What’s Keeping Insurance CEOs Awake at Night? Especially in the Northwest Robert P. Hartwig, Ph.D., CPCU, Senior Vice President & Chief Economist Insurance

What’s Keeping Insurance CEOs Awake at Night?

Especially in the Northwest

Robert P. Hartwig, Ph.D., CPCU, Senior Vice President & Chief EconomistInsurance Information Institute 110 William Street New York, NY 10038

Tel: (212) 346-5520 Fax: (212) 732-1916 [email protected] www.iii.org

Washington Insurance CouncilSeattle, WA

July 27, 2005

OUTLINE: What’s Keeping Insurance

CEOs Awake at Night?

• Maintaining Profitability• Underwriting Discipline• Pricing Discipline• Investment Returns• Controlling Expenses• Capital & Capacity• Improving the Operating Environment/Taming Cycle• Tort Environment• Terrorism• Customer Satisfaction & Retention• Q & A

CEO Concern #1MAINTAINING

PROFITABILITY

Sustainable P/C Profitability:An Oxymoron?

Highlights: Property/Casualty,2005:Q1 vs. 2004:Q1

2005 2004 Change

Net Written Prem. 108.4 105.8 +2.4%

Loss & LAE 69.1 68.2 +1.4%

Net UW Gain (Loss) +7.1 +5.3 +34.8%

Net Inv. Income 13.5 9.4 +44.4%

Net Income (a.t.) 17.3 13.4 +29.3%

Surplus* 401.8 393.5 +2.1%

Combined Ratio** 91.9 98.1 -6.2 pt.*2004 figure is as of December 31, 2004. **2004 figure is for full year 2004.Source: ISO, Insurance Information Institute

Growth rate barely 1/2 that of CY2004

Investment Income Rebound?

Lowest in many years

Highlights: Property/Casualty,2004 vs. 2003

2004 2003 Change

Net Written Prem. 423,263 404,432 +4.7%

Loss & LAE 299,545 288,656 +3.8%

Net UW Gain (Loss) 5,043 (4,853) N/A

Net Inv. Income 39,589 38,648 +2.4%

Net Income (a.t.) 38,722 30,029 +28.9%

Surplus* 393,488 347,020 +13.4%

Combined Ratio 98.1 100.1 -2.0 pts.

Source: ISO, Insurance Information Institute

Early Sentiments on 2005 Based on Earnings Reports for First Half Data

• 2005 May Be Generally Better than Expected• Personal Lines Surprises: Generally Upside

PPA and HO premiums have not weakened as much as anticipated and underlying loss costs remain generally favorable (declining frequency); Light CAT losses so far!

• Commercial Lines: MixedUnderwriting results generally not bad by recent historical

standards, but…Weakening pricing environment starting to take its tollReliance on favorable reserve development?

• Reinsurers: MixedConcern over primary pricing trends, Re capacity, CATs

• Brokers: DownBig brokers: loss of contingent commissions, pricing (cycle), fines,

expense management all having impactOngoing search for/execution of new economic model

Advertising Expenditures by P/C Insurance Industry, 1999-2004E

$ Billions

$1.736 $1.737$1.803

$1.708

$2.100

$1.882

$1.5

$1.6

$1.7

$1.8

$1.9

$2.0

$2.1

$2.2

99 00 01 02 03 04ESource: Insurance Information Institute from consolidated P/C Annual Statement data.

Ad spending by P/C insurers is at a record high, signaling

increased competition

P/C Net Income After Taxes1991-2004 ($ Millions)

$14,178

$5,840

$19,316

$10,870

$20,598

$24,404

$36,819

$30,773

$21,865

-$6,970

$3,046

$30,029

$17,

800

$20,559

$38,722

-$10,000

$0

$10,000

$20,000

$30,000

$40,000

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05**ROE figures are GAAP; 2004 figure is return on average surplus. 2005 figure is for First QuarterSources: A.M. Best, ISO, Insurance Information Institute.

2001 ROE = -1.2%

2002 ROE = 2.2%

2003 ROE = 8.9%

2004 ROE = 10.5%*

2004:Q1 ROE = 15.1%

-5%

0%

5%

10%

15%

20%

87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05F

US P/C Insurers All US Industries

ROE: P/C vs. All Industries 1987–2005F*

*GAAP ROEs except 2004/5 P/C figure = return on average surplus. 2005 figure is based on Q1 results.Source: Insurance Information Institute; Fortune for all industry figures

2005 Fortune 500 ROE = 14.5%E

2005 P/C ROAS = 15.1%*

2004 P/C ROAS = 10.5%

16.3 Pts.

Top 10 Largest P/C Stock Companies by ROE (2004)

32%

5%9%

9%

10%13%

14%

14%15%

15%15%

0% 10% 20% 30% 40%

Progressive

Allstate

Hartford

Chubb

Stock Ins. Median

Liberty Mutual*

AIG

Loews

Berkshire Hathaway

Nationwide*

St Paul

*Not a stock company, but reported financial data according to Generally Accepted Accounting Principles.Source: Fortune, April 18, 2005

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

91 92 93 94 95 96 97 98 99 00 01 02 03 04

ROE Cost of Capital

ROE vs. Equity Cost of Capital: US P/C Insurance: 1991 – 2004

Source: The Geneva Association, Ins. Information Inst.

The p/c insurance industry achieved its costs of capital in 2004 for the first time in many years

-13.

2 p

ts -9.0

pts

US P/C insurers missed their cost of capital by an average 6.3 points from 1991 to 2003

-1.7

p

ts +0.

6 p

ts

RNW for Major P/C Lines,1994-2003 Average

14.0%

8.3% 8.3%7.4%

5.5% 5.0% 5.0%

2.9%

-2.1%

19.7%

13.4%

5.8%

-5%

0%

5%

10%

15%

20%

InlandMarine

Fire AllOther

WC PPAuto

AllLines

MedMal

CommAuto

OtherLiab

CMP HO Allied

Source: NAIC; Insurance Information Institute

10-Year returns for some major p/c lines surprisingly good, but

HO is a major laggard

RETURN ON EQUITY (Fortune):Stock & Mutual vs. All Companies*

*Fortune 1,000 group.

Source: Fortune Magazine, Insurance Information Institute.

9%

13.4%14.6%

10.4% 10.0%

14%13%

7%6%

11%12%

-2%

8%7%

2%

10%

13.9%

12.6%

-4%-2%0%2%4%6%8%

10%12%14%16%

1998 2000 2001 2002 2003 2004

StockMutualAll Companies*

Stock insurer ROEs consistently above mutuals

Some mutual insurers sell/market the mutuality

concept effectively

P/C Insurers Up, Brokers & Reinsurers Down in 2005

-4.29%

-3.08%

-1.74%

4.57%

6.83%

9.67%

1.39%

-5% 0% 5% 10% 15%

S&P 500

Life/Health

All Insurers

P/C

Multiline

Reinsurers

Brokers

Source: SNL Securities, Standard & Poor’s, Insurance Information Institute

Total Return 2005 YTD Through July 15, 2005

P/C insurer stocks outperforming the

market

-5%

0%

5%

10%

15%

20%

25%

87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04

US P/C Insurers All US Industries Life

Diversified Finl. Comm. Banks

ROE: Financial Services Industry Segments, 1987–2004*

*All figures GAAP except 2004 P/C figure is return on average surplus.Source: Insurance Information Institute, Fortune, Value Line.

P/C insurance was finally holding its own against other financial services segments until hurricanes

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

91 92 93 94 95 96 97 98 99 00 01 02 03 04E

US P/C Insurers All US Industries Washington

ROE: P/C & All Industries v. WA 1987–2004

Source: Insurance Information Institute; NAIC, Fortune

Washington is now an above-average performer after years of

average (bad) performance

ROE for Major Commercial Lines in WA, 1991 - 2003

18.0%19.5%

16.3%14.5%

8.4%

12.1%

5.5%

2.9%

7.3%

18.3%

-1.7%

14.8%

-4.0%

10.4%

-8.7%

2.9%

-0.9%

11.2%

0.0%

-0.7%

2.7%

6.1% 7.4%

-9.5% -9.1%

-4.0%

-10%

-5%

0%

5%

10%

15%

20%

25%

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Commercial Auto

Commercial Multi-Peril

Source: NAIC

Profits in WA in recent years are generally inadequate and

are well below the Fortune 500 historical return of 13% -14%

ROE for Personal Lines in WA,1992 - 2003

13.2

%

8.3%

8.0%

4.5%

11.2

%15.6

%

13.4

%

7.0%

15.4

%

8.4%

3.3%

10.7

%

12.9

%

8.8%

21.2

%

7.6%

0.2%

16.8

%

-23.

3%

3.6% 5.

4%

4.4% 7.

5%

-11.

9%

-30%

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Personal Auto

Homeowners

Source: NAIC

12-Year Average:

Auto: 9.3%

Home: 5.0%

Personal lines profitability is

improving in WA

Return on Equity: 1994-2003WA & Nearby States PP Auto

5.0%

8.3%

8.3%

9.3%

10.3%

11.1%

0% 2% 4% 6% 8% 10% 12%

California

Idaho

Oregon

Washington

US

Montana

Source: NAIC, Insurance Information Institute

1994 - 2003

Return on Equity: 1994-2003WA & Nearby States HO

4.9%

5.5%

5.7%

6.8%

7.5%

8.1%

0% 2% 4% 6% 8% 10%

Oregon

California

Idaho

Washington

US

Montana


1994-2003

Return on Equity: 1994-2003WA & Nearby States CMP

0.0%

3.0%

5.0%

5.0%

11.4%

14.9%

0% 5% 10% 15% 20%

Idaho

Oregon

Montana

US

California

Washington


1994 - 2003

INSURANCE INDUSTRY INVESTIGATIONS

Thoughts on Economic Consequences

ECONOMIC OUTCOMES• INTERMEDIARY COMPENSATION

Contingent Commissions: Most brokers/agencies will take them (except largest brokers) and most insurers will pay them. Generally structured to achieve profitable growth. Disclosure inevitable but extent unknown.

Large Brokers: Difficulty replacing lost revenue; Search for a new economic model will be difficult (esp. as cycle turns). Calls for all to abandon contingent commissions will go unheeded

• FINITE Product will remain viable, but with disclosure Attempts at strict “bifurcation” will ultimately be recognized as unwise FASB clarifications (eventually)

• OFFSHORE REINSURANCE Insurers proactively examine offshore reinsurance affiliates for ownership and control. Board

restructurings likely and dissolutions of some entities if unable to demonstrate “significant” transfer of risk.

• ACCOUNTING IRREGULARITIES Restatements, starting to wind down More conservative accounting, esp. on risk transfer issue Earnings streams “less smooth” going forward

PUBLIC PERCEPTIONS OF INSURANCE

INDUSTRYHave Public Perceptions of the Industry Been Hurt by Scandal/

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

19

68

19

72

19

78

19

81

19

83

19

85

19

86

19

88

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

BanksElectric Power CompanyConsumer Finance CompaniesAuto & Home Insurance

Source: Insurance Information Institute Annual Pulse Survey, June 2005.

Percent of Public Rating Industry as Very or Mostly Favorable, 1968-2005

Awareness of Insurance Investigations

29%

70%

0%

10%

20%

30%

40%

50%

60%

70%

80%

AWARE NOT AWARE

Pe

rce

nt


Awareness of Investigations

80%

48%

29%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

ENRON &WORLDCOM

MUTUAL FUNDS &INVESTMENT BANKS

INSURANCEINDUSTRY

Pe

rce

nt


CEO Concern #2UNDERWRITING

Can Discipline be Maintained?

($55)

($45)

($35)

($25)

($15)

($5)

$5

$15

$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

E

Underwriting Gain (Loss)1975-2005E*

*2005 estimate is based on annualized actual 05Q1 underwriting profit of $7.1 billion.Source: A.M. Best, Insurance Information Institute

$ B

illi

ons

2004 produced the first underwriting profit ($5.0 billion) since 1978; 2005 could be much larger

90

100

110

120

70

71

72

73

74

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

P/C Industry Combined Ratio*2001 = 115.7

2002 = 107.2

2003 = 100.1

2004 = 98.1

2005:Q1 = 91.9*

Combined Ratios

1970s: 100.3

1980s: 109.2

1990s: 107.8

2000-05E: 103.9

Sources: A.M. Best; ISO, III. *2005 estimate is based on annualized actual first quarter 2005 result.

The industry has just experienced its most

remarkable recovery in recent history

110.

3

110.

2

107.

6

103.

9

109.

7

112.

3

111.

5

122.

2

110.

2

98

94

103.

9

104.

5

103.

5

104.

9

99.8 10

2.7

104.

5 109.

9

110.

9

105.

3

98.4

97

90

112.

5

101.

9

85

90

95

100

105

110

115

120

125

93 94 95 96 97 98 99 00 01 02 03 04E 05F

Commercial--Net Basis Personal--Net Basis

Commercial vs. Personal Lines Combined Ratios

Source: A.M. Best; Insurance Information Institute *1994-2003 average

10-Year Average Combined Ratios*

Commercial: 109.9 Personal: 104.4

Compression of results is due to low

interest. Underwriting is now more important in

long-tail commercial lines

40%

50%

60%

70%

80%

90%

100%

91 92 93 94 95 96 97 98 99 00 01 02 03

Personal Auto Homeowners Commercial Multi Peril

Washington Direct Loss Ratios, 1991-2003


WA loss ratios are falling in personal and commercial lines, mirroring US

CASE STUDY: PERSONAL AUTO

A SUCCESSFUL SHIFT TO THE UNDERWRITING

CULTURE?

101.7 101.3 101.3 101.0

99.5

101.1

103.5

109.5

107.9

104.2

98.4

93.3 93.1

90

95

100

105

110

93 94 95 96 97 98 99 00 01 02 03 04E 05F

Private Passenger Auto Combined Ratio

Average Combined 1993 to 2004= 102.7

Many auto insurers have shown sig-nificant improvements in underwriting

performance since mid-2002

Sources: A.M. Best; III

PPA is the profit juggernaut of the p/c

insurance industry today

50%

55%

60%

65%

70%

75%

93 94 95 96 97 98 99 00 01 02 03 04E 05F

Loss Ratio: Private Passenger Auto Insurance

Source: NAIC; 2003 figure from A.M. Best; Insurance Information Institute

PP Auto has improved

significantly

Widespread introduction of scoring

Spread of segmentation and tiering

$668$691

$706 $704$683 $687

$720

$774

$834$857 $870

$600

$650

$700

$750

$800

$850

$900

$950

95 96 97 98 99 00 01 02 03* 04* 05*

Average Expenditures on Auto Insurance

*Insurance Information Institute Estimates/ForecastsSource: NAIC, Insurance Information Institute

Countrywide auto insurance expenditures are expected to

rise 1.5% in 2005

50%

60%

70%

80%

90%

100%

110%

99

:Q1

99

:Q2

99

:Q3

99

:Q4

00

:Q1

00

:Q2

00

:Q3

00

:Q4

01

:Q1

01

:Q2

01

:Q3

01

:Q4

02

:Q1

02

:Q2

02

:Q3

02

:Q4

03

:Q1

03

:Q2

03

:Q3

03

:Q4

04

:Q1

04

:Q2

04

:Q3

04

:Q4

Collision Comprehensive Liability (BI & PD)

Source: ISO Fast Track; Insurance Information Institute.

Private Passenger Auto:Incurred Loss Ratios, 1999-2004

Loss ratios for all major coverage are trending

downward

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

00

:Q1

00

:Q2

00

:Q3

00

:Q4

01

:Q1

01

:Q2

01

:Q3

01

:Q4

02

:Q1

02

:Q2

02

:Q3

02

:Q4

03

:Q1

03

:Q2

03

:Q3

03

:Q4

04

:Q1

04

:Q2

04

:Q3

04

:Q4

05

:Q1

Auto Insurance Component of CPI Personal Auto-PD Pure Premium

Source: Insurance Information Institute calculations based ISO Fast Track and US BLS data.

Pure Premium Spread: Personal Auto PD Liability, 2000-2005:Q1

Margin necessary to maintain PPA profitability

2000 PPA Combined = 110


-2.2%

-5.3%

-4.0%-3.4%

-1.7%-0.9%

3.5% 3.6% 3.9% 3.5%

-0.3%

4.7%

-6%

-4%

-2%

0%

2%

4%

6%

99 00 01 02 03 04

Frequency Severity

US Bodily Injury: Severity Trends Now Offset Declining Claim Freq.

Source: ISO Fast Track data.

Medical inflation a

powerful cost driver

-8.3%

-3.0%

3.9%3.0%3.2%

5.4%4.6%

2.1%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

01 02 03 04

Frequency Severity

WA Bodily Injury: Frequency & Severity Trends Now Rising


Washington BI trends are mixed since 2001

2.6%

-0.4%

1.8%

-3.6%

-5.1%-4.4%

3.7% 3.6%

1.5%

2.8%

4.1%

6.8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

99 00 01 02 03 04

Frequency Severity

US Collision: Frequency Trend Swamps Rising Claim Severity


-0.4%

1.4%

-6.3%

0.4%

3.5%

-0.2%

2.4%3.2%

-8%

-6%

-4%

-2%

0%

2%

4%

01 02 03 04

Frequency Severity

WA Collision: Frequency & Severity Now Rising


Washington Collision trends not as favorable

as the US

-1.7%-2.6%

3.2%

-5.7%

-2.1%

-8.3%-7.0%

-3.8%-2.2%

3.3%

-4.7%

8.9%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

99 00 01 02 03 04

Frequency Severity

US Comprehensive: Favorable Frequency and Severity Trends


-1.7%-2.6%

3.2%

-5.7%

-2.1%

-8.3%-7.0%

-3.8%-2.2%

3.3%

-4.7%

8.9%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

99 00 01 02 03 04

Frequency Severity

WA Comprehensive: Favorable Frequency and Severity Trends


WHY UNDERWRITING DISCIPLINE MATTERS

97.5

100.6 100.198.1

91.9

9.4%

15.1%

10.5%

15.9%

14.3%

80

85

90

95

100

105

110

1978 1979 2003 2004 2005:Q1*

Co

mb

ine

d R

ati

o

8%

10%

12%

14%

16%

Re

tru

n o

n E

qu

ity

*

Combined Ratio

ROE*

* 2004/5 figures are return on average statutory surplus. 2005:Q1 figure adjusted for impact of special dividend. Source: Insurance Information Institute from A.M. Best and ISO data.

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

Underwriting Matters Because Pricing is Often Undisciplined

99

.5 10

1.1

10

9.5

10

4.2

98

.4

93

.3

93

.1

10

7.9

10

3.5

10

1.3 10

1

$774

$834$855

$868

$687$683

$706

$704$718

$691

$668

90

95

100

105

110

115

95 96 97 98 99 00 01 02 03 04E 05F

Co

mb

ine

d R

ati

o

$500

$600

$700

$800

$900

Av

g. A

uto

Ins

ura

nc

e E

xp

en

dit

ure

PP Auto Combined Ratio

Average Auto InsuranceExpenditure

Private Passenger AutoCombined Ratios, 1993-2005F

Sources: Insurance Information Institute from A.M. Best and NAIC data; 2004/5 expenditure estimates from III.

Somebody forgot there’s a relationship between price and

underwriting performance

Somebody remembered

UNDERWRITING AFFECTS FINANCIAL

STRENGTH

Is There Causefor Concern?

0.4

5

0.4

1

0.4

3

0.4

2 0.6

8

1.2

2

1.7

1

1.1

2

0.4

4

0.5

8 0.8

2

0.9

9

1.0

5

1.7

8

1.1

0.8

3

1.5

6

1.0

8

0.8

0.5

1

0.4

1

0.9

6

1.9

2

1.9

9

3.3

1.7

9

4.93

0

1

2

3

4

5

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

E

Ra

tio

of

Do

wn

gra

des

to

Up

gra

des

Downgrade/Upgrade Ratio*

Sources: Impairment Rate and Rating Transition Study—1977 to 2002, A.M. Best & Co.

*U.S. property/casualty and life/health insurers before 2000; P/C only 2000-2004.

Downgrade to upgrade ratio is falling (primarily because the number of downgrades is falling; only a small increase

in upgrades)

P/C Insurer Downgrades & Upgrades, 2000 to 2004*

*12-month period ended July 12, 2004Source: Insurance Information Institute from A.M. Best data.

77

148 151

188

118

80 77 7657

66

2000 2001 2002 2003 2004*

Downgrades skyrocketed beginning in 2001 while upgrades fell

Historical Ratings Distribution,US P/C Insurers, 2000 vs. 2004

A/A-50.2%

D0.2%C++/C+

2.1%

E/F3.5% A++/A+

8.6%

C/C-0.6%

B++/B+25.8%

B/B-9.1%

Source: A.M. Best: Rating Downgrades Slowed but Outpaced Upgrades for Fourth Consecutive Year, Special Report, November 8, 2004.

A/A-48.4%

D0.2%C++/C+

1.9%

E/F2.3% A++/A+

11.5%

C/C-0.6%

B++/B+28.3%

B/B-6.9%

2000 2004 A++/A+ shrinkage

Cumulative Average Impairment Rates by Best Financial Strength Rating*

0%

10%

20%

30%

40%

50%

60%

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15Average Years to Impairment

D

C/C-

C++/C+

B/B-

B++/B+

A/A-

A++/A+

Sources: A.M. Best: Best’s Impairment Rate and Rating Transition Study—1977-2002, March 1, 2004.

Insurers with strong ratings are far less likely to become impaired over

long periods of time. Especially important in long-tailed lines.

*US P/C and L/H companies, 1977-2002

Number of P/C Insurer Insolvencies, 2000 to 2004

Source: A.M. Best; Weiss Ratings; Insurance Information Institute

30 30

38

21

10

2000 2001 2002 2003 2004

The number of p/c insurer failures fell by more than 50%

in 2004

Reason for P/C Insolvencies(218 Insolvencies, 1993-2002)

Unidentified17%

Impaired Affiliate3%

Overstated Assets2%

Change in Business3%

CAT Losses3%

Reinsurer Failure0%

Rapid Growth10%

Discounted Ops8%

Alleged Fraud3%

Deficient Loss Reserves

51%

Source: A.M. Best, Insurance Information Institute

Reserve deficiencies account for

more than half of all p/c insurers

insolvencies

$ Billions, Calendar Year Basis

$0.5 $0.6$1.1

$1.6 $1.7$2.3

$5.5

$2.9

($0.9)($1.5) ($0.8)

($2)

($1)

$0

$1

$2

$3

$4

$5

$6

P/C Insurance Industry Prior Year Reserve Development by Line, 2002-03*

*Negative numbers indicate favorable development; positive figures represent adverse development.Source: A.M. Best, Ins. Info. Inst.

Major adverse development in

casualty segments, little in personal lines

Why did most lines develop so adversely in 2003?

Who’s to blame?

INSURANCE-TO-VALUE:

Ending the Blame Game is aWin-Win Situation Deal

Insurance-to-Value in HO is a National Problem, Improved Recently

73%

64%61%

25%27%

35%

20%

30%

40%

50%

60%

70%

80%

2002 2003 2004

Proportion of Home Undervalued Average Undervaluation*According MS/B.Source: Marshall & Swift/Boeckh

Less than ITV means homeowners insurers left $8 billion on the table in 2003*

Why People Don’t Increase Homeowners Coverage

Didn't Know Needed To

25%

Other18%

Too Expensive5%

Didn't Have Time30%

Agent Said I'm Covered

26%

Don’t Want Rates to Go Up

17%

22% cite expense as reason they don’t adjust they’re HO coverage

25% don’t realize they need to

30% say they’re too busy (to think about protecting their most valuable asset)

25% say their agent said there’s nothing to worry about

Source: Harris interactive poll conducted for Fireman’s Fund, July 2004.See: http://www.firemansfund.com/dcmssites/about/pdf/firemansfundtoplinerev2.pdf

CATASTROPHE LOSS

MANAGEMENT

Failure to Adequately Manage this Risk Has Been Devastating

Most of US Population & Property Has Major CAT Exposure

WA PERILS

Earthquake

Wildfire

Tsunami

Volcanic Eruption

Terrorism

Washington Earthquakes

Source: National Earthquake Information Center (USGS); Insurance Information Institute

U.S. InsuredCatastrophe Losses ($ Billions)

$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

$4.0

$0

$5

$10

$15

$20

$25

$30

89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05**As of 6/30/05 plus $920 in insured for Hurricane Dennis in July.Note: 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.Source: Property Claims Service/ISO; Insurance Information Institute

$ Billions2004 was the second worst year ever for natural disaster losses in the US after adjusting for inflation.

About 83% of those losses originated in Florida.

-5%

0%

5%

10%

15%

20%

87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03

US P/C Insurers All US Industries P/C excl. Hurricanes

ROE: P/C vs. All Industries 1987–2004E*

*2004 p/c estimate based on first 9 months data.Source: Insurance Information Institute; Fortune

AndrewNorthridge

Hugo Lowest CAT losses in 15 years

Sept. 11

2004 ROE excl. hurricanes

2004 ROE reduced due to

hurricanes

Top 10 Major Disaster Declaration Totals By State(1972- 2004)

57

4844

40 39 3936 34 33 32

29

05

1015202530354045505560

Total Number

Source: Federal Emergency Management Agency (FEMA)

SURPISE: Washington is among the Top 10 states in terms of major disaster declarations

CEO Concern #3PRICING

Can Discipline be Maintained?

-10%

-5%

0%

5%

10%

15%

20%

25%

19

70

19

71

19

72

19

73

19

74

19

75

19

76

19

77

19

78

19

79

19

80

19

81

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

Note: Shaded areas denote hard market periods.Source: A.M. Best, Insurance Information Institute

Strength of Recent Hard Markets by NWP Growth*

Real NWP Growth During Past 3 Hard Markets

1975-78: 8.6%

1984-87: 11.2%

2001-04: 6.9%

1975-78 1984-87 2001-04

*2005 figure is III forecast based on 05Q1 result.

Premium growth is faltering. Real growth in 2005 will be NEGATIVE

$668$691

$706 $704$683 $687

$720

$774

$834$857 $870

$600

$650

$700

$750

$800

$850

$900

$950

95 96 97 98 99 00 01 02 03* 04* 05*




rise 1.5% in 2005

Will the “big guys” stay disciplined? So far, so good. Will adopt tiering

to avoid adverse selection

WA’s 2002 avg. auto ins. expenditure (latest available)

was $788, ranking it 18th

$418$440

$455$481 $488

$508$536

$593

$636$660

$677

$400

$450

$500

$550

$600

$650

$700

95 96 97 98 99 00 01 02 03* 04* 05*

Average Expenditures on Homeowners Insurance


Countrywide home insurance expenditures

are expected to rise 2.5% in 2005

WA’s 2001 avg. HO ins. expenditure (latest

available) was $456, ranking it 32nd

14

%1

1% 13

% 16

% 19

% 22

%2

8% 3

1%

31

%2

8% 30

% 32

%3

3%

28

%2

9%

30

% 32

%3

0%

27

%2

5% 2

8%

22

%1

8%

18

%1

7%

16

%1

2%

12

%1

0% 12

%1

1%

9%

7%

7%

5%

4%

4%

2%

2%

2%

1%

0%

-1%

-2%

-2%

-3%

9%

9%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

Ju

l-0

1A

ug

-01

Sep

-01

Oct

-01

No

v-0

1D

ec-0

1J

an

-02

Feb

-02

Ma

r-0

2A

pr-

02

Ma

y-0

2J

un

-02

Ju

l-0

2A

ug

-02

Sep

-02

Oct

-02

No

v-0

2D

ec-0

2J

an

-03

Feb

-03

Ma

r-0

3A

pr-

03

Ma

y-0

3J

un

-03

Ju

l-0

3A

ug

-03

Sep

-03

Oct

-03

No

v-0

3D

ec-0

3J

an

-04

Feb

-04

Ma

r-0

4A

pr-

04

Ma

y-0

4J

un

-04

Ju

l-0

4A

ug

-04

Sep

-04

Oct

-04

No

v-0

4D

ec-0

4J

an

-05

Feb

-05

Ma

r-0

5A

pr-

05

Ma

y-0

5J

un

-05

Source: MarketScout.com

Commercial Premium Rate Changes Are Sharply Lower

Is moderation due to realization of performance and profit goals, increasing capacity/ capital, or market- share strategies?

82%

77%

83%

100%

71%

82%

93%

87%88%

94%

100%

91%

65%

70%

75%

80%

85%

90%

95%

100%

US Southeast Northwest Southwest Northeast Midwest

General LiabilityCommercial Property

Proportion of Accounts Renewing Negative by Region, 2005:Q2

Source: Board of Governors, Fed. Reserve System; Blue Chip Economic Indicators as of March 2005.

NW GL declines average, CP below

Average Commercial Rate Change by Account Size

Commercial accounts have trending downward for 4-5

quarters, with large commercial leading the way.

Cumulative Quarterly Rate Change by Account Size

Commercial rates are well off their late 2003 peaks for accounts of

all size and are approximately where they were in mid-2002

At which point do the reductions become destructive?

Average Rate Change, All Lines,(1Q:2004 – 1Q:2005)

-0.1%

-3.2%

-7.0%

-9.4%

-5.9%

-10%

-9%

-8%

-7%

-6%

-5%

-4%

-3%

-2%

-1%

0%

1Q04 2Q04 3Q04 4Q04 1Q05Source: Council of Insurance Agents & Brokers; Insurance Information Institute

Magnitude of rate decreases accelerated

during the first quarter of 2005

Rate Changes by Line,1st Qtr. 2005

-13.1%

-8.1%

-5.3%

-9.2%

-6.5%

-4.8%

-0.1%

-3.1%

-8.1%

-6.6%

-4.4%

-14%

-12%

-10%

-8%

-6%

-4%

-2%

0%

Comm Prop BizInterruption

Comm Auto WC GL Umbrella EPL D&O Surety Const. ALL Lines

Source: Council of Insurance Agents & Brokers; Insurance Information Institute

Magnitude of rate decreases accelerated during the first

quarter of 2005

P/C Soft Spots: % Accounts With Negative Price Change(1st Qtr. 2005)

88%

71% 69%60%

80%

70%

18%

50%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%


Terror Comm Auto WC GL EPL Umbrella


Significant moderation now evident in the commercial casualty lines

Property

Casualty/Liability/Terrorism

P/C Soft Spots: % Accounts With Negative Price Change(4th Qtr. 2003)

42%

18%

5%

13% 12% 11%13%

2%0%5%

10%15%20%25%30%35%40%45%50%55%60%




Property


P/C Soft Spots: % Accounts With Negative Price Change(4th Qtr. 2002)

2% 0% 1% 0% 0% 1%

7%

0%0%5%

10%15%20%25%30%35%40%45%50%55%60%




Property


CEO Concern #4INVESTMENTS

Does Investment Performance Affect

Discipline?

Property/Casualty Insurance Industry Investment Gain*

$ Billions

$35.4

$42.8$47.2

$52.3

$44.4

$36.0

$45.3$48.9

$13.5

$56.9$51.9

$57.9

$0

$10

$20

$30

$40

$50

$60

94 95 96 97 98 99 00 01 02 03 04 05**Investment gains consist primarily of interest, stock dividends and realized capital gains and losses.2005 figure is as of 3/31/05.Source: Insurance Services Office; Insurance Information Institute.

Investment gains are rising but in 2004

were still nearly 15% below their 1998 peak

$0

$9

$18

$27

$36

$45

$54

75 76 77 78 79 8081 82 83 84 85 8687 88 89 90 91 92 9394 95 96 97 98 9900 01 02 03 0405*

Net Investment Income$

Bil

lion

s

Growth History

2002: -1.3%

2003: +3.9%

2004: +2.4%

2005:Q1: +20.2%**

Source: A.M. Best, ISO, Insurance Information Institute; *Annualized. **2005:Q1 over 2004:Q1, adjusted for special dividend.

US P/C Net Realized Capital Gains,1990-2005:Q1 ($ Millions)

$2,880

$4,806

$9,893

$1,664

$5,997

$9,244$10,808

$18,019

$13,016

$16,205

$6,631

-$1,214

$6,610

$1,446

$9,298$9,818

-$5,000

$0

$5,000

$10,000

$15,000

$20,000

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05:Q1Sources: A.M. Best, ISO, Insurance Information Institute.

Realized capital gains rebounded strongly in

2003/4 but are 48% below their 1998 peak

-30%

-20%

-10%

0%

10%

20%

30%

40%

19

70

19

72

19

74

19

76

19

78

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

Source: Ibbotson Associates, Insurance Information Institute. *Through July 25, 2005.

Total Returns for Large Company Stocks: 1970-2005*

2003/4 were the first consecutive gains since 1999

S&P 500 was up 9% in 2004. Fears of higher interest rates, inflation, the falling dollar, resurgent oil prices are concerns in 2005

2005

0%

2%

4%

6%

8%

10%

12%

14%

16%

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

*

3-Month T-Bill 1-Yr. T-Bill 10-Year T-Note

Interest Rates: Lower Than They’ve Been in Decades, But…

Source: Board of Governors, Federal Reserve System; Insurance Info. Institute *June 2005 averages.

Lower bond yields were the primary driver behind weak investment income in recent years, with the 10-year note reaching a 45-year low in 2003 and falling again in 2005

Higher ST rates as Fed tightens.

Just 57bp between 1-yr & 10-yr yields*

3.5%3.6%3.7%3.8%3.9%4.0%4.1%4.2%4.3%4.4%4.5%4.6%4.7%4.8%4.9%5.0%

Jan-

04

Feb

-04

Mar

-04

Apr

-04

May

-04

Jun-

04

Jul-

04

Aug

-04

Sep-

04

Oct

-04

Nov

-04

Dec

-04

Jan-

05

Feb

-05

Mar

-05

Apr

-05

May

-05

Jun-

05

Jul-

05

10-Year Treasury Yields Remain Low and Are Falling*

Source: Board of Governors, Federal Reserve System; Insurance Info. Institute *As of 7/13/05.

Persistently low interest rates on the 10-year Treasury is a

major impediment to investment income growth

Nine rate hikes by the Fed since June 2004 have lifted ST rates, but not LT yields

P/C Insurance Industry Investment Portfolio, 2003

Source: 2005 Insurance Fact Book, Insurance Information Institute from the NAIC Annual Statement Database.

Bonds66.3%

Common Stock17.7%

Preferred Stock1.6%Mortgage

Loans0.3%

Other4.8%

Cash & ST Inv.

9.3%

P/C insurers portfolio is very conservatively

invested, with 2/3 of invested assets held as bonds—mostly munis,

high-grade corporate bonds and US Treasury

securities

0%

1%

2%

3%

4%

5%

6%

1m 3m 6m 1yr 2yr 3yr 5yr 7yr 10yr 20yr

Jun-04 Dec-04 Jun-05*

The Treasury Yield CurveHas Become Very Flat

Source: Board of Governors, Federal Reserve System; Insurance Information Institute. *As of 6/23/05.

“Among the biggest surprises of the past year has been the pronounced decline in long-term

interest rates on U.S. Treasury securities despite a 2-percentage point increase in the federal funds

rate. This is clearly without recent precedent.”

-Fed Chairman Alan Greenspan before the Joint Economic Committee of Congress, June 9, 2005

December 2004

June 2004

June 2005

Proportion of P/C Portfolio Invested in Cash and ST Securities

Source: A.M. Best; Insurance Information Institute

6.41%5.64% 5.26%

5.81%

4.08%

5.30% 5.54%

8.47%9.30%

10.00%

0%

2%

4%

6%

8%

10%

12%

95 96 97 98 99 00 01 02 03 04E

Cash & Short-Term SecuritiesHoldings of cash and short-term securities

has more than doubled since 1999

Proportion of P/C Bond Portfolio With Maturities of 1 Year or Less


10.7%

12.4%12.3%11.9%

12.5%

9.9%

12.3%

11.1%

13.8%14.4%

15.0%

8%

9%

10%

11%

12%

13%

14%

15%

16%

94 95 96 97 98 99 00 01 02 03 04E

1-Yr or Less Holdings of bonds with maturities of 1 year or less are up

50% since 1999

Proportion of P/C Bond Portfolio With Maturities of 10 to 20 Years


22.6%

21.0%20.3% 20.7% 20.7% 20.7%

18.9% 18.4%

16.6%15.4% 15.0%

10%

12%

14%

16%

18%

20%

22%

24%

94 95 96 97 98 99 00 01 02 03 04E

10-20YrsHoldings of bonds with maturities of 10-20 years is down by 27.5% since

1999 and 33.6% since 1994

Maturity Distribution of P/CBond Portfolio, 1999–2004E


39.8% 39.6% 42.7% 44.2% 45.5%

27.4% 28.6% 28.9% 29.8% 30.5%

30.8% 29.4% 27.8% 24.5% 23.5%

36.0%

26.0%

32.5%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

99 00 01 02 03 04E

5 Yrs or Less 5-10Yrs Over 10 Years

Average Maturity of Bonds Heldin P/C Portfolio, 1994-2004E*

*III estimate for 2004. Excludes cash and short-term securities.Source: A.M. Best; Insurance Information Institute

Average Maturity in Years

8.708.43

8.238.37 8.43

8.90

8.558.42

8.10

7.637.44

6.5

7.0

7.5

8.0

8.5

9.0

9.5

94 95 96 97 98 99 00 01 02 03 04E

The average maturity of p/c bold holdings is down nearly 1.5 years since 1999

Duration of P/C Fixed Income Portfolio, Selected Cos., 2001-2004*

4.6

4.1 4.1 4.1

3.6

3.03.23.43.63.84.04.24.44.64.8

01 02 03 04 04(Adjusted)*As of Dec. 31 of each year. Based on sample of 50 p/c insurance companies.

Source: Credit Suisse First Boston.

Average duration is falling as insurers minimize interest rate risk and position

themselves for higher long-term yields by staying short and accumulating cash

Adjusted duration includes cash and ST investments in calculation

Reasons for Persistently Low Long-Term Interest Rates in the US

• Expectation of Future Economic WeaknessWeakness may be global in scale Inflation fears for the longer-term are therefore subdued

• Foreign Central Bank Purchases of US TreasurysEspecially China & other Asian central banks

• Falling Interest Rates in Other Major EconomiesOther central banks cutting rates (or holding constant)

• Excess of Savings Elsewhere in World Relative to USDirect result of massive US trade imbalancesMoney comes back to US in form of purchases of US bonds

• Weakness in Euro; Crisis of Confidence in EURotation out of Euro and back into the US dollar

6.0%

3.5%

1.6%

1.0% 1.

4%

3.2%

4.0% 4.

2%

4.1% 4.2% 4.3%

4.2% 4.

4%

6.0%

5.0%

4.6%

4.0% 4.

3% 4.7%

5.3% 5.

5%

5.5%

5.5%

5.5% 5.6%

5.5%

0%

1%

2%

3%

4%

5%

6%

7%

00 01 02 03 04 05F 06F 07F 08F 09F 10F 11F 12-16F

3-Month T-Bill 10-Year T-Note

Interest Rate Forecast,2005F-2016F

Source: Board of Governors, Fed. Reserve System; Blue Chip Economic Indicators as of March 2005.

Long/Short-term rates are expected to rise and then stabilize

CEO Concern #5EXPENSES

Will Expense Ratio Rise as Premium Growth Slows?

Underwriting Expense Ratio*All Lines, 1994-2005F

25.9%26.1% 26.3% 26.5%

27.5%28.0%

27.6%

25.3%

27.0%

24.6% 24.7% 24.8%

22%

23%

24%

25%

26%

27%

28%

29%

94 95 96 97 98 99 00 01 02 03 04E 05F

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

Insurers are keeping expenses under control, but pressure will mount as premium growth slows

CEO Concern #6LEVERAGE &

CAPITAL MGMT.

Can the Industry Efficiently Employ

Its Increasing Capital?

$0

$50

$100

$150

$200

$250

$300

$350

$400

$450

75 767778 7980 818283 848586 8788 899091 9293 949596 979899 0001 02030405*

U.S. Policyholder Surplus: 1975-2005*

Source: A.M. Best, ISO, Insurance Information Institute *As of 3/31/05.

$ B

illi

ons

“Surplus” is a measure of underwriting capacity. It is analogous to “Owners Equity” or “Net Worth” in non-insurance organizations

$53.9 Billion

Capacity TODAY is 21% above its mid-1999 peak and 44% above its 2002 trough

•Surplus (capacity) peaked at $339.3 Billion in mid-1999 and fell by 15.9% ($53.9 billion) to $285.4 billion at year-end 2002

•Surplus is up $125.5B or 44% since year-end 2002

•Surplus increased by $17.4B or 4.4% to $410.9B by 2005:Q1 from $393.5B at year-end 2004

0.5

1.3

2.0

2.8

70 71 72 73 74 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

Net Premiums Written to Policyholder Surplus Ratio,

1970-2005F

Source: A.M. Best; Insurance Information Institute estimate for 2005.

NPW/PHS Ratio

2002 : 1.29

2003: 1.12

2004: 1.08

2005F: 1.04

Leverage is decreasing as PHS grows more quickly than NPW,

holding down profitability

Capital Punishment: What Should & Shouldn’t Be Done With Excess Capital

What Should be Done (Likely favorable impact)• Increase shareholder dividends (stock companies)• Share buybacks (stock companies) • Increase policyholder dividends (mutual companies)• Pay dividend to parent entity (subsidiaries/affiliates)

What Could Be Done (Impact uncertain)• Make acquisitions• “Buy” a ratings upgrade• Expand geographically or into new lines

What Shouldn’t Be Done (Unfavorable impacts likely)• Cut prices significantly leading to huge U/W losses• Offer products as loss leaders (e.g., HO)

Company Amount/Type

Axis Capital $350MM Share Buyback

Progressive $1.487B Share Buyback

Pinnacol Assurance $55MM Policyholder Div.

Unitrin Boost Shareholder Div.

Allianz 60% Increase in SH Div.

Allstate $4B Share Buyback

P/C Companies Announcing Share Buybacks or Boost in Dividend*

*Completed and announced 2004 or 2005 (through 7/13).Source: Insurance Information Institute from Lexis/Nexis search 1/1/2004 – 7/14/05.

CEO Concern #7P/C OPERATING ENVIRONMENT

Have Things Changedfor the Better?

YES!

YES!It Will Be Different This Time Around!

• New Management: Benefit of 20/20 HindsightMost (re)insurer CEOs have been replaced over past 5 yearsNew management teams not eager to repeat past mistakesManagement Mantra: Preaching Disciplined UW & Pricing

• Information Flow: Many insurers have now implemented MIS systems that reduce

recognition lags & reaction times and increase info flow• Compensation Structure: Closer Link to Performance?

Stock incentives playing a lesser roleStrict adherence to UW manual and pricing

• Sarbanes-Oxley & Increased TransparencyCEO/CFO’s personal assets on the lineBoard of Directors quality enhanced; less chummyReserves become more adequateActuaries, UWs, accountants all on board & getting tough Investigations will require more data reporting

YES!It Will Be Different This Time Around!

• Ratings AgenciesHave become de facto regulatorsKeeping a tight leash on upgrades and paying a lot of attention to

capital/reserve adequacy & profitability-industry disciplined• Investment Analysts

Subject insurers to greater scrutiny• Regulators

Finally waking up• Quasi-Regulators

Spitzer, other AGs, SEC will keep industry on its toes• Tort reform is finally happening• Republican Domination of Congress/White House Good for

Industry• We’re Better at Anticipating New/Emerging Risks• Better at Managing Existing Risks/Reducing Volatility

NO!

NO!It Won’t Be DifferentThis Time Around!

• Management Never Learns: Hindsight Means Nothing80 years of history show management repeats same mistakesQuarterly earnings and growth targets are still kingMantra of UW & Pricing discipline is just lip service

• P/C Insurance Will Always Be an Impossible Business Impossible to use past information to determine prices today for a

product sold tomorrow for claims that may arise in the distant future AND expect to be right

• Investor FatigueWall Street is fed up with low returns; no capital for youCapital is now highly opportunistic; not committed to long run

• Investments: Still Used to Paper Over Poor UW & Pricing DecisionsCash flow underwriting is back in vogue (or soon will be)

NO!It Won’t Be DifferentThis Time Around!

• Regulators Still Asleep at the SwitchE.g., Piling on to Spitzer investigationVehement defense on status quo regulatory environment

• Still do Bad Job Managing Variability/Volatility 2004 hurricane season, D&O, Products LiabilityConstantly blindsided

• Tort Reform: Keep on Dreamin’Big loopholes in Class Action Fairness Act Act was watered down (no atty. fee limits or damage caps)Forum shopping at the federal level still possible

• Republican Congress/White House Don’t Care About UsExcept CAFA, little success in Washington over past few yearsSpitzer investigation = opportunity to heap scorn on industry

CEO Concern #8TORT

ENVIRONMENT

Have Things Changedfor the Better?

Personal, Commercial & Self (Un) Insured Tort Costs*

$17.0$49.1 $57.2

$91.4

$17.1

$51.0$70.9

$82.5

$5.4

$20.1

$29.6

$45.3

$0

$50

$100

$150

$200

$250

1980 1990 2000 2003

Commercial Lines Personal Lines Self (Un)Insured

Bil

lion

s

Total = $39.5 Billion

*Excludes medical malpracticeSource: Tillinghast-Towers Perrin




The Nation’s Judicial Hellholes

Source: American Tort Reform Association; Insurance Information Institute

CALIFORNIA

Los Angeles County

Orleans Parish, LA

Jefferson County, TX

South Florida

Philadelphia, PA

Hampton County, SC

ILLINOIS

Madison County

St. Clair County

West Virginia

Business Leaders Ranking of Liability Systems for 2005

Best States1. Delaware2. Nebraska3. North Dakota4. Virginia5. Iowa6. Indiana7. Minnesota8. South Dakota9. Wyoming10. Idaho

Worst States41. Hawaii42. Florida43. Arkansas44. Texas45. California46. Illinois47. Louisiana48. Alabama49. West Virginia50. Mississippi

Source: US Chamber of Commerce 2005 State Liability Systems Ranking Study; Insurance Info. Institute.

New in 2005ND, IN, SD, WY

Drop-OffsID, UT, NH, KS

Newly Notorious

HI, FL

Rising Above

MO, MT

15. Washington25. Oregon37. Montana

WA Rankings2002: 32003: 212004: 242005: 15

Cost of U.S. Tort System($ Billions)

Source: Tillinghast-Towers Perrin.

$129$130$141$144 $148

$159 $156$156$167$169 $180

$205

$233$246

$262$279

$297

$0

$50

$100

$150

$200

$250

$300

$350

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

Tort costs will consume an estimated 2.24% of GDP in 2005

Per capita “tort tax” was $845 in 2003, up from $680 in 2000

Reducing tort costs relative to GDP by just 0.25% (to about 2%) would

produce an economic stimulus of $27.5B

Tort System Costs, 2000-2006E

$179.2

$233.2$245.7

$261.7$278.7

$296.8

$205.5

1.83%

2.03%2.22% 2.23% 2.24% 2.27%2.23%

$100

$150

$200

$250

$300

$350

00 01 02 03 04E 05E 06E

Tor

t S

yste

m C

osts

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

Tor

t C

osts

as

% o

f G

DP

Tort Sytem Costs Tort Costs as % of GDP

Source: Tillinghast-Towers Perrin

After a period of rapid escalation, tort system costs as % of GDP appear to be stabilizing

CEO Concern #9TERRORISM

Will TRIA be Renewed?

TRIA UPDATE• TRIA expires December 31, 2005

• Treasury completed its study of the program 6/30/05 – did not back reauthorization of TRIA in current form

• Insurers & coalition partners have established strong case for TRIA extension, but Treasury believes still clings to 4 myths:1. Terrorism is insurable 3. Insurance is a “free market”

2. Govt. crowds out pvt. capital/innovation 4. Ample capacity now exists

• Basically political/ideological issue for relatively small number in Congress and a few policymakers

• Senate & House hearings held in July 2005

• London terrorist attacks may give TRIA opponents pause

• Legislation now looks likely

…But The Door Was Left Open

If Congress were to reauthorize TRIA, these are the key changes that insurers required to make:

The event size that triggers coverage must be increased from current $5 million level to $500 million.

Dollar deductibles and percentage co-payments must be increased.

Certain lines of insurance, such as commercial auto, GL and other smaller lines must be eliminated from the program.

Reforms to ensure that injured plaintiffs can recover against negligent defendants, but not by exploiting the litigation system.

Terrorism InsuranceMarket Overview

Terrorism Take-Up Rates, Coverage Types & Pricing

Terrorism Coverage: Take-Up Rates by Region

Source: Marsh, Inc.; Insurance Information Institute

30.3%26.2%

21.8%18.6%

53.2% 52.5%46.7%

34.2%

Northeast Midwest South West

2003 2004Terrorism take-up rates

are lowest in the Northeast and Midwest

Standard Fire Policy (SFP) States

Source: Marsh, Inc.

States with legislation that excludes terrorism from SFP policies

States where SFP mandated

Insurers and their trade associations have been

lobbying the legislatures of the SFP states

to limit fire coverage

resulting from a terrorist

attack

WA, ID, OR and CA are all fire following states

CEO Concern #10CUSTOMER

SATISFACTION & RETENTION

Attracting & Retaining Customers is Key for the Bottom Line

Leading Reasons for ChoosingCurrent Home Insurance Provider

60%

49%

43%

42%

32%

24%

21%

63%

0% 10% 20% 30% 40% 50% 60% 70%

Combined All Coverage/Multi-PolicyDiscount

Good Rates

Good Reputation

Convenience of Doing Business

Good Past Experience

Good Coverage/Variety of Products

Agent Recommendation

Family/Friend Recommendation

Source: J.D. Power and Associates, 2004 Homeowners Insurance Study.

Home Insurance Overall Customer Satisfaction Index

855794

784783776770769765764762760

744744743739

729717

887

0 100 200 300 400 500 600 700 800 900 1000

USAAAmica

State FarmErie

ACSCNationwide

ACGHartford

AllstateAverageAmFam

EncompassFarmers

SafecoLiberty Mutual

MetLifeTravelers

Prudential


Other Products /Services Purchased from Current HO Provider

20%

16%

15%

10%

7%

7%

6%

6%

3%

3%

2%

2%

89%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Auto

Valuable Poss. Coverage

Personal Umbrella

Life

Flood

Auto Club/Road Asst.

Earthquake

Boat

Other

Banking/Mortgage

Hurricane Coverage

Finl. Consulting/Inv. Services

Home Office/Biz Equip.


796

818

820

819

786

834

804

805

810

838

780

883

837

Overall Satisfaction

Index

Highest for financial consulting &

investment services

PERSONAL LINES

OVERVIEW

AUTO & HOME:

A SUCCESSFUL SHIFT TO THE UNDERWRITING

CULTURE?

Private Passenger Auto

Private Passenger Auto is Enormous Part of P/C Industry

Total 2003 Direct Personal + Commercial Premiums Written = $442.6 Billion PPA Liability

20.1%

Homeowners11%

PPA Phys Dam14.2%

All Commercial Lines52.1%


Private passenger auto accounted for 34% or $156.6B in

DPW in 2003

$237.3B $48.7B

$91.7B

$64.9B

101.7 101.3 101.3 101.0

99.5

101.1

103.5

109.5

107.9

104.2

98.4

93.3 93.1

90

95

100

105

110

93 94 95 96 97 98 99 00 01 02 03 04E 05F

Private Passenger Auto Combined Ratio

Average Combined 1993 to 2004= 102.7

Many auto insurers have shown sig-nificant improvements in underwriting

performance since mid-2002


PPA is the profit juggernaut of the p/c

insurance industry today

50%

55%

60%

65%

70%

75%

93 94 95 96 97 98 99 00 01 02 03 04E 05F

PP Auto

Loss Ratio: Private Passenger Auto Insurance


PP Auto has improved significantly

$668$691

$706 $704$683 $687

$720

$774

$834$857 $870

$600

$650

$700

$750

$800

$850

$900

$950

95 96 97 98 99 00 01 02 03* 04* 05*




rise 1.5% in 2005

50%

60%

70%

80%

90%

100%

110%

99

:Q1

99

:Q2

99

:Q3

99

:Q4

00

:Q1

00

:Q2

00

:Q3

00

:Q4

01

:Q1

01

:Q2

01

:Q3

01

:Q4

02

:Q1

02

:Q2

02

:Q3

02

:Q4

03

:Q1

03

:Q2

03

:Q3

03

:Q4

04

:Q1

04

:Q2

04

:Q3

04

:Q4

Collision Comprehensive Liability (BI & PD)

Source: ISO Fast Track; Insurance Information Institute.

Private Passenger Auto:Incurred Loss Ratios, 1999-2004

Loss ratios for all major coverage are trending

downward

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

00

:Q1

00

:Q2

00

:Q3

00

:Q4

01

:Q1

01

:Q2

01

:Q3

01

:Q4

02

:Q1

02

:Q2

02

:Q3

02

:Q4

03

:Q1

03

:Q2

03

:Q3

03

:Q4

04

:Q1

04

:Q2

04

:Q3

04

:Q4

05

:Q1

Auto Insurance Component of CPI Personal Auto-PD Pure Premium

Source: Insurance Information Institute calculations based ISO Fast Track and US BLS data.

Pure Premium Spread: Personal Auto PD Liability, 2000-2005:Q1

Margin necessary to maintain PPA profitability



-2.2%

-5.3%

-4.0%-3.4%

-1.7%-0.9%

3.5% 3.6% 3.9% 3.5%

-0.3%

4.7%

-6%

-4%

-2%

0%

2%

4%

6%

99 00 01 02 03 04

Frequency Severity

Bodily Injury: Severity Trends Now Offset Declining Claim Freq.


Medical inflation a

powerful cost driver

-8.3%

-3.0%

3.9%3.0%3.2%

5.4%4.6%

2.1%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

01 02 03 04

Frequency Severity

WA Bodily Injury: Severity Trends Now Offset Declining Claim Freq.


Washington BI trends are mixed

2.6%

-0.4%

1.8%

-3.6%

-5.1%-4.4%

3.7% 3.6%

1.5%

2.8%

4.1%

6.8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

99 00 01 02 03 04

Frequency Severity

Collision: Frequency Trend Swamps Rising Claim Severity


-0.4%

1.4%

-6.3%

0.4%

3.5%

-0.2%

2.4%3.2%

-8%

-6%

-4%

-2%

0%

2%

4%

01 02 03 04

Frequency Severity

WA Collision: Frequency Trend Swamps Rising Claim Severity


Washington Collision trends not as favorable

as the US

-1.7%-2.6%

3.2%

-5.7%

-2.1%

-8.3%-7.0%

-3.8%-2.2%

3.3%

-4.7%

8.9%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

99 00 01 02 03 04

Frequency Severity

Comprehensive: Favorable Frequency and Severity Trends


Vehicles Involved in Injury Crashes, 1993 vs. 2003

Source: U.S. Dept. of Transportation; Insurance Information Institute

182

125133

119

100

110

120

130

140

150

160

170

180

190

Cars Light Trucks

Rate per 100,000 Registered Vehicles

Rate per 100 Million Vehicle Miles Traveled

-27%

2,174

1,4901,624

1,439

100

600

1,100

1,600

2,100

2,600

Cars Light Trucks

1993 2003

Injury crash rate is down 25%+ for cars,

just 3.4% for light trucks/SUVs

-25%

Vehicles Involved in Property Damage-Only Crashes, 1993 vs. 2003

3,956

3,3313,3233,274

3,000

3,100

3,200

3,300

3,400

3,500

3,600

3,700

3,800

3,900

4,000

Cars Light Trucks

1993 2003

Source: U.S. Dept. of Transportation; Insurance Information Institute

Car PD crashes down 16%, but truck/SUV less

than 2%

Rate per 100,000 Registered Vehicles

Rate per 100 Million Vehicle Miles Traveled

-16%

331

279276

271

250

260

270

280

290

300

310

320

330

340

350

Cars Light Trucks

-17%

10%

15%15%

12%14%14%

11% 12%12%

10%

8%

2% 2%

4%

0%

2%

4%

6%

8%

10%

12%

14%

16%

92 93 94 95 96 97 98 99 00 01 02 03E 04E 05F

RNW: Private Passenger Auto, United States, 1992-2002


Private passenger auto profitability deteriorated hroughout the 1990s but

has improved dramatically

Segmentation should help profitability

What’s Driving the Good Results in Private Passenger Auto?

• Favorable Frequency Trend is Obvious Reason• What is Driving Downward Claim Frequency?

More vehicles relative to driversAging population: Now solidly in safest driving yearsSafer vehicles, drivers & roadsCrackdowns of Fraud & AbuseLarger deductiblesPolicyholders have better understanding of relationship between

filing a claim and premium impactSimilar to experience in worker comp area

• Can the Downward Frequency Trend be Sustained?Probably yesMore customers migrating to higher deductible policies Insurance knowledge of policyholder continuing to growSecular trend driving frequency (emphasis on car, road safety, etc.,

will continue indefinitely)

4.8%

8.4%

17.3

% 20.8

%

20.7

%

13.3

%

8.2%

6.5%

22.1

%

18.3

%

17.8

%

15.8

%

12.5

%

7.0%

3.6%

2.9%

0%

5%

10%

15%

20%

25%

Under20

20-24 25-34 35-44 45-54 55-64 65-74 75+

Percent of Total Drivers Share of Accidents

Accidents by Age of Driver, 2003

Source: National Safety Council; Insurance Information Institute

Graduated licensing, more

education should help

Teens are by far the most likely to be involved in accident than the elderly (but elderly more

likely to die in crash)

Homeowners

Homeowners as a Percentage of the P/C Industry

Total 2003 Direct Personal + Commercial Premiums Written = $442.6 Billion

All Commercial Lines52%

PPA Phys Dam14%

Homeowners11%

PPA Liability20%


Homeowners insurance accounted for 11% or $48.7B in

DPW in 2003

$237.3B $48.7B

$91.7B

$64.9B

New Private Housing Starts(Millions of Units)

1.90

1.76

1.72

1.69 1.71 1.

75

1.74 1.

75

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

1.0

1.1

1.2

1.3

1.4

1.5

1.6

1.7

1.8

1.9

2.0

90 92 94 96 98 00 02 04 06F 08F 10F 12-16F

Source: US Department of Commerce; Blue Chip Economic Indicators (3/05), Insurance Info. Institute

Exposure growth forecast for HO insurers is excellent, though new

building is expected to slow modestly

$418$440

$455$481 $488

$508$536

$593

$636$660

$677

$400

$450

$500

$550

$600

$650

$700

95 96 97 98 99 00 01 02 03* 04* 05*

Average Expenditures on Homeowners Insurance


Countrywide home insurance expenditures

are expected to rise 2.5% in 2005

117.7

158.4

113.6118.4

112.7

121.7

101.0

108.2111.4

121.7

109.3

98.2100.9

98.6

113.0109.4

90

100

110

120

130

140

150

160

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04E 05F

Homeowners Insurance Combined Ratio

Average 1990 to 2004E= 114

Insurers have paid out an average of $1.15 in losses for every dollar earned

in premiums over the past 14 years


50%

55%

60%

65%

70%

75%

80%

93 94 95 96 97 98 99 00 01 02 03 04E 05F

Homeowners

Loss Ratio: Homeowners


Homeowners loss ratio is very volatile,

but has improved nationally

Homeowners Paid ClaimFrequency & Severity, 2000 – 2004

$3,587

$4,141

$5,325

$5,824

$4,802

5.17%

4.15%

6.53%

7.27%

6.91%

$3,000

$3,500

$4,000

$4,500

$5,000

$5,500

$6,000

2000 2001 2002 2003 2004

Avg

. Cla

im C

ost

4.0%

4.5%

5.0%

5.5%

6.0%

6.5%

7.0%

7.5%

8.0%

Claim

Frequency

Avg. Claim Severity

Frequency

Sources: ISO; Insurance Information Institute

HO paid claim frequency falling while severity is increasing

Rates of Return on Net Worth for Homeowners Ins: US

Source: NAIC; 2003/4 figures are Insurance Information Institute estimates.

9.7%

6%

-1.7%

-4.2%

3.6%

12.4%

5.4%2.5% 5.4% 3.8%

1.4%

-7.2%

-10%

-5%

0%

5%

10%

15%

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004E

Averages: 1993 to 2004E

US HO Insurance = +3.1%

Homeowners Insurance Expenditureas a % of Median Home Price

$1

07

,20

0

$1

15

,80

0

$1

21

,80

0

$1

28

,40

0

$1

33

,30

0

$1

39

,00

0

$1

47

,80

0

$1

91

,20

0

$1

85

,20

0

$1

69

,50

0

$1

56

,20

0

$1

10

,50

00.39%

0.36%

0.35%

0.38%0.38%

0.37% 0.38%

0.36%

0.37%0.37%0.37%

0.38%

$100,000

$125,000

$150,000

$175,000

$200,000

94 95 96 97 98 99 00 01 02 03 04 05*

0.30%

0.33%

0.35%

0.38%

0.40%Median Sales Price of Existing HomesHO Insurance Expenditure as a % of Sales Price

*Based on NAR existing home sales data as of Feb. 2005 and III HO expenditure estimate for 2005.Source: Insurance Information Institute calculations based on data from National Association of Realtors, NAIC.

HO

Exp

end

iture as %

of Sales P

riceMed

ian

Hom

e S

ales

Pri

ce

The cost of homeowners

insurance relative to the

price of a typical home has fallen

SELECTED COMMERCIAL LINES

Commercial AutoCommercial Multi-Peril

Inland MarineWorkers Comp

Top 10 Concerns of Small Businesses, 2004

2004 Rank Concern 2000 Rank1 Health Insurance Costs 12 Liability Ins. Cost/Availability 133 Workers Comp Costs 74 Fuel Costs 105 Federal Income Taxes 26 Property Taxes NEW7 Cash Flow 98 State Taxes on Biz Inc. 69 Govt. Regulation 4

10 Electricity Costs 19Source: National Federation of Independent Businesses; Insurance Information Institute

How the Risk Dollar is Spent (2004)(Firms with Revenues > $1 billion)

Source: RIMS Benchmark Survey (2004); Insurance Information Institute

Total Mgmt. Liab.8%

Other1%

Total Prof. Liab4%

WC Premiums16%

Retained Liability

3%

Admin Costs9%

Property Premiums

22%

Retained Property

4%

Liabilty Premiums

27%

Retained WC6%

Workers Comp, Liability and

Property coverages are the Risk Manager’s largest budget

items.

Commercial Auto: Combined Ratio,(1994 — 2005F)

104.7

108.1110.1 110.9

113.9

118.1115.7 116.2

102.7

95.193.3

94.9

80

90

100

110

120

94 95 96 97 98 99 00 01 02 03 04E 05FSource: A.M. Best Review/Preview, January 2005; Insurance Information Institute

Commercial auto combined ratio has improved dramatically since

1999-2001.

Commercial Multi-Peril:Combined Ratio, 1994 — 2005F

120.

3

106.

2

116.

8

113.

6

115.

3

115.

0

117.

0

97.3

90.5

117.

2

119

119.

8

108.

5

125

113.

1

115

121

116.

2

116.

3

99.0

99.4

122.

4

80

90

100

110

120

130

94 95 96 97 98 99 00 01 02 03 04E 05F

Commercial Multiperil (Non-Liability) Commercial Multiperil (Liability)

Source: A.M. Best Review/Preview, January 2005; Insurance Information Institute

Liability portion of Commercial Multi-Peril remains problematic

Combined Liability &

Non-Liability

Inland Marine: Combined Ratio,(1994 — 2005F)

100.8

91.9

97.395.7

97.1

101.9

92.9

100.3

83.9

80.7 79.4 80.3

70

80

90

100

110

94 95 96 97 98 99 00 01 02 03 04E 05FSource: A.M. Best Review/Preview, January 2005; Insurance Information Institute

Inland Marine is one of the most

consistently profitable of all major p/c lines

Summary• 2004/5 represent “sweet spot” in the current cycle for p/c insurance

(underwriting/earnings)

• Cyclical concerns quickly becoming significant issue

• Personal lines better positioned than commercial

• Rising investment returns insufficient to support deep soft market in terms of

price, terms & conditions

• Clear need to be more underwriting focused

• Major Challenges:

Maintaining price/underwriting discipline

Managing variability/volatility of results

New/emerging/re-emerging risks

Insurance Information Institute On-Line

If you would like a copy of this presentation, please give me your business card with e-mail address

Documents

What’s Keeping Insurance CEOs Awake at Night? Especially in the Northwest Robert P. Hartwig, Ph.D., CPCU, Senior Vice President & Chief Economist Insurance