the global financial crisis and its impacts on …the global financial crisis and its impacts on...

The Global Financial Crisisand Its Impacts on Energy

Insurance MarketsInsurance Markets Trends & Challenges& C g

Insurance Information InstituteInsurance Information Institute

April 2, 2009

Robert P. Hartwig, Ph.D., CPCU, PresidentInsurance Information Institute ♦ 110 William Street ♦ New York, NY 10038

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

Presentation Outline• The Global Economic Storm: What Weakening Economy and

the Financial Crisis Mean for the P/C Insurance Industry andthe Financial Crisis Mean for the P/C Insurance Industry and Energy Concerns

Recession, Growth & Insurance• Economic Stimulus Package: Worldwide Spending Programs• Economic Stimulus Package: Worldwide Spending Programs

Impacts & Implications for P/C Insurers and the Energy Sector• Insurer Financial Strength & Ratings

Insurers vs Banks: A Difference of Approach to Risk ManagementInsurers vs. Banks: A Difference of Approach to Risk Management • Energy Market Review

Capacity, Rating, Exposure, Profitability, Reinsurance, ARTThe Financial Crisis: Global Energy Supply Demand and InvestmentThe Financial Crisis: Global Energy Supply, Demand and Investment

• Insurance Industry Financial Performance• Capital & Capacity

R l t R t C i i• Regulatory Response to CrisisEmerging Blueprint for Insurance Regulatory Overhaul

THE GLOBAL ECONOMIC

STORMWhat Weakening Economies and the Financial Crisis Mean for thethe Financial Crisis Mean for the

Insurance Industry &E CEnergy Concerns

Real GDP By Market 2007-2010F(% change from previous year)(% change from previous year)

11.9

%0% %10%

12%14% 2007 2008E 2009F 2010F

All major economies except China and Brazil are in recession.

%

9.0

6.8% 8.

0 %

6%8%

10%Steep declines in GDP will negatively

impact exposure growth on a global scale

2.6%

2.0%

2.0% 3.

0%

0.7% 1.0% 1.3%

0.7%0.9%

1.0%

0.9% 1.

9%

0.8%

2.6%

0%2%4%

-0.7

%

-2.1

%

2.5%

% 2.6% .7%-4%

-2%0%

- -2

-4.1

% -2 -2

-6%Euro Area Germany Japan US UK China

Source: Blue Chip Economic Indicators, 3/10/09 edition.

Real GDP for Largest European Economies & Euro Area, 2007-2010F, (% change from prior yr.)Euro Area, 2007 2010F, (% change from prior yr.)

%2007 2008E 2009F 2010F

2.6% 3.

0%

.1%

3.5%

2.8%

.1%2.

6%3%

4%2007 2008E 2009F 2010F

2.

0.7% 1.

0%

0.7%

0.7%

2.

1.3%

0.9% 1.0%

0.8% 1.

0%

0.9% 1.0%

1%

2%

-1%

0%

-2.1

%

2.5%

.7%

-1.8

% -1.4

%

-1.5

%

-3%

-2%

All European economies -2 -2.

-4%Euro Area Germany UK France Netherlands Belgium


pare in recession

US Real GDP Growth*

% %

Recession began in December 2007. Economic toll of credit crunch, housing

3.7%

% 6% 2.5% 3.

6%3.

1%2.

9%

4.8 %

4.8%

%2.

8%

8% 2.3% 2.

8% 2.9% 3.1%4%

6%Economic toll of credit crunch, housing

slump, labor market contraction is growing

0.8% 1.

6

0.1% 0.

9 %

%

0.5%

1. 2

-0.2%0%

2%

-0.5

%

-2.0

%

0.2%

-4%

-2%

The Q4:2008 decline was the steepest since the

-5.3%-6.2%

-8%

-6%

Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q

the steepest since the Q1:1982 drop of 6.4%

20

00

20

01

20

02

20

03

20

04

20

05

20

06

07:1

Q

07:2

Q

07:3

Q

07:4

Q

08:1

Q

08:2

Q

08:3

Q

08:4

Q

09:1

Q

09:2

Q

09:3

Q

09:4

Q

10:1

Q

10:2

Q

10:3

Q

10:4

Q

*Yellow bars are Estimates/Forecasts from Blue Chip Economic Indicators.Source: US Department of Commerce, Blue Economic Indicators 3/09; Insurance Information Institute.

Length of US Recessions,1929-Present*1929 Present

50 Current recession began inMonths in Duration

43

404550 Current recession began in

Dec. 2007 and is already the longest since 1981. If is now tied for the longest recession

“We will rebuild. We will recover.”

253035

tied for the longest recession since the Great Depression.--President Barack Obama

addressing a joint session of Congress

13

811 10

810 11

16 16

8 8

16152025

February 24, 2009

8 86

8 8

05

10

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

* As of April 2009Sources: National Bureau of Economic Research; Insurance Information Institute.

GDP Growth: Advanced & Emerging Economies vs World

1970-2010F Emerging economies (led by China) are

Emerging Economies vs. World

8.0

10.0(led by China) are

expected to grow by 3.3% in 2009

The world economy is forecast to grow by 0.5% in 2009, but could shrink for the first time since WW II —by 1% to

2% according to the World Bank.

4.0

6.0g

0.0

2.0

Advanced economies will

-4.0

-2.0

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Advanced economies will shrink by 1.9% in 2009,

dampening energy demand

7 7 7 7 7 8 8 8 8 8 9 9 9 9 9 0 0 0 0 0 1

Advanced economies Emerging and developing economies World

Source: International Monetary Fund, World Economic Outlook Update, Jan. 28, 2009; Ins. Info. Institute.

Global Industrial Production Is in a Tailspin Reducing Energy Demand

Annualized 3-Month Percent Change

Tailspin, Reducing Energy Demand

10.0

15.0 Industrial demand for energy has been particularly hard hit

0.0

5.0

10 0

-5.0

0.0

Global industrial production was down 13% in late 2008 adversely

-15.0

-10.0

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

down 13% in late 2008, adversely impacting energy demand

Source: International Monetary Fund, World Economic Outlook Update, Jan. 28, 2009; Ins. Info. Institute.

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

Weakening economy, credit h h ti t l

New auto/light truck sales are expected to experience a

1999 2010F (Millions of Units)

17.517.817 418

19

crunch are hurting auto sales; Gas prices less of a factor now.

are expected to experience a net drop of 6.0 million units annually by 2009 compared

with 2005, a decline of 35.5% and the lowest level

i th l t 196016.916.916.6

17.117.4

16.516.1

16

17

8 since the late 1960s

13.112.713

14

15

Impacts of falling auto sales will have a less pronounced effect on a to ins rance e pos re gro th

10.9

12.7

11

12

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

1099 00 01 02 03 04 05 06 07 08 09F 10F

Source: US Department of Commerce; Blue Chip Economic Indicators (2/09); Insurance Information Inst.

Real GDP Growth vs. Real P/C Premium Growth: Modest Association

% 0.3%

25% 8%

Premium Growth: Modest AssociationP/C insurance industry’s growth i i fl d d tl b th

18.6

% 20

13.7

%

15%

20% 6%is influenced modestly by growth

in the overall economy

.2%

% 5.8%

5.6%

17.

7%10%

WP

Gro

wth

2%

4%

DP

Gro

wth

5.

1.8%

4.3% 5

0.3%

3.1%

1.1%

0.8%

0.4%

0.6%

% %1.

6%5

1.2%

%

1.7%

0%

5%

Real

NW

0%

Rea

l GD

-0.9

%% 5%

-1.5

%

-1.6

%-1

.0%

-1.8

%-1

.0%

-0.4

%-0

.3%

-2.9

% -0.5

%-3

.8%

-4.2

%-5% -2%

Real NWP Growth Real GDP

-7.4

%-6

.5-10%

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 08E

09F

-4%Real NWP Growth Real GDP

Sources: A.M. Best, US Bureau of Economic Analysis, Blue Chip Economic Indicators, 3/09; Insurance Information Inst.

Change in Producer Prices for Construction vs. Consumer Prices, 2003 - 2008vs. Consumer Prices, 2003 2008

1 0Dec. 2008

140

150 PPI for inputs to construction industries: 33%

Consumer price index: 14%The inflationary spike of 2008 has

130

The inflationary spike of 2008 has been reversed—for now—easing concerns over claims severities

120

100

110

12/03 12/04 12/05 12/06 12/07 12/08

Source: Associated General Contractors from BLS (CPI, PPI)12

Inflation Rates for Largest European Economies & Euro Area, 2007-2010F, (% change from prior yr.)

2007 2008E 2009F 2010F

7%

4.6%

4%5%5%

2007 2008E 2009F 2010F

Inflation is down sharply across Europe, reducing

% %

3.3%

2.8%

3.7

2.8%

.6%3%

4%4% p , g

claim severity concerns

2.3%

2.3%

1.5% 1.6% 1.

8%

2.

3%1.5%

3%

1.8%

1.5% 1.6% 1.

9%2.1%

2%2%3%

1

0.6%

0.4% 0.

7%

0.5% 0.

8%

1.31

1.3 1

1%1%2%

0%Euro Area Germany UK France Netherlands Belgium


THE $2.75 TRILLION GLOBAL ECONOMIC

STIMULUSSTIMULUSCountries Trying to SpendCountries Trying to Spend

Their Way Out of RecessionTheir Way Out of Recession Will Need More Energy &

M IMore Insurance

Summary of Short-Run Impacts of Global Stimulus Packages on P/C Insurance, Energy Sectors

• No Stimulus Provisions Specifically Address P/C Insurance in US d U f P i i El hUS and Unaware of Provisions Elsewhere

Spending, Aid and Tax Reductions benefit other industries, state and local governments, as well as individual and some corporate taxpayers

• Stimulus Package is Unlikely to Increase US Net Premiums Written by More Than 1% or Approximately $4.5 Bill. in US by 20102010

Little-to-modest impact in Europe and elsewhere

• Several Stimulus Countries’ Plans Direct Spending Toward the Energy Sector

• Stimulus Plans in US, Europe, China and Japan Have Numerous “Green” Provisions that Could Influence Supply andNumerous Green Provisions that Could Influence Supply and Demand for Energy

Source: Insurance Information Institute

Announced Economic Stimulus Packages Worldwide (US$ Bill)*

$787$900

Packages Worldwide (US$ Bill)*U.S. stimulus comprises a mix of

spending tax relief and aid to states

$586

.15.

9

$787

$600$700$800

spending, tax relief and aid to states

Governments around the world are seeking to soften the economic blow

through spending. Deficits as a share of As of March 2009,

these countries h d$

$485

$400$500$600

t oug spe d g. e c ts as a s a e oGDP will mushroom leading to a

potential inflationary threat and higher interest rates the future.

P/C insurers will provide insurance

have approved or proposed at least US$2.3 trillion in stimulus spending

8 0

$130

.43.

0 75.3

0 6 9 8 8 .3 8.0

4 .7 6.8

0.8$200

$300p

necessary for stimulus projects and will benefit from enhanced economic growth

p g

$5.8

$2.0 $33 $7

$8.0

$7.6

$6.9

$2.8

$1.8

$11

$28

$7.4

$13

$36

$40

$0$100

U.S.ex

icoChile

many

ance

U.K.

Spain

Italy

lands

ngary

tugal

eden

China apan

Korea

land*

tralia

India

Dubai

UM

ex Ch

Germa

Fran U Sp It

Nether

laHungPor

tugSwed Ch Ja

pSou

th K

oNew

Zea

lanAustr In Du

Sources: Wall Street Journal, January 8, 2009 with updates by I.I.I.; Institute of International Finance and Brookings Institute.

*As of March 2009.

Green Energy Spending: An Important Component of Some Stimulus Plans

$ Billions

Component of Some Stimulus Plans

$94.1US $787B TotalEuropean green energy

stimulus spending = $54 2B

$221 3

$54.2Europestimulus spending = $54.2B

$634.1B Total

$586 1B T l$221.3

$12.4Japan

China $586.1B Total

$485.9B Total

India

$485.9B Total

$13.7B TotalGreen energy stimulus spending totals $382B in US, Japan and Europe, or 18.1% of their combined $2.1 trillion in stimulus spending

$0 $200 $400 $600 $800 $1,000Source: “Energy Sector Looks for Private, Public Help,” WSJ, 3/9/09, p. A2 from HSBC, New Energy Finance; Ins. Info. Inst.

US Economic Stimulus Package: Where the $787B Goes 5% to Energy Projectsthe $787B Goes—5% to Energy Projects

$ Billions

Protecting the

Health Care, $59 , 7% Education & Training, $53 , 7%

Energy, $43 , 5%

Infrastructure & Science,

Protecting the Vulnerable, $81 , 10%

Other, 8, 1%

$111 , 14%

US stimulus package ll t $43B 5% Tax Relief, $288 , 38%allocates $43B or 5% or

total spending to energy programs

State & Local Fiscal Relief, $144 , 18%

Source: http://www.recovery.gov/ accessed 2/18/09; Insurance Information Institute.

US Economic Stimulus Package: $143.4 in Construction Spending—20% to Energy Projectsp g gy j

Energy & Technology

$ Billions

W kf D l

Energy & Technology, 29.8, 20%

School Building, 9.2, 6%

Workforce Development & Safety, 4.3, 3%

Other, 8.0, 5%

Building Infrastructure, 29.6, 20%

Other, 0.2, 0%

Spending on energy-related construction

Transportation Infrastructure, 49.3, 32%

29.6, 20%related construction projects totals nearly $30B or 20% or all

stimulus-relatedWater & Environmental Infrastructure, 21.4, 14%

stimulus-related construction spending

Source: Associated General Contractors at http://www.agc.org/cs/rebuild_americas_future (2/18/09); Insurance Info. Inst..

Global Green Energy Spending* ($ Billion)

Annual investment needed through 2030 in renewable energy and energy efficiency to keep atmospheric CO2

($ Billion)

$542

$500

$600

C t i t t i

energy and energy efficiency to keep atmospheric CO2 concentration below 450 parts per million—an amount many scientists claim is necessary to prevent serious

consequences from climate change

$300

$400Current investment in green energy falls far short of what some believe is necessary to address climate change issue

$160$150$98

$200

$300 address climate change issue

$98$60$33

$0

$100

2004 2005 2006 2007 2008 2030*Estimated from source below.Source: “Energy Sector Looks for Private, Public Help,” WSJ, 3/9/09, p. A2; New Energy Finance interpretation of International Energy Agency data; Ins. Info. Inst.

Stimulus: Reading The Economic Tea Leaves for the Next 4 to 8 YearsTea Leaves for the Next 4 to 8 Years

• Growing Role of Government: 2009 Stimulus Packages and Other Likely Spending Initiatives in US andand Other Likely Spending Initiatives in US and Elsewhere Guarantee Government Will Play a Much Larger Role Than at Any Other Time in Recent History

Every industry including insurance will and must attempt toEvery industry, including insurance, will and must attempt to maximize direct and indirect benefits from this paradigm shift

• Obama Administration Priorities: Stimulus Package Acts as “Economic Tea Leaf” on the Administration’s Fiscal Priorities for the Next Several Years

• These Include:Alternative EnergygyEnvironmental SpendingHealth CareAging/New InfrastructureAid to States


Aid to States• Global Financial Services Regulatory Reform

Includes insurance

FINANCIAL STRENGTH &

RATINGSIndustry Has Weathered dust y as Weat e ed

the Storms Well

US P/C Insurer Impairment Frequency vs Combined Ratio 1969 2007vs. Combined Ratio, 1969-2007

Combined Ratio after DivP/C I i t F

Impairment rates are highly

115

120

1 61.82

P/C Impairment Frequencyg ycorrelated

underwriting performance and could reached a

record low in 2007

110

ed R

atio

1.21.41.6

ent R

ate

record low in 2007

100

105

Com

bine

0.60.81

Impa

irme

90

95

00.20.4

2007 impairment rate was a record low 0.12%, one-seventh the 0.8% average since 1969; Previous

record was 0.24% in 197290

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

0

Source: A.M. Best; Insurance Information Institute

Summary of A.M. Best’s P/C Insurer Ratings Actions in 2008*Ratings Actions in 2008

P/C insurance is by design a resilient in

Upgraded, 59 , 4.0%

Initial, 41 , 2.8%Downgraded, 55 , 3 8%

design a resilient in business. The dual threat of financial

disasters and catastrophic losses are Under Review, 63 ,

4.3%

O h 59 4 0%

3.8%catastrophic losses are anticipated in the

industry’s risk management strategy.

Other, 59 , 4.0%

Despite financial market turmoil, high cat losses

and a soft market inand a soft market in 2008, 81% of ratings actions by A.M. Best

were affirmations; just 3.8% were downgrades

Affirm, 1,183 , 81.0%*Through December 19.Source: A.M. Best.

24

3.8% were downgrades and 4.0% upgrades

Historical Ratings Distribution,US P/C Insurers 2008 vs 2005 and 2000US P/C Insurers, 2008 vs. 2005 and 2000

2008 2005 2000A++/A+ and

D0.2%C++/C+

1.9%

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

11 5%

C/C-0.6%

A++/A+9.2%

Vulnerable*

A++/A+10.8%Vulnerable*

A++/A+ and A/A- gains

11.5%B/B-6.9%

Vulnerable12.1%

B++/B+21.3%

7.9%

A/A-

B++/B+28.3%

A/A-52 3%

B++/B+26.4%

A/A48.4%

P/C insurer financial strength has improved since 2005

52.3%A/A-

60.0%

Source: A.M. Best: Rating Downgrades Slowed but Outpaced Upgrades for Fourth Consecutive Year, Special Report,November 8, 2004 for 2000; 2006 and 2009 Review & Preview. *Ratings ‘B’ and lower.

has improved since 2005 despite financial crisis

Reasons for US P/C Insurer Impairments 1969 2005Impairments, 1969-2005

2003-2005 1969-2005Deficient

Loss Reserves/In-

d t

Affiliate Problems

8.6%

Reinsurance Failure3.5%

Misc

Sig. Change in Business

4.6%

Deficient Loss

Reserves/In-d tCatastrophe

Losses8.6%

adequate Pricing62.8%

Misc.9.2%

adequate Pricing38.2%

Investment Alleged Fraud11.4%

Deficient Affiliate Problems

Problems*7.3%

Rapid Growth

8.6%

reserves, CAT losses are more

important Rapid

Problems5.6%

Alleged

Catastrophe Losses6.5%

*Includes overstatement of assets.Source: A.M. Best: P/C Impairments Hit Near-Term Lows Despite Surging Hurricane Activity, Special Report, Nov. 2005;

pfactors in

recent years

pGrowth16.5%

gFraud8.6%

Critical Differences Between P/C

Insurers and BanksSuperior Risk Management ModelSuperior Risk Management Model

& Low Leverage MakeBi Diffa Big Difference

Financial Institutions Globally FacingHuge Losses from the Credit Crunch*

$800 Losses as of Sept 2008

Huge Losses from the Credit CrunchBillions

$780

$600

$700

$800 Losses as of Sept 2008Total expected losses

The IMF estimates total “credit-turmoil related” losses will

$600

$400

$500

$600 turmoil-related losses will eventually amount to $1.4 trillion

$205B or 20.8% of estimated total (bank+insurer) losses will be

$200

$300

$400 (bank+insurer) losses will be sustained by insurers worldwide

$106$205

$0

$100

$200

$0Banks Insurers

*Global losses since the beginning of 2007.Source: IMF Global Financial Stability Report, October 2008, IIF, Bloomberg, cited in a presentation by Thomas Hess (Chief Economist, Swiss Re) October 23, 2008, accessed via Geneva Association web site.

28

How Insurance Industry Stability Has Benefitted ConsumersHas Benefitted Consumers

BOTTOM LINE:I M k U lik B ki A O i• Insurance Markets—Unlike Banking—Are Operating Normally

• The Basic Function of Insurance—the Orderly TransferThe Basic Function of Insurance the Orderly Transfer of Risk from Client to Insurer—Continues Uninterrupted

• This Means that Insurers Continue to:P l i ( h 42 b k h d f 3/13)Pay claims (whereas 42 banks have gone under as of 3/13)

The Promise is Being FulfilledRenew existing policies (banks are reducing and eliminating li f dit)lines of credit)Write new policies (banks are turning away people who want or need to borrow)Develop new products (banks are scaling back the products they offer)

Source: Insurance Information Institute29

Reasons Why P/C Insurers Have Fewer Problems Than Banks:

A Superior Risk Management Model• Emphasis on Underwriting

Matching of risk to price (via experience and modeling)

A Superior Risk Management Model

g p ( p g)Limiting of potential loss exposureSome banks sought to maximize volume and fees and disregarded risk

• Strong Relationship Between Underwriting and Risk BearingInsurers always maintain a stake in the business they underwrite keeping “skin in the game”Insurers always maintain a stake in the business they underwrite, keeping skin in the game at all timesBanks 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 LeverageInsurers do not rely on borrowed money to underwrite insurance or pay claims There is no credit or liquidity crisis in the insurance industry

• Conservative Investment PhilosophyHigh quality portfolio that is relatively less volatile and more liquid

• Comprehensive Regulation of Insurance OperationsThe business of insurance remained comprehensively regulated whereas a separate banking system had evolved largely outside the auspices and understanding of regulators (e.g., hedge y g y p g g ( g gfunds, private equity, complex securitized instruments, credit derivatives—CDS’s)

• Greater TransparencyInsurance companies are an open book to regulators and the public

Source: Insurance Information Institute30

ENERGY MARKET REVIEW

Global Energy Business gyIs Deeply Impacted by

C i i b t Oth F tCrisis, but Other Factors Matter TooMatter Too

Key TrendsKey Trends

Capacity & Ratingp y gExposure

ProfitabilityR iReinsurance

Global Energy Insurance Markets: Key TrendsKey Trends

INSURANCE CAPACITYA i l / l ( lif ) i f llAggregate commercial property/casualty (nonlife) capacity fell sharply in 2008 due to

• Reduced Asset Values• Higher Underwriting Losses• Sharply Lower Investment Returns

Surprisingly, overall energy market capacity levels for 2009 p g y, gy p yhave increased, despite start of early stage of market hardening, financial crisis and dislocations of key competitorsHigher capacity and basic laws of supply and demand temperHigher capacity and basic laws of supply and demand temper extent of market hardening and limit price gainsCapacity freed up due in part to reduced construction activity and reduced business interruption levelsand reduced business interruption levelsFallout from Gulf of Mexico windstorm causes some supply issues for offshore and onshore risks Source: Willis Energy Market Review March 2009

Upstream Operating Underwriting C iti 2000 08 (E l GOM)Capacities, 2000-08 (Excl. GOM)

Source: Willis Energy Market Review: March 2009

Downstream Operating Underwriting Capacities 2000-09 (Excl GOM)Capacities, 2000 09 (Excl. GOM)


Upstream Capacities and Average Rating Levels, 1993-2009 (Excl. GOM)Levels, 1993 2009 (Excl. GOM)


Onshore Capacities and Average Rating Levels, 1993-2009 (Excl. GOM)Levels, 1993 2009 (Excl. GOM)


Total Theoretical Liability Capacity, 2000-092000 09



INSURED EXPOSUREGlobal economic downturn, reduced energy demand and collapse of oil prices hit energy industry project activity and asset values with negative impact on energy insurers’ g p gyexposure and therefore premium income levelsImpact is especially acute for industrial energy demandCredit crisis impacting project viability as wellCredit crisis impacting project viability as wellBOTTOM LINE IN 2009: Crisis will have little impact on long-run demand and supply for energy and energy assets

• Global energy demand will begin to rebound in late 2009• Fuel prices are already beginning to rise• Insurance industry will be able to meet the short, intermediate and

ilong-term demands despite current challenges

Source: Willis Energy Market Review March 2009; Insurance Information Institute.


PROFITABILITYSharp decline in investment returns in 2008, unlikely to turnaround anytime soonLoss of investment return necessarily increases pressure onLoss of investment return necessarily increases pressure on (re)insurers to generate underwriting profitsMany insurers will also need to protect capital in 2009 via increased reliance on reinsuranceincreased reliance on reinsuranceHigher cost of capital could be a major issue if capital raises are necessary among for insurers and reinsurersBOTTOM LINE IN 2009: Stable and profitable energy sector (for the most part) particularly for low Nat Cat business

• Movement toward disciplined underwriting is necessary


Energy Losses vs. Global Energy Premium Income 1990 2008*Premium Income 1990-2008*

*Figures include both insured and uninsured losses


Gulf of Mexico Windstorm: Still An Insoluble Problem?Insoluble Problem?

Gulf of Mexico windstorm (GOM) number one d i i h d h i h k f H i Ikunderwriting headache in the wake of Hurricane Ike

Long-term sustainability of Gulf wind insurance product in serious question by both the reinsurance and direct marketsq yOffshore energy losses spike in 2004, 2005 and 2008 due to impact of Big Four (Hurricanes Ivan, Katrina, Rita and Ike)Lloyd’s Franchise Performance Directorate (LFPD) takingLloyd s Franchise Performance Directorate (LFPD) taking keen interest in individual syndicates’ plans to write GOM wind in 2009. Significant product changes expected.M k t t d t ff 30 t l it th iMarket expected to offer 30 percent less capacity than in 2008Catastrophe modeling and capital market parametric p g p psolutions expected to play a role.

Source: Willis Energy Market Review March 2009

Reinsurance & Alternative Risk

TransferC it i DCapacity is Down,

Demand is UpDemand is Up

Reinsurance Market TrendsReinsurance Market TrendsAmid global capital markets turmoil and economic d l b l i i d h f i d l i ldownturn global reinsurance industry has faired relatively well (with a small number of exceptions)Capacity, however, is down due to investment issuesp y, ,But reinsurers seeking price increases as of 1 January and risk appetite more constrained (e.g., U.S. catastrophe risk)Primary insurers exploring lower retentions and otherPrimary insurers exploring lower retentions and other reinsurance mechanisms to protect and enhance their capital positionsI i di ti f i k i k tIncreasing syndication of risk as insurers seek to use portfolio diversification to mitigate counterparty exposureOpportunity for traditional reinsurance market to win back pp ymarket share as some alternative forms of risk transfer have dried up


Global Reinsurance Capacity Shrank in 2008 Mostly Due to Investmentsin 2008, Mostly Due to Investments

Global Reinsurance Capacity Source of Decline

$360

$350$360$370

Global

Change in Unrealized

Capital Losses

Realized Capital Losses31%

$$330$340$350 Global

reinsurance capacity fell by

an estimated 17% in 2008

Losses55%

$300$300$310$320 17% in 2008

H i

$270$280$290

Hurricanes14%

$2702007 2008

45Source: AonBenfield Reinsurance Market Outlook 2009; Insurance Information Institute.

Catastrophe Bond and Sidecar Issuance 2004-2008Issuance, 2004 2008

$ Billions

$7 62$8

$10 The credit crisis and decline in global capital have taken their

t ll lt ti f f

$4 69

$7.62

$6

$8 toll on alternative forms of catastrophe risk transfer

$4.69

$2.73$2.33

$3.85$4

$1.14 $1.50

$0.00

$2.33$1.75

$0.28$0

$2

$02004 2005 2006 2007 2008

46Source: AonBenfield Reinsurance Market Outlook 2009; Insurance Information Institute.

The Global FinancialThe Global Financial Crisis Affects EnergyCrisis Affects Energy Industry Supply andIndustry Supply and Demand & InsuranceDemand & Insurance

ExposureExposure

Severe Recession is Depressing US Energy Demand: Change 2009 vs 2008Energy Demand: Change 2009 vs. 2008

Percentage Change in Consumption, 2009 vs. 2008

-1%

0%

-2.2%-1.3% -1.7% -1.7%

-3%

-2%

I d t i l

-5%

-4% Industrial consumption of electricity has

experienced the most

-6.4%-7%

-6%experienced the most

severe declines

Oil Natural Gas Electricty(Industrial)

Electricty (All) Coal forElectricity

Sources: Energy Information Administration.

World Crude Oil Prices: 1997 March 20091997- March 2009

$160 Dollars per Barrel*PEAK

$120

$140 Crude oil prices peaked at $145.29 in July 2008, th f ll 75% t $34 57

PEAKJul. 2008 $145.29

$80

$100then fell 75% to $34.57

in Jan. 2009 but are rising again to more than

$40

$60

$80 rising again to more than $47/bbl in mid-March

Jan. 1998 $15.21

RECENT16 Mar

$20

$40

TROUGHJan. 2009

$34 57

16 Mar. $47.35

*All countries spot market price weighted by estimated export volume. Source: Energy Information Administration; http://tonto.eia.doe.gov/dnav/pet/hist/wtotworldw.htm

$0Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09

$34.57

US Energy Expenditures as a % of GDP Have Been Hurt by Recession

Percentage of GDP

GDP Have Been Hurt by Recession

12%

14% Recession and 2008 energy price spike sharply

d d d d8%

10% decreased energy demand

4%

6%The energy price bubble pushed energy

expenditures to 9.9% of GDP in 2008. The bursting of the bubble and recession pushed

0%

2%

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 10

bursting of the bubble and recession pushed expenditures down to 7.0% of GDP in 2009.

Source: Energy Information Administration, Short-Term Energy Outlook, March 10, 2009; Ins. Info. Inst.

World Net Effective Electric Power Generation 1990 2030 ( t )

33.335

Power Generation, 1990-2030 (est.)Trillions of Kilowatt Hours

24 4

27.5

30.430

17.3

21.0

24.4

20

25

11.3

14.612.6

10

15The current economic

downturn will have little if5

downturn will have little, if any, long-term impact on electric power generation

01990 1995 2000 2005 2010 2015 2020 2025 2030

Source: Energy Information Administration, 2008 International Energy Outlook, Insurance Information Institute.

Electricity Supply Infrastructure:Despite Crisis, Huge Investments Needed Al With I 2001 2030 (E )Along With Insurance: 2001-2030 (Est.)

$ BillionsEuropean investment $ Billions

$1,876 $1,913$2 000

$2,500 Investments in electricity supply infrastructure

globally are expected to

could total $1.351 trillion

$1,351

$ ,

$1,500

$2,000 globally are expected to total $9.841 trillion

between 2001 and 2030

$809

$377$744

$258$609

$783$799

$500

$1,000

$0

rope

rth

eric

a

cific

ssia

hina

Asi

a

Asi

a

tin eric

a

ddle

ast

fric

a

Eur

Nor

Am

e

Pac

Rus Ch

E. A

S. A

Lat

Am

e

Mid Ea Af

Source: International Atomic Energy Agency , World Outlook for Electricity Investment.52

World Energy Supply Infrastructure Investment by Category: 2001-2030 (Est )Investment by Category: 2001-2030 (Est.)

Generation will account$ Billions

Distribution, $3,755 , 38%

Generation will account for 46% or $4.5 trillion

of all investment through 2030 to meetthrough 2030 to meet

rising demand. Current downturn will have no impact on long-term

Transmission, $1,568 ,

global energy demand and the need to develop supply infrastructure

Generation-New, $4,080 , 42%

16%

Generation-Refurbished, $439 , 4%

Source: International Atomic Energy Agency , World Outlook for Electricity Investment.

World Electricity Generation by Fuel 2005-2030F2005 2030F

5.36

1

16

18

Th h i iTrillions of Kilowatt Hours

15

12

14

16 The sharp increase in generation and the

changing composition of f l ill i fl

7.15

28.38

9

8

10

12 fuel source will influence insurance demand and the

nature of products sold

2.63 3.

16 3.42

2

4

3.75

4 4.99

6

56

4

6

0.76

4

0.95

0

2

Liquids Nuclear Renewables Natural Gas Coalq

2005 2010 2015 2020 2025 2030

Source: US Department of Energy Report #:DOE/EIA-0484 ( Sept. 2008); Insurance Information Institute

World Electricity Generation by Fuel Source Share: 2005 vs 2030F

2005 2030Source Share: 2005 vs. 2030F

Liquids6%

N l

Liquids2% Nuclear

11%

Nuclear15%

Renewable15%

Renewables

Coal41% Coal

47%

Natural Gas

18%

Natural Gas25%Surprisingly, coal as a source

20%p g y,

of electricity generation is expected rise through 2030.

CO2, pollution issues?Source: Insurance Information Institute from data reported in US Department of Energy Report #:DOE/EIA-0484 ( Sept. 2008).

European Electricity Generation,by Fuel: 2005-2030Fby Fuel: 2005 2030F

5.0 Trillions of Kilowatt Hours 4.67

3 54.04.5

3 303.70

3.97 4.21 4.44

2.53.03.5

Gas, renewables grow,

3.30

1.01.52.0

, g ,coal shrinks, implying

different insurance needs in Europe

0.00.51.0

2005 2010 2015 2020 2025 20302005 2010 2015 2020 2025 2030

Liquids Coal Natural Gas Renewables Nuclear

Source: US Department of Energy Report #:DOE/EIA-0484 ( Sept. 2008); Insurance Information Institute

Avg. Annual Change in Consumption of Crude Oil in Major World RegionsCrude Oil in Major World Regions

500000 barrels per day

Demand for oil will increase by j t d 49% i Chi 30%

171158211

410

294242

169162

276230

200300400

a projected 49% in China, 30% in India and Middle East by 2015 but shrink in Europe

171158

615319153668

112169

90566899

3

86162

0100200

-21-3

-182300

-200-100

2005-2015, projected 1990-2005

-349-400-300

ada,

co a

ndU

.S.

U.S

.

opin

g, e

xcl.

a an

d

Latin

mer

ica

Afri

ca

stra

lia,

New alan

d,

OEC

Dur

ope*

Japa

n

Rus

sia

mer

et a

ndm

unis

t

Indi

a

e Ea

st

Chi

na

Can

Mex

i cth

e

Dev

elA

sia ,

Chi

naLA

m

Aus N

ZeaO Eu

JR

For

Sovi

eC

omm

Mid

dle

*Austria, Belgium, the Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Poland, Portugal, the Slovak Republic, Spain, Sweden, Switzerland, Turkey and UK.Source: Wall Street Journal, January 3, 2008 edition; International Energy Agency

Lessons from EnergyLessons from Energy Boom of 2008Boom of 2008

Oil/Energy is a Chief Source of Global Economic InstabilityGlobal Economic Instability

LESSONS OF 2008 ENERGY PRICE BUBBLESteeply rising oil/energy prices lead to severeSteeply rising oil/energy prices lead to severe economic dislocation and hardship on a global scaleReduced economic growth globally (except energy exporting countries)exporting countries)Fuels InflationMakes investment decisions in exploration more

ip

uncertain Encourages collateral boom in other commoditiesDisastrous for transport sector (e.g., airlines)Disastrous for transport sector (e.g., airlines)Food, energy costs are acute problems in poorest parts of the world Increases the power and wealth of certain unstableIncreases the power and wealth of certain unstable countries (e.g., Iran, Nigeria, Venezuela)Influence on biofuels/alternative energy policies

P/C INSURANCE FINANCIAL

PERFORMANCE

A R ili I d iA Resilient Industry in Challenging TimesChallenging Times

ProfitabilityProfitability

Hi t i ll V l tilHistorically Volatile

P/C Net Income After Taxes1991 2009F ($ Millions)*1991-2009F ($ Millions)

,940

,777

$70 000

2001 ROE = -1.2%2002 ROE = 2.2%2003 ROE 8 9%

Insurer profits in US and

819

$61,

$65,

44,1

55

501$50,000

$60,000

$70,000 2003 ROE = 8.9%2004 ROE = 9.4%2005 ROE= 9.4%2006 ROE = 12.2%2007 ROAS1 = 12.3%

in US and globally peaked

in 2006/2007

78 9,31

6

0 20,5

98

$24,

404 $3

6,8

$30,

773

21,8

65 $30,

029 $4

0,55

9

$38,

5

$30,000

$40,000

$ ,2008 ROAS = 1.1%*

$14,

1

$5,8

40

$19

$10,

870

$2 $2

$3,0

46

$5,4

21

$2

$10,000

$20,000

-$6,970-$10,000

$0

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 8F0

*ROE figures are GAAP; 1Return on avg. surplus. 2008 numbers are annualized based on 9-mos. Actual of $4.066 billion.Sources: A.M. Best, ISO, Insurance Information Inst.

62

P/C Insurance Industry ROEs,1975 – 2010F*

25%1977:19.0% 1987:17.3% 1997:11.6% 2006:12.2%

20%

25%

10%

15%

2009F 4 5%

0%

5%2008F: 1.1%

2010F: 6.0%

2009F: 4.5%

-5%

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 06 08F

09F

10F

1975: 2.4% 1984: 1.8% 1992: 4.5% 2001: -1.2%

%

Note: 2009 figure is actual 9-month result.Sources: ISO; Insurance Information Institute. 63

ROE vs. Equity Cost of Capital:US P/C Insurance:1991 2008:Q3

18%

US P/C Insurance:1991-2008:Q3The p/c insurance industry fell well

h f i f i l i 2008

12%

14%

16% short of is cost of capital in 2008

3 pt

s

6%

8%

10%

pts -1

.7 p

ts +2. 3

-9.0

pts

pts

2%

4%

6%

-13.

2 p

US P/C insurers missed their t f it l b 6 7

-

The cost of capitalis the rate of return

-9.7

p

4%

-2%

0% cost of capital by an average 6.7 points from 1991 to 2002, but on

target or better 2003-07

insurers need to attract and retain

capital to the business

-4%91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08*

ROE Cost of Capital*Excludes mortgage and financial guarantee insurers.Source: The Geneva Association, Ins. Information Inst.

g

64

Presidential PoliticsPresidential Politics & P/C Insurance& P/C Insurance

How is Profitability Affected by the President’s Political Party?President s Political Party?

P/C Insurance Industry ROE byPresidential Administration,1950-2008*

15 10%16.43%Carter

Reagan II 15.10%10.13%

8.93%8.65%

Reagan IIG.W. Bush II

NixonClinton I

OVERALL RECORD: 1950 2008*%

8.35%7.98%

7.68%

G.H.W. BushClinton IIReagan I

1950-2008*Democrats 8.05%

6.98%6.97%

5.43%5 03%

Nixon/FordTruman

Eisenhower IEisenhower II

Republicans 8.02%

Party of President has marginal bearing on5.03%

4.83%4.43%

3.55%

Eisenhower IIG.W. Bush I

JohnsonKennedy/Johnson

marginal bearing on profitability of P/C insurance industry

0% 2% 4% 6% 8% 10% 12% 14% 16% 18%

y

*ROE for 2008 based on H1 data. Truman administration ROE of 6.97% based on 3 years only, 1950-52.Source: Insurance Information Institute

P/C Insurance Industry ROE by Presidential Party Affiliation,

1950 2008*25%

BLUE = Democratic President RED = Republican President

n1950–2008*

20% Trum

an

Nixon/FordKennedy/ Johnson

Eisenhower Carter Reagan/Bush Clinton Bush

10%

15%

5%

10%

0%

-5%

50 52 54 56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08*

Source: Insurance Information Institute. *2008 based 9-month data.

P/C PremiumP/C Premium GrowthGrowth

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

Strength of Recent Hard Marketsby NWP Growth

24%

y NW G1975-78 1984-87 2000-03Shaded areas

denote “hard

18%20%22% denote hard

market” periods

Net written premiums fell 1 0%

12%14%16% premiums fell 1.0%

in 2007 (first decline since 1943)

and by 0.4% in 2008, the first back-

4%6%8%

10% 2008, the first backto-back decline

since 1930-33

2%0%2%4%

-2%

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

F20

09F

Sources: A.M. Best (historical and forecast), ISO, Insurance Information Institute69

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

P/C insurers are Protracted i d f15.3% experiencing their

slowest growth rates since 1930-33

period of negative or slow growth is possible due to soft

8.4%10.0% Slow growth means

retention is critical

due to soft markets and

slow economy

5.0%3.9% 4.2%

0 9%0.5%

-1 0% -0.4%

0.9%

*2008 figure is 9-month actual result from ISO.Source: A.M. Best (historical and forecast)

-1.0%2000 2001 2002 2003 2004 2005 2006 2007 2008F 2009F

70

Capital/P li h ldPolicyholder

SurplusSurplusShrinkage, butShrinkage, but

Capital is WithinHi t i NHistoric Norms

U.S. Policyholder Surplus: 1975 2008*

$550

1975-2008*Actual capacity as of 9/30/08 was $478.5, down 7.6%

$400

$450

$500 from 12/31/07 at $517.9B, but 68% above its 2002 trough. Recent peak was $521.8 as of 9/30/07. Estimate

as of 12/31/08 is $438B is 16% below 2007 peak.

$300

$350

$400

$ B

illio

ns The premium-to-surplus ratio stood at $0.94:$1 at

2008 f

$150

$200

$250

$

“Surplus” is a measure of underwriting capacity It is

year end 2008, up from near record low of $0.85:$1

at year-end 2007

$50

$100

$150 underwriting capacity. It is analogous to “Owners Equity” or “Net Worth” in non-insurance organizations

y

$075 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

Source: A.M. Best, ISO, Insurance Information Institute. *Towers Perrin estimate as of 12/31/0872

Policyholder Surplus, 2006:Q4 – 2008:Q4(Est )2006:Q4 2008:Q4(Est.)

$ BillionsCapacity peaked at $ Billions

$512.8$521.8

$505.0$515.6$517.9

$520

$540$521.8 as of 9/30/07

$487.1$496.6

$478.5

$505.0

$480

$500

$438.0

$420

$440

$460 Declines Since 2007:Q3 PeakQ2: -$16.6B (-3.2%)

$380

$400

$420 Q3E: -$43.3B (-8.3%) Q4E: -$84B (-16.1%)

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

Source: ISO (historical); Towers Perrin (Oct. 21) estimates for Q4 2008. Q4 assumes no major Investment market recovery before year-end 2008.

73

U.S. P/C Industry Premiums-to-Surplus Ratio: 1985-2008:Q3

2.0

Surplus Ratio: 1985 2008:Q3Premiums measure risk accepted; surplus is funds

b d t t d l Th l

1.8

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 4

1.6P/C insurers remain well capitalized despite recent

i f it l

1.2

1.4

19980.85:1–the lowest

erosion of capital

1.0

0.85:1 the lowest (strongest) P:S ratio

in recent history. 0.92:1 as of

9/30/080.8

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 0708:Q3

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

Historically, Hard Markets Follow When Surplus “Growth” is Negative

30%

NWP % changeSurplus % change

When Surplus Growth is NegativeSharp decline in capacity is a necessary but not sufficient

20%

25%

30% Surplus % change necessary but not sufficient condition for a true hard market

10%

15%

20%

0%

5%

-10%

-5%

8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7 *

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

*

*Actual 9-month 2008 result.Sources: A.M. Best, ISO, Insurance Information Institute

Investment Performance

Investments are the PrincipleInvestments are the Principle Source of Declining

fi bilif g

Profitability

Distribution of P/C Insurance Industry’s Investment PortfolioIndustry s Investment Portfolio

P tf li F tAs of December 31, 2007

Common Stock

Bonds66.7%

Portfolio Facts•Invested assets totaled $1.3 trillion as of 12/31/07

Common Stock17.9%•Insurers are generally

conservatively invested, with 2/3 of assets invested in bonds as of

Cash & Short-Term Investments

7.2%

12/31/07•Only about 18% of assets were invested in common stock as of

P f d St k

Real Estate0.8%

Other

common stock as of 12/31/07•Even the most conservative of portfolios was hit hard in 2008 Preferred Stock

1.5%Other5.9%

was hit hard in 2008

Source: NAIC; Insurance Information Institute research;.77

Property/Casualty Insurance Industry Investment Gain:1994- 2008:Q3 1Q

$ Billions$63 6

$42 8$47.2

$52.3

$44.4 $45.3$48.9

$59.4$55.7

$63.6$56.9

$51.9

$57.9

$50

$60

$35.4$42.8 $44.4

$36.0

$

$28.3$30

$40

Investment gains are off sharply

$10

$20Investment gains are off sharply in 2008 due to lower yields and poor equity market conditions.

$0

94 95 96 97 98 99 00 01 02 03 04 05* 06 07

08:Q

3

p q y

08

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.

78

P/C Insurer Net Realized Capital Gains 1990-2008:Q3Capital Gains, 1990 2008:Q3

$18.02$18$20$ Billions

$9 89 $10.81$13.02

$16.21

$9 82$12$14$16$18

$2 88$4.81

$9.89

$6.00

$9.24$

$6.63 $6.61$8.97

$3 52

$9.70$9.13$9.82

$6$8

$10$12

$2.88$1.66

$1 21

$3.52

-$2$0$2$4

Realized capital gains exceeded $9 -$1.21

$9 71-$8-$6-$4-$2 Realized capital gains exceeded $9

billion in 2004/5 but fell sharply in 2006 despite a strong stock market. Nearly $9 billion again in 2007, but

$-9.7 billion in 2008 through Q3. -$9.71-$10

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

08:Q

3

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

$ 9.7 billion in 2008 through Q3.

79

Total Returns for Large Company Stocks: 1970-2009*Company Stocks: 1970 2009

S&P 500 is down 12.1% in 2009*

25%

35%

5%

15%

-15%

-5%

-35%

-25% The market crash of 2008 was the biggest since 1931

-45%

1970

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

Source: Ibbotson Associates, Insurance Information Institute. *Through March 18, 2009.80

Treasury Bond Yields HaveGenerally Been FallingGenerally Been Falling

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

8%

10%ForecastJuly 1990-

March 1991 recession

March 2001-November 2001

recession

6%

2%

4%December 2007

– Present(C t

Investment yields on the safest assets

are near multi-d d l

0%

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

10F

(Current Recession) decade lows

-2%

0

Sources: US Bureau of Labor Statistics (history); Blue Chip Economic Indicators, February 2009 issue (forecasts)

Treasury Yield Curves: Pre Crisis vs Current*

4 96% 5 04% 4 96% 5 00% 5.19% 5.11%6%

Pre-Crisis vs. Current

3.83%3 59%

4.82% 4.96% 5.04% 4.96% 4.82% 4.82% 4.88% 4.93% 5.00% 5.11%

4%

5%

Treasury Yield Curve is at its most

2 30%

2.87%

3.59%

3%

4% depressed level in at least 45 years. Investment income will fall

significantly as a result.

0 98%1.37%

1.87%2.30%

2% Stock dividend cuts will further pressure

investment income

0.22% 0.30% 0.46% 0.62%0.98%

0%

1%

Current Yield Curve*Pre-Crisis (July 2007)

investment income

82

0%1M 3M 6M 1Y 2Y 3Y 5Y 10Y 20Y 30Y

*February 2009.Sources: Federal Reserve; Insurance Information Institute.

UnderwritingUnderwriting TrendsTrends

Financial Crisis Does Not DirectlyFinancial Crisis Does Not Directly Impact Underwriting

P f C l C t t hPerformance: Cycle, Catastrophes Were 2008’s Drivers

P/C Insurance Combined Ratio, 1970 2008F*

120Combined Ratios

1970 100 3

1970-2008F*

115

1970s: 100.31980s: 109.21990s: 107.8

1102000s: 102.0*

100

105

95

90

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 08F

Sources: A.M. Best; ISO, III *A.M. Best year end estimate of 103.2; Actual 9-mos. result was 105.6.84

P/C Insurance Industry Combined Ratio, 2001-2009E

120

Ratio, 2001 2009EAs recently as 2001, insurers

paid out nearly $1.16 for every Relatively low CAT

Including Mortgage

115.8 $1 in earned premiums low CAT losses, reserve releases

Mortgage & Fin.

Guarantee insurers

2005 ratio benefited from heavy use of reinsurance

hi h l d t l107.5

103 3

110Best combined ratio since 1949

(87 6)

Cyclical Deterioration

which lowered net losses

100.198.4

100.8 101103.3

101.2

100

(87.6)

92.6

95.7

902001 2002 2003 2004 2005 2006 2007 2008 2008* 2009F

*Includes Mortgage & Financial Guarantee insurers. Sources: A.M. Best.85

Underwriting Gain (Loss)1975 2008:Q3*

3035 Insurers earned a record underwriting profit of

$31 7 billi i 2006 h l b l h

1975-2008:Q3*

1015202530 $31.7 billion in 2006, the largest ever but only the

second since 1978. Cumulative underwriting deficit from 1975 through 2007 is $422 billion.

-10-505

10

$ B

illio

ns

-30-25-20-15-10$

$19.877 Bill

-50-45-40-3530 $

underwriting loss in 08:9M incl. mort. & FG insurers

-55

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

Source: A.M. Best, ISO; Insurance Information Institute * Includes mortgage & finl. guarantee insurers

G su e s

86

Number of Years With Underwriting Profits by Decade 1920s –2000sProfits by Decade, 1920s 2000s

Number of Years with Underwriting ProfitsU d i i fi10

88

10Underwriting profits were common before the 1980s (40 of the 60 years

before 1980 had combined ratios below 100)—but then they vanished. N i l d i i fi

67

56

8 Not a single underwriting profit was recorded in the 25 years from 1979

through 2003.

45

34

0 00

2

01920s 1930s 1940s 1950s 1960s 1970s 1980s 1990s 2000s*

Note: Data for 1920 – 1934 based on stock companies only.Sources: Insurance Information Institute research from A.M. Best Data. *2000 through 2008.

87

Commercial LinesCommercial Lines

Commercial Lines Combined Ratio 1993 2009F

3

Commercial coverages have exhibited significant

Ratio, 1993-2009FMortgage and financial

guarantee may account for up

3

122.

3

5

120

125have exhibited significant

variability over time.gu ee y ccou o upto 4 points on the commercial

combined ratio in 2008

110.

3

110.

2

107.

6

3.9 10

9.7

112.

3

111.

1

110.

2

5 05.4

106.

5

05.1

0

112.

5

110

11510

3

102.

5 10

5.1

1 10

102.

0

100

105

2006/07 benefited from favorable loss cost trends improved tort environment low CAT

91.1 95

90

95trends, improved tort environment, low CAT

losses, WC reforms and reserve releases. Most of these trends reversed in 2008 and

mortgage and financial guarantee segments have big influence 2009 is transition year

85

93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08E 09F

have big influence. 2009 is transition year.

Sources: A.M. Best (historical and forecasts)

Average Commercial Rate Change,All Lines (1Q:2004 4Q:2008)All Lines, (1Q:2004 – 4Q:2008)

0%% Magnitude of price

.2%

%

2.7%

3.0%-4%

-2%

-0.1

% Magnitude of price declines is now

shrinking. Reflects shrinking capital,

reduced investment i d t i ti-3

-5.9

%

7.0%

%

-4.6

% - -3

-5.3

%

-6.0

%

-8%

-6%gains, deteriorating

underwriting performance and

costlier reinsurance

-7

-9.4

%

-9.7

% -8.2

%

-9.6

%

.3%

8% % 1.0%-12%

-10%

-11.

-11.

8

-13.

3% -12.

0 %

-13.

5%

-12.

9% -11

-16%

-14%

4 4 4 4 5 5 5 5 6 6 6 6 7 7 7 7 8 8 8 8

KRW Effect

1Q04

2Q04

3Q04

4Q04

1Q05

2Q05

3Q05

4Q05

1Q06

2Q06

3Q06

4Q06

1Q07

2Q07

3Q07

4Q07

1Q08

2Q08

3Q08

4Q08

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

Catastrophe LossesCatastrophe Losses

The Energy Sector isThe Energy Sector is Vulnerable to a Increasing g

Natural Catastrophe Activity

Natural Catastrophes in 2008 by Type and Locationby Type and Location

750 natural hazard losses events

Energy sector was impacted significantly by catastrophes in 2008: Ike, European

Wind/Winter Storms, China EarthquakeGeophysical (earthquake, tsunami, volcanic)

Meteorological (storm)

Hydrological (flood, mass movement)

Significant loss events

Great natural catastrophesHurricane Ike ( Sept. 6-14, 2008) Caribbean, USACyclone Nargis (May 2-5, 2008) Myanmar

Climatological (extreme temperature, drought, wildfire)

Earthquake (May 12, 2008) China

Winter damage (Jan 10–Feb 13, 2008) China

Source: 2009 Münchener Rückversicherungs-Gesellschaft, Geo Risk Research, NatCatSERVICE As of January 2009

Some of the Costliest Natural Catastrophes in 2008 Impacted the Energy Business and

Its Insurers SignificantlyDeadliest catastrophesD t E t A D th

Its Insurers Significantly

Date Event Area DeathsMay Cyclone Nargis Myanmar 84,500May Earthquake China 70,000January Cold wave Afghanistan, Kyrgyzstan,

Tajikistan1,000

TajikistanAugust/September Floods India, Nepal, Bangladesh 635

Costliest catastrophes (overall losses) US$mMay Earthquake China 85 000May Earthquake China 85,000September Hurricane Ike Caribbean, USA 30,000January/February Winter damage China 21,100August/September Hurricane Gustav Caribbean, USA 10,000

Costliest catastrophes (insured losses) US$mSeptember Hurricane Ike Caribbean, USA 15,000August/September Hurricane Gustav Caribbean, USA 5,000J /F b Wi t d Chi 1 600January/February Winter damage China 1,600March Winter storm Emma Europe 1,500


Number of Natural CatastrophesW ld id 1980 2008

1 200

Worldwide, 1980 - 2008Number of events

Th b f t l

800

1 000

The number of natural catastrophes is rising globally. This has significant ramifications for the

energy sector and its insurers

600

800

Num

ber

energy sector and its insurers

200

400

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Climatological eventsHydrological eventsM t l i l t Climatological events (Extreme temperature, drought, forest fires)

Hydrological events (Flood, mass movement)

Meteorological events(Storm)

Geophysical events (Earthquake, tsunami, volcanic eruption)


Overall and Insured Losses from Natural Catastrophes Worldwide 1980 2008

250

Catastrophes Worldwide, 1980 - 2008The overall and insured

t f t l200

costs from natural catastrophes has been on

the rise in recent year. This has significant

100

150

US

$bn

gimplications for the energy

sector and its insurers

50

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Overall losses (2008 values) Insured losses (2008 values)


U.S. Insured Catastrophe Losses*

0.0

$120$ Billions

2008 CAT losses exceeded$100 Billion CAT year is

$100

.9

$100

$120 2008 CAT losses exceeded 2006/07 combined. 2005 was by

far the worst year ever for insured catastrophe losses in the

CAT year is coming soon

5 5$6

1.

$60

$80 insured catastrophe losses in the US, but the worst has yet to come.

$7.5

2.7 4.7

$22.

95.

5 $16.

9$8

.3$7

.42.

6 $10.

1$8

.34.

6$2

6.5

5.9 $12.

9 $27.

5

$6.7

$25.

2

$9.2$20

$40

$ $2 $4 $5 $ $ $2$ $ $4 $ $$

$0

89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 0708

**20

??

*Excludes $4B $6b offshore energy losses from Hurricanes Katrina & Rita 0 2Excludes $4B-$6b offshore energy losses from Hurricanes Katrina & Rita.**Based on PCS data through Dec. 31. PCS $2.1B loss of for Gustav. $10.655B for Ike of 12/05/08.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. Non-prop/BI losses = $12.2B.Source: Property Claims Service/ISO; Insurance Information Institute

96

Rising Number of U.S. Landfalling Tropical Cyclones Has Been Very Costly

for Energy Insurersfor Energy Insurers

Six tropical cyclones d l df ll i thmade landfall in the

US in 2008

Source: Munich Re from NOAA

Key Issues & yThreats Facing P/C g

Insurers Amid Financial Crisis

Manageable Challenges

Important Issues & Threats Facing P/C Insurers in 2009Facing P/C Insurers in 2009

1. Reloading Capital After “Capital Event”Continued asset price erosion coupled with major “capital event” couldContinued asset price erosion coupled with major capital event could lead to shortage of capital among some companiesP/C insurers have come to assume that large amounts of capital can be raised quickly and cheaply after major events (post-9/11, Katrina). This assumption may be incorrect in the current environmentThis assumption may be incorrect in the current environment.Cost of capital is much higher today, reflecting both scarcity & riskImplications: P/C insurers need to protect capital today and develop detailed contingency plans to raise fresh capital & generate internally

2. Long-Term Loss of Investment ReturnLow interest rates, risk aversion toward equities and many categories of fixed income securities lock in a multi-year trajectory toward ever lower investment gainslower investment gainsMany insurers have not adjusted to this new investment paradigmRegulators will not readily accept it; Many will reject itImplication 1: Industry must be prepared to operate in environment

ith i t t i ti f ll f ti f fit

Source: Insurance Information Inst.

with investment earnings accounting for a smaller fraction of profitsImplication 2: Implies underwriting discipline of a magnitude not witnessed in this industry in more than 30 yearsLessons from the period 1920-1975

Important Issues & Threats Facing P/C Insurers in 2009 (cont’d)

3. Regulatory Overreach P/C insurers get swept into vast federal regulatory

Facing P/C Insurers in 2009 (cont d)

P/C insurers get swept into vast federal regulatory overhaul and subjected to inappropriate , duplicative and costly regulation

4. Tort ThreatNo tort reform (or protection of recent reforms) is forthcoming from the current Congress or Administrationforthcoming from the current Congress or AdministrationErosion of recent reforms is a certainty (already happening)Innumerable legislative initiatives will create opportunitiesInnumerable legislative initiatives will create opportunities to undermine existing reforms and develop new theories and channels of liabilityHistorically extremely costly to p/c insurance industry


Historically extremely costly to p/c insurance industry

AFTERSHOCK: R l RRegulatory Response

C ld B H hCould Be HarshAll Financial SegmentsAll Financial Segments

Including InsurersWill Be Impacted

Post-Crunch: Fundamental Issues To Be Examined GloballyIssues To Be Examined Globally

• Failure of Risk Management, Control & Supervision at Financial Institutions Worldwide: Global ImpactFinancial Institutions Worldwide: Global Impact

Colossal failure of risk management (and regulation)Counterparty risk and collateral management were systemic failure pointsImplications for Enterprise Risk Management (ERM)?Misalignment of management financial incentives

• Focus Will Be on Risk Controls: Implies More Stringent Capital & Liquidity Requirements; Prevention of Systemic Risks

Data reporting requirements also likely to be expandedData reporting requirements also likely to be expandedNon-Depository Financial Institutions in for major regulationChanges likely under US and European regulatory regimesWill new regulations be globally consistent? g g yCan overreactions be avoided?

• Accounting Rule Changes??Problems arose under FAS, IASA t V l ti i l di M k t M k t

Source: Ins. Info. Inst.

Asset Valuation, including Mark-to-MarketStructured Finance & Complex Derivatives

• Ratings on Financial InstrumentsNew approaches to reflect type of asset, nature of risk

Emerging Blueprint for Financial Services Regulatory OverhaulServices Regulatory Overhaul

Phase I: Systemic Risk Regulation/RegulatorIdentification of systemic risk points in the financial systemIdentification of systemic risk points in the financial systemDesign of appropriate regulation to prevent future collapsesWill require international consultation (US can’t manage systemic risk alone)

O i i i i i i• Oversight Responsibility: Likely With Federal ReserveFed would have capacity and power to assess risk across financial markets regardless of corporate form and to intervene when appropriate *appropriateFed could oversee (according to House FS Committee Chairman Barney Frank:

Hedge funds (need to ensure “complete transparency”)Credit ratings agenciesCredit ratings agenciesExecutive compensation (to curb “perverse risk incentives”)

TIMELINE: Frank wants “general outline” by April 2 meeting of G20 industrialized and developing nations

*http://financialservices.house.gov/press110/press0320082.shtml

Source: Wall Street Journal, “Frank Backs Regulator for Systemic Risk,” 2/4/09, p. C3; I.I.I. research.

Emerging Blueprint for Financial Services Regulatory Overhaul (cont’d)Services Regulatory Overhaul (cont d)

Phase I: Systemic Risk Regulation/Regulator: OTHER (cont’d)

• Unification of federal bank regulatory agencies• Creation of a Financial Products Safety Commission to vet products before

sold to investorsC ti f f d l i f i b d id i i• Creation of federal insurance program for muni bonds paid via premiums

• Support for status quo on mark-to-market

Phase II: Sectoral Reform/OverhaulPhase II: Sectoral Reform/Overhaul• Each segment of the financial services industry will be examined and

subject to regulation specific to its function, risks and other factors• TIMELINE: August 2009 or later

Source: Wall Street Journal, “Frank Backs Regulator for Systemic Risk,” 2/4/09, p. C3; I.I.I. research.

Post-Crunch: Fundamental Regulatory Issues & InsuranceRegulatory Issues & Insurance

• Federal Encroachment on Regulation of Insurance in Certain Amid a Regulatory TsunamiCertain Amid a Regulatory Tsunami

$150 billion in aid to AIG makes increased federal involvement in insurance regulation a certaintyStates will lose some of their regulatory authorityWhat Feds get/what states lose is unclear

• Removing the “O” from “OFC”?Treasury in March proposed moving solvency and consumer protection authority to a federal “Office of National Insurance”authority to a federal “Office of National Insurance”Moving toward more universal approach for regulation of financial services, perhaps under Fed/Treasury?Is European (e.g., FSA) approach in store?Treasury proposed assuming solvency and consumer protection roles while also eliminating rate regulationExpect battle over federal regulatory role to continue to be a divisive issue within the industry


yStates will fight to maximize influence, arguing that segments of the financial services industry under their control had the least problems

Possible Regulatory Scenarios for P/C Insurers as of Year End 2009P/C Insurers as of Year-End 2009

• Status Quo: P/C Insurers Remain Entirely Under Regulatory Supervision of the StatesRegulatory Supervision of the States

Unlikely, but some segments of the industry might welcome this outcome above all others

• Federal Regulation: Everything is Regulated by Fedsg y g g yUnlikely that states will be left totally in the cold

• Optional Federal Charter (OFC): Insurers Could Choose Between Federal and State Regulationg

Unlikely to be implemented as envisioned for past several years by OFC supporters

• Dual Regulation: Federal Regulation Layer Above StateF d l l ti t t t i t /f l tiFeds assume solvency regulation, states retain rate/form regulation

• Hybrid Regulation: Feds Assume Regulation of Large Insurers at the Holding Company LevelS t i Ri k R l t F d F R l ti f


• Systemic Risk Regulator: Feds Focus on Regulation of Systemic Risk Points in Financial Services Sector

What are these points for insurers? P/C vs. Life?

Major Regulatory Considerations for Insurance Regulation in 2009for Insurance Regulation in 2009

• Power Sharing: Will Feds and States Divide Regulatory Authority & How?Holding company (federal) and operating company/insurer (state)?

• Pre-Emption: Will Congress Pass Legislation Pre-Empting State Authority?

• Regulatory Consolidation: Will Regulatory Authority (now spread over 4+• Regulatory Consolidation: Will Regulatory Authority (now spread over 4+ agencies) be Consolidated Into One Entity? Will it Involve States?

• Life vs. P/C: Will Separate Regulatory Structures Emerge?

• Guaranty Fund System: FDIC has suggested federalization of system

• State Run Insurers: Who Would Regulate State-Run Insurers (Property, WC)?i iMany coastal states have large state-run entities

About 25 states operate workers comp state funds or monopolistic insurers

• Regulation of Credit Default Swaps as Insurance: Will Feds take this up?g p p

• Insurer Divisiveness: Industry is Not United on Many Key Issues

Source: Insurance Information Institute research.

Insurance Information Institute On LineInstitute On-Line

THANK YOU FOR YOUR TIME AND

YOUR ATTENTION!

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the global financial crisis and its impacts on …the global financial crisis and its impacts on...

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