Will History Repeat Itself?Will History Repeat Itself?

Stephen Farr- Stephen Farr- ModeratorModeratorGallagher Healthcare Insurance Services, IncGallagher Healthcare Insurance Services, Inc

Robert FrancisRobert FrancisThe Doctors CompanyThe Doctors Company

Jonathan D. GaleJonathan D. GaleCatlin Insurance Co. LTDCatlin Insurance Co. LTD

John MizeJohn MizeTowers PerrinTowers Perrin

Paul RomanoPaul RomanoDarwin Professional Underwriters, Inc.Darwin Professional Underwriters, Inc.

OR …..

Said another way:

Will the marketplace again bring on ....

“IRRATIONAL EXHUBERANCE”

According to A.M. Best (6/30/06):

U.S. P&C Market results are as follows: Combined Ratios at 92% Pre-tax Net Income of $43.2 B Surplus has grown to $450 B

Primary Markets’ ResultsPrimary Markets’ Results

$0

$50

$100

$150

$200

$250

$300

$350

$400

$450

$500

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

Source: A.M. Best, ISO, Insurance Information Institute * As of 6/30/06.

Capacity TODAY is $450B, 10.1% above year-end 2005, 54% above its 2002 trough

and 30% above its 1999 peak.

Foreign reinsurance and residual market mechanisms

absorbed 50%+ of 2005 CAT losses of $62.1B

U.S. Policyholder Surplus1975-2006 ($ Millions)*

According to A.M. Best (6/30/06):

U.S. P&C Market results are as follows: Combined Ratios at 92% Pre-tax Net Income of $43.2 B Surplus has grown to $450 B

Medmal Sector shows:• Combined Ratios well below 100%• Operating Ratios well below 80%

Q3 and Q4 may deliver ….

Record numbers since ....

THE WIND

DID NOT BLOW!

Primary Markets’ ResultsPrimary Markets’ Results

$14,178

$5,840

$19,316

$10,870

$20,598

$24,404

$36,819

$30,773

$21,865

-$6,970

$3,046

$30,029

$16,

692

$43,013

$20,559

$38,501

-$10,000

$0

$10,000

$20,000

$30,000

$40,000

$50,000

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

06:Q

1

* ROE figures are GAAP; 1 Return on avg. surplus. 2005 ROAS = 9.8% after adj. for one-time special

dividend paid by the investment subsidiary of one company.

2001 ROE = -1.2%

2002 ROE = 2.2%

2003 ROE = 8.9%

2004 ROE = 9.4%

2005 ROAS1 = 10.5%

2006 ROAS2 = 15.4%

2005 Net Income only now exceeding levels of mid-1990s

P/C Net Income After Taxes1991-2006: Q1 ($ Millions)*

2 Based on Q1 results; For 12 months ending 3/31/06, ROAS=10.1%.Sources: A.M. Best, ISO, Insurance Information Inst.

Agenda

• Format of Discussion

• Introduction of Panelists

• Presentation by Panelists

• 5 minute for Q&A by moderator following each presenter

• 10 minutes for Q&A by audience at end

Agenda / Topics

Do Actuarial Methods Increase the Amplitude of Market Swings?

Presented by:

John Mize, FCAS, MAAA

Tillinghast

Agenda / Topics

Diversity vs Disaster?

 Presented by:

Jonathan Gale, Director of Underwriting

Catlin Bermuda

Agenda / Topics

Rate over Retention

(or Quality over Quantity)

Presented by:

Paul Romano

Darwin

Agenda / Topics

How do we rate?

Rating Actions on Medical Malpractice Companies

and Prospects for the Future 

Presented by:Robert Francis, Chief Operating OfficerThe Doctors Company

Do Actuarial Methods Increase the Amplitude of Market Swings?

Presented by:

John Mize, FCAS, MAAA

Tillinghast

Agenda

• The problem

• An example

• Methods of addressing the problem

• The risks

The Problem

• Actuarial methods use historical development by coverage year to project development of more recent years.

• Severity shifts often affect all open claims, so that mature years’ development factors are affected.

• If severity trends flatten, development factors based on higher trend periods can overstate or understate ultimate losses.

• Occurs in both directions – during surges in severity or during period of unusually low severity trends.

Example

• Professional liability coverage for a large multi-state healthcare system

• Occurrence basis, but claims are reported very quickly

Loss Development Pattern1996 Year

Professional Liability at April 2001

Professional Liability at April 2001

Professional Liabilityat April 2002

Professional Liabilityat April 2003

Professional Liabilityat April 2004

Professional Liabilityat April 2004

Professional Liabilityat April 2005

Professional Liabilityat April 2006

Professional Liabilityat April 2006

Impact – 2001 Year

Impact – 2002 Year

Impact – 2004 Year

How Can WeAddress this Problem?

• Use inflation adjusted actuarial methods – most often used in countries with highly variable inflation rates.

• Judgmentally select loss development factors – assume future development will be like that observed prior to severity shift.

Risks and Issues

• If severity continues to increase, reserves are inadequate.

• Auditors may take a mechanical approach.

• Actuaries tend to be conservative – risk of being low seems higher than risk of being too high.

Panelist Q&APanelist Q&A

Rate over Retention

(or Quality over Quantity)

Presented by:

Paul Romano

Darwin

Agenda

• Lots to consider when making choices

• Logic chain generally leads to retention as the first priority on most classes of business

• Increasingly insuring the frequency of risk lowers margins

Variables

• Community or manual rated versus experience rated class

• Deductible or retention

• Duty to defend or indemnity

• Severity or frequency oriented class

• Type of medical risk

• Geographic influence

• Panel counsel or client discretion

Market Conditions

• Prevailing ‘skin in the game’ – substantial progress from ’01 – ‘03

• Cost of defending frivolous/low impact claims

• The practical side of the psychological factor – an anecdote

Managing the Strategy

• Segregating the business – where it matters and where it may not

• There’s a cost to ‘securitizing’ substantial SIRs

• Establishing guidelines and benchmarking results

• Under-pricing business even with healthy retentions remains hazardous

Panelist Q&APanelist Q&A

Agenda / Topics

Diversity vs Disaster?

 Presented by:

Jonathan Gale, Director of Underwriting

Catlin Bermuda

Agenda

• Diversification benefits from a Reinsurer Standpoint (with a few negatives)

• Monoline benefits from a Specialty Carriers Standpoint (with one positive idea for diversification)

• Do Natural Disasters affect Professional Liability Pricing?

Diversification from a Reinsurer Standpoint?

• Principal Benefits:

Lower Capital Requirements

Pricing Stability

Business is viewed more favourably by Regulators, Rating Agencies and Investors

The Point of Reinsurer Diversification

Diversification OverviewOne Risk

Mean RequiredCapital

=500% of Mean

Diversification OverviewMany Independent Risks

Portfolio RequiredCapital

=250% of Mean

Lower CapitalRequirements –

What Does it Mean?

Example 1 Property Catastrophe Treaty

Individual Risk Monoline Diversified

Limit

10,000,000 10,000,000 10,000,000

Expected Loss

500,000 500,000 500,000

Diversification Credit 0.00% 50.00% 75.00%

Capital Required 9,000,000 4,500,000 2,250,000

Premium Charged 1,000,000 1,000,000 1,000,000

ROC 5.55% 11.11% 22.22%

Required Premiumfor 15% ROC

On Same Risks

Individual Risk Monoline Multi Line

Limit 10,000,000 10,000,000 10,000,00

0

Expected Loss 500,000 500,000 500,000

Premium Charged * 1,850,000 1,175,000 837,500

ROC 15.00% 15.00% 15.00%

* Premium charged is 15% * Capital at Risk + expected Loss

Example 2 Property Catastrophe Treaty

Pricing Stability and Regulatory, Etc.

• Line should be priced more technically over the cycle (i.e., more than one line of business to allocate capacity to so no incentive to follow market down in one individual line)

• Pricing should be lower (see previous slide) to clients over the long term

• For all of the above reasons Regulators, Rating agencies and Investors consider Diversified Companies to be more secure and reward them (generally) accordingly

Negatives

• Theory is fine – execution is difficult • Poor Catastrophe experience in 2005 has led most

companies to seek to diversify further • All rates worldwide (except for peak Catastrophe Zones)

are under pressure including US medical malpractice and US professional lines

• Management temptation to diversify for the sake of diversification and growth – pricing beneath expected loss only a matter of time and history repeats itself!

• Our ideas of what is correlated and uncorrelated could be wrong particularly in extreme events– witness 9/11 and Katrina – diversification credit wholly dependent on knowing and forecasting likely accumulations in extreme events

Monoline Benefitsfrom a Specialty Insurer Standpoint

(With One Positive for Diversification)

• Success of PIAA/ NABRICO Model speaks for itself Local underwriting Local Claims Handling Local knowledge of good doctors; good hospitals; good lawyers

etc. Attention to detail

• Diversification in geographical terms (except for a couple of notable exceptions) was unsuccessful

• Diversification in terms of product line didn’t happen (again with a couple of notable exception)

• Reinsurance achieves all the diversification you need!

Do Natural Disasters Affect Professional Liability Pricing?

YES

Panelist Q&APanelist Q&A

Panelist Q&APanelist Q&A

How do we rate?

Rating Actions on Medical Malpractice Companies

and Prospects for the Future 

Presented by:Robert Francis, Chief Operating OfficerThe Doctors Company

• Effects of rating changes on the medical malpractice segment

• Review of ratings pattern since 1984

• Track the key rating variable

• Postulate near term outlook

American Phys Assurance

COPIC

The Doctors Company

FPIC

Health Care Indemnity

ISMIE

LAMMICO

MAG Mutual

Medical Assurance

MIEC (California)

MLMIC

Medical Mutual of NC

Medical Mutual of MD

Medical Protective

MHA Insurance Company

MICA (AZ)

PIC Wisconsin

Physician Insurance (WA)

Preferred Professionals Insurance

ProNational

SCPIE

State Volunteer Mutual

Utah Medical

Companies Analyzed

Average Ratingsof Rated Peer Group

1984 1987 1990 1993 1996 1999 2002 2005

Source: Best's Aggregates & Averages

A++

B

B+

B++

A-

A

A+

Medical Malpractice Industry Cycle

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

1976 1981 1986 1991 1996 2001

Combined Ratio Operating Ratio

Source: Best's Aggregates & Averages

2005

Initial Ratings Phase

0%

20%

40%

60%

80%

100%

120%

140%

160%

1983 1988 1993 1998 2003

Operating Ratio

10 8

Stability and Upgrades

0%

20%

40%

60%

80%

100%

120%

140%

160%

1983 1988 1993 1998 2003

Operating

11 25

Downgrades

0%

20%

40%

60%

80%

100%

120%

140%

160%

1983 1988 1993 1998 2003

Operating

25 16

Companies Upgraded in 2006 (for 2005)

• The Doctors Company

• American Physicians Assurance

• Medical Protective

Companies Upgraded in 2006 (for 2005)

Operating Ratio Leverage Ratio

The Doctors Company 72% 3.3

American Phys 73% 3.6

Med Pro 121% 2.9

Peer Average 89% 4.3

The Doctors CompanyRatings Changes

0%

20%

40%

60%

80%

100%

120%

140%

160%

1984 1989 1994 1999 2004

Industry Operating RatioTDC Operating Ratio

Source: Best's Aggregates & Averages

A

A+ A

A-B++

A-

Key Elementsin Rating Decisions

• Operating ratio clearly leads the group of key metrics

• Combined ratio and leverage ratio are also important

• Current rating

• Performance relative to the industry

• Pattern of performance

Final Thoughts

• Medical malpractice carriers are less sensitive to rating changes though sensitivity increases with market softness and account size

• Few upgrades likely in 2007

• Some possible in 2008

Questions?Questions?