The “New Normal”of Business and

Insurance

Steven N. Weisbart, Ph.D., CLU, Senior Vice President and Chief EconomistInsurance Information Institute 110 William Street New York, NY 10038

Tel: (212) 346-5540 Cell: (917) 494-5945 stevenw@iii.org www.iii.org

Defense Days Business MeetingWestfield Insurance

Westfield, OHAugust 18, 2009

• The U.S. Economy

• The P-C Insurance Industry

• The Liability Insurance Marketplace

• Litigation/Tort System Cost Trends

Q&A

Presentation Outline:The “New Normal” in…

The “New Normal”in the U.S. Economy

Tough Times forthe Foreseeable Future

• High levels of unemployment/ underemployment

• Low levels of investment return

• Low levels of new borrowing Affects housing, autos, other consumer durables

• Low levels consumer demand/ business investment Significant increase in the personal saving rate, but

virtually all used to pay down outstanding debt

What Does the “New Normal”Economy Look Like?

0

2

4

6

8

10

12

14

16

18

Jan-

00

Jan-

01

Jan-

02

Jan-

03

Jan-

04

Jan-

05

Jan-

06

Jan-

07

Jan-

08

Jan-

09

Traditional Unemployment Rate U-3Unemployment + Underemployment Rate U-6

January 2000 through June 2009, seasonally adjusted

U-6 went from 9.2% in April 2008 to 16.5% in June 2009

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

9.5% June 2009 unemployment rate (U-3) was the highest monthly rate since 1983. Peak rate in the

last 30 years: 10.8% in Nov-Dec 1982.

Unemployment and UnderemploymentRates: Rocketing Up in 2008-9

Percent

U.S. Unemployment Rate ForecastsQuarterly, 2009:Q3 to 2010:Q4

10.0%

10.4%10.6% 10.6% 10.6%

10.5%

9.8%

10.0%10.1%

10.0%9.9%

9.7%9.6%

9.8% 9.8%9.6%

9.3%

8.9%

8.5%

9.0%

9.5%

10.0%

10.5%

11.0%

09:Q3 09:Q4 10:Q1 10:Q2 10:Q3 10:Q4

10 most pessimistic consensus 10 most optimistic

Sources: Blue Chip Economic Indicators (7/09); Insurance Info. Inst.

Broad agreement, for now: Unemployment to peak in 2010:Q1.

-4%

0%

4%

8%

12%

16%

2004

:Q1

2004

:Q2

2004

:Q3

2004

:Q4

2005

:Q1

2005

:Q2

2005

:Q3

2005

:Q4

2006

:Q1

2006

:Q2

2006

:Q3

2006

:Q4

2007

:Q1

2007

:Q2

2007

:Q3

2007

:Q4

2008

:Q1

2008

:Q2

2008

:Q3

2008

:Q4

2009

:Q1

Home Mortgage Consumer Credit Business Corporate

Households and BusinessesAre Now “Deleveraging”

Percent Change in Debt Held (Quarterly since 2004 at Annualized Rate)

Source: Federal Reserve Board, at http://www.federalreserve.gov/releases/z1/Current/z1r-2.pdf

Millions Fewer Private Homesto be Started through 2010

2.07

1.80

1.36

0.90

0.55

0.76

1.48

1.351.

46

1.29

1.20

1.01

1.19

1.47

1.62 1.64

1.57 1.60

1.71

1.85

1.96

0.5

1.0

1.5

2.0

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09F 10F

Measured by number of new units started, exposure growth for HO insurers is low.

Housing start data also affects commercial insurers with construction risk exposure.

I.I.I. estimate: each 100,000 decline in housing starts “costs” home insurers $90

million in gross premium. Estimated premium loss in 2008 vs. 2005: about $1

billion.

Sources: US Department of Commerce; Blue Chip Economic Indicators (7/09); Insurance Information Inst.

Millions of Units

Housing bubble

Recession

Recession

16.916.916.6

17.117.5

17.817.4

16.516.1

13.1

10.1

11.7

9

12

15

18

99 00 01 02 03 04 05 06 07F 08 09F 10F

Yearly new auto/light truck sales are forecast

to drop by 6 million units in 2009 vs. 2007

Falling auto sales will have a smaller effect on auto insurance exposure growth than problems in the housing market will have

on home insurers

Weak Economy, Tight Creditare Hurting Auto Sales

Source: US Department of Commerce; Blue Chip Economic Indicators (7/09); Insurance Information Inst.

Millions of Units Sold

Theory: Re-ignited Inflation Won’t ThreatenUntil the Economy Returns to a Full-Employment

Level—Likely a Few Years Away

The markets are starting to worry that the flood of money for the recovery will re-ignite inflation (the spread between 10-Year TIPS and 10-Year T-Notes is widening).

Source: Cooper, “Hints of Recovery—And Fears of Inflation,” BusinessWeek, May 11, 2009, p. 8

The “New Normal”for the P.C. Insurance

Industry

Premiums, InvestmentsFlat or Down;

Pressure on Expenses

Year-to-Year Change in Net Written Premium, 2000-2009:Q1

Sources: A.M. Best, but 2009:Q1 is from ISO.

5.0%

8.4%

15.3%

10.0%

3.9%

0.5%

4.2%

-1.0% -1.4%

-3.6%2000 2001 2002 2003 2004 2005 2006 2007 2008 2009:Q1

First multi-year decline in NWP since 1930-33

-$55

-$45

-$35

-$25

-$15

-$5

$5

$15

$25

$35

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:Q

1*

Underwriting Gain/(Loss) 1975-2009:Q1

Sources: A.M. Best; ISO; Insurance Information Institute

Billions In the past 34 years, only twice has the p-c insurance industry earned an underwriting profit of over $1.7

billion. In contrast, in that span it’s had underwriting losses of $20 billion or more in 14 years.

Underwriting Expense Ratios LikelyWill Rise as Premium Growth Lags

23.4%

24.3%25.0% 26.2%

24.4%

24.5%24.8%25.6%

24.6%

25.6%

24.7%

26.1%25.9%

27.7%

30.8%

28.3%

26.3%26.4%25.6%

30.0%

31.1%

29.4%

29.9%

29.1%

26.6%

25.0%

22%

24%

26%

28%

30%

32%

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

Personal Commercial

*Ratio of expenses incurred to net premiums written.Sources: A.M. Best; ISO; Insurance Information Institute

2009:Q1 blended ratio was 29.1%

115.8

107.5

100.198.4

100.8

92.6

102.2

105.1

101.2

95.5

90

100

110

120

2001 2002 2003 2004 2005 2006 2007 2008 2008* 2009:Q1

P/C Insurance Industry Combined Ratio, 2001-2009:Q1

*Includes Mortgage & Financial Guarantee insurers. Sources: A.M. Best.

Best combined ratio since 1949

(87.6)

As recently as 2001, insurers paid out nearly $1.16 for every

$1 in earned premiums

Relatively low CAT

losses, reserve releases

Including Mortgage & Fin’l

Guarantee line

Cyclical Deterioration

15

2005 ratio benefited from heavy use of reinsurance which lowered net losses

2%

3%

4%

5%

6%

7%

8%

9%

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09*

10*

P-C Inv Income/Inv Assets 10-Year Treasury Note

P/C Investment Income as a % of Invested Assets Follows 10-Year U.S. T-Note

*Blue Chip consensus forecasts. Sources: Board of Governors, Federal Reserve System; Blue Chip Economic Indicators (7/09 issue) A.M.Best; Insurance Information Institute.

Investment yield historically tracks 10-

year Treasury note quite closely

The “New Normal”in the

Liability Insurance Marketplace

Liability: Average Yearly Cost* Small and Medium-Sized Businesses, 2002-2008

$1.9

6

$0.9

4

$2.3

1

$1.3

0

$1.0

3

$3.2

1

$1.5

6

$1.2

7

$3.0

9

$1.3

7

$1.0

8

$2.3

3

$1.2

4

$0.9

5

$2.4

9

$1.0

6

$1.8

9

$0.9

6

$0.6

5

$0.7

2$1.0

7

$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

$4.00

$0 - $200M $201M-$500M $501M-$1B

2002 2003 2004 2005 2006 2007 2008

*per $1,000 of revenue, across entire liability program (full population)

Source: Marsh, 2008 Limits of Liability Report

Costs have generally declined since 2004

Liability: Average Yearly Cost* Medium and Large Businesses, 2002-2008

$0.3

8

$0.2

4

$0.6

7

$0.4

2

$0.1

7

$0.8

6

$0.3

6

$0.1

8

$0.7

7

$0.4

4

$0.1

3

$0.6

9

$0.3

2

$0.1

6

$0.6

3

$0.1

4

$0.5

4

$0.2

7

$0.1

0

$0.1

3$0.2

3

$0.00

$0.25

$0.50

$0.75

$1.00

$1B-$5B $5B-$10B $10B+

2002 2003 2004 2005 2006 2007 2008

*per $1,000 of revenue, across entire liability program (full population)

Source: Marsh, 2008 Limits of Liability Report

Costs have generally declined since 2004.

Excess Liability Market Capacity– North America

Source: Marsh, 2008 Limits of Liability Report

$2.0

15

$1.6

60

$1.6

45

$1.5

70

$1.5

35

$1.4

25

$1.5

75

$1.7

10$

2.0

45

$1.9

41

$2.0

11

$1.7

21

$1.4

05

$1.3

34

$1.4

32

$1.0

$1.5

$2.0

$2.5

$3.0

Bil

lion

s

In 2008, capacity returned to 2000 levels, but it probably retreated again in 2009

Litigation, Tort System Cost Trends

In the ‘60s, ’70s, and ’80s, Tort System Costs Grew Much Faster than Inflation

2%

4%

6%

8%

10%

12%

1961-70 1971-80 1981-90 1991-2000 2001-08

Tort Costs CPI

Sources: US Bureau of Labor Statistics, Tillinghast-Towers Perrin, 2008 Update on U.S. Tort Costs; Insurance Info. Inst.

In the 1990s and Since 2003, Tort System Cost Growth Has Moderated

-6%

-3%

0%

3%

6%

9%

12%

15%

2001 2002 2003 2004 2005 2006 2007 2008

Rate of Tort System Cost Growth CPI

Sources: US Bureau of Labor Statistics, Tillinghast-Towers Perrin, 2008 Update on U.S. Tort Costs; Insurance Info. Inst.

Over the Last Three Decades, Total Tort Costs* as a % of GDP Appear Somewhat Cyclical

$0

$50

$100

$150

$200

$250

$300

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008E

2010E

Tor

t S

yste

m C

osts

1.50%

1.75%

2.00%

2.25%

2.50%

Tor

t C

osts

as

% o

f G

DP

Tort Sytem Costs Tort Costs as % of GDP

Sources: Tillinghast-Towers Perrin, 2008 Update on US Tort Cost Trends, Appendix 1A; I.I.I. calculations/estimates for 2009 and 2010

Billions

*Excludes the tobacco settlement, medical malpractice

2009-2010 Growth in Tort Costs as % of GDP is due in part to shrinking GDP

In 10 Years, the Average Jury Award Grew (Inflation-Adjusted) by 60%

$602

$725 $747

$756

$834

$827

$1,0

62

$1,0

52

$986

$1,2

24

$790

$931

$928

$913

$991

$1,2

02

$1,1

52

$1,0

46

$1,2

62

$961

$500

$700

$900

$1,100

$1,300

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

($00

0)

Nominal $ 2009 Inflation-Adjusted $

Source: Jury Verdict Research; Insurance Information Institute.

Average Jury Awardsfor Selected Cases

$602

$170

$564

$834

$219

$1,2

24

$472

$1,3

75

$590

$0

$500

$1,000

$1,500

Overall Vehicular Liability Premises Liability

($00

0)

1998 2002 2007

Source: Jury Verdict Research; Insurance Information Institute.

Average Jury Awardsfor Selected Cases (cont’d)

$2,3

38

$2,7

31

$2,8

54

$4,1

64

$4,4

26 $4,8

44

$3,7

17

$4,0

43

$5,4

87

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

Wrongful Death* Medical Malpractice Products Liability

($00

0)

1998 2002 2007

*Adult malesSources: Jury Verdict Research; Insurance Information Institute.

Shareholder Class Action Lawsuits Filed Annually in Federal Courts*

*Securities fraud suits filed in U.S. federal courts; 2009 figure is current through 07/15/09. 2001 figure excludes 312 IPO suits that were unique to that year.

Source: Stanford University School of Law (http://securities.stanford.edu ); Insurance Information Institute

164

202

163

231

188

111

173

241

209 216

186

266

227238

182

119

176

224

87

0

50

100

150

200

250

300

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09*

In 2008, litigation against financial services firms accounted for more than half (114 class actions)

EEOC Workplace Discrimination Complaints, FY1997-FY2008

80.779.6

77.479.9 80.8

84.4

81.379.4

75.4 75.8

82.8

95.4

70

80

90

100

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

Biggest jumps came from retaliation and age discrimination

complaints

Thousands of Complaints

Source: EEOC at http://www.eeoc.gov/stats/charges.html

Insurer Defense and Cost Containment Expensesas a Percent of Incurred Losses, 2005-2008*

28.3

%

11.1

%

10.0

%

6.6%

27.1

%

11.0

%

9.9%

6.6%

24.5

%

12.0

%

11.6

%

6.1%

24.4

%

11.4

%

10.7

%

5.9%

0%

8%

16%

24%

32%

Per

cen

t of

In

curr

ed L

osse

s

2005 2006 2007 2008

*Net of reinsurance, excl. state funds. ***Excludes products liability.Sources: National Association of Insurance Commissioners (NAIC) Annual Statement Database, via Highline Data, LLC; Insurance Information Institute.

Insurer Defense and Cost Containment Expensesas a Percent of Incurred Losses, 2005-2008*

70.0

%

48.0

%

42.2

%

134.

5%

56.6

%

36.7

%

78.6

%

55.1

%

41.2

%

64.5

%

58.1

%

34.3

%

0%

50%

100%

150%

Products Liability Medical Malpractice Comm. M-P**

Per

cent

of

Incu

rred

Los

ses

2005 2006 2007 2008

*Net of reinsurance. **Liability portion only.Sources: National Association of Insurance Commissioners (NAIC) Annual Statement Database, via Highline Data, LLC; Insurance Information Institute.

The Administrative Expense Portion of Tort Costs Has Stabilized Since the 1980s

32.2%

29.0%

26.0%

22.0%

23.0%

23.5%2000-2007

1990-1999

1980-1989

1970-1979

1960-1969

1950-1959

Source: Tillinghast-Towers Perrin, 2008 Update on U.S. Tort Costs

• A switch to small, fuel-efficient cars with less crash-protection could lead to more severe accidents

• If a Financial Products Safety Commission is created as part of regulatory reform, suits might be filed claiming damages resulting manufacture or sale of “defective” financial products

• A more liberal federal judiciary and executive branch could ease standards for bringing tort actions

• There are many emerging risks to be alert to

What Else Could DriveTort System Costs Up?

Landscape of Emerging Risks

Invasionof privacy

Bogus parts

Powersystembreak

Organisedcrime

CO2 trading

Off-shore &internetmarkets

Spaceweather

ElectrosmogResistance to

antibiotics

Drinkingwater quality

Loss of reputation

Businessethics

Intercontinentaldata transmission

Customised drugs

NanotechnologyCaldera

erruption

RSI

Cyberrisks

Dirtybombs

Implants

Indoorpollution

Toxic mold

Foodcontaminants

Stress atwork

EndocrinedisruptorsMedia

risks

Ageinginfrastructures

Tele-medicine

CloningDeteriorating

safetystandards

Alcohol

Contingent Business

Interruption

MegaTsunami

Pervasivecomputing

Privatisation

Botox

Spread ofdiseases

Source: Sean Russell, “Emerging Risks: Risk perception at Swiss Re,” Presentation delivered July 4, 2007, at www.casact.org

• The U.S. economy will likely struggle for perhaps a few more years

• The P-C insurance industry will likely be challenged by low exposure growth, low investment results, and expense and profitability pressures

• The costs of liability insurance and the tort system generally have recently moderated, but not in all cases

• There are many emerging risks to be alert to

Q&A

Presentation Summary

Insurance Information Institute On-Line

Thank you for your timeand your attention.