Trends & Challenges in P/C Insurance Business Today Focus on Iowa Markets

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

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

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

4. P/C INSURANCE FINANCIAL UPDATE

5. Highlights: Property/Casualty Full-Year 2003 vs. 2002

6. Highlights: Property/Casualty 1st Qtr. 2004 vs. 1st Qtr. 2003 *2003 surplus figure is as of 12/31/03 **The combined ratio for full-year 2003 was 100.1

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

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

9. P/C Net Income After Taxes1991-2004E* ($ Millions) • 2001 was first-ever full year net loss • 2002 ROE = 1.0% • 2003 ROE = 9.4% • 2004 ROE = 15.0% (est.) *First quarter results Sources: A.M. Best, ISO, Insurance Information Institute.

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

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

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

13. RNW for Personal Lines in Iowa1991 - 2002 10-Year Average: Auto: 6.6% Home: -10.7% (93-02) Homeowners experience has been very bad and volatile in Iowa, reflecting national trends. Source: NAIC

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

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

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

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

18. 2002 Return on Equity:Iowa & Nearby States PP Auto 2002 Source: NAIC, Insurance Information Institute

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

20. WALL STREET:HIGH EXPECTATIONS

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

22. UNDERWRITING PERFORMANCE

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

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

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

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

27. Key Auto Insurance Stats: IA vs. US2003 vs. 2004* +1.8% +3.4% +2.9% +1.9% * Average for 4 quarters ending with the 1st quarter of 2004 vs. 4 Qtrs ending Q1:03. Source: Insurance Services Office, Insurance Information Institute

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

29. U.S. InsuredCatastrophe Losses ($ Billions) 2004 could become the second worst year ever for natural disaster losses in the US $ Billions *2004 figure is 2004 estimate as of September 20, 2004. Note: 2001 figure includes $20.3B for 9/11 losses reported through 12/31/01. Includes only business and personal property claims, business interruption and auto claims. Source: Property Claims Service/ISO; Insurance Information Institute

30. WHY UNDERWRITING DISCIPLINE MATTERS

31. A 100 Combined Ratio Isn’t What it Used to Be: 95 is Where It’s At Combined ratios today must be below 95 to generate Fortune 500 ROEs * 2004 figure is return on average statutory surplus based in first quarter data Source: Insurance Information Institute from A.M. Best and ISO data.

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

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

34. RATINGS, SOLVENCY, FINANCIAL STRENGTH

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

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

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

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

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

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

41. INVESTMENTS:NO SUBSTITUTE FOR SOUND UNDERWRITING

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

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

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

45. CAPACITY CRUNCH?

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

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

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

49. PRICING TRENDS

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