2008 Seminar on Reinsurance: Professional Liability

1. 2008 Seminar on Reinsurance:Professional Liability May 20, 2008

2. Agenda Section 1 State of the Lawyers Professional Marketplace Section 2 Reinsurance Discussion

3. Section 1: State of the Lawyers Professional Marketplace Large Firms Small Firms

4. Large Firms

5. The Market for Lawyers’ Professional Liability • “Large” defined as more than 50 attorneys • 4Q2007 signaled first significant softening of LPL market since 2006 peak • 5-10% rate reductions were common in late 2007 • Expect to see continued reductions in 2008 • As in past cycles, the LPL market has lagged the D&O market • Law firm losses tend to develop more slowly than D&O losses and premiums as the firms are not typically party to initial litigation • Delay also driven by lag before new capital enters • LPL substantially smaller than D&O market • Law firm losses not reported publicly • 2007 was notable for the increase in insurer capacity • Multi-year coverage is becoming more available

6. Marketplace Conditions • Large law firm losses relatively benign 2003 – 2007 • 1999 – 2002 characterized by greater frequency of severe losses • Financial failures of law firms’ client due to corporate malfeasance • Economic downturn in the late 1990’s • Tax shelter work done by a few firms • Law firm claim frequency remained well below D&O frequency • Financial scandals that generated D&O claims did not include LPL • Central Bank of Denver protections • Stoneridge Investment Partners LLC v Scientific-Atlanta, Inc decision • Other D&O loss categories have generated few, if any, LPL claims: • Laddering • Options backdating • Subprime/credit crunch

7. Large Settlements Since 1986 • Severity today generally remains below $50M ceiling established in the LPL cycle of the late 1980’s to early 1990’s • Largest claims from tax shelters • One hedge fund bankruptcy/fraud situation in early stages One in each cell was reversed on appeal. Source: Data compiled by Aon Professional Services Group from publicly reported information.

8. Underwriters Concerned About Future Losses • Economic downturn • Increased frequency and severity may follow • Business deals and transactions fall apart • Certain areas of practice more active (e.g., bankruptcies) • Ramifications of subprime meltdown/credit crunch • 236 subprime lawsuits as of 3/17/08, 1 legal malpractice* • As of now, not seeing any LPL lawsuits related to subprime • Hedge funds and private equity work • Litigation exposures arising from e-discovery *Source: Industry Focus, April 2008; Advisen Ltd.

9. Small Firms

10. The Market for Lawyers’ Professional Liability • Rate softening varies • Solo practitioners – holding fairly steady • Policyholder dividends • As size of firm increases to 35-50, commercial markets more interested • Rate decreases as high as 10-15% or more • Frequency varies, but generally flat to decline with some instances of increase • Severity increasing at 3-5% • Deterioration in real estate area of practice

11. Underwriters Concerned About Future Losses • Economic downturn (same as large firms) • Increased frequency and severity may follow • Business deals and transactions fall apart • Certain areas of practice more active (e.g., bankruptcies) • Real estate area of practice • Particularly on east coast • Title agents E&O cover as endorsement to LPL policy • High paralegal to qualified attorney ratio – bucket shops for title closings without adequate supervision • Around 15 states where lawyers combined the title closing function • States where speculative or second home purchasing heavily exposed (FL, SC) • “Subprime” itself not necessarily concern as much as devaluation of assets and business failings

12. NABRICO Analysis • Analyze surplus growth for Lawyers Professional Liability writers • NABRICO carriers write Lawyers Professional Liability • Examples: Lawyers Mutual Insurance Company (CA), Wisconsin Lawyers Mutual Insurance Co., Illinois State Bar Assoc. Mutual • Difficult to analyze Commercial lines carriers that write LPL • Examples: CNA, Zurich, Great American • No unique Annual Statement Line • Understand the drivers of surplus growth • How much from operating income (underwriting and investment)? • How much from capital contributions? • Understand the drivers of operating income • Underwriting income and prior year reserve development • Investment income yields and asset distributions Source: Data from SNL compiled by Aon Re

13. Total Change in Surplus • Total surplus up $33M from 2005 to 2006 • Total surplus up $23M from 2006 to 2007

14. Net Income Net Paid In UR Gains Other Components to Change in Surplus

15. Net U/W Income Net Investment Income Federal Income Tax Dividends to PH Components Net Income

16. Prior Year Reserve Development Net U/W Income Before Prior Year Reserve Development Components Underwriting Income

17. Return on Invested Assets

18. Bonds Stocks Cash Other Distribution of Assets

19. Section 2: Reinsurance Discussion Medical Malpractice Lawyers Professional

20. Medical Malpractice Reinsurance Observations • More than enough capacity, with more coming in • Disconnect between supply and demand • Bad faith, ECO/XPL • Connecticut: $38.5M • Florida: $21M, $10M • Illinois: $24M, $12M • Iowa: $13.5M • Maine: $8M • Massachusetts: $26M • New Jersey: $19M • Wisconsin: $23M • Systemic, batch and aggregation • Awards-made coverage

21. Lawyers Professional Reinsurance Observations • Stable to growing capacity, depending on the market segment • Large firm LPL usually combined with D&O and other E&O programs, but sometimes stand-alone • Small firm structures similar to PIAA • More discussions regarding systemic type exposures and coverages – still mostly talk • Rate relief and broader terms for “best in class” • Increased actuarial involvement by all parties to the transaction • Increased interest from the Bermuda market