Top 10 Challenges Facing the Property/Casualty Insurance Industry Robert P. Hartwig, Ph.D., CPCU, President Insurance Information Institute 110 William

Top 10 Challenges Facing the Property/Casualty

Insurance Industry

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

Rhode Island CPCU Society ChapterInsurance ForumAmica Insurance

Lincoln, RI

May 20, 2008

Top 10 Challenges

1. Maintaining Profitability2. Maintaining Underwriting Discipline3. Slow Premium Growth4. Weak Pricing5. Rising Expenses6. Investment Volatility & Adverse Market Conditions7. Credit Crunch & The Weak Economy8. Capital Management & Adequacy9. Catastrophic Loss10. Shifting Legal Liability & Tort Environmen

Mystery BONUS ChallengeQ&A

#1 MAINTAINING

PROFITABILITY

Profits in 2006/07 ReachedTheir Cyclical Peak

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

4,17

8

$5,8

40

$19,

316

$10,

870

$20,

598

$24,

404 $3

6,81

9

$30,

773

$21,

865

$3,0

46

$30,

029

$61,

940

$49,

900

-$6,970

$65,

777

$44,

155

$20,

559

$38,

501

-$10,000

$0

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

$70,000

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

08F

*ROE figures are GAAP; 1Return on avg. surplus. **Return on Average Surplus; Sources: A.M. Best, ISO, Insurance Information Inst.

2001 ROE = -1.2%2002 ROE = 2.2%2003 ROE = 8.9%2004 ROE = 9.4%2005 ROE= 9.6%2006 ROE = 12.2%2007 ROAS1 = 12.3%**

Insurer profits peaked in 2006

-5%

0%

5%

10%

15%

20%

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

08F

US P/C Insurers All US Industries

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

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

Andrew Northridge

Hugo Lowest CAT losses in 15 years

Sept. 11

4 Hurricanes

Katrina, Rita, Wilma

P/C profitability is cyclical, volatile and vulnerable

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

14.0%

16.8%

12.3%

9.4%

13.2%

6.3%

9.8% 10.7%9.8%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

Personal Commercial Reinsurance

2006 2007E 2008F

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

ROEs are declining as underwriting

results deteriorate

-5%

0%

5%

10%

15%

20%

25%

75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 0607

E08

F

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

1975: 2.4%

1977:19.0% 1987:17.3%

1997:11.6%

2006:12.2%

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

10 Years

10 Years 9 Years

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

P/C, L/H Stocks: Lagging the S&P 500 Index in 2008

-4.30%

-54.41%

-17.48%

-24.75%

-8.22%

-7.89%

-17.47%

-5.41%

-60.0% -50.0% -40.0% -30.0% -20.0% -10.0% 0.0%

S&P 500

All Insurers

P/C

Life/Health

Multiline

Reinsurance

Mortgage*

Brokers

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

Total YTD Returns Through May 9, 2008

P/C, Life insurance stocks underperforming S&P—

concerns about soft market, credit/subprime exposure of

some companies

Mortgage & Financial Guarantee insurers were

down 69% in 2008

Factors that Will Influence theLength and Depth of the Cycle

• Capacity: Rapid surplus growth in recent years has left the industry with between $85 billion and $100 billion in excess capital, according to analysts All else equal, rising capital leads to greater price competition and a liberalization of

terms and conditions

• Reserves: Reserves are in the best shape (in terms of adequacy) in decades, which could extend the depth and length of the cycle Looming reserve deficiencies are not hanging over insurers they way they did during

the last soft market in the late 1990s Many companies have been releasing redundant reserves, which allows them to boost

net income even as underwriting results deteriorate Reserve releases will diminish in 2008; Even more so in 2009

• Investment Gains: 2007 was the 5th consecutive up year on Wall Street. With sharp declines in stock prices and falling interest rates, portfolio yields are certain to fallContributes to discipline Realized capital gains are already rising as underwriting profits shrink, but like

redundant reserves, realized capital gains are a finite resource A sustained equity market decline (and potentially a drop in bond prices at some

point) could reduce policyholder surplus

Source: Insurance Information Institute.

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

• Sarbanes-Oxley: Presumably SOX will lead to better and more conservative management of company finances, including rapid recognition of deficient or redundant reserves With more “eyes” on the industry, the theory is that cyclical swings should shrink

• Ratings Agencies: Focus on Cycle Management; Quicker to downgrade Ratings agencies more concerned with successful cycle management strategy Many insurers have already had ratings “haircut” over the last several years they

way they did during the last soft market in the late 1990s; Less of a margin today• Finite Reinsurance: Had smoothing effect on earnings; Finite market is gone• Information Systems: Management has more and better tools that allow

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

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

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


-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

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

ROE Cost of Capital

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

Source: The Geneva Association, Ins. Information Inst.

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

-13.

2 p

ts

+0.

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

-0.1

pts

+1.

7 p

ts

-9.0

pts

The cost of capital is the rate of return

insurers need to attract and retain

capital to the business

+2.

3 p

ts

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

30.7%30.3%

26.4%24.6%

24.2%22.6%

21.8%21.5%

20.9%20.9%

20.5%19.6%19.4%19.1%

14.9%15.4%

31.8%

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

Oil & Gas Equip., ServicesPetroleum Refining

MetalsFood Services

Household & Pers. ProductsPharmaceuticals

Industrial & Farm EquipmentMining & Crude Oil Prod.

Aerospace & DefenseChemicalsSecurities

Food Consumer Prod.Medical Prod. & Equip.

Specialty RetailersHomebuilders

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

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

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

industry groups despite renewed

profitabilityP/C insurers

underperformed the All Industry median for the 19th consecutive

year

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

$ Billions

$1.736 $1.737 $1.803 $1.708

$3.695

$4.323

$2.975

$2.111$1.882

$1.5

$2.0

$2.5

$3.0

$3.5

$4.0

$4.5

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

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

increased competition

#2UNDERWRITING

DISCIPLINE

Disciplined Underwritingis the Key to Success

90

95

100

105

110

115

120

70

71

72

73

74

75

76

77

78

79

80

81

82

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08F

Combined Ratios

1970s: 100.3

1980s: 109.2

1990s: 107.8

2000s: 102.0*

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

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

115.8

107.4

100.198.3

100.7

92.4

98.6

95.6

90

100

110

120

01 02 03 04 05 06 07 08F

P/C Insurance Combined Ratio, 2001-2008F

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

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

2006 produced the best underwriting result

since the 87.6 combined ratio in 1949

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

every dollar they earned in premiums

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

normal CAT activity

87.6

91.292.1 92.3 92.4 92.4

93.1 93.1 93.3

95.6

93.0

85

87

89

91

93

95

97

1949 1948 1943 1937 2006 1935 1950 1939 1953 1936 2007

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

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

2007 was the 20th best since 1920

The industry’s best underwriting years are associated with

periods of low interest rates

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

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

101520253035

75

76

77

78

79

80

81

82

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08

Source: A.M. Best, Insurance Information Institute

$ B

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)1975-2008F*

$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

FINANCIAL STRENGTH &

RATINGS Industry Has Weathered

the Storms Well, But Cycle May Takes Its Toll

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

90

95

100

105

110

115

120

69

70

71

72

73

74

75

76

77

78

79

80

81

82

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07E

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 reach near-record low in 2007

Source: A.M. Best; Insurance Information Institute

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

2007 will be lower; Record is 0.24% in 1972

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

*Includes overstatement of assets.

Source: A.M. Best.

Catastrophe Losses8.6%

Alleged Fraud11.4%

Deficient Loss

Reserves/In-adequate Pricing62.8%

Affiliate Problems

8.6%

Rapid Growth

8.6%

2003-2005 1969-2006

Deficient reserves,

CAT losses are more important factors in

recent years

Reinsurance Failure3.3%

Rapid Growth15.7%

Misc.9.0%

Affiliate Problems

7.2%

Sig. Change in Business

4.4%

Deficient Loss

Reserves/In-adequate Pricing37.6%

Investment Problems*

6.9%

Alleged Fraud8.2%

Catastrophe Losses7.7%

PERSONAL LINES

103.

9

104.

5

103.

5

104.

9

99.8 10

2.7

104.

5

109.

9

110.

9

105.

3

98.4

94.3 96

.4

94.3 95

.6 98.6

85

90

95

100

105

110

115

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

Recent strong results attributable favorable frequency

trends and low CAT activity

Personal LinesCombined Ratio, 1993-2007E

101.7101.3 101.0

99.5

101.1

103.5

109.5

107.9

104.2

98.4

94.395.1 95.5

97.5

99.5

101.3

90

95

100

105

110

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

Private Passenger Auto (PPA) Combined Ratio

Average Combined Ratio for 1993 to 2006:

101.0

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

PPA is the profit juggernaut of the

p/c insurance industry today

Auto insurers have shown significant

improvement in PPA underwriting

performance since mid-2002, but results

are deteriorating.

-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

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, 2000-2007:Q4

Margin necessary to maintain PPA

profitability

2000 PPA Combined=110

Inversion of pure premium spread is a

warning sign that price and costs are out of sync

2006 PPA Combined=95.5

-2.2%

-5.3%

-4.0%-3.3%

-0.9%

-2.6%

-5.4%

-3.8%

-5.0%

3.0%3.6% 3.8% 3.4%

2.8%

4.8%

6.0%

-0.3%

4.7%

-6%

-4%

-2%

0%

2%

4%

6%

8%Frequency Severity

Bodily Injury: Severity Trend Running Ahead of Frequency

Source: ISO Fast Track data.

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%

3.9%3.3%

2.8%

0.5%

2.8%3.7%

2.1%

4.3%

6.2%

-6%

-4%

-2%

0%

2%

4%

6%

8%Frequency Severity

PD Liability: Frequency Trend No Longer Offsets Severity

Fewer accidents, but more damage when they occur:

Higher Deductibles?

Source: ISO Fast Track data.

Auto InsuranceClaim Cost Drivers

Auto Claim Costs Rise Faster than CPI or Health Care Costs

9%

4%

8%

6%

3%4%

0%1%2%3%4%5%6%7%8%9%

10%

Claimed BIEconomic

Loss

Total BIPayment

Claimed PIPEconomic

Loss

Total PIPPayment

CPI CPI-Medical

Sources: Insurance Research Council, Auto Insurance Claims: Countrywide Patterns in Treatment, Cost and Compensation, 2008 Edition; Insurance Information Institute.

Inflation in auto insurance claims is a significant and long-

term cost driver

Claimed BI economic

losses are 3 times the overall

inflation rate

Percent of Claimants With No Disability from Auto Injuries

48%

59%

70% 72%76%

52%56%

68%72%

66%

30%

35%

40%

45%

50%

55%

60%

65%

70%

75%

80%

1987 1992 1997 2002 2007

Bodily Injury Claimants PIP Claimants


Fewer claimants reporting any type

of disability helping to hold down costs

Percent of Claimants Admitted for 1+ Nights in Hospital

11%

7%

5% 5%4%

12%

10%

7%6%

7%

0%

2%

4%

6%

8%

10%

12%

14%

1987 1992 1997 2002 2007



Fewer claimants are spending time in the hospital

Percent of ClaimantsReceiving MRI

12%

15%

18%

15%

18%

22%

0%

5%

10%

15%

20%

25%

1997 2002 2007



More claimants are getting MRIs (and CT scans)

Percent of ClaimantsRepresented by Attorney

55%57%

52%

47%49%

32% 32%28%

31%30%

20%

25%

30%

35%

40%

45%

50%

55%

60%

1987 1992 1997 2002 2007



Attorney representation was falling until recently

Homeowners Insurance

117.7

158.4

113.6118.4

112.7

121.7

101.0

108.2111.4

121.7

109.3

98.394.2

100.1

91.795.5

99.5

113.0109.4

85

95

105

115

125

135

145

155

165

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

Homeowners Insurance Combined Ratio

Average 1990 to 2006= 111.8

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

in premiums over the past 17 years


COMMERCIAL LINES

Commercial AutoCommercial Multi-Peril

Workers Comp

110.

3

110.

2

107.

6

103.

9

109.

7

112.

3

111.

1

122.

3

110.

2

102.

5

105.

4

91.2 94

.0 97.5

102.

0

112.

5

85

90

95

100

105

110

115

120

125

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

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

Commercial coverages have exhibited significant

variability over time.

Commercial Lines Combined Ratio, 1993-2008F

Outside CAT-affected lines, commercial insurance is

doing fairly well. Caution is required in underwriting

long-tail commercial lines.


#3PREMIUM GROWTH

Negative for the FirstTime Since WW II

-10%

-5%

0%

5%

10%

15%

20%

25%

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007F

2008F

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

Strength of Recent Hard Markets by NWP Growth*

1975-78 1984-87 2001-04

Post-Katrina period resembles

1993-97 (post-Andrew)

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

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

2.0% 3.5%

28.1%

-0.1%

-1.5%

1.4%

-2.3%

-8.5%-5.0%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Personal Commercial Reinsurance

2006 2007E 2008F

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

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

#4WEAK PRICING

Under Pressure in 2007/08, Especially Commercial Lines

$651 $6

68 $691 $7

05

$703

$685

$690 $7

24

$780 $8

23 $851

$847

$838

$847

$600

$650

$700

$750

$800

$850

$900

$950

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

Average Expenditures on Auto Insurance

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

Countrywide auto insurance expenditures

are expected to fall 0.5% in 2007, the first drop

since 1999

Lower underlying frequency and modest

severity are keeping auto insurance costs in check

$418$440 $455

$481$488 $508$536

$593

$668

$729

$868

$787$835

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

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

Average Expenditures on Homeowners Insurance**

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

Countrywide home insurance expenditures rose an estimated

4% in 2006

Homeowners in non-CAT zones have seen smaller increases than

those in CAT zones

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

-3.2

%

-5.9

%

-7.0

%

-9.4

%

-9.7

% -8.2

%

-4.6

% -2.7

%

-3.0

%

-5.3

%

-9.6

%

-11.

3%

-11.

8%

-13.

3% -12.

0%

-13.

5%

-16%

-14%

-12%

-10%

-8%

-6%

-4%

-2%

0%

1Q04

2Q04

3Q04

4Q04

1Q05

2Q05

3Q05

4Q05

1Q06

2Q06

3Q06

4Q06

1Q07

2Q07

3Q07

4Q07

1Q08

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

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

KRW Effect

-0.1

%

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

Source: Council of Insurance Agents & Brokers

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

Most Layers of Coverage are Being Challenged/Leaking

Retention$1 Million$2 Million

Primary

Excess

Reinsurance

Retro

$10 Million

$50 Million

$100 Million

Risks are comfortable taking larger retentions

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

Excess squeezed by higher primary

retentions, lower reins. attachments

Reinsurers losing to higher retentions,

securitization

Source: Insurance Information Institute from Aon schematic.

#5RISING 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

#6INVESTMENT OVERVIEW

More Pain, Little Gain

Property/Casualty Industry Investment Results, 1994-2007

$33.

7

$36.

8

$38.

0

$41.

5

$37.

1

$36.

7

$38.

7

$39.

6 $49.

5

$52.

3

$54.

6

$1.7

$6.0 $9

.2 $10.

8

$18.

0

$13.

7 $16.

9

$6.9 $6

.9 $9.3

$9.7

$3.5

$9.0

$40.

8

$38.

6

$39.

9

$20

$30

$40

$50

$60

$70

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

Bill

ion

s

Capital Gains/LossesInvestment Income

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

$52.3

$57.7

$44.0

$35.6

$45.6$48.9

$59.2$55.8

$63.6Realized capital gains rising as underwriting

results slip$57.9

#7CREDIT CRUNCH

& WEAK ECONOMY

Exposure Growth and Frequency/Severity

Can be Affected

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

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

Burst BubbleAsset Price Deflation Subprime mortgage market was first part of credit bubble to burst

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

on those securities amplified via leverage produced contagion effect Many financial institutions around the world found they are exposed Many hedge funds, banks caught holding CDOs, credit default swaps and other

instruments against which they borrowed heavily (sometimes 10:1) Some face margin calls, distressed selling of every type of asset except Treasuries

• Global Economic Impacts: Global Economic Slowdown GDP growth in US down sharply, employment falling; Deceleration abroad too “Decoupling” theory was naïve Crashing dollar is symptom of irresponsible US fiscal policy, trade deficits. IOUs are

being redeemed for hard assets or states in corporations New bubbles forming in commodities and currencies


3.7

%

0.8

%

1.6

%

2.5

%

3.6

%

3.1

%

2.9

%

0.6

%

3.8

%

4.9

%

0.6

%

2.1

%

1.9

%

2.0

% 2.6

%

2.8

%

2.9

%

0.6

%

0.1

%

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.Source: US Department of Commerce, Blue Economic Indicators 4/08; Insurance Information Institute.

Economic growth has slowed dramatically

in 2007/2008

Toward a New WorldEconomic Order

Source: Insurance Information Institute

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

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

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

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

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

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

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

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

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

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

Economic Fix Impacts on Insurers

Fed Rate Cuts

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

Fed Debt Swap

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

Fed Bailout of Bear Stearns

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


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

(cont’d)

Economic Fix Impacts on Insurers

Stimulus Package

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

HousingBailout*

•If banks take 15% “haircut” on appraised mortgage value, can receive up to $300B in FHA loan guarantees •Could cost taxpayers $2.7B (GAO)•States collectively could issue $10B in tax-exempt bonds to subsidize home purchases, help subprime borrowers

Regulatory/ Legislative Action (?)

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

Source: Insurance Information Institute. *FHA Housing and Homeowner Retention Act as of 5/12/08.

Post-Crunch: Fundamental Issues To Be Examined Globally


• Adequacy of Risk Management, Control & Supervision at Financial Institutions Worldwide Colossal failure of risk management (and regulation) Implications for ERM? Includes review of incentives

• Effectiveness and Nature of Regulation What sort of oversite is optimal given recent experience? Credit problems arose under US and European (Basel II) regulatory

regimes Will new regulations be globally consistent? Can overreactions be avoided? Capital adequacy & liquidity

• 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

Insurance &The Economy

Important But Somewhat Muted Impacts

A Few Facts About the Relationship Between Insurance & Economy

• Vast Majority of Insurance Business is Tied to Renewals Approximately 98+% of P/C business (units) is linked to renewals A very large share of p/c insurance premiums are statutorily or de facto

compulsory (e.g., WC, auto liability, surety, usually HO…) P/C insurers have marginal exposure impact due to economy Most life revenues and units are renewals, but some products (e.g.,

variable annuities are sensitive to market volatility) Life insurers who manage 401(k) assets seeing more loans and hardship

withdrawals;• Insurers are Sensitive to Interest Rates

About 2/3 of P/C invested assets and 75% if Life assets are fixed income Historically, yield on industry portfolios has tracked 10-year note closely All else equal, lower total investment gain implies greater emphasis on

underwriting Historically, industry’s best underwriting performances are rooted in

periods when interests rates were low and/or equity market performance poor (1930s – 1950s, early 2000s gave rise to strong 2006/07)


5.2%

-0.9

%-7

.4%

-6.5

%-1

.5%

1.8%

4.3%

18.6

%20

.3%

5.8%

0.3%

-1.6

%-1

.0%

-1.8

%-1

.0%

3.1%

1.1%

0.8%

0.4%

0.6%

-0.4

%-0

.3%

1.6%

5.6%

13.7

%7.

7%1.

2%-2

.9% -0

.5%

-2.9

%-2

.7%

-10%

-5%

0%

5%

10%

15%

20%

25%78

79

80

81

82

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08F

Rea

l 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, 2/08; Insurance Information Inst.

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

2.07

1.80

1.36

0.98

1.10

1.38 1.

45

1.54 1.56

1.51

1.48

1.35

1.46

1.29

1.20

1.01

1.19

1.47

1.62 1.64

1.57 1.60

1.71

1.85

1.96

0.91.01.11.21.31.41.51.61.71.81.92.02.1

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

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

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

Impacts also for comml. insurers with construction risk exposure

New home starts plunged 34% from 2005-2007;

Drop through 2008 trough is 53% (est.)—a net annual decline of

1.09 million units

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

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

exposure loss in 2008 vs. 2005 is estimated at $954 million.

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

February 2008 index value was 175.94, at 206.52, meaning home prices were 14.8% below their

July 2006 peak

Home prices are approximately where

they were in Early 2005

Change in Home Values fromMaximum Price, by City*

-24.

5%

-24.

1%

-23.

8%

-23.

2%

-22.

1%

-21.

6%

-20.

8%

-19.

8% -17.

5% -14.

8%

-14.

7%

-13.

5% -10.

2% -9.1

%

-8.0

%

-7.8

%

-7.4

%

-6.9

%

-6.3

%

-5.1

%

-3.4

%

-30%

-25%

-20%

-15%

-10%

-5%

0%

Las V

egas

Phoen

ix

San D

iego

Detro

it

Mia

mi

Los A

ngeles

Tampa

San F

rancis

co

Was

hing

ton

Compos

ite-2

0

Min

neap

olis

Clevela

nd

Bosto

n

Chica

go

New Y

ork

Atlant

a

Denve

r

Dallas

Seattl

e

Portla

nd

Charlo

tte

Home prices are falling across the

country, down 14.8% on average

*Calculated as of Feb. 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).Source: Case-Schiller Home Price Index at Standardandpoors.com; Insurance Info. Institute

16.816.916.9

16.6

17.1

17.5

17.8

17.4

16.5

16.1

15.3

15.7

16.416.6 16.7

16.9

14.0

14.5

15.0

15.5

16.0

16.5

17.0

17.5

18.0

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

Weakening economy, credit crunch and high gas prices are hurting

auto sales

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

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

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

than problems in the housing market will on home insurers

Auto/Light Truck Sales,1999-2014F (Millions of Units)

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

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

4.5% 4.5% 4.6%4.8% 4.9%

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

3.0%

3.5%

4.0%

4.5%

5.0%

5.5%

6.0%

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

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

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

frequency surge

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

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

$0

$5

$10

$15

$20

$25

$30

$35

$40

$45Wage & SalaryDisbursementsWC NPW

*As of 7/1/07 (latest available).Source: US Bureau of Economic Analysis; Federal Reserve Bank of St. Louis at http://research.stlouisfed.org/fred2/series/WASCUR; I.I.I. Fact Books

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

Net Written Premiums

7/90-3/91

Shaded areas indicate recessions

3/01-11/01

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

Weakening wage and salary growth is

expected to cause a deceleration in workers comp

exposure growth

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

4.9 5.1

3.0 3.2

2.6

1.51.9

3.3 3.4

1.3

2.5 2.3

3.0

3.8

2.2

3.93.4

2.42.82.9

2.4

0

1

2

3

4

5

6

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

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

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

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

Favored Industry Groups for Insurer Exposure Growth

Industry Rationale

Health Care •Economic NecessityRecession Resistant•Demographics: aging/immigrationGrowth

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

Agriculture & Food Processing

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

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

Natural Resources & Commodities

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

Sources: Insurance Information Institute

#8CAPACITY

ADEQUACY

Too Much or Too Little Can Be Problematic

$0

$50

$100

$150

$200

$250

$300

$350

$400

$450

$500

$550

75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

U.S. Policyholder Surplus: 1975-2007*

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

$ B

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

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

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

its record low of $0.84:$1 in 1998

Annual Catastrophe Bond Transactions Volume, 1997-2007

$1,729.8

$966.9

$7,329.6

$4,693.4

$1,991.1

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

$633.0

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

$8,000

97 98 99 00 01 02 03 04 05 06 07

Ris

k C

apita

l Iss

ues

($ M

ill)

0

5

10

15

20

25

30

35

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

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

$564

.0

$646

.9

$311

.0

$952

.4

$418

.1

$566

.8

$310

.1

$658

.8

$769

.2

$4,5

86.5

$5,2

66.0

$763

.7

$5,2

42.3

$4,3

70.0

$7,0

94.1

$22,322.6

$4,4

97.5

$1,5

39.9

$2,7

64.2

$2,3

85.6

$4,2

97.3

$0

$5,000

$10,000

$15,000

$20,000

$25,000

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

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

2007 share buybacks shattered the 2006 record, up 214%

Reasons Behind Capital Build-Up & Repurchase Surge

•Strong underwriting results

•Moderate catastrophe losses

•Reasonable investment performance

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

Returning capital owners (shareholders) is one of the

few options available

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

MERGER & ACQUISITION

Catalysts for P/C Consolidation Growing

in 2008

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

$2,4

35

$5,1

00

$19,

118

$40,

032

$1,2

49

$486

$20,

353

$425

$9,2

64

$35,

221

$55,825

$30,

873

$8,0

59

$11,

534

$1,8

82

$3,4

50

$2,7

80

$5,1

37

$5,6

38

$0

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

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

Tran

sact

ion

Val

ue ($

Mill

)

0

20

40

60

80

100

120

140

Num

ber o

f Tra

nsac

tions

Transaction Values Number of Transactions

Source: Conning Research & Consulting.

M&A activity began to accelerate during the second

half of 2007

No model for successful

consolidation has emerged

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

$542

$446

$1,9

34

$7$1,633

$2,7

20

$689

$60 $2

12

$944

$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

96 97 99 00 01 02 03 04 05 06

Tran

sact

ion

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

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)

#9CATASTROPHIC

LOSS

What Will 2008 Bring?

Most of US Population & Property Has Major CAT Exposure

Is Anyplace

Safe?Source: RMS

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

$3.4

$100

.0

$61.

9

$9.2

$0

$20

$40

$60

$80

$100

$120

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

08:Q

1

20??

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

$ Billions

2006/07 were welcome respites. 2005 was by far the worst year ever for insured catastrophe losses in the US, but the worst has yet to come.

$100 Billion CAT year is coming soon

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.

Global Insured Catastrophe Losses 1970-2007 ($ 2007)

$2.4

$5.0

$5.8

$9.1

$5.0

$6.4

$5.6

$5.4 $1

1.3

$7.0

$4.2 $8

.9$1

0.3

$6.8 $1

1.6

$5.6 $1

5.4

$12.

4 $23.

7$2

7.9

$24.

4$4

2.5

$18.

4 $34.

4$2

5.6

$18.

0$1

1.2 $2

4.9

$43.

1$1

5.0

$41.

8$1

6.7

$21.

6$5

2.8

$113

.9$1

6.9 $2

7.6

$0

$20

$40

$60

$80

$100

$120

71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07

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

$ Billions

Impact of Hurricane Katrina on 2005

losses was dramatic

Global Insured Catastrophe Losses by Region, 2001-2007

0

10

20

30

40

50

60

70

80

90

2001 2002 2003 2004 2005 2006 2007

Seas/SpaceAfricaOceania/AustraliaSouth AmericaAsiaEuropeNorth America*

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

North America accounted for 70% of global

catastrophe losses 2001-2007

$ Billions

The 2008 Hurricane Season:

Preview to Disaster?

Outlook for 2008 Hurricane Season: 60% Worse Than Average

Average* 2005 2008F

Named Storms 9.6 28 15Named Storm Days 49.1 115.5 80

Hurricanes 5.9 14 8Hurricane Days 24.5 47.5 40Intense Hurricanes 2.3 7 4

Intense Hurricane Days 5 7 9

Accumulated Cyclone Energy 96.2 NA 150

Net Tropical Cyclone Activity 100% 275% 160%*Average over the period 1950-2000.Source: Philip Klotzbach and Dr. William Gray, Colorado State University, April 9, 2007.

Landfall Probabilities for 2008 Hurricane Season: Above Average

Average* 2008F

Entire US East & Gulf Coasts 52% 69%US East Coast Including Florida Peninsula

31% 45%

Gulf Coast from Florida Panhandle to Brownsville

30% 44%

Caribbean NA Above Average

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

Hurricane Risk in the Northeast

Is it Real?

Number of Hurricanes Directly & Indirectly Affecting the Northeast Since 1900

22

148912

6

39

33

23

31

4

20

0

8

0

5

10

15

20

25

30

35

40

45

DE NJ NY CT RI MA NH ME

Direct Total, Direct & IndirectTropical cyclone activity in the Northeast is not all

that uncommon

Source: New Hampshire Office of Emergency Management

RI has been affected by 33

hurricanes since 1900

Track of “Long Island Express” Hurricane of 1938

Source: WeatherUnderground.com, accessed February 4, 2006.

“Great New England Hurricane” of 1938 a.k.a.“Long Island

Express” caused severe damage through much of

the Northeast.

600+ Deaths

$308 million

Storm Season of 1944:A Busy one for the Northeast

Three storms affected NY, NJ and New England in 1944, including “Great

Atlantic Hurricane”

46 deaths

$100 million damage

109mph gusts in Hartford

Source: WeatherUnderground.com, accessed May 31, 2006; NOAA loss & fatality figures.

Storm Season of 1954:The Northeast Hit Again

NY/New England areas hit by Carol & Edna two

weeks apart

Carol: 8-10 ft. floodwaters in

Providence

Edna hits Cape Cod

Combined: 80 deaths, $501 million losses


Storm Season of 1960:Brenda & Donna Came to Visit

NY/New England areas were hit twice in 1960.

Donna killed 50, $387 million damage along East Coast


After a 25 Year Hiatus, Hurricane Gloria Hit in 1985


NY/New England areas were hit by Gloria 9/27/85

8 deaths

$900 million damage

Floyd Visited in 1999, Causing $4.5 Billion in Losses

Source: WeatherUnderground.com, accessed September 16, 2007; NOAA loss & fatality figures.

NY/New England areas were hit by Floyd 9/14 – 9/17/99

$4.5 B in damage US

Historical Hurricane Strikes in Bristol County, RI, 1900-2007

Source: NOAA Coastal Services Center, http://maps.csc.noaa.gov/hurricanes/pop.jsp/; Insurance Info. Institute.

Historical Hurricane Strikes in Kent County, RI, 1900-2007


Historical Hurricane Strikes in Newport County, RI, 1900-2007


Historical Hurricane Strikes in Providence County, RI, 1900-2007


Historical Hurricane Strikes in Washington County, RI, 1900-2007


Historical Hurricane Tracks Within 65nm of Rhode Island, 1851-2007


#10SHIFTING LEGAL

LIABILITY & TORT ENVIRONMENT

Will the Tort PendulumSwing Against Insurers?

Bad Year for Tort Kingpins*

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

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

Sou

rce:

San

Die

go U

nion

Tri

bune

, 9/1

9/07

Sou

rce:

Wal

l Str

eet J

ourn

al, 3

/15/

07

Tort System Costs, 1950-2009E

$1.8 $5.4 $7.9$13.9$20.0

$83.7

$130.2

$179.2

$246.0$265

$277

$158.5

$247.0

$42.7

$3.4

0.62%

0.82%

1.03%

1.34%1.22%

1.98%2.14%

1.82% 1.83%1.83%

1.87%

2.24%2.24%

1.53%

1.11%

$0

$50

$100

$150

$200

$250

$300

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

Tor

t S

yste

m C

osts

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

Tor

t C

osts

as

% o

f G

DP

Tort Sytem Costs Tort Costs as % of GDP

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

After a period of rapid escalation,

tort system costs as a % of GDP are

now falling

The Nation’s Judicial Hellholes (2007)

Source: American Tort Reform Association; Insurance Information Institute

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)

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: Excess capital depresses ROEs Policyholder Surplus up 6-7%% in 2007 and up 80% since 2002 Insurers hard pressed to maintain earnings momentum Options: Share Buybacks, Boost Dividends, Invest in Operation, Acquire Option B: Engage in destructive price war and destroy capital

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

• Favorable Fundamentals/Drop-Off in CAT Activity Underlying claims inflation (frequency and severity trends) are benign Lower CAT activity took some pressure of capital base

• Weak Dollar Makes acquisition of US insurers cheaper


Challenges forIndependent Agency System

IA System Will Survive, But Challenges Abound• Scale

Economies of scale are substantial and will be a major driver of agency consolidation. Consolidating back office operations makes sense.

BANKS: Will continue to act as consolidators, less so in soft market• Demographics

Large number of IAs near retirement age, no family successor Family successor clearly not as motivated or skilled, looking for an “out” Spouse not much of a help: unwilling to partner; has unrelated career High schools, colleges rarely offer an direction for insurance careers “Young Agent” initiatives broadly supported by industry

• Aggressive Direct Writers Direct channel will grow; many companies expanding non-contiguously Challenge is and will remain greater on personal lines side Customers will routinely and increasingly interact with insurer and agent using

multiple platforms• Compensation

War of contingencies still looms large Many IAs say they can’t make it without contingent compensation

When it Comes to P/C Insurance, Size Doesn’t Always Matter

Small Can Be Beautiful• Scale

Economies of scale exist but don’t seem to be related to long-term success Most insurers in the US are small and many have been around for a long

time (WBM is in its 113th year—older than AIG, Allstate…)• Small/Medium Insurers Success Based on Relationships and

Service Small insurers have strongest ties to producers and customers

• Growing Pains Maintaining closeness with agents, customers could be difficult Selling the concept of mutuality when large is more difficult (State Farm) Bumping heads with super-regional & nationals, esp. on larger accounts

• Problems/Challenges Lagging behind technologically Need to operate from multiple sales platforms Capital constraints Historically conservative approach means bold new ventures not in

management experience; New underwriting challenges.

Bonus ChallengeREGULATORY &

LEGISLATIVE ENVIRONMENT

Zealoutry & Uncertainty

Legal, Legislative &Regulatory Issues

• Florida “Seeing the Light”?: State finally recognizing that it is overexposed with its 2007 legislation having failed to deliver on political promises made But state taking punitive steps (SB 2860)

• Credit: Perennially under attack, but states shift each year

• Massachusetts Auto: Reforms have led to more competition, lower rates

• Optional Federal Chartering: Recommended in Treasury plan; Still divisive issue

• Tax Issue: Treatment of locales like Bermuda; Effort to “level the playing field”

• National CAT Plan: Hearings in February and in 2007, but no current catalyst

• Flood Reform: Likely to happen; MS Rep. Gene Taylor still wants wind cover

• McCarran-Ferguson: Trent Lott’s gone, some may still push for scaling back Profusion of Quasi-Regulators: AGs, Governors, Congressional representatives

• Bad Faith Legislation: Attempts by trial lawyers and legislative allies to open new tort channels (WA referendum, Florida SB 2862)

• Excess Profits Laws: Laws seek to cap industry profits

Source: III

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

Summary of Treasury “Blueprint”for

Financial Services Modernization

Impacts on Insurers

Treasury Regulatory Recommendations Affecting Insurers

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

• Establishment of an Optional Federal Charter (OFC) Would provide system for federal chartering, licensing,

regulation and supervision of insurers, reinsurer and producers (agents & brokers)

OFC insurers would still be subject to state taxes, provisions for compulsory coverage, residual market and guarantee funds

OFC would specify specific lines covered by charter; Separate charters needed for P/C and Life

• OFC Would Incorporate Several Regulatory Concepts Ensure safety and soundness Enhance competition in national and international markets Increase efficiency through elimination of price controls,

promote more rapid technological change, encourage product innovation, reduce regulatory costs and provide consumer protection

• Establishment of Office of National Insurance (ONI) Department within Treasury to regulate insurance pursuant to OFC Headed by Commissioner of National Insurance Commissioner has regulatory, supervisory, enforcement and

rehabilitative powers to oversee organization, incorporation, operation, regulation of national insurers and national agencies

• Establishment of Office of Insurance Oversight (OIO) Department within Treasury to handle issues needing immediate

attention such “reinsurance collateral”; OIO could focus immediately on “key areas of federal interest in the insurance sector”

OIO: lead regulatory voice on international regulatory policy Would have authority to ensure states achieved uniform

implementation of declared US international insurance policy goals OIO would also serve as advisor to Treasury Secretary on major

domestic and international policy issues• UPDATE: HR 5840 Introduced April 17 Would Establish

Office of Insurance Information (OII) Very similar to OIO

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

Treasury Regulatory Recommendations Affecting Insurers (cont’d)

PRESIDENTIAL POLITICS & P/C PROFITABILITY

Political Quiz

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

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

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

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

15.10%10.45%

8.93%8.65%

8.35%7.98%

7.68%6.98%6.97%

5.43%5.03%

4.83%4.43%

3.55%

16.43%

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

Carter

Reagan II

G.W. Bush II

Nixon

Clinton I

G.H.W. Bush

Clinton II

Reagan I

Nixon/Ford

Truman

Eisenhower I

Eisenhower II

G.W. Bush I

Johnson

Kennedy/Johnson

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

OVERALL RECORD: 1950-2008*

Republicans 8.92%

Democrats 8.00%

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

Insurance Information Institute On-Line

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Documents

Top 10 Challenges Facing the Property/Casualty Insurance Industry Robert P. Hartwig, Ph.D., CPCU, President Insurance Information Institute 110 William