1. NY-262511.027/030514YdmanHR1 CAN THE COMMERCIAL P&C INDUSTRY MAKE GOOD RETURNS? PERSPECTIVES ON INDUSTRY STRUCTURE Mark Shapiro – McKinsey May 19, 2003 This report is solely for the use of client personnel. No part of it may be circulated, quoted, or reproduced for distribution outside the client organization without prior written approval from McKinsey & Company. This material was used by McKinsey & Company during an oral presentation; it is not a complete record of the discussion. Casualty Actuarial Society Conference

2. NY-262511.027/030514YdmanHR1 1 HOW CAN WE ANALYZE INDUSTRY ATTRACTIVENESS? Industry S S Industry structure Producers C C Provider conduct P P Company performance External shocks Profitability/ Value creation Technological progress Employment objectives Asset risk Hazard risk Regulatory changes Technology breakthroughs Pricing & Marketing Capacity change Distribution Internal efficiency and effectiveness Economics of demand Economics of supply Bargaining power of industry ‘chain’ Threat of new entrants Threat of substitution

3. NY-262511.027/030514YdmanHR1 2 INDUSTRY STRUCTURE 1.Supplier power moderate to high Skills and talent challenge Low returns foster investor skepticism Strong belief in the ‘cycle’ 2.Barriers to entry low Limited scale economies Mature products Limited brand identity Switching costs low Access to distribution Cost advantages generally difficult to sustain 5.Industry competitors Intensity of rivalry 5.Rivalry high Industry growth low Longstanding overcapacity Product differences limited Brand identity limited Switching costs low Exit barriers high Shortening product life cycles Limited gains from M&A Insolvencies drawn out/rare Limited product innovation 4.Substitution threat moderate to high Self insurance growing ‘Relevance’ of commodity products declining 3.Buying power high Concentrated distribution Product “relevance” and value to corporates declining Price-driven intermediaries High price sensitivity 2.New entrants 3.Buyers 4.Substitutes 1.Suppliers

4. NY-262511.027/030514YdmanHR1 3 INDUSTRY CONDUCT Limited innovation, differentiation or talent distinctivenessLimited innovation, differentiation or talent distinctiveness Underwriting ‘winners curse’Underwriting ‘winners curse’ Reserve changes can mask operating performanceReserve changes can mask operating performance Role of the brokersRole of the brokers Frequent new entrantsFrequent new entrants – “Clean” capacity – “Naïve” capacity Difficulty returning capital to investorsDifficulty returning capital to investors Difficulty of ‘retiring’ capacity – only catastrophes have accomplished thisDifficulty of ‘retiring’ capacity – only catastrophes have accomplished this Strong belief in “playing the cycle”Strong belief in “playing the cycle” Low returnsLow returns High dispersion of returnsHigh dispersion of returns Limited value creationLimited value creation Loss of relative shareLoss of relative share – As risk management providers – As top financial institutions Steady diversification of leaders into other financial servicesSteady diversification of leaders into other financial services Performance Over Time

5. NY-262511.027/030514YdmanHR1 Industry equates to a highly leveraged investment trust Investor view: Industry equates to a highly leveraged investment trust STRUCTURAL ECONOMICS UNATTRACTIVE Principal ROE drivers Asset yield Asset yield Cost of float (CR vs. alternative cost of funds) Cost of float (CR vs. alternative cost of funds) Leverage Leverage Low growth Over-supply of capital and capacity Pricing trends opaque and secular trend is negative Underwriting profit elusive Interest rate environment hurts –Sustainable earnings –Value of premium flow Reserve adequacy opaque, and reserving distrusted

6. NY-262511.027/030514YdmanHR1 5 Cost of equity (Ke)* SINCE 1983, AVERAGE P&C INSURANCE INDUSTRY RETURNS HAVE LAGGED THE COST OF EQUITY BY ~50% Annual averages, percent Source: A.M. Best; Compustat; McKinsey Analysis Average return on surplus (ROS**) Avg. ’83-90: 5.5%13.8%0.4x Avg. ’90-’01: 5.5%10.7%0.5x Avg. ’83-’01 5.5%11.9%0.5xROS Cost of equity (Ke) ROS/Ke

7. NY-262511.027/030514YdmanHR1 6 RELATIVE TO RATE LEVELS, MARKET VALUATIONS ARE AT TEN YEAR LOWS Source:William Capital; Swiss Re Sigma; Bloomberg Market to book ratio/rate level index Average = 1.4

8. NY-262511.027/030514YdmanHR1 7 Index of average ROE, 1988-01... BUT THERE IS WIDE DIVERGENCE OF PERFORMANCE AMONG COMPETITORS Bottom quartile Third quartile Second quartile Top quartile of players (by ROE) P&C insurersP&C re-insurers Median = 100

9. NY-262511.027/030514YdmanHR1 8 CHARACTERISTICS OF “WINNERS” Good operators Portfolio of attractive lines (typically local or specialty niches) Strong product innovation and/or cross sell Capture value through risk servicing and advisory Excellent enterprise risk management Value based flexible capital deployment Leverage over (or ability to bypass) intermediaries Structural advantages, e.g., brand, IT, distribution (more common in personal lines) Excellent read on supply/demand dynamics

10. NY-262511.027/030514YdmanHR1 9 Source:AM Best, Conning, team analysis P&C “HARD” MARKETS AND UNDERWRITING PROFITS Net written premium % change / Incurred loss % change – 1960-2000 Percent Average length: 2.5 years Percent of premium U.S. non-life underwriting results – 1960-2002

11. NY-262511.027/030514YdmanHR1 Knowledge intensity Capital intensity Winning Today Capital Capital at risk Skills  Distinctive positions in mature markets  Outstanding talent  Innovation  Portfolio Management Winning Tomorrow Capital Skills Capital at risk WINNING IN THE FUTURE