2. Robert P. Hartwig, Ph.D., CPCU, President & Economist Insurance Information Institute  110 William Street  New York, NY 10038 Tel: (212) 346-5520  bobh@iii.org  www.iii.org Presented at the Aon Benfield Hazards Conference Brisbane, Australia September 2009 Geo Political and Economic Issues Affecting Catastrophe Risk Funding Beyond PML: Frequency vs. Severity

3. 2 Presentation Outline Scale and Scope of the Financial Crisis  Impacts of Global Insurance and Reinsurance Markets Catastrophe Severity Trends: A Complicating Factor Catastrophe Risk Funding: 5 Key Lessons of the Financial Crisis 1.Scarcity of Capital 2.Questionable Performance of ART/Capital Market Instruments 3.Increased Cost of Capital 4.Investment Earnings Now Less Able to Offset Catastrophe Losses 5.State-Run Insurers are Vulnerable to Financial Crises Too Financial Strength & Ratings Q & A

4. Scale and Scope of the Financial Crisis on Global (Re) Insurance Markets Significant but Manageable Impacts

5. Potential Writedowns by Segment and Region: 2007-2010* Insurers account for 7.5% of potential securities writedowns globally (8.0% in US, 6.3% in US and 7.4% in Japan) Billions of US Dollars $2,712 $1,193 $4,054 * Includes loans and securities. Europe includes euro countries plus United Kingdom. Insurance category includes life and non-life insurers. Source: IMF Global Financial Stability Report, April 2009.

6. 5 USEurope Insurer writedowns of securities are expected to total 7.5% of all financial institution losses through 2010 Japan * Includes loans and securities. Europe includes euro countries plus United Kingdom. Insurance category includes life and non-life insurers. Source: IMF Global Financial Stability Report, April 2009. Share of Potential Writedowns by Segment and Region: 2007-2010*

7. US Financial Institutions Facing Huge Losses from the Credit Crunch* *Estimate of financial sector writedowns, 2007-2010, as of April 2009. Includes loans and securities. Source: IMF Global Financial Stability Report, April 2009. $ Billions The IMF estimates total US financial sector writedowns from soured assets will reach $2.712 trillion, up 93% from $1.405 trillion from its Sept. 2008 estimate. Insurer losses account for just 8% of the total. $218B or 8% of estimated total (bank+insurer) losses will be sustained by insurers 6

8. Catastrophe Severities Will Continue to Trend Upward Trend Increases Vulnerability of Catastrophe Funding to Financial Crises

9. US$bn Annual totals First half-years *Losses in 2008 values Overall losses*: Insured losses*: Global Natural Disasters: Economic and Insured Losses:1980 – 2009:H1 As of July 2009 Source: Geo Risks Research, NatCatSERVICE© 2009 Münchener Rückversicherungs-Gesellschaft 8 Overall and insured losses (Annual totals vs. first half-years)

10. Insured Property Catastrophe Losses as % Net Premiums Earned, 1984–2008 Sources: ISO, A.M. Best, Swiss Re Economic Research & Consulting; Insurance Information Institute. US CAT losses were a record 14.4% of net premiums earned in 2005 and were 4 times the 1984-2008 average of 3.6%

11. 10 Top 12 Most Costly Disasters in US History, (Insured Losses, $2007) *PCS estimate as of 12/15/08. Sources: ISO/PCS; AIR Worldwide, RMS, Eqecat; Insurance Information Institute inflation adjustments. 9 of the 12 most expensive disasters in US history have occurred since 2004 In 2008, Ike became the 6 th most expensive insurance event and 4 th most expensive hurricane in US history 10

12. Total Value of Insured Coastal Exposure (2007, $ Billions) Source: AIR Worldwide In 2007, Florida still ranked as the #1 most exposed state to hurricane loss, with $2.459 trillion exposure, an increase of $522B or 27% from $1.937 trillion in 2004. RI had $54.1B in exposure up 24% from $43.8B in 2004 The insured value of all coastal property was $8.9 trillion in 2007, up 24% from $7.2 trillion in 2004. $522B increase since 2004, up 27% 11

13. Government Aid After Major Disasters (Billions)* *Adjusted to 2008 dollars by the Insurance Information Institute. Source: United States Senate Budget Committee, Insurance Information Institute as of 12/31/05; Houston Chronicle, 09/24/08 for Ike. There is increased reliance on government aid after major catastrophes despite record private insurer payouts The federal government poured an estimated $137B into areas affected by Hurricane Katrina in 2005

14. CRISIS LESSON 1. Capital is Scarcer Loss Was Manageable in 2007/08, but More Secure Channels Must be Identified

15. 14 Policyholder Surplus, 2006:Q4 – 2009:H1 Source: ISO, AM Best. Declines Since 2007:Q3 Peak 08:Q2: -$16.6B (-3.2%) 08:Q3: -$43.3B (-8.3%) 08:Q4: -$66.2B (-12.9%) 09:Q1: -$84.7B (-16.2%) 09:Q2: -$50.8B (-9.7%) Capacity peaked at $521.8 as of 9/30/07 14

16. 15 U.S. Policyholder Surplus: 1975-2009:H1* Source: A.M. Best, ISO, Insurance Information Institute. *As of 6/30/09 $ Billions “Surplus” is a measure of underwriting capacity. It is analogous to “Owners Equity” or “Net Worth” in non-insurance organizations Actual capacity as of 6/30/09 was $471B, up from $437.1B as of 3/31/09 Recent peak was $521.8 as of 9/30/07. Surplus as of 6/30/09 is 9.8% below 2007 peak; Crisis trough was as of 3/31/09  16.2% below 2007 peak The premium-to-surplus ratio stood at $1.03:$1 as of 3/31/09, up from near record low of $0.85:$1 at year-end 2007 15

17. 16 Ratio of Insured Loss to Surplus for Largest Capital Events Since 1989* *Ratio is for end-of-quarter surplus immediately prior to event. Date shown is end of quarter prior to event. **Latest available Source: PCS; Insurance Information Institute. The financial crisis now ranks as the largest “capital event” over the past 20+ years

18. 17 Premium-to-Surplus Ratios Before Major Capital Events* *Ratio is for end of quarter immediately prior to event. Date shown is end of quarter prior to event. **Latest available Source: PCS; Insurance Information Institute. P/C insurance industry was better capitalized going into the financial crisis than before any “capital event” in recent history

19. Global Reinsurance Capacity Shrank in 2008, Mostly Due to Investments Global Reinsurance Capacity Global reinsurance capacity fell by an estimated 17% in 2008 18 Source of Decline Source: AonBenfield Reinsurance Market Outlook 2009; Insurance Information Institute.

20. CRISIS LESSON 2. ART/Capital Markets May Not Be Accessible During a Financial Crisis Market Seizure: A New Risk

21. Catastrophe Bond and Sidecar Issuance, 2004-2008 $ Billions The credit crisis and decline in global capital have taken their toll on alternative forms of catastrophe risk transfer 20 Source: AonBenfield Reinsurance Market Outlook 2009; Insurance Information Institute.

22. CRISIS LESSON 3. Capital is More Expensive Erosion of Capital Increased Global Demand at Time of Constrained Supply

23. ROE vs. Equity Cost of Capital: US P/C Insurance:1991-2009:Q1* *Excludes mortgage and financial guarantee insurers. Source: The Geneva Association, Ins. Information Inst. The p/c insurance industry fell well short of is cost of capital in 2008 -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, but falling well short in 2008/09 -1.7 pts +2.3 pts -9.0 pts The cost of capital is the rate of return insurers need to attract and retain capital to the business -7.1 pts 22 -8.4 pts

24. 23 Yields Spreads During Financial Crisis, Jan. 2007- Aug. 2009 Yield spreads spiked for all private borrowers in 2007/2008 and remain high for all but the best borrowers. Capital market access is still more expensive. Source: Board of Governors US Federal Reserve Bank; Insurance Information Institute

25. CRISIS LESSON 4. Investment Earnings Can Offset Only a Smaller Share of CAT Losses Low Interest Rates, Shrunken Portfolios = Lower Returns

26. 25 Property/Casualty Insurance Industry Investment Gain:1994- 2009:Q1 1 1 Investment gains consist primarily of interest, stock dividends and realized capital gains and losses. 2006 figure consists of $52.3B net investment income and $3.4B realized investment gain. *2005 figure includes special one-time dividend of $3.2B. Sources: ISO; Insurance Information Institute. Investment gains fell by 51% in 2008 due to lower yields, poor equity market conditions. Falling again in 2009. 25

27. 26 Treasury Yield Curves: Pre-Crisis (July 2007) vs. July 2009 Sources: Board of Governors of the United States Federal Reserve Bank; Insurance Information Institute. Stock dividend cuts will further pressure investment income Treasury Yield Curve is at its most depressed level in at least 45 years. Investment income will fall as a result.

28. ROE vs. Equity Cost of Capital: US P/C Insurance:1991-2009:Q1* *Excludes mortgage and financial guarantee insurers. Source: The Geneva Association, Ins. Information Inst. The p/c insurance industry fell well short of is cost of capital in 2008 -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, but falling well short in 2008/09 -1.7 pts +2.3 pts -9.0 pts The cost of capital is the rate of return insurers need to attract and retain capital to the business -7.1 pts 27 -8.4 pts

29. 28 * 2008/9 figures are return on average statutory surplus. Excludes mortgage and financial guarantee insurers. Source: Insurance Information Institute from A.M. Best and ISO data. A 100 Combined Ratio Isn’t What it Used to Be: 95 is Where It’s At Combined ratios must me must lower in today’s depressed investment environment to generate risk appropriate ROEs

30. CRISIS LESSON 5. Government-Run Insurers are Vulnerable to Financial Crises Too Increased Reliance on Debt Financing is Dangerous

31. U.S. Residual Market Exposure to Loss (Billions of Dollars) Source: PIPSO; Insurance Information Institute In the 19-year period between 1990 and 2008, total exposure to loss in the residual market (FAIR & Beach/Windstorm) Plans has surged from $54.7bn in 1990 to $863.8bn in 2008. Katrina, Rita and Wilma 4 Florida Hurricanes Hurricane Andrew

32. U.S. Residual Market Property Policies In-ForceExposure Source: PIPSO; Insurance Information Institute In the 19-year period between 1990 and 2008, total residual market policy count (FAIR & Beach/Windstorm Plans) has nearly tripled to more than 2.6 million policies Katrina, Rita and Wilma 4 Florida Hurricanes

33. Financial Strength, Catastrophes & Crises Correlations are Weaker than Presumed

34. 33 P/C Insurer Impairments, 1969-2008 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

35. 34 P/C Insurer Impairment Frequency vs. Combined Ratio, 1969-2008 Impairment rates are highly correlated with underwriting performance and reached record lows in 2007/08 Source: A.M. Best; Insurance Information Institute 2008 impairment rate was a record low 0.23%, second only to the 0.17% record low in 2007 and barely one-fourth the 0.82% average since 1969

36. P/C Impairment Frequency vs. Catastrophe Points in Combined Ratio, 1977-2008 Impairment rates are highly correlated with underwriting performance and reached record lows in 2007/08 Source: A.M. Best, PCS; Insurance Information Institute 2008 impairment rate was a record low 0.23%, second only to the 0.17% record low in 2007 and barely one-fourth the 0.82% average since 1969

37. Number of Impairments by State, 1969-2008 TX, FL and CA have the largest number of impairments. Catastrophe risk plays a big role. Other factors influencing impairments include the political environment and business mix Source: A.M. Best; Insurance Information Institute More TX insurers have become impaired over the past 40 years than in any other state

38. 37 Summary of A.M. Best’s P/C Insurer Ratings Actions in 2008* *Through December 19. Source: A.M. Best. 37 Despite financial market turmoil, high cat losses and a soft market in 2008, 81% of ratings actions by A.M. Best were affirmations; just 3.8% were downgrades and 4.0% upgrades P/C insurance is by design a resilient in business. The dual threat of financial disasters and catastrophic losses are anticipated in the industry’s risk management strategy.

39. 38 Historical Ratings Distribution, US P/C Insurers, 2008 vs. 2005 and 2000 Source: A.M. Best: Rating Downgrades Slowed but Outpaced Upgrades for Fourth Consecutive Year, Special Report, November 8, 2004 for 2000; 2006 and 2009 Review & Preview. *Ratings ‘B’ and lower. 20082005 P/C insurer financial strength has improved since 2005 despite financial crisis 2000 A++/A+ and A/A- gains

40. 39 Reasons for US P/C Insurer Impairments, 1969-2008 Source: A.M. Best: 1969-2008 Impairment Review, Special Report, Apr. 6, 2008 Deficient loss reserves and inadequate pricing are the leading cause of insurer impairments, underscoring the importance of discipline. Investment catastrophe losses play a much smaller role.

41. 40 Insurance Information Institute On-Line THANK YOU FOR YOUR TIME AND YOUR ATTENTION! 40