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Financial Strength, Security, Solvency in the P/C Insurance Industry

The Critical Role of State Guarantee Funds

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

National Conference of Insurance Guarantee FundsFt. Lauderdale, FL

April 25, 2008

Presentation Outline• Weakening Economy: Insurance Impacts & Implications

Implications of Treasury “Blueprint” for insurers• Profitability• Financial Strength & Ratings• Guarantee Funds, the Insurance Cycle & CATs• Underwriting Trends• Premium Growth• Rising Expenses• Capacity• Investment Overview• Catastrophic Loss• Shifting Legal Liability & Tort Environment• Regulatory and Legislative Environment

Q&A

Key Issues for Guarantee Fundsto Consider Over the Next 5 Years

• Soft Market Leads to Increased in ImpairmentsEffect occurs with a lag (perhaps as far as the next hard market)Need for assessments increases eventually as well

• Weakening Economy: Muted ImpactShould have little impact on impairments/need for assessments

• Profits: A Profitable Industry is in Everyone’s Best InterestProfitability through 2007 remained fairly strong, suggesting need for cycle-driven assessments is some ways off

• Investment Volatility is the NormHistorically insurers rarely fail/become impaired due to bad investments

• CatastrophesSurge in assessment could result if small, poorly capitaized insurers hit hard

• ReservesCurrently strongDeficiencies associated with insolvency/impairments

A STORMY ECONOMIC FORECAST

What a Weakening Economy & Credit Crunch Mean for

the Insurance Industry

What’s Going On With the US and Global Economies Today?

Fundamental Factors Affecting Global Economy in 2008• Puncture of Two Bubbles: Credit and Housing in US

Burst Bubble Asset Price DeflationSubprime mortgage market was first part of credit bubble to burst

• Credit Crunch: Some credit markets have effectively seized• Global Contagion Effect: Securitization of asset back securities, derivatives

based on those securities amplified via leverage produced contagion effectMany financial institutions around the world found they are exposedMany hedge funds, banks caught holding CDOs, credit default swaps and other instruments against which they borrowed heavily (sometimes 10:1)Some face margin calls, distressed selling of every type of asset except Treasuries

• Global Economic Impacts: Global Economic SlowdownGDP growth in US down sharply, employment falling; Deceleration abroad too“Decoupling” theory was naïve Crashing dollar is symptom of irresponsible US fiscal policy, trade deficits. IOUs are being redeemed for hard assets or states in corporationsNew bubbles forming in commodities and currencies

Source: Insurance Information Institute.

3.7%

0.8%

1.6%

2.5%

3.6%

3.1%

2.9%

0.6%

3.8%

4.9%

0.1%

2.1%

1.9% 2.0%

2.6% 2.

8% 2.9%

0.6%

0.1%

0%

1%

2%

3%

4%

5%

6%

20

00

20

01

20

02

20

03

20

04

20

05

20

06

07:1

Q

07:2

Q

07:3

Q

07:4

Q

08:1

Q

08:2

Q

08:3

Q

08:4

Q

09:1

Q

09:2

Q

09:3

Q

09:4

Q

Real GDP Growth*

*Yellow bars are Estimates/Forecasts.Source: US Department of Commerce, Blue Economic Indicators 4/08; Insurance Information Institute.

Economic growth is slowing dramatically

in 2008

Toward a New WorldEconomic Order

Source: Insurance Information Institute

1. Credit Crunch (incl. Subprime) Issue Will Ultimately Cost Hundreds of Billions Globally (est. up to $600B)

• Problem exacerbated by leveraged bets taken by some financial institutions therefore its reach extends beyond simple defaults

2. Heavy Toll on Capital Base of Some Large Financial Institutions Worldwide (e.g., Bear Stearns)

• Cash infusions necessary; Sovereign Wealth Funds important source• Federal Reserve forced into playing a larger role; must improvise

3. Most Significant Economic Event in a Generation• US economy will recover, but will take 18-24 months

4. Shuffling of Global Economic Deck; Economic Pecking Order Shifting

• China, oil producing countries hold the upper hand5. IOUs are Being Redeemed

• Stakes in hard assets/institutions demanded6. Good News: No Shortage of Available Capital

• Central banks are (generally) making right decisions; Dollar sinks

What’s Being Done to Fix the Economy? Impacts on Insurers

•Fed on 3/14 (via J.P. Morgan) provided Bear with cash after what is effectively a “run on the bank”•“Too Big to Fail” doctrine is activated•Fed acting to prevent broader loss of confidence•3/17: J.P. Morgan buys Bear for $236 million ($2/share); Price increased to $10 on 3/24

Fed Bailout of Bear Stearns

•Fed will swap up to $200B in bank holdings of mortgage back securities for Treasuries up to 28 days; Improves bank finances

Fed Debt Swap

•Reduces bond yields (65% - 80% of portfolio)•Potentially contributes to inflation longer run

Fed Rate Cuts

Impacts on InsurersEconomic Fix


What’s Being Done to Fix the Economy? Impacts on Insurers

(cont’d)

•Treasury March 31 “Blueprint” affects all financial firms•For insurers, major recommendation is established of Optional Federal Charter under Office of National Insurance within Treasury

Regulatory/ Legislative Action (?)

•Keeps more people in their homes and hopefully paying HO insurance premiums•Abandoned and neglected homes have demonstrably worse loss performance

HousingBailout (?)

•Hope is that $168B plan boosts overall economic activity and employment (by 500,000 jobs) and therefore p/c personal and commercial exposures•Contributes to already exploding budget deficits—Washington may expand its search for people and industries to tax

Stimulus Package

Impacts on InsurersEconomic Fix


Post-Crunch: Fundamental Issues To Be Examined Globally


• Adequacy of Risk Management, Control & Supervision at Financial Institutions Worldwide

Colossal failure of risk management (and regulation)Implications for ERM?Includes review of incentives

• Effectiveness and Nature of RegulationWhat sort of oversite is optimal given recent experience?Credit problems arose under US and European (Basel II) regulatory regimesWill new regulations be globally consistent? Can overreactions be avoided?Capital adequacy & liquidity

• Accounting RulesProblems arose under FAS, IASAsset Valuation, including Mark-to-MarketStructured Finance & Complex Derivatives

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

Summary of Treasury “Blueprint”for

Financial Services Modernization

Impacts on Insurers

Treasury Regulatory Recommendations Affecting Insurers

Source: Department of Treasury Blueprint for a Modernized Financial Regulatory System, March 2008.

• Establishment of an Optional Federal Charter (OFC)Would provide system for federal chartering, licensing, regulation and supervision of insurers, reinsurer and producers (agents & brokers)OFC insurers would still be subject to state taxes, provisions for compulsory coverage, residual market and guarantee funds OFC would specify specific lines covered by charter; Separate charters needed for P/C and Life

• OFC Would Incorporate Several Regulatory ConceptsEnsure safety and soundnessEnhance competition in national and international marketsIncrease efficiency through elimination of price controls, promote more rapid technological change, encourage product innovation, reduce regulatory costs and provide consumer protection

• Establishment of Office of National Insurance (ONI)Department within Treasury to regulate insurance pursuant to OFCHeaded by Commissioner of National InsuranceCommissioner has regulatory, supervisory, enforcement and rehabilitative powers to oversee organization, incorporation, operation, regulation of national insurers and national agencies

• Establishment of Office of Insurance Oversight (OIO)Department within Treasury to handle issues needing immediate attention such “reinsurance collateral”; OIO could focus immediately on “key areas of federal interest in the insurance sector”OIO: lead regulatory voice on international regulatory policyWould have authority to ensure states achieved uniform implementation of declared US international insurance policy goalsOIO would also serve as advisor to Treasury Secretary on major domestic and international policy issues

• UPDATE: HR 5840 Introduced April 17 Would Establish Office of Insurance Information (OII)

Very similar to OIOSource: Department of Treasury Blueprint for a Modernized Financial Regulatory System, March 2008.

Treasury Regulatory Recommendations Affecting Insurers (cont’d)

Insurance &The Economy

Important But Somewhat Muted Impacts

A Few Facts About the Relationship Between Insurance & Economy

• Vast Majority of Insurance Business is Tied to RenewalsApproximately 98+% of P/C business (units) is linked to renewalsA very large share of p/c insurance premiums are statutorily or de facto compulsory (e.g., WC, auto liability, surety, usually HO…)P/C insurers have marginal exposure impact due to economyMost life revenues and units are renewals, but some products (e.g., variable annuities are sensitive to market volatility)Life insurers who manage 401(k) assets seeing more loans and hardship withdrawals;

• Insurers are Sensitive to Interest RatesAbout 2/3 of P/C invested assets and 75% if Life assets are fixed incomeHistorically, yield on industry portfolios has tracked 10-year note closelyAll else equal, lower total investment gain implies greater emphasis on underwritingHistorically, industry’s best underwriting performances are rooted in periods when interests rates were low and/or equity market performance poor (1930s – 1950s, early 2000s gave rise to strong 2006/07)


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

%-2

.9%

-2.7

%

-10%

-5%

0%

5%

10%

15%

20%

25%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 08F

Rea

l NW

P G

row

th

-4%

-2%

0%

2%

4%

6%

8%

Real

GDP

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, 2/08; Insurance Information Inst.

Summary of Economic Risks and Implications for (Re) Insurers

•Reduced commercial lines exposure growth•Surety slump•Increased workers comp frequency

General Economic Slowdown/Recession

•Decreased capital gains (which are usually relied upon more heavily as a source of earnings as underwriting results deteriorate)

Stock Market Slump

•Lower investment income Lower Interest Rates

•Reduced exposure growth•Deteriorating loss performance on neglected, abandoned and foreclosed properties

Housing Slump

•Some insurers have some asset risk•D&O/E&O exposure for some insurers•Client asset management liability for some•Bond insurer problems; Muni credit quality

Subprime Meltdown/ Credit Crunch

Risks to InsurersEconomic Concern

New Private Housing Starts,1990-2014F (Millions of Units)

2.07

1.80

1.36

0.98

1.10

1.38 1.

45

1.54 1.56

1.51

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

0.91.01.11.21.31.41.51.61.71.81.92.02.1

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

Source: US Department of Commerce; Blue Chip Economic Indicators (10/07), except 2008/09 figures from 4/08 edition of BCEF; Insurance Info. Institute

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 2008 trough is 53% (est.)—a

net annual decline of 1.09 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 $954 million.

16.816.916.916.6

17.1

17.517.8

17.4

16.5

16.1

15.3

15.7

16.416.6 16.7

16.9

14.0

14.5

15.0

15.5

16.0

16.5

17.0

17.5

18.0

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

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 1.4 million units annually by 2008 compared with 2005, a decline of 9.5%

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,1999-2014F (Millions of Units)

Source: US Department of Commerce; Blue Chip Economic Indicators (10/07), except 2008/09 figures from 4/08 edition of BCEF; Insurance Info. Institute

US Unemployment Rate,(2007:Q1 to 2009:Q4F)

4.5% 4.5% 4.6%4.8% 4.9%

5.2%5.4% 5.5% 5.5% 5.6% 5.5% 5.5%

3.0%

3.5%

4.0%

4.5%

5.0%

5.5%

6.0%

07:Q1 07:Q2 07:Q3 07:Q4 08:Q1 08:Q2 08:Q3 08:Q4 09:Q1 09:Q2 09:Q3 09:Q4

Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (4/08); Insurance Info. Inst.

Rising unemployment rate negative impacts workers comp exposure and could signal a temporary claim

frequency surge

$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

*As of 7/1/07 (latest available).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

Inflation Rate (CPI-U, %),1990 – 2009F

4.9 5.1

3.0 3.22.6

1.51.9

3.3 3.4

1.3

2.5 2.3

3.0

3.8

2.2

4.03.4

2.42.82.9

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* 08F09F

*12-month change Feb. 2008 vs. Feb. 2007; Source: US Bureau of Labor Statistics; Blue Chip Economic Indicators, Mar. 10, 2008; Ins. Info. Institute.

Inflation was just 2.2% in 2007 but is accelerating. Medical cost inflation, important in WC, auto liability

and other casualty covers is running far ahead of inflation. Rising inflation can also lead to rate inadequacy and adverse reserve development

Favored Industry Groups for Insurer Exposure Growth

•Fossil, Solar, Wind, Bio-Fuels, Hydro & OtherEnergy (incl. Alt.)

•Strong global demand, •Supplies remain tight…but beware of bubbles•Significant investments in R&D, plant & equip required

Natural Resources & Commodities

•Weak dollar, globalization persist; Cuba angle?Export Driven

•Consumer Staple Recession Resistant•Grain and land prices high due to global demand, weak dollar (exports)•Acreage Growing Farm Equipment, Transport•Benefits many other industries

Agriculture & Food Processing & Manufacturing

•Economic Necessity Recession Resistant•Demographics: aging/immigration Growth

Health CareRationaleIndustry

Sources: Insurance Information Institute

D&O/E&OTurbulent Markets,

Bankruptcies Can GiveRise to Suits

Shareholder Class Action Lawsuits*

*Securities fraud suits filed in U.S. federal courts; 2008 figure is current through March 31.Source: Stanford University School of Law (securities.stanford.edu); Insurance Information Institute

164202

163

231188

111173

242210215

497

267226237

182

118176

54

0

100

200

300

400

500

600

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

Pace of suits is up due in part to subprime issues,

housing collapse and market volatility.

Defendants include banks, investment banks,

builders, lenders, bond and mortgage insurers

Includes 44 suits related to subprime in 2007/08

A credit crunch creating a “contagion” effect resulting

in significant financial distress and bankruptcies in

other sectors could breed more securities litigation

Origin of D&O Claims for Public Companies, 2006

Customers & Clients, 4%Competitors,

6%

Employees, 25%

Government, 2%

Other 3rd Party, 22%

Shareholders, 40%

40% of D&O suits originate

with shareholders

Source: Tillinghast Towers-Perrin, 2006 Directors and Officers Liability Survey.

PROFITABILITYProfits in 2006/07 Reached

Their Cyclical Peak;

By No Reasonable Standard Can Profits Be Deemed Excessive

P/C Net Income After Taxes1991-2008F ($ Millions)*$1

4,17

8

$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

$49,

900

-$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

*ROE figures are GAAP; 1Return on avg. surplus. **Return on Average Surplus; 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= 9.6%2006 ROE = 12.2%2007 ROAS1 = 12.3%**

Insurer profits peaked in 2006

-5%

0%

5%

10%

15%

20%

87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08F

US P/C Insurers All US Industries

ROE: P/C vs. All Industries 1987–2008E

2008 P/C insurer ROE is I.I.I. estimate.Source: Insurance Information Institute; Fortune

Andrew Northridge

Hugo Lowest CAT losses in 15 years

Sept. 11

4 Hurricanes

Katrina, Rita, Wilma

P/C profitability is cyclical, volatile and vulnerable

Personal/Commercial Lines & Reinsurance ROEs, 2006-2008F*

14.0%16.8%

12.3%

9.4%

13.2%

6.3%

9.8% 10.7%9.8%

0%2%4%6%8%

10%12%14%16%18%

Personal Commercial Reinsurance

2006 2007E 2008F

Sources: A.M. Best Review & Preview (historical and forecast).

ROEs are declining as underwriting

results deteriorate

-5%

0%

5%

10%

15%

20%

25%

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 0607

E08

F

Profitability Peaks & Troughs in the P/C Insurance Industry,1975 – 2008F*

1975: 2.4%

1977:19.0% 1987:17.3%

1997:11.6%

2006:12.2%

1984: 1.8% 1992: 4.5% 2001: -1.2%

10 Years

10 Years 9 Years

*GAAP ROE for all years except 2007 which is actual ROAS of 12.3%. 2008 P/C insurer ROE is I.I.I. estimate.Source: Insurance Information Institute, ISO; Fortune

Insurance Stocks: Mixed Performance Compared to S&P 500 Index in 2008

-4.32%

-46.88%

-8.06%

-16.14%-4.49%

-6.69%

-14.04%

-5.31%

-50.0% -40.0% -30.0% -20.0% -10.0% 0.0%

S&P 500

All Insurers

P/C

Life/Health

Multiline

Reinsurance

Mortgage*

Brokers

*Includes Financial Guarantee.Source: SNL Securities, Standard & Poor’s, Insurance Information Inst.

Total YTD Returns Through April 18, 2008

Insurance stocks caught in financial services downdraft,

concern over soft market

Mortgage & Financial Guarantee insurers were

down 69% in 2008

Factors that Will Influence theLength and Depth of the Cycle

• Capacity: Rapid surplus growth in recent years has left the industry with between $85 billion and $100 billion in excess capital, according to analysts

All else equal, rising capital leads to greater price competition and a liberalization of terms and conditions

• Reserves: Reserves are in the best shape (in terms of adequacy) in decades, which could extend the depth and length of the cycle

Looming reserve deficiencies are not hanging over insurers they way they did during the last soft market in the late 1990sMany companies have been releasing redundant reserves, which allows them to boost net income even as underwriting results deteriorateReserve releases will diminish in 2008; Even more so in 2009

• Investment Gains: 2007 was the 5th consecutive up year on Wall Street. With sharp declines in stock prices and falling interest rates, portfolio yields are certain to fall Contributes to discipline

Realized capital gains are already rising as underwriting profits shrink, but like redundant reserves, realized capital gains are a finite resourceA sustained equity market decline (and potentially a drop in bond prices at some point) could reduce policyholder surplus


Factors that Will Influence the Length and Depth of the Cycle (cont’d)

• Sarbanes-Oxley: Presumably SOX will lead to better and more conservative management of company finances, including rapid recognition of deficient or redundant reserves

With more “eyes” on the industry, the theory is that cyclical swings should shrink• Ratings Agencies: Focus on Cycle Management; Quicker to downgrade

Ratings agencies more concerned with successful cycle management strategyMany insurers have already had ratings “haircut” over the last several years they way they did during the last soft market in the late 1990s; Less of a margin today

• Finite Reinsurance: Had smoothing effect on earnings; Finite market is gone• Information Systems: Management has more and better tools that allow

faster adjustments to price, underwriting and changing market conditions than it had during previous soft markets

• Analysts/Investors: Less fixated on growth, more on ROE through soft mkt.Management has backing of investors of Wall Street to remain disciplined

• M&A Activity: More consolidation implies greater disciplineLiberty Mutual/Safeco deal creates 5th largest p/c insurer. More to come?


-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

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

ROE Cost of Capital

ROE vs. Equity Cost of Capital:US P/C Insurance:1991-2007

Source: The Geneva Association, Ins. Information Inst.

The p/c insurance industry achieved its cost of capital in 2005/6 for the first time in many years

-13.

2 pt

s

+0.2

pts

US P/C insurers missed their cost of capital by an average 6.7 points from 1991 to 2002, but on

target or better 2003-07

-0.1

pts

+1.7

pts

-9.0

pts

The cost of capitalis the rate of return

insurers need to attract and retain

capital to the business

+2.3

pts

Top Industries by ROE: P/C Insurers Still Underperformed in 2006*

30.7%30.3%

26.4%24.6%

24.2%22.6%

21.8%21.5%

20.9%20.9%

20.5%19.6%19.4%19.1%

14.9%15.4%

31.8%

0% 5% 10% 15% 20% 25% 30% 35%

Oil & Gas Equip., ServicesPetroleum Refining

MetalsFood Services

Household & Pers. ProductsPharmaceuticals

Industrial & Farm EquipmentMining & Crude Oil Prod.

Aerospace & DefenseChemicalsSecurities

Food Consumer Prod.Medical Prod. & Equip.

Specialty RetailersHomebuilders

P/C Insurers (Stock)All Industries: 500 Median

*Excludes #1 ranked Airline category at 65.1% due to special one-time bankruptcy-related factors.Source: Fortune, April 30, 2007 edition; Insurance Information Institute

P/C insurer profitability in 2006 ranked 30th out of 50

industry groups despite renewed

profitabilityP/C insurers

underperformed the All Industry median for the 19th consecutive

year

Advertising Expenditures by P/C Insurance Industry, 1999-2007E

$ Billions

$1.736 $1.737 $1.803 $1.708

$3.695

$4.323

$2.975

$2.111$1.882

$1.5

$2.0

$2.5

$3.0

$3.5

$4.0

$4.5

99 00 01 02 03 04 05 06 07ESource: Insurance Information Institute from consolidated P/C Annual Statement data.

Ad spending by P/C insurers is at a record high, signaling

increased competition

FINANCIAL STRENGTH &

RATINGSIndustry Has Weathered

the Storms Well, But Cycle May Takes Its Toll

Reasons for US P/C Insurer Impairments, 1969-2005/6

*Includes overstatement of assets.Source: A.M. Best.

Catastrophe Losses8.6%

Alleged Fraud11.4%

Deficient Loss

Reserves/In-adequate Pricing62.8%

Affiliate Problems

8.6%

Rapid Growth

8.6%

2003-2005 1969-2006

Deficient reserves,

CAT losses are more important factors in

recent years

Reinsurance Failure3.3%

Rapid Growth15.7%

Misc.9.0%

Affiliate Problems

7.2%

Sig. Change in Business

4.4%

Deficient Loss

Reserves/In-adequate Pricing37.6%

Investment Problems*

6.9%

Alleged Fraud8.2%

Catastrophe Losses7.7%

Cumulative Average Impairment Rates by Best Financial Strength Rating*

0%

10%

20%

30%

40%

50%

60%

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15Average Years to Impairment

D

C/C-

C++/C+

B/B-

B++/B+

A/A-

A++/A+

Sources: A.M. Best: Best’s Impairment Rate and Rating Transition Study—1977-2002, March 1, 2004.

Insurers with strong ratings are far less likely to become impaired over

long periods of time. Especially important in long-tailed lines.

*US P/C and L/H companies, 1977-2002

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

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 07E

Com

bine

d R

ati o

00.20.40.60.811.21.41.61.82

Impa

irmen

t Rat

e

Combined Ratio after DivP/C Impairment Frequency

Impairment rates are highly correlated

underwriting performance and could reach near-record low in 2007

Source: A.M. Best; Insurance Information Institute

2006 impairment rate was 0.43%, or 1-in-233 companies, half the 0.86% average since 1969;

2007 will be lower; Record is 0.24% in 1972

Guarantee Funds, The Insurance Cycle & CATs

Assessment Activity Follows Cycle, CATs

Guarantee Fund Assessments,1979 - 2005 ($ Millions)

$46.

2$1

7.8

$49.

8$4

1.1

$30.

6$9

7.4

$292

.4$5

09.4

$903

.2

$433

.6$4

34.8

$66.

6$9

5.3 $2

36.3

$239

.2

$306

.4$7

12.8

$1,1

84.2

$874

.5$9

52.7

$916

.1

$179

.3

$713

.9

$497

.8$5

20.2

$464

.8

$383

.7

$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

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

Assessments set a record in 2002 (2nd to 1987 after adjusting

for inflation)

Assessments have both cyclical and catastrophe components, totaling

$11.2 billion from 1979-2005

Source: National Conference of Insurance Guarantee Funds; Insurance Information Institute

Guarantee Fund Assessments vs. Combined Ratio, 1979-2005

90

95

100

105

110

115

120

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

Com

bine

d R

atio

0

200

400

600

800

1000

1200

1400

Gua

rant

ee F

und

Ass

essm

ents

($ M

ill)

Combined Ratio after Div

Guarantee Fund AssessmentsAssessments rise as

insurer underwriting results deteriorate—

but with a lag

Source: A.M. Best, NCIGF; Insurance Information Institute

0.0%

0.1%

0.2%

0.3%

0.4%

0.5%

0.6%

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Note: Shaded areas denote hard market periods.Source: A.M. Best, NCIGF; Insurance Information Institute

Guarantee Fund Assessments as a Percentage of Net Written Premium

1984-87 2001-04

Guarantee fund assessments tend to

rise well during hard market periods (in the

wake of periods of poor performance)

UNDERWRITINGTRENDS

Extremely Strong 2006/07;Relying on Momentum &

Discipline for 2008

90

95

100

105

110

115

120

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 08F

Combined Ratios1970s: 100.31980s: 109.21990s: 107.82000s: 102.0*

Sources: A.M. Best; ISO, III *Full year 2008 estimates from III.

P/C Insurance Combined Ratio, 1970-2008F*

115.8

107.4

100.198.3

100.7

92.4

98.6

95.6

90

100

110

120

01 02 03 04 05 06 07 08F

P/C Insurance Combined Ratio, 2001-2008F

Sources: A.M. Best; ISO, III. *III estimates for 2008.

2005 figure benefited from heavy use of reinsurance which lowered net losses

2006 produced the best underwriting result

since the 87.6 combined ratio in 1949

As recently as 2001, insurers were paying out nearly $1.16 for

every dollar they earned in premiums

2007/8 deterioration due primarily to falling rates, but results still strong assuming

normal CAT activity

87.6

91.292.1 92.3 92.4 92.4

93.1 93.1 93.3

95.6

93.0

85

87

89

91

93

95

97

1949 1948 1943 1937 2006 1935 1950 1939 1953 1936 2007

Ten Lowest P/C Insurance Combined Ratios Since 1920 vs. 2007

Sources: Insurance Information Institute research from A.M. Best data. *2007: III Earlybird survey.

2007 was the 20th

best since 1920

The industry’s best underwriting years are associated with

periods of low interest rates

The 2006 combined ratio of 92.2 was the best since the 87.6 combined in 1949

-55-50-45-40-35-30-25-20-15-10-505

101520253035

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

Source: A.M. Best, Insurance Information Institute

$ B

illio

ns

Insurers earned a record underwriting profit of $31.7 billion in 2006, the largest ever but only the

second since 1978. Cumulative underwriting deficit from 1975 through 2007 is $422 billion.

Underwriting Gain (Loss)1975-2008F*

$10.

8 $22.

8 $33.

4

$36.

9

$18.

9

($5.0)($6.0)($5.3)

$0.4

($7.0)

8.9

-1.1-1.3-1.6

4.5

-1.20.1

3.5

8.6

6.5

($10)($5)$0$5

$10$15$20$25$30$35$40

00 01 02 03 04 05 06 07F 08F 09F

Res

erve

Dev

elop

men

t ($B

)

(3)(2)(1)012345678910

Com

bine

d R

atio

Poi

nts

PY Reserve DevelopmentCombined Ratio Points

Impact of Reserve Changes on Combined Ratio

Source: A.M. Best, Lehman Brothers estimates for years 2007-2009

Reserve adequacy has

improved substantially

PERSONAL LINES

103.

9

104.

5

103.

5

104.

9

99.8 10

2.7

104.

5

109.

9

110.

9

105.

3

98.4

94.3 96

.4

94.3 95

.6 98.6

85

90

95

100

105

110

115

93 94 95 96 97 98 99 00 01 02 03 04 05 06 07E 08FSource: A.M. Best; Insurance Information Institute.

Recent strong results attributable favorable frequency

trends and low CAT activity

Personal LinesCombined Ratio, 1993-2007E

101.7101.3 101.0

99.5

101.1

103.5

109.5

107.9

104.2

98.4

94.395.1 95.5

97.5

99.5

101.3

90

95

100

105

110

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

Private Passenger Auto (PPA) Combined Ratio

Average Combined Ratio for 1993 to 2006:

101.0

Sources: A.M. Best (historical and forecasts)

PPA is the profit juggernaut of the

p/c insurance industry today

Auto insurers have shown significant

improvement in PPA underwriting

performance since mid-2002, but results

are deteriorating.

Homeowners Insurance

117.7

158.4

113.6118.4

112.7

121.7

101.0

108.2111.4

121.7

109.3

98.394.2

100.1

91.795.5

99.5

113.0109.4

85

95

105

115

125

135

145

155

165

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

Homeowners Insurance Combined Ratio

Average 1990 to 2006= 111.8

Insurers have paid out an average of $1.12 in losses for every dollar earned

in premiums over the past 17 years


COMMERCIAL LINES

Commercial AutoCommercial Multi-Peril

Workers Comp

110.

3

110.

2

107.

6

103.

9 109.

7

112.

3

111.

1

122.

3

110.

2

102.

5 105.

4

91.2 94

.0 97.5

102.

0

112.

5

85

90

95

100

105

110

115

120

125

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

Recent results benefited from favorable loss cost trends, improved tort environment, low CAT losses, WC reforms and reserve releases

Commercial coverages have exhibited significant

variability over time.

Commercial Lines Combined Ratio, 1993-2008F

Outside CAT-affected lines, commercial

insurance is doing fairly well. Caution is required in

underwriting long-tail commercial lines.


112.

1

112 113 11

5.9 12

0.5

120.

1

106.

6

99.4

96.6

93.4

94

96.7

102.

2 105.

6 108.

9 112.

1

105.

9

101.

6

93.8

84.5

82.8

88.3

87.7

94.5 98

122.5

80

85

90

95

100

105

110

115

120

125

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

Comm Auto Liab Comm Auto PD

Commercial Auto Liability& PD Combined Ratios

Average Combined: Liability = 108.8

PD = 97.5

Commercial Auto has improved dramatically

Sources: A.M. Best (historical and forecasts) *Includes both liability and property damage.

119.

0

119.

8

108.

5

125.

0

113.

1

115.

0 121.

0

116.

2

116.

1

104.

9

101.

9 105.

5

100.

7

116.

8

113.

6

115.

3

122.

4

115.

0

117.

0

97.3

89.0

97.7

93.8

83.6

93.5

98.0

80

85

90

95

100

105

110

115

120

125

130

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

CMP-LiabilityCMP-Non-Liability

Commercial Multi-Peril Combined (Liability vs. Non-Liability Portion)

Liab. Combined 1995 to 2004 = 113.8

Non-Liab. Combined = 105.2

CMP- has improved recently

Sources: A.M. Best (historical and forecasts) *Includes both liability and property damage.

WORKERS COMPENSATION

OPERATING ENVIRONMENT

Workers Comp Calendar Year vs. Ultimate Accident Year – Private Carriers

101

97

111

110

107

103

95

101 10

6

119

131 14

0

135

123

88 87 87

101.

5

98.5

100

101 10

7 115 11

8 122

97

104

96

80

90

100

110

120

130

140

94 95 96 97 98 99 00 01 02 03 04 05 06p 07E 08F

Calendar Year Accident Year

Percent

p Preliminary AY figure. Accident Year data is evaluated as of 12/31/2006 and developed to ultimateSource: Calendar Years 1994-2005, A.M. Best Aggregates & Averages; Calendar Year 2006p and Accident Years 1994-2006pbased on NCCI Annual Statement Analysis.Includes dividends to policyholders *2007/2008 figures are A.M. Best estimates/forecasts.

Workers Comp Combined Ratios, 1994-2008F*

Lost-Time Claims

-4.2 -4.4

-6.9

-4.5 -4.1 -3.9

-6.8

-9.2

0.3

-6.5

-4.5

0.5

-3.9

-2.3

-4.5

-6.6

-10

-8

-6

-4

-2

0

2

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

Cumulative Change of –52.1%since 1991 means that lost work

time claims have been cut by more than half

Accident Year

Percent Change

Workers Comp Lost-TimeClaim Frequency (% Change)

2003p: Preliminary based on data valued as of 12/31/20061991-2005: Based on data through 12/31/2005, developed to ultimateBased on the states where NCCI provides ratemaking servicesExcludes the effects of deductible policiesSource: NCCI

4.5%3.6%

2.8% 3.2% 3.5%4.1% 4.6% 4.7%

4.0% 4.4% 4.2% 4.0%

5.1%

7.4%

10.1%

8.3%

10.6%

8.2%

14.0%

7.4%

9.0%

6.8%

11.7%

7.5%

0%

2%

4%

6%

8%

10%

12%

14%

16%

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Change in Medical CPIChange Med Cost per Lost Time Claim

WC Medical Severity Rising Far Faster than Medical CPI

Sources: Med CPI from US Bureau of Labor Statistics, WC med severity from NCCI based on NCCI states.

3.5

pts

WC medical severity rose more than twice as fast as the medical CPI (8.8% vs. 4.0%)

from 1995 through 2006

Med Costs Share of Total Costs is Increasing Steadily

Indemnity55%

Medical45%

Source: NCCI (based on states where NCCI provides ratemaking services).

Indemnity52%

Medical48%

Indemnity41%

Medical59%1986

1996

2006p

PREMIUM GROWTH

At a Virtual Standstillin 2007/08

-10%

-5%

0%

5%

10%

15%

20%

25%

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

F20

08F

Note: Shaded areas denote hard market periods.Source: A.M. Best, Insurance Information Institute

Strength of Recent Hard Markets by NWP Growth*

1975-78 1984-87 2001-04

Post-Katrina period resembles

1993-97 (post-Andrew)

2007: -0.6% premium growth was the first decline since 1943

Growth in Net Written Premium, 2000-2008F

*2008 forecast from A.M. Best.Source: A.M. Best; Forecasts from the Insurance Information Institute.

5.0%

8.4%

15.3%

10.0%

3.9%

0.5%

4.3%

-0.6% -1.0%2000 2001 2002 2003 2004 2005 2006 2007 2008F

P/C insurers are experiencing their slowest growth rates since 1943… underwriting results are deteriorating

Personal/Commercial Lines & Reinsurance NPW Growth, 2006-2008F

2.0% 3.5%

28.1%

-0.1%

-1.5%

1.4%

-2.3%-8.5%

-5.0%-15%-10%

-5%0%5%

10%15%20%25%30%

Personal Commercial Reinsurance

2006 2007E 2008F

Sources: A.M. Best Review & Preview (historical and forecast).

Net written premium growth is expected to be slower for commercial insurers and reinsurers

WEAK PRICING

Under Pressure in 2007/08, Especially Commercial Lines

$651 $6

68 $691 $7

05

$703

$685

$690 $7

24

$780 $8

23 $851

$847

$838

$847

$600

$650

$700

$750

$800

$850

$900

$950

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

Average Expenditures on Auto Insurance

*Insurance Information Institute Estimates/ForecastsSource: NAIC, Insurance Information Institute

Countrywide auto insurance expenditures are expected to fall 0.5%

in 2007, the first drop since 1999

Lower underlying frequency and modest

severity are keeping auto insurance costs in check

$418$440 $455$481$488 $508

$536$593

$668$729

$868

$787$835

$400$450$500$550$600$650$700$750$800$850$900

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

Average Expenditures on Homeowners Insurance**

*Insurance Information Institute Estimates/Forecasts**Excludes cost of flood and earthquake coverage.Source: NAIC, Insurance Information Institute

Countrywide home insurance expenditures rose an estimated

4% in 2006Homeowners in non-CAT zones have seen smaller increases than

those in CAT zones

Homeowners Insurance Expenditures as a % of Median Existing Home

Prices, 1995-2008F$1

17,0

00

$129

,000

$136

,000

$167

,600

$180

,200 $219

,000

$221

,900

$222

,700

$141

,200

$147

,300 $1

95,2

00

$218

,800

$156

,600

$122

,600

0.35

7%

0.35

9%

0.35

3%

0.34

6%

0.37

3%

0.35

9%

0.39

8%

0.39

7%

0.35

4%

0.34

5%

0.37

6%

0.37

1%

0.34

2%0.35

4%

($25,000)

$25,000

$75,000

$125,000

$175,000

$225,000

$275,000

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

Med

ian

Exi

stin

g H

ome

Pric

e

0.31%

0.32%

0.33%

0.34%

0.35%

0.36%

0.37%

0.38%

0.39%

0.40%

0.41%

HO

Ins.

Exp

end.

As %

Hom

e Pr

ice

Median Existing Home Price Homeowners Insurance Expenditure as % Home Price

Record catastrophe losses and declining home prices are pushing HO insurance expenditures as a

% of median home price up

Source: National Association of Realtors, NAIC; Insurance Info. Institute calculations and HO expenditure estimates/forecasts for years 2005-2008.

Average Commercial Rate Change,All Lines, (1Q:2004 – 1Q: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%

-16%

-14%

-12%

-10%

-8%

-6%

-4%

-2%

0%1Q

04

2Q04

3Q04

4Q04

1Q05

2Q05

3Q05

4Q05

1Q06

2Q06

3Q06

4Q06

1Q07

2Q07

3Q07

4Q07

1Q08

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

Magnitude of rate decreases diminished greatly after Katrina but have grown again

KRW Effect

-0.1

%

Cumulative Commercial Rate Change by Line: 4Q99 – 1Q08

Source: Council of Insurance Agents & Brokers

Commercial account pricing has been trending down for 3+ years and is now on par with prices in late 2001, early 2002

Most Layers of Coverage are Being Challenged/Leaking

Retention$1 Million$2 Million

Primary

Excess

Reinsurance

Retro

$10 Million

$50 Million

$100 Million

Risks are comfortable taking larger retentions

Lg. deductibles, self insurance, RRGs, captives erode primary

Excess squeezed by higher primary

retentions, lower reins. attachments

Reinsurers losing to higher retentions,

securitization

Source: Insurance Information Institute from Aon schematic.

RISING EXPENSES

Expense Ratios Will Rise as Premium Growth Slows

Personal vs. Commercial Lines Underwriting Expense Ratio*

23.4%24.3%

25.0%27.1%

24.4%

24.5%24.8%25.6%

24.6%

25.6%24.7%

26.1%26.6%

27.5%

30.8%

27.0%26.3%26.4%25.6%

30.0%

31.1%

29.4%29.9%

29.1%

26.6%

25.0%

20%

22%

24%

26%

28%

30%

32%

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

Personal Commercial

*Ratio of expenses incurred to net premiums written.Source: A.M. Best; Insurance Information Institute

Expenses ratios will likely rise as premium growth slows

CAPACITY/SURPLUS

Accumulation of Capital/ Surplus Depresses ROEs

$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

U.S. Policyholder Surplus: 1975-2007*

Source: A.M. Best, ISO, Insurance Information Institute. *As of December 31, 2007

$ B

illio

ns

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

Capacity as of 12/31/07 was $517.9B, 6.5% above year-end

2006, 81% above its 2002 trough and 55% above its 1999 peak.

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

its record low of $0.84:$1 in 1998

Annual Catastrophe Bond Transactions Volume, 1997-2007

$1,729.8

$966.9

$7,329.6

$4,693.4

$1,991.1

$1,142.8$1,219.5$846.1$984.8$1,139.0

$633.0

$0

$1,000$2,000

$3,000

$4,000

$5,000$6,000

$7,000

$8,000

97 98 99 00 01 02 03 04 05 06 07

Ris

k C

apita

l Iss

ues

($ M

ill)

0

5

10

15

20

25

30

35

Num

ber o

f Iss

uanc

es

Risk Capital Issued Number of Issuances

Source: MMC Securities Guy Carpenter, A.M. Best; Insurance Information Institute.

Catastrophe bond issuance has soared in the wake of

Hurricanes Katrina and the hurricane seasons of 2004/2005,

despite two quiet CAT years

P/C Insurer Share Repurchases,1987- Through Q4 2007 ($ Millions)

$564

.0

$646

.9

$311

.0

$952

.4

$418

.1

$566

.8

$310

.1

$658

.8

$769

.2

$4,5

86.5

$5,2

66.0

$763

.7

$5,2

42.3

$4,3

70.0

$7,0

94.1

$22,322.6

$4,4

97.5

$1,5

39.9

$2,7

64.2

$2,3

85.6

$4,2

97.3

$0

$5,000

$10,000

$15,000

$20,000

$25,000

87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

Sources: Credit Suisse, Company Reports; Insurance Information Inst.

2007 share buybacks shattered the 2006 record, up 214%

Reasons Behind Capital Build-Up & Repurchase Surge

•Strong underwriting results•Moderate catastrophe losses

•Reasonable investment performance

•Lack of strategic alternatives (M&A, large-scale expansion)

Returning capital owners (shareholders) is one of the

few options available

2007 repurchases to date equate to 3.9% of industry surplus, the highest in 20 years

MERGER & ACQUISITION

Catalysts for P/C Consolidation Growing

in 2008

P/C Insurance-Related M&A Activity, 1988-2006

$2,4

35

$5,1

00

$19,

118

$40,

032

$1,2

49$4

86$2

0,35

3$4

25$9

,264

$35,

221

$55,825

$30,

873

$8,0

59$1

1,53

4

$1,8

82

$3,4

50$2

,780

$5,1

37

$5,6

38

$0

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06

Tran

sact

ion

Valu

e ($

Mill

)

0

20

40

60

80

100

120

140

Num

ber o

f Tra

nsac

tions

Transaction Values Number of Transactions

Source: Conning Research & Consulting.

M&A activity began to accelerate during the second

half of 2007

No model for successful

consolidation has emerged

Distribution Sector: Insurance-Related M&A Activity, 1988-2006

$542

$446

$1,9

34

$7$1,633

$2,7

20

$689

$60 $2

12

$944

$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

96 97 99 00 01 02 03 04 05 06

Tran

sact

ion

Valu

e ($

Mill

)

0

50

100

150

200

250

300

Num

ber o

f Tra

nsac

tions

Transaction Values Number of Transactions

Source: Conning Research & Consulting.

No extraordinary trends evident

Distribution Sector M&A Activity, 2005 vs. 2006

Source: Conning Research & Consulting

Title9%Insurer

Buying Distributor

7%

Agency Buying Agency

51%

Other4%

Bank Buying Agency

29%

2005 2006

Title4%

Insurer Buying

Distributor7%

Agency Buying Agency

62%

Other2%

Bank Buying Agency

25%

Number of bank

acquisitions is falling

years

Motivating Factors for Increased P/C Insurer Consolidation

Motivating Factors for P/C M&As• Slow Growth: Growth is at its lowest levels since the late 1990s

NWP growth was 0% in 2007; Appears similarly flat in 2008Prices are falling or flat in most non-coastal markets

• Accumulation of Capital: Excess capital depresses ROEsPolicyholder Surplus up 6-7%% in 2007 and up 80% since 2002Insurers hard pressed to maintain earnings momentum Options: Share Buybacks, Boost Dividends, Invest in Operation, AcquireOption B: Engage in destructive price war and destroy capital

• Reserve Adequacy: No longer a drag on earningsFavorable development in recent years offsets pre-2002 adverse develop.

• Favorable Fundamentals/Drop-Off in CAT ActivityUnderlying claims inflation (frequency and severity trends) are benign

Lower CAT activity took some pressure of capital baseSource: Insurance Information Institute.

INVESTMENT OVERVIEW

More Pain, Little Gain

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$55.8

$63.6$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 071Investment 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 rose in 2007 but are just 9.8% higher than what they were

nearly a decade earlier in 1998

Property/Casualty Industry Investment Results, 1994-2007

$33.

7

$36.

8

$38.

0

$41.

5

$37.

1

$36.

7

$38.

7

$39.

6 $49.

5

$52.

3

$54.

6

$1.7

$6.0 $9

.2 $10.

8

$18.

0

$13.

7 $16.

9

$6.9 $6

.9 $9.3

$9.7

$3.5

$9.0

$40.

8

$38.

6

$39.

9

$20

$30

$40

$50

$60

$70

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

Bill

ions

Capital Gains/LossesInvestment Income

*Primarily interest, stock dividends, and realized capital gains and losses.**Not shown: $1.1B capital loss in 2002.2005 figure includes special one-time dividend of $3.2B. Sources: ISO; Insurance Information Institute.

$52.3

$57.7

$44.0

$35.6

$45.6$48.9

$59.2$55.8

$63.6Realized capital gains rising as underwriting

results slip$57.9

US P/C Net Realized Capital Gains,1990-2007 ($ Millions)

$2,8

80 $4,8

06

$9,8

93

$1,6

64

$5,9

97

$9,2

44 $10,

808

$13,

016 $1

6,20

5

$6,6

31

-$1,

214

$6,6

10 $8,9

71

$18,019

$3,5

24

$9,7

01

$9,1

25

$9,8

18

-$5,000

$0

$5,000

$10,000

$15,000

$20,000

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07Sources: A.M. Best, ISO, Insurance Information Institute.

Realized capital gains rebounded strongly in 2004/5

but fell sharply in 2006 despite strong stock market

as insurers “bank” their gains. Rising again in 2007 as underwriting results slip

-30%

-20%

-10%

0%

10%

20%

30%

40%

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

Source: Ibbotson Associates, Insurance Information Institute. *Through April 23, 2008.

Total Returns for Large Company Stocks: 1970-2008*

S&P 500 was up 3.5% in 2007, down 6.0% YTD 2008*

Markets were up in 2007 for the 5th consecutive year; 2008 could be first down

year since 2002

2%

3%

4%

5%

6%

7%

8%

9%

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

P-C Inv Income/Inv Assets 10-Year Treasury Note

P/C Investment Income as a % of Invested Assets Follows 10-Year US T-Note

*As of January 2008 month-end.Sources: Board of Governors, Federal Reserve System; A.M.Best; Insurance Information Institute.

Investment yield historically tracks 10-year Treasury note quite closely

CATASTROPHICLOSS

What Will 2008 Bring?

Most of US Population & Property Has Major CAT Exposure

Is Anyplace

Safe?

U.S. Insured Catastrophe Losses*$7

.5$2

.7$4

.7$2

2.9

$5.5 $1

6.9

$8.3

$7.4

$2.6 $1

0.1

$8.3

$4.6

$26.

5$5

.9 $12.

9 $27.

5

$6.7

$3.1

$100

.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 0708

:Q1

20??

*Excludes $4B-$6b offshore energy losses from Hurricanes Katrina & Rita. 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

$ Billions

2006/07 were welcome respites. 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

States With Largest Insured Catastrophe Losses in 2007

$ Millions

$1,230

$747 $677

$320$223 $202 $200 $200$262$270$272

$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

CA MN TX GA IL OK KS MO NY CO ALSource: PCS/ISO; Insurance Information Institute.

2007 CAT STATS•1.18 million CAT claims across 41 states arising•23 catastrophic events

Distribution of 2007 US CAT Losses, by Type and Insured Loss

Personal, $4.4 , 68%

Commercial, $1.3 , 20%

Vehicle, $0.8 , 12%Personal (home, condo, rental, contents etc.)

accounted for 68% of all US insured

CAT losses paid in 2007. CAT claim

count was 1.18 million.

Source: PCS division of ISO.

$ Billions

$14.3$34.4$40.2$47.7$63.6$68.4$108.3$132.6$138.4$154.4$168.7

$420.7$502.5$538.4

$2,260.0$2,294.4

$2,589.3

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

Sep. 12-18, 1979 Hollywood Hills, CA

Oct. 9-10, 1982 Los Angeles, Ventura, Orange Cos., CA

Nov. 16-17, 1980 Bradbury, Pacific Palisades, Malibu, Sunland,Carbon Canyon, Lake Elsinore, CA

Oct. 23-25, 1978 Los Angeles, Ventura Cos., CA

May 17-20, 1985 Florida

Jul. 26-27, 1977 Santa Barbara, Montecito, CA

Nov. 24-30, 1980 Los Angeles, San Bernardino, Orange,Riverside, San Diego Cos., CA

Sep. 22-30, 1970 Oakland-Berkeley Hills, CA

Jun. 23-28, 2002 Rodeo-Chediski Complex, AZ

July 2007: Lake Tahoe, CA**

May 10-16, 2000 Cerro Grande, NM

Jun. 27-Jul. 2, 1990 Santa Barbara County, CA

Oct. 27-28, 1993 Orange Co., CA

Nov. 2-3, 1993 Los Angeles Co., CA

Oct. 2007: Southern CA Fires*

Oct. 2003: Southern CA Fires

Oct. 20-21, 1991: Oakland, Alameda Cos., CA

Insured Losses (Millions 2007 $)

Top Catastrophic Wildland Fires In The United States, 1970-2007

Fourteen of the top 17

catastrophic wildfires since

1970 occurred in California

*Estimate from CA Insurance Dept., Jan. 10, 2008. Source: ISO's Property Claim Services Unit; California Department of Insurance; Insurance Information Institute.

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

1987-2006¹Fire, $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.

Global Insured Catastrophe Losses 1970-2007 ($ 2007)

$2.4 $5.0

$5.8 $9.1

$5.0

$6.4

$5.6

$5.4 $1

1.3

$7.0

$4.2 $8

.9$1

0.3

$6.8 $1

1.6

$5.6 $1

5.4

$12.

4 $23.

7$2

7.9

$24.

4 $42.

5$1

8.4 $3

4.4

$25.

6$1

8.0

$11.

2 $24.

9$4

3.1

$15.

0$4

1.8

$16.

7$2

1.6

$52.

8$1

13.9

$16.

9 $27.

6

$0

$20

$40

$60

$80

$100

$120

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

Source: Swiss Re Sigma No.1/08, Natural catastrophes and man-made disasters in 2007

$ Billions

Impact of Hurricane Katrina on 2005

losses was dramatic

Global Insured Catastrophe Losses by Region, 2001-2007

0

10

20

30

40

50

60

70

80

90

2001 2002 2003 2004 2005 2006 2007

Seas/SpaceAfricaOceania/AustraliaSouth AmericaAsiaEuropeNorth America*

Notes: 2001-03 figures for N. America include US only. 2001 figure includes only property losses from 9/11. Source: Insurance Information Institute compiled from Swiss Re sigma issues.

North America accounted for 70% of global

catastrophe losses 2001-2007

$ Billions

The 2008 Hurricane Season:

Preview to Disaster?

Outlook for 2008 Hurricane Season: 60% Worse Than Average

150NA96.2Accumulated Cyclone Energy975Intense Hurricane Days

160%275%100%Net Tropical Cyclone Activity

472.3Intense Hurricanes4047.524.5Hurricane Days8145.9Hurricanes

80115.549.1Named Storm Days15289.6Named Storms

2008F2005Average*

*Average over the period 1950-2000.Source: Philip Klotzbach and Dr. William Gray, Colorado State University, April 9, 2007.

Landfall Probabilities for 2008 Hurricane Season: Above Average

Above Average

NACaribbean

44%30%Gulf Coast from Florida Panhandle to Brownsville

45%31%US East Coast Including Florida Peninsula

69%52%Entire US East & Gulf Coasts

2008FAverage*

*Average over the past century.Source: Philip Klotzbach and Dr. William Gray, Colorado State University, April 9, 2007.

REINSURANCE MARKETS

Reinsurance Prices are Falling in Non-Coastal Zones, Casualty Lines

Share of Losses Paid by Reinsurers, by Disaster*

30%25%

60%

20%

45%

0%

10%

20%

30%

40%

50%

60%

70%

Hurricane Hugo(1989)

Hurricane Andrew(1992)

Sept. 11 TerrorAttack (2001)

2004 HurricaneLosses

2005 HurricaneLosses

*Excludes losses paid by the Florida Hurricane Catastrophe Fund, a FL-only windstorm reinsurer, which was established in 1994 after Hurricane Andrew. FHCF payments to insurers are estimated at $3.85 billion for 2004 and $4.5 billion for 2005.Sources: Wharton Risk Center, Disaster Insurance Project; Insurance Information Institute.

Reinsurance is playing an increasingly

important role in the financing of mega-CATs; Reins. Costs

are skyrocketing

US Reinsurer Net Income& ROE, 1985-2007*

$1.9

4

$2.0

3

$1.9

5 $3.7

1$4

.53

$5.4

3$1

.47

$1.9

9

$1.3

1 $3.1

7$3

.41

$2.5

1$9

.68

$7.9

6

($2.98)

$0.1

2

$1.9

5

$1.3

8$1

.22

$1.8

7

$1.1

7 $2.5

2$1

.79

($4)

($2)

$0

$2

$4

$6

$8

$10

$12

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07*

Net

Inco

me

($ B

ill)

-10%

-5%

0%

5%

10%

15%

20%

RO

E

Net Income ROE

Source: Reinsurance Association of America. *2007 ROE figure is III estimate based return on average 2007 surplus.

Reinsurer profitability rebounded post-Katrina

but is now falling

Shifting Legal Liability & Tort

EnvironmentIs the Tort Pendulum

Swinging Against Insurers?

Bad Year for Tort Kingpins*(Continued)

“King of Class Actions” Bill Lerach•Former partner in class action firm Milberg Weiss•Admitted felon. Guilty of paying 3 plaintiffs $11.4 million in 150+ cases over 25 years & lying about it repeatedly to courts•Will serves 1-2 years in prison and forfeit $7.75 million; $250,000 fine

“King of Torts” Dickie Scruggs•Won billions in tobacco, asbestos and Katrina litigation•Pleaded guilty for attempting to offer a judge $40,000 bribe to resolve attorney fee allocation from Katrina litigation in his firm’s favor. His son/others guilty on related charges•Could get 5 years in prison, $250,000 fine

Sour

ce: S

an D

iego

Uni

on T

ribun

e, 9

/19/

07So

urce

: Wal

l Stre

et Jo

urna

l, 3/

15/0

7

Bad Year for Tort Kingpins*(Continued)

“King of Class Actions” Melvyn Weiss•Former partner in class action firm Milberg Weiss; Earned $251 million in legal fees•Pled guilty to federal charges of racketeering and conspiracy for paying kickbacks to professional plaintiffs•Will serve 18-33 months in prison, pay $9.75 million in restitution; $250,000 fine

Sour

ce: W

all S

treet

Jour

nal,

3/24

/07

This Space Available

$17.0$49.6 $58.7

$85.6$17.1

$51.0$70.9

$85.6

$5.2

$20.4

$30.0

$45.5

$0

$50

$100

$150

$200

$250

1980 1990 2000 2006

Commercial Lines Personal Lines Self (Un)Insured

Bill

ions

Total = $39.3 Billion

*Excludes medical malpracticeSource: Tillinghast-Towers Perrin, 2007 Update on US Tort Cost Trends.




Personal, Commercial & Self (Un) Insured Tort Costs*

Tort System Costs, 1950-2009E

$1.8 $5.4 $7.9$13.9$20.0

$83.7

$130.2

$179.2

$246.0$265

$277

$158.5

$247.0

$42.7

$3.4

0.62%0.82%

1.03%

1.34%1.22%

1.98%2.14%

1.82% 1.83%1.83%1.87%

2.24%2.24%

1.53%

1.11%

$0

$50

$100

$150

$200

$250

$300

50 55 60 65 70 75 80 85 90 95 00 03 06 08E 09E

Tor

t Sys

tem

Cos

ts

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

Tor

t Cos

ts a

s % o

f GD

P

Tort Sytem Costs Tort Costs as % of GDP

Source: Tillinghast-Towers Perrin, 2007 Update on U.S. Tort Costs as % of GDP

After a period of rapid escalation,

tort system costs as a % of GDP are

now falling

The Nation’s Judicial Hellholes (2007)

Source: American Tort Reform Association; Insurance Information Institute

TEXASRio Grande Valley and Gulf Coast

South Florida

ILLINOISCook County West Virginia

Some improvement in “Judicial

Hellholes” in 2007

Watch ListMadison County, ILSt. Clair County, IL

Northern New Mexico

Hillsborough County, FLDelawareCalifornia

Dishonorable MentionsDistrict of Columbia

MO Supreme CourtMI Legislature

GA Supreme CourtOklahoma

NEVADAClark County (Las Vegas)

NEW JERSEYAtlantic 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. Alaska44. Texas45. California46. Illinois47. Alabama48. Louisiana49. Mississippi50. West Virginia

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

New in 2007ME, NH, TN,

UT, WI

Drop-OffsND, VA, SD,

WY, ID

NewlyNotorious

AK

RisingAbove

FL

Midwest/West has mix of good and bad states

REGULATORY & LEGISLATIVE

ENVIRONMENT

Isolated Improvements, Mounting Zealoutry

Legal, Legislative &Regulatory Issues

• Florida “Seeing the Light”: State finally recognizing that it is overexposed with its 2007 legislation having failed to deliver on political promises made

Size of FL Hurricane Catastrophe Fund may be scaled backPrivate reinsurance sector role may expand

• Massachusetts Auto: Reforms have led to more competition, lower rates• Optional Federal Chartering: Recommended in Treasury plan; Still divisive issue• Risk Rentention Groups: Could be expanded to allow property RRGs• Tax Issue: Treatment of locales like Bermuda; Effort to “level the playing field”• National CAT Plan: Hearing in February and in 2007, but no current catalyst• Flood Reform: Likely to happen, but MS Rep. Gene Taylor unsuccessful pushing

for NFIP to cover wind. Sen. Clinton supports idea.• Antitrust: Though Trent Lott is gone, some may still push for scaling back of M-F;

States push own laws (FL)• Profusion of Quasi-Regulators: AGs, Governors, Congressional representatives• Bad Faith Legislation: Attempts by trial lawyers and legislative allies to

open new tort channels (WA referendum, Florida SB 2862) Source: III

PRESIDENTIAL POLITICS & P/C PROFITABILITY

Political Quiz

• Does the P/C insurance industry perform better (as measured by ROE) under Republican or Democratic administrations?

• Under which President did the industry realize its highest ROE (average over 4 years)?

• Under which President did the industry realize its lowest ROE (average over 4 years)?

P/C Insurance Industry ROE byPresidential Administration,1950-2008*

15.10%10.45%

8.93%8.65%

8.35%7.98%

7.68%6.98%6.97%

5.43%5.03%

4.83%4.43%

3.55%

16.43%

0% 2% 4% 6% 8% 10% 12% 14% 16% 18%

CarterReagan II

G.W. Bush IINixon

Clinton IG.H.W. Bush

Clinton IIReagan I

Nixon/FordTruman

Eisenhower IEisenhower II

G.W. Bush IJohnson

Kennedy/Johnson

*ROE for 2007/8 estimated by III. Truman administration ROE of 6.97% based on 3 years only, 1950-52.Source: Insurance Information Institute

OVERALL RECORD: 1950-2008*

Republicans 8.92%

Democrats 8.00%

Party of President has marginal bearing on profitability of P/C insurance industry

-5%

0%

5%

10%

15%

20%

25%

50 52 54 56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 0608

E

P/C Insurance Industry ROE by Presidential Party Affiliation,

1950–2008EBLUE = Democratic President RED = Republican President


Tru

man

Nixon/FordKennedy/ Johnson

Eisenhower Carter Reagan/Bush Clinton Bush

Summary• Results were excellent in 2006/07; Overall profitability reached

its highest level (est. 13-14%) since 1988Strong 2007 but ROEs slipping; Momentum for 2008

• Underwriting results were aided by lack of CATs & favorable underlying loss trends, including tort system improvements

• Property cat reinsurance markets past peak & more competitive• Premium growth rates are slowing to their levels since WW II;

Commercial leads decreases. Firming in personal lines?• Rising investment returns insufficient to support deep soft

market in terms of price, terms & conditions as in 1990s• How/where to deploy/redeploy capital??• Major Challenges:

Slow Growth Environment Ahead; Cyclical & EconomicMaintaining price/underwriting disciplineManaging variability/volatility of resultsManaging regulatory/legislative activism

Insurance Information Institute On-Line

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