CAN THE COMMERCIAL P&C INDUSTRY MAKE GOOD RETURNS? PERSPECTIVES ON INDUSTRY STRUCTURE

1. NY-262511.027/030514YdmanHR1 CAN THE COMMERCIAL P&C INDUSTRY MAKE GOOD RETURNS?PERSPECTIVES ON INDUSTRY STRUCTURE Mark Shapiro – McKinsey Casualty Actuarial Society Conference May 19, 2003 This report is solely for the use of client personnel. No part of it may be circulated, quoted, or reproduced for distribution outside the client organization without prior written approval from McKinsey & Company. This material was used by McKinsey & Company during an oral presentation; it is not a complete record of the discussion.

2. Asset risk • Economics of demand • Pricing & Marketing • Profitability/Value creation • Hazard risk • Economics of supply • Capacity change • Technological progress • Regulatory changes • Bargaining power of industry ‘chain’ • Distribution • Employment objectives • Technology breakthroughs • Threat of new entrants • Internal efficiency and effectiveness • Threat of substitution NY-262511.027/030514YdmanHR1 HOW CAN WE ANALYZE INDUSTRY ATTRACTIVENESS? • S • C • P • Industry • Producers • External • shocks • Industry structure • Provider conduct • Company performance

3. NY-262511.027/030514YdmanHR1 INDUSTRY STRUCTURE • Barriers to entry low • Limited scale economies • Mature products • Limited brand identity • Switching costs low • Access to distribution • Cost advantages generally difficult to sustain • New entrants • Supplier power moderate to high • Skills and talent challenge • Low returns foster investor skepticism • Strong belief in the ‘cycle’ • Industry competitors • Intensity of rivalry • Suppliers • Buyers • Buying power high • Concentrated distribution • Product “relevance” and value to corporates declining • Price-driven intermediaries • High price sensitivity • Rivalry high • Industry growth low • Longstanding overcapacity • Product differences limited • Brand identity limited • Switching costs low • Exit barriers high • Shortening product life cycles • Limited gains from M&A • Insolvencies drawn out/rare • Limited product innovation • Substitutes • Substitution threat moderate to high • Self insurance growing • ‘Relevance’ of commodity products declining

4. NY-262511.027/030514YdmanHR1 INDUSTRY CONDUCT • Performance Over Time • Low returns • High dispersion of returns • Limited value creation • Loss of relative share • As risk management providers • As top financial institutions • Steady diversification of leaders into other financial services • Limited innovation, differentiation or talent distinctiveness • Underwriting ‘winners curse’ • Reserve changes can mask operating performance • Role of the brokers • Frequent new entrants • “Clean” capacity • “Naïve” capacity • Difficulty returning capital to investors • Difficulty of ‘retiring’ capacity – only catastrophes have accomplished this • Strong belief in “playing the cycle”

5. Principal ROE drivers Asset yield Cost of float (CR vs. alternative cost of funds) Leverage NY-262511.027/030514YdmanHR1 STRUCTURAL ECONOMICS UNATTRACTIVE Investor view: Industry equates to a highly leveraged investment trust • Low growth • Over-supply of capital and capacity • Pricing trends opaque and secular trend is negative • Underwriting profit elusive • Interest rate environment hurts • Sustainable earnings • Value of premium flow • Reserve adequacy opaque, and reserving distrusted

6. NY-262511.027/030514YdmanHR1 SINCE 1983, AVERAGE P&C INSURANCE INDUSTRY RETURNS HAVE LAGGED THE COST OF EQUITY BY ~50% Annual averages, percent • ROS • Cost of equity (Ke) • ROS/Ke • Avg. ’83-90: • 5.5% • 13.8% • 0.4x • Avg. ’90-’01: • 5.5% • 10.7% • 0.5x • Avg. ’83-’01 • 5.5% • 11.9% • 0.5x • Cost of equity (Ke)* • Average return on surplus (ROS**) Source: A.M. Best; Compustat; McKinsey Analysis

7. NY-262511.027/030514YdmanHR1 RELATIVE TO RATE LEVELS, MARKET VALUATIONS ARE AT TEN YEAR LOWS • Market to book ratio/rate level index • Average = 1.4 Source: William Capital; Swiss Re Sigma; Bloomberg

8. NY-262511.027/030514YdmanHR1 . . . BUT THERE IS WIDE DIVERGENCE OF PERFORMANCE AMONG COMPETITORS • Index of average ROE, 1988-01 • Median = 100 • P&C insurers • P&C re-insurers • Top quartile of players (by ROE) • Second quartile • Third quartile • Bottom quartile

9. NY-262511.027/030514YdmanHR1 CHARACTERISTICS OF “WINNERS” • Good operators • Portfolio of attractive lines (typically local or specialty niches) • Strong product innovation and/or cross sell • Capture value through risk servicing and advisory • Excellent enterprise risk management • Value based flexible capital deployment • Leverage over (or ability to bypass) intermediaries • Structural advantages, e.g., brand, IT, distribution (more common in personal lines) • Excellent read on supply/demand dynamics

10. NY-262511.027/030514YdmanHR1 P&C “HARD” MARKETS AND UNDERWRITING PROFITS Net written premium % change / Incurred loss % change – 1960-2000 Percent • Average length: 2.5 years U.S. non-life underwriting results – 1960-2002 Percent of premium Source: AM Best, Conning, team analysis

11. NY-262511.027/030514YdmanHR1 WINNING IN THE FUTURE Winning Winning Knowledge intensity • Distinctive positions in mature markets • Outstanding talent • Innovation • Portfolio Management Skills Skills Capital Capital Capital intensity Capital at risk Capital at risk Today Tomorrow