property & casualty market overview and “reconciling environmental disclosure with...
TRANSCRIPT
Property & Casualty Market Overview
and
“Reconciling Environmental Disclosure With Environmental Exposure In An Evolving
Regulatory Climate”
February 17, 2004
Sean Kenny, National Accounts Manager
Chicago Region
AIG Environmental
+12.1%285,400319,922Surplus*
105.0
5,018
26,853
(18,238)
206,234
280,297
2002
-4.7 pts.100.3Combined Ratio
+320.6%21,107Net Income (a.t.)
+3.2%27,704Net Inv. Income
-68.8%(5,698)Net UW Gain (Loss)
+5.5%217,656Loss & LAE
+10.1%308,554Net Written Prem.
Change2003
*Comparison with year-end 2002
Highlights: Property/Casualty First Nine Months 2003
45
64 3 4 4
-14
32
7 6
-2 -1
-6 -6
-3-5
-7
-11
-15
-18-20
-15
-10
-5
0
5
10
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Upgrades Downgrades
*North American insurance holding companies through October 17, 2003
Source: Standard & Poor’s
Downgrades have outpaced upgrades by nearly 4:1 since 2000
Are we at a peak?
Number of Insurer Upgrades Vs. Downgrades, 1993 to 2003*
100110
120130
140150
160170
180190
200210
220230
240250
260
89 90 91 92 93 94 95 96 97 98 99 00 01 02* 03*
Source: Guy Carpenter * III Estimate
Prices rising, limits falling: ROL up significantly
Rate on Line Index (1989+100)
Source: A.M. Best; Insurance Information Institute
1.20%
0.58%
0.21%0.28%
0.79%
0.60%
0.23%
1.02% 1.03%
1.33%
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
•Insurer insolvencies are increasing•10-yr industry failure rate: 0.72%
•Failure rating for B+ or better rating: 0.49%•Failure rate for D through B rating: 1.29%
383030
10-yr Failure Rate
= 0.72%
P/C Company Insolvency Rates, 1993 to 2002
$ Billions, Calendar Year Basis
$2.3 $2.2 $1.2
($8.5)
($1.5)
($7.5)($6.7)($10.0)
$22.7
$0.3
($3.7)($0.3)
$9.9
($15)
($10)
($5)
$0
$5
$10
$15
$20
$25
90 91 92 93 94 95 96 97 98 99 00 01 02
*Negative numbers indicate favorable development; positive figures represent adverse development.Source: A.M. Best, Morgan Stanley, Dowling & Partners Securities
Adverse reserve development of about $23 billion accounted for most of the
industry’s 2002 underwriting loss and “ate” much of the industry’s $37 billion
increase in earned premiums
P/C Insurance Industry Prior Year Reserve Development*
Points (Reduced)/Increased
0.5
(2.4)
5.2
6.3
(0.4)
-3
-2
-10
1
2
3
45
6
7
1998 1999 2000 2001 2002
Source: ISO, A.M. Best, MorganStanley.
Adverse reserve development totaling an estimated $23 billion
added more than 6 points to the p/c combines ratio in 2002
Combined Ratio: Impact of Reserve Changes (Points)
Macro Factors
P/C COST DRIVERS
$0
$50
$100
$150
$200
$250
$300
$350
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 0203*
Source: A.M. Best, Insurance Information Institute *As of 9/30/03.
$ B
illi
ons
Surplus (capacity) peaked at $339.3 Billion in mid-1999 and fell by 15.9% ($53.9 billion) to $285.4 billion at year-end 2002 (a trough?)
•Surplus during the first half of 2003 rose by $34.5B or 12.1% to $319.9B
“Surplus” is a measure of underwriting capacity. It is analogous to “Owners Equity” or “Net Worth” in non-insurance organizations
$19.4 Billion
U.S. Policyholder Surplus: 1975-2003*
$0
$9
$18
$27
$36
$45
75 77 79 81 83 85 87 89 91 93 95 97 99 01 03E
History
1997 Peak = $41.5B
2000= $40.7B
2001 = $37.7B
2002 = $36.7B
2003E = $36.9B
Bil
lion
s
(US
$)
Investment income fell 2.8%in 2002 but rose 3.2% in the first 9 months of 2003 vs. first 9 months of 2002
Note: 2003 estimate is based on annualized 9-month investment income of $27.704 billion.Source: A.M. Best, Insurance Information Institute
-$4.6 Billion
Net Investment Income
0%
2%
4%
6%
8%
10%
12%
14%
16%
3-Month T-Bill 1-Yr. T-Bill 10-Year T-Note
*Average for December 2003.Source: Board of Governors, Federal Reserve System; Insurance Information Institute
1. Historically low interest rates are the primary driver behind lower investment yields. Nevertheless, overall insurer investment performance outpaces all major market indices and almost every major category of mutual fund.
2. 66% of the industry’s invested assets are in bonds
Interest Rates: Lower Than They’ve Been in Decades
$ Billions
$35.4
$42.8$47.2
$52.3
$44.4
$36.6
$44.8
$57.9
$51.9
$56.9
$0
$10
$20
$30
$40
$50
$60
94 95 96 97 98 99 00 01 02 03E
*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 9/30/03.
Investment gains are simply returning to “pre-bubble” levels
Property/Casualty Insurance Industry Investment Gain*
10.1
%
8.0%
2.1% 2.5%
0.2%
6.1% 7.
3% 8.1%
11.2
%
14.7
%
1.3%
9.0%
5.1% 6.
4% 7.3%
5.7% 7.
4%
7.6%
-1.1
%
-2.1
%
10.7
% 12.0
%
-5%
0%
5%
10%
15%
92 93 94 95 96 97 98 99 00 01 02
Health Benefit Costs WC
Source: NCCI; William M. Mercer, Insurance Information Institute.
Health care inflation is affecting the cost of medical care, no matter
what system it is delivered through
Med Claim Costs Rising Sharply
Source: Tillinghast-Towers Perrin.
$129 $130 $141 $144 $148$159 $156 $156 $167 $169 $180
$205$233
$298
$0
$50
$100
$150
$200
$250
$300
$350
90 91 92 93 94 95 96 97 98 99 00 01 02 05F
Tort costs consumed 2.23% of GDP in 2002
Per capita “tort tax” expected to rise to
$1,003 by 2005, up from $807 in 2001
Cost of U.S. Tort System ($ Billions)
419 187 333759
1,185 1,1401,744
1,365
323789
1,7272,288
3,902
9,113
$0
$1,000
$2,000
$3,000
$4,000
$5,000
$6,000
$7,000
$8,000
$9,000
Overall VehicularLiability
PremisesLiability
BusinessNegligence*
WrongfulDeath
MedicalMalpractice
ProductsLiability
($00
0)
1994 2001
*Figure is for 2000 (latest available)Source: Jury Verdict Research; Insurance Information Institute.
Average Jury Awards 1994 vs. 2001
Source: Tillinghast-Towers Perrin; Insurance Information Institute
US Insurers30%Asbestos
Defendants39%
Foreign Insurers
31%
Estimated Total US Settlements & Expenses = $200 billion
$78 billion $60 billion
$62 billion
Who Will Pay for the US Asbestos Mess?
Claims Filed Against U.S. Silica By Claimant (1997-2003)
Source: Coalition for Litigation Justice; (* through 6/30/03)
93 153 505 6541,371
5,142
15,342
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000
1997 1998 1999 2000 2001 2002 2003*
• Leading industrial sand producer U.S. Silica today faces more than 22,000 silica claims!
• Some 15,342 plaintiffs have named the company in lawsuits so far in 2003 - triple the number seen in 2002!
Some 87% of the lawsuits filed are from Mississippi and Texas!
$0
$50
$100
$150
$200
$250
Jan-
01
Feb-0
1
Mar
-01
Apr-0
1
May
-01
Jun-
01
Jul-0
1
Aug-0
1
Sep-0
1
Oct-0
1
Nov-0
1
Dec-0
1
Jan-
02
Feb-0
2
Mar
-02
Apr-0
2
May
-02
Jun-
02
Jul-0
2
Aug-0
2
Sep-0
2
Oct-0
2
Nov-0
2
Dec-0
2
Wa
ter
Da
ma
ge
Pa
id L
os
se
s* ($
Mill
ion
s)
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*
Market Effect: Industry Snapshot
Losses Outweigh Gains : P&C insurers paid $5.7 Billion more in claims & expenses, than they collected in premium in the first nine months of 2003, and $18.2 more in the full year 2002 (data from Insurance Information Institute)
Reserve Deficiency: 2002 P&C adverse reserve development $23 Billion, added 6 points to industry combined ratio
Capacity Rising: Expected to continue through 2004
Insolvency Rising: 2002 rate nearly double the 10 year rate (1993-2002)
More Downgrades: Ratio of downgrades: upgrades nearly 4:1 since 2000
How to Manage the Market:
Watch / know ratings:
Understand what ratings mean. Senior Debt ratings can be telling for long-tail lines.
Among the 10 carriers we track that write environmental insurance, fully 5 have had ratings downgrades since June 2003.
If it seems too good to be true, it probably is--Be wary of irrational pricing
Examine a carrier’s reinsurance collectable exposure
Ask about claims management expertise of carriers
Provide accurate loss data so your carrier can underwrite the risk appropriately
How to Manage the Market:
Be wary of new capital
Avoid 1-year remedies
Judge carrier commitment: look for longevity in market
History of under-disclosure
+ New financial reporting and audit rules
+ Weaknesses in internal controls
+ New legal standards
+ Insurance coverage gaps
=New risks for Corporate America
Overview of Environmental Disclosure
The Known Knowns
Quantified and fully disclosed environmental liabilities and costs
The Known Unknowns
Identified “contingent” environmental liabilities and risks with uncertain future financial impact (may or may not be disclosed)
The Unknown Unknowns
Environmental impairments, contingent liabilities and risks often associated with historical releases of pollutants
Often known or suspected by employees and contractors, but unknown to senior management and the board
No pending legal action
Not disclosed to shareholders
Probably not identified to financial auditors
Probably uninsured
An Analogy for Illustration….
The “known knowns”& “known unknowns”?
The “unknown unknowns”?
What Lies Beneath?
SOX Section 302 CEO/CFO certifications “fairly present….”
SOX Section 404 attestation to “effectiveness” of ”financial controls”
FAS 143 clarifies need to recognize environmental related Asset Retirement Obligations (ARO’s) up front
What to investigate, what to report, how to disclose (under your terms, not the SEC’s)
Is there a plan to investigate, report and market/clean-up environmentally impaired assets? The ‘fence & lock/don’t ask, don’t tell’ game will no longer fly.
Accounting Rules are Evolving - You Need a Plan!
SEC proposal would mandate extensive disclosure surrounding any accounting estimates where:
Assumptions are relied upon;
Subject matter is highly uncertain;
There are a range of estimates; or
Changes will have a material impact.
…….. All characteristic of environmental liabilities
SEC Proposal on Critical Accounting Policies
Internal ControlsInternal Controls
Internal Controls
Areas of concern
Risk identification and investigation
Valuation methodologies
Determination of materiality
“Beyond-GAAP” reporting
Organizational disincentives
Disclosure controls and procedures
Corporate governance
Audit inquiry letters
Management override
Key Question: Is “don’t ask, don’t tell” still a viable policy?
Potential Weaknesses in Controls
Violate debt covenants
Qualified Audit Opinions
Mid period re-statements
Decline in share price
Shareholder suits
Anonymous complaint channels
Uninsured Personal Liability of D’s & O’s
The “Perp Walk”
What’s at Stake?
10-K Environmental Disclosures…….
Lease disclosure……
(the Company) has the option to extend the lease or purchase the facilities. If the lessee does not choose either of these options, then it must sell the assets on behalf of the lessor and guarantee a residual value of up to $545 million based on an estimated total lessor’s investment of $657 million for both projects combined. If the financing is terminated early as a result of significant environmental damage, the lessee could be obligated to pay up to 100% of the lessor’s investment in the facilities.
($657 million, or $112 million of exposure).
.
The schedule below shows this same company’s capital expenditure projections for environmental for the years 2003-2007, and actual spending for the year 2002:
Actual Projected
2002 2003 2004 2005 2006 2007
$20 $5 $5 $12 $50 $96
…..Don’t Always Add Up
Guidance….HUH?
Conditions for “Accrual”
The Company has identified certain events which could give rise to a loss, but which do not meet the conditions for accrual under SFAS 5. SFAS 5 requires disclosure, but not a recording, of potential losses when it is “reasonably possible” that a loss has been incurred.
FASB defines “reasonably possible, as cases in which “the chance of the future event or events occurring is more than remote but less than likely.”
During 2002, we purchased an environmental insurance policy which covers the costs of remediation activities at the identified sites and remains in effect for 30 years. As a result, we will receive reimbursements from the insurance company for environmental remediation costs we incur.
Upon the purchase of this policy, we recorded receivables from the insurance company within other current assets and other non-current assets in amounts equal to our environmental accruals.
A Proactive Approach……...
“…….This insurance program will allow us to quantify and, within the limits of the policy, cap our cost to remediate the site, and provide insurance coverage from future third party claims arising from past or future environmental releases.”
“The remediation cost overrun policy has a term of ten years and provides $25 million in coverage in excess of a self-insured retention amount of $26 million. The pollution legal liability policy provides for $25 million in aggregate closure coverage…..”
A Proactive Approach……...
Enhance Disclosure
Protect Assets, Actions, etc.
Ensure Investor and Shareholder Confidence
Environmental Insurance
Insurance Products to Manage Environmental Liabilities:
•Cleanup Cost Cap
•Pollution Legal Liability
•Environmental Protection Programs
Environmental Insurance
Actual contamination exceeding estimates
New found contamination discovered during remediation
Off-site cleanup costs for conditions emanating from the covered location
Government change orders received during the policy term
Provides Coverage for Cost Overruns of Remediation Projects associated with:
Cleanup Cost Cap
Cleanup Cost Cap
ActualActual ContaminationContamination
Cleanup Cost Cap
Site Boundaries
BufferBuffer LayerLayer
Cost Cost Overrun Overrun
CoverageCoverage
Expected Expected CostCost
LIMIT
Self-Insured Retention
Cleanup Cost Cap ProgramCleanup Cost Cap
EXAMPLE:
Large petroleum & gas company.
$400 million of estimated environmental liabilities.
34 sites at various stages of the cleanup process.
Includes both currently and previously owned sites.
Purchased a policy with aggregate limits of $50,000,000 excess of the Self-Insured Retention for a 10 year term.
Coverage was available for all sites within the portfolio.
Cleanup Cost Cap
Provides Coverage for:
On- and off-site cleanup of pollution conditions
On- and off-site third party bodily injury and property damage associated with pollution conditions
Legal Defense
Non-Owned Disposal Sites
Transported Cargo
Business Interruption
Pollution Legal Liability
Known
Cleanup Cost Cap
Site Boundaries
Unknown
Unknown
Known ButNot Actionable
Known And Unknown CoveragePollution Legal Liability
EXAMPLE:
Company signed settlement agreement with historical general liability insurers.
Needed to release historical insurance from any claims as part of settlement.
Company was concerned about releasing coverage for environmental liabilities arising from past activities, as well as insuring against environmental liabilities arising
from future events.
Pollution Legal Liability
Annual Expected Costs are estimated.
Annual Expected Costs are discounted.
Excess coverage is provided.
Rewards for favorable loss experience.
Basic Structure:
Environmental Protection ProgramsEnvironmental Protection Programs
0
20000
40000
60000
80000
100000
120000
140000
Cleanup Costs
Excess
Expected
NPV
Environmental Protection Programs
Environmental Protection Programs
Excess coverage is provided
Can be used to provide financial assurance to regulatory agencies, investors or other parties.
Insurance Premiums are generally tax deductible - Program may enable the insured to accelerate their tax deduction associated with their environmental liabilities
Insured can disclose that they have secured a program from a AAA company
Benefits:
EXAMPLE:
Mining Company with financial assurance obligations of over $225 million for mine reclamation.
Company was engaged in a prepackage bankruptcy filling.
Mining operations in 5 states with over 600 bonds required.
Purchased an EPP policy which was used to secure the required financial assurance bonds, enabling them to remain a going concern.
Environmental Protection Programs
Insurance Products used to manage Environmental Liabilities:
Cleanup Cost Cap:
Cost overrun protection for current remediation projects
Environmental Insurance
Insurance Products used to manage Environmental Liabilities:
Pollution Legal Liability:
Insurance protection covering cleanup, bodily injury, property damage and legal costs associated with “new” environmental liabilities arising from past, current and future operations.
Environmental Insurance
Insurance Products used to manage Environmental Liabilities:
Environmental Protection Programs:
Pays on behalf of the insured for all costs associated with current cleanup projects while providing overrun protection along with other environmental insurance.
Environmental Insurance
Why Act Now?
Independent Auditors Board of DirectorsShareholders Employees LendersSEC
CFO & CEO