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Robert P. Hartwig, Ph.D., CPCU, President

Catastrophes, the Credit Crisis & Insurance Cycle Impacts & Implications for the P/C Insurance Industry. Ole Miss Insurance Symposium University of Mississippi Oxford, MS March 26, 2008 Download: www.iii.org/media/presentations/MSoverview. Robert P. Hartwig, Ph.D., CPCU, President

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Robert P. Hartwig, Ph.D., CPCU, President

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  1. Catastrophes, the Credit Crisis & Insurance Cycle Impacts & Implications for the P/C Insurance Industry Ole Miss Insurance Symposium University of Mississippi Oxford, MS March 26, 2008 Download: www.iii.org/media/presentations/MSoverview 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

  2. Presentation Outline • Credit Crisis & The Weakening Economy • Insurance Impacts & Implications • Catastrophic Risk • Focus on Mississippi • Profitability & Performance • Overview & Outlook • Legal Liability & Tort Environment • Will the Pendulum Swing Against Insurer • Regulatory and Legislative Environment • Q&A

  3. A STORMY ECONOMIC FORECASTWhat a Weakening Economy & Credit Crunch Mean for the Insurance Industry

  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.

  5. Real GDP Growth* Economic growth is expected to slow dramatically in the year ahead *Yellow bars are Estimates/Forecasts. Source: US Department of Commerce, Blue Economic Indicators 3/08; Insurance Information Institute.

  6. Toward a New WorldEconomic Order • Credit Crunch (incl. Subprime) Issue Will Ultimately Cost Hundreds of Billions Globally (est. up to $600B) • Problem exacerbated by leveraged bets taken by some financial institutions therefore its reach extends beyond simple defaults • Heavy Toll on Capital Base of Some Large Financial Institutions Worldwide (e.g., Bear Stearns) • Cash infusions necessary; Sovereign Wealth Funds important source • Federal Reserve forced into playing a larger role; must improvise • Most Significant Economic Event in a Generation • US economy will recover, but will take 18-24 months • Shuffling of Global Economic Deck; Economic Pecking Order Shifting • China, oil producing countries hold the upper hand • IOUs are Being Redeemed • Stakes in hard assets/institutions demanded • Good News: No Shortage of Available Capital • Central banks are (generally) making right decisions; Dollar sinks Source: Insurance Information Institute

  7. What’s Being Done to Fix the Economy?Impacts on Insurers Source: Insurance Information Institute

  8. What’s Being Done to Fix the Economy?Impacts on Insurers (cont’d) Source: Insurance Information Institute

  9. Post-Crunch: Fundamental Issues To Be Examined Globally • Adequacy of Risk Management, Control & Supervision at Financial Institutions Worldwide • Colossal failure of risk management (and regulation) • Implications for ERM? • Includes review of incentives • Effectiveness and Nature of Regulation • 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 • Accounting Rules • Problems arose under FAS, IAS • Asset Valuation, including Mark-to-Market • Structured Finance & Complex Derivatives • Ratings on Financial Instruments • New approaches to reflect type of asset, nature of risk Source: Insurance Information Institute

  10. Elements of Credit Market Reform Currently Being Considered Source: Wall Street Journal, 3/15/07

  11. Insurance &The EconomyImportant But Somewhat Muted Impacts

  12. 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.

  13. Real GDP Growth vs. Real P/C Premium Growth: Modest Association P/C insurance industry’s growth is influenced modestly by growth in the overall economy Sources: A.M. Best, US Bureau of Economic Analysis, Blue Chip Economic Indicators, 2/08; Insurance Information Inst.

  14. Summary of Economic Risks and Implications for (Re) Insurers

  15. New Private Housing Starts,1990-2014F (Millions of Units) Exposure growth forecast for HO insurers is dim for 2008/09 Impacts also for comml. insurers with construction risk exposure New home starts plunged 34% from 2005-2007; Drop through 2008 trough is 53% (est.)—a net annual decline of 1.09 million units 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. Source: US Department of Commerce; Blue Chip Economic Indicators (10/07), except 2008/09 figures from 3/08 edition of BCEF; Insurance Info. Institute

  16. Auto/Light Truck Sales,1999-2014F (Millions of Units) Weakening economy, credit crunch and high gas prices are hurting auto sales 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 8.3% 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 Source: US Department of Commerce; Blue Chip Economic Indicators (10/07), except 2008/09 figures from 3/08 edition of BCEF; Insurance Info. Institute

  17. Nonresidential Fixed Investment,* 2003 – 2012F Nonresidential Fixed Investment ($ Bill) Sharp dip in business investment growth in 2007/2008 will slow commercial exposure growth *Nonresidential fixed investment consists of structures, equipment and software. Sources: US Bureau of Economic Analysis (Historical), Value Line (2/22/08)estimates/forecasts for 2008-2012.

  18. Employment Change by Industry Jan. 2008 to Feb. 2008p Employment fell by 63,000 in February, the biggest decline in 5 years. Manufacturing and Construction are always the hardest hit in an economic slowdown, with each losing several hundred thousand jobs over the past 12 months. Sources: US Bureau of Labor Statistics; Insurance Information Institute.

  19. US Unemployment Rate,(2007:Q1 to 2009:Q4F) Rising unemployment rate negative impacts workers comp exposure and could signal a temporary claim frequency surge Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (3/08); Insurance Info. Inst.

  20. Wage & Salary Disbursements (Payroll Base) vs. Workers Comp Net Written Premiums Wage & Salary Disbursement (Private Employment) vs. WC NWP $ Billions $ Billions 7/90-3/91 3/01-11/01 Weakening wage and salary growth is expected to cause a deceleration in workers comp exposure growth Shaded areas indicate recessions *As of 7/1/07 (latest available). Source: US Bureau of Economic Analysis; Federal Reserve Bank of St. Louis at http://research.stlouisfed.org/fred2/series/WASCUR; I.I.I. Fact Books

  21. Inflation Rate (CPI-U, %),1990 – 2009F 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 *12-month change Feb. 2008 vs. Feb. 2007; Source: US Bureau of Labor Statistics; Blue Chip Economic Indicators, Mar. 10, 2008; Ins. Info. Institute.

  22. Favored Industry Groups for Insurer Exposure Growth Sources: Insurance Information Institute

  23. D&O/E&OTurbulent Markets, Bankruptcies Can Give Rise to Suits

  24. Shareholder Class Action Lawsuits* Pace of suits is up due in part to subprime issues, housing collapse and market volatility. Defendants include banks, investment banks, builders, lenders, bond and mortgage insurers A credit crunch creating a “contagion” effect resulting in significant financial distress and bankruptcies in other sectors could breed more securities litigation Includes 56 suits related to subprime in 2007/08 *Securities fraud suits filed in U.S. federal courts; 2008 figure is current through March 25. Source: Stanford University School of Law (securities.stanford.edu); Insurance Information Institute

  25. Origin of D&O Claims for Public Companies, 2006 40% of D&O suits originate with shareholders Source: Tillinghast Towers-Perrin, 2006 Directors and Officers Liability Survey.

  26. CATASTROPHE LOSS REVIEW A Decade of Disaster, With Mississippi in the Crosshairs

  27. Most of US Population & Property Has Major CAT Exposure Is Anyplace Safe?

  28. U.S. Insured Catastrophe Losses* $ Billions $100 Billion CAT year is coming soon 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. *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

  29. States With Largest Insured Catastrophe Losses in 2007 2007 CAT STATS • 1.18 million CAT claims across 41 states arising • 23 catastrophic events Source: PCS/ISO; Insurance Information Institute.

  30. Distribution of 2007 US CAT Losses, by Type and Insured Loss $ Billions 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.

  31. Inflation-Adjusted U.S. Insured Catastrophe Losses By Cause of Loss, 1987-2006¹ 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. 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)..

  32. Global Insured Catastrophe Losses by Region, 2001-2007 $ Billions North America accounted for 70% of global catastrophe losses 2001-2007 Notes: 2001-03 figures for N. America include US only. 2001 figure includes only property losses from 9/11. Source: Insurance Information Institute compiled from Swiss Re sigma issues.

  33. HURRICANE KATRINAA Review of Mississippi Insured Losses

  34. Top 10 Most Costly Hurricanes in US History, (Insured Losses, $2005) Seven of the 10 most expensive hurricanes in US history occurred in the 14 months from Aug. 2004 – Oct. 2005: Katrina, Rita, Wilma, Charley, Ivan, Frances & Jeanne Sources: ISO/PCS; Insurance Information Institute.

  35. Insured Loss & Claim Count for Major Storms of 2005* Hurricanes Katrina, Rita, Wilma & Dennis produced a record 3.3 million claims *Property and business interruption losses only. Excludes offshore energy & marine losses. Source: ISO/PCS as of June 8, 2006; Insurance Information Institute.

  36. Hurricane Katrina Claim Status on Storm’s 1st Anniversary* 95% of the 1.2 million homeowners insurance claims in Louisiana & Mississippi are settled, with just 2% in dispute *Hurricane Katrina made its north Gulf coast landfall August 29, 2005. Source: Insurance Information Institute survey, August 2006.

  37. Hurricane Katrina Claim Status on Storm’s 2nd Anniversary* 99% of the 1.2 million homeowners insurance claims in Louisiana & Mississippi were settled as of the storm’s second anniversary in 2007 *Hurricane Katrina made its north Gulf coast landfall August 29, 2005. **Unsettled implies that the claim is in the process of settlement, involved in mediation or litigated. Source: Insurance Information Institute survey, August 2007.

  38. Hurricane Katrina Insured Loss Distribution by State ($ Millions)* Mississippi accounted for 33.5% of the insured losses paid and 29.5% of the claims filed Total Insured Losses = $40.579 Billion *As of June 8, 2006 Source: PCS division of ISO.

  39. Hurricane Katrina Claim Count Distribution by State* MS accounted for 33.5% of the insured losses paid and 29.5% of the claims filed Total # Claims = 1,743,800 *As of June 8, 2006 Source: PCS division of ISO.

  40. Hurricane Katrina Loss Distribution by Line ($ Millions)* Total insured losses are estimated at $40.579 billion from 1.7438 million claims. Excludes $2-$3B in offshore energy losses Katrina had a disproportionate impact on businesses, decimating the economy and making recovery more difficult *As of June 8, 2006 Source: PCS division of ISO.

  41. Mississippi: Katrina Loss Distribution by Line ($ Millions)* Mississippi insured losses are estimated at $13.6 billion from 515,000 claims. Excludes $2-$3B in offshore energy losses *As of June 8, 2006 Source: PCS division of ISO.

  42. Mississippi: Katrina Claim Count Distribution by Line* Commercial (business) claims accounted for 11% of the claims filed but 55% of the insured losses. Homeowners claims accounted for 69% of claims and 40% of losses. *As of June 8, 2006 Source: PCS division of ISO.

  43. MS: Average Cost per Claim by Type of Claim* Commercial (business) claims were 9-10 times more expensive than homeowners claims on average for Hurricane Katrina, but accounted for just 11% of the total number of claims *As of June 8, 2006 Source: PCS division of ISO.

  44. Growth in Mississippi Construction Component of GDP Pre/Post-Katrina Insurance dollars helped construction spending surge in MS Sources: US Bureau of Economic Analysis; Insurance Information Inst.

  45. Mississippi Windstorm Plan:Exposure to Loss ($ Mill) Total exposure to loss in the Mississippi Windstorm Underwriting Association (MWUA) jumped to $5.4 billion in 2006 from $1.9 billion in 2005, an increase of 187%. The total number of policies in the Plan more than doubled between 2005 and 2006. Source: PIPSO; Insurance Information Institute

  46. Katrina’s Path of Destruction Through the Offshore Energy Industry Katrina (& Rita) tore through offshore facilities Source: “Hurricane Katrina: Profile of a Super Cat,” RMS, October 2005.

  47. Insured Offshore Energy Losses for Recent Major Gulf Storms Hurricanes Katrina, Rita and Ivan cost energy insurers at least $7 billion Sources: Insurance Information Institute research estimates. *Midpoint of estimated range for $2.0 to $2.5 billion)

  48. HURRICANES: INSURED LOSS POTENTIAL Katrina:Just the Beginning?

  49. Total Value of Insured Coastal Exposure (2004, $ Billions) Mississippi had $45 billion in insured coastal property exposure in 2004 compared to $209 billion in Louisiana and nearly $2 trillion in Florida Source: AIR Worldwide

  50. Value of Insured Residential Coastal Exposure (2004, $ Billions) Mississippi had $21 billion in insured residential coastal property exposure in 2004 (47% of all MS coastal exposure) Source: AIR

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