2. Trends & Challenges in P/C Insurance Business Today Focus on Iowa Markets Independent Insurance Agents of Iowa 98 th Annual Convention Des Moines, IA September 23, 2004 Robert P. Hartwig, Ph.D., CPCU, Senior Vice President & Chief Economist Insurance Information Institute  110 William Street  New York, NY 10038 Tel: (212) 346-5520  Fax: (212) 732-1916  bobh@iii.org  www.iii.org

3. About the Insurance Information Institute The mission of the Insurance Information Institute (I.I.I.) is to improve public understanding of insurance -- what it does and how it works. The I.I.I. enjoys broad membership throughout the insurance industry, including most of the major p/c insurers and reinsurers operating in the United States, as well as companies operating on a regional basis and internationally. For more than 40 years, the I.I.I. has provided definitive insurance information. Today, the I.I.I. is recognized throughout the insurance industry as well as by the media, governments, regulatory organizations, universities and the public as a primary source of information, analysis and referral concerning insurance. Each year, the I.I.I. works on more than 3,700 news stories, handles more than 6,000 requests for information from its members, the media, and other parties and answers nearly 50,000 questions from consumers. In addition to direct contact with the media, individuals and organizations, the I.I.I. publishes a host of helpful brochures and books on a wide variety of insurance topics, ranging in subjects from 12 Ways to Lower Your Auto Insurance Costs to the I.I.I. Fact Book series. I.I.I.’s members benefit from direct access to all information, I.I.I. staff and its members-only web site. The Institute does not lobby. Its central function is to provide accurate and timely information on insurance subjects. Questions concerning I.I.I. membership should be directed to Cary Schneider at (212) 346-5566 or by email at carys@iii.org.

4. Presentation Outline Profitability  US & Iowa  Wall Street Perspective Underwriting  US & Iowa Ratings, Solvency & Financial Strength Investment Overview Pricing Tort Environment Insurance Scoring The Challenge of Terrorism Q & A

5. P/C INSURANCE FINANCIAL UPDATE

6. Highlights: Property/Casualty Full-Year 2003 vs. 2002 20032002Change Net Written Prem.405,855369,673+9.8% Loss & LAE289,800283,640+2.2% Net UW Gain (Loss)(4,635)(30,840)-85.0% Net Inv. Income38,68637,225+3.9% Net Income (a.t.)29,8773,046+880.9% Surplus*346,987285,386+21.6% Combined Ratio100.1107.3 -7.2 pts.

7. Highlights: Property/Casualty 1 st Qtr. 2004 vs. 1 st Qtr. 2003 ($ Billions)20042003Change Net Written Prem.105,982101,446+4.5% Loss & LAE68,38770,067-2.4% Net UW Gain (Loss)5,647(1,192)N/A Net Inv. Income9,4149,220+2.1% Net Income (a.t.)13,3106,528+103.9% Surplus*361,177346,987+4.1% Combined Ratio**93.399.6** -6.3 pts. *2003 surplus figure is as of 12/31/03 **The combined ratio for full-year 2003 was 100.1

8. Note: Shaded areas denote hard market periods. Source: A.M. Best, Insurance Information Institute Strength of Recent Hard Markets by NWP Growth* Real NWP Growth During Past 3 Hard Markets 1975-78: 8.6% 1985-87: 14.5% 2001-04F: 7.0% 1975-78 1985-872001-04 2004 based on 1 st quarter results from ISO. Insurers need to be able to ride out the industry’s extreme cycles

9. Growth in Direct Written Premiums: Iowa and US *2003 IA figure is III estimate. **2004 US data based on first half results. IA figure is III estimate. Source: A.M. Best, Insurance Information Institute Premium growth in IA has generally trended along with the US, but growth is decelerating rapidly

10. P/C Net Income After Taxes 1991-2004E* ($ Millions) *First quarter results Sources: A.M. Best, ISO, Insurance Information Institute.  2001 was first-ever full year net loss  2002 ROE = 1.0%  2003 ROE = 9.4%  2004 ROE = 15.0% (est.)

11. ROE: P/C vs. All Industries 1987–2004E Source: Insurance Information Institute; Fortune

12. ROE vs. Cost of Capital: US P/C Insurance: 1991 – 2004F Source: The Geneva Association, Ins. Information Inst. The p/c insurance industry likely achieved its costs of capital in 2004 for the first time in many years -14.6 pts -10.2 pts US P/C insurers missed their cost of capital by an average 6.5 points from 1991 to 2003 -1.2 pts +1.1 pts

13. ROE: P/C (US & IA) vs. All Industries, 1991–2003* Source: Insurance Information Institute; NAIC, Fortune Iowa’s p/c insurance market is a slightly above-average performer

14. RNW for Personal Lines in Iowa 1991 - 2002 Source: NAIC 10-Year Average: Auto: 6.6% Home: -10.7% (93-02) Homeowners experience has been very bad and volatile in Iowa, reflecting national trends.

15. RNW for Major Commercial Lines in Iowa, 1991 - 2002 Source: NAIC CMP business has been volatile in Iowa

16. Rates of Return on Net Worth for Homeowners Ins: US vs. IA Source: NAIC, Insurance Information Institute * US Average is 1.35% if excluding 1992 (year of Hurricanes Andrew and Iniki. Averages: 1991 to 2002 US HO Insurance = -3.29%* Iowa HO Insurance = -8.46%

17. Rates of Return on Net Worth for Pvt. Passenger Auto: US vs. IA Source: NAIC, Insurance Information Institute Averages: 1991 to 2002 US PPA Insurance = +9.4%* Iowa PPA Insurance = +7.8%

18. Source: Insurance Information Institute; NAIC, ISO; 2003 WC figure is NCCI ROS estimate. WC went from profit juggernaut to balance sheet black hole within just 4-5 years Rates of Return on Net Worth for Workers Comp Auto: US vs. IA

19. 2002 Return on Equity: Iowa & Nearby States PP Auto Source: NAIC, Insurance Information Institute 2002

20. 2002 Return on Equity: Iowa & Nearby States HO Source: NAIC, Insurance Information Institute 2002

21. WALL STREET: HIGH EXPECTATIONS

22. Insurer Stocks: Outperforming the S&P 500 Source: SNL Securities, Standard & Poor’s, Insurance Information Institute Total Return 2004 YTD Through September 17, 2004 If 2004 represents the cyclical peak for this industry, why aren’t p/c stocks soaring?

23. UNDERWRITING PERFORMANCE

24. P/C Industry Combined Ratio 2001 = 115.7 2002 = 107.2 2003 = 100.1 2004E = 93* Combined Ratios 1970s: 100.3 1980s: 109.2 1990s: 107.8 2000-04: 105.3 Sources: A.M. Best; ISO, III *2004 figures based on first half estimate.

25. Underwriting Gain (Loss) 1975-2004F* *2004 underwriting gain is annualized figure based on first quarter result. Source: A.M. Best, Insurance Information Institute $ Billions 2004 is likely to produce the largest underwriting profit in history = $21.5B based on annualized Q1 result

26. Commercial vs. Personal Lines Combined Ratios Source: A.M. Best; Insurance Information Institute 10-Year Average Combined Ratios Commercial: 111.1 Personal: 105.2

27. Iowa Direct Loss Ratios Source: NAIC; Insurance Information Institute Iowa’s homeowners business is extremely volatile.

28. Key Auto Insurance Stats: IA vs. US 2003 vs. 2004* * Average for 4 quarters ending with the 1 st quarter of 2004 vs. 4 Qtrs ending Q1:03. Source: Insurance Services Office, Insurance Information Institute +1.8% +2.9% +3.4% +1.9%

29. Combined Ratio: Reinsurance vs. P/C Industry Source: A.M. Best, ISO, Reinsurance Association of America, Insurance Information Institute  2001’s combined ratio was the worst- ever for reinsurers; 2002 was bad as well.  2003: Big improvement in primary and reinsurer segments

30. U.S. Insured Catastrophe Losses ($ Billions) *2004 figure is 2004 estimate as of September 20, 2004. 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. Source: Property Claims Service/ISO; Insurance Information Institute $ Billions 2004 could become the second worst year ever for natural disaster losses in the US

31. WHY UNDERWRITING DISCIPLINE MATTERS

32. * 2004 figure is return on average statutory surplus based in first quarter data 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 today must be below 95 to generate Fortune 500 ROEs

33. Source: RIMS, A.M. Best; Insurance Information Institute * 2003 operating ratio is III estimate. Cost of Risk vs. Commercial Lines Operating Ratio*

34. Number of P/C Failures vs. Combined Ratio, 1991-2003 Source: Standard & Poor’s; Insurance Information Institute 2003 failures fell to a 5-year low

35. RATINGS, SOLVENCY, FINANCIAL STRENGTH

36. Downgrade/Upgrade Ratio* Sources: Impairment Rate and Rating Transition Study— 1977 to 2002, A.M. Best & Co.; 2003E from S&P. *U.S. property/casualty and life/health insurers It is in everyone’s best interest to have a financial strong and stable insurance industry

37. Cumulative Average Impairment Rates by Best Financial Strength Rating Sources: A.M. Best: Best’s Impairment Rate and Rating Transition Study—1977-2002, March 1, 2004. Secure:A++, A+, A, A-, B++, B+ Vulnerable:B and Below *US P/C and L/H companies, 1977-2002

38. Reason for P/C Insolvencies (218 Insolvencies, 1993-2002) Source: A.M. Best, Insurance Information Institute Reserve deficiencies account for more than half of all p/c insurers insolvencies

39. P/C Insurance Industry Prior Year Reserve Development* *Negative numbers indicate favorable development; positive figures represent adverse development. Source: A.M. Best, Morgan Stanley, Dowling & Partners Securities, Prudential Securities, Ins. Info. Inst. Adverse reserve development totaled $47.8 billion from 2000 through 2003 Adverse reserve development is the #1 killer of p/c insurance companies: Strength Matters

40. Combined Ratio: Impact of Reserve Changes (Points) Source: ISO, A.M. Best, MorganStanley, Prudential Securities. Prior-year adverse reserve development totaling nearly $14 billion in 2003 added 3.5 points to the p/c combined ratio in 2002

41. Guarantee Fund Net Assessments * (1979-2002) *Excludes NY and workers comp security funds in NJ and PA. Source: National Conference of Insurance Guarantee Funds; Insurance Information Institute Assessments rose dramatically during the last hard market, setting a new record now.

42. INVESTMENTS: NO SUBSTITUTE FOR SOUND UNDERWRITING

43. Net Investment Income History 1997 Peak = $41.5B 2000= $40.7B 2001 = $37.7B 2002 = $37.2B 2003 = $38.7B 2004E = $37.7 $ Billions Growth History 2002: -1.3% 2003: +3.9% 2004E: -2.7% Source: A.M. Best, ISO, Insurance Information Institute

44. Interest Rates: Lower Than They’ve Been in Decades, But… *Week of September 3. Source: Board of Governors, Federal Reserve System; Insurance Information Institute  Lower bond yields were the primary driver behind declining investment income in recent years, with the 10- year note reaching a 45-year low in 2003  Only short-term yields are rising consistently as the Fed hikes rates About 2/3 of invested assets are in the form of bonds

45. *Through September 17, 2004. Source: Ibbotson Associates, Insurance Information Institute Total Returns for Large Company Stocks: 1970-2004*  2003 ended a streak of 3 consecutive years of declines for stocks  Has the bull market run out of steam in 2004? S&P 500 was up 28.7% in 2003 but is up just 1.5% through mid-Sept. as fears of higher interest rates, a sluggish economy, Iraq & high oil prices hurt the market

46. CAPACITY CRUNCH?

47. U.S. Policyholder Surplus: 1975-2004* Source: A.M. Best, ISO, Insurance Information Institute*As of 3/31/04. $ Billions Surplus (capacity) peaked at $339.3 Billion in mid-1999 and fell by 15.9% ($53.9 billion) to $285.4 billion at year-end 2002 Surplus increased by $61.6B or 21.6% to $347.0B in 2003 and 4.9% in the 1 st qtr. of 2004 to $361.2 billion “Surplus” is a measure of underwriting capacity. It is analogous to “Owners Equity” or “Net Worth” in non-insurance organizations $53.9 Billion Capacity TODAY is just 6.5% above its mid-1999 peak

48. US Reinsurers: Change in Policyholder Surplus ($ Billions) Source: A.M. Best; Insurance Information Institute Reinsurer PHS fell 20% from 1998-2002. Capacity today similar to 1998. Same story globally.

49. Capital Myth: US P/C Insurers Have $350 Billion to Pay Terrorism Claims Total PHS = $298.2 B as of 6/30/01 = $291.1 B as of 12/31/02 = $347.0 B as of 12/31/03 *”Target” Commercial includes: Comm property, liability and workers comp; Surplus must also back-up on non-terrorist related property/liability and WC claims Source: Insurance Information Institute estimates based on A.M. Best Q.A.R Data. Only 33% of surplus backs “target” lines net of reserve deficiency

50. PRICING TRENDS

51. Top Concerns US Businesses in 2004 Source: National Federation of Independent Business; Insurance Information Institute % of Firms in 2004 That Consider Problem Critical Customers focus on costs, not security, but the two issues are linked

52. * Cost of risk includes insurance premiums, retained losses and administrative expenses Source: 2003 RIMS Benchmark Survey; Insurance Information Institute Cost of Risk: 1990-2003* 1992-2000 = -41.8% 2000-03 = +147.6%

53. Components of Cost of Risk Per $1,000 of Revenue* * Cost of risk includes insurance premiums, retained losses and administrative expenses Source: 2003 RIMS Benchmark Survey; Insurance Information Institute +45.8%+90.3%+113.8% +107.0% +44.8% +150.0% % Change 2001 -03

54. Source: MarketScout.com Commercial Premium Rate Changes Are Sharply Lower Is moderation due to realization of performance and profit goals, increasing capacity/ capital, or market- share strategies?

55. World Rate-On-Line Index (1990 = 100) Source: Guy Carpenter Reinsurance prices rising, limits falling: ROL up significantly, though not as much as after Hurricane Andrew in 1992

56. P/C Soft Spots: % Accounts With Negative Price Change (2 nd Qtr. 2004) Source: Council of Insurance Agents & Brokers; Insurance Information Institute More moderation is evident in the commercial casualty segments Propert y Casualty/Liability/Terrorism

57. P/C Soft Spots: % Accounts With Negative Price Change (1 st Qtr. 2004) Source: Council of Insurance Agents & Brokers; Insurance Information Institute More moderation is evident in the commercial casualty segments Propert y Casualty/Liability/Terrorism

58. P/C Soft Spots: % Accounts With Negative Price Change (2 nd Qtr. 2002) Source: Council of Insurance Agents & Brokers; Insurance Information Institute Propert y Casualty/Liability/Terrorism

59. Average Expenditures on Auto Insurance: US vs. Iowa Countrywide auto insurance expenditures are expected to rise 3.5% in 2004 *III Estimates; Estimates for 2002-2004 based on BLS CPI data for motor vehicle insurance. Source: NAIC, Insurance Information Institute

60. Average Expenditures on Homeowners Ins.: US vs. Iowa *III Estimates; Estimates for 2002-2003 based on BLS CPI data for tenants and household insurance 2002/3. Source: NAIC, Insurance Information Institute. Average US HO expenditures are expected to rise by just 2.8% in 2004

61. Homeowners Insurance Expenditure as a % of Median Home Price Source: Insurance Information Institute calculations based on data from National Association of Realtors, NAIC. HO Expenditure as % of Sales Price Median Home Sales Price The cost of homeowners insurance relative to the price of a typical home has fallen

62. LEGAL LIABILITY & TORT ENVIRONMENT

63. There is Was is Was a Glimmer of Hope for Tort Reform Best Chance for Tort Reform in Years is Gone Medical Malpractice  States—already happening: 20+ states have caps  Federal reform discussed in Congress but bill failed in Senate  Attempt to get caps for specialties failed February 2004 Class Action Reform  Class Action Fairness Act  Failed by 1 Vote 10/22/03; Failed Again in 2004 Asbestos Reform  Fairness in Asbestos Injury Resolution of 2003; Failed Apr. 2004 Punitive Damages—What’s Reasonable  Supreme Court ruled favorably in Campbell v. State Farm

64. Cost of U.S. Tort System ($ Billions) Source: Tillinghast-Towers Perrin. Tort costs consumed 2.23% of GDP in 2002 Per capita “tort tax” expected to rise to $1,003 by 2005, up from $809 in 2002

65. Where the Tort Dollar Goes (2002) Source:Tillinghast-Towers Perrin Tort System is extremely inefficient:  Only 22% of the tort dollar compensates victims for economic losses  At least 54% of every tort dollar never reaches the victim

66. Personal, Commercial & Self (Un) Insured Tort Costs* Billions Total = $39.5 Billion *Excludes medical malpractice Source: Tillinghast-Towers Perrin Total = $120.2 Billion Total = $157.7 Billion Total = $208.8 Billion

67. Average Jury Awards 1994 vs. 2001and 2002 Source: Jury Verdict Research; Insurance Information Institute. The average jury award appears to be leveling out

68. Business Leaders Ranking of Liability Systems for 2004 Best States 1.Delaware 2.Nebraska 3.Virginia 4.Iowa 5.Idaho 6.Utah 7.New Hampshire 8.Minnesota 9.Kansas 10.Wisconsin Worst States 41. Missouri 42. Arkansas 43. Montana 44. Illinois 45. Texas 46. California 47. Louisiana 48. Alabama 49. West Virginia 50. Mississippi Source: US Chamber of Commerce States Liability Systems Ranking Study; Insurance Info. Institute.

69. The Nation’s Judicial Hellholes Source: American Tort Reform Association; Insurance Information Institute City of St. Louis, MO CALIFORNIA Alameda County Los Angeles County San Francisco County Orleans Parish, LA I Madison County, IL TEXAS Jefferson County Hidalgo County Starr County Mississippi’s 22 nd Judicial District

70. INSURANCE SCORING (CREDIT)

71. Importance of Rating Factors by Coverage Type CoverageFactor 1Factor 2Factor 3 BI LiabilityAge/GenderIns. ScoreGeography PD LiabilityAge/GenderIns. ScoreGeography PIPIns. ScoreGeographyYrs. Insured Med PayIns. ScoreLimitAge/Gender ComprehensiveModel YearAge/GenderIns. Score CollisionModel YearAge/GenderIns. Score Source: The Relationship of Credit-Based Insurance Scores to Private Passenger Automobile Insurance Loss Propensity Michael Miller, FCAS and Richard Smith, FCAS (EPIC Actuaries), June 2003 (Presented at June 2003 NAIC meeting).

72. Texas Auto: Relative Loss Ratio (by Credit Score Decile, Total Market)* * Each decile contains approximately 15,300 policies. Includes standard and non-standard policyholders. Interpretation: Those with poorest credit scores generated losses more than double that of those with the best scores Source: University of Texas, Bureau of Business Research, March 2003. 1 st Decile = Lowest Credit Scores 10 th Decile = Highest Credit Scores. Extremely strong statistical evidence linking credit score with loss/claim outcomes: Credit score & likelihood of positive claim (p<.0001) Size of loss related to credit score (p<.0001) Correlation between relative loss ratio and credit score (r =.95)

73. Texas Auto: Average Loss per Policy (by Credit Score Decile, Total Market) Interpretation: Those with poorest credit scores generated incurred losses 65% higher those with the best scores Source: University of Texas, Bureau of Business Research, March 2003. 1 st Decile = Lowest Credit Scores 10 th Decile = Highest Credit Scores.

74. Indicated Relative Pure Premium by Insurance Score (PD Liability)* Interpretation: Those with poorest credit scores had loss experience 33% above average while those with the best scores had loss experience that was 19% below average Source: EPIC Actuaries, June 2003

75. Example: Credit Discount Can Save $100s per Year* $296 $174 $196 $154 *Annualized savings based on semi-annual data from example Source: Insurance Information Institute Credit discount lowered annual premium by 14.7% Policyholder saved nearly $300 Credit was single largest discount Opponents of credit will force people to pay more for coverage Total Annual Savings from Discounts: $820

76. Adverse Impact: No Evidence

77. New Private Housing Starts (Millions of Units) Source: US Department of Commerce; National Association of Realtors; Insurance Info. Institute *Annualized January 2004 figure New Private Housing Starts Housing market remains strong.

78. U.S. Homeownership Rate, 1990 to 2003 Source: U.S. Census Bureau Homeownership is at a record high. Because you can’t buy a home without insurance, insurance is clearly available and affordable, including to millions of Americans of modest means and all ethnic groups.

79. Homeownership Rates in Iowa, 1990 to 2003 Source: U.S. Census Bureau Homeownership in Iowa is high by historical standards but off its 2001 peak

80. Homeownership Rates in Central Cities, 1990 to 2003 Source: U.S. Census Bureau Homeownership rates in central cities is at an all time record high. Because you can’t buy a home without insurance, insurance is clearly available and affordable, including to millions of Americans of modest means and all ethnic groups.

81. Homeownership Rates Among Minorities is Rising, 1994 to 2003 Source: U.S. Census Bureau Homeownership rates for minorities are at or near record highs Minorities are using their good credit to buy homes and get insurance

82. Percent Change in Homeownership, 1995-2001 *Includes American Indian, Eskimo, Aleut, Asian and Pacific Islander. Source: U.S. Census Bureau Homeownership rates have increased much faster for minority groups than for whites Minorities are using their good credit to buy homes and get insurance 4.3 million minority net new homeowners were created between 1995 and 2001

83. THE CHALLENGE OF TERRORISM

84. Sept. 11 Industry Loss Estimates ($ Billions) Consensus Insured Losses Estimate: $40.2B Source: Insurance Information Institute

85. Terrorism Coverage Take-Up Rate Rising Source: Marsh, Inc.; Insurance Information Institute Terrorism take-up rate for non-WC risk rose through 2003 and continues to rise in 2004 TAKE UP RATE FOR WC COMP TERROR COVERAGE IS 100%!!

86. Source: Eqecat, NCCI. Estimated Workers Comp Insured Losses & Deaths for Terrorist Events 1,000 12,300 173,000 1,300 Fatalities

87. Percent of 2003 Surplus Lost Due to a $25 Billion Terrorism Attack in 2004 With TRIA in Place Source: The Economic Effects of Federal Participation in Terrorism Risk, Analysis Group, September 14, 2004. Even with TRIA in place, some major insurers will lose more than 10% of their policyholder surplus: Terrorism is a clear threat to stability.

88. Summary 2004/5 represent “sweet spot” in the current cycle for p/c insurance (underwriting/earnings); Iowa returns have historically been a better-than-average state for the industry, but some recent volatility Rising investment returns insufficient to support deep soft market in terms of price, terms & conditions Reserve deficiency remains industry’s principal boogieman Major Challenges:  Maintaining price/underwriting discipline  Managing variability/volatility of results  New/emerging/re-emerging risks

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