The Financial Crisisand

Its Effect onthe P/C Insurance Industry

48th Annual Insurance All-Industry DayIllinois State University

Bloomington, ILNovember 12, 2009

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

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

The Economy What It Means for the Industry’s

Exposure Base,Growth,

and Investments

Based on Recent History, the Recovery Is Likely to Last 5 Years, or Even More

43

138 11 10 8 10 11

166

168 8

22

50

80

37

45

39

24

106

36

58

12

92

120

73

0

10

20

30

40

50

60

70

80

90

100

110

120

Aug.1929

May1937

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

Current contraction assumed to continue through September 2009Sources: 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

%

-0.7

%

3.5%

2.4% 2.6%

2.7%

2.8%

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 10/09 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%

95

98

101

104

107

110

113

Mar 01

Jun 0

1

Sep 0

1

Dec 0

1

Mar 02

Jun 0

2

Sep 0

2

Dec 0

2

Mar 03

Jun 0

3

Sep 0

3

Dec 0

3

Mar 04

Jun 0

4

Sep 0

4

Dec 0

4

Mar 05

Jun 0

5

Sep 0

5

Dec 0

5

Mar 06

Jun 0

6

Sep 0

6

Dec 0

6

Mar 07

Jun 0

7

Sep 0

7

Dec 0

7

Mar 08

Jun 0

8

Sep 0

8

Dec 0

8

Mar 09

Jun 0

9

Total Industrial Production, monthly Mar 2001-Sept 2009 (Index 2002=100)*

Source: http://www.federalreserve.gov/releases/g17/ipdisk/ip_sa.txt. *seasonally adjusted5

Recession began December 2007

A bottom?

Index

Hurricane Katrina

March 2001-November 2001

recession

Near-Term Forecasts for QuarterlyIndustrial Production: A Wide Range

5.3%

9.6%

7.7%

6.6% 6.8% 7.1%

1.2%1.7% 1.7%

1.2%1.6%

2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

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

Avg of 10 Most Optimistic Forecasts

Avg of 10 Most Pessimistic Forecasts

Source: Blue Chip Economic Indicators (10/09)

7

State Economic Growth Varied Tremendously in 2008

Lowest growth quintile

8

New Private Housing Starts,1990-2010F (Millions of Units)

2.07

1.80

1.36

0.90

0.58

0.81

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.

960.50.60.70.80.91.01.11.21.31.41.51.61.71.81.92.02.1

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

Exposure growth due to home construction forecast for HO insurers is dim for 2009

with some improvement in 2010.

Impacts also for comml. insurers with construction risk exposure

New home starts plunged 34%

from 2005-2007; Drop through 2009 is 72% (est.)—a net

annual decline of 1.49 million

units, lowest since record

began in 1959

I.I.I. estimates that each incremental 100,000 decline in housing starts costs

home insurers $87.5 million in new exposure (gross premium). The net

exposure loss in 2009 vs. 2005 is estimated at about $1.3 billion.

Source: US Department of Commerce; Blue Chip Economic Indicators (10/09); Insurance Information Inst.

9

16.916.916.6

17.117.5

17.817.4

16.516.1

13.1

10.4

11.8

9

10

11

12

13

14

15

16

17

18

19

99 00 01 02 03 04 05 06 07 08 09F 10F

Low auto sales will have a less pronounced effect on auto insurance

exposure growth than problems in the housing market will on home insurers

Auto/Light Truck Sales,1999-2010F (Millions of Units)

Source: US Department of Commerce; Blue Chip Economic Indicators (10/09); Insurance Information Inst.

Labor Market Trends

Massive Job Losses Sap the Economy & Personal &

Commercial Lines Exposure

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 September 2009, seasonally adjusted

U-6 went from 9.2% in April 2008 to

17.0% in Sept. 2009

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

9.8% Sept. 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

10.1%10.3%

10.4%10.3%

10.2%10.0%

10.1%10.0%

9.8%

9.5%

9.9%9.8%

9.6%

9.2%

8.9%

8.5%

9.0%

9.5%

10.0%

10.5%

11.0%

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

10 most pessimistic consensus/midpoint 10 most optimistic

Sources: Blue Chip Economic Indicators (10/09); Insurance Info. Inst.

Unemployment is expected to peak in late 2009:Q4 or 2010:Q2.

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

Unemployment Rates* by State,September 2009: 15 Highest States

10.5

15.2

12.213

.012.7

11.5

11.1

10.8

10.8

10.712

.2

11.4

10.4

10.2

10.0

0

2

4

6

8

10

12

14

16

MI NV RI CA SC OR DC FL KY NC AL TN IL OH GA

Une

mpl

oym

ent R

ate

(%)

*Seasonally adjusted.

Sources: US Bureau of Labor Statistics at www.bls.gov/web/laumstrk.htm Insurance Information Institute.

The US average was 9.8%

14

% Change in Employment by Industry:All But Government/Health/Education Down

-18.3%

-12.6%

-7.4%-4.8%

1.4% 1.7% 2.2%

-0.4%

-3.4%-2.4%

-20%

-15%

-10%

-5%

0%

5%

Overall, private employment dropped by 5.4% from Sept 2008 to Sept 2009; total nonfarm employment dropped

4.5% in that span

Source: US Bureau of Labor Statistics http://www.bls.gov/news.release/empsit.t14.htm; Ins. Info. Institute.

PercentChange

Change: Sept 2009 vs. Sept 2008

Inflation Trends Pressures Claim Cost

Severities via Medical and Tort Channels

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%

1.9%

-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, 10/09 issue, (forecasts, yellow bars)

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

Recession Post-Recession

17

Insurers 5 Top Concerns/Risksif Inflation is Reignited

• Rising Claim Severities Cost of claims settlement rises across the board (property and

liability)

• Rate Inadequacy Rates inadequate due to low trend assumptions arising from use of

historical data

• Reserve Inadequacy Reserves may develop adversely and become inadequate (deficient)

• Burn Through on Retentions Retentions, deductibles burned through more quickly

• Reinsurance Penetration/Exhaustion Higher costsrisks burn through their retentions more quickly,

tapping into re-insurance more quickly and potential exhausting their reinsurance more quickly

P/C Premium Growth

Primarily Driven by the Industry’s Underwriting Cycle, Not the Economy

19

-6%

-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

09:H

1

Sources: A.M. Best (historical and forecast), ISO, Insurance Information Institute

Strength of Recent Hard Marketsby NWP Growth

1975-78 1984-87 2000-03

19

Net written premiums fell 1.0%

in 2007 (first decline since 1943)

by 1.4% in 2008, and 4.2% in H1 2009, the first 3-

year decline since 1930-33

Shaded areas denote “hard

market” periods

Underwriting Trends

The Economy Doesn’t Directly Affect Underwriting Performance:

Cycle, Catastrophes Are Main Drivers

21

115.8

107.5

100.198.4

100.8

92.6

99.5101.0

95.7

90

100

110

120

2001 2002 2003 2004 2005 2006 2007 2008 2009:H1*

P/C Insurance Industry Combined Ratio, 2001-2009:H1*

*Excludes Mortgage & Financial Guaranty insurers in 2008. Including M&FG, 2008=105.1, 2009=100.9 Sources: A.M. Best, ISO.

Best combined ratio since 1949

(87.6)

As recently as 2001, insurers paid out nearly $1.16 for every

$1 in earned premiums

Relatively low CAT

losses, reserve releases

Cyclical Deterioration

21

2005 ratio benefited from heavy use of reinsurance which lowered net losses

Catastrophic Loss

Catastrophe Loss TrendsAre Getting Worse

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

23

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

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

26

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

1989-2008¹

Wildland Fires, 2.4%

Tornadoes, 27.0%

All Tropical Cyclones, 46.9%

Other, 0.5%Wind/Hail/Flood,

2.9%

Earthquakes, 5.9%

Winter Storms, 7.6%

Terrorism, 6.9%

Source: Insurance Services Office (ISO)..

1 Catastrophes are all events causing direct insured losses to property of $25 million or more in 2007 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.

Top 10 Major Disaster Declaration Totals By State: 1953-2009*

83

74

63 6258 55

51 51 49 49 48 46 44 43 43

0

10

20

30

40

50

60

70

80

90

TX CA FL OK NY LA AL KY AR MO IL MS OH WA TN

Total Number

*Through November 2, 2009.Source: Federal Emergency Management Agency (FEMA) at www.fema.gov/news/disaster_totals_annual.fema

Illinois had almost as many disaster declarations as Louisiana or Alabama*

Government Aid After Major Disasters (Billions)*

$137.1

$48.4

$22.8 $19.5 $17.1 $16.5

$0

$20

$40

$60

$80

$100

$120

$140

$160

Hurricane Katrina(2005)*

Sept. 11 TerroristAttack (2001)

Hurricane Ike(2008)

Hurricane Andrew(1992)

NorthridgeEarthquake (1994)

HurricanesCharley, Frances,

Ivan & Jeanne(2004)

$ B

illio

ns

*Adjusted to 2008 dollars by the Insurance Information Institute.Source: United States Senate Budget Committee, Insurance Information Institute as of 12/31/05; Houston Chronicle, 09/24/08 for Ike.

The federal government poured an estimated

$22.8B into areas affected by Hurricane Ike

Does post-disaster government aid

create moral hazard?

P/C Insurance Financial

PerformanceA Resilient Industry in

Challenging Times

30

P/C Net Income After Taxes1991-2009:H1 ($ Millions)*

$14,

178

$5,8

40

$19,

316

$10,

870

$20,

598

$24,

404 $3

6,81

9

$30,

773

$21,

865

$3,0

46

$30,

029

$62,

496

$2,3

79

$5,7

57

-$6,970

$65,

777

$44,

155

$20,

559 $3

8,50

1

-$10,000

$0

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

$70,000

$80,00091 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08

09:H

1

*ROE figures are GAAP; 1Return on avg. surplus. Excluding Mortgage & Financial Guaranty insurers yields an 4.5% ROAS for 2008 and 2.2%. 2009:Q1 net income was $10.0 billion excl. M&FG.Sources: A.M. Best, ISO, Insurance Information Inst.

2005 ROE= 9.4%2006 ROE = 12.2%2007 ROAS1 = 12.4%2008 ROAS = 0.5%*2009:H1 ROAS = 2.5%*

Insurer profits peaked in 2006 and 2007, but fell 96.2% during the economic

crisis in 2008

30

31

-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 0809

H1

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% and 4.5% in H1 2009.Sources: ISO; A.M. Best; Insurance Information Institute.

2008: 0.5%

P/C Insurance Industry ROEs,1975 – 2009:H1*

09:H1: 2.5%

31

Investment Performance

Investments arethe Main Sourceof Lower Profits

Distribution of P/C Insurance Industry’s Investment Portfolio

Cash & Short-Term Investments

8.0%

Common Stock14.8%

Bonds68.4%

Preferred Stock1.8%

Real Estate0.9%

Other6.2%

Portfolio Facts

•Invested assets totaled $1.2 trillion as of 12/31/08, down from $1.3 trillion as of 12/31/07

•Insurers are generally conservatively invested, with 2/3+ of assets invested in bonds as of 12/31/08

•Only about 15% of assets were invested in common stock as of 12/31/08, down from 18% one year earlier

•Even the most conservative of portfolios were hit hard in 2008

Source: NAIC; Insurance Information Institute research;.

As of December 31, 2008

33

34

Property/Casualty Insurance Industry Investment Gain:1994- 2009:H11

$ Billions

$35.4

$42.8$47.2

$52.3

$44.4

$36.0

$45.3$48.9

$59.4$55.7

$64.0

$31.4

$12.4

$56.9$51.9

$57.9

$0

$10

$20

$30

$40

$50

$60

1Investment gains consist primarily of interest, stock dividends and realized capital gains and losses. 2006 figure consists of $52.3B net investment income and $3.4B realized investment gain. *2005 figure includes special one-time dividend of $3.2B.Sources: ISO; Insurance Information Institute.

Investment gains fell by 51% in 2008 due to lower yields, poor equity market

conditions. Falling again in 2009.

34

35

P/C Insurer Net Realized Capital Gains, 1990-2009:1H

$2.88$4.81

$9.89

$1.66

$6.00

$9.24$10.81

$13.02

$16.21

$6.63

-$1.21

$6.61$8.92

-$11.17

-$19.80

$18.02

$3.52

$9.70$9.13$9.82

-$20-$18-$16-$14-$12-$10-$8-$6-$4-$2$0$2$4$6$8

$10$12$14$16$18$20

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

09H

1

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

Realized capital losses hit a record $19.8 billion in 2008 due to financial market turmoil, a $27.7 billion swing from 2007, followed by an $11.2B

drop in H1 2009. This is a primary cause of 2008/2009’s large drop in profits and ROE.

$ Billions

35

Financial Strength/Capacity

Industry Has Weathered the Storms Well

37

$0

$50

$100

$150

$200

$250

$300

$350

$400

$450

$500

$550

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 0809*

U.S. Policyholder Surplus: 1975-2009:H1*

Source: A.M. Best, ISO, Insurance Information Institute. *As of 6/30/09

$ B

illi

ons

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

Actual capacity as of 6/30/09 was $463.0B, up from $437.1B as of 3/31/09 Recent peak was $521.8 as of

9/30/07. Surplus as of 6/30/09 is 11.2% below 2007 peak; Crisis trough was as of 3/31/0916.2% below 2007 peak

The premium-to-surplus ratio stood at $0.92:$1 as of

6/30/09, up from near record low of $0.85:$1 at

year-end 2007

37

38

Policyholder Surplus, 2006:Q4 – 2009:H1

$ Billions

$487.1$496.6

$512.8$521.8

$478.5

$455.6

$437.1

$463.0

$505.0$515.6

$517.9

$380

$400

$420

$440

$460

$480

$500

$520

$540

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

Source: ISO, AM Best.

Declines Since 2007:Q3 Peak

08:Q2: -$16.6B (-3.2%) 08:Q3: -$43.3B (-8.3%) 08:Q4: -$66.2B (-12.9%) 09:Q1: -$84.7B (-16.2%)

09:Q2: -$58.8B (-11.2%)

Capacity peaked at $521.8 as of 9/30/07

38

39

Premium-to-Surplus Ratios Before Major Capital Events*

$1.65

$1.42 $1.40

$1.03 $1.03$0.92$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**

As o

f6/3

0/0

9**

*

*Ratio is for end of quarter immediately prior to event. Date shown is end of quarter prior to event. **Ratio at point of maximum capital erosion; ***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

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 0809:1H

U.S. P/C Industry Premiums-to-Surplus Ratio: 1985-2009:1H

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.

$0.92:1 as of

6/30/09

Ratio at year-end

41

Ratio of Insured Loss to Surplus for Largest Capital Events Since 1989*

3.3%

9.6%

6.9%

10.9%

16.2%

13.8%

6.2%

0%2%4%6%8%

10%12%14%16%18%

6/3

0/1

98

9H

urr

ica

ne

Hu

go

6/3

0/1

99

2H

urr

ica

ne

An

dre

w

12

/31

/93

No

rth

rid

ge

Ea

rth

qu

ak

e

6/3

0/0

1S

ep

t. 1

1A

tta

ck

s

6/3

0/0

4F

lori

da

Hu

rric

an

es

6/3

0/0

5H

urr

ica

ne

Ka

trin

a

Fin

an

cia

lC

ris

is a

s o

f3

/31

/09

**

*Ratio is for end-of-quarter surplus immediately prior to event. Date shown is end of quarter prior to event. **Date of maximum capital erosion; As of 6/30/09 (latest available) ratio = 11.2%.Source: PCS; Insurance Information Institute.

The financial crisis now ranks as the largest

“capital event” over the past 20+ years

42

P/C Insurer Impairment Frequency vs. Combined Ratio, 1969-2008

90

95

100

105

110

115

120

69 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 06 07 08

Co

mb

ined

Rat

io

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

Imp

airm

ent R

ate

Combined Ratio after DivP/C Impairment Frequency

Impairment rates are highly

correlated with underwriting

performance and reached record lows in 2007/08

Source: A.M. Best; Insurance Information Institute

2008 impairment rate was a record low 0.23%, second only to the 0.17% record low in 2007 and barely one-fourth the 0.82% average since 1969

Number of Impairments by State, Top 10 States, 1969-2008

41

66

242533

63

9691

73

140

0

20

40

60

80

100

120

140

160

TX FL CA IL NY PA LA MO OK OH

No.

of I

mpa

irmen

ts

Catastrophe risk plays a big role. Other factors influencing

impairments include the political environment and business mix

Source: A.M. Best; Insurance Information Institute

Frequency of Impairments by State, 1969-2008

1.34

1.29

1.29

1.29

1.25

1.25

1.23

1.04

0.98

0.98

0.97

0.92

0.92

0.91

0.90

0.89

0.89

0.83

0.78

0.75

0.72

0.70

0.68

0.60

0.58

0.55

0.49

0.46

0.41

0.36

0.36

0.35

0.35

0.25

0.22

0.21

0.21

0.16

0.13

0.13

0.08

0.06

0.00

1.58

2.10

1.35

1.411.

531.571.

63

3.36

3.02

2.90

3.48

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

WY LA FL VI

MT

CA

WV AZ

TX PR UT RI

GA HI

DC

NM SC

OK

MO CO

MS NE

NV

GU

MD NJ

TN KY

OR IL NY

PA

AK

MA

WA IN AL

DE

VA

OH AR

KS

NC MI ID M

ES

D WI

NH IA CT

MN VT

ND

Impa

irmen

t Fre

quen

cy (%

)

WY, LA, FL have the highest impairment rates in the country

(Impairments per 100 Insurers Domiciled in State)

Source: A.M. Best; Insurance Information Institute

IL (0.78%) was slightly under the national

average 0.82%

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.

45

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

46

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%

Critical Differences Between P/C Insurers

and Banks

Superior Risk Management Model & Low Leverage Make

a Big Difference

48

How Insurance Industry Stability Has Benefitted Consumers

BOTTOM LINE:• Insurance Markets—Unlike Banking—Are Operating

Normally• The Basic Function of Insurance—the Orderly Transfer

of Risk from Client to Insurer—Continues Uninterrupted• This Means that Insurers Continue to:

Pay claims (whereas 120 banks have gone under as of 9/25/09) The Promise is Being Fulfilled

Renew existing policies (banks are reducing and eliminating lines of credit) Write new policies (banks are turning away people and businesses who

want or need to borrow) Develop new products (banks are scaling back the products they offer) Compete Intensively (banks are consolidating, reducing consumer choice)

Source: Insurance Information Institute48

49

• Emphasis on Underwriting Matching of risk to price (via experience and modeling) Limiting of potential loss exposure Some banks sought to maximize volume and fees and disregarded risk

• Strong Relationship Between Underwriting and Risk Bearing Insurers always maintain a stake in the business they underwrite, keeping

“skin in the game” at all times Banks and investment banks package up and securitize, severing the link

between risk underwriting and risk bearing, with (predictably) disastrous consequences—straightforward moral hazard problem from Econ 101

• Low Leverage Insurers do not rely on borrowed money to underwrite insurance or pay

claimsThere is no credit or liquidity crisis in the insurance industry49

Why P/C Insurers HaveFewer Problems Than Banks

50

• Conservative Investment Philosophy High quality portfolio that is relatively less volatile and more

liquid

• Comprehensive Regulation of Insurance Operations The business of insurance remained comprehensively

regulated whereas a separate banking system had evolved largely outside the auspices and understanding of regulators (e.g., hedge funds, private equity, complex securitized instruments, credit derivatives—CDS’s)

• Greater Transparency Insurance companies are an open book to regulators and the

public 50

Why P/C Insurers HaveFewer Problems Than Banks (cont’d)

5 Challenges for Insurers in

the Next 5 Years

52

1. Further Erosion of, and“Reloading” of Capital

• Capital losses were the largest in a generation (a “Black Swan”?). It will take years to return to the 2007 peak.

• P/C insurers have come to expect that large amounts of capital can be raised quickly and cheaply after major events (9/11, Katrina). This assumption might be incorrect in the current environment

• The cost of capital is much higher today, reflecting both scarcity and risk

• Possible consequences of a failure to “reload”: insolvencies, forced mergers, calls for government aid, etc.

Implication: P/C (re)insurers need to protect capital and develop detailed contingency plans both to raise fresh capital and generate it internally.

53

2. Long-Term,Low Investment Earnings

• Low interest rates, risk aversion toward equities and many categories of fixed income securities lock in a multi-year trajectory toward ever lower investment gains• Fed actions in Treasury markets will keep yields

low• Implication 1: Industry must be prepared to

operate in environment with investment earnings accounting for a smaller fraction of profits

• Implication 2: Implies underwriting discipline of a magnitude not witnessed in this industry in more than 30 years. Yet to manifest itself.

• Lessons from the period 1920-1975 need to be relearned

• CAT risk and WC is, on net, now being socialized• via state-run insurance and reinsurance mechanisms or • via elaborate subsidy schemes involving assessments,

premium tax credits, etc.• Some (life) insurers sought/received TARP money• Efforts to expand flood program to include wind• Health insurance may be substantively socialized• Terrorism risk—already a major federal role backed by

insurers• Eventual takeover of other lines such as personal auto• Ownership stakes in some insurers via bailouts• States like FL will lean heavily on Washington in the

event of a mega-cat that threatens state finance

3. Socialization/Nationalizationof Insurance

55

• P/C insurers might get swept into vast federal regulatory overhaul and subjected to duplicative and costly regulation• Will some P/C insurers be considered systemically

important (i.e., “too big to fail”)?• Will personal lines insurance policies be regulated

by a new Consumer Financial Protection Agency?• What effect will repeal of McCarran-Ferguson have

on P/C insurers?• Will a new “Office of National Insurance” in the

Treasury Department speed adoption of new international regulatory rules?

4. Major New Layers/Typesof Regulation

56

Attacks on underwriting criteria such as credit, education, occupation, territory increasingView that these criteria are discriminatory and

create an adverse impact on certain populationsImpact will be to degrade the accuracy of rating

systems to increase subsidies Predictive modeling also at risk Danger that bans could be codified at federal level

during regulatory overhaul Bottom Line: Industry must be prepared to defend

existing and new criteria indefinitely

5. New Restrictions on Underwriting

57

Insurance Information Institute On-Line

THANK YOU FOR YOUR TIMEAND YOUR ATTENTION!

57