2012 Casualty Market Overview

A Tale of Two MarketsThe State of The US Casualty Market

Presented By:

Anthony DeFelice

It was the Best of Times, It was the Worst of Times

2

3

Industry Experts Weigh In

It was the Worst of Times There’s no question that the market turn is definitive. It is

here. William R. Berkley Insurance Industry leaders believe the worst of the financial

crisis now behind us; Industry now in the early stages of a hard market. Insurance Information Institute

The signs all point to an industry awareness that the risk being assumed needs more rate to produce adequate returns. Aspen Re

4

Industry Experts Weigh In

It was the Best of Times Positive premium rate movement remains in an early stage,

but market competition remains fierce. Fitch December 2011

The company remains skeptical that a long term reversal in market pricing has arrived. A.M. Best

As far as a hard market, we are not quite there yet, I think we’re still a year or two out. A.M. Best

2012 State of the Market?

Brittle?

Hardening?

Tightening?

Firming?

Transitioning?

One Word Can not capture the Dynamics of the Market

5

A Tale of Two Markets

Incumbent Business New Businessvs

Guaranteed Cost High Deductiblevs

Lead Umbrella Excess Limitsvs

High Hazard Risks Low - Moderate Hazard Risksvs

Difficult Loss History Favorable Loss History

Markets with Legacy Issues New Market Capacity

vs

vs

6

7

Casualty Market Engine – Difficult Starting

View Related Article

Casualty Recap – 2011

9th year of soft casualty pricing Many years producing double digit reductions Rate reductions slowed following Financial Crisis Exposures increasing End of 2011beginning sees upward movement (rate) in

the aggregate

8

Let’s review Industry Issues

Market Balance

Record Policy Holder Surplus

Market Competition

Rising Combined Ratios

Lagging Investment Results

Slowing Reserve Releases

Rising Tort Costs

Economic Pressures

Rate Increases

9

POLICY HOLDER

SURPLUS

10

Policyholder Surplus, 2006:Q4–2012:Q1

Sources: A.M .Best; ISO; Insurance Information Institute Graph.

($ Billions)

$487.1$496.6

$512.8$521.8

$478.5

$455.6

$437.1

$463.0

$490.8

$511.5

$540.7$530.5

$544.8

$559.2 $559.1

$538.6

$550.3

$570.7$566.5

$505.0$515.6$517.9

$420

$440

$460

$480

$500

$520

$540

$560

$580

06:Q4 07:Q1 07:Q2 07:Q3 07:Q4 08:Q1 08:Q2 08:Q3 08:Q4 09:Q1 09:Q2 09:Q3 09:Q4 10:Q1 10:Q2 10:Q3 10:Q4 11:Q1 11:Q2 11:Q3 11:Q4 12:Q1

2011:Q1Previous Surplus Peak

Quarterly Surplus Changes Since 2011:Q1 Peak

11:Q2: -$7.4B (-1.0%)11:Q3: -$27.9B (-4.6%)11:Q4: -$16.2B (-2.5%)12:Q1: +$3.2B (+0.7%)

Surplus as of 3/31/12 hit an all time record high of $570.7B, 0.7% or $3.2B

above the previous record set as of 3/31/11.

* Includes $22.5B of paid-in capital from a holding company parent for one insurer’s investment in a non-insurance business in early 2010.

The Industry now has $1 of surplus for every $0.80 of NPW, close to the strongest claims-

paying status in its history.

Drop due to near-record 2011 CAT losses

11

MARKET COMPETITION

RECORD CAPACITY

Approximately $2.5 Billion of Available Capacity

$1.3 Billion available on Single Risk Through Traditional Sources

Ample Capacity for 98% of Corporate Risks

Class 1 Rails, Energy, Multi-National Conglomerates, Large Life Science, are exceptions

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RISING COMBINED RATIOS

13

Underwriting Gain (Loss)1975–2012:Q1*

* Includes mortgage and financial guaranty insurers in all years.Sources: A.M. Best; ISO; Insurance Information Institute Graph.

Large Underwriting Losses Are NOT Sustainable Current Investment Environment

-$55

-$45

-$35

-$25

-$15

-$5

$5

$15

$25

$35

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 10 11 11

Cumulative underwriting deficit from 1975 through

2011 is $479B

($ Billions) Underwriting losses in

2011 totaled $36.5B, the

largest since 2001

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General Liability Combined Ratio: 2005–2012F

112.

9

95.1 99

.0

94.2

109.

9

107.

1 110.

8

104.

3

80

85

90

95

100

105

110

115

05 06 07 08 09 10 11 12F

Commercial General Liability Underwriting Performance Has Deteriorated in Recent Years

Sources: Conning Research and Consulting; Insurance Information Institute Graph. 15

Other & Products Liability Combined Ratio: 1991–2012F

11

0.3

10

9.1

11

2.0

12

2.6

12

4.4

11

1.8

11

4.4

11

2.1

96

.3 99

.0

95

.1

10

5.4

10

9.8

10

0.0 10

6.6

12

5.51

32

.8

13

3.2

11

4.5

143.6

12

3.5

11

0.6

80

90

100

110

120

130

140

150

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11P12F

Liability Lines Have Performed Better in the Post-Tort Reform Era (~2005), but There Has Been Some Deterioration in Recent Years

Sources: A.M. Best; Insurance Information Institute Graph. 16

Commercial Auto Combined Ratio: 1993–2012F

11

2.1

11

2.0

11

3.0

11

5.9

10

2.7

95

.2

92

.9

92

.1

92

.4

94

.1 96

.8 99

.1

97

.8

10

3.6

10

2.1

11

8.1

11

5.7

11

6.2

80

85

90

95

100

105

110

115

120

125

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12F

Commercial Auto is Expected to Deteriorate as Loss Frequency and Severity Trends Deteriorate 2011-2012

Sources: A.M. Best; Insurance Information Institute Graph.17

Workers Compensation Combined Ratio: 1994–2012F

10

2.0

97

.0 10

0.0

10

1.0

11

0.9

11

0.0

10

7.0

10

2.7

98

.4

10

3.6

10

4.4 1

10

.6 11

6.8

11

8.5

12

0.5

12

1.7

10

7.0

11

5.3

11

8.2

80

85

90

95

100

105

110

115

120

125

130

94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11P 12F

Workers Comp Underwriting Results Are Deteriorating Markedly and the Worst They Have Been in a Decade

Sources: A.M. Best; Insurance Information Institute Graph. 18

Another Look at Combined Ratios

19

* Excludes Mortgage & Financial Guarantee Losses

Year * PublishedCombined

Reserve Release Effect

Combined Without Reserve Release

CAT Effect Combined Without “Noise”

2006 92.7 -2 94.7 +2.7 92

2007 95.7 -3 98.7 +1.6 97.1

2008 101.0 -4.25 105.3 +5.0 100.3

2009 99.3 -5 104.3 +2.6 101.7

2010 100.9 -4.25 105.2 +4.4 100.8

2011 (est) 106.4 -1.8 108.2 +8.0 100.2

LAGGING INVESTMENT

RETURNS

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Treasury Yield Curves: Pre-Crisis (July 2007) vs. August 2012

0.09% 0.10% 0.14% 0.18% 0.27%

1.14%

1.68%

4.82% 4.96% 5.04% 4.96% 4.82% 4.82% 4.88% 5.00% 4.93% 5.00%5.19%

0.71%0.37%

2.77%2.40%

0%

1%

2%

3%

4%

5%

6%

1M 3M 6M 1Y 2Y 3Y 5Y 7Y 10Y 20Y 30Y

August 2012 Yield CurvePre-Crisis (July 2007)

Treasury yield curve remains near its most depressed level

in at least 45 years. Investment income is falling as a result. Fed is unlikely to hike rates until well into 2014

at the earliest.

The Fed Is Actively Signaling that it Is Determined to Keep Rates Low Through Mid-2015; This Adds to Pricing Pressure for Insurers.

Source: Federal Reserve Board of Governors; Insurance Information Institute Graph.

21

Property/Casualty Insurance Industry Investment Income: 2000–2012F1

$38.9$37.1 $36.7

$38.7

$54.6

$51.2

$47.1 $47.6$49.0

$46.6

$39.6

$49.5

$52.3

$30

$40

$50

$60

00 01 02 03 04 05 06 07 08 09 10 11 12F

Investment Income in 2011 Was Surprisingly Strong, Though Investment Income Is Likely to Weaken in 2012 Due to Persistently Low Interest Rates

1 Investment gains consist primarily of interest and stock dividends.*2012F is based on annualized Q1:2012 actual figure of $11.656B.Sources: ISO; Conning Research & Consulting; Insurance Information Institute Graph.

($ Billions)

Investment earnings in 2011 were 10.3% below

their 2007 pre-crisis peak

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P/C Net Income After Taxes1991–2012:Q1 ($ Millions)

$1

4,1

78

$5

,84

0

$1

9,3

16

$1

0,8

70

$2

0,5

98

$2

4,4

04 $

36

,81

9

$3

0,7

73

$2

1,8

65

$3

,04

6

$3

0,0

29

$6

2,4

96

$3

,04

3

$3

5,2

04

$1

9,1

50

$1

0,1

41

$2

8,6

72

-$6,970

$6

5,7

77

$4

4,1

55

$2

0,5

59

$3

8,5

01

-$10,000

$0

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

$70,000

$80,000

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12:Q1

2005 ROE*= 9.6% 2006 ROE = 12.7% 2007 ROE = 10.9% 2008 ROE = 0.1% 2009 ROE = 5.0% 2010 ROE = 6.6% 2011 ROAS1 = 3.5% 2012:Q1 ROAS1 = 7.2%

P-C Industry 2012:Q1 profits were up 29% from 2011:Q1, due primarily to lower catastrophe losses

• ROE figures are GAAP; 1Return on avg. surplus. Excluding Mortgage & Financial Guaranty insurers yields a 8.2% ROAS for 2012:Q1, 4.6% ROAS for 2011, 7.6% for 2010 and 7.4% for 2009.

Sources: A.M. Best; ISO; Insurance Information Institute Graph. 23

A 100 Combined Ratio Isn’t What ItOnce Was: Investment Impact on ROEs

Combined Ratio / ROE

* 2008 -2012 figures are return on average surplus and exclude mortgage and financial guaranty insurers. 2012:Q1 combined ratio including M&FG insurers is 99.0, ROAS = 7.2%; 2011 combined ratio including M&FG insurers is 108.2, ROAS = 3.5%. Sources: A.M. Best; ISO; Insurance Information Institute Graph.

97.5

100.6 100.1 100.8

92.7

101.099.3

100.9

97.6

106.4

95.78.2%

4.6%

7.6%7.4%4.4%

9.6%

15.9%

14.3%

12.7% 10.9%

8.8%

80

85

90

95

100

105

110

1978 1979 2003 2005 2006 2007 2008 2009 2010 2011 2012:Q10%

3%

6%

9%

12%

15%

18%

Combined Ratio ROE*

Combined Ratios Must Be Lower in Today’s Depressed Investment Environment to Generate Risk Appropriate ROEs

A combined ratio of about 100 generates an ROE of ~6.7% in 2012, ~7.5% ROE in 2009/10,

10% in 2005 and 16% in 1979

Year Ago

2011:Q1 = 102.2, 6.1% ROE

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-1.8

%

-1.8

%

-2.0

%

-3.6

%

-3.3

%

-3.3

%

-3.7

%

-4.3

%

-5.2

%

-5.7

%

-7.3%

-1.9

%

-2.1

%

-3.1

%

-8%-7%-6%-5%-4%-3%-2%-1%0%

Perso

nal L

ines

Pvt Pass

Aut

o

Pers P

rop

Comm

ercia

l

Comm

l Aut

o

Credit

Comm

Pro

p

Comm

Cas

Fidelity

/Sur

ety

War

rant

y

Surplu

s Line

s

Med

Mal

WC

Reinsu

rance

**

Lower Investment Earnings Place a Greater Burden on Underwriting and Pricing Discipline

*Based on 2008 Invested Assets and Earned Premiums**US domestic reinsurance onlySources: A.M. Best; Insurance Information Institute Graph.

Reduction in Combined Ratio Necessary to Offset 1% Decline in Investment Yield to Maintain Constant ROE, by Line*

25

SLOWING RESERVE

RELEASES

26

2

(2)

(8)

(3)

(7)(10) (10)

(4)

(0)

11

24

15

119

(5)

(9)

(14)

(10) (11)(7)

(5)(2)

-$20

-$15

-$10

-$5

$0

$5

$10

$15

$20

$25

$309

2

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08

09

10

11

E

12

F

13

F

Pri

or

Yr.

Re

se

rve

Re

lea

se

($

B)

-6

-4

-2

0

2

4

6

8 Imp

ac

t on

Co

mb

ine

d R

atio

(Po

ints

)

Prior Yr. ReserveDevelopment ($B)

Impact onCombined Ratio(Points)

P/C Reserve Development, 1992–2013F

Reserve Releases Remained Strong in 2010 But Tapered Off in 2011. Releases Are Expected to Further Diminish in 2012 and 2103

Note: 2005 reserve development excludes a $6 billion loss portfolio transfer between American Re and Munich Re. Including this transaction, total prior year adverse development in 2005 was $7 billion. The data from 2000 and subsequent years excludes development from financial guaranty and mortgage insurance. Sources: Barclays Capital; A.M. Best; Insurance Information Institute Graph.

Prior year reserve releases totaled $8.8

billion in the first half of 2010, up from

$7.1 billion in the first half of 2009

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RISING TORT COSTS

28

29

30

#1 Texas $482M Patent Infringement

#2 Mississippi $322M Product/Asbestos

#3 Virginia $212M Product

#4 Nevada $183M Product

#5 Michigan $144M Medical Malpractice

#6 Texas $116M Fraud

#7 Nevada $104M Product

#8 Illinois $95M Sexual Harassment

#9 West Virginia $91M Nursing Home

#10 Illinois $90M Product

Top 10 Verdicts 2011

Source: Lawyers USA Weekly

31

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Top Ten Jury Verdicts

In 2011, the average size of “top ten verdicts” rose by $27 Million or 17% to $184 Million

In 2011, the lowest award in the top 10 is nearly $90 Million - $10 Million more than 2010

In 2011 the top award was $482 Million, slightly lower than the $505 Million figure for 2010

The Total of the largest five liability verdicts was $1.1 Billion in 2010, up 77% from 2009 which was up 52% from 2008 Bloomberg

Source: “Top 10 Jury Verdicts of 2011.” Lawyers USA. 17 January 2011

AON GRIP DATA

CIAB DATA

34

35

Aon Grip Data – Risk Management Accounts

Primary Casualty – Quarterly Year-Over-Year Change in Average Rate

-3.9

-6.1

-1.8-2.0

-0.2

0.7 0.8

2.1

-1.0

-3.9

-1.2

-0.7 -0.8

1.82.1

2.4

-3.5

-1.1

-2.7

-3.3

-0.4

1.8

2.8

0.1

-7.0

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

Q3 '10 Q4 '10 Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12

% R

ate

Ch

ange

Workers Compensation General Liability Auto Liability

Data Source: Aon Analytics Research and Aon GRIPSM

Aon Grip Data – Risk Management Accounts

Umbrella/Excess Liability – Quarterly Year-Over-Year Change in Average Rate

-2.9

-3.9

-2.2 -2.1

-0.1

-0.5

2.6

3.2

-3.5

-4.5

-2.4-2.1

-1.6 -1.7

0.7

0.1

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

Q3 '10 Q4 '10 Q1 '11 Q2 '11 Q3 '11 Q4 '11 Q1 '12 Q2 '12

% R

ate

Ch

ange

Lead Total Program

Data Source: Aon Analytics Research and Aon GRIPSM

36

Change in Commercial Rate Renewals, by Line: 2012:Q2

Sources: Council of Insurance Agents and Brokers; Insurance Information Institute Graph.

Major Commercial Lines Renewed Uniformly Upward in Q2:2012 for Only the Fourth time Since 2003; Property Lines & Workers Comp Leading the Way; Cat Losses and Low

Interest Rates Provide Momentum Going Forward

Percentage Change (%)

4.7%5.1%

7.2%

8.3%

0.6%

3.0%3.8% 3.9% 4.1% 4.3%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

Su

rety

Co

mm

l Au

to

Um

bre

lla

Bu

sin

ess

Inte

rru

ptio

n

Ge

ne

ral

Lia

bili

ty

EP

L

D&

O

Co

nst

ruct

ion

Co

mm

erc

ial

Pro

pe

rty

Wo

rke

rsC

om

p

Workers Comp rate increases are large than any other line, followed

by Property lines

37

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Storm Clouds on the Horizon?

Will Industry Surplus Begin to Decline?

Will Combined Ratios in Casually Lines Continue to Increase?

How will the Global Economy react in 2012?

Will “Social Inflation” continue to impact the Tort System?

Will reserve releases turn to reserve strengthening?

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