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Overview & Outlook for P/C Insurance Focus on Michigan Markets

Overview & Outlook for P/C Insurance Focus on Michigan Markets. Insurance Institute of Michigan Boyne Falls, MI June 19, 2007. Robert P. Hartwig, Ph.D., CPCU, President & Chief Economist Insurance Information Institute  110 William Street  New York, NY 10038

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Overview & Outlook for P/C Insurance Focus on Michigan Markets

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  1. Overview & Outlook for P/C InsuranceFocus on Michigan Markets Insurance Institute of Michigan Boyne Falls, MI June 19, 2007 Robert P. Hartwig, Ph.D., CPCU, 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. Presentation Outline • P/C Profit Overview—2006, A Cyclical Peak • Michigan Markets Overview • Underwriting Trends: Unsustainable? • Premium Growth: Approaching a Standstill • Pricing: Competitive Pressures Mounting • Capital & Capacity: UnderleveragedROE Pressure • Catastrophe Loss Management • What is the Appropriate Role for Government? • Reinsurance Summary • Financial Strength & Ratings • Investments: Less Bang for the Buck • Tort System: Great News for a Change (Mostly) • Legislative & Regulatory Update • Q&A

  3. P/C PROFIT:An Historical PerspectiveProfits in 2006 ReachedTheir Cyclical Peak

  4. P/C Net Income After Taxes1991-2006 ($ Millions)* Though up in 2006, insurer profits are highly volatile (2001 was the industry’s worst year ever). ROEs generally fall below that of most other industries. • 2001 ROE = -1.2% • 2002 ROE = 2.2% • 2003 ROE = 8.9% • 2004 ROE = 9.4% • 2005 ROE= 10.5% • 2006 ROAS1 = 14.0% *ROE figures are GAAP; 1Return on avg. Surplus. Sources: A.M. Best, ISO, Insurance Information Inst.

  5. ROE: P/C vs. All Industries 1987–2008E P/C profitability is cyclical, volatile and vulnerable Sept. 11 Hugo Katrina, Rita, Wilma Lowest CAT losses in 15 years Andrew Northridge 4 Hurricanes *2007-08 P/C insurer ROEs are I.I.I. estimates. Source: Insurance Information Institute; Fortune

  6. Profitability Peaks & Troughs in the P/C Insurance Industry, 1975 – 2008F 1977:19.0% 1987:17.3% 2006:14.0% 10 Years 1997:11.6% 9 Years 10 Years 1975: 2.4% 1984: 1.8% 1992: 4.5% 2001: -1.2% *2007-08 P/C insurer ROEs are I.I.I. estimates. Source: Insurance Information Institute; ISO, A.M. Best.

  7. Insurance & Reinsurance Stocks: Slow Start in 2007 in P/C, Reins. Total YTD Returns Through June 15, 2007 P/C insurance, reinsurance stocks lagging on soft market concerns and worries over 2007 hurricane season Source: SNL Securities, Standard & Poor’s, Insurance Information Institute

  8. Top Industries by ROE: P/C Insurers Still Underperformed in 2006* P/C insurer profitability in 2006 ranked 30th out of 50 industry groups despite renewed profitability P/C insurers underperformed the All Industry median for the 19th consecutive year *Excludes #1 ranked Airline category at 65.1% due to special one-time bankruptcy-related factors. Source: Fortune, April 30, 2007 edition; Insurance Information Institute

  9. Advertising Expenditures by P/C Insurance Industry, 1999-2005 Ad spending by P/C insurers is at a record high, signaling increased competition Source: Insurance Information Institute from consolidated P/C Annual Statement data.

  10. MICHIGAN MARKETSGrowth & Profitability Overview

  11. Growth in Direct Written Premiums: Michigan and US Decline in premiums in MI was marginal (-0.50%) in 2004-5 while US was down 2.5% Source: Insurance Information Institute; NAIC.

  12. ROE: P/C (US & MI) vs. All Industries, 1991–2005* MI has recently under-performed US P/C insurers. Source: Insurance Information Institute; NAIC, Fortune. *Latest available.

  13. ROE for Major Commercial Lines in Michigan, 1994 - 2005 Commercial Auto and CMP rebounded in Michigan in recent years Source: NAIC

  14. ROE for Personal Linesin Michigan, 1994 - 2005 12-Year Average: Auto: 4.2% Home: -1.2% Source: NAIC

  15. Rates of Return on Net Worth for Homeowners Ins: US vs. MI Will coastal insurers reallocate resources to Midwest/Plains? Averages: 1994 to 2005 US HO Insurance = 2.46% Michigan HO Insurance = -1.2% Source: NAIC, Insurance Information Institute

  16. Rates of Return on Net Worth for Pvt. Passenger Auto: US vs. MI Averages: 1994 to 2005 US PPA Insurance = +8.94% Michigan PPA Insurance = +4.2% Source: NAIC, Insurance Information Institute

  17. Rates of Return on Net Worth for Workers Comp: US vs. MI Averages: 1994 to 2005 US WC Insurance = +8.5% Michigan WC Insurance = +14.2% Source: NAIC, Insurance Information Institute

  18. Rates of Return on Net Worth for Comm. M-P: US vs. MI Averages: 1994 to 2005 US Comm. M-P Insurance = +5.4% Michigan Comm. M-P Insurance = +6.9% Source: NAIC, Insurance Information Institute

  19. Rates of Return on Net Worth for Comm. Auto: US vs. MI Averages: 1994 to 2005 US Comm. Auto Insurance = +6.9% Michigan Comm. Auto Insurance = +7.5% Source: NAIC, Insurance Information Institute

  20. PP AUTO: 10yr Avg Return on Equity, MI & Nearby States 1996-2005 Source: NAIC, Insurance Information Institute

  21. HOME: 10yr Avg Return on Equity, MI & Nearby States 1996-2005 Source: NAIC, Insurance Information Institute

  22. WC: 10yr Avg Return on Equity, MI & Nearby States 1996-2005 Source: NAIC, Insurance Information Institute

  23. UNDERWRITINGExtremely Strong 2006, Momentum for 2007/08

  24. P/C Insurance Combined Ratio, 1970-2008F Combined Ratios 1970s: 100.3 1980s: 109.2 1990s: 107.8 2000s: 102.4* *Through 2008E; 103.6 through 2006 actual. Sources: A.M. Best; ISO, III

  25. P/C Insurance Combined Ratio, 2001-2008F 2007/8 deterioration due primarily to falling rates, but results still strong assuming normal CAT activity As recently as 2001, insurers were paying out nearly $1.16 for every dollar they earned in premiums 2006 produced the best underwriting result since the 91.2 combined ratio in 1949 2005 figure benefited from heavy use of reinsurance which lowered net losses Sources: A.M. Best; ISO, III. *Estimates/forecasts based on III’s 2007 Early Bird survey.

  26. Ten Lowest P/C Insurance Combined Ratios Since 1920 The industry’s best underwriting years are associated with periods of low interest rates The 2006 combined ratio of 92.4 was the best since the 87.6 combined in 1949 Sources: Insurance Information Institute research from A.M. Best data.

  27. Underwriting Gain (Loss)1975-2006 Insurers earned an underwriting profit of $31.2 billion in 2006, the largest ever but only the second since 1978. Despite the 2006 underwriting profit, the cumulative underwriting deficit since 1975 is $419 billion. $ Billions Source: A.M. Best, Insurance Information Institute

  28. Commercial Lines Combined Ratio, 1993-2006E* Commercial coverages have exhibited extreme variability. Are current results anomalous? Outside CAT-affected lines, commercial insurance is doing fairly well. Caution is required in underwriting long-tail commercial lines. 2006 results will benefited from relatively disciplined underwriting and low CAT losses Source: A.M. Best; Insurance Information Institute .

  29. Personal LinesCombined Ratio, 1993-2006E A very strong 2006 resulted from favorable frequency & severity trends and low CAT activity Source: A.M. Best; Insurance Information Institute.

  30. Impact of Reserve Changes on Combined Ratio Reserve adequacy has improved substantially Source: A.M. Best, Lehman Brothers for years 2005E-2007F

  31. PREMIUM GROWTHDeceleration in 2006, Even Slower in 2007

  32. Strength of Recent Hard Markets by NWP Growth* 1975-78 1984-87 2001-04 2006-2010 (post-Katrina) period could resemble 1993-97 (post-Andrew) 2005: biggest real drop in premium since early 1980s *2007-10 figures are III forecasts/estimates. 2005 growth of 0.4% equates to 1.8% after adjustment for a special one-time transaction between one company and its foreign parent. 2006-2008 figures from III Groundhog Survey. Note: Shaded areas denote hard market periods. Source: A.M. Best, Insurance Information Institute

  33. Growth in Net Written Premium, 2000-2008F P/C insurers will experience their slowest growth rates since the late 1990s…but underwriting results are expected to remain healthy Source: A.M. Best; Forecasts from the Insurance Information Institute’s Groundhog survey: http://www.iii.org/media/industry/financials/groundhog2007/.

  34. PRICING Under Pressure in 2007

  35. *Insurance Information Institute Estimates/Forecasts Source: NAIC, Insurance Information Institute Average Expenditures on Auto Insurance Countrywide auto insurance expenditures are expected to fall 0.5% in 2007, the first drop since 1999 Lower underlying frequency and modest severity are keeping auto insurance costs in check

  36. Average Homeowners Insurance Expenditure, Selected States, 2004* 5 most expensive states are mostly coastal Most Midwest states have below average home insurance costs. OH ranks 45th and WI 49th ID, UT are the least expensive Source: NAIC; Insurance Information Institute. *Latest available.

  37. *Insurance Information Institute Estimates/Forecasts **Excludes cost of flood and earthquake coverage. Source: NAIC, Insurance Information Institute Average Expenditures on Homeowners Insurance** Countrywide home insurance expenditures rose an estimated 6% in 2006, 4% in 2007 Homeowners in non-CAT zones will see smaller increases, but larger in CAT zones

  38. Average Commercial Rate Change,All Lines, (1Q:2004 – 1Q:2007) Magnitude of rate decreases diminished greatly after Katrina but have grown again KRW Effect Source: Council of Insurance Agents & Brokers; Insurance Information Institute

  39. Average Commercial Rate Change by Line: 4Q99 – 1Q07 Commercial accounts trended downward from early 2004 to mid-2005 though that trend moderated post-Katrina Source: Council of Insurance Agents & Brokers

  40. Percent of Commercial Accounts Renewing w/Positive Rate Changes, 2ndQtr. 2006 Largest increases for Commercial Property & Business Interruption are in the Southeast, smallest in Midwest Source: Council of Insurance Agents and Brokers

  41. Percent of Commercial Accounts Renewing w/Positive Rate Changes, 1stQtr. 2007 Commercial Property & Business Interruption increases are disappearing in the Southeast; Completely gone in the Midwest & Northeast “Soft” market seemed to hit Midwest about 1 year before the rest of the US Source: Council of Insurance Agents and Brokers

  42. CAPACITY/SURPLUSThe Industry in Underleveraged

  43. U.S. Policyholder Surplus: 1975-2006 Capacity as of 12/31/06 was $487.1B (est.), 14.4% above year-end 2005, 71% above its 2002 trough and 46% above its 1999 peak. $ Billions Foreign reinsurance and residual market mechanisms absorbed 45% of 2005 CAT losses of $62.1B “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.

  44. Annual Catastrophe Bond Transactions Volume, 1997-2006 Catastrophe bond issuance has soared in the wake of Hurricanes Katrina and the hurricane seasons of 2004/2005 Source: MMC Securities and Guy Carpenter; Insurance Information Institute.

  45. MERGER & ACQUISITIONFew Catalysts for Major P/C Consolidation

  46. P/C Insurance-Related M&A Activity, 1988-2006 IN 2007, Liberty Mutual acquired Ohio Casualty for $2.7B, D.E. Shaw acquired James River for $575 million* No model for successful consolidation has emerged *Announced May 7 and June 11, respectively. Source: Conning Research & Consulting.

  47. INVESTMENT IRONYMarkets & Interest Rates Up, Returns Flat

  48. Property/Casualty Insurance Industry Investment Gain* Investment gains fell in 2006 and are now only comparable to gains seen in the late 1990s *Investment gains consist primarily of interest, stock dividends and realized capital gains and losses. 2006 figure consists of $52.3B net investment income and $3.4B realized investment gain. **2005 figure includes special one-time dividend of $3.2B. Source: ISO; Insurance Information Institute.

  49. CATASTROPHICLOSSInsurers Accused of Crying Wolf Over Cats

  50. U.S. Insured Catastrophe Losses* $ Billions $100 Billion CAT year is coming soon 2006 was a welcome respite. 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

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