Steven N. Weisbart, Ph.D., CLU, Vice President & Chief Economist

1. Catastrophes,the Credit Crunch,and the Insurance CycleImpacts & Implicationsfor the P/C Insurance Industry Casualty Actuaries of the Mid-Atlantic Region Sheraton University City Hotel Philadelphia, PA June 5, 2008 Steven N. Weisbart, Ph.D., CLU, Vice President & Chief Economist Insurance Information Institute  110 William Street  New York, NY 10038 Tel: (212) 346-5540  Cell: (917) 494-5945 stevenw@iii.org  www.iii.org

2. The Weakening Economyandthe Credit Crunch

3. Real Annual GDP Growth, 2000-2009F Blue bars are actual; Yellow bars are forecasts March 2001-November 2001 recession Recession? Sources: US Department of Commerce, Blue Economic Indicators 4/08; Insurance Information Institute.

4. Real Quarterly GDP Growth, 2005-2009F Red bars are actual, seasonally adjusted; Yellow bars are forecasts 3 Major hurricanes Recession? Sources: US Department of Commerce; Blue Economic Indicators 4/08; Insurance Information Institute.

5. Case-Schiller Home Price Index Monthly: 20 City Composite (Jan 2000=100) Peak in July 2006 at 206.52. Home prices more than doubled between January 2000 and July 2006 Home prices are now about where they were in Oct 2004 March 2008 index value was 172.16: home prices were 16.6% below their July 2006 peak Source: http://www2.standardandpoors.com/spf/pdf/index/CSHomePrice_History_052703.xls

6. New Private Housing Starts,1990-2014F (Millions of Units) I.I.I. estimate: 100,000 housing starts = $87.5 million in gross premium. 2008 vs. 2005 net premium loss is $954 million (I.I.I. est). Source: US Department of Commerce; Blue Chip Economic Indicators (10/07), except 2008/09 figures from 4/08 edition of BCEI; Insurance Info. Institute

7. Housing Starts, Annual Data The slump is in single-family housing. Starts of multi-family buildings have held at 310,000 to 350,000 units each year. Thousands of Units Source: US Census Bureau

8. Quarterly Housing Starts The slump is in single-family housing. Starts of multi-family buildings have held at 70,000 to 90,000 units each quarter. Thousands of Units Source: US Census Bureau

9. Homeowner Vacancy Rates,Quarterly, 1990-2008:Q1 July 1990-March 1991 recession March 2001-November 2001 recession Vacancy rates began rising in 2005:Q3 Source: U.S. Census Bureau, http://www.census.gov/hhes/www/housing/hvs/qtr108/q108tab1.html

10. Rental Vacancy Rates,Quarterly, 1990-2008:Q1 July 1990-March 1991 recession March 2001-November 2001 recession Vacancy rates began falling in 2004:Q2 Source: U.S. Census Bureau, http://www.census.gov/hhes/www/housing/hvs/qtr108/q108tab1.html

11. Auto/Light Truck Sales,1999-2014F (Millions of Units) Weakening economy, credit crunch, high gas prices hurt auto sales 2008 vs. 2005: -8.3% Falling auto sales will have a smaller 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 BCEI; Insurance Info. Institute

12. Do Increases in Gas Prices AffectAuto Collision Claim Frequency? Paid Claim Frequency = (No. of paid claims)/(Earned Car Years) x 100 Sources: Energy Information Administration (http://tonto.eia.doe.gov/dnav/pet/hist/mg_tt_usA.htm); ISO Fast Track Monitoring System, Private Passenger Automobile Fast Track Data: Fourth Quarter 2007, published March 31, 2008 and earlier reports.

13. Do Changes in Miles Driven AffectAuto Collision Claim Frequency? Paid Claim Frequency = (No. of paid claims)/(Earned Car Years) x 100 Sources: Federal Highway Administration (http://www.fhwa.dot.gov/ohim/tvtw/08martvt/08martvt.pdf; ISO Fast Track Monitoring System, Private Passenger Automobile Fast Track Data: Fourth Quarter 2007, published March 31, 2008 and earlier reports.

14. Miles Driven vs. Gas Pricesin Recent Months Gas Price/ Gallon Miles Driven 2008 2007 Sources: Energy Information Administration (http://tonto.eia.doe.gov/dnav/pet/hist/mg_tt_usA.htm); Federal Highway Administration (http://www.fhwa.dot.gov/ohim/tvtw/08martvt/08martvt.pdf; .

15. Inflation Rate (CPI-U), % Changefrom Prior Quarter, Annualized Inflation is up again. Medical cost inflation, important in WC, auto liability and other casualty covers is running far ahead of overall inflation. Source: US Bureau of Labor Statistics; Blue Chip Economic Indicators, Apr. 10, 2008; Ins. Info. Institute.

16. US Unemployment Rate,(2007:Q1 to 2009:Q4F) Higher unemployment rate reduces workers comp exposure; could signal a temporary claim frequency surge Blue bars are actual; Yellow bars are forecasts Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (4/08); Insurance Info. Inst.

17. Implications forthe P/C Insurance Industry

18. 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, 4/08; I.I.I.

19. 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

20. What’s Being Done to “Fix” the Economy?

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

22. Post-Crunch:Four Fundamental IssuesTo Be Examined Globally

23. Post-Crunch: Fundamental Issues To Be Examined Globally • Effectiveness and Nature of Regulation • What sort of oversight is optimal given recent experience? • Credit problems arose under both US and European (Basel II) regulatory regimes • Will new regulations be globally consistent? • Can overreactions be avoided? • Capital adequacy & liquidity • Ratings on Financial Instruments • New approaches to reflect type of asset, nature of risk Source: Insurance Information Institute

24. 2 More Fundamental IssuesTo Be Examined Globally • Adequacy of Risk Management at Financial Institutions Worldwide • Colossal failure of risk management (and regulation) • Implications for ERM? • Includes review of incentives • Accounting Rules • Problems arose under FAS, IAS • Asset Valuation, including Mark-to-Market • Structured Finance & Complex Derivatives Source: Insurance Information Institute

25. Legal Aspectsof the Credit CrunchTurbulent MarketsGive Rise to Lawsuits

26. Shareholder Class Action Lawsuits* Count is current as of May 30. Suits filed/year Defendants include banks, investment banks, builders, lenders, bond and mortgage insurers *Securities fraud suits filed in U.S. federal courts. Not included above are 313 suits (all but 1 filed in 2001) relating to IPO allocations. Source: Stanford University School of Law (http://securities.stanford.edu

27. 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.

28. Catastrophic Losses

29. On Average, the U.S. has a $35B+ (Direct EconomicLosses, 2005 $) Catastrophic Year Every 8 Years Chart shows effects of hurricanes but not other causes of catastrophic levels of property loss. 27 Years Sources: Source: Roger Pielke et al, “Normalized Hurricane Damage in the United States: 1900-2005,” NaturalHazards Review, Vol. 9, No. 1 (February 1, 2008), pp. 29-41; Bonnie Cavanaugh, “A Century of Aftershocks,” Best’s Review, April 2006, pp. 24-31.

30. Largest Insured Losses (Adjusted to 2005 Exposure Levels) from 10 Hurricanes With continued coastal development, $35B+ storms will be more common. 32 Source: AIR Worldwide **ISO/PCS estimate as of June 8, 2006

31. Insured Losses (adjusted to 2005 exposure levels) from 10 Most Damaging US Earthquakes 3 of the Top 10 are not West Coast events With development along major fault lines, the threat of $30B+ quakes looms large Source: AIR Worldwide

32. Number of Tornadoes, 1985 – 2007 There are usually more than 1,000 confirmed tornadoes each year in the US. They accounted for about 25% of catastrophe losses since 1985. Sources: US Dept. of Commerce, Storm Prediction Center, National Weather Service,at http://www.spc.noaa.gov/climo/torn/monthlytornstats.pdf

33. Top Five Catastrophic Wildland Fires In California, 1970-2007* Insured Losses (Billions 2006 $) *Estimated insured losses. Adjusted to 2006 dollars by the Insurance Information Institute. 2007 fire losses are stated in 2007 dollars.Source: ISO's Property Claim Services Unit; Insurance Information Institute.

34. Global Insured Catastrophe Lossesby Region, Excluding U.S.,2001-2007 Sources: Insurance Information Institute compiled from Swiss Re sigma issues.

35. Don’t Overlook the Catastrophes that Didn’t Happen (or Haven’t Yet) • In 2007 two Category 5 storms struck the Gulf of Mexico • Luckily for the U.S., neither made landfall here • Unluckily for Mexico, both made landfall there. • Stephen Flynn’s The Edge of Disaster • Nassim Taleb’s Fooled by Randomness and The Black Swan

36. U.S. Insured Catastrophe Losses* 2004 and 2005 remind us that it’s possible to suffer damage from more than one hurricane and/or other catastrophe in a year. 2007 (in Mexico) reminds us that it’s possible to have two CAT-5 storms in one year. $ Billions Is a $100 Billion CAT year coming soon? *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

37. 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)..

38. The 2008 Hurricane Season:Is a Bad Year in the Forecast?

39. Number of Major (Category 3, 4, 5) Hurricanes Striking the US by Decade Mid 1920s – mid-1960s: AMO Warm Phase Mid-1990s – 2030s? AMO Warm Phase Already as many major storms in 2000-2007 as in all of the 1990s *Figure for 2000s is extrapolated based on data for 2000-2007 (6 major storms: Charley, Ivan, Jeanne (2004) & Katrina, Rita, Wilma (2005)). Source: Tillinghast from National Hurricane Center: http://www.nhc.noaa.gov/pastint.shtm.

40. Atlantic Sea Surface Temperatures, 1948-2007 Source: AIR web site, http://www.air-worldwide.com/_public/html/air_currentsitem.asp?ID=1364

41. Outlook for 2008 Hurricane Season: 60% Worse Than Average *Average over the period 1950-2000. Source: Philip Klotzbach and Dr. William Gray, Colorado State University, April 9, 2008.

42. Major Hurricanes Might FormBut Not Make Landfall • From Hurricane Irene in 1999 to Hurricane Lili in 2002, 21 consecutive hurricanes developed in the Atlantic basin without a single U.S. landfall. • “This is how nature sometimes works.” • From 1966 to 2003, of 79 major (3-4-5) hurricanes, 19 (24%) made landfall. • During 2004-5, 7 of 13 (54%) major hurricanes made landfall • During 2006-7, 0 of 4 (0%) major hurricanes made landfall Source: Philip Klotzbach and William Gray, “Extended Range Forecast of Atlantic Seasonal Hurricane Activity and U.S. Landfall Strike Probability for 2008,” Department of Atmospheric Science, Colorado State University, April 9, 2008, p. 27.

43. Catastrophe Litigation

44. P/C Insurers Have Won Virtually Every Major Post-Katrina Case • Most cases centered on validity of flood exclusion and various wind vs. water theories • The victories in court came at a high public relations cost • Post-Katrina litigation was dragged out over a 2+-year period accounting for the vast majority of negative press in the first 16 months after the storm • While the industry was successful at explaining the rationale for pursuing most cases, it struggled with the classic David vs. Goliath story • The hostile stories feed “Insurance Hoax” genre of stories • View that insurers systematically deny, delay and lowball • Bad Faith litigation might be wave of future (e.g., LA AG suit) • FL significantly added to negative press in 2007 • Exacerbated by hundreds of thousands of nonrenewals

45. Flood InsurancePeople Buy It After a Flood…but Just for a Year or Two

46. Number of New NFIP Flood Policies in the Gulf States Since Katrina* The number of flood insurance policies sold in the Gulf states in the 2 years following Katrina increased by 618,335 or 21.6% *Change from July 2005 through August 2007. Sources: NFIP ; Insurance Information Institute.

47. Percent Growth of NFIP Flood Policies in Gulf States Since Katrina* The number of flood insurance policies sold in the Gulf states in the 2 years following Katrina increased by 21.6% *Change from July 2005 through August 2007. Sources: NFIP ; Insurance Information Institute.

48. Percentage of NFIP Flood Policies Issued Since Katrina That Are Not Renewed* Flood policy nonrenewal rates in Gulf states are surprisingly high *Policies issued since July 2005 as of August 2007. **US figure is nonrenewal rate for all policies in force, average over 12 month period ending August 2007. Sources: NFIP ; Insurance Information Institute.

49. What Could Happenin theMid-Atlantic States?

50. Nightmare Scenario: Insured Property Losses for NJ/NY CAT 3/4 Storm Insured Losses: $110B Economic Losses: $200B+ Distribution of Insured Property Losses, by State, ($ Billions) Total Insured Property Losses = $110B, nearly 3 times that of Hurricane Katrina Source: AIR Worldwide