 18, 2010

Download at: www.iii.org/presentationsSteven N. Weisbart, Ph.D., CLU, Senior Vice President & Chief EconomistInsurance Information Institute 110 William Street New York, NY 10038Office: 212.346.5540 Cell: 917.494.5945 [email protected] www.iii.org

2

Economic (and Related) TrendsThat Will Affect the Industry

in the Next Few Years

3

3 Economic Trends That Will Affectthe Industry in the Next Few Years

Consumers’ Diminished Buying Power, especially for Financial Products

Consumers’ (and Regulators’) Preferences for Managing TMI (Too Much Information)

The Growth/Spread of Financial Services Regulation and the Cost of Compliance

4

Economic Trends That Will Affect theIndustry in the Next Few Years

Consumers’ Diminished Buying Power, especially for Financial Products Economic Environment:

– Slow Income Growth– High Unemployment

Continued Reducing Financial Obligations

Catching Up on Deferred Purchases of Durable Goods (especially cars, eventually houses)

5

Forecast: A Weak RecoveryReal GDP Growth, Yearly, 1970-2014F

Estimates/Forecasts from Blue Chip Economic Indicators, 10/2010 issue.Sources: (GDP) U.S. Department of Commerce at http://www.bea.gov/national/xls/gdpchg.xls.

-3%

0%

3%

6%

9%

Real GDP Growth (%)

The “consensus” forecast is for several years of real yearly GDP growth under 3%--weaker than after most recent recessions

6

Unemployment and UnderemploymentRate “Normality”: Years to Go

2

4

6

8

10

12

14

16

18

Jan00

Jan01

Jan02

Jan03

Jan04

Jan05

Jan06

Jan07

Jan08

Jan09

Jan10

Traditional Unemployment Rate U-3

Unemployment + Underemployment Rate U-6

October 2010 unemployment rate (U-3) was

9.6%. Peak rate in the last 30

years: 10.8% in Nov - Dec 1982

Source: U.S. Bureau of Labor Statistics; Insurance Information Institute.

U-6 hit 17.5% in Oct 2009 but is now

17.0%

January 2000 through October 2010, Seasonally Adjusted (%)

Recession ended in

November 2001

Unemployment kept rising

slightly for 19 months more

Recession began in

December 2007

Recession ended in

June 2009

Gap between U-3 and U-6 is

normally 4 percentage

points but is now 7.4 points

7

The Number of Long-termUnemployed Is Still High*

3275

3204

3233

3026

2966

3147

2806

2929

3008

2748

2646

2682

2752

2769

2839

2760

2891

2657

3141

3398

3519

3969

4041

3982

4321

4066

3557

4120

3910

3717

3526

3486

3362

3412

3228

2991

3019

3121

3060

3635

3350

3458

1757

1927 19

87

2347

2534

2531 30

54

3452

2916

2828

2942

3240

3163

2840

2632

2696

2436

2253

2161

2208

2151 22

35

2336

2519

2207 25

91 2647 29

17

3182

3680 39

48

4381

4965

4988

5438

5594

5887

6130

6313

6133

6547

6716

6763

6751

6572

6249

6123

6206

3255

3267

3658

3404

3371

3346

0

4000

8000

12000

16000Less than 5 weeks 5-14 weeks15-26 weeks over 26 weeks

*Through October 2010; Seasonally adjusted Sources: Bureau of Labor Statistics; Insurance Information Institute.

Mean DurationNov 2008 = 18.9 WeeksOct 2010 = 33.9 Weeks

Number of People(Thousands)

Highest number on record (since 1948)

8

Unemployment and UnderemploymentRate “Normality”: Years to Go

Recession “officially”

ends

10.5%

11.0%

11.5%

12.0%

12.5%

13.0%

13.5%

14.0%

1987

:Q1

1987

:Q3

1988

:Q1

1988

:Q3

1989

:Q1

1989

:Q3

1990

:Q1

1990

:Q3

1991

:Q1

1991

:Q3

1992

:Q1

1992

:Q3

1993

:Q1

1993

:Q3

1994

:Q1

1994

:Q3

1995

:Q1

1995

:Q3

1996

:Q1

1996

:Q3

1997

:Q1

1997

:Q3

1998

:Q1

1998

:Q3

1999

:Q1

1999

:Q3

2000

:Q1

2000

:Q3

2001

:Q1

2001

:Q3

2002

:Q1

2002

:Q3

2003

:Q1

2003

:Q3

2004

:Q1

2004

:Q3

2005

:Q1

2005

:Q3

2006

:Q1

2006

:Q3

2007

:Q1

2007

:Q3

2008

:Q1

2008

:Q3

2009

:Q1

2009

:Q3

2010

:Q1

16.0%

16.5%

17.0%

17.5%

18.0%

18.5%

19.0%Debt Service Ratio Financial Obligations Ratio

Households Are Sharply ReducingTheir Financial Obligations

Source: Federal Reserve Board, at http://www.federalreserve.gov/releases/housedebt (last frb update: Sept 27, 2010)

Debt Service Ratio

Financial Obligations Ratio: mortgage and consumer debt, auto lease, residence rent, HO insurance, and property tax payments

as % of personal disposable income.

Financial Obligations Ratio

The Financial Obligations Ratio dropped almost 2 percentage points from 2007:Q3 to 2010:Q2, but it might be tough to shrink further if interest rates and property taxes rise.

Debt Service Ratio: mortgage and consumer debt as % of personal disposable income.

Lowest point since 1983:Q3

10

Registered Passenger Carsand Other 2-axle, 4-tire Vehicles

181.

97

181.

33

183.

60

187.

32

190.

78

194.

13 198.

86

199.

97

203.

17 207.

79 212.

70

221.

82

220.

93

222.

86 228.

28

231.

91

234.

52

237.

40

238.

31

175

200

225

250

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

It is likely that the number of vehicles dropped during and following the “Great Recession.” Recovery depends on employment and lending trends.

Sources: http://www.bts.gov/publications/national_transportation_statistics/html/table_01_11.html Insurance Information Institute

Millions

Recession years in gold

11

16.9

16.5

16.1

13.1

10.3

11.4

12.6

14.0 14

.7 15.1

16.9

16.617

.117.5

17.8

17.4

9

10

11

12

13

14

15

16

17

18

19

99 00 01 02 03 04 05 06 07 08 09 10F 11F 12F 13F 14F

Millions of Units Sold

The Car-Buying Slump Will Create Pressure to Replace Aging Vehicles

Sources: U.S. Department of Commerce; Blue Chip Economic Indicators (10/10) forecasts; Insurance Information Institute.

If the forecasts hold, by year-end 2011, there will be roughly 12 million more older vehicles on the road than if there were no slump. Buying new

vehicles will compete with paying for insurance, funding retirement.

In a “normal” 2-year span, new cars would replace about 25

million old cars, but in 2009-10 only about 17 million old cars will

be replaced

12

Economic Trends That Will Affectthe Industry in the Next Few Years

Consumers’ Diminished Buying Power, especially for Financial Products Taxes and Health-related Costs Will Take

Higher a Percentage of Income

Impact of Lost Home Equity as an “ATM”

Eventual Rises in Inflation and Interest Rates

13

$1.50

$1.58$1.64

$1.69$1.75

$1.78$1.83

$1.87$1.90

$1.42$1.36

$1.32$1.26

$1.22$1.19

$1.0

$1.1

$1.2

$1.3

$1.4

$1.5

$1.6

$1.7

$1.8

$1.9

$2.0

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09

Trillions of Dollars

Real Consumer Spending* on Health

*Chained 2005 dollars; includes net health insurance outlaysSources: U.S. Department of Commerce, Bureau of Economic Analysis; Insurance Information Institute.

Health spending has grown as a percent of Personal Consumption Expenditures, crowding out spending on other items,

and this trend is likely to continue, at least in the next few years.

These data are adjusted for general inflation but not “medical inflation”

In 1995, Health Spending was 19.6% of Personal

Consumption Expenditures. By 2009 this grew to 20.7%

15

4.8% 4.6%

6.1%

4.3%

6.9%

5.1% 5.2%

0.7%

4.5%

7.7%

4.8%

7.1%

5.4%5.7%

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

96 97 98 99 2000 01 02 03 04 2005 06 07 08 09

Change in Nominal Disposable HouseholdIncome (Household Income Net of Taxes)

Sources: U.S. Department of Commerce, Bureau of Economic Analysis; Insurance Information Institute.

With high unemployment likely for years to come,disposable household income is unlikely to grow much. Federal income

tax cuts, though helpful, may be offset by state tax increases.

Percent Change from Prior Year

16

Homeowners Aren’t Using TheirHome Equity as an ATM Any More

Consumers’ Diminished Buying Power, especially for Financial Products Taxes and Health-related Costs Will Take

Higher a Percentage of Income

Impact of Lost Home Equity as an “ATM”

Eventual Rises in Inflation and Interest Rates

Roughly 28% of homes with mortgages now

have negative equity or under 5% positive

equity

17

Economic Trends That Will Affect theIndustry in the Next Few Years

Regulators’ Recent Approaches to combat “TMI” (too much information) New SEC rules: 401(k) expense charges

New mortgage rules to come from the Consumer Financial Protection Bureau?

Fair Value in Insurance– Medical loss ratios in small group and individual

health insurance contracts

18

Economic Trends That Will Affect the Industry in the Next Few Years

Consumers’ are struggling to deal with “TMI” (too much information). Insurers can help with Information Presentation/Design: Visibility,

Simplicity

Better (simpler, more logical) bases for selecting coverage types/amounts

– For example, how do you choose your auto liability limits?

What your umbrella liability policy requires? Household Income, Net Worth, or Recent Liability

Judgments

19

Some Suggestions Improving Policyholder Information Processing

A Tip from Behavioral Economics Some health plans waive or lower co-pays if patients

take medications as prescribed– This results in higher claims for drugs but lower overall costs

as patients recover more quickly and stay well longer

Should homeowners insurers waive “hurricane deductibles” if a home is built/retrofitted to IBHS standards?

Should disability insurers retroactively waive some of the waiting period if claimants take their medicine as prescribed?

20

Some Suggestions Improving Policyholder Information Processing

Product Bundles: A tip from Car Companies A standard P-C Catastrophe “rider” (a bundle that

includes flood, earthquake, terrorism, etc.)

A standard Life/Disability/Annuity combination policy that provides “income insurance”

Needed: A “Rule of Thumb” What percent of a Household’s income should be

devoted to all insurance/financial protection products?

Financial Services Reform

21

Systemic Risk Oversight,Federal Insurance Office (FIO):

Compliance Costs to Soar?

22

Systemic Risk: Oversight

Financial Stability Oversight Council

Mission: to oversee systemic risk of large financial

holding companies [a.k.a. TOO BIG TO FAIL]

FSOC could determine that insurers present

systemic risk to the financial system, leading to

supervision by the Federal Reserve.

Supervision would subject such insurers to

tougher prudential standards involving capital

levels and other requirements

Source: Insurance Information Institute (I.I.I.) updates/research; The Financial Services Roundtable;Adapted from summary by Dewey & LeBoeuf LLP

23

Systemic Risk: Resolution Authority

FDIC Resolution Authority: Orderly Liquidation

The FDIC would have an “Orderly Liquidation Authority” mechanism to

resolve distress at financial institutions.

Insurance holding companies and any non-insurance subsidiaries

of insurers may be subject to this authority.

Insurers are generally exempt from this liquidation authority, but the

FDIC would have “backup authority” to place an insurer into orderly

liquidation under state law if the state regulator has not done so

within 60 days of a systemic risk determination.

Liquidation Fund Assessments

The liquidation fund would be funded by assessments on large financial

companies, potentially including insurers.

Source: Insurance Information Institute (I.I.I.) updates/research; The Financial Services Roundtable; Adapted from summary by Dewey & LeBoeuf LLP

24

Federal Insurance Office (FIO):What Will It Do?

An office within US Treasury headed by a Director appointed by

Treasury Secretary; charged to:

Study the insurance industry (all lines except health insurance, long-

term care insurance and federal crop insurance) to gain expertise.

Identify regulatory gaps that could contribute to a systemic crisis in the

insurance industry or the U.S. financial system.

Gather information from the insurance industry to analyze it and

issue reports. May require insurers to submit data; FIO director

can issue subpoenas to obtain such info (but small insurers are

exempt).

Monitor the extent to which under-served communities have

access to affordable insurance products.

Oversee the federal Terrorism Risk Insurance Program.


25

Federal Insurance Office (FIO):What Will It Do? (Cont.)

FIO will also:

Recommend to the FSOC on whether an insurer (or reinsurer) poses a

systemic risk and should become supervised by the Federal Reserve.

Report yearly on the insurance industry to Congress and the President.

Other reports within 18 months:

On the modernization of insurance regulation in the U.S.

On the U.S. and global reinsurance market

Deal with international insurance matters.

Pre-empt state law when the FIO determines that state law

is inconsistent with a negotiated international agreement and

treats a non-U.S. insurer less favorably than a U.S. insurer.


26

What Else in the Financial Services Reform Law Might Affect Insurance?

Bureau of Consumer Financial Protection

A new entity within the Federal Reserve with authority

to regulate financial products offered to consumers.

The law specifically exempts insurance products

from this bureau’s authority.

But after the Bureau is functioning and has

promulgated consumer protection rules for other

financial products,…


New Rulemakings Under The Dodd Frank Wall Street Reform and Consumer Protection Act

24

6156

31

54

2

17

4

95

9

0

10

20

30

40

50

60

70

80

90

100

Bureau ofConsumerFinancialProtection

CFTC FinancialStability

OversightCouncil

FDIC FederalReserve

FTC OCC Office ofFinancialResearch

SEC Treasury

A total of at least 243 new rulemakings are expected under the Dodd-Frank financial reform by Federal Agency*

* Total eliminates double counting for joint rule-makings and this estimate only includes explicit rule-makings in the bill, and thus likely represents a significant underestimate.Source: Wall Street Journal, July 14, 2010; Davis Polk & Wardwell. 27

Solvency II

28

Move Toward More Stringent Regulatory Requirements for

Insurers Originating in Europe

29

Solvency II: The EU’s Effort to Modernize Insurance Solvency Regulation

Solvency II is a comprehensive framework for defining capital levels and relating them to procedures to identify, measure and manage risk levels Solvency I was mainly an update of existing EU solvency regimes,

which had been in existence since the 1970s.

Since deficiencies had been identified over the years, individual EU members adopted various fixes resulting in a patchwork of regulatory requirements inconsistent with the goal of harmonized insurance regulation across the EU. Solvency II addresses this goal of harmonization.

Scheduled to Take Effect in the EU on Dec. 31, 2012

Source: European Commission; Wikipedia: http:en.wikipedia.org/wiki/Solvency_II; Insurance Information Institute

30

Solvency II: The EU’s Effort to Modernize Insurance Solvency Regulation

Consists of 3 Main “Pillars” Pillar 1: Quantitative Requirements (e.g., amount of

required capital)– Establishes qualitative and quantitative requirements for

calculation of technical provisions and Solvency Requirement Ratio (SCR) using either a standard regulator-provided formula or an internal model developed by the (re)insurer itself

Pillar 2: Governance Requirements

Pillar 3: Disclosure and Transparency Requirements

Source: European Commission; Wikipedia: http:en.wikipedia.org/wiki/Solvency_II; Insurance Information Institute

31

Premiums Written per $1 of Surplus*,2000-2009

*for L-H companies, surplus includes AVR and IMRSources: ISO, A.M .Best, I.I.I.

$2.34

$2.08$2.20

$1.89

$1.63

$1.98

$1.46

$0.96$1.14

$1.33$1.20

$1.10 $1.03$0.93 $0.86

$0.96$0.82

$1.63$1.55

$1.83

$0.0

$0.5

$1.0

$1.5

$2.0

$2.5

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

L-H P-CLowest (Strongest) Ratios in History

The lower the ratio, the more capital and surplus the industry hasfor the risk assumed (as proxied by Net Written Premiums).

32

Convincing the General PublicThat Insurers

Are Stronger and Safer Than Banks

A Challenge

P/C Insurer Impairments, 1969–2010*8

15

12

71

19

34

91

31

21

99

16

14

13

36

49

31 3

45

04

85

56

05

84

12

91

61

23

11

8 19

49 50

47

35

18

14 15 16 18

45

0

10

20

30

40

50

60

70

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

10

*Through June 21, 2010Source: A.M. Best Special Report “1969-2009 Impairment Review,” June 21, 2010; Insurance Information Institute.

The Number of Impairments Varies Significantly Over the P/C Insurance Cycle, With Peaks Occurring Well into Hard Markets

8 of the 18 are Florida

carriers

Number of Impaired L/H Insurers,1976–2009

61

11

71

0 12 13

12

32

16

16

16

23 2

75

54

68

13

82

41

21

11

91

81

22

61

08 1

05 5

10

38 9

12

0

10

20

30

40

50

60

70

80

90

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

Source: A.M. Best Special Report “1969-2009 Impairment Review”; Insurance Information Institute.

The Number of Impairments Spiked in 1989-92, with Smaller Spikes in 1983 and 1999. But in the Financial Crisis, When Hundreds of Banks Failed,

Virtually No Life Insurers Failed.

Average number

of impairments,

1976-2009: 18.6

Compare this stellar performance in 2008-09 with that of banks.

Number of Failed FDIC-Insured Banks,and Impaired Insurers, 2007–2010*

3

25

140146

8 9 125

16 18

40

20

40

60

80

100

120

140

160

2007 2008 2009 2010*

FDIC-Insured Bank Failures Impaired L-H Insurers Impaired P-C Insurers

*Bank failures through Nov 12, 2010; P-C impaired insurers through June 21, 2010; L-H impairments in 2010 NA.Sources: A.M. Best Special Reports; FDIC; Insurance Information Institute.

In the Financial Crisis, When Hundreds of Banks Failed,Virtually No Life or P-C Insurers Failed.

36

Two Populations with Very Different Financial Vulnerabilities and Needs:

Ages 65-74 and Ages 75+

Opportunities for Growth

37

Key Demographicsfor People Age 65+ in 2009

Source: http://www.bls.gov/cex/csxstnd.htm#2009

65-74 75+ Difference

% Educational Attainment: Grades

1-89-12

College

8%42%50%

12%48%40%

The 65-74 age group

is more educated

Male %Female %

46%54%

39%61%

Age of household reference person

68.9 81.6

Number of people in consumer unit

1.9 1.6

This will change as the “baby boom”

generation hits this age range

Labor Force Participation Rate, Ages 65-69, Quarterly, 1998-2010:Q3

25.2%

25.2%26.3%

26.5%

26.2%

27.9%

27.2%

27.4% 27.9%

27.3% 27.8%

27.6%

26.8% 27.6%

29.3%

29.5%

27.9% 28.5%

28.7%

30.8%

29.3% 30.1%

29.1%30.3%

30.1% 30.9%

31.0%

30.7%

31.0%

31.4%

30.9%

31.2%

31.6%

31.3%

31.5%

27.0%

22.9%

23.0%

22.8%

23.0%

22.3%

22.5%

22.1%

23.5% 24.4%

24.4%

24.3% 24.9%

24.4%

24.4%24.8%

20%

22%

24%

26%

28%

30%

32%

1998.1

1998.2

1998.3

1998.4

1999.1

1999.2

1999.3

1999.4

2000.1

2000.2

2000.3

2000.4

2001.1

2001.2

2001.3

2001.4

2002.1

2002.2

2002.3

2002.4

2003.1

2003.2

2003.3

2003.4

2004.1

2004.2

2004.3

2004.4

2005.1

2005.2

2005.3

2005.4

2006.1

2006.2

2006.3

2006.4

2007.1

2007.2

2007.3

2007.4

2008.1

2008.2

2008.3

2008.4

2009.1

2009.2

2009.3

2009.4

2010.1

2010.2

2010.3

Source: US Bureau of Labor Statistics, US Department of Labor; Insurance Information Institute.

The brown bars indicate recessions.

Labor Force participation rate

The labor force participation rate for workers 65-69 might grow even faster in the future as seniors find they can’t fully retire on their meager retirement savings.

Labor Force Participation Rate,Ages 70-74, Quarterly, 1998-2010:Q3

14.2%

13.8%14.2%

14.0%

14.0%14.4%

14.4% 14.9%

14.9% 15.4%

15.6%

15.3%

16.4% 17.0%

15.8%16.2% 16.7%

16.9%

17.2%

17.0%

16.7%

16.8%

18.0%

17.5%

17.3%

16.9%

18.6%

18.2%

17.7%

17.9%18.9%

19.2%

18.0%

18.1%

17.4%

14.6%

13.1%13.6%

12.4%12.9%

12.4%

12.2%

12.5% 13.1%

13.3%

13.5%

13.6%

13.8% 14.4%

13.7% 14.2%

10%

12%

14%

16%

18%

20%



The labor force participation rate for workers 70-74 grew by about 50% since 1998,but growth has stalled since the Great Recession began.

Labor Force Participation Rate,Ages 75 & over, Quarterly, 1998-2010:Q3

5.4%

5.1%5.1% 5.2%

5.0%

5.5%

5.9%

5.8% 5.9% 6.0% 6.1%

6.5%

6.1%

6.6%

6.3%

6.7%

6.4%6.6%

6.0%

6.5%6.5%

7.1%

7.0%

6.9%6.9%

7.2%7.4%7.6%7.6%

7.0%7.2% 7.3%7.3%

6.9%

7.7%

5.8%

5.4%

5.1%

4.8%5.0%

4.6%4.6%

4.5%

5.2%5.4%

5.3%

5.2% 5.3%

5.2%5.2%

5.1%

4%

5%

6%

7%

8%



These people were born before 1935

This percent is forecast to grow to

10.3% by 2018

The labor force participation rate for workers 70-74 grew by about 50% since 2002,but growth has stalled since the Great Recession began.

41

Overview of Annual Income for People Age 65+ in 2009

Source: http://www.bls.gov/cex/csxstnd.htm#2009 ; I.I.I.

65-74 75+ Change from 65-74 to 75+

After-tax income $46,147 $31,272 $-14,875

Earnings $20,573 $6,106 $-14,467

Social Security $23,578 $22,038 $-1,540

All other income $3,135 $3,571 $436

Avg annual expenditures $42,957 $31,676 $-11,281

After-tax Income minus expenditures

$3,190 $-404

Shift from saving to dis-saving

Almost all of the income drop was due to stopping

earning

42

Overview of Annual Expendituresfor People Age 65+ in 2009

Source: http://www.bls.gov/cex/csxstnd.htm#2009 ; I.I.I.

65-74 75+ Change from 65-74 to 75+

Avg annual expenditures $42,957 $31,676 $-11,281

Healthcare expenses $4,906 $4,779 $-127

Vehicle costs $6,657 $3,334

Housing (ex mortgage int) $12,486 $11,208

Public Transportation $376 $297 $-79

Food at home $3,567 $2,851 $-716

Cash contributions 2,087 $2,378 $291

All other expenditures $4,401 $1,520 $-2,881

Vehicle insurance $1,214 $712 $-502

Life/other personal insurance

$397 $234 $-163

Mortgage interest $1,976 $603 $-1,373

Healthcare costs don’t drop with drop in income

Mortgages finally paid off? Probably not true for the

next generation

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