casualty insurance markets in turbulent times trends & challenges robert p. hartwig, ph.d.,...

Casualty Insurance Markets in Turbulent TimesTrends & Challenges

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

Insurance Information Institute

March 2008

Presentation Outline

• Shifting Legal Liability & Tort Environment• The Economic Storm: What it Means for the Insurance

Industry• Profitability & Performance: Strong but Starting to

Experience Cyclical Weakening• Ratings & Financial Strength: Weathering the Storm?• Underwriting Trends: Strength in Numbers• Premium Growth: At a Standstill• Capacity: Too Much of a Good Thing?• Investment Overview: More Pain, Less Gain

Q&A

Shifting Legal Liability & Tort

Environment

Recent Reforms Have Helped, but Will Tort Pendulum Swing Against

Corporations & Insurers?

$17.0$49.6 $58.7

$85.6$17.1

$51.0$70.9

$85.6

$5.2

$20.4

$30.0

$45.5

$0

$50

$100

$150

$200

$250

1980 1990 2000 2006

Commercial Lines Personal Lines Self (Un)Insured

Bil

lion

s

Total = $39.3 Billion

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




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

Growth in Cost of U.S. Tort System,1951-2009F

Source: Tillinghast-Towers Perrin.

9.8%

11.9%

3.2%

13.8%

5.6% 5.7%

0.4%

-5.4%

2.4%

4.7%

11.6% 11.8%13.7%

-10%

-5%

0%

5%

10%

15%

1951-60

1961-70

1971-80

1981-90

1991-2000

2001 2002 2003 2004 2005 2006 2007E 2008E

Tort costs moderated beginning in 2003 as many improvements in the tort system began to bear fruit

Asbestos-related and other costs drove tort growth sharply upward in 2001 and 2002

2001-2005: 7.8%

2006-2009F: 1.6%

Cost of US Tort System ($ Billions)

$129

$130 $1

41

$144

$148 $1

59

$156

$156 $1

67

$169 $1

80 $205

$233 $2

46 $260

$261

$247

$253 $2

65 $277

$0

$50

$100

$150

$200

$250

$300

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

07E

08E

09E

Tort costs consumed 1.87% of GDP in 2006, down from 2.24% in 2003

Per capita “tort tax” was $825 in 2006, up from $680 in 2000

Reducing tort costs relative to GDP by just 0.25% (to 1.84%) would produce an

economic stimulus of $31.1B

Source: Tillinghast-Towers Perrin, 2007 Update on US Tort Cost Trends.

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

Tort System Costs and Tort Costs as a Share of GDP, 2000-2009F

$179

$233$246

$265

$253

$260

$261

$277

$247

$205

1.82%2.03%

2.22% 2.23%

1.83%1.84%

2.10%

1.83%1.87%

2.24%

$100

$120

$140

$160

$180

$200

$220

$240

$260

$280

$300

00 01 02 03 04 05 06 07E 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

After a period of rapid escalation, tort system costs as % of GDP are now falling

Source: Tillinghast-Towers Perrin, 2007 Update on US Tort Cost Trends.

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

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

New in 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

Total Top 10 Verdicts, 1995 through 2006

Source: Lawyers USA, 2007

Number of Top 10 Jury Awards, 1995 - 2007

22 2220

17

8 75 4 3 2 2 2 2 1 1 1

6

0

5

10

15

20

25

TX, NY and CA lead the U.S. in jumbo-size jury awards

Source: LawyersWeekly USA,, January 22, 2008. *All against Iran for terrorist activity

Sum of Top 10 Jury Awards

$ Millions

$615.0$815.0

$2,953.7

$5,158.8

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

2004 2005 2006 2007

Source: Insurance Information Institute from LawyersWeekly USA, January 2005, 2006, 2007 and 2008.

Total of Top 10 awards in 2007 was 25% lower than in 2006

2007 Top Ten Verdicts

Source: LawyersWeekly USA, January 22, 2008.

Value Issue State

$109 Million Medical Malpractice New York

$102.7 Million Premises Liability, Death Florida

$55.2 Million Product Liability, Death California

$54 Million Private Air Crash Florida

$54 Million Nursing Home, Death New Mexico

$50 Million DUI Crash Florida

$50 Million Product Liability, Death Alabama

$47.6 Million Prempro Nevada

$47.5 Million Vioxx New Jersey

$45 Million Auto Crash, Death Florida

2006 Top Ten Verdicts

Source: LawyersWeekly USA, 2007.

Value Issue State

$216.7 Million Medical Malpractice Florida

$160 Million Nursing Home Negligence Texas

$106 Million Wrongful Death California

$61 Million Workplace Harassment California

$51 Million Vioxx Louisiana

$47.5 Million Death of Prisoner Texas

$46 Million Auto Accident Missouri

$44.2 Million Business Dispute Florida

$44 Million Police Brutality Maryland

$38.5 Million Product Liability Texas

INFLUENCE OF TORT ENVIRONMENT AND LEGAL

LIABILITY TRENDS ON PRICING AND AVAILABILITY

Excess Liability Market Capacity – North America

Source: Marsh, 2007 Limits of Liability Report

$1.660$1.645

$1.570$1.535$1.425

$1.575

$1.710

$2.045

$1.941$2.011

$1.721

$1.405$1.334

$1.432

$1.0

$1.2

$1.4

$1.6

$1.8

$2.0

$2.2

$2.4

$2.6

$2.8

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

Bil

lio

ns

Capacity is up 16.5% since its 2003 trough

Liability: Average Cost per $1,000 of Revenue* United States, 2001 to 2007

$1.2

5

$0.6

5

$0.6

7

$0.3

3

$0.1

7

$0.1

1

$0.2

3

$3.2

1

$1.5

6

$1.2

7

$0.8

6

$0.3

6

$0.1

8 $0.4

8

$2.4

9

$1.0

7

$1.0

6

$0.6

3

$0.2

3

$0.1

4

$0.3

2

$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

$4.00

$0 - $200M $201M-$500M

$501M-$1B $1B-$5B $5B-$10B $10B+ All

2001 2004 2007

*Across entire liability program (full population)

Source: Marsh, 2007 Limits of Liability Report

Liability insurance costs relative to the client’s revenues are down by 25% - 35% since 2004

31.3

%

22.0

% 37.5

%

20.8

%

46.7

%

40.8

%

37.5

%

24.9

%

11.2

%

10.1

%

39.7

% 53.8

%

40.5

%

22.6

%

11.3

%

10.0

%

42.2

%

70.0

%

48.0

%

28.3

%

10.0

%

11.1

%

36.7

% 56.6

%

27.1

%

10.1

%

11.0

%

31.7

% 51.6

%

29.2

%

19.0

%

5.5%10

.4%

8.4%9.

9%

134.5%

0%

20%

40%

60%

80%

100%

120%

140%

160%

CommercialMultiperil**

ProductsLiability

MedicalMalpractice

GeneralLiability

Comm. Auto Liability

WorkersComp

2001 2002 2003 2004 2005 2006

Defense Costs and Cost Containment Expenses as % of Incurred Losses*

* Net of reinsurance; excludes state funds. **Liability portion onlySource: Insurance Information Institute 2008 Fact Book from NAIC Statement Database.

Defense costs as a percentage of incurred

losses are flat or tracking upward

Average Total Liability Limits Purchased by All U.S. Firms*

*Includes underlying primary limits

Source: Limits of Liability 2007, Marsh, Inc.

$77.9

$85.8$83.2

$85.9$88.7

$99.1

$105.0$101.8

$95.7

$87

$77$75

$66 $66

$50

$60

$70

$80

$90

$100

$110

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

Limits purchased fell by 37.1% between 2000 and 2007.

Price/capacity are issues.

$ Millions

Average Underlying Limits – U.S. (Attachment Points)

*Source: Marsh, 2007 and 2006 Limits of Liability Report

$ Millions$2.2

$2.1

$1.8 $1.8

$2.0$1.9$1.9

$1.8

$1.0

$1.2

$1.4

$1.6

$1.8

$2.0

$2.2

$2.4

2000 2001 2002 2003 2004 2005 2006 2007

Average Jury Awards1994 vs. 2001 and 2005

419

187

333 1,

185

1,14

0

1,74

4

948

245 63

6

2,50

1 3,28

9

1,39

4

407

541

6,27

3

3,83

0

8,11

86,

358

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

$8,000

$9,000

$10,000

Overall VehicularLiability

PremisesLiability

WrongfulDeath*

MedicalMalpractice

ProductsLiability

($00

0)

1994 2001 2005

*Award trends in wrongful deaths of adult males.Source: Jury Verdict Research; Insurance Information Institute.

The average jury award continued to rise through 2005

Trends in Million Dollar Verdicts*4%

10%

8%

23%

22%

36%

48%

4%

8%

12%

31% 37

%

49%

59%

13%

14%

29%

51%

62%

5%

17%

13%

32%

41%

55%

64%

4%

39%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

VehicularLiability

PersonalNegligence

PremisesLiability

BusinessNegligence

GovernmentNegligence

MedicalMalpractice

ProductsLiability

1996-1998 1999-2001 2002-2003 2004-2005

*Verdicts of $1 million or more.Source: Jury Verdict Research; Insurance Information Institute.

Across all liability types, million dollar-plus awards rose from 10% of all awards from 1996-98 to 17% in 2004-05.

Some Emerging and Potential Casualty & Litigation Risks

Source: Insurance Information Institute

1. Securities Litigation• Increased market volatility generally leads to more litigation. Subprime and

broader credit crunch are central issues.

2. Bad Faith Litigation• Major area of focus for trial bar; Potential ballot referenda (e.g., WA)

3. Products Liability on Imported Goods• Defective products, drugs; Increased federal penalties/activism: CPSC

4. Climate Change• CO2 Supreme Court decision/EPA• Claims that hurricanes, rising sea levels, wildfiresGHG emissions• Carbon emissions caps, sequestration (storage & infrastructure)

5. Energy• Capacity and technology currently pushed to the edge• Alternative fuels (e.g., is ethanol really “clean”?), Sequestration

6. Latent Occupational Disease• Manifestation is significantly delayed from exposure• Degenerative neurological disorders (e.g., Parkinsons), Cancers

Emerging and Potential Casualty & Litigation Risks (cont’d)


7. First Responder Litigation• Disease manifestation traced back to disaster response

8. Employment Practices Liability• Weak labor market, layoffs could spawn more litigation, especially age

discrimination cases

9. Environmental Liability• Continued erosion of “absolute pollution exclusion”• “Green” movement; increased environmental awareness

10. Nanotechnology• Science is wide open on any harm caused

11. Assisted Living Facilities• Surge in nursing home population ahead; Fertile ground for litigation

12. Financial Fiduciary/Advice• Extent of liability for management of funds could be stretched• Litigation based on “faulty” advice; Failure to follow investor wishes

A STORMY ECONOMIC FORECAST

What a Weakening Economy & Credit Crunch Mean for

the Insurance Industry

What’s Going On With the US Economy Today?

Fundamental Factors Affecting US Economy in 2008• Puncture of Two Bubbles: Credit and Housing• Credit Crunch: Credit is the lifeblood of the US economy, but some

markets have effectively seized (at least to some degree) Problem originated with interest rates being left too low for too long in the

early 2000s Subprime mortgage market first part of credit bubble to burst; Spread via

securitization and amplified via leverage and concentration of risk As lenders tighten standards, credit issues have spread to prime borrowers,

commercial mortgages, munis, credit cards, student loans• General Economic Impacts: Burst BubbleAsset Deflation

Home price bubble is bursting: Loss of value in most valuable asset impacts wealth via loss of home equity

Negative “wealth effect” implies consumers (2/3 of spending) become more cautious

Business scale back as prospects diminish in classic economic slowdown Job growth stagnating (-17,000 in Jan. 2008)

Source: Insurance Information Institute.

What’s Being Done to Fix theUS Economy?

Fundamental Factors Affecting US Economy in 2008• Federal Reserve: Slashing RatesDown 2.25 points since April

Necessary but not sufficient. Need to reopen credit arteries

• Federal/State Government: Traditional role of government is to provide economic stimulus, appropriate regulation President signed $170 billion stimulus package Feb. 13 Hope is that it will create 500,000 jobs Expansion of jumbo mortgage limit from $417,000 nationally to $700K+ in some

expensive real estate markets (expands Federal guarantee limit) Dinallo/Spitzer proposals to rescue monoline (bond) insurers

• Private Sector: Scrubbing Balance Sheets Financial institutions trying to determine exposure and recognize via accounting

statements (e.g., writedowns) Attempt to create some sort of private rescue package for bond insurers Purchase of distressed assets by some; Sovereign Wealth Fund infusions Buffet efforts in muni markets


Summary of Economic Risks and Implications for Insurers

Economic Concern Risks to Insurers

Credit Crunch/ Subprime Problems

•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

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

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•Increased workers comp frequency

3.7

%

0.8

%

1.6

%

2.5

%

3.6

%

3.1

%

2.9

%

0.6

%

3.8

%

4.9

%

0.5

%

2.3

%

2.5

%

2.7

%

2.8

%

2.9

%

2.9

%

0.6

%

1.1

%

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 2/08; Insurance Information Institute.

Economic growth is expected to slow

dramatically in the year ahead

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%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 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,1990-2013F (Millions of Units)

2.07

1.80

1.36

1.02

1.17

1.54 1.

58 1.65

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

1.0

1.1

1.2

1.3

1.4

1.5

1.6

1.7

1.8

1.9

2.0

2.1

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07F 08F 09F 10F 11F 12F 13F

Source: US Department of Commerce; Blue Chip Economic Indicators (10/07), except 2008/09 figures from 2/08 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 51% (est.)—a net

annual decline of 1.05 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 $920 million.

16.916.9

16.6

17.1

17.5

17.8

17.4

16.5

16.1

15.7

16.0

16.4

16.7 16.8 16.9

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

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 1.2 million units annually by 2008 compared with 2005, a

decline of 7.1%

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,1999-2013F (Millions of Units)

Source: US Department of Commerce; Blue Chip Economic Indicators (10/07), except 2008/09 figures from 2/08 edition of BCEF; Insurance Info. Institute

$1

,08

2

$1

,14

4

$1

,22

6

$1

,30

7

$1

,37

0

$1

,39

6

$1

,43

8

$1

,49

5

$1

,56

3

$1

,64

1

$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

$1,600

$1,8000

3

04

05

06

07

E

08

F

09

F

10

F

11

F

12

F

0%

1%

2%

3%

4%

5%

6%

7%

8%

% C

han

ge

Nonresidential Fixed Investment% Change Nonresidential Fixed Investment

Nonresidential Fixed Investment,* 2003 – 2012F

Sharp dip in business

investment in 2007/2008 will

slow commercial exposure growth

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

Sources: US Bureau of Economic Analysis (Historical), Value Line (2/22/08) estimates/forecasts for 2008-2012.

Non

resi

den

tial F

ixed

In

vest

men

t ($

Bill

)

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

1.1%

3.5% 3.6%

-1.0%

0.2%0.7%

1.8%

2.4%2.7% 2.7% 2.6% 2.6%

-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 (2/08); Insurance Info. Inst.

Industrial production shrank during the final quarter of 2007 and is expected to grow only very slowly

during the first half of 2008

Industrial production affects exposure both directly and indirectly

Employment Change by Industry

(27,000)(28,000)

11,000

(11,000)

47,000

19,000

(18,000)

(40,000)

(30,000)

(20,000)

(10,000)

0

10,000

20,000

30,000

40,000

50,000

60,000

Construction Manuf. Retail Trade Professional& Biz

Services

Education &Health

Leisure &Hospitality

Government

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

Employment fell by 17,000 in January, the first decline since Aug. 2003.

Manufacturing and Construction are always the hardest hit in an economic slowdown, with each losing more than 150,000 jobs over the past 12 months.

Dec. 2007 to Jan. 2008p

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

4.5% 4.5% 4.6%4.8%

5.0%5.2%

5.3% 5.4% 5.3% 5.3%5.2% 5.2%

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 (2/08); 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

4.3

2.9

2.32.82.9

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 Jan. 2008 vs. Jan. 2007; CPI rose at 6.8% pace NSource: US Bureau of Labor Statistics; Blue Chip Economic Indicators, Feb. 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

Potential Industry Groups for Insurer Exposure Growth

Industry Rationale

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

Alternative Energy •Solar, Wind, Bio-Fuels, Hydro & Other

Agriculture & Food Processing & Manufacturing

•Consumer StapleRecession Resistant•Grain and land prices high due to global demand, weak dollar (exports)•Ethanol/Bio-Fuel Source•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

Credit Crunch: Key Points


1. Credit Issue Will Ultimately Cost Hundreds of Billions Globally

• 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; US Bond Insurers

• Cash infusions necessary; Sovereign Wealth Funds primary source

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 hand

5. IOUs are Being Redeemed• Stakes in hard assets/institutions demanded;

6. Good News: No Shortage of Available Capital• Central banks are (generally) making right decisions; Dollar sinks

Shareholder Class Action Lawsuits*

*Securities fraud suits filed in U.S. federal courts; 2008 figure is current through February 29.Source: Stanford University School of Law (securities.stanford.edu); Insurance Information Institute

164202

163

231188

111

173

242210215

497

267226237

182

118

176

24

0

100

200

300

400

500

600

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

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

housing collapse and market volatility.

Defendants include banks, investment banks,

builders, lenders, bond and mortgage insurers

Includes 44 suits related to subprime in 2007/08

Financial Restatements Filed Continue to Grow

116 158 216 233 270 330

613

1,195

1,538

514

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Sources: Huron Consulting Group 1997-2002, Glass Lewis & Co. 2003-2006

Restatements can serve as starting points for plaintiff attorneys looking to form class actions

Restatements rose to a record 1,538 in 2006, as companies came under continuing intense scrutiny.

Origin of D&O Claims for Public Companies, 2006

Customers & Clients, 4%Competitors,

6%

Employees, 25%

Government, 2%

Other 3rd Party, 22%

Shareholders, 40%

40% of D&O suits originate

with shareholders

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

Average Settlement Value of Shareholder Class Actions*

(Excl. Settlements Above $1 Billion)

$8.5 $8.8$10.7 $11.1

$15.7$13.9

$21.6$19.7

$24.7$22.7

$33.2

$23.8

$0

$5

$10

$15

$20

$25

$30

$35

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

Settlement values have been on the rise

The average settlement reached a record high of

$33.2 million in 2007

*Does not include partial or tentative settlements.Source: NERA Economic Consulting, Recent Trends in Shareholder Class Actions, Dec. 2007.

$ Millions

Shareholder Class Actions:Median Investor Losses vs. Ratio of

Settlement to Loss, 1991-2007*

$60 $62 $63$85

$66

$119$113

$176

$296$319

$333

$407

$310

$162

$217

$94$96

4.7%4.8%

5.9% 6.1%

7.2%

4.9%

4.0%

3.4%

2.1%2.4%

3.1%

2.4%2.9%

2.9%

4.7%

5.5%5.8%

$0

$50

$100

$150

$200

$250

$300

$350

$400

$450

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

Med

ian

In

vest

or L

osse

s

0%

1%

2%

3%

4%

5%

6%

7%

8%

Med

ian

Rat

io o

f In

vest

or L

oss

to

Set

tlem

ent

Median Investor Losses Median Rate of Settlement to Investor Losses (%)

Source: NERA Economic Consulting, Recent Trends in Shareholder Class Actions, Dec. 2007. *Refers to settlement year.

As losses rise, ratio of settlement to

loss has been falling.

Shareholders recovered 2.4% of losses in 2007

PROFITABILITY & PERFORMANCE

Profits in 2006/07 ReachedTheir Cyclical Peak

P/C Net Income After Taxes1991-2007F ($ 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

$63,

500

-$6,970

$63,

695

$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

07E

*ROE figures are GAAP; 1Return on avg. surplus. 2007E figure is annualized actual 9-month net income of $49.399B **Return on Average Surplus; Actual 9-month 2007 result. 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%2007E ROAS1 = 13.1%**

Insurer profits peaked in 2006/7

-5%

0%

5%

10%

15%

20%

US P/C Insurers All US Industries

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

*2007 is actual 9-month ROAS of 13.1%. 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 9-month ROAS of 13.1%. 2008 P/C insurer ROE is I.I.I. estimate.Source: Insurance Information Institute; Fortune

-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 07E

ROE Cost of Capital

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

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

+3.

1 p

ts

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

-11.76%

-36.25%

-9.68%

-18.90%

-9.59%

-5.08%

-11.49%

-9.38%

-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 February 29, 2008

P/C insurance stocks not affected as much as the overall

market by credit, subprime concerns

Mortgage & Financial Guarantee insurers were

down 69% in 2008

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

FINANCIAL STRENGTH &

RATINGS Industry Has Weathered

the Storms Well, But Cycle Has an Impact Too

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

07

E

Co

mb

ine

d R

ati

o

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2

Imp

air

me

nt

Ra

te

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

*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%

Cumulative Average Impairment Rates by Best Financial Strength Rating*

0%

10%

20%

30%

40%

50%

60%

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

D

C/C-

C++/C+

B/B-

B++/B+

A/A-

A++/A+

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

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

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

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

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

Combined Ratios

1970s: 100.3

1980s: 109.2

1990s: 107.8

2000s: 101.8*

Sources: A.M. Best; ISO, III *Estimate based on actual 9-month data.

P/C Insurance Combined Ratio, 1970-2007E*

115.8

107.4

100.198.3

100.7

92.593.8

90

100

110

120

01 02 03 04 05 06 07F

P/C Insurance Combined Ratio, 2001-2007E

Sources: A.M. Best; ISO, III. *Actual 9-month result.

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

normal CAT activity

87.6

91.2

92.1 92.3 92.4 92.593.1 93.1 93.3

93.8

93.0

85

86

87

88

89

90

91

92

93

94

95

1949 1948 1943 1937 1935 2006 1950 1939 1953 1936 2007E

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

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

2007 was one of the Top 12

best since 1920

The industry’s best underwriting years are associated with

periods of low interest rates

The 2006 combined ratio of 92.5 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

07F

Source: A.M. Best, Insurance Information Institute *Actual 2007:9M underwriting profit = $18.146B annualized to $24.192B.

$ B

illi

ons

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

second since 1978. Expected gain for 2007 is approximately $24 billion. Cumulative

underwriting deficit since 1975 is $417 billion.

Underwriting Gain (Loss)1975-2007F*

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

$6.5

$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

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

$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. Inflation is a

threat.

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

Release

Strengthening

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.

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

KEY COMMERCIAL LINES

PERFORMANCE

112.

1

112

113 11

5.9 12

0.5

120.

1

106.

6

99.4

96.6

93.4

94

96.7

102.

2 105.

6 108.

9 112.

1

105.

9

101.

6

93.8

84.5

82.8

88.3

87.7

94.5 98

122.5

80

85

90

95

100

105

110

115

120

125

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

Comm Auto Liab Comm Auto PD

Commercial Auto Liability& PD Combined Ratios

Average Combined: Liability = 108.8

PD = 97.5

Commercial Auto has improved dramatically

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

119.0

119.8

108.5

125.0

113.1

115.0

121.0

116.2

116.1

104.9

101.9 105.5

100.7

116.8

113.6

115.3

122.4

115.0

117.0

97.3

89.0

97.7

93.8

83.6

93.5

98.0

80

85

90

95

100

105

110

115

120

125

130

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

CMP-Liability

CMP-Non-Liability

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

Liab. Combined 1995 to 2004 = 113.8

Non-Liab. Combined = 105.2

CMP- has improved recently

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

99.8 10

6.6

107.

9 115.

7

129.

7

133.

8

154.

8

142.

3

137.

5

111

101

91.2

83

94.5

138.

6

117.

6

104.

5 110.

9

122.

5

124.

3

115.

9

117.

4

113.

1

99

104.

5

108.

5

112.

3

95.4

80

90

100

110

120

130

140

150

160

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

Med MalProducts & Other Liability*

Medical Malpractice & Products & Other Liability* Combined Ratios

Tort sensitive lines improved

dramatically since the early 2000s, but

some deterioration is now occurring

Sources: A.M. Best (historical and forecasts) *Includes professional liability, D&O, E&O, Excess Casualty/Umbrella, Environmental/Pollution, GL and EPL.

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

101

97

111

110

107

103

95

101 10

6

119

131

140

135

123

88 87 87

101.

5

98.5

100

101 10

7 115 11

8 122

97

104

96

80

90

100

110

120

130

140

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

Calendar Year Accident Year

Percent

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

Includes dividends to policyholders *2007/2008 figures are A.M. Best estimates/forecasts.

Workers Comp Combined Ratios, 1994-2008F*

Lost-Time Claims

-4.2 -4.4

-6.9

-4.5 -4.1 -3.9

-6.8

-9.2

0.3

-6.5

-4.5

0.5

-3.9

-2.3

-4.5

-6.6

-10

-8

-6

-4

-2

0

2

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

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

time claims have been cut by more than half

Accident Year

Percent Change

Workers Comp Lost-TimeClaim Frequency (% Change)

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

4.5%3.6%

2.8% 3.2% 3.5%4.1%

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

5.1%

7.4%

10.1%

8.3%

10.6%

8.2%

14.0%

7.4%

9.0%

6.8%

11.7%

7.5%

0%

2%

4%

6%

8%

10%

12%

14%

16%

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

Change in Medical CPIChange Med Cost per Lost Time Claim

WC Medical Severity Rising Far Faster than Medical CPI

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

3.5

pts

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

from 1995 through 2006

Med Costs Share of Total Costs is Increasing Steadily

Indemnity55%

Medical45%

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

Indemnity52%

Medical48%

Indemnity41%

Medical59%1986

1996

2006p

PREMIUM GROWTH

At a Virtual Standstillin 2007/08

-10%

-5%

0%

5%

10%

15%

20%

25%

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

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

*2007 figure is actual 9-month figure.

Post-Katrina period resembles

1993-97 (post-Andrew)

2007: 0.0% premium growth is the lowest since 1943

Growth in Net Written Premium, 2000-2008F

*2007 figure based on actual 9-month results.Source: A.M. Best;

5.0%

8.4%

15.3%

10.0%

3.9%

0.5%

2.7%

0.0%

2000 2001 2002 2003 2004 2005 2006 2007*

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

but underwriting results are expected to remain relatively healthy

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

109.4110.2

118.8

109.5

112.5

110.2

107.6

104.1

109.7 110.2

102.5

105.4

90.5

102.0

111.1112.3

122.3

$7.3

0

$6.4

9

$13.

91

$13.

15

$11

.94

$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

Co

mm

erc

ial L

ine

s C

om

bin

ed

Ra

tio

($1)

$1

$3

$5

$7

$9

$11

$13

$15

Co

st

of

Ris

k/$

10

00

Re

ve

nu

e

CommercialCombined Ratio

Cost of Risk

Source: RIMS, 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 30% - 35% of the risk dollar

COMPETIVE PRICING

Intense Competitive Pressure in 2007/08,

Especially Commercial

Average Commercial Rate Change,All Lines, (1Q:2004 – 4Q:2007)

-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%

-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

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 – 4Q07

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

Average Commercial Rate Changes by Line: 4Q99 – 4Q07

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

Post-Katrina bump was short-lived

Rate Changes by Line,4th Qtr. 2005

-1.0% -0.9%

-4.6% -4.7%

-2.0%

-2.7%

-0.4%

-4.6%

0.2%

-4.2%

-3.0%

-5%

-4%

-3%

-2%

-1%

0%

1%

Comm Prop BizInterruption

Comm Auto WC GL Umbrella EPL D&O Surety Const. ALL Lines


Strong tightening in 05Q4—the Katrina effect

Rate Changes by Line,4th Qtr. 2007

-13.0%

-8.9%

-11.9%-13.0%

-11.9%

-7.6%

-9.3%

-12.2%

-1.7%

-11.0%

-6.1%

-14%

-12%

-10%

-8%

-6%

-4%

-2%

0%

Comm Prop BizInterruption

Comm Auto WC GL Umbrella EPL D&O Surety Const. ALL Lines


ALTERNATIVE RISK TRANSFER

Total Commercial Risk Protection Market (US, 2004)

Commercial Insurance, 70%

Alternatives, 30%

Source: Conning; MarketStance analysis; Insurance Information Institute.

Alternative market mechanisms cover

about 30 percent of the total commercial risk

protection market

$ Billions

Alternative markets include captives, RRGs,

large deductible programs, etc.

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

733

542

380

382

242

208

165

158

989

740

563

381

235

208

161

160

166*

*

987*

169*

*

383*

0

200

400

600

800

1,000

Berm

uda

Caym

ans

Verm

ont

BVI

Guer

nsey

Barbad

os

Luxem

bourg

Turks &

Cai

cos

Isle

of M

an

Haw

aii

2005 2006

Leading Captive Domiciles Worldwide, 2005 vs. 2006

Mixed growth rates in captive domiciles worldwide in 2006 as competition intensifies in

traditional market.

*BI estimate. **Excludes credit life insurers.

Sources: Business Insurance, March 12, 2007, III

542

158

122

58 53 59

33 15 13 15 6

563

160

146

97

74 70

39 30 21 17 10

0

100

200

300

400

500

600

VT HI SC NV AZ DC NY UT MT GA KY

2005 2006

Leading US Captive Domiciles, 2005 vs. 2006

U.S. captive domiciles experienced dramatic

growth in 2006.

Sources: Business Insurance, March 12, 2007; III

100%

67%

67%

62%

40%

20%

19%

18%

13%

4% 1.3%

0

0

0

1

1

1

1

UT NV KY MT AZ SC DC NY GA VT HI

Fastest Growing US Captive Domiciles, 2006 over 2005

Newer U.S. captive domiciles led the way in growth rates in 2006,

but from small bases in 2005 (e.g., UT increased from 15 domiciles in

2005 to 30 in 2006)

Sources: Business Insurance, March 12, 2007; III

RISING EXPENSES

Expense Ratios Rise as Premium Growth Slows:A Cyclical Phenomenon

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

43.6

%

43.2

%

42.8

%

38.8

%

37.5

%

36.7

%

34.8

%

32.7

%

27.6

%

27.3

%

26.5

%

25.9

%

26.0

%

26.1

%

27.4

%

25.5

%

26.3

%

20.0

%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

30 35 40 45 50 55 60 65 70 75 80 85 90 95 00 05 06 17

Underwriting Expense Ratio, P/C Insurance, 1930-2006

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

TRANSFORMATIONAL CHANGE: Taking down the cost of selling insurance to 20% of premium or less by 2017 would

be transformational.

CAPACITY/SURPLUS

Accumulation of Capital/ Surplus Depresses ROEs

$0

$50

$100

$150

$200

$250

$300

$350

$400

$450

$500

$550

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

U.S. Policyholder Surplus: 1975-2007*

Source: A.M. Best, ISO, Insurance Information Institute. *As of September 30, 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 9/30/07 was $521.8B, 5.3% above year-end

2006, 80% above its 2002 trough and 54% above its 1999 peak.

Premium-to-surplus ratio neared a record

low of $0.84:$1 at year end 2007, suggesting

excess capital

Capacity exceeded a half trillion dollars for the first time during

the 2nd quarter of 2007

Q3 = First 3 quarters as of 9/30/07Source: Insurance Information Institute; 1985–2006, A.M. Best Aggregates & Averages;; 2007 ISO

0

100

200

300

400

500

600

0.0

0.5

1.0

1.5

2.0

2.5

NWP Surplus P:S Ratio

$ Billions P:S Ratio

Calendar Year

P/C Industry Premium-to-SurplusRatio, 1985-2007:Q3

Private Carriers

$521.8B

$76 B

$145 B

$450 B

Low P:S Ratio 0.84:1 in 1998 0.86:1

1.92:1

At 0.86:1 as of 9/30/07, now approaching record premium-to-

surplus ratio 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 Q3 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

$17,412.7

$4,4

97.5

$1,5

39.9

$2,7

64.2

$2,3

85.6

$4,2

97.3

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$14,000

$16,000

$18,000

$20,000

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

07Q

3

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

First 9-months 2007 share buybacks are already

133% of the 2006 record

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 4.4% of industry surplus, the highest in 20 years

Largest Sovereign Wealth Funds($ Billions, as of September 2007)

$341

$330

$300

$250

$200

$159

$50

$43

$40

$38

$875

$0 $200 $400 $600 $800 $1,000

United Arab Emirates

Norway

Singapore (GIC)

Saudi Arabia

Kuwait

China

Singapore (Tamasek)

Libya

Algeria

Qatar

US (Alaska)

Source: Morgan Stanley; Council of Foreign Relations http://www.cfr.org/publication/15251/#2; Insurance Information Institute

Abu Dhabi Investment Authority

controls some $875 billion in assets

Though not major investors in the insurance industry, SWFs held nearly

$3 trillion in assets, double the $1.5 trillion of hedge funds but a fraction

of the $53 trillion held by institutional investors like hedge

funds and endowments

MERGER & ACQUISITION

Are 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

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


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

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

Direct Independent Agents

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

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

Direct channels account for less than 30% of commercial

insurance purchases (vs. 65% personal lines)

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

$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**

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. **Annualized 9-month result of $47.718B.Sources: ISO; Insurance Information Institute.

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

nearly a decade earlier in 1998

2%

3%

4%

5%

6%

7%

8%

9%

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

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

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

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

Investment yield historically tracks 10-year Treasury note quite closely

REINSURANCE MARKETS

Reinsurance Prices are Stabilizing; Falling in Some

Areas

Share of Losses Paid by Reinsurers, by Disaster*

30%25%

60%

20%

45%

0%

10%

20%

30%

40%

50%

60%

70%

Hurricane Hugo(1989)

Hurricane Andrew(1992)

Sept. 11 TerrorAttack (2001)

2004 HurricaneLosses

2005 HurricaneLosses

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

Reinsurance is playing an increasingly

important role in the financing of mega-

CATs;

US Reinsurer Net Income& ROE, 1985-2006

$1.9

4

$2.0

3

$1.9

5 $3.7

1

$4.5

3

$5.4

3

$1.4

7

$1.9

9

$1.3

1 $3.1

7

$3.4

1

$2.5

1

$9.6

8

($2.98)

$0.1

2

$1.9

5

$1.3

8

$1.2

2

$1.8

7

$1.1

7 $2.5

2

$1.7

9

($4)

($2)

$0

$2

$4

$6

$8

$10

$12

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

Net

Inco

me

($ B

ill)

-10%

-5%

0%

5%

10%

15%

20%

RO

E

Net Income ROE

Source: Reinsurance Association of America.

Reinsurer profitability has rebounded

Summary of Risks to Reinsurers: Economic

Risk Impacts on Reinsurers

General Economic Slowdown/Recession

•Reduced exposure growth for primary insurers negatively impacts reinsurer premium growth

Subprime Meltdown/ Credit Crunch

•Some insurers have some asset risk•D&O/E&O/Financial Guarantee exposure for some (re)insurers•More difficult to raise capital if needed•Post-crash: new regulations, acctg. Rules

Falling Interest Rates/ Stock Market Slump

•Lower investment income•Deteriorating loss performance on neglected, abandoned and foreclosed properties

Currency Risks •Weak dollar repatriation of profits less attractive

Inflation •Rate inadequacy occurs more rapidly•Reserve deficiencies emerge•Burn-through of retentions faster

Tax Policy •Potential crackdown on tax havens and certain tax treatments globally

Summary of Risks to Reinsurers: Competitive Risks

Risk Impacts on Reinsurers

Soft Markets Loss of Pricing & Underwriting Discipline

•Highly competitive reinsurance market, excess capacity could lead to unfavorable reinsurance environment as:•Pricing weakens•Reserve adequacy deteriorates•Terms & conditions broaden•Multi-year deals become more common

Disintermediation •Increasing securitization of CAT, casualty & mortality risk•Higher retentions (attachment points)•More government-run reinsurers

Consolidation •Could face larger, better capitalized competitors with global scale and scope•Reinsurance broker concentration rising

Ease of Entry •Barriers to entry into reinsurance business are low and getting lower•Large number of alternative sources of capital•Class of 20XX will compete against you someday

Sources: Insurance Information Institute.

Summary of Risks to Reinsurers: Property Risks

Risk Rationale

Escalation of Insured Losses Due to Major Natural CATs

•Long-term trend is clearly toward larger scale CAT losses•Demand surge•Accuracy of CAT models; Forecast horizons?•Litigation challenging contract language

Mega Man-Made Disasters

•Multi-billion dollar marine hull & cargo losses now possible•Aviation hull PML up (e.g., A380)•Mega-scale energy sector losses possible•Potential simultaneous casualty exposure

Terrorism •Despite TRIA (and other programs abroad) costs could still be high

Emerging Markets •Large CAT losses outside US will be more common; Risks not well understood


Summary of Risks to Reinsurers: Casualty Risks

Risk Rationale

Credit Crunch/ Subprime Meltdown

•D&O/E&O exposure

Products Liability/ Incl. Food Safety

•Large number of high profile issues•US beefing up enforcement, fines•More opportunities for trial lawyers

Climate Change •Supreme Court ruled EPA can regulate CO2 emissions as a pollutant; Potentially opens door to much future litigation•Alternative fuels, sequestration liability

Employment Practices Liability

•EPL cover more common for even smaller risks. Reinsurers have accommodated•Economic downturn will increase litigation

Nanotechnology •Long-term risks associated with use of nanotech products is unknown

Summary of Risks to Reinsurers: Casualty Risks (cont’d)

Risk Rationale

Pharmaceuticals •Remains major trial lawyer target despite tort reforms•Shift from chemistry-based to gene-based therapies could shift liability environment

Environmental •“Greening” of US, Europe and even China may lead to more stringent environmental regulations and harsher penalties•More opportunities to sue created

Latent Disease in Occupational Settings

•Evidence associating certain degenerative neurological disorders (e.g., Parkinson’s) with occupation, but manifesting years later•Lung ailments also an issue

Erosion of Tort Reforms

•New tort reforms less likely under current Congress•Erosion of recent reforms inevitable•Export of US tort experience abroad


Summary• Economy will provide muted bumps for insurers• Results were excellent in 2006/07; Overall profitability reached its highest level

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

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

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

leads decreases.• Rising investment returns insufficient to support deep soft market in terms of

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

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

Insurance Information Institute On-Line

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casualty insurance markets in turbulent times trends & challenges robert p. hartwig, ph.d.,...

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