State Farm Insurance Companies

Agenda State Farm Overview State Farm Investment Department State Farm Fixed Income

State Farm Overview

Company Evolution George J. Mecherle Auto Health Life Fire SF Bank & Mutual Funds

“About State Farm” State Farm’s mission is to: help people manage the risks of everyday life, recover from the unexpected, and realize their dreams.

State Farm Data 23 Affiliated Companies 16,900 Agents 68,000 Employees 76.2 Million Policies & Accounts $ 59.2 Billion Revenue (12/31/05) $159.7 Billion in Assets (12/31/05) $ 50.2 Billion Net Worth (12/31/05) Ranked #22 within Fortune 500 Ranked #1 in Illinois

Industry Positions #1 U.S. Auto insurer since % Market Share at end of 2005 Over 40 million Auto policies #1 U.S. Home insurer since % Market Share at end of 2005 Over 25 million Fire policies SF Bank $12.2 billion in total assets (12/2005) Top 5% of banks nationwide Mutual Funds $2.8 billion in assets (12/2005)

State Farm Investment Department

Investment Department Invested Assets* ($ Billions) Cash & equivalentxxx Bondsxxx Stocksxxx Mortgages & Real Estatexxx Total$ xxx * (12/31/2006)

Why does State Farm have an Investment Department? Amount of “float” the business generates –Premiums –Reserves Cost of the float –Claims –Operating expenses Long-term outlook for both these factors –Write more policies

Property/Casualty Company Change in Adjusted Surplus Underwriting Losses including Policyholders’ Dividends (25.0) % Stock Portfolio Appreciation 30.0 % Net Investment Income 55.0 % Other (3.0) % Net Increase to Surplus 57.0 % Example: XYZ Property Casualty Company (5-year period)

Structure Investment Policy to Withstand Worse Case Scenario Major underwriting losses Discovery of gross underestimation of cost of unpaid claims Collapse in stock and long-term bond prices

Insurance Company Financial Adequacy Ratios Premiums / surplus – tests adequacy of capital to prolonged poor underwriting results Loss reserves / surplus – tests potential for estimation error relative to capital Equities / surplus – tests potential for stock market declines to reduce capital

State Farm’s Top 10 Catastrophe Pay-outs (Auto & Fire Combined)

Investment Department Goals Support insurance & financial service operations Invest long-term

Support Insurance and Financial Service Operations State Farm Companies are first and foremost insurance companies with growing financial service operations Make investment decisions for investment reasons first

Long Term Investing Long-term investors have earned higher returns over the years from equity investments versus any other asset class Equities: Goal: Maximize shareholder value Return: Potentially unlimited Fixed Income: Goal: Capital preservation Return: Generally limited to coupon or yield

Risk vs. Return, 1926 – 2005 (nominal returns) Asset Class Compound Return % Holding Period Simple AverageMaxMinRange Small Company Stocks Large Company Stocks Long-Term Corporate Bonds Long-Term Government Bonds Treasury Bills Consumer Price Index Data Source: Stocks, Bonds, Bills and Inflation 2006 Yearbook, Ibbotson Associates, Inc., Chicago, Illinois

State Farm Fixed Income

Global Major Markets market value of invested assets StocksBonds Corporate Bonds $ 6.7 trillion

Stocks, U.S.Bonds, U.S. Corporate Bonds $ 3.1 trillion U.S. Major Markets market value of invested assets

Major Market Indices $ 13.1 trillion market value Capitalization-weighted Index S&P 500 Index stocks Lehman Aggregate Index bonds 994 issuers 7,158 issues $ 8.8 trillion par outstanding Asset Classes –U.S. Government (35.7%) Treasury bonds Agencies –Corporate Bonds (23.1%) –Mortgage-Backed (35.1%) –Asset-Backed (1.2%) –Commercial Mortgage-Backed (5.0%) –Taxable Municipals (new as of Oct. 1, 2003)

Bonds* – 12/31/2006 U.S. Treasuries Other U.S.-Government-Backed Agencies Mortgage-Backed Securities Asset-Backed Securities Corporate Bonds Canadian Pay Bonds Taxable Municipal Bonds Municipal Bonds (Tax-Advantaged) Community Investments Total * Insurance Company Portfolios

State Farm Investment Philosophies and Disciplines: Buy and Hold Dollar-Cost Average Portfolio Ladder Duration Target

Corporate Bonds Private vs. Public Analyzing and investing in corporate bonds Pricing corporate bonds

Fundamental Credit Analysis Industry Analysis – Porter’s 5 Forces Business Risk Analysis Financial Risk Analysis

Porter’s Five Forces of Competition Barriers to Entry Threat of Substitute Products Power of Suppliers Power of Buyers Rivalry among Existing Competitors Source: Michael Porter, Competitive Strategy

Business Risk Analysis Industry Characteristics Competitive Position Management

Financial Risk Analysis Financial Characteristics Financial Policy Profitability Capital Structure Cash Flow Protection Financial Flexibility

Common Financial Ratios EBIT / Interest – tests the adequacy of operations to meet interest payments CA / CL – tests liquidity Debt / Cap – tests leverage (loan to value) Funds from Operations / Debt – tests cash flow adequacy to repay debt

Idiosyncratic Risk Systematic Credit Risk Yield Curve T-Bill Credit Spread Risk-Free Rate { { = Yield Corporate Bond Pricing

Why can’t I find a quote for Duke Energy bonds – herein lies the answer:

Trace Data:

This is how we keep track of bond prices:

Example of 10-Year AT&T bond yield: Idiosyncratic Risk Systematic Credit Risk * Yield Curve T-Bill 10-year Credit Spread 10-yr Risk-Free Rate { { = Yield 7.40% 1.70 % 0.70 % 3.00 % 2.00 % 2.40 % 5.00 % * Swap Spreads or Agencies

Example of 10-Year AT&T bond prices: 6 % coupon 10-year AT&T corporate bond trading at a yield of 7.4% = $90.23 (discount) 8% coupon 10-year AT&T corporate bond trading at a yield of 7.4% = $ (premium) The coupons are different but both bonds trade at the same yield, 7.4%.

Example of 10-Year AT&T bond bid/ask yields: Bid (yield at which you can sell) Assume 10-Year Treasury is 5.00% 2.45% Yield on Bid Side 7.45% Offer (yield at which you can buy) Assume 10-Year Treasury is 5.00% 2.40% Yield on Offer Side 7.40% Remember from finance class – bond prices and yields are inversely related – a lower yield means a higher price. Think of bid/ask spread for stocks. You have to buy at a higher price than you can sell. The same holds true for bonds.

Investing in a New Public Corporate Bond Issue New deal is announced Perform fundamental credit analysis Road shows, Conference calls, Red-herring prospectus Price guidance Determine relative value Submit order Deal goes “subject” Receive allocation and final spread Price the deal, bill & deliver

Questions?

Contact Information State Farm Insurance Human Resources Three State Farm Plaza South, K-1 Bloomington, IL Need more information? Visit our website!