The Insurance Cycle and Credit Crisis

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Slide 1: The Insurance Cycle and Credit Crisis: Impacts & Implications for the P/C Insurance Industry NAMIC Personal Lines Marketing & Underwriting Seminar Orlando, FL April 16, 2008 Robert P. Hartwig, Ph.D., CPCU, President Insurance Information Institute ♦ 110 William Street ♦ New York, NY 10038 Tel: (212) 346-5520 ♦ Fax: (212) 732-1916 ♦ bobh@iii.org ♦ www.iii.org Slide 2: Presentation Outline • Weakening Economy: Insurance Impacts & Implications  Implications of Treasury “Blueprint” for insurers • • • • • • • • • Profitability Underwriting Trends Premium Growth Rising Expenses Capacity Investment Overview Catastrophic Loss Shifting Legal Liability & Tort Environment Regulatory and Legislative Environment Q&A Slide 3: What a Weakening Economy & Credit Crunch Mean for the Insurance Industry A STORMY ECONOMIC FORECAST Slide 4: What’s Going On With the US and Global Economies Today? Fundamental Factors Affecting Global Economy in 2008 • Puncture of Two Bubbles: Credit and Housing in US  Burst BubbleAsset Price Deflation  Subprime mortgage market was first part of credit bubble to burst • • Credit Crunch: Some credit markets have effectively seized Global Contagion Effect: Securitization of asset back securities, derivatives based on those securities amplified via leverage produced contagion effect  Many financial institutions around the world found they are exposed  Many hedge funds, banks caught holding CDOs, credit default swaps and other instruments against which they borrowed heavily (sometimes 10:1)  Some face margin calls, distressed selling of every type of asset except Treasuries • Global Economic Impacts: Global Economic Slowdown  GDP growth in US down sharply, employment falling; Deceleration abroad too  “Decoupling” theory was naïve  Crashing dollar is symptom of irresponsible US fiscal policy, trade deficits. IOUs are being redeemed for hard assets or states in corporations  New bubbles forming in commodities and currencies Source: Insurance Information Institute. Slide 5: Real GDP Growth* 6% 5% 3.7% 3.1% 4% 3.6% 2.9% 3.8% Economic growth is slowing dramatically in 2008 2.6% 2.8% 09:3Q 2.9% 09:4Q 2.1% 2% 0.8% 1.6% 0.6% 2000 2001 2002 2003 2004 2005 2006 07:1Q 07:2Q 07:3Q 07:4Q 08:2Q 08:3Q 08:4Q 09:1Q Yellow bars are Estimates/Forecasts. Source: US Department of Commerce, Blue Economic Indicators 4/08; Insurance Information Institute. 09:2Q 0% 08:1Q 0.1% 0.1% 1% 0.6% 1.9% 2.0% 3% 2.5% 4.9% Slide 6: Toward a New World Economic Order 1. Credit Crunch (incl. Subprime) Issue Will Ultimately Cost Hundreds of Billions Globally (est. up to $600B) • 2. Heavy Toll on Capital Base of Some Large Financial Institutions Worldwide (e.g., Bear Stearns) 3. Most Significant Economic Event in a Generation 4. Shuffling of Global Economic Deck; Economic Pecking Order Shifting 5. IOUs are Being Redeemed • • • China, oil producing countries hold the upper hand Stakes in hard assets/institutions demanded • US economy will recover, but will take 18-24 months • • Cash infusions necessary; Sovereign Wealth Funds important source Federal Reserve forced into playing a larger role; must improvise Problem exacerbated by leveraged bets taken by some financial institutions therefore its reach extends beyond simple defaults 6. Good News: No Shortage of Available Capital Source: Insurance Information Institute Central banks are (generally) making right decisions; Dollar sinks Slide 7: What’s Being Done to Fix the Economy?Impacts on Insurers Economic Fix Fed Rate Cuts Fed Debt Swap Fed Bailout of Bear Stearns Impacts on Insurers •Reduces bond yields (65% - 80% of portfolio) •Potentially contributes to inflation longer run •Fed will swap up to $200B in bank holdings of mortgage back securities for Treasuries up to 28 days; Improves bank finances •Fed on 3/14 (via J.P. Morgan) provided Bear with cash after what is effectively a “run on the bank” •“Too Big to Fail” doctrine is activated •Fed acting to prevent broader loss of confidence •3/17: J.P. Morgan buys Bear for $236 million ($2/share); Price increased to $10 on 3/24 Source: Insurance Information Slide 8: What’s Being Done to Fix the Economy?Impacts on Insurers (cont’d) Economic Fix Stimulus Package Impacts on Insurers •Hope is that $168B plan boosts overall economic activity and employment (by 500,000 jobs) and therefore p/c personal and commercial exposures •Contributes to already exploding budget deficits— Washington may expand its search for people and industries to tax •Keeps more people in their homes and hopefully paying HO insurance premiums •Abandoned and neglected homes have demonstrably worse loss performance •Treasury March 31 “Blueprint” affects all financial firms •For insurers, major recommendation is established of Optional Federal Charter under Office of National Insurance within Treasury Housing Bailout (?) Regulatory/ Legislative Action (?) Source: Insurance Information Slide 9: Post-Crunch: Fundamental Issues To Be Examined Globally •             Adequacy of Risk Management, Control & Supervision at Financial Institutions Worldwide Effectiveness and Nature of Regulation Colossal failure of risk management (and regulation) Implications for ERM? Includes review of incentives • • • Accounting Rules What sort of oversite is optimal given recent experience? Credit problems arose under US and European (Basel II) regulatory regimes Will new regulations be globally consistent? Can overreactions be avoided? Capital adequacy & liquidity Problems arose under FAS, IAS Asset Valuation, including Mark-to-Market Structured Finance & Complex Derivatives New approaches to reflect type of asset, nature of risk Source: Insurance Information Ratings on Financial Instruments Slide 10: Summary of Treasury “Blueprint”for Financial Services Modernization Impacts on Insurers Slide 11: Treasury Regulatory Recommendations Affecting Insurers •  Would provide system for federal chartering, licensing, regulation and supervision of insurers, reinsurer and producers (agents & brokers)  OFC insurers would still be subject to state taxes, provisions for compulsory coverage, residual market and guarantee funds  OFC would specify specific lines covered by charter; Separate charters needed for P/C and Life  Ensure safety and soundness  Enhance competition in national and international markets  Increase efficiency through elimination of price controls, promote more rapid technological change, encourage product innovation, reduce regulatory costs and provide consumer protection Establishment of an Optional Federal Charter (OFC) • OFC Would Incorporate Several Regulatory Concepts Source: Department of Treasury Blueprint for a Modernized Financial Regulatory System, March 2008. Slide 12: Treasury Regulatory Recommendations Affecting Insurers (cont’d) •    Establishment of Office of National Insurance (ONI) •       Establishment of Office of Insurance Oversight (OIO) Department within Treasury to regulate insurance pursuant to OFC Headed by Commissioner of National Insurance Commissioner has regulatory, supervisory, enforcement and rehabilitative powers to oversee organization, incorporation, operation, regulation of national insurers and national agencies Department within Treasury to handle issues needing immediate attention such “reinsurance collateral”; [Recognizes that OFC debate is “difficult and ongoing”] OIO could focus immediately on “key areas of federal interest in the insurance sector” OIO would be the lead regulatory voice on international regulatory policy Would have authority to ensure states achieved uniform implementation of declared US international insurance policy goals OIO would also serve as advisor to Treasury Secretary on major domestic and international policy issues Ultimately incorporated into OFC framework Source: Department of Treasury Blueprint for a Modernized Financial Regulatory System, March 2008. Slide 13: Insurance & The Economy Important But Somewhat Muted Impacts Slide 14: A Few Facts About the Relationship Between Insurance & Economy • Vast Majority of Insurance Business is Tied to Renewals  Approximately 98+% of P/C business (units) is linked to renewals  A very large share of p/c insurance premiums are statutorily or de facto compulsory (e.g., WC, auto liability, surety, usually HO…)  P/C insurers have marginal exposure impact due to economy  Most life revenues and units are renewals, but some products (e.g., variable annuities are sensitive to market volatility)  Life insurers who manage 401(k) assets seeing more loans and hardship withdrawals; • Insurers are Sensitive to Interest Rates  About 2/3 of P/C invested assets and 75% if Life assets are fixed income  Historically, yield on industry portfolios has tracked 10-year note closely  All else equal, lower total investment gain implies greater emphasis on underwriting  Historically, industry’s best underwriting performances are rooted in periods when interests rates were low and/or equity market performance poor (1930s – 1950s, early 2000s gave rise to strong 2006/07) Source: Insurance Information Institute. Slide 15: Real GDP Growth vs. Real P/C Premium Growth: Modest Association 20% 15% Real NWP Growth 18.6% 20.3% 25% P/C insurance industry’s growth is influenced modestly by growth in the overall economy 13.7% 8% 6% 4% 2% 0% -2% -4% Real GDP Growth 10% 5% 0% -5% -10% Sources: A.M. Best, US Bureau of Economic Analysis, Blue Chip Economic Indicators, 2/08; Insurance Information 5.2% 78 -0.9% 79 80-7.4% 81 -6.5% -1.5% 82 1.8% 83 4.3% 84 85 86 5.8% 87 0.3% 88 -1.6% 89 -1.0% 90 -1.8% 91 -1.0% 92 3.1% 93 1.1% 94 0.8% 95 0.4% 96 0.6% 97 -0.4% 98 -0.3% 99 1.6% 00 5.6% 01 02 7.7% 03 1.2% 04 -2.9% 05 -0.5% 06 -2.9% 07 -2.7% 08F Real NWP Growth Real GDP Slide 16: Summary of Economic Risks and Implications for (Re) Insurers Economic Concern Subprime Meltdown/ Credit Crunch Housing Slump Lower Interest Rates Stock Market Slump General Economic Slowdown/Recession Risks to Insurers •Some insurers have some asset risk •D&O/E&O exposure for some insurers •Client asset management liability for some •Bond insurer problems; Muni credit quality •Reduced exposure growth •Deteriorating loss performance on neglected, abandoned and foreclosed properties •Lower investment income •Decreased capital gains (which are usually relied upon more heavily as a source of earnings as underwriting results deteriorate) •Reduced commercial lines exposure growth •Surety slump •Increased workers comp frequency Slide 17: New Private Housing Starts, 1990-2014F (Millions of Units) 2.1 2.0 1.9 1.8 1.7 1.6 1.5 1.4 1.3 1.2 1.1 1.0 0.9 1.62 1.64 1.57 1.60 1.71 Impacts also for comml. insurers with construction risk exposure 1.85 1.96 Exposure growth forecast for HO insurers is dim for 2008/09 1.80 New home starts plunged 34% from 2005-2007; Drop through 2008 trough is 53% (est.)—a net annual decline of 1.09 million units 1.54 1.56 2.07 1.48 1.46 1.47 1.19 1.20 1.29 1.35 I.I.I. estimates that each incremental 100,000 decline in housing starts costs home insurers $87.5 million in new exposure (gross premium). The net exposure loss in 2008 vs. 2005 is estimated at $954 million. 1.36 1.01 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07F08F 09F 10F11F 12F 13F 14F Source: US Department of Commerce; Blue Chip Economic Indicators (10/07), except 2008/09 figures from 4/08 edition of BCEF; Insurance Info. Institute 0.98 1.10 1.38 1.45 1.51 Slide 18: Auto/Light Truck Sales, 1999-2014F (Millions of Units) 18.0 17.5 17.0 16.5 16.0 15.5 15.0 14.5 14.0 99 00 01 02 03 04 05 06 07F 08F 09F 10F 11F 12F 13F 14F Source: US Department of Commerce; Blue Chip Economic Indicators (10/07), except 2008/09 figures from 4/08 edition of BCEF; Insurance Info. Institute 17.8 17.4 17.5 17.1 Weakening economy, credit crunch and high gas prices are hurting auto sales 16.9 16.9 16.6 16.5 16.1 New auto/light trick sales are expected to experience a net drop of 1.4 million units annually by 2008 compared with 2005, a decline of 9.5% 16.9 16.8 16.6 16.7 16.4 15.7 Impacts of falling auto sales will have a less pronounced effect on auto insurance exposure growth than problems in the housing market will on home insurers 15.3 Slide 19: US Unemployment Rate, (2007:Q1 to 2009:Q4F) 6.0% 5.5% 5.0% 4.5% 4.0% 3.5% 3.0% 07:Q1 07:Q2 07:Q3 07:Q4 08:Q1 08:Q2 08:Q3 08:Q4 09:Q1 09:Q2 09:Q3 09:Q4 Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (4/08); Insurance Info. Inst. 5.2% 4.6% 4.8% 4.9% 5.4% 5.5% 5.5% 5.6% 5.5% 5.5% 4.5% 4.5% Rising unemployment rate negative impacts workers comp exposure and could signal a temporary claim frequency surge Slide 20: Inflation Rate (CPI-U, %), 1990 – 2009F 6 5 4 3 2 1 0 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 08F 09F 12-month change Feb. 2008 vs. Feb. 2007; Source: US Bureau of Labor Statistics; Blue Chip Economic Indicators, Mar. 10, 2008; Ins. Info. 4.9 5.1 Inflation was just 2.2% in 2007 but is accelerating. Medical cost inflation, important in WC, auto liability and other casualty covers is running far ahead of inflation. Rising inflation can also lead to rate inadequacy and adverse reserve development 3.0 3.2 2.9 2.8 2.6 2.4 1.5 1.9 3.3 3.4 2.5 2.3 1.3 3.8 3.0 2.2 4.0 3.4 2.4 Slide 21: PROFITABILITY Profits in 2006/07 Reached Their Cyclical Peak; By No Reasonable Standard Can Profits Be Deemed Excessive Slide 22: P/C Net Income After Taxes 1991-2008F ($ Millions) $70,000 $60,000 $50,000 $40,000 $14,178 $10,870 2001 ROE = -1.2% 2002 ROE = 2.2% 2003 ROE = 8.9% 2004 ROE = 9.4% 2005 ROE= 9.6% 2006 ROE = 12.2% 2007 ROAS1 = 12.3%** $65,777 $61,940 Insurer profits peaked in 2006 $36,819 $38,501 $44,155 $30,773 $24,404 $20,598 $21,865 $30,000 $20,000 $10,000 $0 -$10,000 $5,840 $19,316 $20,559 ROE figures are GAAP; 1Return on avg. surplus. Return on Average Surplus; Sources: A.M. Best, ISO, Insurance Information Inst. 08F 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 -$6,970 $3,046 $30,029 $49,900 Slide 23: ROE: P/C vs. All Industries 1987–2008E 20% P/C profitability is cyclical, volatile and vulnerable 15% 10% Sept. 11 5% 0% Hugo Andrew Lowest CAT losses in 15 years Northridge 91 92 93 94 95 96 97 98 99 00 01 02 03 Katrina, Rita, Wilma -5% 87 88 89 90 4 Hurricanes 08F 04 05 06 07 US P/C Insurers 2008 P/C insurer ROE is I.I.I. estimate. Source: Insurance Information Institute; Fortune All US Industries Slide 24: Personal/Commercial Lines & Reinsurance ROEs, 2006-2008F 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 2006 2007E 2008F 16.8% 13.2% 14.0% 9.4% 6.3% ROEs are declining as underwriting results deteriorate 9.8% 12.3% 10.7% 9.8% Personal Commercial Reinsurance Sources: A.M. Best Review & Preview (historical and forecast). Slide 25: Profitability Peaks & Troughs in the P/C Insurance Industry,1975 – 2008F* 25% 1977:19.0% 20% 15% 10% 5% 0% 10 Years 1987:17.3% 1997:11.6% 10 Y ears 9 Year s 2006:12.2% 1975: 2.4% -5% 1984: 1.8% 1992: 4.5% 2001: -1.2% GAAP ROE for all years except 2007 which is actual ROAS of 12.3%. 2008 P/C insurer ROE is I.I.I. estimate. Source: Insurance Information Institute, ISO; Fortune 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07E 08F Slide 26: Factors that Will Influence the Length and Depth of the Cycle • Capacity: Rapid surplus growth in recent years has left the industry with between $85 billion and $100 billion in excess capital, according to analysts  All else equal, rising capital leads to greater price competition and a liberalization of terms and conditions • Reserves: Reserves are in the best shape (in terms of adequacy) in decades, which could extend the depth and length of the cycle  Looming reserve deficiencies are not hanging over insurers they way they did during the last soft market in the late 1990s  Many companies have been releasing redundant reserves, which allows them to boost net income even as underwriting results deteriorate  Reserve releases will diminish in 2008; Even more so in 2009 • Investment Gains: 2007 was the 5th consecutive up year on Wall Street. With sharp declines in stock prices and falling interest rates, portfolio yields are certain to fall Contributes to discipline  Realized capital gains are already rising as underwriting profits shrink, but like redundant reserves, realized capital gains are a finite resource  A sustained equity market decline (and potentially a drop in bond prices at some point) could reduce policyholder surplus Source: Insurance Information Institute. Slide 27: Factors that Will Influence the Length and Depth of the Cycle (cont’d) • Sarbanes-Oxley: Presumably SOX will lead to better and more conservative management of company finances, including rapid recognition of deficient or redundant reserves  With more “eyes” on the industry, the theory is that cyclical swings should shrink • Ratings Agencies: Focus on Cycle Management; Quicker to downgrade  Ratings agencies more concerned with successful cycle management strategy  Many insurers have already had ratings “haircut” over the last several years they way they did during the last soft market in the late 1990s; Less of a margin today • • • Finite Reinsurance: Had smoothing effect on earnings; Finite market is gone Information Systems: Management has more and better tools that allow faster adjustments to price, underwriting and changing market conditions than it had during previous soft markets Analysts/Investors: Less fixated on growth, more on ROE through soft mkt.  Management has backing of investors of Wall Street to remain disciplined Source: Insurance Information Institute. Slide 28: ROE vs. Equity Cost of Capital: US P/C Insurance:1991-2007 18% 16% 14% +1.7 pts -9.0 pts -13.2 pts The p/c insurance industry achieved its cost of capital in 2005/6 for the first time in many years +2.3 pts 12% 10% +0.2 pts -0.1 pts 8% 6% 4% 2% 0% -2% -4% 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 91 92 93 94 95 96 97 98 99 00 The cost of capital is the rate of return insurers need to attract and retain capital to the business 02 03 04 05 06 07 01 Source: The Geneva Association, Ins. Information Inst. ROE Cost of Capital Slide 29: Top Industries by ROE: P/C Insurers Still Underperformed in 2006 Oil & Gas Equip., Services Petroleum Refining Metals Food Services Household & Pers. Products Pharmaceuticals Industrial & Farm Equipment Mining & Crude Oil Prod. Aerospace & Defense Chemicals Securities Food Consumer Prod. Medical Prod. & Equip. Specialty Retailers Homebuilders P/C Insurers (Stock) All Industries: 500 Median 31.8% 30.7% P/C insurer 30.3% profitability in 2006 26.4% th ranked 30 out of 50 24.6% 24.2% industry groups 22.6% despite renewed 21.8% 21.5% profitability 20.9% P/C insurers 20.9% underperformed 20.5% the All Industry 19.6% 19.4% median for the 19.1% 19th consecutive 14.9% 15.4% 5% 10% 15% 20% 25% 30% year 0% 35% 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 Slide 30: Advertising Expenditures by P/C Insurance Industry, 1999-2007E $ Billions $4.5 $4.0 $3.5 $3.0 $2.5 $2.0 $1.5 Ad spending by P/C insurers is at a record high, signaling increased competition $2.975 $4.323 $3.695 $1.736 $1.737 $1.803 $1.708 99 00 01 02 $1.882 $2.111 03 04 05 06 07E Source: Insurance Information Institute from consolidated P/C Annual Statement data. Slide 31: FINANCIAL STRENGTH & RATINGS Industry Has Weathered the Storms Well, But Cycle May Takes Its Toll Slide 32: P/C Insurer Impairment Frequency vs. Combined Ratio, 1969-2007E 120 115 Combined Ratio Impairment rates are highly correlated underwriting performance and could reach nearrecord low in 2007 Combined Ratio after Div P/C Impairment Frequency 110 105 100 95 90 2006 impairment rate was 0.43%, or 1-in-233 companies, half the 0.86% average since 1969; 2007 will be lower; Record is 0.24% in 1972 2 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 Source: A.M. Best; Insurance Information Institute 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07E Impairment Rate Slide 33: Reasons for US P/C Insurer Impairments, 1969-2005 2003-2005 Affiliate Problems 8.6% Catastrophe Losses 8.6% Alleged Fraud 11.4% Rapid Growth 8.6% Deficient Loss Reserves/Inadequate Pricing 62.8% 1969-2005 Sig. Change in Business 4.6% Misc. 9.2% Reinsurance Failure 3.5% Deficient Loss Reserves/Inadequate Pricing 38.2% Investment Problems 7.3% Deficient reserves, CAT losses are more important factors in recent years Affiliate Problems 5.6% Catastrophe Losses 6.5% Alleged Fraud 8.6% Rapid Growth 16.5% Includes overstatement of assets. Source: A.M. Best: P/C Impairments Hit Near-Term Lows Despite Surging Hurricane Activity, Special Report, Nov. 2005; Slide 34: UNDERWRITING TRENDS Extremely Strong 2006/07; Relying on Momentum & Discipline for 2008 Slide 35: P/C Insurance Combined Ratio, 1970-2008F 120 Combined Ratios 1970s: 100.3 1980s: 109.2 1990s: 107.8 2000s: 102.0* 115 110 105 100 95 90 Sources: A.M. Best; ISO, III 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08F Full year 2008 estimates from III. Slide 36: P/C Insurance Combined Ratio, 2001-2008F 120 115.8 110 As recently as 2001, insurers were paying out nearly $1.16 for every dollar they earned in premiums 107.4 2007/8 deterioration due primarily to falling rates, but results still strong assuming normal CAT activity 2006 produced the best underwriting result since the 87.6 combined ratio in 1949 100 100.1 100.7 98.3 95.6 92.4 05 06 07 08F 98.6 90 2005 figure benefited from heavy use of reinsurance which lowered net losses 01 02 03 04 Sources: A.M. Best; ISO, III. III estimates for 2008. Slide 37: Ten Lowest P/C Insurance Combined Ratios Since 1920 vs. 2007 97 95 93 91.2 91 89 87.6 87 85 1949 1948 1943 1937 2006 1935 1950 1939 1953 1936 2007 Sources: Insurance Information Institute research from A.M. Best data. 2007: III Earlybird survey. The 2006 combined ratio of 92.2 was the best since the 87.6 combined in 1949 2007 was the 20th best since 1920 93.0 93.1 93.1 93.3 95.6 92.1 92.3 92.4 92.4 The industry’s best underwriting years are associated with periods of low interest rates Slide 38: Underwriting Gain (Loss) 1975-2008F 35 30 25 20 15 10 5 0 -5 -10 -15 -20 -25 -30 -35 -40 -45 -50 -55 Insurers earned a record underwriting profit of $31.7 billion in 2006, the largest ever but only the second since 1978. Cumulative underwriting deficit from 1975 through 2007 is $422 billion. $ Billions Source: A.M. Best, Insurance Information Institute 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Slide 39: Impact of Reserve Changes on Combined Ratio $40 Reserve Development ($B) $35 $30 $25 $20 $15 0.1 $0.4 $10.8 $10 $5 $0 ($5) ($10) 00 01 02 03 04 8.6 8.9 6.5 $33.4 3.5 $22.8 $36.9 10 9 8 Reserve 7 adequacy has 6 4.5 improved 5 substantially 4 3 2 1 -1.2 -1.6 -1.3 -1.1 0 (1) ($5.0) (2) ($5.3) ($7.0)($6.0) (3) 06 07F 08F 09F PY Reserve Development Combined Ratio Points 05 Source: A.M. Best, Lehman Brothers estimates for years 2007-2009 Combined Ratio Points $18.9 Slide 40: PERSONAL LINES Slide 41: Personal Lines Combined Ratio, 1993-2007E 109.9 115 104.5 104.9 103.9 103.5 105 100 95 90 85 99.8 102.7 104.5 105.3 110 110.9 98.4 96.4 94.3 Recent strong results attributable favorable frequency trends and low CAT activity 93 94 95 96 97 98 99 00 01 02 03 04 05 Source: A.M. Best; Insurance Information Institute. 94.3 06 07E 08F 95.6 98.6 Slide 42: Private Passenger Auto (PPA) Combined Ratio 110 105 PPA is the profit juggernaut of the p/c insurance industry today 101.7101.3 101.3 101.0 109.5 107.9 103.5 104.2 101.1 99.5 98.4 Auto insurers have shown significant improvement in PPA underwriting performance since mid-2002, but results are deteriorating. 99.5 97.5 94.3 95.1 95.5 100 95 Average Combined Ratio for 1993 to 2006: 101.0 93 94 95 96 97 98 99 00 01 02 03 90 04 05 06 07E 08F Sources: A.M. Best (historical and forecasts) Slide 43: Pure Premium Spread: Personal Auto PD Liability, 2000-2007:Q4 Auto Insurance Component of CPI Personal Auto-PD Pure Premium 10% 8% 6% 4% 2% 0% -2% -4% Margin necessary to maintain PPA profitability Inversion of pure premium spread is a warning sign that price and costs are out of sync 2000 PPA Combined=110 Source: Insurance Information Institute calculations based ISO Fast Track and US BLS data. 00:Q1 00:Q2 00:Q3 00:Q4 01:Q1 01:Q2 01:Q3 01:Q4 02:Q1 02:Q2 02:Q3 02:Q4 03:Q1 03:Q2 03:Q3 03:Q4 04:Q1 04:Q2 04:Q3 04:Q4 05:Q1 05:Q2 05:Q3 05:Q4 06:Q1 06:Q2 06:Q3 06:Q4 07:Q1 07:Q2 07:Q3 07:Q4 2006 PPA Combined=95.5 Slide 44: Bodily Injury: Severity Trend Running Ahead of Frequency 8% 6% 4% 2% 0% Medical inflation is a powerful cost driver Frequency Severity 6.0% 4.7% 3.0% 3.6% 4.8% 3.8% 3.4% 2.8% -0.3% -2% -0.9% -3.3% -2.6% -3.8% -5.4% -5.0% -2.2% -4% -6% -4.0% -5.3% 99 00 01 02 03 04 05 06 07 Source: ISO Fast Track data. Slide 45: PD Liability: Frequency Trend No Longer Offsets Severity Frequency 8% Severity 6.2% 6% Fewer accidents, but more damage when they occur: Higher Deductibles? 3.3% 3.7% 2.1% 0.6% 4.3% 4% 2% 0% -2% -4% -6% 3.9% 2.8% 0.5% 2.8% 0.8% 0.3% -1.5% -2.0% -2.3% -2.1% -1.9% -3.8% 99 00 01 02 03 04 05 06 07 Source: ISO Fast Track data. Slide 46: PIP: Severity Trend Now Offsets Smaller Claim Frequency Decline Frequency 20% Severity 16.1% 15% 10% Fraud caused problems from 1999-2001 6.5% 4.8% 0.5% -0.6% -4.0% -7.2% -5.4% -5.1% -4.0% 6.1% 2.3% 6.3% 5% 3.2% 1.1% 0.0% -1.1% 0% -5% -10% -1.6% Is No-Fault living on borrowed time? 99 00 01 02 03 04 05 06 07 Average of 4 quarters ending with 3rd quarter 2007. Source: ISO Fast Track data. Slide 47: Collision: Frequency and Severity Claim Trend Adverse 8% 6% 4% 2% 0% -2% -4% -6% 6.8% 4.1% 2.6% 3.0% 1.9% Frequency Severity 3.7% 3.7% 1.5% 3.8% 3.1% 2.3% 0.1% -0.4% -1.7% -3.8% -5.1% -4.6% -3.7% 99 00 01 02 03 04 05 06 07 Source: ISO Fast Track data. Slide 48: Comprehensive: Favorable Frequency and Severity Trends 20% 15% 10% 5% 0% 8.9% Weather related claims from Hurricanes Katrina, Rita & Wilma: 681,900 claims valued $3.29 billion 3.3% 3.3% 14.9% Frequency Severity -1.3% -9.8% -2.1% -6.9% -4.7% -5.7% -10% -15% -8.0% -4.1% -5% 99 00 01 02 03 04 05 06 Source: ISO Fast Track data. -6.5% -1.4% -1.7% -2.6% -2.4% -3.1% 07 Slide 49: Auto Insurance Claim Cost Drivers Slide 50: Percent of Claimants With No Disability from Auto Injuries 80% 75% 70% 65% 60% 55% 50% 45% 40% 35% 30% Bodily Injury Claimants PIP Claimants 76% 72% 68% 70% 66% 59% 52% 48% 56% 72% Fewer claimants reporting any type of disability helping to hold down costs 1992 1997 2002 2007 1987 Sources: Insurance Research Council, Auto Insurance Claims: Countrywide Patterns in Treatment, Cost and Compensation, 2008 Edition; Insurance Information Institute. Slide 51: Percent of Claimants Admitted for 1+ Nights in Hospital 14% 12% 10% 8% 6% 4% 2% 0% Bodily Injury Claimants PIP Claimants 11% 12% 10% 7% Fewer claimants are spending time in the hospital 7% 5% 5% 7% 4% 6% 1987 1992 1997 2002 2007 Sources: Insurance Research Council, Auto Insurance Claims: Countrywide Patterns in Treatment, Cost and Compensation, 2008 Edition; Insurance Information Institute. Slide 52: Percent of Claimants Receiving MRI 25% 20% 15% 10% 5% 0% Bodily Injury Claimants PIP Claimants 22% 18% 15% 12% 15% 18% More claimants are getting MRIs (and CT scans) 1997 2002 2007 Sources: Insurance Research Council, Auto Insurance Claims: Countrywide Patterns in Treatment, Cost and Compensation, 2008 Edition; Insurance Information Institute. Slide 53: Percent of Claimants Represented by Attorney 60% 55% 50% 45% 40% 35% 30% 25% 20% 55% 57% Bodily Injury Claimants PIP Claimants 52% 47% 49% Attorney representation was falling until recently 32% 32% 30% 28% 31% 1987 1992 1997 2002 2007 Sources: Insurance Research Council, Auto Insurance Claims: Countrywide Patterns in Treatment, Cost and Compensation, 2008 Edition; Insurance Information Institute. Slide 54: Homeowners Insurance Slide 55: Homeowners Insurance Combined Ratio 165 155 145 135 125 158.4 Average 1990 to 2006= 111.8 Insurers have paid out an average of $1.12 in losses for every dollar earned in premiums over the past 17 years 117.7 115 113.0 105 95 85 118.4 113.6 112.7 121.7 121.7 111.4 109.4108.2 109.3 98.3 100.1 99.5 95.5 94.2 91.7 101.0 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07E 08F Sources: A.M. Best (historical and forecasts) Slide 56: COMMERCIAL LINES Commercial Auto Commercial Multi-Peril Workers Comp Slide 57: Commercial Lines Combined Ratio, 1993-2008F 125 120 Commercial coverages have exhibited significant variability over time. 112.5 112.3 110.3 110.2 111.1 109.7 Outside CAT-affected lines, commercial insurance is doing fairly well. Caution is required in underwriting long-tail commercial lines. 122.3 110.2 115 110 105 100 107.6 103.9 102.0 102.5 105.4 90 85 93 94 95 96 97 98 99 00 01 02 03 04 05 Sources: A.M. Best (historical and forecasts) 91.2 95 Recent results benefited from favorable loss cost trends, improved tort environment, low CAT losses, WC reforms and reserve releases 06 07E 08F 94.0 97.5 Slide 58: PREMIUM GROWTH At a Virtual Standstill in 2007/08 Slide 59: Strength of Recent Hard Markets by NWP Growth* 25% 20% 15% 10% 5% 0% -5% -10% 1975-78 1984-87 2001-04 Post-Katrina period resembles 1993-97 (postAndrew) 2007: -0.6% premium growth was the first decline since 1943 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007F 2008F Note: Shaded areas denote hard market periods. Source: A.M. Best, Insurance Information Institute Slide 60: Growth in Net Written Premium, 2000-2008F 15.3% 10.0% 8.4% 5.0% P/C insurers are experiencing their slowest growth rates since 1943… underwriting results are deteriorating 4.3% 0.5% -0.6% -1.0% 2007 2008F 3.9% 2000 2001 2002 2003 2004 2005 2006 2008 forecast from A.M. Best. Source: A.M. Best; Forecasts from the Insurance Information Institute. Slide 61: Personal/Commercial Lines & Reinsurance NPW Growth, 2006-2008F 30% 25% 20% 15% 10% 5% 0% -5% -10% -15% 2006 2007E 2008F Net written premium growth is expected to be slower for commercial insurers and reinsurers 2.0%-0.1%1.4% 3.5% -1.5% -2.3% Personal Commercial 28.1% -5.0% -8.5% Reinsurance Sources: A.M. Best Review & Preview (historical and forecast). Slide 62: All P/C Lines Distribution Channels, Direct vs. Independent Agents Direct Independent Agents 70% 60% 50% 40% 30% 20% 10% 0% 02 03 04 05 06 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 Independent agents steadily lost market share from the early 1980s through the early 2000s across all P/C lines, but have gained in recent years. Direct channels include exclusive agency companies, direct marketers and direct sales (e.g., internet) Source: Insurance Information Institute; based on data from Conning and A.M. Best. Slide 63: WEAK PRICING Under Pressure in 2007/08, Especially Commercial Lines Slide 64: Average Expenditures on Auto Insurance $950 $900 $850 $800 $750 $668 $705 $691 $703 $685 $690 $724 $650 $600 Insurance Information Institute Estimates/Forecasts Source: NAIC, Insurance Information Institute $651 $700 94 95 96 97 98 99 00 01 02 03 04 05* 06* 07* $780 Countrywide auto insurance expenditures are expected to fall 0.5% in 2007, the first drop since 1999 $847 $851 Lower underlying frequency and modest severity are keeping auto insurance costs in check $823 $838 $847 Slide 65: Average Expenditures on Homeowners Insurance** $900 $850 $800 $750 $700 $650 $600 $536 $550 $508 $488 $481 $500 $455 $440 $418 $450 $400 95 96 97 98 99 00 01 02 Countrywide home insurance expenditures rose an estimated $868 $835 4% in 2006 $787 Homeowners in non$729 CAT zones have seen $668 smaller increases than $593 those in CAT zones Insurance Information Institute Estimates/Forecasts Excludes cost of flood and earthquake coverage. Source: NAIC, Insurance Information Institute 03 04 05 06* 07* Slide 66: RISING EXPENSES Expense Ratios Will Rise as Premium Growth Slows Slide 67: Personal vs. Commercial Lines Underwriting Expense Ratio* 32% 30% 28% 26% 24% 22% 20% 96 97 98 99 00 01 02 03 04 05 06 07E 08F 23.4% 25.0% 25.6% 25.6% 29.4% 29.9% 31.1% 30.8% 30.0% 27.0% 27.5% 26.6% 26.3% 25.6% 26.4% 27.1% 26.6% 25.0% 24.5% 26.1% 24.8% 24.7% 24.6% 24.4% 29.1% Personal Commercial 24.3% Expenses ratios will likely rise as premium growth slows Ratio of expenses incurred to net premiums written. Source: A.M. Best; Insurance Information Institute Slide 68: CAPACITY/ SURPLUS Accumulation of Capital/ Surplus Depresses ROEs Slide 69: U.S. Policyholder Surplus: 1975-2007 $550 $500 $450 $400 Capacity as of 12/31/07 was $517.9B, 6.5% above year-end 2006, 81% above its 2002 trough and 55% above its 1999 peak. $ Billions $350 $300 $250 $200 $150 $100 $50 $0 The premium-to-surplus fell to $0.85:$1 at yearend 2007, approaching its record low of $0.84:$1 in 1998 “Surplus” is a measure of underwriting capacity. It is analogous to “Owners Equity” or “Net Worth” in non-insurance organizations 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 Source: A.M. Best, ISO, Insurance Information Institute. As of December 31, 2007 Slide 70: Annual Catastrophe Bond Transactions Volume, 1997-2007 Risk Capital Issued Number of Issuances $7,329.6 $8,000 $7,000 Risk Capital Issues ($ Mill) $5,000 $4,000 $3,000 $2,000 $1,000 $0 97 $4,693.4 20 15 $633.0 $846.1$984.8 $1,139.0 $1,219.5 $966.9 $1,729.8 $1,991.1 10 5 0 $1,142.8 98 99 00 01 02 03 04 05 06 07 Source: MMC Securities Guy Carpenter, A.M. Best; Insurance Information Institute. Number of Issuances $6,000 Catastrophe bond issuance has soared in the wake of Hurricanes Katrina and the hurricane seasons of 2004/2005, despite two quiet CAT years 35 30 25 Slide 71: MERGER & ACQUISITION Catalysts for P/C Consolidation Growing in 2008 Slide 72: P/C Insurance-Related M&A Activity, 1988-2006 Transaction Values Number of Transactions $55,825 $40,032 $60,000 $50,000 Transaction Value ($ Mill) $35,221 $40,000 $30,000 $11,534 $1,882 $5,100 $5,137 $2,435 $5,638 $8,059 $30,873 100 80 60 $9,264 $20,000 $3,450 40 20 0 $1,249 $486 $0 Source: Conning Research & Consulting. 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 $425 $10,000 $2,780 Number of Transactions M&A activity began to accelerate during the second half of 2007 No model for successful consolidation has emerged $20,353 140 120 $19,118 Slide 73: Distribution Sector: InsuranceRelated M&A Activity, 1988-2006 Transaction Values Number of Transactions $3,000 $1,934 $2,720 $2,500 Transaction Value ($ Mill) No extraordinary trends evident $1,633 $944 300 250 200 150 Number of Transactions $2,000 $1,500 $542 $689 $1,000 $500 $0 $7 100 50 0 $446 Source: Conning Research & Consulting. 96 97 99 00 01 02 03 $60 04 $212 05 06 Slide 74: Distribution Sector M&A Activity, 2005 vs. 2006 2005 Other 4% Title 9% Agency Buying Agency 51% Insurer Title Buying 4% Distributor 7% 2006 Other 2% Agency Buying Agency 62% Insurer Buying Distributor 7% Bank Buying Agency 25% Bank Buying Agency 29% Number of bank acquisitions is falling years Source: Conning Research & Consulting Slide 75: Motivating Factors for Increased P/C Insurer Consolidation Motivating Factors for P/C M&As • Slow Growth: Growth is at its lowest levels since the late 1990s  NWP growth was 0% in 2007; Appears similarly flat in 2008  Prices are falling or flat in most non-coastal markets • Accumulation of Capital: Excess capital depresses ROEs     Policyholder Surplus up 6-7%% in 2007 and up 80% since 2002 Insurers hard pressed to maintain earnings momentum Options: Share Buybacks, Boost Dividends, Invest in Operation, Acquire Option B: Engage in destructive price war and destroy capital • Reserve Adequacy: No longer a drag on earnings  Favorable development in recent years offsets pre-2002 adverse develop. • Favorable Fundamentals/Drop-Off in CAT Activity  Underlying claims inflation (frequency and severity trends) are benign  Lower CAT activity took some pressure of capital base Source: Insurance Information Institute. Slide 76: INVESTMENT OVERVIEW More Pain, Little Gain Slide 77: Property/Casualty Insurance Industry Investment Gain1 $ Billions $60 $50 $40 $35.4 $30 $20 $10 $0 $42.8 $47.2 $57.9 $52.3 $51.9 $44.4 $36.0 $45.3 $56.9 $48.9 $59.4 $63.6 $55.8 Investment rose in 2007 but are just 9.8% higher than what they were nearly a decade earlier in 1998 94 95 96 97 98 99 00 01 02 03 04 05 06 07 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. 1 Slide 78: CATASTROPHIC LOSS What Will 2008 Bring? Slide 79: Most of US Population & Property Has Major CAT Exposure Is Anyplace Safe? Slide 80: U.S. Insured Catastrophe Losses $120 $100 $80 $60 $40 $4.7 $20 $0 $7.5 $2.7 2006/07 were welcome respites. 2005 was by far the worst year ever for insured catastrophe losses in the US, but the worst has yet to come. $22.9 $5.5 $16.9 $2.6 $10.1 $26.5 $8.3 $7.4 $8.3 $4.6 $12.9 $27.5 $61.9 $9.2 95 96 97 98 99 00 01 02 $5.9 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 07 20?? 89 90 91 92 93 94 03 04 05 06 $6.7 $100.0 $ Billions $100 Billion CAT year is coming soon Slide 81: States With Largest Insured Catastrophe Losses in 2007 $ Millions $1,400 $1,200 $1,000 $800 $600 $400 $200 $0 $1,230 2007 CAT STATS $747 •1.18 million CAT claims across 41 states arising $677 •23 catastrophic events $320 $272 $270 $262 $223 $202 $200 $200 CA MN TX GA IL OK KS MO NY CO AL Source: PCS/ISO; Insurance Information Institute. Slide 82: Distribution of 2007 US CAT Losses, by Type and Insured Loss $ Billions Commercial, $1.3 , 20% Personal (home, condo, rental, contents etc.) accounted for 68% of all US insured CAT losses paid in 2007. CAT claim count was 1.18 million. Source: PCS division of ISO. Vehicle, $0.8 , 12% Personal, $4.4 , 68% Slide 83: Top Catastrophic Wildland Fires In The United States, 1970-2007 Insured Losses (Millions 2007 $) Oct. 20-21, 1991: Oakland, Alameda Cos., CA Oct. 2003: Southern CA Fires Oct. 2007: Southern CA Fires $2,589.3 $2,294.4 $2,260.0 $538.4 Oct. 27-28, 1993 Orange Co., CA $502.5 Jun. 27-Jul. 2, 1990 Santa Barbara County, CA $420.7 May 10-16, 2000 Cerro Grande, NM $168.7 July 2007: Lake Tahoe, CA** $154.4 Jun. 23-28, 2002 Rodeo-Chediski Complex, AZ $138.4 Sep. 22-30, 1970 Oakland-Berkeley Hills, CA $132.6 Nov. 24-30, 1980 Los Angeles, San Bernardino, Orange, $108.3 Riverside, San Diego Cos., CA Jul. 26-27, 1977 Santa Barbara, Montecito, CA $68.4 May 17-20, 1985 Florida $63.6 Oct. 23-25, 1978 Los Angeles, Ventura Cos., CA $47.7 Nov. 16-17, 1980 Bradbury, Pacific Palisades, Malibu, Sunland, $40.2 Carbon Canyon, Lake Elsinore, CA Oct. 9-10, 1982 Los Angeles, Ventura, Orange Cos., CA $34.4 Sep. 12-18, 1979 Hollywood Hills, CA $14.3 Nov. 2-3, 1993 Los Angeles Co., CA $0 $500 Fourteen of the top 17 catastrophic wildfires since 1970 occurred in California $1,500 $2,000 $2,500 $3,000 $1,000 Estimate from CA Insurance Dept., Jan. 10, 2008. Source: ISO's Property Claim Services Unit; California Department of Insurance; Insurance Information Institute. Slide 84: Inflation-Adjusted U.S. Insured Catastrophe Losses By Cause of Loss, 1987-2006¹ Fire, $6.6 , 2.2% Wind/Hail/Flood, $9.3 , 3.1% Earthquakes, $19.1 , 6.4% Winter Storms, $23.1 , 7.8% Civil Disorders, $1.1 , 0.4% Water Damage, $0.4 , 0.1% Utility Disruption, $0.2 , 0.1% Tornadoes, $77.3 , 26.0% Terrorism, $22.3 , 7.5% All Tropical Cyclones, $137.7 , 46.3% 1 Catastrophes are all events causing direct insured losses to property of $25 million or more in 2006 dollars. Catastrophe threshold changed from $5 million to $25 million beginning in 1997. 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. Source: Insurance Services Office (ISO).. Insured disaster losses totaled $297.3 billion from 1987-2006 (in 2006 dollars). Wildfires accounted for approximately $6.6 billion of these—2.2% of the total. Slide 85: The 2008 Hurricane Season: Preview to Disaster? Slide 86: Outlook for 2008 Hurricane Season: 60% Worse Than Average Average Named Storms Named Storm Days Hurricanes Hurricane Days Intense Hurricanes Intense Hurricane Days Accumulated Cyclone Energy Net Tropical Cyclone Activity 9.6 49.1 5.9 24.5 2.3 5 96.2 100% 2005 28 115.5 14 47.5 7 7 NA 275% 2008F 15 80 8 40 4 9 150 160% Average over the period 1950-2000. Source: Philip Klotzbach and Dr. William Gray, Colorado State University, April 9, 2007. Slide 87: Landfall Probabilities for 2008 Hurricane Season: Above Average Average Entire US East & Gulf Coasts US East Coast Including Florida Peninsula Gulf Coast from Florida Panhandle to Brownsville Caribbean 52% 31% 30% NA 2008F 69% 45% 44% Above Average Average over the past century. Source: Philip Klotzbach and Dr. William Gray, Colorado State University, April 9, 2007. Slide 88: REINSURANCE MARKETS Reinsurance Prices are Falling in Non-Coastal Zones, Casualty Lines Slide 89: Share of Losses Paid by Reinsurers, by Disaster 70% 60% 50% 40% 30% 20% 10% 0% Hurricane Hugo Hurricane Andrew Sept. 11 Terror 2004 Hurricane 2005 Hurricane (1989) (1992) Attack (2001) Losses Losses 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 2005. Sources: Wharton Risk Center, Disaster Insurance Project; Insurance Information Institute. Reinsurance is playing an increasingly important role in the financing of megaCATs; Reins. Costs are skyrocketing 30% 25% 60% 45% 20% Slide 90: US Reinsurer Net Income & ROE, 1985-2007 $9.68 $12 $10 $8 Net Income ($ Bill) $7.96 Reinsurer profitability rebounded post-Katrina but is now falling $4.53 $5.43 $1.95 $3.71 $1.95 $1.94 $3.17 $3.41 $2.51 20% 15% 10% $6 $1.87 $2.03 $1.17 $2.52 $1.79 $1.38 $1.47 $1.99 $2 $0 ($2) ($4) $0.12 $1.22 $1.31 $4 5% 0% -5% Net Income 85 86 87 88 89 90 91 92 93 ROE ($2.98) 07* 94 95 99 00 01 02 03 04 96 97 98 05 06 -10% Source: Reinsurance Association of America. 2007 ROE figure is III estimate based return on average 2007 surplus. ROE Slide 91: Shifting Legal Liability & Tort Environment Is the Tort Pendulum Swinging Against Insurers? Slide 92: Bad Year for Tort Kingpins (Continued) “King of Class Actions” Bill Lerach •Former partner in class action firm Milberg Weiss •Admitted felon. Guilty of paying 3 plaintiffs $11.4 million in 150+ cases over 25 years & lying about it repeatedly to courts •Will serves 1-2 years in prison and forfeit $7.75 million; $250,000 fine “King of Torts” Dickie Scruggs •Won billions in tobacco, asbestos and Katrina litigation •Pleaded guilty for attempting to offer a judge $40,000 bribe to resolve attorney fee allocation from Katrina litigation in his firm’s favor. His son/othersguilty on related charges •Could get 5 years in prison, $250,000 fine Source: San Diego Union Tribune, 9/19/07 Source: Wall Street Journal, 3/15/07 Slide 93: Bad Year for Tort Kingpins* (Continued) “King of Class Actions” Melvyn Weiss •Former partner in class action firm Milberg Weiss; Earned $251 million in legal fees •Pled guilty to federal charges of racketeering and conspiracy for paying kickbacks to professional plaintiffs •Will serve 18-33 months in prison, pay $9.75 million in restitution; $250,000 fine Source: Wall Street Journal, 3/24/07 This Space Available Slide 94: Personal, Commercial & Self (Un) Insured Tort Costs* $250 $200 Billions Total = $159.6 Billion Commercial Lines Personal Lines Self (Un)Insured Total = $216.7 Billion $45.5 $30.0 $85.6 $70.9 Total = $39.3 Billion $150 $100 $50 $0 Total = $121.0 Billion $20.4 $51.0 $49.6 1990 $58.7 2000 $85.6 $5.2 $17.1 $17.0 1980 2006 Excludes medical malpractice Source: Tillinghast-Towers Perrin, 2007 Update on US Tort Cost Trends. Slide 95: Tort System Costs, 1950-2009E $300 $250 2.24% $277 2.24% $265 2.14% $246.0 1.98% $247.0 1.82% 1.83% 1.83% 1.53% 1.87% $179.2 1.34% $158.5 1.22% 1.11% $130.2 1.03% 0.82% $83.7 0.62% $42.7 $20.0 $5.4 $7.9$13.9 $1.8 $3.4 50 55 60 65 70 75 80 85 90 95 00 03 06 08E 09E 2.0% $200 $150 $100 $50 $0 1.5% 1.0% 0.5% 0.0% Tort Costs as % of GDP Tort Sytem Costs Source: Tillinghast-Towers Perrin, 2007 Update on U.S. Tort Costs as % of GDP Tort Costs as % of GDP Tort System Costs After a period of rapid escalation, tort system costs as a % of GDP are now falling 2.5% Slide 96: The Nation’s Judicial Hellholes (2007) Watch List Madison County, IL St. Clair County, IL Northern New Mexico Hillsborough County, FL Delaware California Some improvement in “Judicial Hellholes” in 2007 NEVADA Clark County (Las Vegas) ILLINOIS Cook County West Virginia NEW JERSEY Atlantic County (Atlantic City) Dishonorable Mentions District of Columbia MO Supreme Court MI Legislature GA Supreme Court Oklahoma TEXAS Rio Grande Valley and Gulf Coast South Florida Source: American Tort Reform Association; Insurance Information Institute Slide 97: Business Leaders Ranking of Liability Systems for 2007 New in 2007 Best States 2. Delaware ME, NH, TN, UT, WI 3. Minnesota 4. Nebraska Drop-Offs 5. Iowa ND, VA, SD, 6. Maine WY, ID 7. New Hampshire 8. Tennessee 9. Indiana Midwest/West 10. Utah has mix of good 11. Wisconsin and bad states Worst States Newly • Arkansas Notorious • Hawaii AK • Alaska Rising • Texas Above • California FL • Illinois • Alabama • Louisiana • Mississippi • West Virginia Source: US Chamber of Commerce 2007 State Liability Systems Ranking Study; Insurance Info. Institute. Slide 98: REGULATORY & LEGISLATIVE ENVIRONMENT Isolated Improvements, Mounting Zealoutry Slide 99: Legal, Legislative & Regulatory Issues • Florida “Seeing the Light”: State finally recognizing that it is overexposed with its 2007 legislation having failed to deliver on political promises made  Size of FL Hurricane Catastrophe Fund may be scaled back  Private reinsurance sector role may expand  Citizens actuary: extending rate freeze through 2010 unwise; 44% increase not excessive • • • • • • • Massachusetts Auto: Reforms have led to more competition, lower rates Optional Federal Chartering: Recommended in Treasury plan; Still divisive issue Tax Issue: Treatment of locales like Bermuda; Effort to “level the playing field” National CAT Plan: Hearing in February and in 2007, but no current catalyst Flood Reform: Likely to happen, but MS Rep. Gene Taylor unsuccessful pushing for NFIP to cover wind. Sen. Clinton supports idea. McCarran-Ferguson: Even though Trent Lott is gone, some may still push for scaling back of M-F Profusion of Quasi-Regulators: AGs, Governors, Congressional representatives Source: III • Bad Faith Legislation: Attempts by trial lawyers and legislative allies to Slide 100: PRESIDENTIAL POLITICS & P/C PROFITABILITY Slide 101: Political Quiz • Does the P/C insurance industry perform better (as measured by ROE) under Republican or Democratic administrations? • Under which President did the industry realize its highest ROE (average over 4 years)? • Under which President did the industry realize its lowest ROE (average over 4 years)? Slide 102: P/C Insurance Industry ROE by Presidential Administration,1950-2008 Carter Reagan II G.W. Bush II Nixon Clinton I G.H.W. Bush Clinton II Reagan I Nixon/Ford Truman Eisenhower I Eisenhower II G.W. Bush I Johnson Kennedy/Johnson 16.43% 15.10% 10.45% 8.93% OVERALL RECORD: 8.65% 1950-2008* 8.35% 7.98% Republicans 8.92% 7.68% 6.98% Democrats 8.00% 6.97% Party of President has 5.43% 5.03% marginal bearing on 4.83% profitability of P/C 4.43% insurance industry 3.55% 2% 4% 6% 8% 10% 12% 14% 16% 18% 0% ROE for 2007/8 estimated by III. Truman administration ROE of 6.97% based on 3 years only, 1950-52. Source: Insurance Information Institute Slide 103: P/C Insurance Industry ROE by Presidential Party Affiliation, 1950–2008E Truman 25% 20% 15% 10% 5% 0% -5% BLUE = Democratic President RED = Republican President Eisenhower Kennedy/ Johnson Nixon/Ford Carter Reagan/Bush Clinton Bush Source: Insurance Information Institute 50 52 54 56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08E Slide 104: Summary • Results were excellent in 2006/07; Overall profitability reached its highest level (est. 13-14%) since 1988 • Underwriting results were aided by lack of CATs & favorable underlying loss trends, including tort system improvements • Property cat reinsurance markets past peak & more competitive • Premium growth rates are slowing to their levels since WW II; Commercial leads decreases. Firming in personal lines? • Rising investment returns insufficient to support deep soft market in terms of price, terms & conditions as in 1990s • How/where to deploy/redeploy capital?? • Major Challenges:  Slow Growth Environment Ahead; Cyclical & Economic  Maintaining price/underwriting discipline  Managing variability/volatility of results  Managing regulatory/legislative activism  Strong 2007 but ROEs slipping; Momentum for 2008 Slide 105*: Insurance Information Institute On-Line If you would like a copy of this presentation, please give me your business card with e-mail address