PowerPoint File

Financial Crisis and the Future of P/C Insurance

Challenges Amid the Global Economic and Regulatory Storm

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

Society for Insurance ResearchSavannah, GA

October 21, 2008Download at: www.iii.org/media/presentations/SIR

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

• The Weakening Economy: Insurance ImpactsExposure & Claim ImpactsWhat Accelerating Inflation Means for InsurersLooming Financial Services Regulatory Reform

• P/C Insurance Industry Overview & Outlook

Q & A

Federal Government’s Financial Rescue

Package*(a.k.a. “The Bailout”)

Plan Details &Insurer 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.

Deals Exceeding $100 Million

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

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efed

Ban

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San

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hin

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$ 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.

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

Reasons Why Insurers Are Better Risk

Managers Than Banks

Insurers Will Emerge With Their Risk Management Model Largely Intact

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


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; Prevention of Systemic Risks 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

Government Takeover of Fannie Mae &

Freddie Mac

Beneficial for Insurers

Treasury’s Fannie/Freddie Rescue Package Should Help Residential Property Insurers

Source: Wall Street Journal Online, 9/7/08; Insurance Information Institute.

THE PROBLEM• Fannie Mae/ Freddie Mac borrow huge sums to buy

mortgages from mortgage lenders and do so with an implicit government guarantee that should these mortgage sour the government will come to the rescue

• Together the entities own or guarantee $5.4 trillion in mortgages (about 50% of US total)

• Collectively Fan/Fred have lost about $14 billion over the past 4 quarters and their capital is nearly depleted

• Loss of confidence in Fannie/Freddie is primary reason why Fed’s slashing of rates since has not lowered interest rates (esp. on mortgages)

Treasury’s Fannie/Freddie Rescue Package Should Help Residential Property Insurers

Source: Federal Housing Finance Agency; Wall Street Journal Online, 9/7/08; Insurance Information Institute.

THE SOLUTION: A 4-POINT PLAN1. Government seizes Fannie Mae/ Freddie Mac and places

them in “conservatorship” under their regulator the Federal Housing Finance Agency (FHFA) Current CEOs ousted. Fannie will be run by Herb Allison (CEO

TIAA-CREF) and Freddie by David Moffet (CEO US Bancorp)

2. Treasury purchases senior preferred stock; Govt. gains 79.9% ownership. Could buy up to $100 billion per firm.

3. Treasury will buy mortgage backed securities (MBS) in the open market issued by Fan/Fred in attempt to lower borrowing costs ($ unspecified)

4. Treasury establishing new lending facilities for Fan/FredTotal federal involvement could amount to $200 billion

Why Treasury’s Fannie/Freddie Rescue Package Should Help Residential Property Insurers


• Crash in housing market is already costing home insurers alone about $1 billion annually in lost premium growth based on 50%+ decline in new home construction (about 1 million fewer homes per year) Plan should lower interest rates, accelerate clearing away

existing inventory and stimulate new construction (don’t expect big gains until 2010 at earliest)

Mortgage rates fell ½ point day after announcement• Home in or headed for foreclosure are likely to suffer

worse than average loss experience (neglect, abuse, abandonment, vandalism, theft…). Plan may bring interest rate relief to people who’s mortgages will reset over the next several years, averting some foreclosures.

• Insurers hold tens of billion in Fan/Fred MBS debt as well as shares in both companies. Both survive.

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

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

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

Fed slashes interest rates by 325 basis points (from 5.25% to 2.00

from July 2007 to mid-2008)

Credit Crisis: Fed Interest Rate Cuts Failed to Reduce Mortgage Rates

Mortgage FF spread increased to 4.5% from

about 1% pre-crisis

Interest rate on conventional mortgages remained high

despite Fed rate cuts

Au

g-08

THE ECONOMIC STORM

What a Weakening Economy and The Threat of Inflation Mean for

the Insurance Industry

Exposure & Claim Cost Effects

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

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.

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)


$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

p PreliminarySource: US Department of Labor, Bureau of Labor Statistics (BLS), National Bureau of Economic Research; NCCI Frequency and Severity Analysis

Workplace Injury Incidence RatesDeclined in Last 4 Economic Downturns

0

5

10

15

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

2007p

Inc

ide

nc

e R

ate

s p

er

10

0 F

TE

Wo

rke

rs(B

LS

)

0

1250

2500

3750

Cla

ims

pe

r 10

0,0

00

Wo

rke

rs(N

CC

I)

Recessions

Manufacturing Industry Injuries and Illnesses per 100 Full-Time Workers

Private Industry Injuries and Illnesses per 100 Full-Time WorkersNCCI Lost-Time Claims per 100,000 Workers

$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.

Summary of Economic Risks and Implications for (Re) Insurers

Economic Concern Risks to Insurers

Subprime Meltdown/ Credit Crunch

•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•Mortgage insurers face losses; Also tightening standards and slowing real estate market•Banks less able to lend, slowing construction

Lower Interest Rates •Lower investment income

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

General Economic Slowdown/Recession

•Reduced commercial lines exposure growth•Surety slump•Decreased workers comp frequency due to drop in high hazard class employment

The Housing CrashCollapse of Home Price Bubble

Will Influence Auto &Home Purchases and Slow Insurer Exposure Growth

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

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.


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

Inflation: Important Economic Risks and Implications for Insurers

Effects of Inflation Risks to Insurers & Buyers

Claim Severity Increase

•Claims (property and liability) costs may rise as the price of goods and services increase•PMLs could be (much) higher

Rate Inadequacy •Accelerating inflation historically contributed to rate inadequacy because ratemaking is largely a retrospective process•Many types of loss trends are sensitive to the pace of inflation: medical cost, tort, etc.•Historical loss cost trends could be biased predictors of future loss if inflation accelerates

Inflation: Important Economic Risks and Implications for Insurers (cont’d)

Effects of Inflation Risks to Insurers

Reserve Deficiency

•Reserves are established using certain assumptions about future development and discounting factors•If inflation accelerates, development could be more rapid and/or be more substantial (in dollar terms) than assumed and discount factors may be too low

Inadequate Insurance Limits

•Policyholders could find themselves inadequately insured as claims costs escalate

Inadequate Reinsurance

•Inflation can lead to a more rapid and unexpected exhaustion of reinsurance because losses are higher than expected

Comparative 2007 Inflation Statistics Important to Insurers ( %)

2.8

4.43.9

2.3

4.1

6.7

0

1

2

3

4

5

6

7

8

CPI-U Core CPI* TotalMedical

Care

PhysicianServices

HospitalServices

LegalServices

Infl

atio

n R

ate

(%)

*Core CPI is the Consumer Price Index for all Urban Consumers (CPI-U) less food and energy costs.Source: US Bureau of Labor Statistics; Insurance Information Institute.

CPI and “Core” CPI are not representative of

many of the costs insurers face

Medical/Legal costs typically run well ahead of inflation

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

Tort Cost Growth & Medical Cost Inflation vs. Overall Inflation (CPI-U), 1961-2008*

0%

2%

4%

6%

8%

10%

12%

14%

1961-70 1971-80 1981-90 1991-2000 2001-08E

Tort Costs Medical Costs CPI

*Medical cost and CPI-U through April 2008 from BLS. Tort figure is for full-year 2008 from Tillinghast.

Tort System is an Inflation Amplifier

Avg. Ann. Change: 1961-2008*

Torts Costs: +8.4%Med Costs: +6.0%

Overall Inflation: +4.2%

Sources: US Bureau of Labor Statistics, Tillinghast-Towers Perrin, 2007 Update on U.S. Tort Costs; Insurance Info. Inst.

Tort costs move with inflation but at twice the rate

4.5%3.5%

2.8% 3.2% 3.5%4.1%

4.6% 4.7%4.0% 4.4% 4.2% 4.0% 4.4%

5.1%

7.4%

10.1%

8.3%

10.6%

7.3%

13.6%

7.6%

6.2%

9.2%

7.2%

8.6%

6.0%

0%

2%

4%

6%

8%

10%

12%

14%

16%

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007p

Change in Medical CPIChange Med Cost per Lost Time Claim

WC Medical Severity Rising Far Faster than Medical CPI

Sources: NCCI; Med CPI from Economy.com; WC med severity from NCCI based on NCCI states.

1.6

pts

WC medical severity rose more than twice as fast as the medical CPI (8.3% vs. 4.0%)

from 1995 through 2007p

$8.4 $8.5 $8.3$9.1 $9.5

$10.3$11.3

$12.2$13.5

$14.5

$16.5$17.7

$19.0$20.2

$22.1

$24.0$25.4

$5

$10

$15

$20

$25

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

Annual Change 1991–1993: +1.9%

Annual Change 1994–2001: +8.9%

Annual Change 2002-2006: +7.8%

Accident Year

MedicalClaim Cost ($000s)

2007p: Preliminary based on data valued as of 12/31/20071991-2006: Based on data through 12/31/2006, developed to ultimateBased on the states where NCCI provides ratemaking services; Excludes the effects of deductible policies

Workers Comp Medical Claims Costs Continue to Climb

Cumulative Change = +200%(1993-2007p)

Med Costs Share of Total Costs is Increasing Steadily

Indemnity54%

Medical46%

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

Indemnity53%

Medical47%

Indemnity41%

Medical59%1987

1997

2007pMed cost inflation is one factor to high WC severity.

Med cost are now nearly 60% of all lost time claim costs

WC Med Cost Will Equal 70% of Total by 2017 if Trends Hold


Indemnity30%

Medical70%

2017 Estimate

This trend will likely be supported

by the increased labor force

participation of workers age 55 and

older.

Rising Energy Costs

Driving Patterns and Auto Claiming Behavior

Miles Driven vs. Gas Pricesin Recent Months

200,000

210,000

220,000

230,000

240,000

250,000

260,000

270,000

280,000

Jan Feb Mar Apr May June Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug

$2.00

$2.50

$3.00

$3.50

$4.00

$4.50

Miles Driven Gas Prices

Sources: Energy Information Administration (http://tonto.eia.doe.gov/dnav/pet/hist/mg_tt_usA.htm); Federal Highway Administration (http://www.fhwa.dot.gov/ohim/tvtw/08juntvt/index.cfm).

Miles DrivenGas Price/ Gallon

2007 2008

Miles driven in June were down 4.7% vs. June 2008; Between Nov. 2007 and June 2008 Americans drove 53.2B fewer miles

As gas prices fall, willing people drive more?

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

$4.00

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

2008

Re

tail G

as

Pri

ce

, In

fla

tio

n a

dju

ste

d (

$/g

allo

n)

-4%

-2%

0%

2%

4%

6%

8%

% C

ha

ng

e M

ile

s D

riv

en

Inflation adjusted gas prices

% change in miles driven

Retail Gas Price* and Percent Change In Miles Driven, 1970 – 2008:H1

*1970-1977 retail gas prices based on leaded only. 1970-2007 adjusted to 2007 dollars.

Sources: Energy Highway Administration, Federal Highway Administration.

There is a strong association between gas prices and miles driven.

Until 2007/8 miles driven had not declined since the energy crises of the 1970s

Do Increases in Gas Prices 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$1.27 $1.24

$1.07$1.18

$1.52 $1.46 $1.39$1.60

$1.90

$2.31

$2.62$2.84

$3.48

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

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

$4.00

Av

g G

as

Pri

ce

/Ga

l

Collision Claim Frequency Gas Prices

Sources: Energy Information Administration (http://tonto.eia.doe.gov/dnav/pet/hist/mg_tt_usA.htm); 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

Through Q2 2008, there is a small reduction in

collision claim frequency due to high gas prices

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

Auto Insurance: Claim Frequency Impacts of Energy Crisis of 1973/4

Source: ISO, US DOT.

Oct. 17, 1973: Arab oil embargo

begins

Frequency Impacts

Collision: -7.7%

PD: -9.5%

BI: -13.3%

March 17, 1974: Arab

oil states announce

end to embargo

Driving Stats

Gas prices rose 35-40%

Miles driven fell 6.7% in

1974

Frequency began to rebound almost

immediately after the embargo

ended

Auto Insurance: Claim Severity Impacts of Energy Crisis of 1973/4

Source: ISO.

Severity Impacts

Collision: -7.5%

PD: +15.9%

BI: N/A*

Driving Stats

Gas prices rose 35-40%

Miles driven fell 6.7% in

1974

Oct. 17, 1973: Arab oil embargo

begins

March 17, 1974: Arab

oil states announce

end to embargo

Collision severity began

to rebound almost

immediately after the embargo

ended; PD accelerated as inflation rose; No discernable trend change

in BI.

Cost of PIP Claims byVehicle Size*

$5,554

$4,859

$4,500

$5,000

$5,500

$6,000

Light Vehicle (Less than 2,771 lbs) Heavy Vehicle (More than 3,726 lbs)

Substitution of more fuel efficient but lighter

vehicles is associated with high more severe and costly PIP (no-fault)

claim costs

*Claims with payment in 2007. Excludes death and permanent total disability claims.Source: Auto Injury Insurance Claims: Countrywide Patterns in Treatment, Costs and Compensation, August 2008; Insurance Information Institute.

Proportion of Claimants Missing No Work Following a Claim*

38%

46%

30%

35%

40%

45%

50%

Light Vehicle (Less than 2,771 lbs) Heavy Vehicle (More than 3,726 lbs)

*Claims with payment in 2007. Excludes death and permanent total disability claims.Source: Auto Injury Insurance Claims: Countrywide Patterns in Treatment, Costs and Compensation, August 2008; Insurance Information Institute.

Substitution of more fuel efficient but lighter

vehicles is associated with a higher proportion of

claimants missing work following an accident

Claimants in lighter vehicles were also 12% more likely to

be hospitalized

Summary of Impacts of Energy Crises of 1970s on Auto Insurance

Measure Impact on Auto Insurers

Frequency •Falls initially•Rebounds almost shortly after shock passes•Rises to expected “no-crisis” levels with 2-3 years

Severity (Avg. Cost per Claim)

•Typically accelerates following surges in oil prices•Sensitive to inflationary pressures

Loss Cost (dollars of loss per insured vehicle)

•In general, initial slight decrease•Typically rebounds within 1 to 2 years

Source: ISO; Insurance Information Institute

Differences & Similarities Between Energy Crises of 1970s and Today

• Gas is Available In 1973/4 gas supplies were disrupted forcing a

reduction in driving, contributing to the declines in frequency

• Speed Limits Unlikely to be Reduced 55 MPH national speed limit imposed in 1974 Repealed in 1995, returning authority to states

• Ability to Migrate to More Fuel Efficient Fuels is Greater Today

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.

-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 08F09F10F

US P/C Insurers All US Industries

ROE: P/C vs. All Industries 1987–2010F

2008 P/C insurer figure is annualized H1 return on average surplus. Excluding mortgage and financial guarantee insurers = 7.6%. Source: ISO, Fortune; Insurance Information Institute.

Andrew Northridge

Hugo Lowest CAT losses in 15 years

Sept. 11

4 Hurricanes

Katrina, Rita, Wilma

P/C profitability is cyclical and volatile

Mortgage & Financial Guarantee Impact

-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 06 07*

08F

09F

10F

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 Years10 Years

9 Years

*GAAP ROE for all years except 2007 and 2008 which are ROAS (statutory Return on Average Surplus).2008 ROAS is annualized based on H1 2008. Excluding mortgage and financial guarantee insurers = 7.6%Sources: ISO; Insurance Information Institute.

2008: 5.4%(7.6% excl. M&FG)

P/C Insurance Industry ROEs,1975 – 2010F*

2010: 5.0%

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

-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 08*

ROE Cost of Capital

ROE vs. Equity Cost of Capital:US P/C Insurance:1991-2008:H1

*Excludes mortgage and financial guarantee insurers.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 p

ts

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

-1.7

pts

+2.

3 p

ts

-9.0

pts

The cost of capital is the rate of return

insurers need to attract and retain

capital to the business

-1.3

pts

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, at end of 2007 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• Investment Gains: With sharp declines in stock prices and falling interest rates,

portfolio yields are certain to fallContributes to discipline and shallower cycle• 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• 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 would imply greater discipline


Summary of Economic Risks and Implications for (Re) Insurers

Economic Concern Risks to Insurers

Subprime Meltdown/ Credit Crunch

•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•Mortgage insurers face losses; Also tightening standards and slowing real estate market•Banks less able to lend, slowing construction

Lower Interest Rates •Lower investment income

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

General Economic Slowdown/Recession

•Reduced commercial lines exposure growth•Surety slump•Decreased workers comp frequency due to drop in high hazard class employment

P/C Stocks: Mirroring theS&P 500 Index in 2008

-15.75%

-83.29%

-54.89%

-82.25%

-51.08%

-19.13%

-47.26%

-35.95%

-100.0% -80.0% -60.0% -40.0% -20.0% 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 Institute.

Total YTD Returns Through October 17, 2008Insurance stocks caught in

financial services downdraft

Mortgage & Financial Guarantee insurers were down

69% in 2007

Top Industries by ROE: P/C Insurers Still Underperformed in 2007*

26.3%26.1%

24.9%23.9%

23.0%22.0%21.8%

20.6%20.4%20.4%20.3%20.0%19.4%19.2%

14.0%15.2%

56.0%

0% 10% 20% 30% 40% 50% 60%

Household & Pers. ProductsPetroleum Refining

Hotels, Casinos, ResortsOil and Gas Equip., Services

Food ServicesMetals

Food Consumer Prod.Network & Other Comms.

Aerospace & DefenseMedical Prod. & Equip.

Electronics, Electrical Equip.Pharmaceuticals

Industrial & Farm Equip.Wholesalers: Diversified

Packaging, Containers

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

Source: Fortune, May 5, 2008 edition; Insurance Information Institute

P/C insurer profitability in 2007 ranked 31st out of 51

industry groups despite renewed

profitability, underperforming the All Industry median

for the 20th 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

PREMIUM GROWTH

At a Virtual Standstillin 2007, 2008 and

Possibly 2009

-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

22%

24%

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

2008

F20

09F

2010

F

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

Strength of Recent Hard Marketsby NWP Growth

1975-78 1984-87 2000-03

Shaded areas denote “hard

market” periods

Negative growth in

2008 before turning

positive in 2009

In 2007 net written premiums fell 1.0%, the first

decline since 1943

Year-to-Year Change in Net Written Premium, 2000-2010F

Source: A.M. Best; ISO. 2008F is first half actual figure.

5.0%

8.4%

15.3%

10.0%

3.9%

0.5%

4.2%

-1.0% -0.6%

1.0%2.0%

2000 2001 2002 2003 2004 2005 2006 2007 2008F 2009F 2010F

P/C insurers are experiencing their

slowest growth rates since 1943

Slow growth means retention is critical

Protracted period of

negative or slow growth is possible due to soft

markets and slow

economy

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

2.0% 3.5%

28.1%

-0.4% -1.8%-3.0% -5.0%

1.0%4.0%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Personal Commercial Reinsurance

2006 2007 2008F

Sources: A.M. Best Review & Preview (historical and revised year-end forecast as of 10/03/08).

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

0%

10%

20%

30%

40%

50%

60%

70%

83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06

Direct Independent Agents

All P/C Lines Distribution Channels, Direct vs. Independent Agents

Source: Insurance Information Institute; based on data from Conning and A.M. Best.

Independent agents steadily lost market share from the early 1980s through the early 2000s across all P/C lines, but have gained in recent

years. Direct channels include exclusive agency companies, direct marketers and

direct sales (e.g., internet)

0%

10%

20%

30%

40%

50%

60%

70%

80%

72 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06


Personal Lines Distribution Channels, Direct vs. Independent Agents


Independent agents have lost significant personal lines market

share since the early 1970s, but the trend has slowed or even ended.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

72 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06


Commercial P/C Distribution Channels, Direct vs. Independent Agents


Independent agents have seen only modest erosion in commercial lines

market share in recent decades

Channel ClutterDistribution Fusion

• Consumers Will Demonstrate Demand for Identical Product and Service via Multiple Distribution ChannelsCaptive/Exclusive Agent, IAs, Direct Marketing (incl.

Internet) will continue to co-exist for many years. More channels may be developed in the future.

Multi-channel distribution is already the normConsumers don’t necessarily think about channels

per se; In their minds distribution/service access are fused and should be seamless

Adds to expense, but produces more customer touch points, marketing opportunities and improves retention

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

0.8

%

0.8

%

0.5

%

0.4

%

0.3

%

0.3

% 0.5

%

0.6

%

0.5

%

0.1

% 0.5

%

0.9

% 1.1

% 1.3

% 1.7

%

2.6

%

2.6

%

2.7

% 3.0

%

3.1

%

0.2

%

0%

1%

1%

2%

2%

3%

3%

4%

Ja

n-0

7

Fe

b-0

7

Ma

r-0

7

Ap

r-0

7

Ma

y-0

7

Ju

n-0

7

Ju

l-0

7

Au

g-0

7

Se

p-0

7

Oc

t-0

7

No

v-0

7

De

c-0

7

Ja

n-0

8

Fe

b-0

8

Ma

r-0

8

Ap

r-0

8

Ma

y-0

8

Ju

n-0

8

Ju

l-0

8

Au

g-0

8

Se

p-0

8

Monthly Change in Auto Insurance Prices*

*Percentage change from same month in prior year.Source: US Bureau of Labor Statistics; Insurance Information Institute.

Auto insurance prices have clearly

begun to rise in recent months

Insurance Expenditures as a Percentage of Total Household Spending

Source: Insurance Information Institute 2008 Fact Book; US Bureau of Labor Statistics.

Auto & Home insurance expenditures account for

2.6% of household spending

109.4110.2

118.8

109.5

112.5

110.2

107.6

104.1

109.7 110.2

102.5

105.4

90.591.4

102.0

111.1112.3

122.3

$7.3

0

$6.4

9

$13.

91

$13.

15

$11.

94

$11.

55

$11.

95

$8.3

0

$13.

50

$8.4

2

$4.8

3

$5.2

0

$5.7

1

$5.2

5

$5.7

0

$7.7

0

$6.4

0

$6.1

0

90

95

100

105

110

115

120

125

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

Co

mm

erc

ial L

ine

s C

om

bin

ed

Ra

tio

$0

$2

$4

$6

$8

$10

$12

$14

Co

st

of

Ris

k/$

10

00

Re

ve

nu

e

CommercialCombined Ratio

Cost of Risk

Source: RIMS Benchmark Survey, A.M. Best 2007 Aggregates & Averages; Insurance Information Institute

Cost of Risk vs. Commercial Lines Combined Ratio

How the Risk Dollar is Spent (2006)

Source: RIMS (2007); Insurance Information Institute

Firms w/Revenues < $1 Billion

Prof. Liability Costs, 7%

Other Costs, 4%

Property Premiums,

18%

Retained Property

Losses, 5%

Liability Premiums,

20%

Admin Costs, 14%

WC Premiums,

14%

Liability Retained

Losses, 5%

Total Mgmt. Liab., 5%

Retained WC Losses, 7%

Firms w/Revenues > $1 Billion

Retained WC, 21%

Other Costs, 4%

Property Premiums,

13%Retained Property

Losses, 11%

Liability Premiums,

11%

Total Mgmt. Liab., 7%

WC Premiums,

5%

Retained Liability

Losses, 13%

Admin Costs, 12%

Prof. Liability Costs, 2%

Total liability costs account for 35% - 40% of the risk dollar

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

Cumulative Commercial Rate Change by Line: 4Q99 – 2Q08

Source: Council of Insurance Agents & Brokers

Commercial account pricing has been trending down for 4+ years and is now

on par with prices in late 2001

Average Commercial Rate Changeby Account Size: 4Q99 – 2Q08


While pricing has moved in synch across account size,

large accounts have seen the most pronounced declines

Average Commercial Rate Changeby Line: 4Q99 – 2Q08


Pricing has generally been negative since early 2004

Post-Katrina property insurance price impact

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.

U.S. Domiciled Captives- Net Premiums Written ($ Millions)

$8.4

$9.0

$9.3

$9.9

$10.2

$8.0

$8.5

$9.0

$9.5

$10.0

$10.5

2002 2003 2004 2005 2006

$ M

illi

ons

Source: A.M. Best, 2007 Special Report: U.S. Captive Insurers – 2006 Market Review

Following a five-year period of rapid growth, U.S. captive insurers saw net premiums written increase by just 2.7 percent in 2006, after 6.2 percent growth in 2005.

Risk Retention Group Premiums,1988 – 2006*

$1,7

37.7 $2

,197

.8

$2,4

49.1

$2,7

73.7

$585

.8

$527

.2

$493

.7

$493

.6

$419

.3

$358

.4

$250

.2 $575

.5

$707

.6

$751

.9

$790

.5

$875

.3

$775

.5

$944

.0 $1,2

65.1

0

500

1,000

1,500

2,000

2,500

3,000

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

*2006 ProjectedSource: Risk Retention Reporter, Insurance Info. Institute

Millions of Dollars

Risk retention (& self-insurance) group premiums have risen rapidly in recent years and represent a form

of competition to traditional insurers and captives

Could be expanded to property risks

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

08

F

Combined Ratios

1970s: 100.3

1980s: 109.2

1990s: 107.8

2000s: 102.0*

Sources: A.M. Best; ISO, III *A.M. Best year end estimate of 103.2; Actual H1 result was 102.1.

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

115.8

107.5

100.198.4

100.8

92.6

105107

103.2101.2

95.7

90

100

110

120

2001 2002 2003 2004 2005 2006 2007 2008 2008* 2009F 2010F

P/C Insurance Industry Combined Ratio, 2001-2010F

*Includes Mortgage & Financial Guarantee insurers. Sources: A.M. Best, ISO; III.

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

Best combined ratio since 1949

(87.6)

As recently as 2001, insurers paid out nearly $1.16 for every

$1 in earned premiums

Relatively low CAT

losses, reserve releases

Including Mortgage

& Fin. Guarantee insurers

Cyclical Deterioration

87.6

91.292.1 92.3 92.4 92.6

93.1 93.1 93.3

95.7

93.0

85

87

89

91

93

95

97

1949 1948 1943 1937 1935 2006 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 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 92.6 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, ISO; Insurance Information Institute * Includes mortgage * finl. guarantee insurers

$ B

illi

ons

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)1975-2008:H1*

$5.635 Bill underwriting loss in 08:H1 incl. mort. & FG insurers

$1

0.8 $

22

.8 $3

3.4

$3

6.9

$1

8.9

($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

Re

se

rve

De

ve

lop

me

nt

($B

)

(3)(2)(1)012345678910

Co

mb

ine

d R

ati

o P

oin

ts

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

Cumulative Prior Year Reserve Development by Line (As of 12/31/06)

-$1,

886 -$

1,17

4

-$1,

116

-$77

9

-$47

5

-$41

3

-$25

4

-$10

0

-$10

0

-$96

-$53

-$48

$366

$1,176$1,172

-$3,006-$3,500

-$3,000

-$2,500

-$2,000

-$1,500

-$1,000

-$500

$0

$500

$1,000

$1,500

PPA Liab

ility

PPA PD

Home

Med

Mal

Special

ty P

rop

Comm

. Auto

Prod. L

iabili

ty

Finl.

Guaran

ty

Inte

rnat

ional

Other

Special

ty L

iab.

Wor

ker's

Comp

Fideli

ty/S

urety

Comm

ercia

l Mul

ti

Other

Liab

ility

Reinsu

rance

$ B

illi

ons

Sources: Lehman Brothers; A.M. Best’s Aggregates & Averages Schedule P, Part 2.

Reserve redundancies in most lines have resulted in

releases in recent years but that is ending

Release

Strengthening

$147

.0

$156

.3

$168

.9

$177

.5

$180

.0 $198

.9

$187

.2

$198

.1

$200

.4

$209

.2

$201

.6

$214

.2

$224

.7

$242

.2

$280

.8

$292

.6

$299

.7

$308

.8

$320

.6

$288

.1

$298

.6

$314

.4

$0

$50

$100

$150

$200

$250

$300

$350

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

$ B

illi

ons

Total losses paid by insurers increased by $152 billion or more than 100%

from 1987 through 2007

Sources: A.M. Best; 2007 figure is from ISO. *2008 is annualized Q1 ISO result; Insurance Information Institute.

Dip in 2006/07 was associated with drop in catastrophe losses, which is unlikely to

persist. Losses and loss ratios in 2007 rose and are rising in 2008. During 2006/07, the price of many types of insurance fell.

Losses Paid by Property/Casualty Insurers Have Steadily Increased for Decades

EMERGING RISKS

Common Mistake is to Assume all Emerging Risks

are About Underwriting

Emerging Risks Impacting the Global (Re)Insurance Industry


Issue IssueErosion of Tort Reform Inflation Risk

Bad Faith Litigation Employment Practices Liability

Post-Catastrophe Litigation Energy Sector

Climate Change (liability>property) Nursing Home/Asst. Living

Products Liability (Imports, Food) Currency Risk

Regulatory Risk Economic Shock/Contagion Effects

Securities Litigation Terrorism

Asset Valuation Risk (Mark-to-Market) Nanotechnology

Environmental Liability Pharmaceuticals

Latent Occupational Disease Disintermediation

Socialization of Insurance Markets US Tax Policy

KEY LINES

110.

3

110.

2

107.

6

103.

9

109.

7

112.

3

111.

1

122.

3

110.

2

102.

5

105.

4

91.1 93

.5

104

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 07 08F

Recent results benefited from favorable loss cost trends, improved tort environment,

low CAT losses, WC reforms and reserve releases. Most of these trends now reversed

and mortgage and financial guarantee segments have big influence.

Commercial coverages have exhibited significant

variability over time.

Commercial Lines Combined Ratio, 1993-2008F

Mortgage and financial guarantee may account for

up to 4 points on the combined ration in 2008

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

AUTO INSURANCE

Recent Underwriting Trends by Coverage Type

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

93.9

97.6

102.

5

85

90

95

100

105

110

115

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

Recent strong results attributable favorable frequency

trends and low CAT activity

Personal LinesCombined Ratio, 1993-2008E

Recent deterioration due to price competition and higher

CAT losses in 2008

Pvt. Passenger Auto Insurance Net Premiums Written, 1998-2008E

$ Billions

$117.4 $118.6 $119.7

$128.0

$159.6 $160.2 $159.1 $160.5$157.3

$151.2

$139.7

$100

$110

$120

$130

$140

$150

$160

$170

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

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

Competition, tight credit and the weak

economy imply sluggish growth for

auto insurers

101.7101.3 101.0

99.5

101.1

103.5

109.5

107.9

104.2

98.4

94.395.1 95.5

98.3

100.8101.3

90

95

100

105

110

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

Private Passenger Auto (PPA) Combined Ratio

Average Combined Ratio for 1993 to 2007:

100.8

Sources: A.M. Best (historical); Insurance Information Institute

PPA has been an important source of earnings in recent

years

Auto insurers have shown significant improvement in

PPA underwriting performance since mid-

2002, but results are deteriorating.

-4%

-2%

0%

2%

4%

6%

8%

10%

00

:Q1

00

:Q2

00

:Q3

00

:Q4

01

:Q1

01

:Q2

01

:Q3

01

:Q4

02

:Q1

02

:Q2

02

:Q3

02

:Q4

03

:Q1

03

:Q2

03

:Q3

03

:Q4

04

:Q1

04

:Q2

04

:Q3

04

:Q4

05

:Q1

05

:Q2

05

:Q3

05

:Q4

06

:Q1

06

:Q2

06

:Q3

06

:Q4

07

:Q1

07

:Q2

07

:Q3

07

:Q4

08

:Q1

08

:Q2

Auto Insurance Component of CPI Personal Auto-PD Pure Premium

Source: Insurance Information Institute calculations based ISO Fast Track and US BLS data.

Pure Premium Spread: Personal Auto PD Liability, 2000-2008:Q2

Margin necessary to maintain PPA

profitability

2000 PPA Combined=110

A favorable inversion of the pure premium spread

began in mid-2008

2006 PPA Combined=95.5

-2.2%

-5.3%

-4.0%-3.3%

-0.9%

-2.6%

-5.4%

-3.8%

-5.0% -5.1%

3.0%3.6% 3.8% 3.4%

2.8%

4.8%

6.0% 5.6%

-0.3%

4.7%

-6%

-4%

-2%

0%

2%

4%

6%

8%

99 00 01 02 03 04 05 06 07 08*

Frequency Severity

Bodily Injury: Severity Trend Running Ahead of Frequency

Source: ISO Fast Track data. *Result for 4 quarters ending with Q2 2008.

Medical inflation is a powerful cost driver

0.8%

-1.5%

0.3%

-2.0% -2.3% -2.1% -1.9%

-3.8%

0.6%0.0%

3.9%3.3%

2.8%

0.5%

2.8%3.7%

2.1% 2.0%

4.3%

6.2%

-6%

-4%

-2%

0%

2%

4%

6%

8%

99 00 01 02 03 04 05 06 07 08*

Frequency Severity

PD Liability: Frequency Trend No Longer Offsets Severity

Fewer accidents, but more damage when they occur


-1.6%

1.1%

-1.1%

0.0%

-0.6%

-7.2%-5.4% -5.1%

-4.0% -4.8%

3.2%

6.5%

-4.0%

0.5%

4.8%6.1% 6.7%

2.3%

6.3%

16.1%

-10%

-5%

0%

5%

10%

15%

20%

99 00 01 02 03 04 05 06 07 08*

Frequency Severity

PIP: Severity Trend Now Offsets Smaller Claim Frequency Decline

Fraud caused problems from

1999-2001


2.6%

-0.4%

1.9%

-3.8%

-5.1%-4.6%

-1.7%

-3.7%

2.3%

3.7% 3.7%

1.5%

3.8%3.1%

0.5%

0.7%

0.1%

3.0%4.1%

6.8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

99 00 01 02 03 04 05 06 07 08*

Frequency Severity

Collision: Frequency and Severity Claim Trend Adverse


-1.7

%

-2.6

%

3.3%

-5.7

% -2.1

%

-8.0

%

-3.1

%

-9.8

% -6.5

%

0.7%

-6.9

%

14.9

%

-1.3

%

-1.4

%

6.9%

-4.1

%

-2.4

%

3.3%

-4.7

%

8.9%

-15%

-10%

-5%

0%

5%

10%

15%

20%

99 00 01 02 03 04 05 06 07 08*

Frequency Severity

Comprehensive: Weather Hurts Frequency and Severity Trends

Weather related claims from

Hurricanes Katrina, Rita & Wilma:

681,900 claims valued $3.29 billion


Severe first half weather (floods, hail, tornadoes)

5 Levels of Underwriting Innovation

• LEVEL I: Traditional Underwriting Relies on traditional underwriting tools to determine limited number of risk cells

• Level II: Predictive Modeling, Data Mining Has led to quantum leap in matching of risk with price Explosion in price points/identifiable and priceable market segments Enabled by reduction in computing and data storage costs—trends that will continue

• Level III: Revealed Risk (Telematics) Let the customer reveal to the insurer over time his/her individual risk profile Requires continuous monitoring or periodic sampling of individual risk (policyholder)

via “Black Box”• Level IV: Pavlov Policies

Provide continuous positive (or negative) reinforcement (feedback) Continuously changing and observable insurance premium Examples: ING Direct bank accounts; Continuous credit score monitoring; Zillow, etc.

—Idea is to provide continuous feedback in dollar terms WhatsMyPremiumToday.com;

• Level V: Experimentation and Behavioral Economics Conduct large-scale behavioral experiments to ascertain risk seeking/avoidance

behavior in wide variety of circumstances across wide cross section of customers relevant to insurance

Could be based on observation of actual behavior as well

Interactive Insurance Policies• Emulate Financial/Retirement Planning Engines

Allow people to “build” and modify policies at any time (goes well beyond Your Choice Auto)

Create “What If” scenario capacity with impact on premium; Examples: What if I had an at-fault accident?Product reports surcharge and new premium What if I bought a new Porshe vs. a used one? What if I increased my liability limits? What kinds of car would lower my premium by 10%? When I move to Mayberry what will my new premium be?

Can do something similar for home insurance• The Talking Insurance Policy (Interactive Policy Documentation)

Most people do not understand and never read their policy—not because they’re lazy or dumb but because it is often written in impenetrable legalese

Policy is online in customer’s account. Mouse-overs allow audio/visual pop-ups that explain policy in plain English and offer tips (e.g., Flood is excluded…call your Allstate agent to day to arrange flood coverage from the NFIP …)

• Gaming Game initializes with insureds parameters (vehicle, location, etc.) Policyholder “drives” in game and makes choices that influence premium, which

comtinuously changes based on those choices (e.g., speed, DUI, observe traffic signals, trade in vehicle for sports car…)

Homeowners Insurance

117.7

158.4

113.6118.4

112.7

121.7

101.0

108.2111.4

121.7

109.3

98.394.4

100.3

88.9

95.6

104

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 07 08F

Homeowners Insurance Combined Ratio

Average 1990 to 2007= 110.8

Insurers have paid out an average of $1.11 in losses for every dollar earned

in premiums over the past 18 years

Sources: A.M. Best (historical); I.I.I. estimate for 2008.

Homeowners Insurance Net Premiums Written, 1998-2008E

$ Billions

$29.0$30.7

$32.4$35.2

$52.2$54.6 $54.9 $55.0

$49.5$45.8

$40.0

$20

$30

$40

$50

$60

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

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

Competition and the collapse in housing mean

little growth for home insurers

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

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

Policyholder Surplus, 2006:Q4 – 2008:Q2

$ Billions

$487.1

$496.6

$512.8

$521.8

$505.0

$515.6$517.9

$460

$470

$480

$490

$500

$510

$520

$530

06:Q4 07:Q1 07:Q2 07:Q3 07:Q4 08:Q1 08:Q2

Source: ISO; Insurance Information Institute.

Surplus is down 3.2% or $16.6 billion since its Q3 2007 peak. Q3 2008 will record a big drop.

Capacity peaked at $521.8 as of 9/30/07

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

Nu

mb

er o

f Iss

uan

ces

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

MERGER & ACQUISITION

Are Catalysts for P/C Consolidation Growing

in 2008?

P/C Insurer M&A Activity,* 1997-2008**

$18,289

$11,450

$599

$12,823

$800

$9,325

$36,407

$13,808

$3,318$8,683

7

15

10

2

0

2

01

9

3

1 2$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

$40,000

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

Tran

sact

ion

Val

ue ($

Mill

)

0

2

4

6

8

10

12

14

16

Num

ber o

f Tra

nsac

tions

Transaction Values Number of Transactions

Source: Lehman Brothers. *Deals exceeding $500 million. *Through July 24, 2008.

M&A activity began to accelerated in 2007. The largest deals in 2008 are Liberty Mutual’s/Safeco for $6.2B;

Tokio Marine/Philadelphia Consolidated for $4.7 B; Allied World/Darwin for $550 million

Distribution of P/C Insurer Acquisitions, Jan. 2007 – June 2008

Personal, 23%, 23%

Commercial, 45%, 45%

Personal & Commercial, 32%,

32%

SUMMARY STATS

•22 deals

•$23 billion total transaction value

•$475 million median deal value

•Acquirers mostly p/c insurers and limited number of private equity deals

Source: SNL, Lehman Brothers.

Deals Exceeding $100 Million

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 2008 Prices are falling or flat in most non-coastal markets

• Accumulation of Capital: Aggregate capitalization is high Policyholder Surplus up 6-7%% in 2007 and up 80% since 2002

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

• Low Share Prices: Acquisitions are “cheap” Share prices of most p/c insurers are down 30% - 90%

• Mergers Could Ease Capital Concerns Combined operations could require less total capital

• Need to Spin-Off Ops to Raise Cash Some insurers looking to shed non-core assets; Refocusing trend


Motivating Factors for Decreased P/C Insurer Consolidation

Motivating Factors Against P/C M&As• Credit Crunch: Little financing capital available with current

freeze in credit markets and equity investors on the sidelines• Soft Market Conditions: Market remains soft (esp. commercial)

Underwriting results deteriorated significantly in 2008

• Investment Volatilty: Investment volatility makes valuation more uncertain and deals less attractive

• Limited Number of Players Simply not that many companies in play Exclude if mutual (though mutuals can acquire), too big, cultural, etc.)

• Regulatory Uncertainty:• Nature of new regulations to be imposed on financial services in general and

insurers in particular is unclear

• Taxation: Future tax treatments issues unresolved


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

Val

ue ($

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

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$55.7

$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

-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

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 July 2008.Sources: Board of Governors, Federal Reserve System; A.M.Best; Insurance Information Institute.

Investment yield historically tracks 10-year Treasury note quite closely

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

2008 & Beyond

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

Shifting Legal Liability & Tort

Environment

Is the Tort PendulumSwinging Against Insurers?

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

Isolated Improvements, Mounting Zealoutry

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!

Download at: www.iii.org/media/presentations/SIR

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