Demotech, Inc. Introduces Itself to Independent Insurance Agents and Brokers of South Carolina

1. Demotech, Inc. Introduces Itself toIndependent Insurance Agents and Brokers of South Carolina Joseph L. Petrelli President Demotech, Inc.

2. Demotech’s Founding Principles and Philosophy Demotech, Inc. is a financial analysis firm specializing in evaluating the financial stability of regional and specialty insurers. Since 1985, Demotech has served the insurance industry by assigning accurate, reliable and proven Financial Stability Ratings® (FSRs) for Property & Casualty insurers and Title underwriters. FSRs are a leading indicator of financial stability, providing an objective baseline of the future solvency of an insurer. Demotech's philosophy is to review and evaluate insurers based on their area of focus and execution of their business model rather than solely on financial size. This philosophy was the catalyst for the Demotech Company Classification System, which was published in Insurance Journal, in order to stratify and categorize insurers into operational categories. Visit www.demotech.com for more information.

3. Demotech, Inc. • Incorporated in 1985, Demotech, Inc. is a financial analysis firm specializing in evaluating the financial stability of regional and specialty insurers. • Since 1989, Demotech has served the insurance industry by assigning accurate, reliable and proven Financial Stability Ratings® (FSRs) for Property & Casualty insurers and Title underwriters. • FSRs are a leading indicator of financial stability, providing an objective baseline of the future solvency of an insurer. • Demotech's philosophy is to review and evaluate insurers based on their area of focus and execution of their business model rather than solely on financial size. This philosophy was the catalyst for the Demotech Company Classification System, which was published in Insurance Journal, in order to stratify and categorize insurers into operational categories.

4. Demotech’s Acceptances • Demotech was the first company to have its rating process formally reviewed and accepted by: • Fannie Mae (1989) • Freddie Mac (1990) • HUD (1994 & 2005) • 1996 - Worked with Florida Office of Insurance Regulation (then DOI) to develop FSRs for Florida “take out” insurers to depopulate the residual market. • 2005 - Accepted by HUD for rating Professional Liability insurers of long term care facilities • 2009 – Began receiving carve-back on insolvency provision from several insurance agents’ errors and omissions insurance carriers. • 2010 - Participant in independent Florida State University and Wharton School studies evaluating insurer financial ratings.

5. Serious About Solvency® - Our Perspective • Demotech’s business model is to support financially stable insurers that are unrated or underrated by other services, typically regional and specialty insurers. • Demotech encourages companies to focus on long-term solvency which emphasizes increasing loss and loss adjustment expense (LAE) reserves to adequate levels as opposed to reasonable levels. • Adequate – no development • Reasonable – acceptable in regards to jurisdiction mandated levels, but may lead to adverse development • Earnings should be stabilized by booking adequate loss and LAE reserves, not manipulated by accruing loss and LAE reserves at an optimistic level and then increasing today’s loss and LAE reserves tomorrow.

6. Why Do Others Seem to Favor Larger Insurers? • Magnitude of surplus • Broad array of insurance products to diversify the insurer • Diversification as to geographical exposure • Well-known names • Access to capital if they are publicly traded companies. In practice, size and diversity have had limited impact on financial success or the risk of insolvency. Adequate premiums, liquid investments, adequate loss and loss adjustment expense reserves and the quality and quantity of reinsurance have proven to be more critical to solvency then size alone, i.e. Mission, Transit, Kemper, Executive Life.

7. We Believe Many Regional and Specialty Insurers Are Unappreciated by Other Rating Services • Focus on their niche, not diversified, do not seek authority to dabble in several lines of business. • May not be widely licensed in numerous jurisdictions because they are state or regional specialists who know their markets and their producers. • Purchase conservative reinsurance treaties that protect their surplus, thereby forsaking potential profitability to retain the financial stability and consistency required by their agents and insureds.

8. Our View on Regional and Specialty Insurers • Maintain consistent underwriting discipline – even if the cost is marketshare. • Purchase large quantities of high quality reinsurance. • Maintain stable relationships with agents and core customers. • Support their niches because they understand them and thrive by serving those sectors that their underwriters understand.

9. Financial Stability Ratings® Financial Stability Ratings® (FSRs) are a leading indicator of the financial stability of Property and Casualty insurers and Title underwriters. An FSR summarizes Demotech’s opinion as to the insurer’s ability to insulate itself from the business cycle that exists in the general economy as well as the underwriting cycle that exists in the insurance industry. An FSR summarizes our opinion as to the relative ability of an insurer to survive a downturn in general economic conditions as well as a downturn in the underwriting cycle.

10. Financial Stability Ratings® Our focus is unique. While we acknowledge and recognize the importance of profitability, we believe that balance sheet strength and financial integrity are the ultimate determinants of the long term financial stability required to honor meritorious claims. Accordingly, while operating profit remains an important element in the assignment of FSRs, the ability of an insurer to remain financially stable under a variety of economic stress tests requires a focus on balance sheet integrity. Quality and quantity of reinsurance, relative adequacy of loss and loss adjustment expense reserves, the liquidity and quality of assets and rate adequacy are some of the more critical items we evaluate.

11. Financial Stability Ratings® Our rating process provides an objective baseline for assessing solvency based upon changes in financial stability, as manifested in an insurer’s balance sheet. FSRs are based upon a series of quantitative ratios and considerations that comprise our Financial Stability Analysis Model. The Financial Stability Analysis Model is the major component of the FSR assignment process and can be applied to statutory insurance accounting data or data compiled under Generally Accepted Accounting Principles (GAAP). The Financial Stability Analysis Model includes a tactile review as well as computation and analysis of critical financial ratios to determine the current and anticipated financial stability of the insurance company being reviewed. The Financial Stability Analysis Model cross checks and analyzes financial statement calculations and relationships. A critical item to determine the financial stability of a P&C insurer is the calculation of financial stability ratios measured against our financial stability benchmarks. These ratios and benchmarks have been compiled on an industry-wide basis and have been substantiated by third parties.

12. Independent Analysis of Ratings In February 2011, Florida State University’s College of Business Risk Management and Insurance compared our FSRs with ratings issued by Best, Standard and Poor’s, Moody’s and Fitch. The study reviewed thousands of insurer ratings issued over a nine year period. The results were released in a preliminary summary entitled A Comprehensive Examination of Insurer Financial Strength Ratings.

13. Independent Analysis of Ratings The study concluded that: • Demotech serves the need of another unique group of insurers, namely those that are geographically focused. • Comparisons of Demotech ratings to other agencies show relative consistency in the factors that drive Demotech ratings compared to agencies such as A. M. Best, Moody’s, Standard and Poor’s, and Fitch. • There is also general consistency in the firms that each agency would categorize as financially secure. • These results have important public policy implications for insurers, regulators and consumers as they work to better understand the ratings process. Of particular importance to most is the comparability of Demotech ratings to other agencies. • Given that lenders often have requirements related to the use of rated insurers and some states require ratings to operate in a state, the results suggest that Demotech serves an important service within the ratings community and plays a very important role in the insurance market.

17. Insurance Agents Errors & OmissionsInsolvency ExclusionsHistorical Perspective & Present Day Solution • Insurance agents are generally not legally liable for an insurer's failure to pay a loss due to the insurer's financial impairment. • According to IRMI, the insolvency exclusion in an agent’s errors and omissions insurance policy (E&O) is “an exclusion found in some insurance agents E&O liability policies that precludes coverage for claims resulting from an insurer's inability to pay a claim due to its insolvency. * • Favorably worded versions of the insolvency exclusion bar coverage only when the agent should have known or failed to discover the insurer's financial problems at the time coverage was arranged. • Other insurers provide exceptions to the exclusion, provided coverage is placed with insurers of a stated Best's rating and financial class (e.g., B+/X) or a Demotech Financial Stability Rating® of A or better. *(http://www.irmi.com/online/insurance-glossary/terms/i/insurer-insolvency-exclusion.aspx)

18. Conclusion These cases, and an analysis prepared by C. Burke Coleman, Demotech’s counsel, indicated that the legal standard for agents’ liability on insolvency does NOT include a Best’s rating. Essentially the legal standard is: • Carrier must be licensed or otherwise authorized to do business in the state. • Carrier must be in good standing with department of insurance • Carrier should be solvent, based on its published financial statements

19. Agents are Being Harmed, not Helped • Your E&O carrier does not sit on your board, • Is not part of your management team and, • Is not a shareholder in your agency. • Yet they somehow feel entitled to restrict the markets you can use. • The wording of insolvency exclusions is inconsistent. • The court cases involving whether or not an E&O claim is related to an “error” or an insolvency are inconsistent. • Independent agents need and deserve well defined, consistent E&O coverage to be able to effectively generate competition among carriers for production.

20. Solutions to the Insolvency Exclusion

21. Insurers Offering Insolvency Coverage to Companies Rated A or better by Demotech • Arch Insurance Company • Lexington Insurance • Darwin • Century Surety Company • Gotham Insurance Company • Allied World Assurance Company • NAMICO Insurance Company • Professional Underwriters Group, Jay Martin (Axis) • More Coming! 

22. The Level Playing Field • As a courtesy to producers of a rated carrier, Demotech will work with the agent to secure an exception to the insolvency exclusion in their policy. • Demotech will work with the carrier to obtain Insolvency Gap Coverage, a fully insured program offered by Century Surety Company, to protect agents of record against insolvency. The policy indemnifies and defends when a gap in an Agent of Record’s E&O coverage is created by the insolvency exclusion. • Demotech will work with the carrier to secure an excess E&O policy from Gotham Insurance Company. Gotham’s excess E&O policy expands the insolvency exclusion to explicitly provide coverage for insolvency when carriers earn an FSR of A or better.

23. The Level Playing Field Our multi-faceted program is designed to assist agents, markets and clients: • Option 1 - E&O insurance written with a carve back to provide coverage for the insolvency of carriers rated A or better by Demotech, Inc. • Option 2 - Agents of XYZ Insurance Company Master Policy for E&O • Option 3 - XYZ Insurance Company purchases an Insolvency Gap Coverage to protect its producers.

24. Option 1 – Independent Agent’s Solution • E&O insurance written with a carve back to provide coverage for the Insolvency of carriers rated by Demotech. • For any agent or agency that meets or exceeds the otherwise applicable underwriting criteria; • The agent or agency can submit its latest available, previously completed application provided to their current carrier; • With a copy of their current declarations page and receive a quote that provides errors and omissions insurance coverage INCLUDING an insolvency carve back.

25. Option 2 – Your Market Working With You • An “Agents of XYZ Insurance Company” E&O policy to provide agents appointed by an insurer with E&O policy including insolvency coverage. • In this situation, XYZ Insurance Company purchases a master errors and omissions policy to protect “Agents of XYZ Insurance Company” on an excess basis. • This coverage INCLUDES the insolvency carveback that is necessary to developing and sustaining a relationship between a producer and a market.

26. Option 3 – Your Market Working With You • XYZ Insurance Company purchases a policy to provide protection against the insolvency gap in an agent’s existing E&O coverage. • XYZ Insurance Company can apply for an insolvency gap coverage that provides its agents with protection against the unlikely insolvency of XYZ Insurance Company. • This policy is financially underwritten by Demotech, Inc. with quotes issued by Century Surety Company.

27. The Insolvency Exclusion Insolvency Exclusions are arbitrary, inconsistently constructed and the decisions issued in court cases demonstrate this! • Demotech has been able to assist independent agents and their markets due to the long-term credibility of our Financial Stability Ratings®. • The list of E&O solutions continues to grow. In the meantime, please let us know how we can assist you.