Financial Crisis: Private & Public Sector Impacts Challenges Amid Economic and Regulatory...

Financial Crisis: Private & Public Sector Impacts Challenges Amid Economic and

Regulatory Uncertainty

Robert P. Hartwig, Ph.D., CPCU, PresidentInsurance Information Institute 110 William Street New York, NY 10038

Tel: (212) 346-5520 Fax: (212) 732-1916 [email protected] www.iii.org

Southeastern Regulators Association ConferenceOrlando, FL

October 20, 2008

Presentation Outline

• Financial Crisis: Federal Government’s Financial Rescue PackageEmergency Economic Stabilization Act of 2008 (w/revisions)Troubled Asset Relief Program (TARP) Impacts for Financial Services and Insurers

• Regulatory Aftershocks• The Weakening Economy: Impact Analysis• P/C Insurance Industry Overview • Southeast US Catastrophe Exposure• Tort & Regulatory Environment

Q & A

Federal Government’s Financial Rescue

Package*(a.k.a. “The Bailout”)

Plan Details & Implications

*Including additional provision of the Emergency Economic Stabilization Act of 2008

Federal Government FinancialServices Rescue Package

Source: US Treasury, CNN Money.com and I.I.I. research.

THE SOLUTION: A 5-POINT PLAN1. Treasury Purchase of Equity Stakes in Banks

Treasury will buy up to $250B in senior preferred shares in wide variety of banks (out of $700B in EESA)

9 largest banks get $125B Stakes come in the form of non-voting shares and pay

5% for first 5 years and 9% thereafter Feds get warrants to buy up to 15% more shares Banks can buy back stake from government Must agree to limits on CEO compensation GOAL: Bolster bank capital/liquidity

2. Backing New Debt from Banks FDIC will guarantee new, senior unsecured debt issued by

banks, thrifts and bank holding cos. Must mature within 3 years; Banks can opt in until 6/30/2009

GOAL: Restore confidence of buyers of bank debt that they will be paid back (no matter what happens to bank)


THE SOLUTION: A 5-POINT PLAN (Cont’d)3. More Coverage for Bank Deposits

FDIC will provide unlimited coverage for all non-interest bearing accounts through 12/31/09. (Such accounts are typically used by businesses to meet short-term expenses such as payrolls)

Paid for by fees/premiums paid to FDIC GOAL: Boost liquidity for otherwise healthy banks

(esp. regional and local banks that might see nervous depositors withdraw money in favor of bigger banks

4. Buy Short-Term Commercial Paper Federal Reserve will buy until 4/30/09 high-quality 3-month

debt issued by businesses in commercial paper market Commercial paper is the prime source of funding to cover

op. expenses at many large corps. and financial institutions GOAL: Guarantees there will be a buyer of debt, so private

sector buyers will be willing to buy tooSource: US Treasury, CNN Money.com and I.I.I. research.


THE SOLUTION: A 5-POINT PLAN (cont’d)5. Buy Troubled Assets: “Troubled Asset Relief

Program” (TARP) Up to $450B available (theoretically) available to

purchase troubled assets from banks (and others?) Limits on CEO Compensation in Participating Firms Pricing: Debt Sold to Feds via Reverse Auction• Reverse auction is one in which sellers bid lowest price it will

accept from the government (i.e., rather a traditional auction in which the highest bid from buyer wins). Helps ensure that the Feds (taxpayer) does not overpay for questionable debt

• Will be sold in multi-billion dollar increments and run by outside asset managers in amounts ranging up to $50 billion

• Recoupment provision allows government to assess users of program to make taxpayers whole if program loses money

• GOAL: By removing “toxic” assets with uncertain underlying value from bank balance sheets, banks should be better able to attract capital

Source: I.I.I. research.

Distribution of $700 Billion in Funds Under Emergency Economic Stabilization Act of 2008

9 Large Banks*, 125 , 18%

Regional & Local Banks, 125 , 18%

Troubled Asset Purchases, 450 ,

64%

Shifting Emphasis

•Original EESA allocated all $700B to Troubled Asset Relief Program

•View was that TARP would take too long and that liquidity/credit crisis required direct infusion of capital in banks by feds

Source: US Treasury Department; Insurance Information Institute research.

Stakes Taken by Federal Government in 9 Large US Banks

$25

$25

$15

$10

$10

$10

$3

$2

$25

0 5 10 15 20 25 30

Citigroup

JP Morgan Chase

Wells Fargo*

Bank of America

Merrill Lynch

Goldman Sachs

Morgan Stanley

Bank of NY Mellon

State Street

*Includes $5 billion for purchase of Wachovia.Source: USA Today, Oct. 15, 2008, p. 1B.

•Feds announced a total $125B stake in 9 large banks on Oct. 14.

•Another $125B will be infused in regional and local banks

•Sum comes from $700B in Troubled Asset Relief Program in the Emergency Economic Stabilization Act of 2008

Top 10 Largest Bank Failures

$12.2 $13.0 $15.1 $18.5 $21.7 $30.2 $32.0 $32.5 $40.0

$307.0

$0

$50

$100

$150

$200

$250

$300

$350

Hom

efed

Ban

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992,

San

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icag

o)

Was

hin

gton

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tual

(20

08,

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ttle

)

$ B

illi

ons

Source: FDIC; Insurance Information Institute research.

Resurgent bank failures (13 in 2008 as of Oct. 12)

are symptomatic of weakness in the financial system. FDIC says many

more may fail

Failure of IndyMac was the 4th largest in

history

Sept. 25 failure of Washington

Mutual was bar far the largest in

US history. Sold to JP Morgan Chase by govt. for $1.9B

plus WaMu’s loans and deposits

Top 10 P/C Insolvencies, Based Upon Guaranty Fund Payments*

$2,265.8

$1,272.7

$1,049.7$843.4

$699.4$566.5 $555.8 $543.1 $531.6 $516.8

$0

$500

$1,000

$1,500

$2,000

$2,500

* Disclaimer: This is not a complete picture. If anything the numbers are understated as some states have not reported in certain years.

Source: National Conference of Insurance Guaranty Funds, as of September 17, 2008.

$ MillionsThe 2001 bankruptcy of Reliance Insurance was the largest ever among p/c insurers

Top 10 Life Insolvencies, Based On GuarantyFund Payments and Net Estimated Costs*

$2,821.7

$173.6 $172.4 $131.6 $107.8 $106.9 $81.9 $61.6 $61.5 $57.2$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

Executive LifeIns. Co. 1991

Corporate LifeIns. Co. 1994

NationalHeritage LifeIns. Co. 1995

LondonPacific Life &Annuity Co.

2004

Inter-American Ins.Co. of Illinois

1991

GuaranteeSecurity LifeIns. Co. 1992

New JerseyLife Ins. Co.

1993

AmericanChambers LifeIns. Co. 2000

AmericanIntegrity Ins.

Co. 1993

First NationalLife Ins. Co.of America

1999

*As of 2007.

Source: National Organization of Life and Health Guaranty Funds

$ Millions(Year Indicates Year of Liquidation)

The 1991 bankruptcy of Executive Life was by far the largest ever

among life insurers


Source: Insurance Info. Inst. research.

Other Recent Provisions1. Fannie/Freddie Will Increase Mortgage Buying

• Feds step-up buying MBS in open market

2. 10-Day Ban on Short-Selling 829 Financial Stocks• Most major public insurers on list• Expired Oct. 7

3. Increase FDIC Insurance Limits on Deposits to $250,000 from $100,000

4. Establish Financial Oversight Board• Includes Treasury Secretary, Fed Chairman and others TBD


Source: Insurance Info. Inst. research.

5. Conversion of Last 2 Remaining Investment Banks (Goldman Sachs and Morgan Stanley) to Bank Holding Companies• Recognition that Wall Street as it existed for decades is dead• High leverage investment bank model no longer viable in

current market environment• New entities will be subject to stringent federal regulation in

exchange for more access to federal dollars/liquidity facilities• Capital and liquidity requirements will be greatly enhanced• Reduced leverage means new entities will be less profitable

Other Recent Provisions (cont’d)

Liquidity Enhancements Implemented by Fed Due to Crisis

• Lowered Interest Rates for Direct Loans to Banks Federal funds rate cut from 5.5% in mid-2007 to 1.5% now Most recent cut from 2.0% to 1.5% globally coordinated on Oct. 7

• Injected Funds Into Money Markets• Increased FDIC Insurance Limits to $250,000 from $100,000• Coordinated Exchange Transactions w/Foreign Central Banks• Injected Cash Directly Into Banks; Will Take Ownership Stake• Created New and Expanded Auction & Lending Programs for

Banks e.g., Term Auction Facility expanded to $900B

• Started Direct Lending to Investment Banks for the First Time Ever

• Authorized Short-Term Lending to Fannie/Freddie, Backstopping a Treasury Credit Line

Source: Wall Street Journal, 9/22/08, p. A8; Insurance Information Institute research as of Oct. , 2008.

Why Have Credit Markets Frozen & Why Are They So Hard to Thaw?

1. CRISIS OF CONFIDENCE: Banks are Fearful of Lending to Each Other as Well as Even Highly-Rated Corporate Risks Lehman and bank bankruptcies have deeply damaged faith in the

financial integrity of financial institutions Fear has spread to European banks Concern that US actions are insufficient and Europe’s too uncoordinated CONSEQUENCES: Lending is shriveling and LIBOR is rising

2. DELEVERAGING: Banks & Investors Want to Reduce Debt Issuing new loans, even short term, slows purge of debt from balance

sheets

3. TANGLED WEB OF RISK: Financial Innovations Designed to Spread and Hedge Against Risk Obscure Where Risk is Held an in What AmountsGenesis of the Systemic Risk The packaging, securitization and global sale of collateralized debt

obligations (CDOs) such as mortgage backed securities (MBS) has made every financial institution in the world vulnerable

Explosive and widespread use of derivative hedges such as credit default swaps create large numbers of potentially vulnerable counterpartiesSource: Wall Street Journal, 10/7/08, p. A2; Insurance Information Institute research.

Positive Signs & Silver Liningsin the Economy

1. CREDIT THAW: Banks are beginning to lend to each other and to others in unsecured credit markets Key interest rates falling (LIBOR)

2. DELEVERAGING: Banks, Businesses & Consumers reducing debt loads to more manageable levels

3. ENERGY PRICES FALLING: Oil prices are down more than 50% and gas prices down about 33% Falling energy prices are potent economic stimulus and confidence builder Helps all industries

4. INFLATION THREAT WANING: Falling energy, commodities prices will help consumers and cut off price spiral Less erosion in real wages

5. AFFORDABILITY IN HOUSING: Rapidly falling home prices will attract more buyers, more quickly Critical to clear away excess inventory, stem foreclosures

Source: Insurance Information Institute

The Deleveragingof America

Economic Downdraft and Regulatory Questions

Leverage Ratios for InvestmentBanks and Traditional Banks*

33.0

24.3

23.3

21.5

15.4

13.3

12.4

10.8

10.5

44.0

0 10 20 30 40 50

Merrill Lynch

Morgan Stanley

Goldman Sachs

Lehman Brothers

Fannie Mae

Citibank

JP Morgan Chase

Wells Fargo

Wachovia

Bank of America

*Based on data for last quarter reported (May or June 2008).Source: “The Perils of Leverage,” North Coast Investment Research, Sept. 15, 2008

Investment bank leverage ratios were extremely high.

Lehman filed for bankruptcy 9/15

Merrill merged with JP Morgan Chase

Goldman and Morgan converted to bank holding companies

How Does Leverage Work?

• Example of Non-Leverage Transaction Buy 1 share of stock for $100 Price of share rises to $110 RETURN = $10 or 10%

• Leveraged Transaction Invest $10 and borrow $90 Stock rises to $110 RETURN = $10 or 100% (less borrowing costs)

• This Pleasant Arithmetic Works Equally Unpleasantly in the Opposite Direction

• Declining asset values, seizing of credit markets made such borrowing impossible and the operating model of investment banks nonviable

Source: Insurance Information Institute.

Investment banks and others juiced their returns

by making big, bad bets with (mostly) borrowed

money on mortgage securities

Credit Default Swaps: Notional Value Outstanding, 2002:H2 – 2008:H1*

*End of calendar half (H1 = June 30, H2 = December 31).

Source: International Swaps and Derivatives Association: http://www.isda.org/statistics/recent.html

$1.6 $2.7 $3.8 $5.4$8.4

$12.4$17.1

$26.0

$34.4

$45.5

$62.2

$54.6

$0

$10

$20

$30

$40

$50

$60

$70

02:H2 03:H1 03:H2 04:H1 04:H2 05:H1 05:H2 06:H1 06:H2 07:H1 07:H2 08:H1

$ TrillionsAt year end 2007, the

notional value of CDS’s outstanding was $62.2

trillion or 4.5 times US GDP, up nearly 40 fold from 2002.

The 12% decline in 08:H1 was the first since 2001.

NY Insurance Superintendant Eric Dinallo is considering regulation of CDS’s as

insurance (would reverse 2000 decision that CDS’s

are not insurance)

0%

3%

6%

9%

12%

15%

20

04

:Q1

20

04

:Q2

20

04

:Q3

20

04

:Q4

20

05

:Q1

20

05

:Q2

20

05

:Q3

20

05

:Q4

20

06

:Q1

20

06

:Q2

20

06

:Q3

20

06

:Q4

20

07

:Q1

20

07

:Q2

20

07

:Q3

20

07

:Q4

20

08

:Q1

20

08

:Q2

Home Mortgage Consumer Credit Business Corporate

Percent Change in Debt Growth(Quarterly since 2004:Q1, at Annualized Rate)

Source: Federal Reserve Board, at http://www.federalreserve.gov/releases/z1/Current/z1r-2.pdf

Deflation of housing bubble is very evident

Corporate deleveraging

Consumer desperation?

Ratio of Debt Service Payments to Disposable Income, 1980 – 2008:Q2

10.0

10.5

11.0

11.5

12.0

12.5

13.0

13.5

14.0

14.5

15.0

80q

181

q1

82q

183

q1

84q

185

q1

86q

187

q1

88q

189

q1

90q

191

q1

92q

193

q1

94q

195

q1

96q

197

q1

98q

199

q1

00q

101

q1

02q

103

q1

04q

105

q1

06q

107

q1

08q

1

HOUSEHOLD DELEVERAGING

In Q2 2008 13.85% of disposable personal income went to service

mortgage and consumer debt, down from a peak of 14.42% in Q4 2006,

Long-term ratio of debt service to income is 12.1%, well below where it is today

Source: Board of Governors of the Federal Reserve: http://www.federalreserve.gov/releases/housedebt/default.htm;

08q

2

% of Disposable Personal Income

Government Rescue Package of AIG

Motivation &Structural Details

AIG Rescue Package by the Fed

• AIG suffered a liquidity crisis due to large positions, mostly associated with Credit Default Swaps, related to mortgage debt through its AIG Financial Products division

• The losses at AIGFP brought AIG’s holding company to the brink of bankruptcy by Sept. 16 (AIG has 245 divisions, 71 are US domiciled insurers) Efforts to create large credit pool via private banks failed

• AIG’s separately regulated insurance subsidiaries were solvent at all times and met local capital requirements in all jurisdictions*

• Federal Reserve Agreed to Lend AIG $85 Billion to Prevent Bankruptcy, of which $70B has been borrowed (as of 10/10) 2-year term @ 850 bps over LIBOR (about 11 to 11.5%); 8% unborrowed Fed gets 79.9% stake in AIG (temporary nationalization) CEO Robert Willumstad replaced by former Allstate CEO Edward Liddy

• Proceeds from sale of non-core assets will be used to repay loan• New CEO says most insurance divisions are “core” *Sources: AIG press releases and regulator statements.

Expansion of AIG Rescue Package by the Fed on Oct. 8, 2008

• On Oct. 8 the Federal Reserve Bank of NY agreed to provide liquidity to AIG’s Securities Lending Program Fed will borrow investment grade fixed income securities from AIG’s

domestic life insurance companies, on commercial terms and conditions, in exchange for cash

Puts Fed into traditional lender of last resort position • Problem in the Securities Lending Program (SLP)

AIG lent securities to 3rd parties, receiving collateral in return Invested some of collateral in other assets whose value declined When borrowers of securities returned them, AIG had to make up

difference and sometimes couldn’t lend out securities for fresh collateral • NY Fed Authorized to Borrow $37.8B

AIG’s total securities lending obligations = $37.2B as of Oct. 6• Objective is to Provide Liquidity to SLP while Providing

Enhanced Credit Protection to NY Fed by Giving them Possession of Third Party Investment Grade Securities*

*Sources: AIG press releases; Wall Street Jounal and regulator statements.

Rational for Federal Reserve’s Rescue Package of AIG

• “Too Big to Fail” Doctrine Applied to Insurance for First Time

• AIG is the Largest Insurer in the US and One of the Top 5 Globally: Internationally Disruptive Disorderly unwinding of CDS positions (which guarantee large

amounts of debt) would have had large negative consequences on already fragile credit markets

• Fear Was that Generally Healthy Insurance Operations Affecting Millions of People and Businesses Would Have to Be Sold at Fire Sale Prices

• Loan Allowed Time for an Orderly Sale of Assets and a Minimal Disruption on Credit Markets while also Protecting Policyholders

• New CEO says most insurance divisions are “core” Source: Insurance Information Institute research.

AIG Actions to Date*• On October 3, New CEO Ed Liddy Announced Plan to Sell Assets and Focus

on Core Commercial P/C Operations Worldwide P/C premiums totaled approximately $40B in 2007

• Overall Impact May Be More Transformational for Global Life Industry• Will Sell:

All of Its US Life Insurance Operations Valued at as much as $24B**

Sell some foreign life operations, which collectively generated $64.5B in premiums, deposits and other considerations in 2007 (24.5% in Japan and 37.5% in Europe) Involves sale of American Life Ins. Co. (operates in Japan, Europe and Middle East &

elsewhere) as well as other life units operating in Japan and Taiwan Will retain majority stake in another life insurer operating in China and other Asian

countries May sell personal lines business (excluding Private Client Group)

Accounts for $4.8 billion in premiums ($4.1 billion excluding Private Client Group) and 3% market share in personal auto.

AIG's personal lines business (excluding its PCG is 73% direct and 27% agency*** Wind down AIG Financial Products (root of AIG’s problems), try to extract value Will sell aircraft leasing and asset management businesses Other, small insurance units and minor assets to be sold as well

*As of Oct. 5, 2008; **UBS analyst Andrew Klingerman (WSJ, Oct. 4, 2008) * **Barclay’s Capital, Oct. 3, 2008Sources: AIG, Wall Street Journal (Oct. 4, 2008), Insurance Information Institute research.

“Rescue” Treatment of AIGvs. Eight Large Banks

AIG 8 Large Banks*

U.S. Treasury’s ownership

79.9% of common stock Non-voting preferred stock; no dilution of common stock ownership

Interest/DividendsPayable toTreasury

•8.5% on unused line of credit up to $85 billion•8.5%+3-month LIBOR on borrowed money (total recently = 12.92%)•2% one-time fee on credit line

•5% on preferred stock**, rising to 9% after 5 years•Can borrow from the Fed’s discount “window” for as little as 1.75%

Time limit to pay off credit line

2 years Indefinite

“Toxic” assets

Unclear whether can sell to Treasury

Can sell to Treasury

*Citigroup, Bank of America (includes Merrill Lynch), JPMorganChase, Wells Fargo, Goldman, MorganStanley, State Street, Bank of New York Mellon. **$25 billion for Citi, BoA, JPMorgan, and Wells; $10 billion for Goldman and Morgan Stanley; $3 billion for BONY; $2 billion for State Street.

Leading U.S. Writers of P/C Insurance by DWP, 2007 ($ Billions)1

1Before reinsurance transactions, excluding state funds.

Source: National Association of Insurance Commissioners (NAIC) Annual Statement Database, via HighlineData LLC.

$49.4

$37.7

$29.1 $27.7$22.2 $20.2

$16.1 $15.4 $14.0 $11.5

$0

$10

$20

$30

$40

$50

State FarmIL Group

AIG ZurichInsurance

Group

AllstateInsurance

Group

TravelersGroup

LibertyMutual

InsuranceGroup

NationwideGroup

BerkshireHathawayIns. Group

ProgressiveGroup

HartfordFire &

CasualtyGroup

Direct Written Premiums (DWP) $ Billions

AIG is the second largest p/c insurer in the US and the

largest commercial insurer (11% markets share)

Leading U.S. Writers of Life Insurance By DWP, 2007 ($ Billions)1

1Premium and annuity totals, before reinsurance transactions, excluding state funds.

Source: National Association of Insurance Commissioners (NAIC) Annual Statement Database, via HighlineData LLC.

$53.0 $51.9

$42.3$38.0

$32.4$29.8 $29.7

$22.7 $21.9 $21.5

$0

$10

$20

$30

$40

$50

$60

AIG MetropolitanGroup

Prudential ofAmerica

ING AmericaInsuranceHoldingGroup

Hartford Fire& Casualty

Group

John HancockGroup

Aegon USAHoldingGroup

PrincipalFinancial

Group

New YorkLife Group

LincolnNational

Direct Written Premiums (DWP) $ Billions

AIG is the largest life insurer in the US in addition to being the

second largest p/c insurer

AFTERSHOCK: Regulatory Response

Could Be Harsh

All Financial Segments Including InsurersWill Be Impacted

Incurred Liabilities of the Federal Government Due to Financial Crisis

$700

$200

$29$122.8

$0

$100

$200

$300

$400

$500

$600

$700

$800

Mortgage SecurityBuyouts & Bank

Stakes

Fannie/FreddieTakeover

AIG Loans Bear Stearns IlliquidAsset Assumption

$ B

illi

ons

*As of October 10, 2008. Amounts reflect maximum losses under terms at time of announcement.Source: Wall Street Journal, 9/22/08, p. A8; Insurance Information Institute research. AIG amount consistent of$85B loan on Sept. 16 and additional $37.8B on Oct. 8.

The Fed (and hence taxpayer) are now exposed to as much as

$1.047 trillion in new debt tied to the current financial crisis*

$ Billions

$250B for Bank

Stakes

From Hubris to the Humblingof American Capitalism?

“Government is not the solution to our problem, government is the problem.”

--Ronald Reagan, from his first inaugural address, January 20, 1981

From Hubris to the Humblingof American Capitalism?

--President George W. Bush, Sept. 19, 2008, on the $700 billion financial institution bailout

“Given the precarious state of today’s financial markets, andtheir vital importance to the dailylives of the American people,Government intervention is notOnly warranted, it is essential.”

Post-Crunch: Fundamental Issues To Be Examined Globally

Source: Ins. Info. Inst.

• Failure of Risk Management, Control & Supervision at Financial Institutions Worldwide: Global Impact Colossal failure of risk management (and regulation) Implications for Enterprise Risk Management (ERM)? Misalignment of management financial incentives

• Focus Will Be on Risk Controls: Implies More Stringent Capital & Liquidity Requirements Data reporting requirements also likely to be expanded Non-Depository Financial Institutions in for major regulation Changes likely under US and European regulatory regimes Will new regulations be globally consistent? Can overreactions be avoided?

• Accounting Rules Problems arose under FAS, IAS Asset Valuation, including Mark-to-Market Structured Finance & Complex Derivatives

• Ratings on Financial Instruments New approaches to reflect type of asset, nature of risk

Post-Crunch: Fundamental Regulatory Issues & Insurance


• Federal Encroachment on Regulation of Insurance in Certain Amid a Regulatory Tsunami $123 billion in loans to AIG makes increased federal involvement in

insurance regulation a certainty States will lose some of their regulatory authority What Feds get/what states lose is unclear

• Removing the “O” from “OFC”? Treasury in March proposed moving solvency and consumer

protection authority to a federal “Office of National Insurance” Moving toward more universal approach for regulation of financial

services, perhaps under Fed/Treasury Is European (e.g., FSA) approach in store? Treasury proposed assuming solvency and consumer protection roles

while also eliminating rate regulation Expect battle over federal regulatory role to continue to be a divisive

issue within the industry States will fight to maximize influence, arguing that segments of the

financial services industry under their control had the least problems

Post-Crunch: Fundamental Regulatory Issues & Insurance


• Unclear How Feds Will Approach and Implement New Regulations on Financial Services Industry Option A: Could take “Big Bang” Approach and pass massive,

sweeping reform measure that draws little distinction between various segments of the financial services industry

Option B: Limited legislation pertaining to all segments with detailed treatment of each segment

• Removing the “O” from “OFC”? Treasury in March proposed moving solvency and consumer

protection authority to a federal “Office of National Insurance” Moving toward more universal approach for regulation of financial

services, perhaps under Fed/Treasury Is European (e.g., FSA) approach in store? Treasury proposed assuming solvency and consumer protection roles

while also eliminating rate regulation Expect battle over federal regulatory role to continue to be a divisive

issue within the industry States will fight to maximize influence, arguing that segments of the

financial services industry under their control had the least problems

Reasons Why Insurers Are Better Risk

Managers Than Banks

Risk ManagementMatters

6 Reasons Why P/C Insurers Have Fewer Problems Than Banks

1. Superior Risk Management Model Insurers overall approach to risk focuses on underwriting discipline,

pricing accuracy and management of potential loss exposure Banks eventually sought to maximize volume, disregarded risk

2. Low Leverage Insurers do not rely on borrowed money to underwrite insurance

3. Conservative Investment Philosophy High quality portfolio that is relatively less volatile and more liquid

4. Strong Relationship Between Underwriting and Risk Bearing Insurers always maintain a stake in the business they underwrite Banks and investment banks package up and securitize, severing the link

between risk underwriting and risk bearing, with disastrous consequences

5. Tighter Solvency Regulation Insurers are more stringently regulated than banks or investment banks

6. Greater Transparency Insurers are an open book to regulators and the public


THE ECONOMIC STORM

Weakening Economy, Threat of Inflation

3.7%

0.8%

1.6%

2.5%

3.6%

2.9%2.8%

2.0%

1.5%

0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Real Annual GDP Growth, 2000-2009F

March 2001-November

2001 recession

Recession is likely second half 2008 into first half 2009

* Red bars are actual; Yellow bars are forecastsSources: US Department of Commerce (actual), Blue Economic Indicators 10/08 (forecasts).

3.7

%

0.8

% 1.6

% 2.5

%

3.6

%

3.1

%

2.9

%

0.1

%

4.8

%

4.8

%

0.9

%

2.8

%

-0.3

%

-0.1

%

1.2

% 2.1

%

2.5

%

-1.1%

-0.2%

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

2

00

0

2

00

1

2

00

2

2

00

3

2

00

4

2

00

5

2

00

6

07

:1Q

07

:2Q

07

:3Q

07

:4Q

08

:1Q

08

:2Q

08

:3Q

08

:4Q

09

:1Q

09

:2Q

09

:3Q

09

:4Q

Real GDP Growth*

*Yellow bars are Estimates/Forecasts from Blue Chip Economic Indicators.Source: US Department of Commerce, Blue Economic Indicators 10/08; Insurance Information Institute.

Recession likely began Q2:08. Economic toll of credit

crunch, housing slump, labor market contraction and high

energy prices is growing

Real GDP Growth by State, 2006-2007

Growth in Southeast is weak

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

Ja

n-0

0

Ja

n-0

1

Ja

n-0

2

Ja

n-0

3

Ja

n-0

4

Ja

n-0

5

Ja

n-0

6

Ja

n-0

7

Ja

n-0

8

January 2000 through August 2008

Unemployment will likely continue to approach 6% during this cycle, impacting payroll sensitive p/c and non-life exposures

Source: US Bureau of Labor Statistics; Insurance Information Institute.

August 2008 unemployment jumped to 6.1%, its highest

level since Sept. 2003

Unemployment Rate:On the Rise

Average unemployment rate since 2000 is 5.0%

Previous Peak: 6.3% in June 2003

Trough: 4.4% in March 2007

Au

g-08

U.S. Unemployment Rate,(2007:Q1 to 2009:Q4F)*

4.7%

4.6% 4.

7%

4.5%

4.5%

4.5% 4.

6% 4.8% 4.

9%

5.3%

6.0%

6.3%

6.7% 6.

9% 7.0%

7.0%

4.0%

4.5%

5.0%

5.5%

6.0%

6.5%

7.0%

7.5%

06:Q1 06:Q2 06:Q3 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

* Blue bars are actual; Yellow bars are forecastsSources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (10/08); Insurance Info. Inst.

Rising unemployment will erode payrolls and workers

comp’s exposure base.

Unemployment is expected to peak at about 7% in the

second half of 2009.

4.1%4.7% 4.8% 4.9%

6.1% 6.3% 6.5% 6.8%7.6% 7.7%

11.8%

0%

2%

4%

6%

8%

10%

12%

14%

WV LA AR AL US GA FL KY SC MS PR

Unemployment Rates in the Southeast, August 2008

Unemployment rates in the Southeast are generally higher

than that of the US overall

Source: US Bureau of Labor Statistics.

Total Private Employment* Grew by25½ Million Workers from 1991 to 2008

89.7

89.9 91

.7 94.9 97

.7 100.

1 103.

0 106.

0 108.

6

108.

8

108.

2

115.

4

115.

2

110.

9 114.

0

111.

8

111.

0

109.

8

80

90

100

110

120

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

*seasonally adjusted at mid-yearSource: U.S. Bureau of Labor Statistics, at http://data.bls.gov/cgi-bin/surveymost

Millions

The US economy added 25.5 million jobs between 1991 and

2008, but job growth has recently stagnated, impacted payrolls and the workers comp exposure base

Monthly Change Employment*(Thousands)

-76-83 -88

-67

-47

-100

-67 -73

-159-180

-160

-140

-120

-100

-80

-60

-40

-20

0

Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08

Job losses now total 760,000 (from January through

September 2008)

Source: US Bureau of Labor Statistics: http://www.bls.gov/ces/home.htm; Insurance Info. Institute

Average Weekly Real Earnings in Private Employment Were Flat from 1999 to 2008$2

59.2

$257

.9

$258

.3

$260

.1

$258

.0

$260

.7 $264

.3

$271

.5 $276

.1 $279

.4

$279

.3

$281

.2

$276

.1

$275

.1

$277

.3

$276

.9

$275

.0

$276

.0

$250

$260

$270

$280

$290

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

Sources: U.S. Bureau of Labor Statistics; I.I.I.

(at mid-year)

Constant 1982 dollars

Virtually all of the real wage growth occurred between 1995 and 1999 and has now stagnated

New Private Housing Starts,1990-2019F (Millions of Units)

2.07

1.80

1.36

0.96

0.90

1.17

1.50

1.66

1.66 1.68

1.62

1.48

1.35

1.46

1.29

1.20

1.01

1.19

1.47

1.62 1.64

1.57 1.60

1.71

1.85

1.96

0.80.91.01.11.21.31.41.51.61.71.81.92.02.1

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07F08F09F10F11F12F13F14F 15-19F

Exposure growth forecast for HO insurers is dim for 2008/09

Impacts also for comml. insurers with construction risk exposure

New home starts plunged 34% from 2005-2007;

Drop through 2009 trough is 57% (est.)—a net annual decline of

1.17 million units

I.I.I. estimates that each incremental 100,000 decline in housing starts costs

home insurers $87.5 million in new exposure (gross premium). The net

exposure loss in 2008 vs. 2005 is estimated at about $1 billion.

Source: US Department of Commerce; Blue Chip Economic Indicators (10/08); Insurance Information Inst.

16.216.4

16.916.916.6

17.117.5

17.817.4

16.516.1

13.813.5

14.7

15.515.8

16.1

13

14

15

16

17

18

19

99 00 01 02 03 04 05 06 07F 08F 09F 10F 11F 12F 13F 14F 15-19F

Weakening economy, credit crunch and high gas prices are hurting

auto sales

New auto/light trick sales are expected to experience a net

drop of 3.3 million units annually by 2008 compared

with 2005, a decline of 18.3%

Impacts of falling auto sales will have a less pronounced effect on auto insurance exposure growth

than problems in the housing market will on home insurers

Auto/Light Truck Sales,1999-2019F (Millions of Units)

Source: US Department of Commerce; Blue Chip Economic Indicators (10/08); Insurance Information Inst.

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07*

$0

$5

$10

$15

$20

$25

$30

$35

$40

$45Wage & SalaryDisbursementsWC NPW

*Average of quarterly figures.Source: US Bureau of Economic Analysis; Federal Reserve Bank of St. Louis at http://research.stlouisfed.org/fred2/series/WASCUR; I.I.I. Fact Books

Wage & Salary Disbursements (Payroll Base) vs. Workers Comp

Net Written Premiums

7/90-3/91

Shaded areas indicate recessions

3/01-11/01

Wage & Salary Disbursement (Private Employment) vs. WC NWP$ Billions $ Billions

Weakening wage and salary growth is

expected to cause a deceleration in workers comp

exposure growth

$1

,08

2

$1

,14

4

$1

,22

6

$1

,30

7

$1

,36

8

$1

,40

5

$1

,36

7

$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

$1,600

03 04 05 06 07 08F 09F

-4%

-2%

0%

2%

4%

6%

8%

% C

ha

ng

e

Nonresidential Fixed Investment% Change Nonresidential Fixed Investment

Nonresidential Fixed Investment,* 2003 – 2009F (Billions of 2000 $)

Sharp dip in business investment growth in 2007-2009 will slow commercial

exposure growth. Investment is projected to

fall by 2.8% in 2009

*Nonresidential fixed investment consists of structures, equipment and software.

Sources: US Bureau of Economic Analysis (Historical), Blue Chip Economic Indicators (10/08) for forecasts.

Non

resi

den

tial F

ixed

In

vest

men

t ($

Bill

)

Total Industrial Production,(2007:Q1 to 2009:Q4F)

1.5%

3.2%3.6%

0.3% 0.4%

-3.1%-2.5%

-2.1%

-0.8%

0.8%

2.1%2.6%

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

07:Q1 07:Q2 07:Q3 07:Q4 08:Q1 08:Q2 08:Q3 08:Q4 09:Q1 09:Q2 09:Q3 09:Q4Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (10/08); Insurance Info. Inst.

Industrial production contracted sharply

during Q2 2008 and is expected to shrink through early 2009

Industrial production affects exposure both directly and indirectly

5.2%

-0.9

%-7

.4%

-6.5

%-1

.5%

1.8%

4.3%

18.6

%20

.3%

5.8%

0.3%

-1.6

%-1

.0%

-1.8

%-1

.0%

3.1%

1.1%

0.8%

0.4%

0.6%

-0.4

%-0

.3%

1.6%

5.6%

13.7

%7.

7%1.

2%-2

.9% -0

.5%

-3.4

%-4

.9%

-10%

-5%

0%

5%

10%

15%

20%

25%7

87

98

08

18

28

38

48

58

68

78

88

99

09

19

29

39

49

59

69

79

89

90

00

10

20

30

40

50

60

70

8F

Rea

l N

WP

Gro

wth

-4%

-2%

0%

2%

4%

6%

8%

Rea

l G

DP

Gro

wth

Real NWP Growth Real GDP

Real GDP Growth vs. Real P/C Premium Growth: Modest Association

P/C insurance industry’s growth is influenced modestly by growth

in the overall economy

Sources: A.M. Best, US Bureau of Economic Analysis, Blue Chip Economic Indicators, 8/08; Insurance Information Inst.

The Housing CrashCollapse of Home Price Bubble

Will Influence Auto &Home Purchases

Case-Schiller Home Price Index: 20 City Composite

0

50

100

150

200

250

Ja

n-0

0

Ja

n-0

1

Ja

n-0

2

Ja

n-0

3

Ja

n-0

4

Ja

n-0

5

Ja

n-0

6

Ja

n-0

7

Ja

n-0

8

January 2000 = 100

Peak in July 2006 at 206.52, meaning home prices had

more than doubled between Jan. 2000 and July 2006

July 2008 index value was 166.23, meaning home prices were 19.5%

below their July 2006 peakHome prices are

approximately where they were in mid 2004

Source: Standardandpoors.com (SPCS20R Index); Insurance Info. Institute

Jul-

08

Loss of home equity is hurting car sales

Change in Home Values from July 2006 Housing Bubble Peak, by City*

-34.

4%

-34.

2%

-32.

9%

-30.

9%

-29.

7%

-27.

9%

-26.

5%

-24.

4%

-21.

8%

-19.

5%

-16.

0% -11.

5%

-10.

7%

-10.

4%

-8.6

%

-7.2

%

-5.4

%

-3.0

%

-1.9

%

-1.8

%

4.1%

-40%

-35%

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

Phoen

ix

Las V

egas

Mia

mi

San D

iego

Los A

ngeles

San F

rancis

co

Tampa

Detro

it

Was

hing

ton

Compos

ite-2

0

Min

neap

olis

Clevela

nd

Chica

go

New Y

ork

Bosto

n

Atlant

a

Denve

r

Portla

nd

Seattl

e

Dallas

Charlo

tte

Home prices are falling across the country, down 19.5% on average in July 2008

*Calculated as of July 2008 (latest available) by III from monthly Case-Schiller price index data. Date of maximum price varies by city (July 2006 for 20-city composite: SPCS20R Index).Source: Case-Schiller Home Price Index at Standardandpoors.com; Insurance Info. Institute

Home equity is a common source of wealth used to

fund car purchases

Home Price History:Anatomy of a Bubble

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

Annual Change on a Monthly Basis: Jan. 1988 – Jul. 2008

Source: Standardandpoors.com (CSXR series); Insurance Info. Institute

Jan. 1988

Early stages of S&L fallout; Credit tightens

post-Oct. 1987 crash

April 1991

Max pace of decline.

S&L bank shakeout; Recession, Gulf War,

Energy price spike

Aug. 1990

Price decline begins.

Gulf War, Energy price spike, Recession

March 1996

House price recovery begins after 6 years of falling or flat prices.

Feb. 2002

Home price increases slow post 9/11 and tech bubble collapse; recession ends late 2001. Stock markets

down; Lowest interest rates in 40 years begin to fuel massive real estate

and credit bubble

Jul. 2004

Peak annual increase reached: 20.5%;

Credit standards deteriorate rapidly; Explosion in subprime loans, MBS, CDS

Jan. 2007

Home prices

begin to fall

Jul. 2008

Home prices plunge

17.5% vs. July 2007

Inflation Overview

Pressures Claim Costs, Expands Probable & Possible Max Losses

Annual Inflation Rates(CPI-U, %), 1990-2009F

4.9 5.1

3.0 3.2

2.6

1.51.9

3.3 3.4

1.3

2.5 2.3

3.0

3.8

2.8

4.94.4

2.52.82.9

2.4

0

1

2

3

4

5

6

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08* 08F 09F

*12-month change September 2008 vs. September 2007 Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators, October 10, 2008. (forecasts)

In September 2008, on a year-over-year basis inflation was 4.9% -- still high but down from its peak of 5.6% in August

Do Changes in Miles Driven AffectAuto Collision Claim Frequency?

7.00

6.81

6.59

6.80 6.78

6.91

6.65

6.32

6.035.93

5.71

5.84 5.82

5.5

6.0

6.5

7.0

96 97 98 99 00 01 02 03 04 05 06 07 08*

Pa

id C

laim

Fre

q

2400

2500

2600

2700

2800

2900

3000

3100

Bil

lio

ns

of

Mil

es D

rive

n

Collision Claim FrequencyBillions of Vehicle Miles

Sources: Federal Highway Administration (http://www.fhwa.dot.gov/ohim/tvtw/08juntvt/08juntvt.pdf; ISO Fast Track Monitoring System, Private Passenger Automobile Fast Track Data: First Half 2008, published October 1, 2008 and earlier reports. 2008 figure is for 4 quarters ending Q2 2008.

Paid Claim Frequency = (No. of paid claims)/(Earned Car Years) x 100

Medical & Tort Cost Inflation

Amplifiers of Inflation, Major Insurance Cost Driver

Consumer Price Index for Medical Care vs. All Items, 1960-2007

207.3

351.1

0

100

200

300

400

60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 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

Ind

ex V

alu

e (1

982-

84=

100)

All Items Medical Care

Source: Department of Labor (Bureau of Labor Statistics; Insurance Information Institute.

(Base: 1982-84=100)

Inflation for Medical Care has been surging

ahead of general inflation (CPI) for 25

years. Since 1982-84, the cost of medical care has

more than tripled

Soaring medical inflation is among the most serious

long-term challenges facing

casualty, disability and LTC insurers

P/C INSURANCE PROFITABILITY

In the Midstof a Cyclical Decline

P/C Net Income After Taxes1991-2009F ($ Millions)*

$14,

178

$5,8

40

$19,

316

$10,

870

$20,

598

$24,

404 $3

6,81

9

$30,

773

$21,

865

$3,0

46

$30,

029

$61,

940

$27,

866

$25,

000

-$6,970

$65,

777

$44,

155

$20,

559

$38,

501

-$10,000

$0

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

$70,000

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

08F

09F

*ROE figures are GAAP; 1Return on avg. surplus. 2008 numbers are annualized based on H1 actual.Sources: A.M. Best, ISO, Insurance Information Inst.

2001 ROE = -1.2%2002 ROE = 2.2%2003 ROE = 8.9%2004 ROE = 9.4%2005 ROE= 9.4%2006 ROE = 12.2%2007 ROAS1 = 12.3%2008 ROAS = 5.4%*

Insurer profits peaked in 2006.

PRICING TRENDS

Under Pressure

$651 $6

68 $691 $7

05

$703

$685

$690 $7

26

$781 $8

24 $859

$834

$837

$840

$829

$600

$650

$700

$750

$800

$850

$900

$950

94 95 96 97 98 99 00 01 02 03 04 05 06* 07* 08*

Average Expenditures on Auto Insurance

*Insurance Information Institute Estimates/ForecastsSource: NAIC, Insurance Information Institute estimates 2006-2008 based on CPI data.

Countrywide auto insurance expenditures are expected to increase about 2.5% in 2008,

highest since 2002/03

Lower underlying frequency and modest severity have kept auto insurance costs in check

$418$440$455

$481$488$508

$536

$593

$668

$729$760$775$764$757

$400

$450

$500

$550

$600

$650

$700

$750

$800

95 96 97 98 99 00 01 02 03 04 05 06* 07* 08*

Average Expenditures on Homeowners Insurance**

*Insurance Information Institute Estimates/Forecasts**Excludes cost of flood and earthquake coverage.Source: NAIC, Insurance Information Institute estimates 2006-2008 based on CPI data.

Countrywide home insurance

expenditures are expected to rise by an estimated 2% in 2008

Homeowners in non-CAT zones have seen smaller increases than

those in CAT zones

Average Commercial Rate Change,All Lines, (1Q:2004 – 2Q:2008)

-3.2

%

-5.9

%

-7.0

%

-9.4

%

-9.7

% -8.2

%

-4.6

% -2.7

%

-3.0

%

-5.3

%

-9.6

%

-11.

3%

-11.

8%

-13.

3% -12.

0%

-13.

5%

-12.

9%

-16%

-14%

-12%

-10%

-8%

-6%

-4%

-2%

0%

1Q04

2Q04

3Q04

4Q04

1Q05

2Q05

3Q05

4Q05

1Q06

2Q06

3Q06

4Q06

1Q07

2Q07

3Q07

4Q07

1Q08

2Q08

Source: Council of Insurance Agents & Brokers; Insurance Information Institute

KRW Effect

-0.1

% A flattening in the magnitude of price declines is evident

CAPACITY/SURPLUS

Capital/ Surplus Falling

from 2007 Peak

$0

$50

$100

$150

$200

$250

$300

$350

$400

$450

$500

$550

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

U.S. Policyholder Surplus: 1975-2008:H1*

Source: A.M. Best, ISO, Insurance Information Institute. *As of June 30, 2008

$ B

illi

ons

“Surplus” is a measure of underwriting capacity. It is analogous to “Owners Equity” or “Net Worth” in non-insurance organizations

Capacity as of 6/30/08 was $505.0, down 2.5% from 12/31/07 was $517.9B, but 80% above its 2002 trough.

Recent peak was $521.8 as of 9/30/07

The premium-to-surplus fell to $0.85:$1 at year-end 2007, approaching

its record low of $0.84:$1 in 1998

INVESTMENT OVERVIEW

More Pain, Little Gain

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

19

70

19

71

19

72

19

73

19

74

19

75

19

76

19

77

19

78

19

79

19

80

19

81

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

*

Source: Ibbotson Associates, Insurance Information Institute. *Through October 17, 2008.

Total Returns for Large Company Stocks: 1970-2008*

S&P 500 was up 3.53% in 2007, but down 36.0% so far in 2008*

Markets were up in 2007 for the 5th consecutive year

before the crash of 2008

Property/Casualty Insurance Industry Investment Gain1

$ Billions

$35.4

$42.8$47.2

$52.3

$44.4

$36.0

$45.3$48.9

$59.4$55.7

$63.6

$24.8

$56.9$51.9

$57.9

$0

$10

$20

$30

$40

$50

$60

94 95 96 97 98 99 00 01 02 03 04 05* 06 07

08H1

1Investment gains consist primarily of interest, stock dividends and realized capital gains and losses. 2006 figure consists of $52.3B net investment income and $3.4B realized investment gain. *2005 figure includes special one-time dividend of $3.2B.Sources: ISO; Insurance Information Institute.

Investment gains are off in 2008 due to lower yields and

poor equity market conditions.

P/C Insurer Net Realized Capital Gains, 1990-2008:H1

$2.88

$4.81

$9.89

$1.66

$6.00

$9.24

$10.81

$13.02

$16.21

$6.63

-$1.21

$6.61

$8.97

-$1.07

$18.02

$3.52

$9.70$9.13

$9.82

-$2

$0

$2

$4

$6

$8

$10

$12

$14

$16

$18

$20

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

08:H

1

Sources: A.M. Best, ISO, Insurance Information Institute.

Realized capital gains exceeded $9 billion in

2004/5 but fell sharply in 2006 despite a strong stock market. Nearly $9 billion again in 2007, but $-1.1

billion in 2008:H1.

$ Billions

FINANCIAL STRENGTH &

RATINGS Industry Has Weathered

the Storms Well

P/C Insurer Impairments,1969-2007

815

12

711

934

913

12

19

916

14

13

36

49

31 3

449

49

54

60

58

41

29

15

12

31

18 19

49 50

47

35

18

13 15

4

0

10

20

30

40

50

60

70

69

70

71

72

73

74

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

The number of impairments varies significantly over the p/c insurance cycle,

with peaks occurring well into hard markets

Source: A.M. Best; Insurance Information Institute

P/C Insurer Impairment Frequency vs. Combined Ratio, 1969-2007

90

95

100

105

110

115

120

69

70

71

72

73

74

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

Co

mb

ined

Ratio

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2

Imp

air

men

t R

ate

Combined Ratio after DivP/C Impairment Frequency

Impairment rates are highly correlated

underwriting performance and could reached a

record low in 2007

Source: A.M. Best; Insurance Information Institute

2007 impairment rate was a record low 0.12%, one-seventh the 0.8% average since 1969;

Previous record was 0.24% in 1972

Reasons for US P/C Insurer Impairments, 1969-2005

*Includes overstatement of assets.

Source: A.M. Best: P/C Impairments Hit Near-Term Lows Despite Surging Hurricane Activity, Special Report, Nov. 2005;

Catastrophe Losses8.6%

Alleged Fraud11.4%

Deficient Loss

Reserves/In-adequate Pricing62.8%

Affiliate Problems

8.6%

Rapid Growth

8.6%

2003-2005 1969-2005

Deficient reserves,

CAT losses are more important factors in

recent years

Reinsurance Failure3.5%

Rapid Growth16.5%

Misc.9.2%

Affiliate Problems

5.6%

Sig. Change in Business

4.6%

Deficient Loss

Reserves/In-adequate Pricing38.2%

Investment Problems*

7.3%

Alleged Fraud8.6%

Catastrophe Losses6.5%

CATASTROPHICLOSS

Southeast is Very Vulnerable

Most of US Population & Property Has Major CAT Exposure

Is Anyplace

Safe?

U.S. Insured Catastrophe Losses*$7

.5

$2.7

$4.7

$22.

9

$5.5 $1

6.9

$8.3

$7.4

$2.6 $1

0.1

$8.3

$4.6

$26.

5

$5.9 $1

2.9 $2

7.5

$6.7

$22.

0$1

00.0

$61.

9

$9.2

$0

$20

$40

$60

$80

$100

$120

89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

08**

20??

*Excludes $4B-$6b offshore energy losses from Hurricanes Katrina & Rita.**Based on preliminary PCS data through June 30. PCS $1.8B loss of for Gustav. $9.8B for Ike of 9/22.Note: 2001 figure includes $20.3B for 9/11 losses reported through 12/31/01. Includes only business and personal property claims, business interruption and auto claims. Non-prop/BI losses = $12.2B.Source: Property Claims Service/ISO; Insurance Information Institute

$ Billions2008 CAT losses already exceed 2006/07 combined. 2005 was by

far the worst year ever for insured catastrophe losses in the US, but the worst has yet to come.

$100 Billion CAT year is coming soon

Top 12 Most Costly Disasters in US History, (Insured Losses, $2007)

$4.0 $5.0 $6.0 $7.0 $7.8 $8.2 $9.8 $10.9 $10.9

$22.0 $22.9

$43.6

$0

$5

$10

$15

$20

$25

$30

$35

$40

$45

$50

Jeanne(2004)

Frances(2004)

Rita (2005)

Hugo(1989)

Ivan (2004)

Charley(2004)

Ike(2008)*

Wilma(2005)

Northridge(2004)

9/11Attacks(2001)

Andrew(1992)

Katrina(2005)

$ B

illi

ons

*Based on average of midpoints of range estimates from risk modelers AIR, RMS and Eqecat as of 9/15/08.Sources: ISO/PCS; AIR Worldwide, RMS, Eqecat; Insurance Information Institute inflation adjustments.

10 of the 12 most expensive disasters in US

history have occurred since 2004

Inflation-Adjusted U.S. Insured Catastrophe Losses By Cause of Loss,

1987-2006¹

Fire, $6.6 , 2.2%

Tornadoes, $77.3 , 26.0%

All Tropical Cyclones, $137.7 ,

46.3%

Civil Disorders, $1.1 , 0.4%

Utility Disruption, $0.2 , 0.1%

Water Damage, $0.4 , 0.1%Wind/Hail/Flood,

$9.3 , 3.1%

Earthquakes, $19.1 , 6.4%

Winter Storms, $23.1 , 7.8%

Terrorism, $22.3 , 7.5%

Source: Insurance Services Office (ISO)..

1 Catastrophes are all events causing direct insured losses to property of $25 million or more in 2006 dollars. Catastrophe threshold changed from $5 million to $25 million beginning in 1997. Adjusted for inflation by the III.2 Excludes snow. 3 Includes hurricanes and tropical storms. 4 Includes other geologic events such as volcanic eruptions and other earth movement. 5 Does not include flood damage covered by the federally administered National Flood Insurance Program. 6 Includes wildland fires.

Insured disaster losses totaled $297.3 billion from

1987-2006 (in 2006 dollars). Wildfires accounted for

approximately $6.6 billion of these—2.2% of the total.

Total Value of Insured Coastal Exposure (2004, $ Billions)

$1,901.6$740.0

$662.4$505.8

$404.9$209.3

$148.8$129.7$117.2$105.3

$75.9$73.0

$46.4$45.6$44.7$43.8

$12.1

$1,937.3

$0 $500 $1,000 $1,500 $2,000 $2,500

FloridaNew York

TexasMassachusetts

New JerseyConnecticut

LouisianaS. Carolina

VirginiaMaine

North CarolinaAlabamaGeorgia

DelawareNew Hampshire

MississippiRhode Island

Maryland

Source: AIR Worldwide

Northeast states have significant exposure. In 2004

Florida had more insured coastal exposure—at nearly $2 trillion than any other state. Future “Mega-Losses” are

UNAVOIDABLE.

Total Value of Insured Coastal Exposure (2007, $ Billions)

$2,378.9$895.1

$772.8$635.5

$479.9$224.4

$191.9$158.8$146.9$132.8

$92.5$85.6

$60.6$55.7$51.8$54.1

$14.9

$2,458.6

$0 $500 $1,000 $1,500 $2,000 $2,500 $3,000

FloridaNew York

TexasMassachusetts

New JerseyConnecticut

LouisianaS. Carolina

VirginiaMaine

North CarolinaAlabamaGeorgia

DelawareNew Hampshire

MississippiRhode Island

Maryland

Source: AIR Worldwide

In 2007, Florida still ranked as the #1 most exposed state to hurricane loss, with $2.459 trillion exposure, an increase of $522B or 27% from

$1.937 trillion in 2004.

The insured value of all coastal property was $8.9 trillion in 2007, up 24% from $7.2 trillion in 2004.

$522B increase since 2004, up 27%

Insured Losses from Top 10 Hurricanes Since 1900 & Katrina Adjusted for Inflation, Growth in Coastal

Properties, Real Growth in Property Values & Increased Property Insurance Coverage

$10.1 $11.0 $12.4 $12.6 $13.1 $14.5

$20.8 $21.1

$31.3

$41.1

$65.3

$0

$10

$20

$30

$40

$50

$60

$70

Number 9(1909,

FL)

Hazel(1954,NC)

Number 4(1938,NY)

Number 2(1919,

FL)

Number 4(1928,

FL)

Bestsy(1965,LA)

Number 2(1915,TX)

Number 1(1900,TX)

Andrew(1992,

FL)

Katrina(2005,LA)*

Number 6(1926, FL)

$ B

illi

ons

The p/c insurance industry will likely experience a $20B+ event approximately every 10-12 years, on average—mostly

associated with hurricanes

*ISO/PCS estimate as of June 8, 2006.Source: Hurricane Katrina: Analysis of the Impact on the Insurance Industry, Tillinghast, October 2005; Insurance Info. Institute.

(Billions of 2005 Dollars) Great Miami Hurricane

Galveston Storm

Government as Property Insurer of

Last Resort

Credit and Economic Crisis Increases Vulnerability

U.S. Residual Market Exposure to Loss (Billions of Dollars)

Source: PIPSO; Insurance Information Institute

$54.7

$150.0

$281.8$244.2

$292.0

$372.3$430.5

$770.4

$656.7

$221.3

$419.5

$0

$100

$200

$300

$400

$500

$600

$700

$800

$900

1990 1995 1999 2000 2001 2002 2003 2004 2005 2006 2007

Exposure to Loss

In the 17-year period between 1990 and 2007, total exposure to loss in the

residual market (FAIR & Beach/Windstorm) Plans has surged

132 fold from $54.7bn in 1990 to $770.4bn in 2007.

Florida Citizens Annual Exposure to Loss (Billions of Dollars)

*PIPSO Data. **Florida Citizens as of July 2008.Source: PIPSO; Florida Citizens; Zurich American Insurance Co; Insurance Information Institute

$439.1$485.1

$373.7

$210.6$206.7$195.5$154.6

$0

$100

$200

$300

$400

$500

$600

2002* 2003 2004 2005 2006 2007 2008**

Exposure to Loss

Since its creation in 2002, total exposure to loss in Florida Citizens has increased by 184 percent, from $154.6bn to $439.1bn in 2008.

Credit crisis likely makes ability to raise cash for any Cat Fund shortfall more

difficult and more expensive

Beach and Windstorm PlansExposure to Loss ($ Billion), 2007

*As of Aug. 31, 2008

Source: PIPSO; NCIUA; TWIA.

$66.6

$15.8

$67.8

$5.6

$0

$10

$20

$30

$40

$50

$60

$70

$80

AL MS NC* SC TX*

Exposure to Loss

NA

FHCF: Capacity Shortfall, But Strong Liquidity

Source: SBAFLA; FHCF

• FHCF total reimbursement capacity est. at $13.3 billion for 12mth period and $11.8 billion if bonding limited to 6mth period

• Ests. reflect a shortfall from FHCF’s theoretical capacity of $10 billion to $15 billion

• Shortfall in FHCF capacity estimate is the result of: Current conditions in the financial markets due to liquidity crisis Increases in interest rates Slight reduction in FHCF’s assessment base Expenses paid out of the fund for $4 billion put option agreement with

Berkshire Hathaway Investment losses

• But – the FHCF has a strong liquidity position: $2.8 billion in year-end cash for payment of claims Plus $3.5 billion in five-year floating rate notes totaling $6.5 billion Additional $4 billion from Berkshire Hathaway put option

Natural Catastrophe Plans (1)


• Homeowners’ Defense Act of 2007 (H.R. 3355) (Co-authors Rep. Tim Mahoney (D-FL) and Rep. Ron Klein (D-FL)): Would create a national catastrophe fund Allow states to pool catastrophe risk and transfer risk to

private market via cat bonds or reinsurance Also create a federal loan program to provide funds to state

reinsurance plans both prior and after a disaster Bill passed House Nov. 2007, but is currently stalled in the

Senate (S. 2310)

• Allstate -- ProtectingAmerica.org: Created in 2005 by coalition of emergency management

officials, first responders, disaster relief experts, insurers and others

Propose establishing a national catastrophe fund to serve as financial backstop for state catastrophe funds

Backs H.R. 3355

Natural Catastrophe Plans (2)


• The Hartford – Coastal Catastrophe Partnership: Seek to put risk back on private insurers Mandate flood insurance for all coastal homeowners Create a Federal and state-level reinsurance funds to backstop

losses by private insurers Establish untaxed savings accounts (“supplemental catastrophic

security accounts”) to pay for property insurance

• The Travelers, Nationwide and broker groups: Create Federally regulated “Coastal Hurricane Zone” from

Texas to Maine. Fed. Govt would not have a financial role, but would oversee

wind underwriting by private insurers, including pricing Federal reinsurance sold at cost for extreme events such as $100

billion+ hurricane Risk-based, actuarially sound rates using approved standards

and wind risk models Incentives for state and local governments to adopt federal

guidelines for appropriate building codes and land use planning.

Shifting Legal Liability & Tort

Environment

Is the Tort PendulumAbout to Swing?

The Nation’s Judicial Hellholes (2007)

Source: American Tort Reform Association; Insurance Information Institute

TEXAS

Rio Grande Valley and Gulf Coast

South Florida

ILLINOIS

Cook County West Virginia

Some improvement in “Judicial

Hellholes” in 2007

Watch ListMadison County, ILSt. Clair County, IL

Northern New Mexico

Hillsborough County, FLDelawareCalifornia

Dishonorable Mentions

District of ColumbiaMO Supreme Court

MI LegislatureGA Supreme Court

Oklahoma

NEVADA

Clark County (Las Vegas)

NEW JERSEY

Atlantic County (Atlantic City)

Business Leaders Ranking of Liability Systems for 2007

Best States1. Delaware2. Minnesota3. Nebraska4. Iowa5. Maine6. New Hampshire7. Tennessee8. Indiana9. Utah10. Wisconsin

Worst States41. Arkansas42. Hawaii43. Alaska

44.Texas45. California46. Illinois47. Alabama48. Louisiana49. Mississippi50. West Virginia

Source: US Chamber of Commerce 2007 State Liability Systems Ranking Study; Insurance Info. Institute.

New in 2007

ME, NH, TN, UT, WI

Drop-Offs

ND, VA, SD, WY, ID

Newly Notorious

AK

Rising Above

FL

Midwest/West has mix of good and bad states

REGULATORY & LEGISLATIVE

ENVIRONMENT

Significant DiversityAcross States

Rating of Auto/Home Insurance Regulatory & Operating Environment*

Source: James Madison Institute, February 2008.

ME

NH

MA

CT

PA

WVVA

NC

LA

TX

OK

NE

ND

MN

MI

IL

IA

ID

WA

OR

AZ

HI

NJ

RI

MDDE

AL

VT

NY

DC

SC

GA

TN

AL

FL

MS

ARNM

KYMOKS

SDWI

IN

OH

MT

CA

NV

UT

WY

CO

AK

Most states (25) get a “B”, but 7 got A’s, 10 got C’s (including DC), 5 earned D’s and 4 got F’s

*Criteria considered were auto/home residual mkts., auto/home mkt. concentration, loss ratio stability, reg. env.,form regulation, credit scores, territorial restrictions

= A= B= C= D= F

Source: James Madison Institute, Feb. 2008

Insurance Information Institute On-Line

THANK YOU FOR YOUR TIME AND

YOUR ATTENTION!

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