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Property/Casualty Insurance: An Industry Overview Focus on Energy Markets and Global Economic Concerns

Property/Casualty Insurance: An Industry Overview Focus on Energy Markets and Global Economic Concerns Insurance Information Institute February 1, 2008 Robert P. Hartwig, Ph.D., CPCU, President Insurance Information Institute  110 William Street  New York, NY 10038

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Property/Casualty Insurance: An Industry Overview Focus on Energy Markets and Global Economic Concerns

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  1. Property/Casualty Insurance: An Industry OverviewFocus on Energy Markets andGlobal Economic Concerns Insurance Information Institute February 1, 2008 Robert P. Hartwig, Ph.D., CPCU, President Insurance Information Institute 110 William Street New York, NY 10038 Tel: (212) 346-5520 Fax: (212) 732-1916 bobh@iii.org  www.iii.org

  2. Presentation Outline • Profitability • Financial Strength • Underwriting Trends: Overall & Commercial Lines • Premium Growth • Capacity • Investment Overview • Catastrophic Loss • Energy Market Overview • Shifting Legal Liability & Tort Environment • Weakening Economy, Credit Crunch Concerns • Q&A

  3. PROFITABILITYProfits in 2006/07 ReachedTheir Cyclical Peak;ROEs Already Falling

  4. P/C Net Income After Taxes1991-2007F ($ Millions)* • 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 *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.

  5. ROE: P/C vs. All Industries 1987–2008E P/C profitability is cyclical, volatile and vulnerable Sept. 11 Hugo Katrina, Rita, Wilma Lowest CAT losses in 15 years Andrew Northridge 4 Hurricanes *2007 is actual 9-month ROAS of 13.1%. 2008 P/C insurer ROE is I.I.I. estimate. Source: Insurance Information Institute; Fortune

  6. Profitability Peaks & Troughs in the P/C Insurance Industry,1975 – 2008F* 1977:19.0% 1987:17.3% 2006:12.2% 10 Years 1997:11.6% 9 Years 10 Years 1975: 2.4% 1984: 1.8% 1992: 4.5% 2001: -1.2% *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

  7. ROE vs. Equity Cost of Capital:US P/C Insurance:1991-2007E The p/c insurance industry achieved its cost of capital in 2005/6 for the first time in many years +1.7 pts +3.1 pts -9.0 pts -0.1 pts +0.2 pts -13.2 pts 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 The cost of capital is the rate of return insurers need to attract and retain capital to the business Source: The Geneva Association, Ins. Information Inst.

  8. P/C, L/H Stocks: Beat the S&P 500 Index in 2007 Total YTD Returns Through December 2007* P/C insurance stocks benefiting from benign hurricane season, strategic buying as a countercyclical play Mortgage & Financial Guarantee insurers are down 69% for the year, Title insurers down 22% *As of Dec. 28; S&P 500 was up 3.53% as 12/31/07. **Includes Financial Guarantee. Source: SNL Securities, Standard & Poor’s, Insurance Information Inst.

  9. Top Industries by ROE: P/C Insurers Still Underperformed in 2006* P/C insurer profitability in 2006 ranked 30th out of 50 industry groups despite renewed profitability P/C insurers underperformed the All Industry median for the 19th consecutive year *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

  10. FINANCIAL STRENGTH & RATINGSIndustry Has Weathered the Storms Well, But Cycle May Takes Its Toll

  11. P/C Insurer Impairment Frequency vs. Combined Ratio, 1969-2007E Impairment rates are highly correlated underwriting performance and could reach near-record low in 2007 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 Source: A.M. Best; Insurance Information Institute

  12. Reasons for US P/C Insurer Impairments, 1969-2005 2003-2005 1969-2005 Deficient reserves, CAT losses are more important factors in recent years *Includes overstatement of assets. Source: A.M. Best: P/C Impairments Hit Near-Term Lows Despite Surging Hurricane Activity, Special Report,Nov. 2005;

  13. UNDERWRITINGTRENDSExtremely Strong 2006/07;Relying on Momentum & Discipline for 2008

  14. P/C Insurance Combined Ratio, 1970-2007E* Combined Ratios 1970s: 100.3 1980s: 109.2 1990s: 107.8 2000s: 101.8* Sources: A.M. Best; ISO, III *Estimate based on actual 9M result..

  15. P/C Insurance Combined Ratio, 2001-2007E 2007 deterioration due primarily to falling rates, but results still strong assuming normal CAT activity As recently as 2001, insurers were paying out nearly $1.16 for every dollar they earned in premiums 2006 produced the best underwriting result since the 87.6 combined ratio in 1949 2005 figure benefited from heavy use of reinsurance which lowered net losses Sources: A.M. Best; ISO, III. *Actual 9-month result.

  16. Ten Lowest P/C Insurance Combined Ratios Since 1920 vs. 2007E 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 Sources: Insurance Information Institute research from A.M. Best data. *2007: III Earlybird survey.

  17. Underwriting Gain (Loss)1975-2007F* 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. $ Billions Source: A.M. Best, Insurance Information Institute *Actual 2007:9M underwriting profit = $18.146B annualized to $24.192B.

  18. Impact of Reserve Changes on Combined Ratio Reserve adequacy has improved substantially Source: A.M. Best, Lehman Brothers estimates for years 2007-2009

  19. Cumulative Prior Year Reserve Development by Line (As of 12/31/06) Strengthening Reserve redundancies in most lines have resulted in releases in recent years Release Sources: Lehman Brothers; A.M. Best’s Aggregates & Averages Schedule P, Part 2.

  20. COMMERCIAL LINESCommercial AutoCommercial Multi-PerilWorkers Comp

  21. Commercial Lines Combined Ratio, 1993-2008F Commercial coverages have exhibited significant variability over time. Outside CAT-affected lines, commercial insurance is doing fairly well. Caution is required in underwriting long-tail commercial lines. Recent results benefited from favorable loss cost trends, improved tort environment, low CAT losses, WC reforms and reserve releases Source: A.M. Best; Insurance Information Institute .

  22. COMMERCIAL MULTI-PERIL & COMMERCIAL AUTO

  23. Commercial Auto Liability& PD Combined Ratios Average Combined: Liability = 108.8 PD = 97.5 Commercial Auto has improved dramatically Sources: A.M. Best; III

  24. Commercial Multi-Peril Combined (Liability vs. Non-Liability Portion) CMP- has improved recently Liab. Combined 1995 to 2004 = 113.8 Non-Liab. Combined = 105.2 Sources: A.M. Best; III

  25. WORKERS COMPENSATION OPERATING ENVIRONMENT

  26. Workers Comp Combined Ratios, 1994-2006P Percent p Preliminary AY figure. Accident Year data is evaluated as of 12/31/2006 and developed to ultimate Source: 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

  27. Workers Comp Lost-Time Claim Frequency (% Change) Percent Change Cumulative Change of –52.1% since 1991 means that lost work time claims have been cut by more than half Accident Year 2003p: Preliminary based on data valued as of 12/31/2006 1991-2005: Based on data through 12/31/2005, developed to ultimate Based on the states where NCCI provides ratemaking services Excludes the effects of deductible policies Source: NCCI

  28. Workers Comp Indemnity Claims Costs Have Accelerated, 1993-2006p Indemnity Claim Cost (000s) Annual Change 1991–1996: +1.2% Annual Change 1997–2005: +6.6% Cumulative Change = +108.5% (1993-2006p) Accident Year 2005p: Preliminary based on data valued as of 12/31/2006 1991-2005: Based on data through 12/31/2005, developed to ultimate Based on the states where NCCI provides ratemaking services Excludes the effects of deductible policies Source: NCCI

  29. WC Medical Severity Rising Far Faster than Medical CPI WC medical severity rose more than twice as fast as the medical CPI (8.8% vs. 4.0%) from 1995 through 2006 3.5 pts Sources: Med CPI from US Bureau of Labor Statistics, WC med severity from NCCI based on NCCI states.

  30. Med Costs Share of Total Costs is Increasing Steadily 2006p 1996 1986 Source: NCCI (based on states where NCCI provides ratemaking services).

  31. REINSURANCE MARKETSReinsurance Prices are Stabilizing; Falling in Some Areas

  32. Share of Losses Paid by Reinsurers, by Disaster* Reinsurance is playing an increasingly important role in the financing of mega-CATs; Reins. Costs are skyrocketing *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.

  33. US Reinsurer Net Income& ROE, 1985-2006 Reinsurer profitability has rebounded Source: Reinsurance Association of America.

  34. PREMIUM GROWTHAt a Virtual Standstillin 2007/08

  35. Strength of Recent Hard Markets by NWP Growth* 1975-78 1984-87 2001-04 Post-Katrina period resembles 1993-97 (post-Andrew) 2007: Projected 0% premium growth would be the first since 1943 Note: Shaded areas denote hard market periods. Source: A.M. Best, Insurance Information Institute *2007 figure (0.0%) is actual 9-month result.

  36. Growth in Net Written Premium, 2000-2007E P/C insurers could experience their slowest growth rates since the 1940s…but underwriting results are expected to remain healthy *2007 figure based on actual 9-month results. Source: A.M. Best; Forecasts from the Insurance Information Institute.

  37. COMPETITIVE PRICING ENVIRONMENT

  38. Average Commercial Rate Change,All Lines, (1Q:2004 – 4Q:2007) Magnitude of rate decreases diminished temporarily after Katrina but have grown again -0.1% KRW Effect Source: Council of Insurance Agents & Brokers; Insurance Information Institute

  39. Cumulative Commercial Rate Change by Line: 4Q99 – 4Q07 Commercial account pricing has been trending down for 3+ years and is now on par with prices in late 2001, early 2002 Source: Council of Insurance Agents & Brokers

  40. Average Commercial Rate Changes by Line: 4Q99 – 4Q07 Commercial account pricing has been trending down for 3+ years and is now on par with prices in late 2001, early 2002 Source: Council of Insurance Agents & Brokers

  41. COST OF RISK

  42. Cost of Risk Compared with Insurer Results 1990-2006 Source: 2006 RIMS Benchmark Survey

  43. Utilities: How the Risk Dollar is Spent(Respondent Revenues < $1B) Source: 2006 RIMS Benchmark Survey

  44. Utilities: How the Risk Dollar is Spent(Respondent Revenues > $1B) Source: 2006 RIMS Benchmark Survey

  45. CAPACITY/SURPLUSAccumulation of Too Much CapitalDepresses ROEs

  46. U.S. Policyholder Surplus: 1975-2007* Capacity as of 6/30/07 was $521.8B, 5.3% above year-end 2006, 80% above its 2002 trough and 54% above its 1999 peak. Capacity exceeded a half trillion dollars for the first time during the 2nd quarter of 2007 $ Billions Premium-to-surplus ratio reached a record low of $0.81:$1 at year end 2007, suggesting excess capital “Surplus” is a measure of underwriting capacity. It is analogous to “Owners Equity” or “Net Worth” in non-insurance organizations Source: A.M. Best, ISO, Insurance Information Institute. *As of September 30, 2007

  47. P/C Industry Premium-to-SurplusRatio, 1985-2007:Q3Private Carriers $521.8B $450 B $145 B $76 B $ Billions P:S Ratio At 0.86:1 as of 9/30/07, now approaching all-time record premium-to-surplus ratio of 0.84:1 in 1998 1.92:1 Low P:S Ratio 0.84:1 in 1998 0.86:1 Q3 = First 3 quarters as of 9/30/07 Source: Insurance Information Institute; 1985–2006, A.M. Best Aggregates & Averages;; 2007 ISO Calendar Year

  48. Annual Catastrophe Bond Transactions Volume, 1997-2006 Catastrophe bond issuance has soared in the wake of Hurricanes Katrina and the hurricane seasons of 2004/2005 Source: MMC Securities and Guy Carpenter; Insurance Information Institute.

  49. P/C Insurer Share Repurchases,1987- Through Q3 2007 ($ Millions) 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 First 9-months 2007 share buybacks are already 133% of the 2006 record 2007 repurchases to date equate to 4.4% of industry surplus, the highest in 20 years Sources: Credit Suisse, Company Reports; Insurance Information Inst.

  50. MERGER & ACQUISITIONCatalysts for P/C Consolidation Growing in 2008

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