“A Plague on Your Houses”

What’s Wrong With Homeowners Insurance Markets

National Conference of State Legislators CouncilSan Francisco, CA

July 24, 2003

Robert P. Hartwig, Ph.D., CPCU, Senior Vice President & Chief EconomistInsurance Information Institute 110 William Street New York, NY 10038

Tel: (212) 346-5520 Fax: (212) 732-1916 bobh@iii.org www.iii.org

Presentation Outline

• Homeowners Insurance Market Financial Performance

• P/C Insurance Industry Financial OverviewThe truth about insurer investment performance

• Impact of Rising HO Insurance Costs and Tighter Underwriting on Real Estate Industry & Homebuyers

• Use of Credit Information in Underwriting Homeowners Insurance

• C.L.U.E. Reports

HOMEOWNERS INSURANCE:

Recent Financial Performance

Industry Net Premiums Written by Product Lines

Source: A.M. Best

1960NPW=$14.7 Billion

2001NPW=$369.1 Billion

Fire2%

A&H4%

ComIMP7%

Allied2%

WC8%

Other Lines19%

OtherLiab7%

HomeMP11%

AutoPhys17%

AutoLiab23%

Fire12% A&H

9%

ComIMP0%

Allied5%

WC8% Other

Lines9%

OtherLiab7%

HomeMP5%

AutoPhys15%

AutoLiab28%

2.9 3.4 3.8 4.2 4.7 5.7 6.8 7.8 8.8 9.8 10

.811

.71

2.5

13

.21

4.1

15

.21

6.7

17

.11

7.7

18

.61

9.3

20

.52

1.5

22

.62

4.0

25

.42

6.9 29

.0 30

.6 32

.4 35

.14

0.0

$0

$5

$10

$15

$20

$25

$30

$35

$40

$45

19

71

19

72

19

73

19

74

19

75

19

76

19

77

19

78

19

79

19

80

19

81

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

($ B

illi

on

s) .

Homeowners Multi-Peril InsuranceNet Premiums Written

Source: Best’s Aggregates & Averages - Property/Casualty

Revenue Growth Drivers:•New home construction•Trend toward larger, more expensive homes•Home price inflation•Home improvements•Rates

113117.7

158.4

113.6118.4

112.7

121.7

101

109.4 108.2111.4

121.7

113

95

100

105

110

115

120

125

130

135

140

145

150

155

160

165

90

91

92

93

94

95

96

97

98

99

00

01

02

Homeowners Insurance Combined Ratio

Average 1990 to 2002= 116.0

Insurers have paid out an average of $1.16 in losses for every dollar earned

in premiums over the past 13 years

2002 Loss: $4.7 Billion

2001 Loss: $7.4 Billion

Sources: A.M. Best; III

Rates of Return on Net Worth

Source: NAIC, Insurance Information Institute

* Average is 0.71% if excluding 1992 (year of Hurricanes Andrew and Iniki.

Note: 2002 Homeowners figure is III estimate.

-0.9%-6.6%

-54.3%

2.5%-1.7% -4.2%

3.8%

-7.2%-4.0%

12.2% 10.8% 10.1%13.7% 14.0% 14.1% 13.9% 13.4% 15.2% 14.6%

10.4%

3.6%

12.4%

5.4%5.4%

10.0%11.9%

-60%

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

NAIC HomeownerMulti-Peril

Fortune All-Industry*

Averages: 1990 to 2002

HO Insurance = -3.52%*

Fortune 500 = 12.64%

$0

$50

$100

$150

$200

$250

Wa

ter

Da

ma

ge

Pa

id L

os

se

s*

($M

illio

ns

)

0

5000

10000

15000

20000

25000

30000

Cla

im C

ou

nt

Paid Losses

Claim Count

Source: Texas Department of Insurance; Insurance Information Institute

* Data are for TDI Cause 61: Discharge – Other Damage. Not all claims in cause 61 are mold and mold claims may also arise from other (non-water) causes of loss.

Texas: Mold Losses/Claims Are Finally Moderating*

California: Surging Water Claim Frequency and Costs:

Symptom of Growing Mold Problem

$224.1

$298.9$316.5

$441.6

$496.3

$562.4

24%

36%

27%

32%33%

31%

$100

$150

$200

$250

$300

$350

$400

$450

$500

$550

$600

1997 1998 1999 2000 2001 2002

20%

22%

24%

26%

28%

30%

32%

34%

36%

38%

Paid Water Losses ($ Mill) Water Claims as % of All Homeowners Claims

Source: Insurance Information Network of California; Insurance Information Institute

•Water losses paid rose 151% from 1997 to 2002 and 77% since 1999

•Water claims accounted for less than 1/4 of all HO claims in 1997, now they for 1/3.

California may be in a drought, but homeowners say they’re drowning

Average Expenditures on Homeowners Insurance: US

$418$440

$455$481 $488

$508$520

$532

$569

$615

$400

$500

$600

$700

95 96 97 98 99 00 01* 02* 03* 04*

*III Estimates; Estimates for 2001-2003 based on BLS CPI data for tenants and household insurance.Source: NAIC, Insurance Information Institute

Average US HO expenditures are expected to rise by 7% in

2003, 8% in 2004

Reasons for Rising HO Insurance Prices

• Enormous underwriting losses are the primary reason for rising homeowners insurance rates today Function of frequency/severity of claims and events

• Home price/repair inflation• Constant threats:

CAT losses (>$100B since 1990); Not just hurricanes/earthquakes, but also major hail/wind events

• New issues such as “toxic” mold cost billions; no prior premium collected

• Litigation is a problem (property & liability related)• Falling capacity; Rising reinsurance costs• Attempts to weaken insurers ability to underwrite

Credit restrictions raise costs for millions (WA, MD & others) CA “emergency” reg. preventing insurers from using claims history in coverage decisions

(Safeco moratorium on new HO policies)

PROPERTY/CASUALTY INSURANCE INDUSTRY:

Recent Financial Performance

P/C Net Income After Taxes1991-2002 ($ Millions)

$14,178

$5,840

$19,316

$10,870

$20,598

$24,404

$36,819

$30,773

$21,865$20,559

-$6,970

$2,903

-$10,000

$0

$10,000

$20,000

$30,000

$40,000

91 92 93 94 95 96 97 98 99 00 01 02

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

2001 was the first year ever with a full year net loss

2002 ROE = 1.0%

-5%

0%

5%

10%

15%

20%

87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03F

US P/C Insurers All US Industries

ROE: P/C vs. All Industries 1987–2003F

Source: Insurance Information Institute; Fortune

There is an enormous gap between the p/c industry’s rate of return and that of most major industry groups

2001 Return on Equity (Profitability)

-7.2%

-5.5%

-0.5%

0.2%

1.0%

2.0%

10.4%

-10% -5% 0% 5% 10% 15%

Fortune 500

PP Auto

Comm Auto

Workers Comp

All P/C

Comm Multi Peril

Homeowners

Source: National Association of Insurance Commissioners, Insurance Information Institute

2001 (Selected Lines)

Investment Issues:

The Truth About P/C Insurer Investment Performance

$0

$9

$18

$27

$36

$45

75 77 79 81 83 85 87 89 91 93 95 97 99 01 03E

Net Investment Income

History

1997 Peak = $41.5B

2000= $40.7B

2001 = $37.7B

2002 = $36.7B

2003E = $35.9B

Bil

lion

s

(US

$)

Investment income fell 2.8%in 2002 and 0.3% in Q1 of 2003 (v. Q1:2002) due primarily to historically low interest rates

Note: 2003 estimate is based on annualized first quarter investment income of $8.984 billion.Source: A.M. Best, Insurance Information Institute

-$5.6 Billion

-30%

-20%

-10%

0%

10%

20%

30%

40%

19

70

19

71

19

72

19

73

19

74

19

75

19

76

19

77

19

78

19

79

19

80

19

81

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

*As of July 23, 2003.Source: Ibbotson Associates, Insurance Information Institute

Total Returns for Large Company Stocks: 1970-2003*

2002 was 3rd consecutive year of decline for stocks

Will it be the last?

S&P 500 up 12.4% so

far this year

P/C Industry Investments,by Type (as of Dec. 31, 2001)

Other5%

Bonds66%

Real Est. & Mortgages

1%

Common Stock21%

Cash & ST Secs.6%

Preferred Stock1%

Bond Holdings, by Type

Industrial & Misc. 32.5%

Special Revenue 30.5%

Governments 18.0%

States/Terr/Other 15.4%

Public Utilities 3.1%

Parents/Subs/Affiliates 0.5%

Source: A.M. Best, Insurance Information Institute

Common stock accounts for about 1/5 of invested

assets

Property/Casualty Insurance Industry Investment Gain*

$ Billions

$35.4

$42.8$47.2

$52.3

$44.4

$36.6

$57.9

$51.9

$56.9

$0

$10

$20

$30

$40

$50

$60

94 95 96 97 98 99 00 01 02

*Investment gains consists primarily of interest, stock dividends and realized capital gains and losses.Source: Insurance Services Office; Insurance Information Institute estimate annualized as of 9/30/02.

Investment gains are simply returning to “pre-bubble” levels

HOUSING MARKETS:

Recent Performance &

Insurance Impact

Difficult to See Where Insurance Issues Significantly Harming Residential

Real Estate Markets• “Record for Home Sales Likely in 2003”

“Record low mortgage interest rates, a growing number of households, rising consumer confidence and an improving economy mean probably will set a third consecutive record for both existing- and new-home sales this year.”

David Lereah, NAR Chief Economist, June 3, 2003

• “Existing Home Sales Still on a Roll in April” “Sales of existing homes single-family homes rose in April 2003 and are at

the fifth highest level of activity ever recorded.” As reported on www.realtor.org on June 13, 2003

• “Most Metro Area Home Prices Rising Above Norms” “…short supply is continuing to put pressure on home prices in many

areas, with more buyers than sellers…” David Lereah, NAR Chief Economist, February 12, 2002

New Private Housing Starts(Millions of Units)

1.19

1.01

1.20

1.29

1.461.35

1.48 1.47

1.62 1.64 1.57 1.60

1.71 1.681.62

1.0

1.1

1.2

1.3

1.4

1.5

1.6

1.7

1.8

1.9

2.0

90 91 92 93 94 95 96 97 98 99 00 01 02 03E 04F

Source: US Department of Commerce; Blue Chip Economic Indicators (5/03), Insurance Info. Institute

New Private Housing Starts

•Housing market remain strong.

•Virtually no exposure impact for insurers

Homeownership Rates,1990 to 2003*

* First QuarterSource: U.S. Census Bureau

63.9%64.1%64.5%

64.0%

64.7%

65.4%65.7%

66.3%66.8%

67.4%67.8%67.9%68.0%

90 92 93 94 95 96 97 98 99 00 01 02 03*

Homeownership is at a record high. Because you can’t buy a home without

insurance, insurance is clearly available and affordable, including to

millions of Americans of modest means and all ethnic groups.

Homeownership Rates in Central Cities, 1990 to 2003*

*First quarter 2003.Source: U.S. Census Bureau

48.7%

49.2%

48.6%48.5%

49.5%49.7%

49.9%50.0%50.4%

51.4%51.9%51.8%51.9%

48.7%

90 91 92 93 94 95 96 97 98 99 00 01 02 03*

Homeownership rates in central cities is rising to record/near record levels Because you can’t

buy a home without insurance, insurance is clearly available and affordable, including to

millions of Americans of modest means and all ethnic groups.

Homeowners Insurance Expenditure as a % of Median Home Price

$107

,200

$115

,800

$121

,800

$128

,400

$133

,300

$139

,000

$147

,800

$158

,300

$110

,500

0.39%

0.38% 0.38%

0.37% 0.37% 0.37%

0.36%

0.35% 0.35%

$100,000

$125,000

$150,000

$175,000

$200,000

94 95 96 97 98 99 00 01 02

0.30%

0.33%

0.35%

0.38%

0.40%Median Sales Price of Existing HomesHO Insurance Expenditure as a % of Sales Price

Source: Insurance Information Institute calculations based on data from National Association of Realtors, NAIC.

HO

Exp

end

iture as %

of Sales P

riceMed

ian

Hom

e S

ales

Pri

ce

The cost of homeowners

insurance relative to the

price of a typical home has fallen!

Change in Cost of Homes vs. Change in Cost of Homeowners Insurance

$3,300

-$2

$5,300

$22

$6,000

$15

$6,600

$26

$4,900

$7

$5,700

$12

$8,800

$12

$10,500

$41

$8,500

$50

-$2,000

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

1995 1996 1997 1998 1999 2000 2001 2002 2003E

Change in Cost of Median Existing Home

Change in Average Homeowners Insurance Expenditure

Recent increases in the cost of homeowners insurance

are miniscule in comparison to the soaring cost of homes

Note: 2003 home price increase based on NAR’s est. of $166,900 median home for 2003.Source: Insurance Info. Inst. calculations based on data from Natl. Association of Realtors, NAIC.

Cumulative Change in the Price of Homes & Homeowners Insurance

$3,300

-$2

$8,600

$20

$14,600

$35

$21,200

$61

$26,100

$68

$31,800

$80

$40,600

$92

$51,100

$133

$59,600

$183

-$10,000

$0

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

1995 1996 1997 1998 1999 2000 2001 2002 2003E

Cumulative Change in Cost of Median Existing Home

Cumulative Change in Average HO Insurance Expenditure

Increases in the price of homes has outstripped the increase in HO insurance

costs by more than $59,400, a factor of 326 to 1!

Note: 2003 home price increase based on NAR’s est. of $166,900 median home for 2003.Source: Insurance Info. Inst. calculations based on data from Natl. Association of Realtors, NAIC.

Property Taxes12%

Principal & Interest

84%

Homeowners Insurance

4%

Composition of Monthly Homeowners Payments

Sources: Mortgage interest rates: Freddie Mac; Median Home Price (existing homes): National Associationof Home Builders; Property Taxes: US Census Bureau; Homeowners Insurance: III and NAIC.

Property Taxes13%

Principal & Interest

83%

Homeowners Insurance

4%

2002 Total Monthly Payment: $1,0941997 Total Monthly Payment: $945

$791

$116

$38

$46

$144

$904

2002

Median Home Price

$158,300

Mortgage Rate (30-yr)

6.54%

Principal & Interest*,1

$10,851

Property Taxes*

$1,726

Homeowners Insurance*

$553 (est.)

1997 $121,800 7.83% $7,495 $1,390 $455

*Annual basis. 1Assues 90% of purchase price is financed (i.e., 10% down payment).

THE USE OF CREDIT INFORMATION IN

HOMEOWNERS INSURANCE UNDERWRITING

Why Do Insurers Use Credit Information?

Why Insurers Use Credit Information in Insurance Underwriting

1. There is a strong correlation between credit standing and loss ratios in both auto and homeowners insurance.

2. There is a distinct and consistent decline in relative loss ratios (which are a function of both claim frequency and cost) as credit standing improves.

3. The relationship between credit standing and relative loss ratios is statistically irrefutable.

4. The odds that such a relationship does not exist in a given random sample of policyholders are usually between 500, 1,000 or even 10,000 to one.

Source: Insurance Information Institute.

1.593

0.9110.795

0.656

1.066

0.0

0.5

1.0

1.5

2.0

Score Range

Rel

ativ

e P

erfo

rman

ce

Homeowners Company A

Source: Tillinghast Towers-Perrin

Interpretation:

Those with scores under 645 had losses that were 59.3% above average; those with best scores had losses 34.4% below average

1.2001.083

0.9000.783

1.150

0.0

0.5

1.0

1.5

2.0

Score Range

Rel

ativ

e P

erfo

rman

ce

Homeowners Company B

Source: Tillinghast Towers-Perrin

Interpretation:

Those with scores under 560 had losses that were 20% above average; those with best scores had losses 21.7% below average

2.533

1.241

0.9090.807 0.734 0.715 0.637

1.357

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Score Range

Rel

ativ

e P

erfo

rman

ce

Homeowners Company C

Source: Tillinghast Towers-Perrin

Interpretation:

Those with scores under 530 had losses that were 153% above average; those with best

scores had losses 36.3% below average.

Statistical CorrelationHomeowners HO - 3

Number of Adverse Public Records

1000

1540

0200400600800

1000120014001600

zero one or more

96%

Lo

ss R

atio

Re

lativ

ity

Source: Fair, Isaac

Interpretation:

Existence of adverse public records correlated with higher loss ratios

Statistical CorrelationHomeowners HO - 3

Number of Trade Lines 60+ Days Delinquent inLast 24 Months

10001293

1804

0200400600800

100012001400160018002000

Zero One 2+

89%

Lo

ss R

atio

Re

lativ

ity

Source: Fair, Isaac

Interpretation:

Higher number of delinquencies correlated with higher loss ratios

Statistical CorrelationHomeowners HO - 3

Number of Trade Lines Open in Last 12 Months

10001147 1220

15031658

0200400600800

10001200140016001800

Zero One Two Three 4+

60%

Lo

ss R

atio

Re

lativ

ity

Source: Fair, Isaac

Interpretation:

Higher number of trade credit lines opened correlated with higher loss ratios

Intuition Behind Insurance Scoring*

1. Personal Responsibility Responsibility is a personality trait that carries over into many

aspects of a person’s life It is intuitive and reasonable to believe that the responsibility

required to prudently manage one’s finances is associated with other types of responsible and prudent behaviors, for example: Proper maintenance of homes and automobiles Safe operation of cars

2. Stability It is intuitive and reasonable to believe that financially stable

individuals are likely to exhibit stability in many other aspects of their lives.

3. Stress/Distraction Financial stress could lead to stress, distractions or other

behaviors that produce more losses (e.g., deferral of car/home maintenance).

*This list is neither exhaustive nor is it intended to characterize the behavior of any specific individual.

Source: Insurance Information Institute

The Controversy Over C.L.U.E. Reports

Comprehensive Loss Underwriting Exchange Reports (CLUE)

Why Insurers Use CLUE:• Enormous informational asymmetry between homeowner and

insurer Reduction of that asymmetry means that policyholder pays a price

more closely associated with the risk assumed Overall pricing system is more fair, equitable Claim frequency depends on property AND owner

Consumers Who Learn About CLUE, Like It!• Majority of Americans, when CLUE is explained to them,

believe CLUE is a good idea• Most buyers would want to see seller’s CLUE report• Most sellers want buyers to see their CLUE report• Why do some realtors want to hide info from buyers?

Some Groups Want to Ban C.L.U.E. Reports

Ad run by realtors in AZ in January 2003: But how would homeowners be

helped if CLUE is banned?

CLUE helps protect homebuyers by letting them see what problems a house has had before they buy it

A house without problems or that has been properly repaired will command a

premium, benefiting sellers

A house can be made safer and less expensive to insure if repairs have

been made properly

Don’t YOU want to know what you’re buying before you make the biggest investment of your life???

Comprehensive Loss Underwriting Exchange Reports (CLUE)

CLUE is:• Available to homeowner for just $12.95• Can be shared online by property owner• Can help a homeowner sell a home at a premium

No claims Claim properly addressed (e.g., new roof, plumbing

upgraded)

Realtors who oppose CLUE are on the wrong side of this issue

Insurance Information Institute On-Line

If you would like a copy of this presentation, please give me your business card with e-mail address

10

0.1

10

4.6 1

06

.5

10

4.8

10

7.7

11

1.1

10

8.3

10

6.1

10

6.8 1

08

.9

10

9

10

4.7

10

2

10

1.7

10

1.3

10

1.3

10

1

99

.5 10

1.1

10

3.5

10

9.5

10

8

10

3

90

95

100

105

110

115

80

81

82

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

00

01

02

Auto Combined Ratio(1980-2002E)

Sources: A.M. Best; III