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H O U L I H A N L O K E Y H O W A R D & Z U K I N

Mergers & Acquisitions in the Property/Casualty Insurance

Market

Casualty Actuaries of Greater New York

Spring 2004 Meeting

June 3, 2004

2

Agenda – Property & Casualty Insurance

• Industry Fundamentals

• Historical M&A Trends

• Recent M&A Trends

• M&A Outlook

3

Overview

• P&C consolidation has declined markedly and relatively steadily over the past five years

• Transformational deals are out of favor

– St. Paul / Travelers is the exception, not the rule

• Going forward, P&C acquisition activity should increase as rates soften and organic growth is more challenging

– However, M&A activity will be more thoughtful, as quality insurers consolidate and diversify with smaller niche acquisitions

Industry Fundamentals

5

Story of 2000 – 2004

The Race Between Premium Prices and Development

6

Decelerating Hard Market

• Property & Casualty companies enjoyed an extended run of rate increases beginning in 2000

• Overall rates have begun to fall back to the levels last seen in late 1999, the end of the last soft market cycle

– Increases began to decelerate in 2003

– Property has softened (large account)

– D&O and Med Mal still rising

• Question is whether the casualty lines have caught up after years of under-reserving

7

Decelerating Hard Market

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

Fall 98 Spring 99 Fall 99 Spring 00 Fall 00 Spring 01 Fall 01 Spring 02 Fall 02 Spring 03

Personal Auto Homeowners Commercial Lines

Fall 03

Average Commercial and Personal Lines Rate Changes

8

Adverse Reserve Development

• The rating agencies are skeptical of the capital position of many insurers

– Fitch estimates the reserving shortfall to be $77 billion

• Asbestos – no trust fund and no end in sight

• M&A Impact: Given the magnitude of the downside, prudence has dictated caution among would-be acquirors given sellers’ natural information advantage

9

$250

$275

$300

$325

$350

$375

1999 2000 2001 2002 2003

$ B

illio

ns

0.75 x

1.00 x

1.25 x

1.50 x

NP

W /

Su

rplu

s

Industry Surplus Operating Leverage

Capital Turning the Corner

• The tragedy of September 11th, adverse loss development and the equity markets devastated the P&C sector’s surplus

• Thanks to the hard market, the industry is now generating a torrent of cash flow and surplus has surpassed 1999 levels, assuming proper reserving

22%

10

Capital Management

What to do with the build up of surplus?

• Increase Dividends

– With the new tax laws, dividending is an attractive option

– Montpelier Re increased its dividend yield to nearly 4% in 2003

• Growth through Acquisitions

– Buyers may be able to take advantage of smaller insurers which have been weakened by capital pressures and rating agency actions

– Many of the Bermuda players have picked off liability-free business from weakened peers

Historical M&A Trends

12

M&A Drivers

M&A DriverP&C InsuranceApplicability

Technological Change

Financial Markets

Management/Personality

Regulatory / Political

Focus / Diversification

13

Fragmented P&C Insurance Market

2,700

2,800

2,900

3,000

3,100

3,200

3,300

3,400

3,500

3,600

19

69

19

72

19

75

19

78

19

81

19

84

19

87

19

90

19

93

19

96

19

99

20

02

Nu

mb

er

of

P&

C C

om

pa

nie

s

14

Deal Volume – Relatively Cyclical

• Not surprisingly, P&C insurance M&A deal volume is reasonably cyclical

0

2,000

4,000

6,000

8,000

10,000

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

YTD

Tota

l M

&A

Deals

An

nou

nced

0

20

40

60

80

100

120

P&

C M

&A

Deals

An

nou

nced

Total M &A Activity P&C M &A Activity

15

31-Jul-200031-Aug-200029-Sep-200031-Oct-200030-Nov-200029-Dec-200031-Jan-200128-Feb-200130-Mar-200130-Apr-2001

31-May-200129-Jun-200131-Jul-2001

31-Aug-200128-Sep-200131-Oct-200130-Nov-200131-Dec-200131-Jan-200228-Feb-200229-Mar-200230-Apr-2002

31-May-200228-Jun-200231-Jul-2002

30-Aug-2002

0

20

40

60

80

100

120

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

YTD

P&

C M

&A

Deals

Announce

d

P&

C R

ate

P&C M &A Activity

P&C M&A Activity• Generally, deal volume is inversely correlated with P&C rates

P&C rates

16

1.00 x

1.20 x

1.40 x

1.60 x

1.80 x

2.00 x

2.20 x

2.40 x

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

Pri

ce-t

o-B

oo

k

2.00 %

3.00 %

4.00 %

5.00 %

6.00 %

7.00 %

8.00 %

9.00 %

10.00 %

Inte

rest

Rat

e

Price-to-Book US 10 Year Treasury Yield

Valuations and the Cycle

• The interplay between interest rates and P&C rates impacts P&C company valuations as well as deal volume

Asbestos; Product Liab.

Hurricane Andrew 9/11

P&C rates

Recent M&A Trends

18

Is Hank right?

“…[T]wo drunks helping one another home…” - Hank Greenberg on P&C acquisitions

19

Recent M&A Activity: A Look Back

• Large transactions on the decline

– Bifurcation – strong grow and weak pare back or run-off

– Renewal rights deals flourish as buyers have the upper hand

• Bermuda Class of 2001

– Filling the capacity shortfall

– Cash flowing and surplus spiking…

• Focus and rationalization

– Pendulum swings away from diversification

– Sponsored spin-offs rise in popularity

20

The Death of the Mega-Deal?• There have been 44 P&C mergers valued at $500 million or more

since 1997 but all but five occurred in the 1997 – 2001 period

Source: SNL DataSource

71 83 52 45 48 40 43 2

315

11

15

7

0

20

40

60

80

100

120

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

Nu

mb

er

of D

ea

ls

$-

$5

$10

$15

$20

$25

$30

$35

$40

$45

$50

Deals less than $500 mm Deals greater than $500 mm Deal Value

21

Deal Valuations Decline

• Median multiples have declined drastically over the last few years but may be on the rise again

--

0.50 x

1.00 x

1.50 x

2.00 x

19

97

19

98

19

99

20

00

20

01

20

02

20

03

Pri

ce-t

o-B

oo

k

--

5.0 x

10.0 x

15.0 x

20.0 x

Pri

ce-t

o-E

arn

ing

s

Price-to-Book Price-to-Earnings

22

The Rise of Renewal Rights Transactions

• Renewal rights deals have become increasingly popular given market skepticism regarding the adequacy of reserves

• Competition for growth in soft cycle should cause a decline in renewal rights deals

0

10

20

30

40

50

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

Nu

mb

er

of D

ea

ls

Renewal Rights Deals Other Asset Deals

23

Bermuda: Consolidation?

• Newer Bermuda players focused on secondary offerings, providing original venture investors a chance to reduce positions

• To date in 2004, a total of 15 insurance offerings have priced, raising $4.9 billion with selling shareholders receiving 77% of those proceeds.

• Starting in 2005, the Bermuda players will contend with slowing growth

• Some of the Bermuda insurers have already begun to participate on the M&A front by purchasing the renewal rights of weaker competitors

Buyer Transaction

XL Capital Renewal rights of DPIC Companies from RSA

Endurance Specialty Renewal rights of HartRe

AXIS Capital Renewal rights of Kemper Insurance

Arch Capital Renewal rights of CNA's Liability Insurance Business

24

Past as Prelude: Bermuda Class of 1993

Source: A.M. Best, Bermudan Business, Aon Capital Markets

4,000

3,500

3,000

2,500

2,000

1,500

1,000

500

0

Cum

ulat

ive

Cap

ital R

aise

d ($

mm

)

1993 1994 1995 1996 1997 1998

IPO Stage M&A Stage

Partner Re. Ltd.IPO Nov. 1993

Global Capital Reinsurance Ltd.Sold to Exel Ltd. Jun. 1997

Global Capital Reinsurance Ltd.IPO Dec. 1995

LaSalle Re. Ltd.IPO Nov. 1995

LaSalle Re Merged with Trenwick Oct. 2000

Centre Cat Ltd.Sold to Ace Ltd. Apr. 1998Tempest Reinsurance Co.

Sold to Ace Ltd. Jul. 1996

IPC Holdings Ltd.IPO Mar. 1996

RenaissanceRe Holdings Ltd.IPO Jul. 1995Mid Ocean Ltd.

IPO Aug. 1993Mid Ocean Ltd.Sold to Exel Ltd. 1998

Companies that went public and later were acquired

Companies that went public and expanded beyond their original mandate

Companies that remained private until acquired

25

Rationalization

• Verdict: focus is the safe bet

– Management is heeding the Street and divesting

– Examples: Safeco, CNA, RSA and Zurich

• Contra-case

– Diversification: risky but necessary?

26

Divestiture Mechanism: The Spinoff

• As profitability and competition have become increasingly challenging, many insurers are focusing on core markets

• In addition to divestitures, insurers have taken advantage of the capital markets by spinning off more profitable businesses

Company IPO Amount Parent

Assurant $1.76 billion Fortis

Genworth $3.8 billion General Electric

Affirmative Insurance $259 million Vesta

Travelers $4.3 billion Citigroup

M&A Outlook

28

Outlook

• Soft Cycle Spurs M&A activity– Bermuda consolidates again…– Diversification returns?– New hybrid capital – prolonging the inevitable?

• Russian Roulette Returns?– Sellers gain leverage and liabilities back on the table

• Specialty consolidation and the return of the roll-up– WC, E&S and NSA

• Focus on expenses in downturn– Outsourcing?

• Europeans bargain shoppers– Weak dollar could tempt buyers