Challenges & Opportunities in the P/C Insurance Industry Focus on Massachusetts Markets

1. Challenges & Opportunitiesin the P/C Insurance IndustryFocus on Massachusetts Markets Massachusetts Association of Insurance Agents 2006 Annual Convention Boston, MA November 3, 2006 Robert P. Hartwig, Ph.D., CPCU, Executive Vice 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: US vs. MA & Nearby States • Underwriting Trends • Primary & Reinsurance • Pricing/Availability Trends • Financial Strength & Ratings • Investments • Capital & Capacity • Catastrophe Loss Management • Residual Property Markets: US and MA • Key Line Results • Post-Katrina Litigation Update • Optional Federal Chart (OFC) • Terrorism: Are TRIA’s Days Numbered?

3. P/C PROFIT OVERVIEWAwash in Profits, Starved for Growth

4. P/C Net Income After Taxes1991-2006E ($ Millions)* • 2001 ROE = -1.2% • 2002 ROE = 2.2% • 2003 ROE = 8.9% • 2004 ROE = 9.4% • 2005 ROE= 10.5% • 2006 ROAS1,2 = 13.0% 2006 Net Income may shatter previous records *ROE figures are GAAP; 1Return on avg. surplus. 2005 ROAS = 9.8% after adj. for one-time special dividend paid by the investment subsidiary of one company. 2Based on H1 results; Sources: A.M. Best, ISO, Insurance Information Inst.

5. ROE: P/C vs. All Industries 1987–2006:H1 Insurers will outperform only if CAT losses are “normal” 2004/5 ROEs excl. hurricanes Sept. 11 Hugo Katrina, Rita, Wilma Lowest CAT losses in 15 years Andrew Northridge 4 Hurricanes *2006 P/C insurer ROE based on annualized H1 results. Source: Insurance Information Institute; Fortune

6. The Importance of Profits • Profits compensate shareholders for the assets they put at risk • Profitable companies can access capital markets under favorable terms after mega-CATs or if market conditions are poor (e.g., post-9/11); Others will fail, are dissolved or acquired • Preferred treatment by reinsurers • Profits lead directly to increased capacity • Profits build contingent capacity for mega-CATs • Profits enable investments in the future of the enterprise (tech, people, etc.) and to seize upon new opportunities (new states, M&A, etc.) • Profitable companies have higher financial strength and credit ratings • Profitable companies have more political and public policy clout • Can lobby effective at state and federal level • Can help support research and

7. WALL STREET:MAINTAINING THE CONFIDENCE OF WALL STREET IS CRITICAL FOR MANY INSURERS

8. Change in YTD Stock Performance by Sector Pre- & Post-Katrina/Rita/Wilma P/C & reinsurer stocks hurt but now fully recovered. Brokers rose on expectation of tighter conditions and demand for broker services; closure of Spitzer issues. Katrina: Aug. 29 Rita comes ashore Sept. 24 Wilma landfall Oct. 24 Source: SNL Securities; Insurance Information Institute

9. P/C Insurance Stocks: Slow Start, Strong Finish in 2006 Total YTD Returns Through October 27, 2006 P/C & reinsurer stocks now up in 2006 on low CAT losses, strong earnings Broker stocks hurt by weak earnings Source: SNL Securities, Standard & Poor’s, Insurance Information Institute

10. MASSACHUSETTS PROFITABILITY KEY LINES &NEARBY STATES

11. All P/C Lines ROE:US vs. MA, 1995–2004 Profitability in MA insurance markets is on average better than the US (PP Auto is the exception) US = 7.7% MA = 11.1% Source: NAIC

12. Private Passenger Auto ROE:US vs. MA, 1995–2004 Profitability in the MA auto market lags behind the US US = 8.5% MA = 5.9% Source: NAIC

13. Homeowners Insurance ROE: US vs. MA, 1995–2004 Profitability in the MA homeowners market exceeds that of the US due to relatively low CAT losses 1995-2004 Avg. US = 2.4% MA = 13.3% Source: NAIC

14. PP Auto: Average Return on Equity: US & MA, RI, CT, NH, VT, NY, NJ1995-2004 1995-2004 MA offers the lowest PP auto profitability of any state in the Northeast Source: NAIC

15. Average Return on Equity: US & MA, RI, CT, NH, VT, NY, NJ, Homeowners1995-2004 1995-2004 MA homeowners insurance has been relatively profitable Source: NAIC

16. *Latest available. Source: NAIC, Insurance Information Institute (III) Average Expenditure for HO Ins.:US & Northeast States (2003)* MA homeowners insurance expenditures are about average

17. Average Premiums for Auto Insurance US & Northeast States (2003)* *Latest available. Source: NAIC, Insurance Information Institute (III) MA PP auto insurance expenditures are well above the US average

18. UNDERWRITINGSurprisingly Strong in 2005, Stage is Set for a Good 2006!

19. P/C Industry Combined Ratio 2005 figure reflects heavy use of reinsurance which lowered net losses, but still a substantial deterioration from first half 2005 2006 is could produce the best underwriting result since the 94.9 combined ratio in 1955 Sources: A.M. Best; ISO, III. *III forecasts/estimates for 2006 full year.

20. Personal LinesCombined Ratio, 1993-2006E A very strong 2006 is order due underwriting innovations and low CAT activity Source: A.M. Best; Insurance Information Institute.

21. Commercial Lines Combined Ratio, 1993-2006E* Outside CAT-affected lines, commercial insurance is doing fairly well. Caution is required in underwriting long-tail commercial lines. 2006 results will benefit from relatively disciplined underwriting and low CAT losses Source: A.M. Best; Insurance Information Institute .

22. Underwriting Gain (Loss)1975-2006F* Insurers sustained a $5.9 billion underwriting loss in 2005. First half 2006 underwriting gain was $15.1B implying a record gain of about $30B for full-year $ Billions Source: A.M. Best, Insurance Information Institute *2006F of $30.2B is annualized H1 gain of $15.1B

23. A 100 Combined Ratio Isn’t What it Used to Be: 95 is Where It’s At Combined ratios today must be below 95 to generate Fortune 500 ROEs * 2006 figure is return on average statutory surplus. Source: Insurance Information Institute from A.M. Best and ISO data.

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

25. 2004 Prior Year Reserve Development by Line ($ Millions) Longer-tail casualty coverages have been the source of most reserve problems in recent years Reserve Strengthening Reserve Releases Source: A.M. Best, Lehman Brothers.

26. EXPENSESWill Expense Ratio Rise as Premium Growth Slows?

27. Personal Lines Underwriting Expense Ratio,*1994-2005 Expenses ratios will likely rise as premium growth slows *Ratio of expenses incurred to net premiums written. Source: A.M. Best; Insurance Information Institute

28. Personal vs. Commercial Lines Underwriting Expense Ratio* Expenses ratios will likely rise as premium growth slows *Ratio of expenses incurred to net premiums written. Source: A.M. Best; Insurance Information Institute

29. REINSURANCE MARKETSHigher Reinsurance Costs Squeezing Insurers, Pushing Property CAT Prices Upward

30. Global Number of Catastrophic Events, 1970–2005 The number of natural and man-made catastrophes has been increasing on a global scale for 20 years Record 248 man-made CATs & record 149 natural CATs in 2005 Man-made disasters: without road disasters. Source: Swiss Re, sigma No. 1/2005 and 2/2006.

31. Combined Ratio: Reinsurance vs. P/C Industry Katrina, Rita, Wilma Sept. 11 4 Florida Hurricanes HurricaneAndrew Source: A.M. Best, ISO, Reinsurance Association of America, Insurance Information Institute

32. Share of Losses Paid by Reinsurers, by Disaster* Reinsurance is playing an increasingly important role in the financing of mega-CATs; Reins. Costs are skyrocketing *Excludes losses paid by the Florida Hurricane Catastrophe Fund, a FL-only windstorm reinsurer, which was established in 1994 after Hurricane Andrew. FHCF payments to insurers are estimated at $3.85 billion for 2004 and $4.5 billion for 2005. Sources: Wharton Risk Center, Disaster Insurance Project; Insurance Information Institute.

33. Reinsurance Prices Surged in 2006 Following Record CATs in 2005 In hurricane-prone areas, property CAT reinsurance prices are up 100-300%+ US cat reinsurance price index: 1994 = 100 Sources: Swiss Re, Cat Market Research; Insurance Information Institute estimate for 2006.

34. A Look Ahead to Reinsurance Markets for 2007 • Despite lack of major hurricane in 2006, reinsurance pricing strong in US for 2007 • New capital entry not sufficient to fully meet demand • Reinsurance prices flat at best outside peak CAT zones • Retrocessional market still tight • Softening in European p/c reinsurance markets • Softening in US casualty reinsurance markets • More pronounced if property cat reinsurers shift emphasis • Capital market role expanding • Hedge funds, private equity • Securitization: Insurance Linked Securities • Some concern over staying power, (lack of) regulation • Complement or competitor to traditional reinsurance? Sources: Insurance Information Institute.

35. UNDERWRITING AFFECTS FINANCIAL STRENGTHIs There Causefor Concern?

36. Reasons for US P/C Insurer Impairments, 1969-2005 2003-2005 1969-2005 Deficient reserves, CAT losses are more important factors in recent years *Includes overstatement of assets. Source: A.M. Best: P/C Impairments Hit Near-Term Lows Despite Surging Hurricane Activity, Special Report,Nov. 2005;

37. Historical Ratings Distribution,US P/C Insurers, 2000 vs. 2005 2000 2005 A++/A+ shrinkage Ratings agencies increasing emphasis on multiple eventsrequire more capital Source: A.M. Best: Rating Downgrades Slowed but Outpaced Upgrades for Fourth Consecutive Year, Special Report,November 8, 2004 for 2000; 2006 Review & Preview for 2005 distribution. *Ratings ‘B’ and lower.

38. 2006 SRQ CAT Model Reqs.* All Property Exposure Auto Physical Damage Reinsurance Assumed Pools & Assessments All Flood Exposure WC Losses from Quake Fire Following Storm Surge Demand Surge Secondary Uncertainty ALSO “A.M. Best will perform additional “stress-tested” risk-adjusted capital analysis for a second event in order to determine the potential financial condition of an entity post a severe event.” IMPLICATION: Some insurers may be required to carry more capital to maintain the same rating. Ratings Agencies Tightening Requirements for CATs Best currently estimates PML for 100-yr. wind & 250-yr. quake to determine capital adequacy *SRQ = Supplemental Rating Questionnaire Source: A.M. Best Review & Preview, January 2006.

39. PRICE & AVAILABILITYPricing Pictureis Mixed

40. 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 *2006-10 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 figure of 2.9% is based on 2006:H1 data. Note: Shaded areas denote hard market periods. Source: A.M. Best, Insurance Information Institute

41. Property Catastrophe Price Index*1994 - 2006 US CAT prices are continue to rise faster than anywhere else in the world *Insurance Information Institute figure of 13.8% for 2005 based estimated 2005 DPE of $417.7B and insured CAT losses of $57.7B. Includes primary and reinsurance coverage. Sources: ISO, A.M. Best, Swiss Re Economic Research & Consulting; Insurance Information Institute.

42. *Insurance Information Institute Estimates/Forecasts Source: NAIC, Insurance Information Institute Average Expenditures on Auto Insurance Countrywide auto insurance expenditures are expected to rise just 0.5% in 2006 Will the “big guys” stay disciplined? So far, so good. Tiering adopted to avoid adverse selection

43. *Latest available. Source: NAIC, Insurance Information Institute (III) Average Premiums for HO Insurance US & New England States (2003)*

44. *Insurance Information Institute Estimates/Forecasts Source: NAIC, Insurance Information Institute Average Expenditures on Homeowners Insurance Countrywide home insurance expenditures are expected to rise 4% in 2006, but much more in hurricane zones Hurricane zone residents can expect increases in the 20%-100% range, especially if insured by a state entity

45. Average Premiums for Auto Insurance US & New England States (2003)* *Latest available. Source: NAIC, Insurance Information Institute (III)

46. New Private Housing StartsWill Slow Through 2009 Millions of Units Homeowners accounts for 12% of Direct Premiums Written New home construction is expected to fall by 18% from 2005-2009 as interest rates rise. Exposure growth forecast for HO insurers will slow as a result. Source: US Department of Commerce; Blue Chip Economic Indicators (3/06), Insurance Info. Institute

47. Average Commercial Rate Change,All Lines, (1Q:2004 – 3Q:2006) Magnitude of rate decreases has diminished greatly since mid-2005 but is growing again Source: Council of Insurance Agents & Brokers; Insurance Information Institute

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

49. Average Commercial Rate Change by Account Size Accounts of all sizes are renewing downward and more quickly than in 06Q2 Source: Council of Insurance Agents & Brokers

50. 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