Thirteen days before Election Day, Robert Hartwig, Ph.D., CPCU, addressed the ICT Property and Casualty Symposium, for the first time virtually, even though he has appeared in person at the annual event at least 15 times previously. Hartwig said then that he looked back to the Truman Administration, 70 years ago, to see if the property/casualty insurance industry was better off with a Republican or Democratic presidential administration.
With little suspense, Hartwig revealed the historical perspective on Oct. 21, the final of four presentations that made up the 28th Annual Property and Casualty Symposium which was streamed live over three consecutive weeks during the month. Hartwig’s take on an election victory: “It doesn’t really make much of a difference.”
Hartwig’s rationale is that hurricanes, earthquakes, tornadoes, wildfires and even pandemics “really don’t care who is living at 1600 Pennsylvania Ave.” Referencing a 70-year history, Hartwig said the profits of the industry grew by an average of 8.1 percent during the presidential term of Democrats and 7.8 percent when Republicans occupied the White House. It was during Jimmy Carter’s administration, said Hartwig, that the industry experienced its greatest profitability, at 16.43 percent return on equity. The second term of Ronald Reagan wasn’t far behind, at 15.10 percent. Trump’s score of 6.9 percent average growth was based on the 2017-2019 growth rate, thereby preceding the COVID effects.
Hartwig, who is now the clinical associate professor of finance, risk management and insurance at the Darla Moore School of Business, University of South Carolina, formerly served as chief economist and president of the Insurance Information Institute. He also serves as director of the Risk and Uncertainty Management Center at the university.
Looking back 50 years, Hartwig traced the ups and downs of premium growth through the customary peaks and valleys until 2012 when more stable growth was maintained. The period had premium growth peaks in 1976 and 1985-86 of greater than 20 percent and in 2002 of about 15 percent, which were consistent with the cyclical nature of the industry, he said. Recent years were less volatile. Disregarding the “statistical artifact” of 10.8 percent premium growth in 2018 spurred by the 2017 Tax Cuts and Jobs Act, the industry averaged “a relatively narrow growth range of about four percent” each year since 2012. Prior to COVID, Hartwig said, “we were expecting something consistent with that.”
Pre-COVID premium was projected to increase by 3.8 percent during 2020. By midyear, premium was growing at 2.9 percent. “That’s apt to descend further as the effects of COVID become more manifest,” said Hartwig, expecting the sharpest declines to come from the most economically sensitive lines, such as workers’ compensation, where private sector payrolls declined as unemployment rose.
Hartwig estimated COVID’s potential impact on various lines, basing his expectations in part on a Willis Towers Watson analysis. Due to falling payrolls, Hartwig expects written premium in workers’ comp to go down by 12.5 percent to 25 percent, equating to a $5.9 billion to $11.75 billion reduction in direct written premium in the line for the year. He said the large range of his estimate is dependent “on the pace of economic recovery.” Other economically sensitive lines of marine/aviation/transport and commercial auto will also see declines. He considered the $10 billion give back in personal auto, where personal auto insurers refunded portions of their insureds’ premium due to all the parked cars during lockdowns, to materially affect the line’s end-of-year results.
The premium refunds in personal auto are expected to be balanced by a reduction in claiming activity; the commercial vehicle line is also expected to have a reduction in losses. Where losses go up, said Hartwig, depends on claims experience related to COVID, and so far, the industry has “avoided the worst case scenarios.” Hartwig pointed to the industry’s successes in defending business interruption claims and not being overwhelmed by presumptions in workers’ comp, even though some states are more liberal than others.
AM Best’s prediction for 2020’s underwriting performance across P/C lines was for a 99.1 percent combined ratio, said Hartwig. Pre-COVID, the industry held at “almost no deviation from plan,” said Hartwig, as the actual number was a 99.2 percent combined ratio at midyear. “That number will absolutely rise materially,” said Hartwig, probably above 100, as the second half of the year has brought hurricanes, tropical events, wildfires and some continuation of rioting activity. Still, he predicted the combined ratio among P/C lines would be less than the worst recent year when 2017 ended with a combined ratio of 103.7 percent. That was a bad year in Texas, as well, said Hartwig, recalling Hurricane Harvey.
Despite early estimates of extremely high COVID insured losses, U.S. industry forecasters have “coalesced around a number in the $60 billion range.” Hartwig said he thinks that estimate is still high for the U.S.; he does not expect a new high record of P/C losses from COVID. Lines with the highest potential losses are Business Interruption/Contingency and Workers’ Comp; however, these losses will be somewhat offset by a reduction in loss frequency overall that results from reduced economic activity. “Whether they offset each other or not is unclear,” said Hartwig who expects that the rapid shrinking of the economy will definitely reduce claim frequency.
The low end estimates are riding on the likelihood that courts continue to reject business interruption claims as insured losses. Viral outbreaks, said Hartwig, are not insurable by the private sector. “Not only are there pathogen exclusions in business interruption policies, but the original wording of the policy itself requires that there be actual physical loss of the property,” he said, adding that the industry has communicated that clearly to lawmakers and regulators at both the state and federal level. “There has never been any intent to insure economic consequences of pandemics by private property and casualty insurers in the U.S,” said Hartwig.
Driving that point home, Hartwig said, estimates were made early on that capturing business interruption losses under all commercial property policies, even if limited to businesses of fewer than 100 employees, would cost $52 billion to $431 billion a month, depending on underlying assumptions. The potential for such losses for all businesses of all sizes was estimated at $1.0 trillion to $1.1 trillion a month, said Hartwig. With total U.S. capacity at $800 billion, it became clear, said Hartwig, that “the industry has never intended to, nor has it ever priced for, pandemic-related risks on the property side. …The language in the policies is fairly explicit about that, and the courts are recognizing that.”
Still, said Hartwig, plaintiff attorneys don’t easily walk away from what they see as an opportunity. More than 1,200 COVID-related lawsuits have been filed since mid-March, with business income loss accounting for the vast majority of cases. “Trial lawyers never cease to use a crisis to their advantage where they tend to find coverage where none exists, and find coverage where none was intended, and find coverage where no premium was paid,” said Hartwig.
On top of 2020’s pandemic, economic recession, highest unemployment in decades and a very contentious election, said Hartwig, Mother Nature exacted a toll on the U.S. In this first year of the new decade, catastrophe losses will reach an amount possibly greater than the decade’s average is expected to be, given the plus-$10 billion each decade has had over the prior decade since the 1980s. In the 1980s, Hartwig recapped, cat losses averaged $5 billion per year; the 1990s saw the average climb to $15 billion. Then, in the 2000s, the average annual cat losses went to $25 billion, and in the 2010s to $35 billion. Hartwig predicted that cat losses in 2020 will reach $45 billion, the average expected annual insurance cat loss that keeps pace with the trend set over the past 40 years. “That’s a concerning beginning of the new decade,” he said.
COVID-19’s insured property losses remain uncertain, Hartwig said, but if they reach the expected $20 billion (a combined estimate for property and casualty), they will make the top 10 list for most costly disasters in U.S. history. Hurricane Katrina, at $51.6 billion remains at the top of the list. Because the rest of the world’s 2020 catastrophes mirror ours, the global pool of capital that responds to U.S. claims is being tapped globally, said Hartwig. This is leading to rising reinsurance prices in 2021.
COVID-19 has contributed not only to the rise in reinsurance pricing, but also to the addition of restrictions in terms and conditions in reinsurance treaties. Hartwig said there will be widespread communicable disease exclusions. He likened the new restrictive treaty language to how the market responded with terrorism risk exclusions after 9/11/2001. “It will take some time for the market to calm down,” Hartwig said.
Some insurers and trade associations are working on federal legislation to address contagious disease risk, he said. Hartwig recalled that it took 14 months to get the Terrorism Risk Insurance Act passed, post 9/11, so he expects some time before a national solution is crafted, especially because there is some resistance to what seems to be on the table.
Hartwig considers PRIA, the Pandemic Risk Insurance Act that has been proposed in Washington, a well-intentioned but bad idea. Modeled after TRIA, it caps liability at $750 billion with the federal government picking up 95 percent of insured losses above individual insurer’s deductibles. The program would have a $50 billion potential balance sheet exposure on the part of insurers, said Hartwig.
Another proposal, dubbed the Business Continuity Protection Program, has insurance industry association support from APCIA, NAMIC and Big I. This proposal relies on the creation of a federal program where businesses could opt in to what amounts to a federally funded business interruption program. Businesses could purchase revenue replacement assistance to cover up to 80 percent of payroll, employee benefits and operating expenses. Relief payments would be provided for three months, and payouts would be based on the prior year’s tax return. The BCPP creates no balance sheet risk to the insurance industry, Hartwig said.
What moves pandemics, such as COVID-19, into uninsurable events by the private insurance industry is their improbability and unpredictability. As Hartwig looked back over the past several months and the impact of the coronavirus, he called the experience a black swan event, a term popularized in 2008 by Nassim Nicholas Taleb in his book, The Black Swan: The Impact of the Highly Improbable. Hartwig said it was the government-mandated business closures that were the real black swan event, not the coronavirus. “Pandemics have recurred regularly throughout all of recorded human history…. What was different is the decision to shut down the U.S. economy and, indeed, much of the global economy. That was the black swan. That’s what makes it an uninsurable event.
“Potentially, if you’re looking at events with return periods every 30 to 40 years that cause some minor destruction to the economy and some casualty related losses, that may be insurable. But when you have thousands of government bureaucrats making different decisions and different assessments about what to close, when and for how long, then that becomes essentially an exercise in futility and impossibility,” said Hartwig.
Departing from a preoccupation with the election and COVID-19, Hartwig examined other factors affecting the insurance industry, such as the economy, insurers’ investments, the overall litigation environment and data breaches.
As Hartwig has said many times before to symposium attendees, the economy and the insurance industry are “pretty much joined at the hip.” Direct written premium growth in the P/C industry closely tracks growth in the gross domestic product. In the first half of 2020, GDP “has fallen off a cliff.” The result, predicted Hartwig, will be a sharp decline in DWP even though it hasn’t happened yet. Hartwig attributed the lag in part to insurance pricing taking time to adjust and exposures changing.
Unemployment peaked at close to 15 percent in April; at the end of September it was down to 7.9 percent. The U.S. has recovered about half of the 22 million jobs that were lost in March and April. The remaining 11 million jobs will take longer to recover, Hartwig said.
Texas unemployment follows a similar pattern, peaking at 13.5 percent and reaching 8.3 percent by the end of September, which was an increase from 6.8 percent at the end of August. Texas lost a total of 1.4 million jobs and still has about 752,000 jobs to go just to match where the state was in February of this year, said Hartwig.
The reason Texas is underperforming the rest of the nation is it has a very high exposure to the oil and gas business, which, Hartwig said, “has been suffering dramatically.” Hartwig also pointed to the large number of jobs lost in the leisure and hospitality industry, common to every state.
On the investment side, equity investments which make up about 40 percent of insurers’ portfolios continue to be volatile. What was up by 29 percent last year is down by 33 percent as of late March, then up by nearly eight percent by mid-October, said Hartwig. “Volatility is with us for the indefinite future,” he said.
The more conservative investments of insurers in bonds, which make up about 50 percent of the industry’s assets, is affected by historically low interest rates. Hartwig said the Federal Reserve has vowed to keep interest rates low at least through 2023. COVID-19 federal rate cuts have pushed interest off a cliff, said Hartwig. “Low interest rates are really the new normal as far as the eye can see,” he said.
Hartwig said the industry is very close to its lowest yield on investments since 1961, when insurers earned 2.8 percent. The forecast for 2020 is 3.0 percent.
On the litigation front, Hartwig criticized trial lawyer aggression following coronavirus shutdowns, but he also looked at a troubling historic pattern.
Jury awards have rapidly escalated, he learned as he looked at data through 2017, the most recent available. “There is a lot of jackpot justice going on out there,” he said. While Texas locales were absent from the American Tort Reform Association’s map of the nation’s judicial hellholes for 2019-2020, Hartwig tempered the good news with the observation: “There’s a lot of competition here in terms of a poor tort environment.” He foresees a resurgence of interest in tort reform legislation.
Behind COVID, said Hartwig, there is another epidemic: data breaches. Hartwig considers the number of breaches and compromising of records to be grossly underestimated when looking only at what is publicly recorded and publicly known, and these numbers are rising. The reality, Hartwig said, is businesses of all sizes are targeted. Employees who have not been trained are victimized frequently. The number of insurers continues to grow in this space, said Hartwig, as the understanding of the risk and how to insure it develops.
Still, Hartwig concluded: “The industry entered COVID strong, stable, sound and secure. I have every confidence how it will exit this COVID period whenever we declare this to be ended. Unfortunately, we are seeing some contractions in the marketplace as a result of COVID, but this is normal as a result of a shock that is producing in this case a lot of litigation and accumulation of risk on the part of particularly many commercial insurers and of course their reinsurers. … This rapid economic slowdown obviously has already begun to temper P/C growth. That has not fully run its course yet. It will probably have an impact that will last into 2021 as well because the economy will not be miraculously healed on Jan. 1.”