Challenges and Opportunitiesfor Insurers in the Current

Economic Environment

CEA International Insurance ConferenceLondon, England

June 11, 2010Steven N. Weisbart, Ph.D., CLU, Senior Vice President & Chief EconomistInsurance Information Institute 110 William Street New York, NY 10038Office: 212.346.5540 Cell: 917.494.5945 stevenw@iii.org www.iii.org

2

Four of the Many ChallengesFacing Insurers Today

Pricing, Investing: Will Inflation—As Insurers Experience It—Spike, Stay Low, or be Negative?

Can Insurers Achieve Target Profits in an Era of Low Investment Returns?

How Much More Capital Will Regulators, Rating Agencies, and Others Demand That Insurers Acquire and Hold?

How Best to Prepare for the Next Chapter of the Global Financial Crisis?

3

Challenge:An Inflation Spike?

Low Inflation?Deflation?

The Only Certainty: Broad Ambiguity

In 2008, Central Banks in Europe, the UK, andthe US Dramatically Expanded the Money Supply

Source : Ecowin

0

500000

1000000

1500000

2000000

2500000

300000026

/05/

2006

26/0

8/20

06

26/1

1/20

06

26/0

2/20

07

26/0

5/20

07

26/0

8/20

07

26/1

1/20

07

26/0

2/20

08

26/0

5/20

08

26/0

8/20

08

26/1

1/20

08

26/0

2/20

09

26/0

5/20

09

26/0

8/20

09

26/1

1/20

09

Mo

illio

ns

of

Do

llars

or

Eu

ros

0

50000

100000

150000

200000

250000

300000US Federal reserve Banks, Total assets or liabilities, dollars

Euro Zone, Eurosystem, Total assets or liabilities, EUR

United Kingdom, Bank of England, assets, GBP

Inflation Rates for Largest European Economies & Euro Area, 2009-2011F

0.3%

0.3%

2.2%

0.1%

1.0%

1.3%

1.1%

2.4%

1.4%

1.1%

1.6%

1.6%

1.8%

1.6%

1.4%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

Euro Area Germany UK France Netherlands

2009 2010F 2011F

Source: Blue Chip Economic Indicators, 3/10/10 edition.

% Change from Prior Year Inflation is below 1.5% across major European economies and

interest rates remain low as a result, obscuring tight conditions

in trade credit markets

P/C Insurers Experience Inflation More Intensely than 2009 CPI Suggests

Source: CPI is Blue Chip Economic Indicator 2009 estimate, 12/09; Legal services, medical care and motor vehicle body work are avg. monthly year-over-year change from BLS; BI and no-fault figures from ISO Fast Track data for 4 quarters ending 09:Q3. Tort costs is 2009 Towers-Perrin estimate. WC figure is I.I.I. estimate based on historical NCCI data.

-0.4%

2.7% 3.0% 3.1%3.8%

4.3%

5.5%6.2%

-2%

0%

2%

4%

6%

8%

OverallCPI

LegalServices

US TortCosts

MedicalCare

MotorVehicleBodyWork

BodilyInjury

Severity

WC MedSeverity

No-FaultClaim

Severity

(Percent)

Healthcare and Legal/Tort Costs Are a Major P/C Insurance Cost Driver. These Are Expected to Increase Above the Overall Inflation Rate (CPI) Indefinitely

6

In the UK, the Household Rebuilding CostIndex is Also Higher Than the British CPI

Source : Association of British Insurers

Annual Change in the Household Rebuilding Cost Index and Retail Prices Index

0,00

1,00

2,00

3,00

4,00

5,00

6,00

7,00

8,00

9,00

10,00

janv-9

8

avr-

98

juil-

98

oct

-98

janv-9

9

avr-

99

juil-

99

oct

-99

janv-0

0

avr-

00

juil-

00

oct

-00

janv-0

1

avr-

01

juil-

01

oct

-01

janv-0

2

avr-

02

juil-

02

oct

-02

janv-0

3

avr-

03

juil-

03

oct

-03

janv-0

4

avr-

04

juil-

04

oct

-04

janv-0

5

avr-

05

juil-

05

oct

-05

janv-0

6

avr-

06

juil-

06

oct

-06

janv-0

7

avr-

07

juil-

07

oct

-07

janv-0

8

avr-

08

juil-

08

oct

-08

janv-0

9

Annual In

crease

(%

)

HRCI RPI

Household Rebuilding Cost Index

British CPI

French Health Insurance Tells the Same Story (as Does Many Other Countries)

Source : INSEE

100

105

110

115

120

125

130

135

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

100

= 1

998

CPI

Health Insurance CPI

9

Risks for Insurersif Inflation Is ReignitedRising Claim Severities

Cost of claims settlement rises across the board (property and liability)

Rate InadequacyRates inadequate due to low trend assumptions arising from

use of historical data

Reserve InadequacyReserves may develop adversely and become inadequate

(deficient)

Burn Through on RetentionsRetentions, deductibles burned through more quickly

Reinsurance Penetration/ExhaustionHigher costs risks burn through their retentions more

quickly, tapping into reinsurance more quickly and potentially exhausting their reinsurance more quickly

10

Challenge:Low Investment Returns

andHigh Downside Risk

11

World Economic Outlook: 2009-2011P

Sources: IMF, World Economic Outlook; Insurance Information Institute.

2.3%

6.3%

3.1%

1.0%1.9%

-5.2%-4.1%

-2.4%

2.4%

-3.2%

2.0%1.5%2.6%

6.5%

2.4%

-6%

-4%

-2%

0%

2%

4%

6%

8%

AdvancedEconomies

EmergingEconomies

United States Euro Area Japan

2009 2010P 2011P

Outlook uncertain: The world economy is recovering from the global crisis, but at different speeds in different parts of the world, according to the IMF. Insurance exposure growth will vary

regionally and by industry.

This growth is strong, but most insurance activity is in the U.S. and Europe, where growth will be weak.

3-Month Interest Rates forMajor Global Economies, 2008-2011F

1.8%

0.6%

2.1%

1.3%

0.2%

1.2%

0.4%

1.2%

4.0%

0.4%

2.6%

0.5%

2.5%

4.4%

1.7%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

Euro Area Japan UK China US

2009

2010F

2011F

Source: Blue Chip Economic Indicators, 3/10/10 edition.

Due to central bank action and lingering economic weakness, interest rates are

expected to remain low in much of the world, depressing insurer investment earnings. But in spite of low rates, credit market conditions

remain tight.

Internationally, Most Short-termInterest Rates Are Still Quite Low

Central Bank Current Interest Rate

Last Changed

Bank of Canada 0.25% April 21, 2009

Bank of England 0.50% March 5, 2009

Bank of Japan 0.10% Dec 19, 2008

European Central Bank 1.00% May 7, 2009

U.S. Federal Reserve 0.25% Dec 16, 2008

The Reserve Bank of Australia 4.50% May 4, 2010

China 5.31% Dec 22,2008

Hong Kong SAR 0.50% Dec 17, 2008

India 5.00% Mar 19, 2010

Korea, Republic of 2.00% Feb 16, 2009

Source: http://www.fxstreet.com/fundamental/interest-rates-table/

14

Challenge:How Much Capital

is Enough?

50

100

150

200

250

300

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Global Natural Catastrophes 1980–2009Overall and insured losses with trend

US

$bn

Overall losses (in 2009 values) Insured losses (in 2009 values)

Trend insured lossesTrend overall losses

Source: Munich Re NatCatSERVICE; Insurance Information Institute.

Global natural catastrophe loss trends portend an even more

disastrous decade ahead. Terrorism and environmental

and other man-made disasters could exacerbate the trend.

Annual insured losses exceeding

$100B by decade’s end?

16

Global Reinsurance Capacity Source of Decline

Global Reinsurance Capacity Shrankin 2008, Mostly Due to Investments

$360

$300

$270

$290

$310

$330

$350

$370

2007 2008

55% 14%

31%

Source: AonBenfield Reinsurance Market Outlook 2009; Insurance Information Institute.

Global Reinsurance CapacityFell by an Estimated 17% in 2008

Change inUnrealizedCapital Losses

RealizedCapitalLosses

Hurricanes

17

“Bullets Dodged”

Being “overcapitalized”—the criticism often leveled at insurers before the financial crisis began—was a good thing

We might have needed some billions of that capital for death and medical benefits if the H1N1 “swine” influenza pandemic—which began in April 2009— had been much worse than it was

18

Challenge:How to Prepare

for the NextGlobal Financial Crisis?

19

If fiscal imbalances are not addressed through spending cuts and revenue increases, only two options remain:

inflation for countries that borrow in their own currency and can monetize their deficits; or

default for countries that borrow in a foreign currency or can’t print their own.

Thus, the recent ... global financial crisis is not over; it has, instead, reached a new and more dangerous stage. ... now comes the rescue of the rescuers – i.e., governments. The scale of these bailouts is mushrooming. …But who will then bail out governments...? Our global debt mechanics are looking increasingly like a Ponzi scheme.

Source: Return to the Abyss, by Nouriel Roubini, Commentary, Project Syndicate at http://www.project-syndicate.org/commentary/roubini25/English

The Next Global Financial CrisisMight Come Sooner Than We Think

20

Lessons Learned

The effects of the crisis on insurance companies varied considerably, depending on

What products they sold

What investments they made

The economic environment in which they operated, and

How strong they were entering the crisis

21

Insurance LOBs Most DirectlyAffected by the Financial Turmoil

Mortgage and Financial Guarantee insurance

Trade Credit insurance

Credit Default Swaps (not legally insurance, but functioned that way)

Variable annuities (unit-linked life insurance products) with downside investment guarantees

22

Lessons Learned

The insurance sector’s business model is robust and generally able to withstand and conduct normal operations during

a sudden and sharp asset value meltdown

a soft pricing market,

an eroding exposure base, and

a challenging [man-made and natural] CAT environment

All at the same time!

23

In the Last Crisis, the Insurance SectorHelped Stabilise the World Economy

“…the insurance sector has arguably helped to provide a stabilising influence in light of its longer-term investment horizon and conservative investment approach.”

Source: OECD, The Impact of the Financial Crisis on the Insurance Sector and Public Policy Responses, April 2010

Thank you for your timeand your attention!