I.I.I. quarterly P/C industry snapshot:Fourth quarter 2017

Information and analysis provided by the Insurance Information Institute

2

2017:Q4 Overview:The insurance industry and the economy

• Ample (excess?) capital continues to spur competition.

• Premium rates are flat or falling in most markets, except auto, where loss costs force rates higher.

• 2018 Combined Ratio will vary by line of business but will likely be close to 100, except Commercial Auto (108) and Workers Comp (95).

• Exposures will grow with the economy.

P/C insurance markets

Financial markets The U.S. economy

• Interest rates remain near historic lows. Projections for rate increases have gotten more modest.

• Overall inflation remains below 2 percent; that’s likely to continue for five or more years.

• Carriers are giving alternative investments –ETFs, equities, real estate – a close look.

• Real GDP continues its slow, steady 2-3 percent annual growth.

• Unemployment rates suggest we are near full employment but other measures say no.

• This is the second longest expansion since WWII, but there are no signs of a future recession.

Commercial lines trends: 2017:Q4

4

Investments predict premium growth*

*Commercial property direct premiums written (fire, allied lines, CMP, inland marine, burglary and theft); business fixed investment (structures, equipment, and software).

Note: Recession indicated by gray shaded column. Data are seasonally adjusted annual rates.

Sources: https://fred.stlouisfed.org/series/PNFI#0; National Bureau of Economic Research (recession dates); Insurance Information Institute.

-20%

-10%

0%

10%

20%

30%

07:Q2 08:Q2 09:Q2 10:Q2 11:Q2 12:Q2 13:Q2 14:Q2 15:Q2 16:Q2 17:Q2

Recession

% change, property ins premiums

% change, fixed investment

4.9%

% change from same quarter, prior year

Business fixed investment is forecast to grow at 5%–6% in 2017:2H and at 4.5%–5.5% in 2018.

Investment in equipment and software is expected to grow but investment in structures is expected to shrink.

5

As hiring goes, exposures follow

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

0

5,000

10,000

15,000

20,000

25,000

07:Q1 08:Q1 09:Q1 10:Q1 11:Q1 12:Q1 13:Q1 14:Q1 15:Q1 16:Q1 17:Q1

Manufacturing Construction Mining & other extraction

20,095

22,391

17,668

Employment in the three industries that are the heart of workers composition exposure is not quite back yet to the level reached before the Great Recession.

000 at quarter-end

6

Price changes* for hospital care

*Percentage change from same month in prior year; through October 2017; seasonally adjusted.

Sources: US Bureau of Labor Statistics; National Bureau of Economic Research (recession dates); Insurance Information Institute.

0%

2%

4%

6%

8%

10%

12%

99 01 03 05 07 09 11 13 15 17

Recession

Hospital CPI

For the past 5 years,

price changes

ranged from 3%-6%

Over the last two decades, prices for hospital care rose, on average, several percentage points faster than for medical services generally.

Personal lines trends: 2017:Q4

8

Driving patterns predict claim frequency

Billions of miles driven in prior year

Sources: Federal Highway Administration; Rolling four-quarter average frequency from Fast Track Monitoring System; Insurance Institute for Highway Safety; Insurance Information Institute.

5.5

5.6

5.7

5.8

5.9

6.0

6.1

6.2

2,900

2,950

3,000

3,050

3,100

3,150

3,200

3,250

06:Q

2

06:Q

4

07:Q

2

07:Q

4

08:Q

2

08:Q

4

09:Q

2

09:Q

4

10:Q

2

10:Q

4

11:Q

2

11:Q

4

12:Q

2

12:Q

4

13:Q

2

13:Q

4

14:Q

2

14:Q

4

15:Q

2

15:Q

4

16:Q

2

16:Q

4

17:Q

2

Miles driven Collision claim frequency

Overall collision claims per 100 insured vehicles

The only force that could derail this relationship would be a sharp and persistent rise in the cost of gasoline.

Recession

9

58

60

62

64

66

68

70

72

74

76

78

32

34

36

38

40

42

44

46

90:Q

1

91:Q

1

92:Q

1

93:Q

1

94:Q

1

95:Q

1

96:Q

1

97:Q

1

98:Q

1

99:Q

1

00:Q

1

01:Q

1

02:Q

1

03:Q

1

04:Q

1

05:Q

1

06:Q

1

07:Q

1

08:Q

1

09:Q

1

10:Q

1

11:Q

1

12:Q

1

13:Q

1

14:Q

1

15:Q

1

16:Q

1

16:Q

3

17:Q

3

Renter-occupied Owner-occupied

To rent or to buy?

Sources: U.S. Census Bureau at http://www.census.gov/housing/hvs/data/histtabs.html, Table 8; Insurance Information Institute.

Millions of owner-occupied

housing units

Millions of renter-occupied

housing units

Since 2004 the number of renter-occupied housing units has grown by about 10.5 million units (+34%), but there has been no growth in the number of owner-occupied housing units in 12 years. Did this streak end in 2017?

Economic and financial trends:

2017:Q4

11

P/C industry net income after taxes*

*Through second quarter. Adjusted for inflation using the BLS CPI calculator, to 2017 dollars.Sources: A.M. Best Special Report, ”A.M. Best First Look – 2Qtr 2017 U.S. Property/Casualty Financial Results”; ISO, a Verisk Analytics company; Insurance Information Institute.

$36.6

$15.6

$6.6

$18.6

$5.2

$17.6

$25.2$26.8

$31.9

$22.0

$15.5

$0

$5

$10

$15

$20

$25

$30

$35

$40

07 08 09 10 11 12 13 14 15 16 17

Billions, 2017 dollars

In the first half of the year, net income varied. 2017 was the third-lowest profit in the last 11 years.

12

Key sources of P/C insurer profits

Data are before taxes and exclude extraordinary items.

Sources: NAIC data, sourced from S&P Global Market Intelligence; Insurance Information Institute.

$27.8

$14.1

$25.8 $28.4$25.4 $27.1

$30.2 $31.6$26.6 $27.1

-$6.3-$2.5

-$5.7

-$26.1

-$7.5

$2.4 $0.3

$3.5

-$1.5-$4.5

-$30

-$20

-$10

$0

$10

$20

$30

$40

$50

08 09 10 11 12 13 14 15 16 17

Net investment gains Underwriting gains/losses

$ Billions

13

Sources of investment gains

Through second quarter.

Sources: ISO/PCI; Insurance Information Institute.

$29.0 $26.9$23.6 $24.8 $23.7 $23.2 $23.0 $23.4 $22.2 $23.5

-$1.2

-$12.8

$2.2$3.9

$1.7 $3.9$7.2 $8.2

$4.4 $3.6

-$20

-$10

$0

$10

$20

$30

$40

08 09 10 11 12 13 14 15 16 17

Net investment income Realized capital gains/losses

Billions

In the first half of the year, net investment income has been steady, but realized capital gains/losses have been quite variable.

14

Bond yields

Note: Recession indicated by gray shaded column.

Sources: https://fred.stlouisfed.org/series/AAA#0 ; National Bureau of Economic Research (recession dates); Insurance Information Institute.

3.00%

3.25%

3.50%

3.75%

4.00%

4.25%

4.50%

4.75%

5.00%

5.25%

5.50%

5.75%

6.00%0

7:Q

1

07:Q

3

08:Q

1

08:Q

3

09:Q

1

09:Q

3

10:Q

1

10:Q

3

11:Q

1

11:Q

3

12:Q

1

12:Q

3

13:Q

1

13:Q

3

14:Q

1

14:Q

3

15:Q

1

15:Q

3

16:Q

1

16:Q

3

17:Q

1

17:Q

3

Yie

ld

3.65%

Top investment-grade bond yields have ranged from 3.8% to 4.0% for the last 3 years. 2017:Q3 was 3.65%. These yields probably won’t rise much above 4.5% through 2018.

15

Change* in the core** Consumer Price Index

*Monthly, year-over-year, through October 2017. Seasonally adjusted. **CPI less food and energy.

Sources: US Bureau of Labor Statistics; National Bureau of Economic Research (recession dates); Insurance Information Institute.

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

04 05 06 07 08 09 10 11 12 13 14 15 16 17

Recession Core CPI

Over the last decade, prices tracked by the Core CPI have generally risen about 2% per year.

Quarterly industry snapshotspecial report: 2017:Q4

Is a hard market coming?

17

Is a hard market coming?

How is a hard market defined?

A hard market occurs when insurance premiums grow substantially faster than the economy.

– Premiums are measured by Net Written Premiums

– The economy is measured by nominal GDP

The last hard market was 15 years ago. Are we due for another one?

With three major hurricanes, an earthquake and record wildfires in the third quarter of the year, following an above-average catastrophe first-half, there is talk about a “hard market” emerging.

18

Three hard markets in the last 45 years

Shaded areas indicate hard markets.

Sources: A.M. Best (1971-2013), ISO (2014-16); U.S. Commerce Dept., Bureau of Economic Analysis; Insurance Information Institute calculations.

8.7%

14.6%

-10%

-5%

0%

5%

10%

15%

20%

72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16

10.7%

16.6%

12.0%

Net Premium Growth (All P/C Lines) Minus Nominal GDP, Annual Change

19

What predicts a hard market?

There are a number of theories. A hard market is thought to develop when…

Return on equity falls to 4 percent or below

Surplus drops due to financial market declines and/or significant underwriting losses

There are unusually large losses due to catastrophes

20

P/C industry ROE and hard markets

Year P/C Industry

ROE less

than 4%

Growth of

(NWP-GDP) in

following year

Hard Market?

1975 2.4% 10.7% Yes

1984 1.8% 14.6% Yes

2001 -1.2% 12.0% Yes

2002 2.1% 5.1% Yes

2017 <4% ? ?

This has been a reliable predictor. The last four times ROE fell below 4 percent, a hard market followed. One of those times (2002), a hard market was

already under way.

21

Policyholder surplus and hard markets

Year Surplus

decline

Growth of

(NWP-GDP) in

following year

Hard Market?

1984 -2.7% 14.6% Yes

1999 -0.9% -1.5% No

2000 -4.7% 5.1% Yes

2001 -8.0% 12.0% Yes

2008 -12.5% -2.2% No

2011 -0.8% 0.2% No

2017 >0%? ? ?

This has not been a reliable predictor. Three times after a decline in surplus, a hard market followed. Three times it did not.

22

Catastrophe claims and hard markets

Year CAT claims over

$35 billion

($2016, billions)

Growth of

(NWP-GDP) in

following year

Hard Market?

1992 $39.6 0.9% No

2001 $36.4 12.0% Yes

2004 $36.4 -6.2% No

2005 $77.1 -3.1% No

2011 $35.2 0.2% No

2012 $36.8 1.3% No

2017 $80+ ? ?

This is the least reliable predictor. Only one year of outsized catastrophe losses (2001) ushered in a hard market.

23

Hard markets: Conclusion

Industrywide low return on equity is the best predictor of a hard market.

As of this writing, return on equity in 2017 might fall to 4 percent or below, implying a hard market will develop in 2018.

Quarterly industry snapshot

For more information, contact:

Dr. Steven Weisbart | stevenw@iii.org