Overview & Outlook for P/C Insurance An Industry at the Crossroads 2007 PAAS Annual Forum Scottsdale, AZ June 4, 2007 Robert P. Hartwig, Ph.D., CPCU, President & Chief Economist Insurance Information Institute  110 William Street  New York, NY Tel: (212)  Fax: (212)  

Presentation Outline P/C Profit Overview—2006, A Cyclical Peak Underwriting Trends: Unsustainable? Premium Growth: Approaching a Standstill Pricing: Competitive Pressures Mounting Capital & Capacity: Underleveraged  ROE Pressure Catastrophe Loss Management  What is the Appropriate Role for Government? Reinsurance Summary Financial Strength & Ratings Investments: Less Bang for the Buck Tort System: Great News for a Change (Mostly) Legislative & Regulatory Update Q&A

P/C PROFIT: An Historical Perspective Profits in 2006 Reached Their Cyclical Peak

P/C Net Income After Taxes ($ Millions)* *ROE figures are GAAP; 1 Return on avg. 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= 10.5%  2006 ROAS 1 = 14.0% Though up in 2006, insurer profits are highly volatile (2001 was the industry’s worst year ever). ROEs generally fall below that of most other industries.

ROE: P/C vs. All Industries 1987–2008E * P/C insurer ROEs are I.I.I. estimates. Source: Insurance Information Institute; Fortune Andrew Northridge Hugo Lowest CAT losses in 15 years Sept Hurricanes Katrina, Rita, Wilma P/C profitability is cyclical, volatile and vulnerable

Profitability Peaks & Troughs in the P/C Insurance Industry, 1975 – 2008F * P/C insurer ROEs are I.I.I. estimates. Source: Insurance Information Institute; ISO, A.M. Best. 1975: 2.4% 1977:19.0%1987:17.3% 1997:11.6% 2006:14.0% 1984: 1.8% 1992: 4.5% 2001: -1.2% 10 Years 9 Years

ROE vs. Equity Cost of Capital: US P/C Insurance: E 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 pts +0.2 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 pts +3.0 pts -9.0 pts The cost of capital is the rate of return insurers need to attract and retain capital to the business +2.0 pts

Insurance & Reinsurance Stocks: Slow Start in 2007 in P/C, Reins Source: SNL Securities, Standard & Poor’s, Insurance Information Institute Total YTD Returns Through June 1, 2007 P/C insurance, reinsurance stocks lagging on soft market concerns and worries over 2007 hurricane season

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

Advertising Expenditures by P/C Insurance Industry, Source: Insurance Information Institute from consolidated P/C Annual Statement data. Ad spending by P/C insurers is at a record high, signaling increased competition

UNDERWRITING Extremely Strong 2006, Momentum for 2007/08

P/C Industry Combined Ratio Sources: A.M. Best; ISO, III. *Estimates/forecasts based on III’s 2007 Early Bird survey figure benefited from heavy use of reinsurance which lowered net losses 2006 produced the best underwriting result since the 91.2 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

Ten Lowest P/C Insurance Combined Ratios Since 1920 Sources: Insurance Information Institute research from A.M. Best data. The 2006 combined ratio of 92.4 was the best since the 87.6 combined in 1949 The industry’s best underwriting years are associated with periods of low interest rates

Underwriting Gain (Loss) Source: A.M. Best, Insurance Information Institute $ Billions Insurers earned an underwriting profit of $31.2 billion in 2006, the largest ever but only the second since Despite the 2006 underwriting profit, the cumulative underwriting deficit since 1975 is $419 billion.

Commercial Lines Combined Ratio, E* Source: A.M. Best; Insurance Information Institute. Outside CAT- affected lines, commercial insurance is doing fairly well. Caution is required in underwriting long- tail commercial lines results will benefited from relatively disciplined underwriting and low CAT losses Commercial coverages have exhibited extreme variability. Are current results anomalous?

Personal Lines Combined Ratio, E Source: A.M. Best; Insurance Information Institute. A very strong 2006 resulted from favorable frequency & severity trends and low CAT activity

Impact of Reserve Changes on Combined Ratio Source: A.M. Best, Lehman Brothers for years 2005E-2007F Reserve adequacy has improved substantially

PREMIUM GROWTH Deceleration in 2006, Even Slower in 2007

Note: Shaded areas denote hard market periods. Source: A.M. Best, Insurance Information Institute Strength of Recent Hard Markets by NWP Growth* * figures are III forecasts/estimates growth of 0.4% equates to 1.8% after adjustment for a special one-time transaction between one company and its foreign parent figures from III Groundhog Survey (post-Katrina) period could resemble (post-Andrew) 2005: biggest real drop in premium since early 1980s

Growth in Net Written Premium, F Source: A.M. Best; Forecasts from the Insurance Information Institute’s Groundhog survey: P/C insurers will experience their slowest growth rates since the late 1990s…but underwriting results are expected to remain healthy

PRICING Under Pressure in 2007

Average Expenditures on Auto Insurance *Insurance Information Institute Estimates/Forecasts Source: 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

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 6% in 2006, 4% in 2007 Homeowners in non- CAT zones will see smaller increases, but larger in CAT zones

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

Average Commercial Rate Change by Line: 4Q99 – 1Q07 Source: Council of Insurance Agents & Brokers Commercial accounts trended downward from early 2004 to mid-2005 though that trend moderated post-Katrina

Percent of Commercial Accounts Renewing w/Positive Rate Changes, 2 nd Qtr Source: Council of Insurance Agents and Brokers Largest increases for Commercial Property & Business Interruption are in the Southeast, smallest in Midwest

Percent of Commercial Accounts Renewing w/Positive Rate Changes, 1 st Qtr Source: Council of Insurance Agents and Brokers Commercial Property & Business Interruption increases are disappearing in the Southeast; Completely gone in the Midwest & Northeast “Soft” market seemed to hit Midwest about 1 year before the rest of the US

CAPACITY/ SURPLUS The Industry in Underleveraged

U.S. Policyholder Surplus: Source: A.M. Best, ISO, Insurance Information Institute. $ Billions “Surplus” is a measure of underwriting capacity. It is analogous to “Owners Equity” or “Net Worth” in non-insurance organizations Capacity as of 12/31/06 was $487.1B (est.), 14.4% above year- end 2005, 71% above its 2002 trough and 46% above its 1999 peak. Foreign reinsurance and residual market mechanisms absorbed 45% of 2005 CAT losses of $62.1B

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

MERGER & ACQUISITION Few Catalysts for Major P/C Consolidation

P/C Insurance-Related M&A Activity, *Announced May 7, Source: Conning Research & Consulting surge due mostly to 2 deals. No trend started. Liberty Mutual acquired Ohio Casualty for $2.7B* No model for successful consolidation has emerged

INVESTMENT IRONY Markets & Interest Rates Up, Returns Flat

Property/Casualty Insurance Industry Investment Gain * *Investment gains consist primarily of interest, stock dividends and realized capital gains and losses figure consists of $52.3B net investment income and $3.4B realized investment gain. **2005 figure includes special one-time dividend of $3.2B. Source: ISO; Insurance Information Institute. Investment gains fell in 2006 and are now only comparable to gains seen in the late 1990s

CATASTROPHIC LOSS Insurers Accused of Crying Wolf Over Cats

U.S. Insured Catastrophe Losses* *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 was a welcome respite 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

U.S. Catastrophe Losses 2006: States With Largest Losses ($ Millions) *ISO defines a catastrophe event as an event causing $25 million or more in insured property losses. Source: ISO; Insurance Information Institute SURPRISE!! Indiana led the US with $1.5 billion in insured CAT losses in 2006 Some 33 catastrophe events* in 34 states cost insurers an estimated $8.8bn in 2006, compared with $61.9bn in Cat losses in the following five states -- totaling $4.5bn -- represent half the total catastrophe losses for the year.

Inflation-Adjusted U.S. Insured Catastrophe Losses By Cause of Loss, ¹ Source: Insurance Services Office (ISO).. 1 Catastrophes are all events causing direct insured losses to property of $25 million or more in 2005 dollars. Catastrophe threshold changed from $5 million to $25 million beginning in 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 $289.1 billion from (in 2005 dollars). Tropical systems accounted for nearly half of all CAT losses from , up from 27.1% from

Total Value of Insured Coastal Exposure (2004, $ Billions) Source: AIR Worldwide Florida & New York lead the way for insured coastal property at more than $1.9 trillion each. Northeast state insured coastal exposure totals $3.73 trillion.

New Condo Construction in South Miami Beach, Number of New Developments: 15 Number of Individual Units: 2,111 Avg. Price of Cheapest Unit: $940,333 Avg. Price of Most Expensive Unit: $6,460,000 Range: $395,000 - $16,000,000 Overall Average Price per Unit: $3,700,167* Aggregate Property Value: At least $6 Billion *Based on average of high/low value for each of the 15 developments Source: Insurance Information Institute from accessed April 5,

The 2007 Hurricane Season: Preview to Disaster?

Outlook for 2007 Hurricane Season: 85% Worse Than Average Average* F Named Storms Named Storm Days Hurricanes Hurricane Days Intense Hurricanes2.375 Intense Hurricane Days5711 Accumulated Cyclone Energy96.2NA170 Net Tropical Cyclone Activity100%275%185% *Average over the period Source: Philip Klotzbach and Dr. William Gray, Colorado State University, May 31, 2007.

REINSURANCE MARKETS Big Risk, Big Reward or Big Government?

Share of Losses Paid by Reinsurers, by Disaster* *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 Sources: Wharton Risk Center, Disaster Insurance Project; Insurance Information Institute. Reinsurance is playing an increasingly important role in the financing of mega- CATs; Reins. Costs are skyrocketing

Ratio of Reinsurer Loss & Underwriting Expense to Premiums Written, Source: Reinsurance Association of America. Despite the respite in 2006, reinsurers paid an average of $1.11 in loss and expense for every $1 in written premium since 1985

FINANCIAL STRENGTH & RATINGS Industry Has Weathered the Storms Well

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

P/C Insurer Impairments, The number of impairments varies significantly over the p/c insurance cycle, with peaks occurring well into hard markets Source: A.M. Best; Insurance Information Institute

STATE RESIDUAL MARKETS How Big is Too Big?

Florida Citizens Exposure to Loss (Billions of Dollars) Source: PIPSO; Insurance Information Institute Exposure to loss in Florida Citizens nearly doubled in 2006

Major Residual Market Plan Estimated Deficits 2004/2005 (Millions of Dollars) * MWUA est. deficit for 2005 comprises $545m in assessments plus $50m in Federal Aid. Source: Insurance Information Institute Hurricane Katrina pushed all of the residual market property plans in affected states into deficits for 2005, following an already record hurricane loss year in 2004

What Role Should the Federal Government Play in Insuring Against Natural Disaster Risks?

Comprehensive National Catastrophe Plan Schematic Personal Disaster Account Private Insurance State Regional Catastrophe Fund National Catastrophe Contract Program Source: NAIC, Natural Catastrophe Risk: Creating a Comprehensive National Plan, Dec. 1, 2005; Insurance Information. Inst. State Attachment 1:50 Event 1:500 Event

Legislation has been introduced and ideas espoused by ProtectingAmerica.org will likely get a more thorough airing in 2007/8

FLORIDA’S APPROACH TO MANAGING HURRICANE RISK Does it Add Up?

Pre- vs. Post-Event in FL for 2007 Hurricane Season Billions Total = $20.0 Billion Notes: Pre-event funding includes funds available to Citizens, FHCF and private carriers plus contingent funding available through private reinsurance to pay claims in Post-event funding is on a present value basis and does not include financing costs. Probabilities are expressed as “odds of a single storm of this magnitude or greater happening in 2007.” Source: Tillinghast Towers Perrin, Study of Recent Legislative Changes to Florida’s Property Insurance Mechanisms, 3/07. $35.0B $25.0B $43.8B $49.5B $55.0B $80.0B There is a very significant likelihood of major, multi- year assessments in 2007

Per Household Savings vs. Long- Term Costs of FL Legislation for 2007 Hurricane Season Billions Total = $1,726 Notes: Assumes average homeowners insurance premium of $1300 in Savings for 2007 reflects 24.3% savings on hurricane costs, assumed to be 63% of premium. Savings based on statewide OIR estimate. Actual savings may be less. Direct costs include assessments paid by policyholders on home and personal auto premiums. Indirect costs include assessments on commercial lines passed on to policyholders via higher prices. Amounts are in nominal dollars, or the total cost of borrowing including finance charges over the term of the bond. Source: Tillinghast Towers Perrin, Study of Recent Legislative Changes to Florida’s Property Insurance Mechanisms, 3/07. $2,552 $6,031 $7,635 $8,191 $8,708 $13,971 Savings dwarfed by potential costs under most scenarios

Average Annual Assessment per Household, 1-in-100 Year Event in 2007 Source: Tillinghast Towers Perrin, Study of Recent Legislative Changes to Florida’s Property Insurance Mechanisms, 3/07. The average Florida household will pay $8,699 over 30 years in assessments if a 1-in-100 year event strikes in Assessments could rise if additional storms hit in 2007 or beyond.

Savings vs. Costs by Region: Neither Equitable nor Proportionate TALLAHASSEE Average Savings:$20 Cost of 1-in-30 Storm: $2,000 Cost is 100 times avg. savings TAMPA Average Savings:$100 Cost of 1-in-30 Storm: $2,300 Cost is 23 times avg. savings ORLANDO Average Savings:$30 Cost of 1-in-30 Storm: $2,075 Cost is 69 times avg. savings MIAMI Average Savings:$1,120 Cost of 1-in-30 Storm: $3,375 Cost is 3 times avg. savings STATEWIDE AVERAGE Average Savings:$265 Cost of 1-in-30 Storm: $2,550 Cost is 10 times avg. savings Source: Tillinghast Towers Perrin, Study of Recent Legislative Changes to Florida’s Property Insurance Mechanisms, 3/07.

Source: Insurance Research Council Public Attitude Monitor 2006: Unfairness of Taxpayer Subsidies Most non-coastal dwellers believe taxpayer subsidies for coastal property owners are unfair Coastal States

KEY LINES Discipline Will Remain (Mostly) Intact in 2007

Private Passenger Auto

Private Passenger Auto Combined Ratio Average Combined 1993 to 2005= Most auto insurers have shown sig- nificant improvements in underwriting performance since mid-2002 Sources: A.M. Best; III PPA is the profit juggernaut of the p/c insurance industry today

Homeowners Insurance

Homeowners Insurance Combined Ratio Average 1990 to 2005= Insurers have paid out an average of $1.13 in losses for every dollar earned in premiums over the past 16 years Sources: A.M. Best; III

COMMERCIAL MULTI-PERIL & COMMERCIAL AUTO

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

Commercial Auto Liability & PD Combined Ratios Average Combined: Liability = PD = 97.1 Sources: A.M. Best; III Commercial Auto has improved dramatically

WORKERS COMPENSATION OPERATING ENVIRONMENT

Percent p Preliminary AY figure. Accident Year data is evaluated as of 12/31/2006 and developed to ultimate Source: Calendar Years , A.M. Best Aggregates & Averages; Calendar Year 2006p and Accident Years pbased on NCCI Annual Statement Analysis. Includes dividends to policyholders Workers Comp Combined Ratios, P

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-Time Claim Frequency (% Change) 2003p: Preliminary based on data valued as of 12/31/ : 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

Indemnity Claim Cost (000s) Annual Change 1991–1996: +1.2% Annual Change 1997–2005: +6.6% 2005p: Preliminary based on data valued as of 12/31/ : 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 Accident Year Workers Comp Indemnity Claims Costs Have Accelerated, p Cumulative Change = % ( p)

Annual Change 1991–1996: +4.1% Annual Change 1997–2005: +9.5% Accident Year Medical Claim Cost ($000s) 2006p: Preliminary based on data valued as of 12/31/ : 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 Workers Comp Medical Claims Continue to Climb Cumulative Change = +200% ( p)

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

Legal Liability & Tort Environment Definitely Improving But Not Out of the Woods

Personal, Commercial & Self (Un) Insured Tort Costs* Billions Total = $39.3 Billion *Excludes medical malpractice Source: Tillinghast-Towers Perrin, 2006 Update on US Tort Cost Trends. Total = $121.0 Billion Total = $159.6 Billion Total = $231.3 Billion

Tort System Costs, F After a period of rapid escalation, tort system costs as % of GDP are now falling Source: Tillinghast-Towers Perrin, 2006 Update on US Tort Cost Trends;2006 is III estimate.

KATRINA TORT UPDATE Suits Add to Uncertainty, Expense

Likely Market Impacts of Post- Katrina Litigation Litigation Creates an Additional Layer of Uncertainty in What is Already a Very Difficulty Market  Ultimate Thrust of Litigation is to Compel Insurers to Pay Water Damage (Flood/Surge) Losses for Which They Have Never Received A Penny in Premium Some Courts’ Apparent Willingness to Retroactively Rewrite Long-Standing, Regulator Approved Terms & Conditions of Insurance Contracts Creates an Unpriceable Risk  Compounded by juries willing to award millions in punitives People Discouraged from Buying Flood Coverage BOTTOM LINE: Weather, Courts, Juries Together Create Nearly Impossible Operating Environment Coverage Under These Circumstances Will Necessarily Become More Expensive, Less Available

REGULATORY UPDATE Busy Year for Insurers in Washington

Federal Legislative Update Federal Terrorism Reinsurance (TRIA) TRIA expires 12/31/07. The current federal program offers $100 billion of coverage subject to a $27.5B industry aggregate retention. New Democratic Congress (with Committee chairs from urban Northeast states) predisposed to extend. Despite resistance/lackluster Administration support TRIA will likely extended for a multi-year period, perhaps 6-8 but potentially as long as 15 years (last extension in 2005 was for 2 years) Potential changes include extensions of coverage for domestic terrorism losses (not included currently), and a lower industry retention for nuclear, biological, chemical, or radiological (NBCR) attacks. There could possibly be a modestly higher industry retention for non-NBCR losses, and it needs to be resolved whether liability and group life losses will be covered. Original hope for first-half 2007 extension have faded. Now looking at fall or even 11 th -hour extension as in Sources: Lehman Brothers, Insurance Information Institute

Federal Legislative Update Natural Disaster Coverage Some insurers are pushing for federal catastrophic risk fund coverage in the wake of billions of dollars of losses suffered by insurers from the hurricane seasons. Legislative relief addressing property/casualty insurers’ exposure to natural catastrophes, such as the creation of state and federal catastrophe funds, has been advocated by insurers include Allstate and State Farm recently. However, there is active opposition many other insurers and all reinsurers. There are supporters in Congress, mostly from CAT-prone states. Skeptics in Congress believe such a plan would be a burden on taxpayers like the NFIP and that the private sector can do a better job. Unlike TRIA, the industry is not unified on this issue. Allowing insurers to establish tax free reserves for future catastrophe losses has also been proposed, but Congress has not yet indicated much support. Sources: Lehman Brothers, Insurance Information Institute

Federal Legislative Update McCarran-Ferguson Insurance Antitrust Exemption Under McCarran-Ferguson Act of 1945, insurers have limited immunity under federal anti-trust laws allowing insurers to pool past claims information to develop accurate (actuarially credible) rates. Very low level of understanding of M-F in Washington Certain legislators threaten to revoke McCarran-Ferguson because of alleged collusion in the wake of Hurricane Katrina. However, the view among some Washington insiders is that such a move would hurt small insurers with less resources rather than the large insurers perhaps being targeted. The current bills designed to revoke McCarran-Ferguson are S.618 and H.R The government appointed Antitrust Modernization Commission in an April 2007 report strongly encouraged Congress to re-examine the McCarran-Ferguson Act. Notably, 4 of the commissions 12 members called for a full repeal of the law. Sources: Lehman Brothers, Insurance Info. Institute

Summary Personal & Commercial lines results were unsustainably good 2006; Overall profitability reached its highest level (est. 14%) since Strong momentum into 2007 and maybe 2008 Underwriting results were aided by lack of CATs & favorable underlying loss trends, including tort system improvements Property cat reinsurance markets peaking & more competitive Premium growth rates are slowing to their levels since the late 1990s; Commercial leads decreases Rising investment returns insufficient to support deep soft market in terms of price, terms & conditions Clear need to remain underwriting focused How/where to deploy/redeploy capital?? Major Challenges:  Slow Growth Environment Ahead  Maintaining price/underwriting discipline  Managing variability/volatility of results

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