understand underwriting cycle-ncci ais 2013

7/27/2019 Understand Underwriting Cycle-NCCI AIS 2013

1/51

2013 Annual Issues Symposium

Copyright 2013 NCCI Holdings, Inc. All Rights Reserved.

All You Need to Knowto Understand theUnderwriting Cycle

Harry Shuford

Practice Leader and Chief EconomistMay 16, 2013


2/51

Copyright 2013 NCCI Holdings, Inc. All Rights Reserved.2

Percent

-40

-30

-20

-10

0

10

20

30

40

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

This Tells You Everything You Need to Knowto Understand the P/C Industry

Source: Bests Aggregates & Averages

Calendar Year


3/51


Anatomy of the Underwriting CycleA Financial Economics Perspective

Outline

Four Decades and Four Hard Markets

What Precedes a Hardening?

Financial Markets and the P/C Industry


4/51 Copyright 2013 NCCI Holdings, Inc. All Rights Reserved.4


Four Decades and Four Hard Markets

Common PhasesDifferent Amplitudes

The Industry

Personal Lines

Commercial Lines

Workers Compensation

Other Commercial


5/51 Copyright 2013 NCCI Holdings, Inc. All Rights Reserved.

5

The Underwriting Cycleas Measured by Premium

Growth



6

-10

-5

0

5

10

15

20

25

30

35

40

45

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2011

Calendar Year

Percent Change

Sources: Bests Aggregates & Averages and Highline Data

Changes in Net Written PremiumP/C Industry



7

-10

-5

0

5

10

15

20

25

30

35

40

45

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2011

Calendar Year

Percent Change


Changes in Net Written PremiumPersonal Lines


8/51


-10

-5

0

5

10

15

20

25

30

35

40

45

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2011

Calendar Year

Percent Change


Changes in Net Written PremiumCommercial Lines


9/51


-10

-5

0

5

10

15

20

25

30

35

40

45

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2011

Calendar Year

Percent Change


Changes in Net Written PremiumWorkers Compensation


10/51


-10

-5

0

5

10

15

20

25

30

35

40

45

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2011

Calendar Year

Percent Change


Changes in Net Written PremiumOther Commercial Lines


11/51


The Underwriting Cycleas Measured by Premium Growth

All Lines of Business Follow

the Same Pattern

This Suggests A Common Driver


12/51



What Precedes a Hardening?

Financial Returns

P/C IndustryReturn to Investors By LineOperating Gains


13/51


3.6

17.4

14.7

13.4

9.7

8.5

1.3

2.8

15.1

13.913.4

9.7

8.0

9.5

3.6

11.2

5.8

9.710.1

13.1

9.6

6.6 6.3

-2.3

3.2

9.5

10.611.4

14.4

12.7

0.6

5.9 6.6

3.5

20.520.7

-3.9-5

0

5

10

15

20

25

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

Calendar Year

Percent

Hard Markets Are a Response toLow or Negative Returns to Investors

Annual After-Tax Return on Surplus

Note: After-tax return on surplus includes realized capital gains



14/51


-6

1

4 4

1 12

-3

4

1

4 4

9

5

10

-7

-1

6

86

15

12

0

5 5

0

-25

-20

-15

-10

-5

0

5

10

15

20

25

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Calendar Year

Percent

Returns on Insurance Operations TrackMoves in Return on Surplus

P/C Industry

Pretax Operating Gain RatioPrivate Carriers

Combined Ratio less Investment Gain on Insurance Transaction and Other Income


R I O i T k


15/51


-5

-1

21

-3 -3

0

-5

31

3

1

6

3

1

-5-6

-2

6

97

10

7

-2

0 1

-5

-25

-20

-15

-10

-5

0

5

10

15

20

25

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Calendar Year

Percent


Personal Lines




R t I O ti T k


16/51


-8

2

6 7

4 4 4

-2

6

1

5

7

13

7

3

6

-8

-1

7 7

5

19

17

2

10 10

6

-25

-20

-15

-10

-5

0

5

10

15

20

25

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Calendar Year

Percent


Commercial Lines




W k C ti W Diff t


17/51


-4

-7

-5-6

-5 -4

-9

-3

8

14

18

1618

7

4

0

-8

0

2

6

10

14

11

75

3

0

-25

-20

-15

-10

-5

0

5

10

15

20

25

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Calendar Year

Percent

Workers Compensation Was Different:Losses in the 1980s, Gains in the 1990s

Workers Compensation




Ret ns on Ins ance Ope ations T ack


18/51


-9

5

910

7 79

-1

5

-4

1

5

11

7

3

7

-8

-1

87

4

21

18

1

11 12

7

-25

-20

-15

-10

-5

0

5

10

15

20

25

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Calendar Year

Percent


All Commercial Lines Other Than Workers Compensation





19/51


The Underwriting Cycleas Measured by Premium

Growth

Underwriting Results ImproveDuring Hard Markets

Underwriting Results


20/51


Percent

-40

-30

-20

-10

0

10

20

30

40

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

Underwriting Profit/Loss to Surplus

Underwriting ResultsImprove During Hard Markets

P/C Industry

Underwriting and Investment Contributions to Surplus


Calendar Year

Assessing the Financial Markets


21/51




Anatomy of the Underwriting Cycle


22/51



Greenspans Stock Market Exuberance in the 1990s

and

Investment and Insurance Market Cycles

Did the Stock Market Bubble Impact


23/51


-0.3

0.0

0.3

0.6

0.9

1.2

1.5

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

-9

0

9

18

27

36

45

Did the Stock Market Bubble ImpactUnderwriting Practices?

Change inSurplus:Premium Premium


S:P With Realized and

Unrealized Gains

Calendar Year



24/51


-0.3

0.0

0.3

0.6

0.9

1.2

1.5

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

-9

0

9

18

27

36

45





Unrealized Gains

S:P Without

Unrealized Gains

The

Bubble

Calendar Year



25/51


-0.3

0.0

0.3

0.6

0.9

1.2

1.5

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

-9

0

9

18

27

36

45





Unrealized Gains

S:P Without

Unrealized Gains

The

Bubble

Calendar Year

Impact on Premium of Rate/Loss Cost


26/51


Impact on Premium of Rate/Loss CostDepartures, Schedule Rating, and/or Dividends

NCCI StatesPrivate Carriers

-7.1-7.4

-7.1

-8.5

-10.5

-14.6

-17.7

-22.6-23.2

-19.2

-14.3

-4.0 -1.7

2.10.7

-2.2

-4.7-7.4

-8.3 -8.7-8.0

-25

-20

-15

-10

-5

0

5

10

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011p

Rate/Loss Cost Departure

Schedule Rating

Dividends

Percent

p Preliminary

Dividend ratios are based on calendar year statisticsNCCI benchmark level does not include an underwriting contingency provisionBased on data through 12/31/2011 for the states where NCCI provides ratemaking services

Policy Year



27/51



What Precedes the Cycle?

NCCIs research shows that:

Workers compensation underwriters shared the

Irrational Exuberance of the dot.com bubble

Unrealized gains on P/C company portfolios ofcommon stocks are included in P/C surplus

Eliminating these unrealized gains from reportedsurplus reveals the bubble

As the bubble grew, workers compensation rate

departures increased



28/51




What Is in the Industrys Portfolio?

P/C Companies Portfolios


29/51


/ pDiversifiedMore Than 80% in Bonds

Financial Markets and the P/C Industry Portfolio

Investment Portfolio Composit ion

Top 100 Groups

(excludes investments in related companies)

Bonds 2010

Direct Obligations

US Treasury 7%

Other Gov't. 3%

States, etc. 6%

Political Subdivisions 11%

Industrial/Corporate 22%

Total Direct 49%

Secured Obligations

US Special Revenue Bonds 20%

Total Mortgage Backed Bonds 15%

Total Secured 35%

Total Bonds 84%

Stocks

Common Stock 15%

Preferred Stock 1%

Total Stocks 16%

Total Portfolio 100%

Sources: Highline data, NCCI calculations



30/51


y g yA Financial Economics Perspective

What Precedes the Cycle?

NCCIs research shows that:

P/C markets tighten in periods of decliningestimates of investment returns

P/C markets ease in periods when new investments

are expected to return more than the industrysexisting portfolio

New money yieldestimated return at current market yields usingexisting portfolio mix

Lower Interest During and Immediately After


31/51


Recessions Results in Reduced Yields on P/CFixed Income Portfolios

0

2

4

6

8

10

12

14

'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 '11 '12

Embedded Yield

Source: NCCI

The Fed Typically Reduces Short-Term Interest Rates


32/51


Before the Start of a Recession, With DeclinesContinuing After the Economy Begins to Expand

0

5

10

15

20

'68 '70 '72 '74 '76 '78 '80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12

Percent

Effective Federal Funds Rate

Shaded areas indicate U.S. economic recessionsSource: Board of Governors of the Federal Reserve System

The Fed Typically Reduces Short-Term Interest Rates


33/51



0

5

10

15

20

'68 '70 '72 '74 '76 '78 '80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12

Percent



The Fed Typically Reduces Short-Term Interest Ratesf h f i i h li


34/51



0

5

10

15

20

'68 '70 '72 '74 '76 '78 '80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12

Percent



The Fed Typically Reduces Short-Term Interest RatesB f th St t f R i With D li


35/51



0

5

10

15

20

'68 '70 '72 '74 '76 '78 '80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12

Percent


10-Year Treasury Constant Matur ity Rate


Lower Interest During and Immediately AfterR i R lt i R d d Yi ld P/C


36/51



0

2

4

6

8

10

12

14

'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 '11 '12

New Money Yield

Embedded Yield

Source: NCCI

Lower Interest During and Immediately AfterR i R lt i R d d Yi ld P/C


37/51



0

2

4

6

8

10

12

14

'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 '11 '12

New Money Yield

Source: NCCI

?

The Underwriting CycleA E i Ph


38/51


An Economic Phenomenon

As Measured by Changes in Written Premium, the Timingof the Underwriting Cycle Is Largely Common to AllCategories of P/C Insurance

In Particular, Markets Harden Following Low or NegativeReturns/Operating Gains; Again, the Timing Is Common toAll Categories of P/C Insurance

Therefore It Seems Likely That There Is a CommonDriver

Turning Points in Investment Market Trends Are Difficult toPredict

The Deteriorating Investment Market Returns ThatTypically Precede Insurance Market Hardening Likely AreUnanticipated

The Drivers of P/C Insurancef


39/51


Performance

35 Years of Underwriting Performance

Typically Losses; Occasionally Wide Swings

Underwriting ResultsT i ll L O i ll Wid S i


40/51


Percent

-40

-30

-20

-10

0

10

20

30

40

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011


Typically Losses; Occasionally Wide SwingsP/C Industry

1982 and Prior does not include Total Other Income


Calendar Year



41/51


A Financial Economics Perspective

What Drives the P/C Return on Surplus?

Trying to Balance Underwriting and Investment Results

Underwriting ResultsTypically Losses; Occasionally Wide Swings


42/51


Percent

-40

-30

-20

-10

0

10

20

30

40

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011


Typically Losses; Occasionally Wide SwingsP/C Industry



Calendar Year

Volatility of Return on Surplus:Due to Underwriting Results


43/51


Percent

-40

-30

-20

-10

0

10

20

30

40

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

Return on Surplus


Due to Underwriting ResultsP/C Industry




Calendar Year

Stability of Portion of Return on SurplusThat Is Due to Investment Results


44/51


Percent

-40

-30

-20

-10

0

10

20

30

40

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

Net Investment Income (Inc l. Realized Capital Gains) to Surplus

That Is Due to Investment ResultsP/C Industry




Calendar Year

Why the Downtrend inInvestment Return to Surplus?


45/51


Investment Return to Surplus?

Declining Leverage

(Reserves to Surplus)

Declining Returns on Invested Assets

This Tells You Everything You Need toKnow to Understand the P/C Industry


46/51


Know to Understand the P/C IndustryP/C Industry


0.0

0.5

1.0

1.5

2.0

2.5

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Reserves/Surplus RatioHas Been Trending Downward

Reserves/Surplus



Percent

Calendar Year

This Tells You Everything You Need toKnow to Understand the P/C Industry


47/51


Know to Understand the P/C IndustryP/C Industry


0%

1%

2%

3%

4%

5%

6%

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Net Investment Income/Invested AssetsHas Been Trending Downward

Net Investment Income/Invested Assets



Calendar Year

Return on Surplus: Offsetting Trends inUnderwriting and Investment Returns


48/51


Percent

-40

-30

-20

-10

0

10

20

30

40

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

Return on SurplusUnderwriting Profit/Loss to SurplusNet Investment Income (Inc l. Realized Capital Gains) to Surplus

Underwriting and Investment ReturnsP/C Industry




Calendar Year



49/51






50/51




Just Like Banking, the P/C Industry Is a Financial Sector:

Underwriting as the Source of Funds To Support Investments

This Tells You Everything You Need to Knowto Understand the P/C Industry


51/51


Percent

Calendar Year

-40

-30

-20

-10

0

10

20

30

40

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011


Net Investment Income (Inc l. Realized Capital Gains) to Surplus

/ y



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