Soft Markets andSoft Markets andHard Truths in the Property/Liability Insurance Industry

Alabama I-Day 2009University of Alabama Tuscaloosa, AL

Steven N Weisbart Ph D CLU Senior Vice President and Chief Economist

University of Alabama Tuscaloosa, ALOctober 7, 2009

Steven N. Weisbart, Ph.D., CLU, Senior Vice President and Chief EconomistInsurance Information Institute ♦ 110 William Street ♦ New York, NY 10038

Tel: (212) 346-5540 ♦ Cell: (917) 494-5945 ♦ stevenw@iii.org ♦ www.iii.org

Presentation Outline

• Hard Truths about the U S EconomyHard Truths about the U.S. Economy• Soft Markets in the Property-Liability

I I d tInsurance Industry• Hard Truths in Property-Liability

Insurance Operations• Hard Truths About Property-LiabilityHard Truths About Property Liability

Investment Performance & Insuring CapacityCapacity

Q&A

Hard Tr thsHard Truthsaboutabout

the U S Economythe U.S. EconomyBeen Down So Long It Looks Like Up to Me

Length of U.S. Business Cycle Contractions 1945-Present*Contractions, 1945 Present

25 Current recession began in Dec. Duration (Months)

20

25 g2007 and is already the longest

since the Great Depression.

15

16 16

2210

811 10

810 11

68 8

0

5

0Feb.1945

Nov.1948

July 1953 Aug.1957

Apr.1960

Dec.1969

Nov.1973

Jan. 1980 Jul. 1981 Jul. 1990 Mar.2001

Dec.2007

* As of September 2009, inclusiveSources: National Bureau of Economic Research; Insurance Information Institute.

Month Recession Started

Length of U.S. Business Cycles, 1945-Present*1945 Present

120Contraction Expansion followingDuration (Months)

106

2

120

90100110120

92

73

60708090

2237

45

39 36

58

30405060

8 11 10 8 10 1116

616

8 8

223

24

3

120

102030

0Feb.1945

Nov.1948

July1953

Aug.1957

Apr.1960

Dec.1969

Nov.1973

Jan.1980

Jul. 1981 Jul. 1990 Mar.2001

Dec.2007

* As of April 2009, inclusiveSources: National Bureau of Economic Research; Insurance Information Institute.

Month Recession Started

Real Quarterly GDP Changes (annualized),

2005:Q3-2010:Q4F Red bars are actual; Yellow

4%8%

Q QSpike due almost entirely to the weak dollar

(growing exports and slowing imports)

;bars are forecasts/estimates

3.1%

2.1%

5.4

4%

3.0%

%

3.2% 3.

6%

2.1%

5%

3.0%

2.4% 2.5% 2.7%

2.7% 2.9%

2%

4%

6%

2

1.4

0.1%

1.2% 2

1.5

0%.7%

2%

0%

2%

%

-1.0-0.

-2.7

%

6%

-4%

-2%

The Q1:2009 decline was th t t i th

-5.4

%

-6.4

%

-8%

-6%

5:3Q

5:4Q

6:1Q

6:2Q

6:3Q

6:4Q

7:1Q

7:2Q

7:3Q

7:4Q

8:1Q

8:2Q

8:3Q

8:Q

4

9:1Q

9:2Q

9:3Q

9:4Q

0:1Q

0:2Q

0:3Q

0:4Q

the steepest since the Q1:1982 drop of 6.4%

05 05 06 06 06 06 07 07 07 07 08 08 08 08 09 09 09 09 10 10 10 10

Sources: US Department of Commerce, Bureau of Economic Analysis (actual) at http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htmBlue Chip Economic Indicators 9/09 issue (forecasts).

EmploymentEmployment

U.S. Nonfarm Private Employment, Monthly Nov 2007 – August 2009Monthly, Nov 2007 August 2009

0 1 0 9 8 8 7 6138 5

Millions The U.S. economy lost about 6 million

Employment peak; recession starts

138.

0

138.

1

138.

0

137.

9

137.

8

137.

8

137.

7

137.

6

137.

6

137.

4

137.

0

136.

7

36.2

136 5137.0137.5138.0138.5 lost about 6 million

jobs in 12 months

13

135.

1

134.

3

.7134 5135.0135.5136.0136.5

1

133.

133.

0

132.

5

132.

2

1.7 4132.5

133.0133.5134.0134.5

1

131

131.

4

131.

2

130.5131.0131.5132.0

130.0Nov07

Dec07

Jan08

Feb08

Mar08

Apr08

May08

June08

Jul08

Aug08

Sep08

Oct08

Nov08

Dec08

Jan09

Feb09

Mar09

Apr09

May09

Jun09

Jul09

Aug09

Seasonally adjusted. Source: US Bureau of Labor Statistics

Unemployment and UnderemploymentRates: Rocketing Up in 2008-9

18Traditional Unemployment Rate U-3Unemployment + Underemployment Rate U-6

January 2000 through August 2009, seasonally adjustedg p

Percent

14

1618 Unemployment + Underemployment Rate U-6

U-6 went from 9.2% in April 2008 to

16 8% in Aug 20099.7% Aug. 2009 unemployment rate (U-3) was the highest monthly rate since 1983.

1012

16.8% in Aug. 2009g yPeak rate in the last 30 years: 10.8% in

Nov-Dec 1982.

6

8

24

00 01 02 03 04 05 06 07 08 09

Jan-

0

Jan-

0

Jan-

0

Jan-

0

Jan-

0

Jan-

0

Jan-

0

Jan-

0

Jan-

0

Jan-

0

Source: US Bureau of Labor Statistics; Insurance Information Institute.

U.S. Unemployment Rate ForecastsQuarterly 2009:Q3 to 2010:Q4Quarterly, 2009:Q3 to 2010:Q4

11.0%Unemployment is expected to

peak in late 2009:Q4 or 2010:Q1.

10 3% 10 3% 10 3%10.5%

11.0% p Q Q

9.8%

10.1%10.3% 10.3% 10.3%

10.2%

9 6%

9.9%10.0%

9.9%9.7%9.7% 9.7%

10.0%

9.6%9.5%9.5% 9.5%

9.1%9.0%

9.5%

8.8%

8.5%09:Q3 09:Q4 10:Q1 10:Q2 10:Q3 10:Q4

Rising unemployment will erode payrolls and workers comp’s exposure base.

10 most pessimistic consensus/midpoint 10 most optimistic

Sources: Blue Chip Economic Indicators (9/09); Insurance Info. Inst.

Has the Contraction Endedand Recovery Begun?and Recovery Begun?

Source: http://www.calculatedriskblog.com/

Will the Recession End Soon?Feb-Sep 2009 Initial Jobless Claims*Feb Sep 2009 Initial Jobless Claims

658659660

640643647650650658659

651648638

63263062632

640

660

620625

630627623

617618616607

600

620

585

567 571567573570

580

600

567560557

566 567

540

560

4 8 4 1 8 5 6 3 0 7 4 8 5 1 8 5 2 9

4-week moving avg (000)

Feb

14

Feb

21

Feb

2 8

Mar

7

Mar

14

Mar

21

Mar

28

Apr

4

Apr

11

Apr

18

Apr

25

May

2

May

9

May

16

May

23

May

30

Jun

6

Jun

13

Jun

20

Jun

27

Jul 4

Jul 1

1

Jul 1

8

Jul 2

5

Aug

1

Aug

8

Aug

15

Aug

22

Aug

29

Sep

5

*seasonally adjusted; state programs only Source: http://www.dol.gov/opa/media/press/eta/ui/current.htm

HousingHousing

High Ratio of Unsold-Homes Inventory to Sales Will Likely Keep Prices Falling

Inventory of unsold homes number of homes sold

to Sales Will Likely Keep Prices FallingMillions of Homes, Annual Rate

7.1

6.56

7

8y

# of house sales fell;inventory wasn’t the problem

# of house sales is rising but so is inventory

.0 7 8 6 9 9 8 4.1

6

5.7

4.9

4.49 4.71

4.55 4.66

4.72 4.89 5.

24

4

5

6

2.8 3.

5 4. 3.7

3.6 3.8

3.6 3. 3.9

3.8 44 4

2

3

0

1

05 06 07 08

n-09

b 09 r 09

r 09

y 09

n 09 l 09

Jan

Feb

Mar

Apr

May

Jun

Jul

Source: http://www.realtor.org/research/research/ehsdata

“Shadow” Inventory of Unsold Homes: It’s Worse Than You ThinkHomes: It s Worse Than You Think

• “About 1.8 million homes are currently in foreclosure and theyAbout 1.8 million homes are currently in foreclosure and they will continue to weigh on home prices for at least the rest of the year.”Zillo com’s latest Homeo ner Confidence S r e (p blished• Zillow.com’s latest Homeowner Confidence Survey (published August 18, 2009) asked homeowners how likely they would put their homes on the market if they saw signs of a turnaround in the next 12 months:the next 12 months:

Very likely, 8% (7.5 million homes)Likely, 9% (7.5 million homes)Likely, 9% (7.5 million homes)But Adam York, economist for Wells Fargo Securities, “contends that the amount of homes that have not yet been listed for sale could be around 4-5 millioncould be around 4-5 million.

Sources: Julie Haviv, “’Shadow’ inventory lurks over U.S. housing recovery,” Reuters, at http://www.reuters.com/article/GCA-Housing/idUSTRE56U5YZ20090731 and http://zillow.mediaroom.com/index.php?s=173

High Inventory Means Millions Fewer Private Housing StartsFewer Private Housing Starts

.07

2 1

Measured by number of new units started, exposure growth for HO insurers is low.

Housing start data also affects commercial

Millions of Units

Housing

2.

1.80

62 .64

7 60 1.71

1.85 1.

96

1 71.81.92.02.1 Housing start data also affects commercial

insurers with construction risk exposure.g

bubble

Recession

1.361.

48

1.351.

46

1.29

209

1.47

1.6 1.

1.57 1.6

1 31.41.51.61.7

R i

0.90

80

1.2

1.01

1.1

0 91.01.11.21.3

I I I ti t h 100 000 d li i h i

Recession

0.58

0.8

0 50.60.70.80.9 I.I.I. estimate: each 100,000 decline in housing

starts “costs” home insurers $90 million in gross premium. Estimated premiumloss in

2008 vs. 2005: about $1 billion.

0.40.5

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08F 09F 10FSources: US Department of Commerce; Blue Chip Economic Indicators (9/09); Insurance Information Inst.

The “Silver Lining”?I fl i Mi h BInflation Might Be

Relatively LowRelatively Low

After Recent Recessions,the Annual Inflation Rate Droppedthe Annual Inflation Rate Dropped

6% Average inflation rate, 1992-2007: 2.67% Post-Recession

4.9%5.1%

3.8% 3.8%4%

5%Recession Post-

Recession

3.0%3.2%

2.6%

1 9%

3.3%3.4%

2.5%2.3%

3.0% 2.8%

1 8%

2.8%2.9%2.4%3%

1.5%1.9%

1.3%1.8%

-0.5%1%

2%

0.5%

-1%

0%90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09F10F

Sources: US Bureau of Labor Statistics (actual, blue bars); Blue Chip Economic Indicators, 9/09 issue, (forecasts, yellow bars)

Section Summary: Hard Truths About the U.S. Economy

• Continued high levels of unemployment/

y

g p yunderemployment

• Continued low levels consumer demand/• Continued low levels consumer demand/ business investment

Significant increase in the personal saving rate butSignificant increase in the personal saving rate, but virtually all used to pay down outstanding debtLow or no growth in insured exposuresLow- or no-growth in insured exposures

• Low levels of new borrowingAffects housing, autos, other consumer durables

S ft M k t i thSoft Markets in the Property/LiabilityProperty/Liability Insurance IndustryInsurance Industry

P i il D i bPrimarily Driven bythe Industry’s Underwriting Cycle,

N t th ENot the Economy

40 Years ofHard and Soft Markets

22%24%

S f1975-78 1984-87 2000-03Shaded areas

denote “hard I 2007 i

16%18%20%22% denote hard

market” periods In 2007 net written premiums fell, the first decline since

1943

10%12%14%16%

2%4%6%8%

-4%-2%0%2%

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

2007

2008

2009

:Q1

Sources: A.M. Best, ISO, Insurance Information Institute

Year-to-Year Change in Net Written Premium 2000-2009*Written Premium, 2000 2009

P/C insurers are Protracted i d f

15.3%experiencing their

slowest growth rates since 1943

period of negative or slow growth is possible due to soft

5 0%

8.4%10.0% Slow growth means

retention is critical

due to soft markets and

slow economy

5.0%3.9%

0.5%

4.2%

-1.0% -1.4%-3.5%

Sources: A.M. Best (historical through 2008; ISO for 2009. *first quarter 2009 only

3.5%2000 2001 2002 2003 2004 2005 2006 2007 2008 2009*

Does National Economic Growth Affect Real P/C Premium Growth? Not Much

% 0.3%

25% 8%

Real P/C Premium Growth? Not Much

18.6

% 20

13.7

%

15%

20% 6%

.2%

% 5.8%

5.6%

17.

7%10%

WP

Gro

wth

2%

4%

DP

Gro

wth

5.

1.8%

4.3 % 5

0.3%

3.1%

1.1%

0.8%

0.4%

0.6%

% %1.

6%5

1.2%

%

1.7%

0%

5%

Real

NW

0%

Rea

l GD

-0.9

%% 5%

-1.5

%

-1.6

%-1

.0%

-1.8

%-1

.0%

-0.4

%-0

.3%

-2.9

% -0.5

%-3

.8%

-4.2

%-5% -2%

Real NWP Growth Real GDP

-7.4

%-6

.5-10%

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 08E

09F

-4%Real NWP Growth Real GDP

Sources: A.M. Best, US Bureau of Economic Analysis, Blue Chip Economic Indicators, 2/09; Insurance Information Inst.

Even When the Payroll Base is Rising, Soft Markets Reduce Workers Comp PremiumsMarkets Reduce Workers Comp Premiums

7/90 3/91 3/01 11/01

Wage & Salary Disbursement (Private Employment) vs. WC NWP$ Billions $ Billions

12/07 ?

$6,000

$7,000

$35

$40

$45Wage & Salary DisbursementsWC NPW

7/90-3/91 3/01-11/01 12/07-?

$4,000

$5,000

$25

$30

$35

Weakening wage

$2,000

$3,000

$10

$15

$20Weakening wage

and salary growth is

expected to cause a deceleration in

$0

$1,000

$0

$5

$10Shaded areas indicate recessions a deceleration in workers comp

exposure growth

89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08**9-month data for 2008Source: US Bureau of Economic Analysis; Federal Reserve Bank of St. Louis at http://research.stlouisfed.org/fred2/series/WASCUR; I.I.I. Fact Books

H d T th i thHard Truths in the Property/LiabilityProperty/Liability

Insurance OperationsInsurance OperationsP i il D i bPrimarily Driven by

the Industry’s Underwriting Cycle,N t th ENot the Economy

The P/C Industry’s Combined Ratio Seems Headed Up Again

120

Seems Headed Up, AgainThe industry’s combined ratio appears to be on a “cyclical upturn”

dating to 2006. In 2008, even excluding net CAT losses (which added Combined Ratio

15.8115

120g , g (

3.4 points to the combined ratio vs. 2007) and M&FG losses (another 4.1 points vs. 2007), the 2008 ratio would have been 97.6.

09:Q1 combined ratio was11

07.4

1105

11009:Q1 combined ratio was 98.4 excl. M&FG vs. 96.8

in 08:Q1

10

100.

1

8.3 100.

7

102.

0105.

1

100

1 98

92.4 95

.5

90

95

852001 2002 2003 2004 2005 2006 2007 2008 2009:Q1E

Sources: A.M. Best, ISO; III preliminary estimates.

Medical Cost Inflation is One of the Most Serious Long-term Challenges Facing

Casualty WC and Health InsurersCasualty, WC, and Health Insurers

Since 1982-84, (index =100) the cost of

320

380

100

medical care has nearly quadupled (to 375), while the overall cost of living

merely doubled (to 215)

260

e (1

982-

84=1

140

200

Inde

x V

alue

80

140

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 9*

I

All Items Medical Care

8 8 8 8 8 8 8 8 9 9 9 9 9 9 9 9 9 9 0 0 0 0 0 0 0 0 0 09

Source: Department of Labor (Bureau of Labor Statistics); not seasonally adjustedhttp://www.bls.gov/news.release/pdf/cpi.pdf *through July 2009

WC Medical Severity Rising Far Faster than Medical CPI

13 6%15%

Faster than Medical CPI

10 1% 10.6%

13.6%

12%

7.4%

10.1%

8.3%7.3% 7.6%

9.2%

7.2%

8.6%9%

5.1%6.2% 6.0%

6%

4.5%3.5%

2.8% 3.2% 3.5%4.1% 4.6% 4.7%

4.0% 4.4% 4.2% 4.0% 4.4%3%

Change in Medical CPICh M d C t L t Ti Cl i0%

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Change Med Cost per Lost Time Claim

Sources: Med CPI from I.I.I. Inflation Watch; WC med severity from NCCI based on NCCI states.

Since 2003, Tort System Cost Growth Has Moderated but Could Spike AgainHas Moderated but Could Spike Again

15% Rate of Tort System Cost Growth CPI

9%

12%

%

6%

9%

0%

3%

-6%

-3%

2001 2002 2003 2004 2005 2006 2007 2008

Sources: US Bureau of Labor Statistics, Tillinghast-Towers Perrin, 2008 Update on U.S. Tort Costs; Insurance Info. Inst.

Catastrophic Losses*: Was 2005an Outlier or a Harbinger?an Outlier or a Harbinger?

$61 9$70

$ Billions Is $25 billion the new level of expected $61.9

$50

$60level of expected

yearly CAT losses?Before 2001, CAT

losses a eraged abo t

$22 9$26.5 $27.5 $26.0$30

$40losses averaged about $8-10 billion per year.

$7.5$2 7$4.7

$22.9

$5.5

$16.9

$8.3$7.4$2 6

$10.1$8.3$4.6 $5.9

$12.9$6.7 $6.9$9.2

$10

$20

$2.7$4.7 $2.6 $4.6

$0

89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 0809

**0

*Excludes $4B-$6b offshore energy losses from Hurricanes Katrina & Rita. **2009:1HNote: 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

30

A Million More Florida Resident Households in the Next Decade?

8.2 8.

3 8.5

8.5

Households in the Next Decade?Millions of Households

The State of Florida

7.4 7.5

7.5 7.5 7.6 7.6 7.

7 7.9 8.

0 8.1 8

7 5

8.0

The State of Florida now (Feb 09) forecasts nearly 1 million more

households by 2019 (up

Hurricane Wilma

5 6.6 6.

8 7.0 7.

1 7.3 7

7.0

7.5 y ( palmost 13%). There will be more businesses, too.

7 5.8 5.

9 6.0 6.

2 6.3 6.

5 6

6.0

6.5 Hurricane Andrew

5.1 5.

3 5.4 5.

5 5.6 5.

5 0

5.5

5.0

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09F

10F

11F

12F

13F

14F

15F

16F

17F

18F

19F

Source: http://edr.state.fl.us/conferences/population/demographic.htmData are from Feb. 18, 2009 Florida Demographic Estimating conference

High Population Growth in Coastal Alabama Puts More Insured Value at Risk

Source: South Alabama Regional Planning g gCommission, “Coastal Alabama River Basin Management Plan”, January 2004.

High Population Growth Forecast for Coastal Areas in Baldwin County, AL, 2000-2030y

High population growth in coastal g

Alabama puts more insured value

at risk

Source: South Alabama Regional Planning Commission, “Coastal Alabama River Basin Management Plan”, January 2004.

High Mobile County Population Growth Forecast 2000-2030 is Near but Not Directly on the Coasty

Source: South Alabama Regional Planning Commission, “Coastal Alabama River Basin M t Pl ” J 2004Management Plan”, January 2004.

Major (Category 3, 4, 5) Hurricanes Striking the US by DecadeStriking the US by Decade

Mid 1920s – mid-1960s: Mid-1990s – 2030s?AMO W PhColorado State

3 10 1089

AMO Warm Phase AMO Warm Phaseteam forecasts 3 more intense hurricanes in

20093 10 10

76

56

88

5

8

65

45

1900s 1910s 1920s 1930s 1940s 1950s 1960s 1970s 1980s 1990s 2000s 2010s 2020s*Figure for 2000s is extrapolated based on data for 2000-2008 (7 major storms: Charley, Ivan, Jeanne (2004), Katrina, Rita, Wilma (2005), Ike (2008)).Sources: Tillinghast from National Hurricane Center: http://www.nhc.noaa.gov/pastint.shtm.; I.I.I.

Inflation-Adjusted U.S. Insured Catastrophe Losses By Cause of Loss,

1987 2006¹1987-2006¹Fire, $6.6 , 2.2% Civil Disorders, $1.1

, 0.4% Water Damage, $0.4

T d $77 3

,

Utility Disruption, $0.2 , 0.1%

g , $, 0.1%Wind/Hail/Flood,

$9.3 , 3.1%

Earthquakes, $19.1 , 6.4%

Tornadoes, $77.3 , 26.0%Winter Storms,

$23.1 , 7.8%

Terrorism, $22.3 , 7.5%

Insured disaster losses totaled $297.3 billion from 1987-2006 (in 2006 dollars). Hurricanes

d t d t d fAll 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.

and tornadoes accounted for approximately 75% of these.

Source: Insurance Services Office (ISO)..

p g p p yCatastrophe 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.

Number of Tornadoes in Each Calendar Quarter 2005–2009:Q2Calendar Quarter, 2005 2009:Q2

9441,000 2005 20062007 2008 The first two quarters

700

800

9002007 20082009

The first two quarters of 2009 were more

typical of prior years than 2008.

504543

617

394

571

500

600

700

209 235160

244193

360305

157

394

200

300

400

160112 81

157118105

0

100

200

1st Qtr 2nd Qtr 3rd Qtr 4th QtrSources: US Dept. of Commerce, Storm Prediction Center, National Weather Service,at http://www.spc.noaa.gov/climo/torn/monthlytornstats.pdf 2009:Q2 is I.I.I. estimate

Underwriting Expense Ratios LikelyWill Rise as Premium Growth LagsWill Rise as Premium Growth Lags

31 1%32%Personal Commercial 2009:Q1 blended

30.8% 30.0%

31.1%

29.4%29 9%

30%

32% Qratio was 29.1%

27.7%28.3%

26 3%26.4%2 6%

29.9%29.1%

26.6%28%

24.3%25.0% 26.2%

24.5%24.8%25.6%25.6%26.1%25.9%

26.3%26.4%25.6%%

25.0%26%

23.4%24.4% 24.6%

24.7%

22%

24%

22%96 97 98 99 00 01 02 03 04 05 06 07 08

*Ratio of expenses incurred to net premiums written.Sources: A.M. Best; ISO; Insurance Information Institute

Section Summary: Hard Truths about P-L Insurance Operations

• The financial crisis/great recession didn’t directly

p

g yaffect P-L underwriting performance; the underwriting cycle and catastrophes were 2008’s drivers

• Premium levels will likely continue to be soft, driven by low exposure growth, low inflation

• The potential for significant catastrophe losses p g premains high

• Expense ratios will likely grow unless expenses p y g pcan be reduced

Hard Truths aboutHard Truths about Property/Liability p y y

Investment Performance and Insuring Capacity

Asset Allocation of P/C Insurance Industry’s Cash & Invested AssetsIndustry s Cash & Invested Assets

As of September 30, 2008

Common Stock

Bonds66.7%

C h & Sh

16.3%

Portfolio Facts•Invested assets Cash & Short-

Term Investments7.6%

•Invested assets totaled $1.26 trillion as of 9/30/08All ti Preferred Stock

1.2%•Allocations were virtually unchanged from 12/31/07

Other8.2%

Source: SNL Financial LC 41

Bond Yields Tend to Follow Inflation, but the Relationship is a Loose Onebut the Relationship is a Loose One

10%CPI-U % Change U.S. Treasury 10-Year Note Yield

8%

10%ForecastJuly 1990-

March 1991 recession

March 2001-November 2001

recession

6%

2%

4%

0%

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09F

10F

-2%

0

Sources: US Bureau of Labor Statistics (history); Blue Chip Economic Indicators, 8/09 (forecasts)

P/C Investment Income as a % of Invested Assets Follows 10 Year U S T Note

9%

P-C Inv Income/Inv Assets 10-Year Treasury Note

Assets Follows 10-Year U.S. T-Note

8%

9% OMB forecasts that T-note yields won’t exceed 5.2% for the next decade. If

recent history holds, P-C net investment yield will be somewhat lower.

6%

7%

4%

5%

2%

3%

0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 F F F F F F

Investment yield historically tracks 10-year Treasury note quite closely

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09F

10F

11F

12F

13F

14F

Sources: history: Board of Governors, Federal Reserve System; A.M.Best; Insurance Information Institute.Forecasts: Office of Management and Budget, Mid-Session Review, Fiscal Year 2010.

P/C Industry Investment Income* 1994 2008Income*, 1994-2008

3 54.6

$55 Investment income might moderate further if rates for new bond

$49.

5 $52.

3 $5

$51.

2

$51.

4

$45

$50further if rates for new bond

investments stay low and/or if insurers shift to shorter-maturity bonds and

more US government notes.

6.8 38.0 $4

1.5

7.1

6.7

$38.

7

$39.

6

$40.

8

$38.

6

$39.

9

$35

$40

Bill

ions

$33.

7 $36 $3 $3 $36 $$

$30

$35

Investment income CAGR 1994-2007 was just 3.8%.

$25

1994 95 96 97 98 99

2000 01 02 03 04

2005

** 06 07 08

09**

*

*Primarily interest and stock dividends ** Investment income (excluding one time dividend) jumped inPrimarily interest and stock dividends. Investment income (excluding one-time dividend) jumped in 2005 as insurers that had accumulated cash captured rising bond interest rates. Also, 2005 figure includes special one-time dividend of $3.2B. ***2009 figure is Q1 actual, annualizedSources: ISO; Insurance Information Institute.

P/C Industry Net Realized Capital Gains and Losses 1990 2009:Q1Gains and Losses, 1990-2009:Q1

$16.21$18.02

$

$20$ Billions

$4 81

$9.89

$6.00$9.24

$10.81$13.02

$6.63 $6.61$8.97$9.70$9.13$9.82

$8

$12

$16

$2.88$4.81

$1.66

-$1 21 -$0.41

$3.52

$4

$0

$4

$1.21

-$12

-$8

-$4

Nearly $9 billion in realized it l i i 2007 b t

-$19.80-$24

-$20

-$16 capital gains in 2007, but$-19.7 billion in 2008.

-$24

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

09:Q

1

Sources: A.M. Best, ISO, Insurance Information Institute.

Policyholder Surplus by Quarter,2006:Q4 – 2009:Q12006:Q4 2009:Q1

Billions$525

6 512.

8

$521

.8

5.0515.

6

$517

.9

$500

$525

$487

.1

$496

. 6 $5

78.5

$505$5$

$475

$

$47

$455

.6

1

$450

D li Si 2007 Q3 P k $

$437

.1

$400

$425 Decline Since 2007:Q3 Peak

2009Q1: -$84.7B (-16.2%)$400

06:Q4 07:Q1 07:Q2 07:Q3 07:Q4 08:Q1 08:Q2 08:Q3 08:Q4 09:Q1Source: ISO

U.S. P/C Industry Premiums-to-Surplus Ratio: 1985-2009:Q1

2.0

Surplus Ratio: 1985 2009:Q1Premiums are a rough measure of risk accepted; surplus is funds beyond reserves to pay unexpected losses. The larger surplus is in relation to premiums—the lower the

Ratio at year-end

1.8

larger surplus is in relation to premiums the lower the ratio of premiums to surplus—the greater the industry’s

capacity to handle the risk it has accepted.

1 4

1.61.03:1 as

of 3/31/09

1.2

1.4

19980.85:1–the lowest

3/31/09

1.0

0.85:1 the lowest (strongest) P:S ratio

in recent history.

0.885 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 0809:Q1

Sources: A.M. Best, ISO, Insurance Information Institute.

Largest Capital Events asa Percent of Surplus 1989 presenta Percent of Surplus, 1989-present

18%The financial crisis now ranks as the largest “capital event”

10 9%

16.2%13.8%

12%

15%

18% as the largest capital event over the past 20+ years

9.6%6.9%

10.9%

6.2%6%

9%

12%

3.3%

0%

3%

6%

0%

/30/

1989

urric

ane

Hug

o

/30/

1992

urric

ane

And

rew

2/31

/93

rthr

idge

thqu

ake

6/30

/01

Sept

. 11

Atta

cks

/30/

04Fl

orid

arr

ican

es

6/30

/05

urric

ane

Kat

rina

nanc

ial

sis

as o

f31

/09*

*

6/ Hu 6/ Hu A 12 N

orEa

rt S A 6/ FH

ur 6 Hu K

Fin

Cris 3/

3

Ratio is for end-of-quarter surplus immediately prior to event. Date shown is end of quarter prior to event. Sources: PCS; Insurance Information Institute.

Premium-to-Surplus Ratios Before Major Capital Events*Before Major Capital Events

P/C insurance industry was better it li d i i t th

$1.65

$1.42 $1 40$1 5$1.7$1.9 capitalized going into the

financial crisis than before any “capital event” in recent history

$1.42 $1.40

$1.03 $1.03$0 88

$1.05$1.15

$1.1$1.3$1.5

$0.88

$0 5$0.7$0.9

$0.5

/30/

1989

Hur

rican

eH

ugo

/30/

1992

Hur

rican

eA

ndre

w

2/31

/93

orth

ridge

rthq

uake

6/30

/01

Sept

. 11

Atta

cks

6/30

/04

Flor

ida

urric

anes

6/30

/05

Hur

rican

eK

atrin

a

6/30

/07

Fina

ncia

lC

risis

As

of3/

31/0

9**

6/ H 6/ H A 12 No

Ear 6 F

Hu H F 3

*Ratio is for end of quarter immediately prior to event. Date shown is end of quarter prior to event. **Latest availableSource: PCS; Insurance Information Institute.

In 2008, A.M. Best Affirmed or Upgraded 88% of P/C Insurers*Upgraded 88% of P/C Insurers

In 2008, despite fi i l k t

Upgraded, 59 , 4.2%financial market turmoil, high cat losses and a soft

market A M BestDowngraded, 55 ,

3.9%

market, A.M. Best lowered ratings on just 3.9% of P-C insurers. It placed another 4.4%

Under Review, 63 ,4.4%

punder review

Other, 59 , 4.2%

Affirm, 1,183 , 83.4%, , ,

*Through December 19.Source: A.M. Best.

50

Reasons for US P/C Insurer Impairments 1969 2008Impairments, 1969-2008

Reinsurance Sig. Change Deficient

Deficient loss reserves and inadequate i i th

Failure3.7%

Misc.9.1%

Sig. Change in Business

4.2%

Loss Reserves/In-

adequate Pricing38 1% pricing are the

leading cause of insurer

impairments

38.1%

Investment Problems

7 0% impairments, underscoring the

importance of discipline. Affiliate

Impairment

7.0%

pInvestment

catastrophe losses play a much

ll lRapid

Impairment7.9%

All d F d

Catastrophe Losses

Source: A.M. Best: 1969-2008 Impairment Review, Special Report, Apr. 6, 2008

smaller role.Growth14.3%

Alleged Fraud8.1%

Losses7.6%

P/C Insurance Industry ROEs,1975 – 2009F*

25%1977:19.0% 1987:17.3% 1997:11.6% 2006:12.2%

20%

25%

10%

15%

0%

5%2008: 0.3%

-5%

0%

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

1975: 2.4% 1984: 1.8% 1992: 4.5% 2001: -1.2%

Note: 2008 result excluding Mortgage & Financial Guarantee insurers is 4.2%.Sources: ISO; A.M. Best (2009F); Insurance Information Institute. 52

Section Summary: Hard Truths about P-L Investments & Capacity

• Even though the industry has had its largest

p y

g y g“capital event,” it is still well positioned to conduct business as usual

• Yields on bonds are expected to continued at low levelslow levels

Nearly a decade of investing at these levels means they’re “baked in” to investment performance for athey re baked in to investment performance for a long time

Insurance Information Institute On LineInstitute On-Line

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