2008 Seminar on Reinsurance:Professional LiabilityMay 20, 2008

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Agenda

Section 1 State of the Lawyers Professional Marketplace

Section 2 Reinsurance Discussion

Section 1: State of the Lawyers Professional Marketplace Large Firms

Small Firms

Large Firms

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The Market for Lawyers’ Professional Liability

“Large” defined as more than 50 attorneys

4Q2007 signaled first significant softening of LPL market since 2006 peak

• 5-10% rate reductions were common in late 2007

• Expect to see continued reductions in 2008

As in past cycles, the LPL market has lagged the D&O market

• Law firm losses tend to develop more slowly than D&O losses and premiums as the firms are not typically party to initial litigation

• Delay also driven by lag before new capital enters

– LPL substantially smaller than D&O market

– Law firm losses not reported publicly

• 2007 was notable for the increase in insurer capacity

Multi-year coverage is becoming more available

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Marketplace Conditions

Large law firm losses relatively benign 2003 – 2007

1999 – 2002 characterized by greater frequency of severe losses

• Financial failures of law firms’ client due to corporate malfeasance

• Economic downturn in the late 1990’s

• Tax shelter work done by a few firms

Law firm claim frequency remained well below D&O frequency

• Financial scandals that generated D&O claims did not include LPL

– Central Bank of Denver protections

– Stoneridge Investment Partners LLC v Scientific-Atlanta, Inc decision

• Other D&O loss categories have generated few, if any, LPL claims:

– Laddering

– Options backdating

– Subprime/credit crunch

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Large Settlements Since 1986

One in each cell was reversed on appeal.

Settlements by YearAmount 1994 & prior 1995-1999 2000-2004 2005 2006 200720M - 30M 8 6 7 2 2 0>30M - 40M 3 2 1 2 0 140M - <57.5M 4 2 0 1 1 057.5M - <100M 0 0 0 1 0 1100M + 0 0 1 0 0 0

Severity today generally remains below $50M ceiling established in the LPL cycle of the late 1980’s to early 1990’s

• Largest claims from tax shelters

• One hedge fund bankruptcy/fraud situation in early stages

Source: Data compiled by Aon Professional Services Group from publicly reported information.

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Underwriters Concerned About Future Losses

Economic downturn

• Increased frequency and severity may follow

• Business deals and transactions fall apart

• Certain areas of practice more active (e.g., bankruptcies)

Ramifications of subprime meltdown/credit crunch

• 236 subprime lawsuits as of 3/17/08, 1 legal malpractice*

• As of now, not seeing any LPL lawsuits related to subprime

Hedge funds and private equity work

Litigation exposures arising from e-discovery

*Source: Industry Focus, April 2008; Advisen Ltd.

Small Firms

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The Market for Lawyers’ Professional Liability

Rate softening varies

• Solo practitioners – holding fairly steady

– Policyholder dividends

• As size of firm increases to 35-50, commercial markets more interested

– Rate decreases as high as 10-15% or more

Frequency varies, but generally flat to decline with some instances of increase

Severity increasing at 3-5%

Deterioration in real estate area of practice

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Underwriters Concerned About Future Losses

Economic downturn (same as large firms)

• Increased frequency and severity may follow

• Business deals and transactions fall apart

• Certain areas of practice more active (e.g., bankruptcies)

Real estate area of practice

• Particularly on east coast

• Title agents E&O cover as endorsement to LPL policy

• High paralegal to qualified attorney ratio – bucket shops for title closings without adequate supervision

• Around 15 states where lawyers combined the title closing function

• States where speculative or second home purchasing heavily exposed (FL, SC)

“Subprime” itself not necessarily concern as much as devaluation of assets and business failings

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NABRICO Analysis

Analyze surplus growth for Lawyers Professional Liability writers

• NABRICO carriers write Lawyers Professional Liability

– Examples: Lawyers Mutual Insurance Company (CA), Wisconsin Lawyers Mutual Insurance Co., Illinois State Bar Assoc. Mutual

• Difficult to analyze Commercial lines carriers that write LPL

– Examples: CNA, Zurich, Great American

– No unique Annual Statement Line

Understand the drivers of surplus growth

• How much from operating income (underwriting and investment)?

• How much from capital contributions?

Understand the drivers of operating income

• Underwriting income and prior year reserve development

• Investment income yields and asset distributions

Source: Data from SNL compiled by Aon Re

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0%

2%

4%

6%

8%

10%

12%

2005 2006 2007

Total Change in Surplus

Total surplus up $33M from 2005 to 2006

Total surplus up $23M from 2006 to 2007

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-4%

-2%

0%

2%

4%

6%

8%

10%

2005 2006 2007

Components to Change in Surplus

Net Income Net Paid In UR Gains Other

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-10%

-5%

0%

5%

10%

15%

2005 2006 2007

Components Net Income

Net U/W Income Net Investment Income

Dividends to PHFederal Income Tax

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-1%

0%

1%

2%

3%

4%

5%

6%

2005 2006 2007

Components Underwriting Income

Prior Year Reserve Development

Net U/W Income Before Prior Year Reserve Development

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Return on Invested Assets

0.0%

2.5%

5.0%

7.5%

2005 2006 2007

18

0%

20%

40%

60%

80%

100%

2005 2006 2007

Distribution of Assets

Bonds Stocks Cash Other

Section 2: Reinsurance Discussion Medical Malpractice

Lawyers Professional

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Medical Malpractice Reinsurance Observations

More than enough capacity, with more coming in

Disconnect between supply and demand

Bad faith, ECO/XPL

• Connecticut: $38.5M

• Florida: $21M, $10M

• Illinois: $24M, $12M

• Iowa: $13.5M

• Maine: $8M

• Massachusetts: $26M

• New Jersey: $19M

• Wisconsin: $23M

Systemic, batch and aggregation

Awards-made coverage

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Lawyers Professional Reinsurance Observations

Stable to growing capacity, depending on the market segment

Large firm LPL usually combined with D&O and other E&O programs, but sometimes stand-alone

Small firm structures similar to PIAA

More discussions regarding systemic type exposures and coverages – still mostly talk

Rate relief and broader terms for “best in class”

Increased actuarial involvement by all parties to the transaction

Increased interest from the Bermuda market