State Insurance Trade Association Annual Meeting Seattle, WA September 25, 2007

1. Why 2008 is Shaping Up to Be a Make or Break Year for the P/C Insurance IndustryTrends, Challenges & Opportunity State Insurance Trade Association Annual Meeting Seattle, WA September 25, 2007 Robert P. Hartwig, Ph.D., CPCU, President 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 • Subprime Lending Crisis: What Does it Mean for Insurers? • Underwriting Trends: Unsustainable? • Premium Growth: Approaching a Standstill • Pricing: Competitive Pressures Mounting • Capital & Capacity: UnderleveragedROE Pressure • Catastrophe Loss Management • Reinsurance Summary • Financial Strength & Ratings • Investments: Less Bang for the Buck • Tort System: Great News for a Change (Mostly) • Legislative & Regulatory Updat

3. P/C PROFIT:An Historical PerspectiveProfits in 2006/7 ReachedTheir Cyclical Peak

4. P/C Net Income After Taxes1991-2007F ($ Millions)* • 2001 ROE = -1.2% • 2002 ROE = 2.2% • 2003 ROE = 8.9% • 2004 ROE = 9.4% • 2005 ROE= 9.4% • 2006 ROAS1 = 14.0% • 2007F ROAS = 13.1%** Insurer profits peaked in 2006/7. “Normal” CAT year, average investment gain imply flattening *ROE figures are GAAP; 1Return on avg. surplus. 2007F figure is annualized actual first half net income of $32.596B **Actual first half 2007 result. 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 is actual first half ROAS of 13.1%. 2008 P/C insurer ROE is I.I.I. estimate. Source: Insurance Information Institute; Fortune

6. RETURN ON EQUITY (Fortune):Stock & Mutual vs. All Companies* Mutual insurer ROEs are typically lower than for stock companies, but gap has narrowed. All are cyclical. *Fortune 1,000 group. Source: Fortune Magazine, Insurance Information Institute.

7. 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 is actual first half ROAS of 13.1%. 2008 P/C insurer ROE is I.I.I. estimate. Source: Insurance Information Institute; Fortune

8. ROE vs. Equity Cost of Capital:US P/C Insurance:1991-2007E The p/c insurance industry achieved its cost of capital in 2005/6 for the first time in many years +3.5 pts +3.1 pts -9.0 pts -0.1 pts +0.2 pts -13.2 pts US P/C insurers missed their cost of capital by an average 6.7 points from 1991 to 2002, but on target or better 2003-07 The cost of capital is the rate of return insurers need to attract and retain capital to the business Source: The Geneva Association, Ins. Information Inst.

9. Insurance & Reinsurance Stocks: Slow Start in 2007 in P/C, Reins. Total YTD Returns Through September 21, 2007 P/C insurance, reinsurance stocks lagging on soft market concerns, worries over 2007 hurricane season and subprime selloff Source: SNL Securities, Standard & Poor’s, Insurance Information Inst. *Includes Financial Guarantee

10. 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

11. Advertising Expenditures by P/C Insurance Industry, 1999-2006 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.

12. THE SUBPRIME CRISISWhat Does it Mean for the Insurance Industry

13. Insurer Exposure to Subprime Mortgage Backed Securities* $ Billions • As of June 30, 2007, p/c & life insurers had $91.48B in exposure to residential mortgage backed securities or about 15% of the $600 billion subprime market. • Most securities rate AA or higher (93% AA or high among life insurers • Insurers & reinsurers maintain sufficient liquidity to weather subprime storm virtually unscathed *Includes direct ownership of subprime loans, collateralized debt and loan obligations, bond fund and hedge fund exposures. Source: Standard & Poor’s Survey as reported in SNL Insurance Weekly, September 4, 2007.

14. Repackaged Mortgage-Backed Securities Contain Varying Degrees of Risk CLASS A Suffers losses only when more than 67% of underlying portfolio not repaid CLASS A Safest class. Typically purchased by insurers, federal agencies and institutional money managers CLASS C Riskiest class. Absorbs first 34% of losses in portfolio. Typically purchased by hedge funds and other high-risk risk investors. CLASS B Absorbs middle third of losses Source: Mark Stancher and Kyongsoo Noh, “Subprime Not Quite Sublime? Recent Developments in the Subprime Mortgage Markets,” Insights 7/13/07, JPMorgan Asset Management, accessed at http://www.jpmorgan.com/pages/jpmorgan/am/ia/research_and_publications/insights

15. Implications of Sub-Prime Mess & Credit Crunch on P/C Insurers • P/C Insurers Not Heavily Exposed to Subprime Residential Mortgage Securities (RMBS) • Subprime exposure equal to about 3% - 10% of policyholder surplus • Asset Quality High • Average security in P/C insurer portfolio carries AA rating • Most P/C exposure to subprime market is in AAA tranches • P/C Insurers Do Not Have Much Leverage in Business Model • 0-10% of capital structure typically • Insurers accept risk primarily through underwriting • Some leverage gained via reinsurers, who likewise are not heavily exposed to subprime RMBS • Rarely Necessarily for Insurers to Liquidate Securities • Major CAT could be exception, but even payouts occur gradually and can be paid primarily out of cash flow • Implies insurers unlikely to be forced into “fire sale” to pay losses while bond and stock prices are depressed Source: Merrill Lynch, Insurance Information Institute;

16. Implications of Sub-Prime Mess & Credit Crunch on P/C Insurers (cont’d) • Impact on Profits • Widening credit spreads do not impact insurers business model, which is not leverage-based, so earnings should not be affected • Rising interest rates could push up average yield on insurers’ bond portfolio (about 2/3 of invested assets) • Ability to realize capital gains will be hurt if swoon persists • Fed cut fed funds rate 50 bps 9/18—huge stock rally • Mark-to-Market (or Mark-to-Make Believe?) • Insurers required to carry securities categorized as “available for sale” at market value (most investments in this category) • Rising rates/falling prices for corporate bonds and RMBS and CDOs will have to be marked to a lower market value • Impact will be to decrease paper value of policyholder surplus (net worth) and depress book value of stock insurers Source: Merrill Lynch, Insurance Information Institute;

17. D&O/E&O Implications ofSub-Prime Meltdown • D&O/E&O Losses Pegged to Subprime Meltdown Variously Estimated at $1 Billion to $3 Billion, based on Experience in Past Financial Crises • Pure play subprime lenders typically purchase low limits of cover • Lender’s liability coverage (an E&O exposure) difficult to purchase last few years • Usually regulatory fines and penalties not compensable under D&O, therefore substantial share of costs may not be insured • Defense cost shouldered by D&O insurers could be large • Hedge funds sometimes carry D&O apart from parent entity • Bond Ratings Agencies May be Object of Significant Litigation • Likely to fail due First Amendment “free speech” opinions defense • Class Actions Against Mortgage Brokers and Lenders Based on Allegations Non-Suitability and Deceptive Sales Practices Will Be Attempted. • Most states don’t require brokers to carry E&O (maybe fidelity); If they do, limits usually about $300-$500K; No D&O • Defendants will argue cases should be heard in fed court (due to federal guarantees on many loans) which are less receptive to class actions • Defendants will argue lack of homogeneity and cite Class Action Fairness Act to get cases heard individually Source: Lehman Brothers; Insurance Information Institute;

18. UNDERWRITINGExtremely Strong 2006, Momentum for 2007/08?

19. P/C Insurance Combined Ratio, 1970-2008F* Combined Ratios 1970s: 100.3 1980s: 109.2 1990s: 107.8 2000s: 102.2** Sources: A.M. Best; ISO, III *Actual figure of 92.7 through first half 2007. **Through 2007:H1.

20. 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 87.6 combined ratio in 1949 2005 figure benefited from heavy use of reinsurance which lowered net losses Sources: A.M. Best; ISO, III. *III estimates for 2007/8.

21. Ten Lowest P/C Insurance Combined Ratios Since 1920 (& 2007:H1) 2007 is off to a great start The industry’s best underwriting years are associated with periods of low interest rates The 2006 combined ratio of 92.5 was the best since the 87.6 combined in 1949 Sources: Insurance Information Institute research from A.M. Best data. *2007 first half actual.

22. Underwriting Gain (Loss)1975-2007F* Insurers earned a record underwriting profit of $31.7 billion in 2006, the largest ever but only the second since 1978. Expect figure near $28 billion in 2007 assuming “normal” CAT losses. Cumulative underwriting deficit since 1975 is $412 billion. $ Billions Source: A.M. Best, Insurance Information Institute *Actual 2007:H1 underwriting profit = $14.402B annualized to $28.8B.

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

24. Private Passenger Auto (PPA) Combined Ratio Auto insurers have shown significant improvement in PPA underwriting performance since mid-2002, but results are deteriorating. PPA is the profit juggernaut of the p/c insurance industry today Average Combined Ratio for 1993 to 2005: 101.0 Sources: A.M. Best; III

25. Homeowners Insurance Combined Ratio Average 1990 to 2006= 111.8 Insurers have paid out an average of $1.12 in losses for every dollar earned in premiums over the past 17 years Sources: A.M. Best; III

26. Commercial Lines Combined Ratio, 1993-2006 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 benefited from relatively disciplined underwriting, low CAT losses and reserve releases Source: A.M. Best; Insurance Information Institute .

27. Cumulative Prior Year Reserve Development by Line (As of 12/31/06) Strengthening Reserve redundancies in most lines have resulted in releases in recent years Release Sources: Lehman Brothers; A.M. Best’s Aggregates & Averages Schedule P, Part 2.

28. The Big Question: Is the Industry More Disciplined Today? • Signs suggest that the answer is yes • Current period of sustained underwriting profitability is the first since the 1950s • While prices are falling, underlying lost cost trends (frequency and severity trends) are generally favorable to benign • Suggest impact of falling prices will be less pronounced than late 1990s • Reserve situation appears much improved and under control • Management Information Systems: Much More Sophisticated • Insurers can monitor and make adjustments much more quickly • Adjustments made quickly by line, geographic area, producer, etc. • Investment Income • Relative to late 1990s, interest rates and stock markets returns are lower • Has effect of imposing (some) discipline • Ratings Agencies • More stringent capital requirements • Quicker to downgrade

29. WORKERS COMPENSATION OPERATING ENVIRONMENT

30. Workers Comp Combined Ratios, 1994-2006P Percent p Preliminary AY figure. Accident Year data is evaluated as of 12/31/2006 and developed to ultimate Source: Calendar Years 1994-2005, A.M. Best Aggregates & Averages; Calendar Year 2006p and Accident Years 1994-2006pbased on NCCI Annual Statement Analysis. Includes dividends to policyholders

31. Workers Comp Lost-Time Claim Frequency (% Change) Percent Change Cumulative Change of –52.1% since 1991 means that lost work time claims have been cut by more than half Accident Year 2003p: Preliminary based on data valued as of 12/31/2006 1991-2005: Based on data through 12/31/2005, developed to ultimate Based on the states where NCCI provides ratemaking services Excludes the effects of deductible policies Source: NCCI

32. Workers Comp Indemnity Claims Costs Have Accelerated, 1993-2006p Indemnity Claim Cost (000s) Annual Change 1991–1996: +1.2% Annual Change 1997–2005: +6.6% Cumulative Change = +108.5% (1993-2006p) Accident Year 2005p: Preliminary based on data valued as of 12/31/2006 1991-2005: Based on data through 12/31/2005, developed to ultimate Based on the states where NCCI provides ratemaking services Excludes the effects of deductible policies Source: NCCI

33. Med Costs Share of Total Costs is Increasing Steadily 2006p 1996 1986 Source: NCCI (based on states where NCCI provides ratemaking services).

34. PREMIUM GROWTHAt a Virtual Standstillin 2007/08

35. 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 Note: Shaded areas denote hard market periods. Source: A.M. Best, Insurance Information Institute *2007-10 figures are III forecasts/estimates.

36. 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 *2007 figure base on 2007 actual first half result of 0.1%. Source: A.M. Best; Forecasts from the Insurance Information Institute.

37. Most Layers of Coverage are Being Challenged/Leaking Reinsurers losing to higher retentions, securitization Retro $100 Million Excess squeezed by higher primary retentions, lower reins. attachments Reinsurance $50 Million Excess Lg. deductibles, self insurance, RRGs, captives erode primary $10 Million Primary $2 Million Retention $1 Million Risks are comfortable taking larger retentions Source: Insurance Information Institute from Aon schematic.

38. Risk Retention Group Premiums,1988 – 2006* Millions of Dollars Risk retention (& self-insurance) group premiums have risen rapidly in recent years and represent a form of competition to traditional insurers and captives *2006 Projected Source: Risk Retention Reporter, Insurance Info. Institute

39. Leading Captive Domiciles Worldwide, 2005 vs. 2006 Large and growing number of captive domiciles worldwide bleeding away tradition commercial risks *BI estimate. **Excludes credit life insurers. Sources: Business Insurance, March 12, 2007, III

40. Leading US Captive Domiciles, 2005 vs. 2006 U.S. captive domiciles experienced dramatic growth in 2006, hurting traditional commercial insurers, especially in the middle market space Sources: Business Insurance, March 12, 2007; III

41. PRICING Under Intense Pressure in 2007/08

42. *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

43. *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 Homeowners in non-CAT zones will see smaller increases, but larger in CAT zones

44. EXPENSESWill Expense Ratio Rise as Premium Growth Slows?

45. 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

46. CAPACITY/SURPLUSThe Industry is Underleveraged

47. U.S. Policyholder Surplus: 1975-2007* Capacity as of 6/30/07 was $512.8B, 5.3% above year-end 2006, 80% above its 2002 trough and 54% above its 1999 peak. Capacity exceeded a half trillion dollars for the first time during the 2nd quarter of 2007 $ 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. *As of June 30, 2007

48. 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.

49. INVESTMENT IRONYMore Pain, Little Gain

50. Net Investment Income Investment income posted modest gains in 2006, but is running flat in 2007 $ Billions Growth History 2002: -1.3% 2003: +3.9% 2004: +3.4% 2005: +24.4%* 2006: +5.2% 2007: 0.0%** Source: A.M. Best, ISO, Insurance Information Institute; *Includes special dividend of $3.2B. Increase is 15.7% excluding dividend. **Based on annualized H1 result of $26.128B.