1. Insurance Failures: Does The Past Teach Us Anything?
CAS 2003 Annual Meeting
Laline Carvalho
Director

2. Notable Quotes
“Stephen King couldn’t come up with more bizarre ways to lose money than this industry – mold, terrorism – and if you make a nickel, the regulators take it away from you.”
Paul Karon, President, Benfield Blanch (Reins. Broker)
“Ours is a business of bad surprises.”
Ohio Casualty CEO Dan Carmichael, discussing the company’s 3Q ’02 reserve addition
“In the soft market, everybody was a pig, feeding at the same buffet. But they didn’t all eat the same menu. The ones who ate a lot of casualty business gobbled up all the shrimp, and they got salmonella poisoning.”
Paul Karon, at NAII

3. US Insurer Rating Distribution

4. Default Breakdown by Rating

5. History of U.S. Insurer Failures

6. Property/Casualty Insurer Financial Performance Versus Number of Failures
* Estimated

7. INSOLVENCIES: CONTRIBUTING FACTORS
Size Matters
Smaller companies seem to be at higher risk
Geographic and/or Line of Business Concentration
The higher the concentration, the greater susceptibility to unfavorable changes in the regulatory or competitive environment

8. INSOLVENCIES: CONTRIBUTING FACTORS
Financial Flexibility
Group affiliation or ownership
Access to capital markets or other forms of capital is key

9. INSOLVENCIES: CONTRIBUTING FACTORS
Poor Controls
Lack of strong corporate oversight
Giving the pen to MGAs and MGUs
Lack of Proper Communication Channels
The danger of silo cultures
Underwriters and actuarials need to interact

10. INSOLVENCIES: CONTRIBUTING FACTORS
Too Much Emphasis on Growth, Too Little Emphasis on Bottom Line Profitability
Significant underpricing of the business
Compensation systems geared towards growth (Sending the wrong message)
Unsuccessful acquisition strategies

11. INSOLVENCIES: CONTRIBUTING FACTORS
Poor Capital and Risk Management Strategies
Risks of excessive financial leverage, poor investment and reinsurance strategies, excessive catastrophe exposure
The use of financial reinsurance
Quality of Capital Just as Important as Quantity!

12. INSOLVENCIES: CONTRIBUTING FACTORS
Over-Reliance on Reinsurance
Exposure to credit risk
The willingness issue
Potential cash flow crunch

13. INSOLVENCIES: CONTRIBUTING FACTORS
Significant Reserve Deficiencies
The accident years
Asbestos exposure
Workers compensation
D&O liability

14. Loss Reserves – The Industry’s Achilles Heel
Uncertainty about many companies’ prospects exists, despite the hard market, because of potential adverse reserve development
Willful management manipulation of reserves to boost earnings can turn what would have been minor, non-material adjustments into a solvency-threatening event
Many p/c insurers have consequently materially misstated their income statements and balance sheets
This persistent problem continues to threaten the credibility of many companies

15. 2002 Commercial Lines Adverse Reserve Development*
Total 2002 Adverse Development: $11.5 Billion
(*) Interactively rated companies

16. Rating Actions in Primary P/C Sector
Major rating changes:
Allianz U.S A+ from AA-
Chubb AA from AA+
Hartford AA- from AA
Kemper B- from A
Liberty Mutual A from A+
St. Paul A+ from AA-
State Farm AA from AAA
Zurich U.S A+ from AA-

17. Reinsurer Rating Actions, 2001-2003
14 of 20 Largest Reinsurers Downgraded

18. Challenges Remain
The Outlook for Commercial Lines Insurers and Reinsurers Remains Negative
Recent rating downgrades reflect the market's failure to establish a sustainable level of profitability
Potential further reserve development remains a concern
Relatively short window of time to make up for sins of the past
Will the hard market be sustained beyond 2004/2005?

19. Challenges Remain
The Outlook for Commercial Lines Insurers and Reinsurers Remains Negative
Commodity product
Very low barriers to entry
The cycle is still here

20. Some Leading Indicators To Follow
Management’s strategies
How will they manage the cycle?
Risk management capabilities and quality of controls
Loss reserving practices
Ability to generate earnings over the long-term
Cash flow trends
Capital adequacy and quality of capital
Financial flexibility

21. Future Trends
Looking ahead, the acid test for the whole industry will be how it responds when prices begin to trend downward, as they inevitably will. Real competitive advantage will accrue to those organizations that have flexible business models, the tools to identify trends, and, most importantly, the wherewithal to cut back on capacity when the time comes.