Soft Markets andHard Truths in the Property/Liability Insurance Industry

Steven N. Weisbart, Ph.D., CLU, Senior Vice President and Chief EconomistInsurance Information Institute 110 William Street New York, NY 10038

Tel: (212) 346-5540 Cell: (917) 494-5945 stevenw@iii.org www.iii.org

Alabama I-Day 2009University of Alabama Tuscaloosa, AL

October 7, 2009

• Hard Truths about the U.S. Economy• Soft Markets in the Property-Liability

Insurance Industry• Hard Truths in Property-Liability

Insurance Operations• Hard Truths About Property-Liability

Investment Performance & Insuring Capacity

Q&A

Presentation Outline

Hard Truthsabout

the U.S. EconomyBeen Down So Long It Looks Like Up to Me

Length of U.S. Business Cycle Contractions, 1945-Present*

811 10

810 11

16

6

16

8 8

22

0

5

10

15

20

25

Feb.1945

Nov.1948

July 1953 Aug.1957

Apr.1960

Dec.1969

Nov.1973

Jan. 1980 Jul. 1981 Jul. 1990 Mar.2001

Dec.2007

* As of September 2009, inclusive

Sources: National Bureau of Economic Research; Insurance Information Institute.

Current recession began in Dec. 2007 and is already the longest

since the Great Depression.

Duration (Months)

Month Recession Started

Length of U.S. Business Cycles, 1945-Present*

8 11 10 8 10 1116

616

8 8

2237

45

39

24

106

36

58

12

92

120

73

0

10

20

30

40

50

60

70

80

90

100

110

120

Feb.1945

Nov.1948

July1953

Aug.1957

Apr.1960

Dec.1969

Nov.1973

Jan.1980

Jul. 1981 Jul. 1990 Mar.2001

Dec.2007

Contraction Expansion following

* As of April 2009, inclusive

Sources: National Bureau of Economic Research; Insurance Information Institute.

Duration (Months)

Month Recession Started

3.1%

2.1%

5.4%

1.4%

0.1%

3.0%

1.2%

3.2% 3.

6%

2.1%

1.5%

-5.4

%

-6.4

%

-1.0

%

3.0%

2.4%

2.5% 2.7%

2.7% 2.9%

-0.7

%

-2.7

%-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

05:3

Q

05:4

Q

06:1

Q

06:2

Q

06:3

Q

06:4

Q

07:1

Q

07:2

Q

07:3

Q

07:4

Q

08:1

Q

08:2

Q

08:3

Q

08:Q

4

09:1

Q

09:2

Q

09:3

Q

09:4

Q

10:1

Q

10:2

Q

10:3

Q

10:4

Q

Real Quarterly GDP Changes (annualized),

2005:Q3-2010:Q4F

Sources: US Department of Commerce, Bureau of Economic Analysis (actual) at http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm Blue Chip Economic Indicators 9/09 issue (forecasts).

Spike due almost entirely to the weak dollar (growing exports and slowing imports)

Red bars are actual; Yellowbars are forecasts/estimates

The Q1:2009 decline was the steepest since the

Q1:1982 drop of 6.4%

Employment

U.S. Nonfarm Private Employment, Monthly, Nov 2007 – August 2009

138.

0

138.

1

138.

0

137.

9

137.

8

137.

8

137.

7

137.

6

137.

6

137.

4

137.

0

136.

7

136.

2

135.

1

134.

3

133.

7

133.

0

132.

5

132.

2

131.

7

131.

4

131.

2

130.0130.5131.0131.5132.0132.5133.0133.5134.0134.5135.0135.5136.0136.5137.0137.5138.0138.5

Nov07

Dec07

Jan08

Feb08

Mar08

Apr08

May08

June08

Jul08

Aug08

Sep08

Oct08

Nov08

Dec08

Jan09

Feb09

Mar09

Apr09

May09

Jun09

Jul09

Aug09

Seasonally adjusted. Source: US Bureau of Labor Statistics

Millions The U.S. economy lost about 6 million jobs in 12 months

Employment peak; recession starts

2

4

6

8

10

12

14

16

18

Jan-

00

Jan-

01

Jan-

02

Jan-

03

Jan-

04

Jan-

05

Jan-

06

Jan-

07

Jan-

08

Jan-

09

Traditional Unemployment Rate U-3Unemployment + Underemployment Rate U-6

January 2000 through August 2009, seasonally adjusted

U-6 went from 9.2% in April 2008 to

16.8% in Aug. 2009

Source: US Bureau of Labor Statistics; Insurance Information Institute.

9.7% Aug. 2009 unemployment rate (U-3) was the highest monthly rate since 1983. Peak rate in the last 30 years: 10.8% in

Nov-Dec 1982.

Unemployment and UnderemploymentRates: Rocketing Up in 2008-9

Percent

U.S. Unemployment Rate ForecastsQuarterly, 2009:Q3 to 2010:Q4

9.8%

10.1%10.3% 10.3% 10.3%

10.2%

9.6%

9.9%10.0%

9.9%

9.7%

9.5%9.5%9.7% 9.7%

9.5%

9.1%

8.8%

8.5%

9.0%

9.5%

10.0%

10.5%

11.0%

09:Q3 09:Q4 10:Q1 10:Q2 10:Q3 10:Q4

10 most pessimistic consensus/midpoint 10 most optimistic

Sources: Blue Chip Economic Indicators (9/09); Insurance Info. Inst.

Unemployment is expected to peak in late 2009:Q4 or 2010:Q1.

Rising unemployment will erode payrolls and workers comp’s exposure base.

Has the Contraction Endedand Recovery Begun?

Source: http://www.calculatedriskblog.com/

Will the Recession End Soon?Feb-Sep 2009 Initial Jobless Claims*

620

640643

647650650

658659651648

638

625632630627

632

623617618616

607

585

567560

557

566571

567573570

540

560

580

600

620

640

660

Feb

14

Feb

21

Feb

28

Mar

7

Mar

14

Mar

21

Mar

28

Ap

r 4

Ap

r 11

Ap

r 18

Ap

r 25

May

2

May

9

May

16

May

23

May

30

Jun

6

Jun

13

Jun

20

Jun

27

Jul 4

Jul 1

1

Jul 1

8

Jul 2

5

Au

g 1

Au

g 8

Au

g 15

Au

g 22

Au

g 29

Sep

5

4-week moving avg (000)

*seasonally adjusted; state programs only Source: http://www.dol.gov/opa/media/press/eta/ui/current.htm

Housing

2.8 3.

5 4.0

3.7

3.6 3.8

3.6 3.

9

3.9

3.8 4.1

7.1

6.5

5.7

4.9

4.49 4.71

4.55 4.66

4.72 4.89 5.

24

0

1

2

3

4

5

6

7

8

05 06 07 08

Jan-

09

Feb

09

Mar

09

Apr

09

May

09

Jun

09

Jul 0

9

Inventory of unsold homes number of homes sold

Source: http://www.realtor.org/research/research/ehsdata

High Ratio of Unsold-Homes Inventory to Sales Will Likely Keep Prices Falling

Millions of Homes, Annual Rate

# of house sales fell;inventory wasn’t the problem

# of house sales is rising but so is inventory

“Shadow” Inventory of Unsold Homes: It’s Worse Than You Think

• “About 1.8 million homes are currently in foreclosure and they will continue to weigh on home prices for at least the rest of the year.”

• Zillow.com’s latest Homeowner Confidence Survey (published August 18, 2009) asked homeowners how likely they would put their homes on the market if they saw signs of a turnaround in the next 12 months: Very likely, 8% (7.5 million homes)

Likely, 9% (7.5 million homes)

But Adam York, economist for Wells Fargo Securities, “contends that the amount of homes that have not yet been listed for sale could be around 4-5 million.

Sources: Julie Haviv, “’Shadow’ inventory lurks over U.S. housing recovery,” Reuters, at http://www.reuters.com/article/GCA-Housing/idUSTRE56U5YZ20090731 and http://zillow.mediaroom.com/index.php?s=173

High Inventory Means Millions Fewer Private Housing Starts

2.07

1.80

1.36

0.90

0.58

0.80

1.48

1.351.

46

1.29

1.20

1.01

1.19

1.47

1.62 1.64

1.57 1.60 1.

71

1.85

1.96

0.40.50.60.70.80.91.01.11.21.31.41.51.61.71.81.92.02.1

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08F 09F 10F

Measured by number of new units started, exposure growth for HO insurers is low.

Housing start data also affects commercial insurers with construction risk exposure.

I.I.I. estimate: each 100,000 decline in housing starts “costs” home insurers $90

million in gross premium. Estimated premium loss in 2008 vs. 2005: about $1

billion.

Sources: US Department of Commerce; Blue Chip Economic Indicators (9/09); Insurance Information Inst.

Millions of Units

Housing bubble

Recession

Recession

The “Silver Lining”?Inflation Might Be

Relatively Low

After Recent Recessions,the Annual Inflation Rate Dropped

4.9%5.1%

3.0%3.2%

2.6%

1.5%1.9%

3.3%3.4%

1.3%

2.5%2.3%

3.0%

3.8%

2.8%

3.8%

1.8%

-0.5%

2.8%2.9%2.4%

-1%

0%

1%

2%

3%

4%

5%

6%

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09F10F

Sources: US Bureau of Labor Statistics (actual, blue bars); Blue Chip Economic Indicators, 9/09 issue, (forecasts, yellow bars)

Average inflation rate, 1992-2007: 2.67% Post-

Recession Post-Recession

• Continued high levels of unemployment/ underemployment

• Continued low levels consumer demand/ business investment Significant increase in the personal saving rate, but

virtually all used to pay down outstanding debt

Low- or no-growth in insured exposures

• Low levels of new borrowing Affects housing, autos, other consumer durables

Section Summary: Hard Truths About the U.S. Economy

Soft Markets in the Property/Liability Insurance Industry

Primarily Driven bythe Industry’s Underwriting Cycle,

Not the Economy

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

22%

24%

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

:Q1

Sources: A.M. Best, ISO, Insurance Information Institute

40 Years ofHard and Soft Markets

1975-78 1984-87 2000-03Shaded areas denote “hard

market” periods In 2007 net written premiums fell, the first decline since

1943

Year-to-Year Change in Net Written Premium, 2000-2009*

Sources: A.M. Best (historical through 2008; ISO for 2009. *first quarter 2009 only

5.0%

8.4%

15.3%

10.0%

3.9%

0.5%

4.2%

-1.0% -1.4%-3.5%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009*

P/C insurers are experiencing their

slowest growth rates since 1943

Slow growth means retention is critical

Protracted period of

negative or slow growth is possible due to soft

markets and slow

economy

5.2%

-0.9

%-7

.4%

-6.5

%-1

.5%

1.8%

4.3%

18.6

%20

.3%

5.8%

0.3%

-1.6

%-1

.0%

-1.8

%-1

.0%

3.1%

1.1%

0.8%

0.4%

0.6%

-0.4

%-0

.3%

1.6%

5.6%

13.7

%7.

7%1.

2%-2

.9% -0

.5%

-3.8

%-4

.2%

1.7%

-10%

-5%

0%

5%

10%

15%

20%

25%7

87

98

08

18

28

38

48

58

68

78

88

99

09

19

29

39

49

59

69

79

89

90

00

10

20

30

40

50

60

70

8E

09

F

Rea

l N

WP

Gro

wth

-4%

-2%

0%

2%

4%

6%

8%

Rea

l G

DP

Gro

wth

Real NWP Growth Real GDP

Does National Economic Growth Affect Real P/C Premium Growth? Not Much

Sources: A.M. Best, US Bureau of Economic Analysis, Blue Chip Economic Indicators, 2/09; Insurance Information Inst.

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08*

$0

$5

$10

$15

$20

$25

$30

$35

$40

$45Wage & Salary DisbursementsWC NPW

*9-month data for 2008Source: US Bureau of Economic Analysis; Federal Reserve Bank of St. Louis at http://research.stlouisfed.org/fred2/series/WASCUR; I.I.I. Fact Books

Even When the Payroll Base is Rising, Soft Markets Reduce Workers Comp Premiums

7/90-3/91

Shaded areas indicate recessions

3/01-11/01

Wage & Salary Disbursement (Private Employment) vs. WC NWP$ Billions $ Billions

12/07-?

Weakening wage and salary growth is

expected to cause a deceleration in workers comp

exposure growth

Hard Truths in the Property/Liability

Insurance OperationsPrimarily Driven by

the Industry’s Underwriting Cycle,Not the Economy

115.

8

107.

4

100.

1

98.3 10

0.7

92.4

102.

0105.

1

95.5

85

90

95

100

105

110

115

120

2001 2002 2003 2004 2005 2006 2007 2008 2009:Q1E

The P/C Industry’s Combined Ratio Seems Headed Up, Again

Sources: A.M. Best, ISO; III preliminary estimates.

The industry’s combined ratio appears to be on a “cyclical upturn” dating to 2006. In 2008, even excluding net CAT losses (which

added 3.4 points to the combined ratio vs. 2007) and M&FG losses (another 4.1 points vs. 2007), the 2008 ratio would have been 97.6.

Combined Ratio

09:Q1 combined ratio was 98.4 excl. M&FG vs. 96.8

in 08:Q1

Medical Cost Inflation is One of the Most Serious Long-term Challenges Facing

Casualty, WC, and Health Insurers

80

140

200

260

320

380

82

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08

09*

Ind

ex V

alu

e (1

982-

84=

100)

All Items Medical Care

Source: Department of Labor (Bureau of Labor Statistics); not seasonally adjustedhttp://www.bls.gov/news.release/pdf/cpi.pdf *through July 2009

Since 1982-84, (index =100) the cost of medical care has nearly quadupled (to 375), while the overall cost of living

merely doubled (to 215)

4.5%3.5%

2.8% 3.2% 3.5%4.1%

4.6% 4.7%4.0% 4.4% 4.2% 4.0% 4.4%

5.1%

7.4%

10.1%

8.3%

10.6%

7.3%

13.6%

7.6%

6.2%

9.2%

7.2%

8.6%

6.0%

0%

3%

6%

9%

12%

15%

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Change in Medical CPIChange Med Cost per Lost Time Claim

WC Medical Severity Rising Far Faster than Medical CPI

Sources: Med CPI from I.I.I. Inflation Watch; WC med severity from NCCI based on NCCI states.

Since 2003, Tort System Cost Growth Has Moderated but Could Spike Again

-6%

-3%

0%

3%

6%

9%

12%

15%

2001 2002 2003 2004 2005 2006 2007 2008

Rate of Tort System Cost Growth CPI

Sources: US Bureau of Labor Statistics, Tillinghast-Towers Perrin, 2008 Update on U.S. Tort Costs; Insurance Info. Inst.

Catastrophic Losses*: Was 2005an Outlier or a Harbinger?

$7.5$2.7$4.7

$22.9

$5.5

$16.9

$8.3$7.4$2.6

$10.1$8.3$4.6

$26.5

$5.9

$12.9

$27.5

$6.7

$26.0

$6.9

$61.9

$9.2

$0

$10

$20

$30

$40

$50

$60

$70

89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

09**

*Excludes $4B-$6b offshore energy losses from Hurricanes Katrina & Rita. **2009:1HNote: 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

$ Billions

30

Is $25 billion the new level of expected

yearly CAT losses?Before 2001, CAT

losses averaged about $8-10 billion per year.

5.1 5.

3 5.4 5.

5 5.6 5.

7 5.8 5.

9 6.0 6.

2 6.3 6.

5 6.6 6.

8 7.0 7.

1

7.3 7.

4 7.5

7.5 7.5

7.6 7.6 7.

7 7.9 8.

0 8.1 8.

2 8.3 8.

5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

09F

10F

11F

12F

13F

14F

15F

16F

17F

18F

19F

Source: http://edr.state.fl.us/conferences/population/demographic.htm

Data are from Feb. 18, 2009 Florida Demographic Estimating conference

A Million More Florida Resident Households in the Next Decade?

Millions of Households

The State of Florida now (Feb 09) forecasts nearly 1 million more

households by 2019 (up almost 13%). There will be more businesses, too.

Hurricane Andrew

Hurricane Wilma

Source: South Alabama Regional Planning Commission, “Coastal Alabama River Basin Management Plan”, January 2004.

High Population Growth Forecast for Coastal Areas in Baldwin County, AL, 2000-2030

High population growth in coastal

Alabama puts more insured value

at risk

High Mobile County Population Growth Forecast 2000-2030 is Near but Not Directly on the Coast

Source: South Alabama Regional Planning Commission, “Coastal Alabama River Basin Management Plan”, January 2004.

Major (Category 3, 4, 5) Hurricanes Striking the US by Decade

3 10 10

76

5

4

6

88

5

8

6

9

1900s 1910s 1920s 1930s 1940s 1950s 1960s 1970s 1980s 1990s 2000s 2010s 2020s

*Figure for 2000s is extrapolated based on data for 2000-2008 (7 major storms: Charley, Ivan, Jeanne (2004), Katrina, Rita, Wilma (2005), Ike (2008)).Sources: Tillinghast from National Hurricane Center: http://www.nhc.noaa.gov/pastint.shtm.; I.I.I.

Mid 1920s – mid-1960s:AMO Warm Phase

Mid-1990s – 2030s?AMO Warm Phase

Colorado State team forecasts 3

more intense hurricanes in

2009

Inflation-Adjusted U.S. Insured Catastrophe Losses By Cause of Loss,

1987-2006¹

Fire, $6.6 , 2.2%

Tornadoes, $77.3 , 26.0%

All Tropical Cyclones, $137.7 ,

46.3%

Civil Disorders, $1.1 , 0.4%

Utility Disruption, $0.2 , 0.1%

Water Damage, $0.4 , 0.1%Wind/Hail/Flood,

$9.3 , 3.1%

Earthquakes, $19.1 , 6.4%

Winter Storms, $23.1 , 7.8%

Terrorism, $22.3 , 7.5%

Source: Insurance Services Office (ISO)..

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.

Insured disaster losses totaled $297.3 billion from 1987-2006 (in 2006 dollars). Hurricanes and tornadoes accounted for approximately 75% of these.

Number of Tornadoes in Each Calendar Quarter, 2005–2009:Q2

209

504

235

160

244

543

193

112

360

944

305

81

157

617

118

394

571

105

0

100

200

300

400

500

600

700

800

900

1,000

1st Qtr 2nd Qtr 3rd Qtr 4th Qtr

2005 20062007 20082009

Sources: US Dept. of Commerce, Storm Prediction Center, National Weather Service,at http://www.spc.noaa.gov/climo/torn/monthlytornstats.pdf 2009:Q2 is I.I.I. estimate

The first two quarters of 2009 were more

typical of prior years than 2008.

Underwriting Expense Ratios LikelyWill Rise as Premium Growth Lags

23.4%

24.3%25.0% 26.2%

24.4%

24.5%24.8%25.6%

24.6%

25.6%

24.7%

26.1%25.9%

27.7%

30.8%

28.3%

26.3%26.4%25.6%

30.0%

31.1%

29.4%

29.9%

29.1%

26.6%

25.0%

22%

24%

26%

28%

30%

32%

96 97 98 99 00 01 02 03 04 05 06 07 08

Personal Commercial

*Ratio of expenses incurred to net premiums written.Sources: A.M. Best; ISO; Insurance Information Institute

2009:Q1 blended ratio was 29.1%

• The financial crisis/great recession didn’t directly affect P-L underwriting performance; the underwriting cycle and catastrophes were 2008’s drivers

• Premium levels will likely continue to be soft, driven by low exposure growth, low inflation

• The potential for significant catastrophe losses remains high

• Expense ratios will likely grow unless expenses can be reduced

Section Summary: Hard Truths about P-L Insurance Operations

Hard Truths about Property/Liability

Investment Performance and Insuring Capacity

Asset Allocation of P/C Insurance Industry’s Cash & Invested Assets

Cash & Short-Term Investments

7.6%

Common Stock16.3%

Other8.2%

Preferred Stock1.2%

Bonds66.7%

Portfolio Facts

•Invested assets totaled $1.26 trillion as of 9/30/08

•Allocations were virtually unchanged from 12/31/07

Source: SNL Financial LC

As of September 30, 2008

41

Bond Yields Tend to Follow Inflation, but the Relationship is a Loose One

-2%

0%

2%

4%

6%

8%

10%

90

91

92

93

94

95

96

97

98

99 00

01

02

03

04

05

06

07

08

09F

10F

CPI-U % Change U.S. Treasury 10-Year Note Yield

Sources: US Bureau of Labor Statistics (history); Blue Chip Economic Indicators, 8/09 (forecasts)

ForecastJuly 1990-March 1991

recession

March 2001-November 2001

recession

2%

3%

4%

5%

6%

7%

8%

9%

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

09F

10F

11F

12F

13F

14F

P-C Inv Income/Inv Assets 10-Year Treasury Note

P/C Investment Income as a % of Invested Assets Follows 10-Year U.S. T-Note

Sources: history: Board of Governors, Federal Reserve System; A.M.Best; Insurance Information Institute.Forecasts: Office of Management and Budget, Mid-Session Review, Fiscal Year 2010.

Investment yield historically tracks 10-year Treasury note quite closely

OMB forecasts that T-note yields won’t exceed 5.2% for the next decade. If

recent history holds, P-C net investment yield will be somewhat lower.

P/C Industry Investment Income*, 1994-2008

$33.

7 $36.

8

$38.

0 $41.

5

$37.

1

$36.

7

$38.

7

$39.

6

$49.

5 $52.

3 $54.

6

$51.

2

$51.

4

$40.

8

$38.

6

$39.

9

$25

$30

$35

$40

$45

$50

$551994

95

96

97

98

99

2000

01

02

03

04

2005** 06

07

08

09**

*

Bill

ion

s

*Primarily interest and stock dividends. ** Investment income (excluding one-time dividend) jumped in 2005 as insurers that had accumulated cash captured rising bond interest rates. Also, 2005 figure includes special one-time dividend of $3.2B. ***2009 figure is Q1 actual, annualizedSources: ISO; Insurance Information Institute.

Investment income might moderate further if rates for new bond

investments stay low and/or if insurers shift to shorter-maturity bonds and

more US government notes.

Investment income CAGR 1994-2007 was just 3.8%.

P/C Industry Net Realized Capital Gains and Losses, 1990-2009:Q1

$2.88$4.81

$9.89

$1.66

$6.00

$9.24$10.81

$13.02

$16.21

$6.63

-$1.21

$6.61$8.97

-$19.80

-$0.41

$18.02

$3.52

$9.70$9.13$9.82

-$24

-$20

-$16

-$12

-$8

-$4

$0

$4

$8

$12

$16

$20

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

09:Q

1

Sources: A.M. Best, ISO, Insurance Information Institute.

Nearly $9 billion in realized capital gains in 2007, but

$-19.7 billion in 2008.

$ Billions

Policyholder Surplus by Quarter,2006:Q4 – 2009:Q1

Billions$4

87.1

$496

.6 $512

.8

$521

.8

$478

.5

$455

.6

$437

.1

$505

.0

$515

.6

$517

.9

$400

$425

$450

$475

$500

$525

06:Q4 07:Q1 07:Q2 07:Q3 07:Q4 08:Q1 08:Q2 08:Q3 08:Q4 09:Q1

Source: ISO

Decline Since 2007:Q3 Peak

2009Q1: -$84.7B (-16.2%)

0.8

1.0

1.2

1.4

1.6

1.8

2.0

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 0809:Q1

U.S. P/C Industry Premiums-to-Surplus Ratio: 1985-2009:Q1

Sources: A.M. Best, ISO, Insurance Information Institute.

19980.85:1–the lowest

(strongest) P:S ratio in recent history.

Premiums are a rough measure of risk accepted; surplus is funds beyond reserves to pay unexpected

losses. The larger surplus is in relation to premiums—the lower the ratio of premiums to surplus—the greater

the industry’s capacity to handle the risk it has accepted.

1.03:1 as of

3/31/09

Ratio at year-end

Largest Capital Events asa Percent of Surplus, 1989-present

3.3%

9.6%

6.9%

10.9%

16.2%

13.8%

6.2%

0%

3%

6%

9%

12%

15%

18%

6/3

0/1

989

Hu

rric

an

eH

ug

o

6/3

0/1

992

Hu

rric

an

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nd

rew

12/3

1/9

3N

ort

hri

dg

eE

art

hq

uake

6/3

0/0

1S

ep

t. 1

1A

ttacks

6/3

0/0

4F

lori

da

Hu

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es

6/3

0/0

5H

urr

ican

eK

atr

ina

Fin

an

cia

lC

risis

as o

f3/3

1/0

9**

Ratio is for end-of-quarter surplus immediately prior to event. Date shown is end of quarter prior to event. Sources: PCS; Insurance Information Institute.

The financial crisis now ranks as the largest “capital event”

over the past 20+ years

Premium-to-Surplus Ratios Before Major Capital Events*

$1.65

$1.42 $1.40

$1.03 $1.03$0.88

$1.05$1.15

$0.5

$0.7

$0.9

$1.1

$1.3

$1.5

$1.7

$1.9

6/3

0/1

989

Hu

rric

an

eH

ug

o

6/3

0/1

992

Hu

rric

an

eA

nd

rew

12/3

1/9

3N

ort

hri

dg

eE

art

hq

uake

6/3

0/0

1S

ep

t. 1

1A

ttacks

6/3

0/0

4F

lori

da

Hu

rric

an

es

6/3

0/0

5H

urr

ican

eK

atr

ina

6/3

0/0

7F

inan

cia

lC

risis

As o

f3/3

1/0

9**

*Ratio is for end of quarter immediately prior to event. Date shown is end of quarter prior to event. **Latest availableSource: PCS; Insurance Information Institute.

P/C insurance industry was better capitalized going into the

financial crisis than before any “capital event” in recent history

In 2008, A.M. Best Affirmed or Upgraded 88% of P/C Insurers*

Upgraded, 59 , 4.2%

Other, 59 , 4.2%

Affirm, 1,183 , 83.4%

Downgraded, 55 , 3.9%

Under Review, 63 , 4.4%

*Through December 19.Source: A.M. Best.

50

In 2008, despite financial market turmoil, high cat losses and a soft

market, A.M. Best lowered ratings on just 3.9% of P-C insurers. It placed

another 4.4% under review

Reasons for US P/C Insurer Impairments, 1969-2008

Source: A.M. Best: 1969-2008 Impairment Review, Special Report, Apr. 6, 2008

Deficient loss reserves and inadequate

pricing are the leading cause of

insurer impairments,

underscoring the importance of

discipline. Investment

catastrophe losses play a much smaller role.

Reinsurance Failure3.7%

Rapid Growth14.3%

Misc.9.1%

Affiliate Impairment

7.9%

Sig. Change in Business

4.2%

Deficient Loss

Reserves/In-adequate Pricing38.1%

Investment Problems

7.0%

Alleged Fraud8.1%

Catastrophe Losses7.6%

-5%

0%

5%

10%

15%

20%

25%

75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

1975: 2.4%

1977:19.0% 1987:17.3% 1997:11.6% 2006:12.2%

1984: 1.8% 1992: 4.5% 2001: -1.2%

10 Years10 Years

9 Years

Note: 2008 result excluding Mortgage & Financial Guarantee insurers is 4.2%.Sources: ISO; A.M. Best (2009F); Insurance Information Institute.

2008: 0.3%

P/C Insurance Industry ROEs,1975 – 2009F*

52

• Even though the industry has had its largest “capital event,” it is still well positioned to conduct business as usual

• Yields on bonds are expected to continued at low levels Nearly a decade of investing at these levels means

they’re “baked in” to investment performance for a long time

Section Summary: Hard Truths about P-L Investments & Capacity

Insurance Information Institute On-Line

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