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 ♦ bobh@iii.org ♦ 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

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www iii orgwww.iii.org

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