Property & Casualty Market Overview and

1. Property & Casualty Market Overview and “Reconciling Environmental Disclosure With Environmental Exposure In An Evolving Regulatory Climate” February 17, 2004 Sean Kenny, National Accounts Manager Chicago Region AIG Environmental

2. 2003 • 2002 • Change • Net Written Prem. • 308,554 • 280,297 • +10.1% • Loss & LAE • 217,656 • 206,234 • +5.5% • Net UW Gain (Loss) • (5,698) • (18,238) • -68.8% • Net Inv. Income • 27,704 • 26,853 • +3.2% • Net Income (a.t.) • 21,107 • 5,018 • +320.6% • Surplus* • 319,922 • 285,400 • +12.1% • Combined Ratio • 100.3 • 105.0 • -4.7 pts. Highlights: Property/Casualty First Nine Months 2003 *Comparison with year-end 2002

3. Number of Insurer Upgrades Vs. Downgrades, 1993 to 2003* • Downgrades have outpaced upgrades by nearly 4:1 since 2000 • Are we at a peak? *North American insurance holding companies through October 17, 2003 Source: Standard & Poor’s

4. Rate on Line Index (1989+100) Prices rising, limits falling: ROL up significantly Source: Guy Carpenter * III Estimate

5. P/C Company Insolvency Rates, 1993 to 2002 • Insurer insolvencies are increasing • 10-yr industry failure rate: 0.72% • Failure rating for B+ or better rating: 0.49% • Failure rate for D through B rating: 1.29% 10-yr Failure Rate = 0.72% 30 30 38 Source: A.M. Best; Insurance Information Institute

6. P/C Insurance Industry Prior Year Reserve Development* Adverse reserve development of about $23 billion accounted for most of the industry’s 2002 underwriting loss and “ate” much of the industry’s $37 billion increase in earned premiums *Negative numbers indicate favorable development; positive figures represent adverse development. Source: A.M. Best, Morgan Stanley, Dowling & Partners Securities

7. Combined Ratio: Impact of Reserve Changes (Points) Adverse reserve development totaling an estimated $23 billion added more than 6 points to the p/c combines ratio in 2002 Source: ISO, A.M. Best, MorganStanley.

8. P/C COST DRIVERS Macro Factors

9. U.S. Policyholder Surplus: 1975-2003* • 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 (a trough?) • Surplus during the first half of 2003 rose by $34.5B or 12.1% to $319.9B $19.4 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, Insurance Information Institute *As of 9/30/03.

10. Net Investment Income Investment income fell 2.8%in 2002 but rose 3.2% in the first 9 months of 2003 vs. first 9 months of 2002 -$4.6 Billion Billions (US$) • History • 1997 Peak = $41.5B • = $40.7B • = $37.7B • = $36.7B • E = $36.9B Note: 2003 estimate is based on annualized 9-month investment income of $27.704 billion. Source: A.M. Best, Insurance Information Institute

11. Interest Rates: Lower Than They’ve Been in Decades • Historically low interest rates are the primary driver behind lower investment yields. Nevertheless, overall insurer investment performance outpaces all major market indices and almost every major category of mutual fund. • 66% of the industry’s invested assets are in bonds *Average for December 2003. Source: Board of Governors, Federal Reserve System; Insurance Information Institute

12. Property/Casualty Insurance Industry Investment Gain* Investment gains are simply returning to “pre-bubble” levels *Investment gains consists primarily of interest, stock dividends and realized capital gains and losses. Source: Insurance Services Office; Insurance Information Institute estimate annualized as of 9/30/03.

13. Med Claim Costs Rising Sharply Health care inflation is affecting the cost of medical care, no matter what system it is delivered through Source: NCCI; William M. Mercer, Insurance Information Institute.

14. Cost of U.S. Tort System ($ Billions) Tort costs consumed 2.23% of GDP in 2002 Per capita “tort tax” expected to rise to $1,003 by 2005, up from $807 in 2001 Source: Tillinghast-Towers Perrin.

15. Average Jury Awards 1994 vs. 2001 *Figure is for 2000 (latest available) Source: Jury Verdict Research; Insurance Information Institute.

16. Who Will Pay for the US Asbestos Mess? Estimated Total US Settlements & Expenses = $200 billion $78 billion $60 billion $62 billion Source: Tillinghast-Towers Perrin; Insurance Information Institute

17. Claims Filed Against U.S. Silica By Claimant (1997-2003) • Leading industrial sand producer U.S. Silica today faces more than 22,000 silica claims! • Some 15,342 plaintiffs have named the company in lawsuits so far in 2003 - triple the number seen in 2002! Some 87% of the lawsuits filed are from Mississippi and Texas! Source: Coalition for Litigation Justice; (* through 6/30/03)

18. Texas: Mold Losses/Claims Are Finally Moderating* * Data are for TDI Cause 61: Discharge – Other Damage. Not all claims in cause 61 are mold and mold claims may also arise from other (non-water) causes of loss. Source: Texas Department of Insurance; Insurance Information Institute

19. Market Effect: Industry Snapshot • Losses Outweigh Gains : P&C insurers paid $5.7 Billion more in claims & expenses, than they collected in premium in the first nine months of 2003, and $18.2 more in the full year 2002 (data from Insurance Information Institute) • Reserve Deficiency: 2002 P&C adverse reserve development $23 Billion, added 6 points to industry combined ratio • Capacity Rising: Expected to continue through 2004 • Insolvency Rising: 2002 rate nearly double the 10 year rate (1993-2002) • More Downgrades: Ratio of downgrades: upgrades nearly 4:1 since 2000

20. How to Manage the Market: • Watch / know ratings: • Understand what ratings mean. Senior Debt ratings can be telling for long-tail lines. • Among the 10 carriers we track that write environmental insurance, fully 5 have had ratings downgrades since June 2003. • If it seems too good to be true, it probably is--Be wary of irrational pricing • Examine a carrier’s reinsurance collectable exposure • Ask about claims management expertise of carriers • Provide accurate loss data so your carrier can underwrite the risk appropriately

21. How to Manage the Market: • Be wary of new capital • Avoid 1-year remedies • Judge carrier commitment: look for longevity in market

22. History of under-disclosure + New financial reporting and audit rules + Weaknesses in internal controls + New legal standards + Insurance coverage gaps = New risks for Corporate America Overview of Environmental Disclosure

23. An Analogy for Illustration…. • The Known Knowns • Quantified and fully disclosed environmental liabilities and costs • The Known Unknowns • Identified “contingent” environmental liabilities and risks with uncertain future financial impact (may or may not be disclosed) • The Unknown Unknowns • Environmental impairments, contingent liabilities and risks often associated with historical releases of pollutants • Often known or suspected by employees and contractors, but unknown to senior management and the board • No pending legal action • Not disclosed to shareholders • Probably not identified to financial auditors • Probably uninsured

24. What Lies Beneath? The “known knowns”& “known unknowns”? The “unknown unknowns”?

25. Accounting Rules are Evolving - You Need a Plan! • SOX Section 302 CEO/CFO certifications “fairly present….” • SOX Section 404 attestation to “effectiveness” of ”financial controls” • FAS 143 clarifies need to recognize environmental related Asset Retirement Obligations (ARO’s) up front • What to investigate, what to report, how to disclose (under your terms, not the SEC’s) • Is there a plan to investigate, report and market/clean-up environmentally impaired assets? The ‘fence & lock/don’t ask, don’t tell’ game will no longer fly.

26. SEC Proposal on Critical Accounting Policies SEC proposal would mandate extensive disclosure surrounding any accounting estimates where: • Assumptions are relied upon; • Subject matter is highly uncertain; • There are a range of estimates; or • Changes will have a material impact. …….. All characteristic of environmental liabilities

27. Internal ControlsInternal ControlsInternal Controls

28. Potential Weaknesses in Controls • Areas of concern • Risk identification and investigation • Valuation methodologies • Determination of materiality • “Beyond-GAAP” reporting • Organizational disincentives • Disclosure controls and procedures • Corporate governance • Audit inquiry letters • Management override • Key Question: Is “don’t ask, don’t tell” still a viable policy?

29. What’s at Stake? • Violate debt covenants • Qualified Audit Opinions • Mid period re-statements • Decline in share price • Shareholder suits • Anonymous complaint channels • Uninsured Personal Liability of D’s & O’s • The “Perp Walk”

30. 10-K Environmental Disclosures……. • Lease disclosure…… • (the Company) has the option to extend the lease or purchase the facilities. If the lessee does not choose either of these options, then it must sell the assets on behalf of the lessor and guarantee a residual value of up to $545 million based on an estimated total lessor’s investment of $657 million for both projects combined. If the financing is terminated early as a result of significant environmental damage, the lessee could be obligated to pay up to 100% of the lessor’s investment in the facilities. • ($657 million, or $112 million of exposure). .

31. …..Don’t Always Add Up • The schedule below shows this same company’s capital expenditure projections for environmental for the years 2003-2007, and actual spending for the year 2002: Actual Projected 200220032004200520062007 $20 $5 $5 $12 $50 $96

32. Guidance….HUH? Conditions for “Accrual” The Company has identified certain events which could give rise to a loss, but which do not meet the conditions for accrual under SFAS 5. SFAS 5 requires disclosure, but not a recording, of potential losses when it is “reasonably possible” that a loss has been incurred. FASB defines “reasonably possible, as cases in which “the chance of the future event or events occurring is more than remote but less than likely.”

33. A Proactive Approach……... • During 2002, we purchased an environmental insurance policy which covers the costs of remediation activities at the identified sites and remains in effect for 30 years. As a result, we will receive reimbursements from the insurance company for environmental remediation costs we incur. • Upon the purchase of this policy, we recorded receivables from the insurance company within other current assets and other non-current assets in amounts equal to our environmental accruals.

34. A Proactive Approach……... “…….This insurance program will allow us to quantify and, within the limits of the policy, cap our cost to remediate the site, and provide insurance coverage from future third party claims arising from past or future environmental releases.” “The remediation cost overrun policy has a term of ten years and provides $25 million in coverage in excess of a self-insured retention amount of $26 million. The pollution legal liability policy provides for $25 million in aggregate closure coverage…..”

35. Environmental Insurance • Enhance Disclosure • Protect Assets, Actions, etc. • Ensure Investor and Shareholder Confidence

36. Environmental Insurance Insurance Products to Manage Environmental Liabilities: • Cleanup Cost Cap • Pollution Legal Liability • Environmental Protection Programs

37. Cleanup Cost Cap Provides Coverage for Cost Overruns of Remediation Projects associated with: • Actual contamination exceeding estimates • New found contamination discovered during remediation • Off-site cleanup costs for conditions emanating from the covered location • Government change orders received during the policy term

38. Cleanup Cost Cap Cleanup Cost Cap Site Boundaries ActualContamination

39. Cleanup Cost Cap Cleanup Cost Cap Program Cost Overrun Coverage LIMIT BufferLayer Self-Insured Retention Expected Cost

40. Cleanup Cost Cap EXAMPLE: • Large petroleum & gas company. • $400 million of estimated environmental liabilities. • 34 sites at various stages of the cleanup process. • Includes both currently and previously owned sites. • Purchased a policy with aggregate limits of $50,000,000 excess of the Self-Insured Retention for a 10 year term. • Coverage was available for all sites within the portfolio.

41. Pollution Legal Liability Provides Coverage for: • On- and off-site cleanup of pollution conditions • On- and off-site third party bodily injury and property damage associated with pollution conditions • Legal Defense • Non-Owned Disposal Sites • Transported Cargo • Business Interruption

42. Pollution Legal Liability Known And Unknown Coverage Unknown Site Boundaries Cleanup Cost Cap Known Known But Not Actionable Unknown

43. Pollution Legal Liability EXAMPLE: • Company signed settlement agreement with historical general liability insurers. • Needed to release historical insurance from any claims as part of settlement. • Company was concerned about releasing coverage for environmental liabilities arising from past activities, as well as insuring against environmental liabilities arising from future events.

44. Environmental Protection Programs Environmental Protection Programs Basic Structure: • Annual Expected Costs are estimated. • Annual Expected Costs are discounted. • Excess coverage is provided. • Rewards for favorable loss experience.

45. Environmental Protection Programs

46. Environmental Protection Programs Benefits: • Excess coverage is provided • Can be used to provide financial assurance to regulatory agencies, investors or other parties. • Insurance Premiums are generally tax deductible - Program may enable the insured to accelerate their tax deduction associated with their environmental liabilities • Insured can disclose that they have secured a program from a AAA company

47. Environmental Protection Programs EXAMPLE: • Mining Company with financial assurance obligations of over $225 million for mine reclamation. • Company was engaged in a prepackage bankruptcy filling. • Mining operations in 5 states with over 600 bonds required. • Purchased an EPP policy which was used to secure the required financial assurance bonds, enabling them to remain a going concern.

48. Environmental Insurance Insurance Products used to manage Environmental Liabilities: Cleanup Cost Cap: Cost overrun protection for current remediation projects

49. Environmental Insurance Insurance Products used to manage Environmental Liabilities: Pollution Legal Liability: Insurance protection covering cleanup, bodily injury, property damage and legal costs associated with “new” environmental liabilities arising from past, current and future operations.

50. Environmental Insurance Insurance Products used to manage Environmental Liabilities: Environmental Protection Programs: Pays on behalf of the insured for all costs associated with current cleanup projects while providing overrun protection along with other environmental insurance.