Property & Casualty Update

Property & Casualty Update Market Update May 2014 Competition Creates Advantageous Market for Commercial Clients Profitability for property and casualty insurers is the New markets have come best it has been in years, resulting in increased capacity. in on the property side As the property and casualty markets soften, rates are with significant capacity, becoming increasingly competitive. Notable exceptions to both traditional and this trend include workers compensation, certain types of nontraditional. We re construction, and umbrella polices for large fleets. seeing increased capacity According to Tim DeSett, Executive Vice President, Risk Practices, carriers but also from new markets have come in on the property side with significant Bermudian and European capacity, both traditional and nontraditional. We re seeing increased carriers in the U.S. not only from U.S.-based capacity not only from U.S.-based carriers but also from Bermudian and European carriers in the U.S. These Bermudian and European carriers who ve always written North American risk now want to do it direct, here. They are putting boots on the ground. That s helping create a lot of capacity in the marketplace, DeSett explains. Given what happens when the supply of any product exceeds demand, prices are moving downward, creating favorable conditions for commercial clients. L O C K T O N C O M P A N I E S

Surplus Capacity Benefits Commercial Clients In simplest terms, capacity is the supply of insurance available to meet the demand. Capacity depends on the industry s financial ability to accept risk. A property/casualty insurer must maintain a certain level of capital and policyholder surplus to underwrite risks. This capital is known as capacity. When the industry is hit by high losses, such as after the World Trade Center terrorist attack, capacity shrinks. It can be restored by increases in net income, favorable investment returns, reinsuring more risk, and/or raising additional capital. When there is excess capacity, premiums tend to decline as insurers compete for market share. ISO/PCI and the Insurance Information Institute jointly released 2013 year-end results. The data shows that Policy Holders Surplus is at an all-time high of $653.3 billion, and profitability in the property and casualty industry is at the highest level in years. Why? 1 1. Catastrophe losses were down in 2013, after two of the worst CAT years on record. CAT losses dropped from $35 billion in 2012 to $12.9 billion in 2013. 2. Favorable development of prior-year claims reserves in 2013 totaled $16.0, up from $10.2 billion in 2012. Reserve releases typically are associated with lower-than-expected costs for claims occurring in past accident years. 3. The combined ratio improved from 102.9 in 2012 to 96.1 in 2013. The fact that the number is less than 100 means insurers are spending less than they are paying out, generating an underwriting profit. 4. Premium growth is accelerating modestly, up 4.6 percent in 2013 from 4.3 percent in 2012. 1 http://www.iii.org/articles/2013-year-end-results.html 2

Market Update, Property & Casualty Lockton Large Property The large property insurance market is as soft as we have seen it, according to Jim Rubel, Executive Vice President, Major Accounts-Property. Accounts with high-catastrophe (CAT) Client reaction to improvement in the exposure, but no claimed losses, are benefitting from especially marketplace has not been to chase the low low prices. In fact, we have seen double-digit rate reductions. price. Instead, many clients have come to Meanwhile, accounts formerly penalized for CAT losses are seeing even larger rate decreases in some instances. This may be due to one of two factors: 1. The recent reassessment of RMS modeling corrected the overcharging that was common among properties that had previously claimed losses. 2. A significant amount of capacity is shifting from treaty reinsurance to the direct and facultative side. As carriers walk away from some of their treaty capacity, they re moving the surplus to the retail side. This has created an increase in supply of capacity and a subsequent decrease in price. 3 appreciate the value of long-term relationships, even if they leave a couple of points on the table. Vince Gaffigan, Executive Vice President, Director of Risk Consulting

Mid-Market Property In contrast to the large layered and shared property market, the mid-market sector isn t experiencing the same dramatic decreases. Rather, pricing is mostly flat or moderately down. Jim Collins, Senior Vice President, Enterprise Team Leader, also notes that carriers are pulling back on their efforts to add wind and hail deductibles. This had been a key area of focus, particularly in the Midwest, where last year s tornado season called attention to wind and hail coverage. The middle-market package business remains competitive with ample capacity, and we expect to see even more competitive pricing in this area during the next quarter. Generally, Lockton is seeing flat prices or small decreases in package business. 4

Casualty They vary by industry, but casualty insurance rates are generally flat or slightly down. There is ample capacity and, as Executive Vice President Mark Zwickel notes, rate relief is attainable especially when we impose competition on the incumbent carrier rather than simply waiting for the market to decrease organically. Several casualty insurance carriers are looking to grow, and aggressively. It s still a buyer s market. If a company can effectively manage its risk profile, they will find plenty of potential suitors. If they don t, they can expect greater than average increases or, at the very least, they won t benefit from the decreases the rest of the market is seeing. While pricing is favorable for casualty insurance buyers overall, the markets remain cautious when underwriting risks for difficult product exposures. They are asking a lot of questions and looking for the best in class. According to Vince Gaffigan, workers compensation remains a concern for most carriers, although it depends on the level of retention. In general, the lower the retention, the more pressure to pay a higher premium. Workers compensation is probably one of the worst-performing line items, and one where we see the least amount of aggressive capacity. The other is with umbrella with a large transportation fleet, DeSett says, emphasizing the point that these are notable exceptions in an otherwise softening casualty market. 5

As Zwickel explains, there are some new entrants in the California workers compensation market, which previously was the toughest segment of the market. Rates for California workers compensation are now in the low single-digit increases, after a couple of years of 20-30 percent increases. Excess workers compensation capacity is challenged when sitting over a self-insured retention, as explained by Matt Edelheit, Senior Vice President in Lockton s Denver office. In the middle market, few carriers are willing to write it. This is creating pricing increases for buyers. The market psychology changed somewhat following the January reinsurance treaty renewals. Now markets are looking toward June treaty renewals to see if the momentum is sustained. In fact, June treaty renewals could be a turning point for the marketplace. It will be interesting to see if pricing continues with flat to modest increases, or if there will be overall decreases. Note: A treaty is a form of reinsurance in which the ceding company agrees to cede certain classes of business to a reinsurer. The agreement is known as a treaty. With facultative reinsurance, on the other hand, each exposure the ceding company wishes to reinsure is offered to the reinsurer and contained in a single transaction. A New Trend? According to DeSett, we may be seeing the start of a bundling trend, as markets attempt to round out their penetration on existing accounts. At least one carrier is already playing its hand with this. If it writes the primary, it will offer a bundled quote, whether you ask for it or not. Similarly, if it writes just the domestic program, it may offer a proposal for the foreign casualty. While it s not a proven trend, it will be interesting to see how effectively this strategy works. 6

International Property & Casualty Middle-market international package rates remain soft, primarily due to the low incidence and severity of international liability claims and competition. By contrast, the property element of international package programs remains challenging. Carriers continue to increase rates, reduce important limits, and restrict terms and conditions. Due to high concentrations of risk, carriers are often shifting CAT coverages from local admitted policies in-country to the U.S. Master. This potentially creates a complex compliance situation with respect to claim settlement. Several carriers taking a hard stance on international CAT risk have realized significant account attrition and are now striving to improve analytics, data, and modeling to potentially reinvest and become more competitive. International Casualty Large Multinational Risk Competition remains strong in this space among the limited numbers of carriers writing this class of business successfully. Risks with low incidence of loss and noncomplex/low-hazard products continue to see flat rates or slight rate decreases, especially under competition. Loss-sensitive and high-hazard-exposure clients continue to see improved underwriting discipline, unless competition is introduced. 7

Large multinational clients have generally accepted Global Compliance Standards, ensuring that local policies are required in most jurisdictions to remain compliant with local insurance and regulatory directives. Risk discussions and carrier solutions are shifting to new and emerging international risks, such as: Shifting investment (new emerging markets Supply chain. and decreased dependency on Brazil, Russia, India, China). Increased emerging market cultural awareness, with respect to litigation and fair labor practices. Foreign Corrupt Practices Act (FCPA). Foreign Accounts Tax Compliance Act (FATCA). Risk quality and exposure in emerging markets. Intellectual property risks. TRIA Concerns Continue The most common cause for concern today is whether the Terrorism Risk Insurance Act (TRIA) will be reinstated. Some carriers are putting endorsements on policies that will provide cover until the end of December. Carriers are especially showing caution when it comes to writing a lot of business in congested areas. The large carriers with big market shares of any coverage (property, workers compensation, construction projects, etc.) are taking a hard look at aggregation. You may see carriers decline a risk or be cautious about writing a lot of business in highly congested areas. To counter this anxiety, Lockton has developed a property product that companies can purchase now to ensure a line of capacity if TRIA is not reinstated. For a deposit, it locks up a set amount of capacity at a future date for a set price. This has been particularly attractive to real estate companies who need terrorism coverage to close deals. Generally, Lockton recommends that large property accounts purchase their terrorism coverage separately from a general policy, for several reasons: 1. If TRIA is not reinstated, the client has the capacity at hand now. 2. Because TRIA doesn t apply outside of the U.S., separate terrorism cover is necessary for global companies. 3. For TRIA to kick in, the event must be certified as an Act of Terrorism by the Secretary of the Treasury, Attorney General, and Secretary of State. The certification by government officials isn t an issue with a separate policy. (This issue surfaced with the 2013 Boston Marathon.) 8

Executive Risk Overall, capacity in the executive risk market is abundant. With large programs, carriers are more eager to write excess coverage than primary. Jed Shea, Senior Vice President in Lockton s Financial Services Practice, also observes that some underwriters are falling behind their new business budgets, which means we can expect to see pricing soften as the year progresses, assuming no major event impacts the industry during the coming months. Public Company Generally speaking, prices are firming modestly for public companies, with high single-digit increases in most cases. The increases are less in the excess layers in fact, prices are flat with potential decreases due to ample capacity. The defense expenses that result from securities-related claims continue to escalate. Carriers appear to be catching up with the premium and deductible increases. As a company, if you do a good job of managing your risk profile, you ll find a lot of potential suitors. If you don t, you won t benefit from the decreases the rest of the market has seen. Eric Silverstein, Senior Vice President, Risk Management Leader Other factors driving this market: Merger objection claims have not been catastrophic, but they have been frequent. That has unexpectedly hurt the profitability of primary directors and officers (D&O) underwriters. Policy language remains broad. Some underwriters are imposing merger-related claims retentions in certain circumstances, however. 9

Private Company Market conditions are firming. Major underwriters continue to struggle with profitability with private company D&O and employment practices (EPL), resulting in a different landscape than the public company space. Capacity is currently stable. We are seeing moderate rate increases in the 5 to 10 percent range. EPL retentions are increasing, based on loss history and location of employees. Construction Depending on building type and geography, the construction market is following the general pace of the commercial market, with competitive pricing and good capacity. Also, the boost in infrastructure spending has prompted carriers to move capacity to the residential space. Mary Ann Krautheim, Senior Vice President in Lockton s Construction Practice, identifies two exceptions to the otherwise competitive pricing in construction: 1. New York remains a difficult market for casualty insurance. Labor law issues have created a tight market for general liability in terms of both capacity and price. 2. Underwriters who previously welcomed apartment construction are now wary of the possibility the buildings will turn into condominiums. As a result, capacity is less robust than it had been for apartment construction. Conclusion Given current market conditions and emerging trends, companies that effectively manage their risk profile will find plenty of potential suitors in the coming months along with the cost advantages that result from competition among carriers with surplus capacity. 10

Insurer losses stabilized in 2013. Market Update, Property & Casualty Lockton 2011 and 2012: Some of the costliest catastrophe loss years. In 2013: Insured losses fell by $22.1B. 96.1% combined ratio in 2013, down from 102.9% in 2012. U.S. PROPERTY & CASUALTY INDUSTRY AT A GLANCE $ Billions Underwriting Performance Improving Net Underwriting Gains (Losses) U.S. 2003 2013 UNDERWRITING PERFORMANCE: IMPROVING NET UNDERWRITING GAINS (LOSSES) 2003 2013 40 30 20 10 0-10 -20 t Dynamics -30 Premium -40 Growth Steady 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Insurance Information Institute Sources: Insurance Information Institute *Includes mortgage guarantee insurers um growth accelerated y in 2013 to 4.6%, from in 2012. u:\ips master template\market update\2014\may 2014\pc market update_may14.pptx NET WRITTEN PREMIUM GROWTH: MODEST YEAR-TO-YEAR CHANGE IN NWP 2003 2013 ercial lines rates g or rising by single for most lines ming a favorable loss y). Net premium growth rose lines experiencing rd pricing, particularly rs compensation. slightly to 4.6% in 2013, an increase from 4.3% in 2012. 10.0% 3.9% 0.5% 4.2% -0.6% -1.4% Combined Ratio U.S. 2007 2013 110% Net Written Premium Growth Year-to-Year Change in NWP 2003 to 2013 The industry realized 105.1% 105% an underwriting 102.4% profit in 2013 as a 101.0% 100% result of premium growth, increased reserve releases, 95.1% and 95% fewer catastrophe losses, trending 90% pricing downward. 85% 0.9% 108.1% 2007 2008 2009 2010 2011 3.3% 4.3% 4.6% -3.7% 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Insurance Information Institute Source: Insurance Information Institute All charts include mortgage and financial guaranty insurers. t update\2014\may 2014\pc market update_may14.pptx 11 4

. catastrophe loss years. n from 102.9% in 2012. Market Update, Property & Casualty Lockton 3 2013 U.S. PROPERTY & CASUALTY INDUSTRY AT A GLANCE Combined Ratio U.S. 2007 2013 COMBINED RATIO: IMPROVING U.S. 2007 2013 110% 108.1% 105% 100% 95% 95.1% 105.1% 102.4% 101.0% 102.9% 96.1% The industry combined ratio, a measure of underwriting profit, fell to 96.1% in 2013, down from 102.9% in 2012. 011 2012 2013 90% urrent Dynamics 85% vestment Gains Still Challenged 2007 2008 2009 2010 2011 2012 2013 Source: Insurance Information Institute Investment income key to carriers financial health. Continued low interest rates affect gains, and are Low interest still challenging the rates continue to industry INVESTMENT GAINS: MODEST IMPROVEMENT 2003 2013 challenge insurers, although total Investment gains rose by 8.5% in 2013, compared rose 8.5% to to 2012. investment gains $58.8 billion, up from $54.2 billion Challenged investment in 2012. results offset insurer profitability. Investment Performance 5 U.S. Property Casualty Investment Gains 2003 2013 Dollars in Billions $70 $60 $50 $40 $30 $20 $45.3 $48.9 $59.4 $55.7 $63.6 $31.4 $38.9 $52.9 $56.2 $54.2 $58.8 $10 $0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Investment gains consist primarily of interest, stock dividends, and realized capital gains and losses Sources: Investment ISO; gains Insurance consist primarily Information of interest, Institute. stock dividends, and realized capital gains and losses. Source: ISO; Insurance Information Institute. All charts include mortgage and financial guaranty insurers. ter template\market update\2014\may 2014\pc market update_may14.pptx 2014 Lockton, Inc. All rights reserved. Images 2014 Thinkstock. All rights reserved. 12 8