09iiireport

8/10/2019 09iiireport

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Financial Crisis and the

Future of the P/CInsurance Industry

Challenges Amid theGlobal Economic Storm

Robert P. Hartwig, Ph.D., CPCU, President

Insurance Information Institute 110 William Street New York, NY 10038Tel: (212) 346-5520 [email protected] www.iii.org

Northwest Insurance Council

2009 Annual Luncheon

Seattle, WAJanuary 27, 2009


2/70

THE ECONOMIC

STORMWhat a Weakening Economy andF inancial Crisis Mean for the

I nsurance I ndustry

Exposure & ClaimCost Effects


3/70

3.7

%

0.8% 1.6% 2

.5% 3

.6%

3.1

%

2.9

%

0.1

%

4.8

%

4.8

%

0.9%

2.8

%

-0.5

%

-3.3

%

-0.8

%

1.2% 2

.2%

2.6

%3.0

%3.3

%

3.2

%

-5.2%

-0.2%

-6%

-4%

-2%

0%

2%

4%

6%

2000

2001

2002

2003

2004

2005

2006

07:1Q

07:2Q

07:3Q

07:4Q

08:1Q

08:2Q

08:3Q

08:4Q

09:1Q

09:2Q

09:3Q

09:4Q

10:1Q

10:2Q

10:3Q

10:4Q

Real GDP Growth*

*Yellow bars are Estimates/Forecasts from Blue Chip Economic Indicators.Source: US Department of Commerce, Blue Economic Indicators 1/09; Insurance Information Institute.

Recession began in

December 2007. Economictoll of credit crunch, housingslump, labor market

contraction is growing


4/70

Real GDP By Market 2007-2010F

(% change from previous year)

2.6

%

2.0

%

2.0

% 3.0

%

11

.9%

1.0

%

1.4

%

0.4% 1.

3%

0.8%

9.5

%

-1.2

%

-1.3

%

-1.4

%

-1.6

%

-1.8

%

7.1

%

1.2%

1.2%

1.2% 2

.4%

1.1

%

7.9%

2.6

%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

Euro Area Germany Japan US UK China

2007 2008E 2009F 2010F

Source: Blue Chip Economic Indicators, 1/10/09 edition.

All major economies exceptChina are in recession.

Steep declines in GDP willnegatively impact exposure

growth on a global scale


5/70

$5

.8

$2

.0 $69.0

$33.0

$14.0

$8

.0

$7

.6

$6

.9

$2

.8

$1

.8

$586

.0

$1

05

.0

$11.3

$7

.4

$4

.0$36.8

$825

$29.7

$0

$100

$200

$300

$400

$500

$600

$700

$800

$900

U.S.

Mex

icoCh

ile

Germ

any

Fran

ceU.

K.Sp

ainItaly

Neth

erlan

ds

Hung

ary

Portu

gal

Swed

enCh

inaJa

pan

SouthK

orea

Austr

aliaIn

diaDu

bai

Announced Economic Stimulus

Packages Worldwide ($ Billions)*

Sources: Wall Street Journal, January 8, 2009; Institute of International Finance.

U.S. stimulus comprises: $550 billionspending and $275 billion tax relief

As of Dec. 18 except U.S. and Germany

Governments around the world areseeking to soften the economic blow

through spending. Deficits as a share ofGDP will mushroom leading to a

potential inflationary threat and higherinterest rates the future.

P/C insurers will provide insurancenecessary for stimulus projects and willbenefit from enhanced economic growth


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Length of US Recessions,1929-Present*

43

13

8 11 10 8 10 11

16

6

16

8 8

13

0

5

10

15

20

25

30

35

40

45

50

Aug.

1929

May

1937

Feb.

1945

Nov.

1948

July

1953

Aug.

1957

Apr.

1960

Dec.

1969

Nov.

1973

Jan.

1980

Jul.

1981

Jul.

1990

Mar.

2001

Dec.

2007

* As of January 2 9

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

Current recession began inDec. 2007 and is already the

longest since 1981. If itextends beyond April, it willbecome the longest recessionsince the Great Depression.

Months in Duration


7/70


8/70

U.S. Unemployment Rate,(2007:Q1 to 2010:Q4F)*

4.5

%

4.5

%4

.6% 4

.8%

4.9%

5.4

%

6.1

%

6.9%

7.4

% 7

.9% 8

.3%

8.4

%

8.4

%

8.3

%

8.2

%

8.0

%

4.0%

4.5%

5.0%

5.5%

6.0%

6.5%

7.0%7.5%

8.0%

8.5%

9.0%

07:Q1 07:Q2 07:Q3 07:Q4 08:Q1 08:Q2 08:Q3 08:Q4 09:Q1 09:Q2 09:Q3 09:Q4 10:Q1 10:Q2 10:Q3 10:Q4

* Blue bars are actual; Yellow bars are forecasts

Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (1/09); Insurance Info. Inst.

Rising unemploymentwill erode payrolls

and workers compsexposure base.

Unemployment isexpected to peakabove 8% in the

second half of 2009.

hl h l *


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Monthly Change Employment*

(Thousands)

-76 -83 -88 -67 -47

-100-67

-127

-403 -423

-584

-524

-700

-600

-500

-400

-300

-200

-100

0

Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08

Job losses in 2008 totaled 2.589million, the highest since 1945 atWW IIs end; 11.1 million peopleare now defined as unemployed.

Source: US Bureau of Labor Statistics: http://www.bls.gov/ces/home.htm; Insurance Info. Institute

The Nov./Dec. 2008 losses were the largestsince May 1980 loss of 431,000, but less

than the Dec. 1974 loss of 602,000
http://www.bls.gov/ces/home.htmhttp://www.bls.gov/ces/home.htm


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

2.0

7

1.8

0

1.3

6

0.9

3

0.7

2

0.9

5

1.4

8

1.3

51.4

6

1.2

9

1.2

0

1.01

1.1

9

1.4

7 1

.62 1.64

1.5

71

.60 1.

71

1.8

5 1.9

6

0.7

0.8

0.9

1.0

1.11.2

1.3

1.4

1.5

1.6

1.71.8

1.9

2.0

2.1

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

Exposure growth forecast for HOinsurers is dim for 2009 with some

improvement in 2010.

Impacts also for comml. insurerswith construction risk exposure

New homestarts plunged

34% from2005-2007;

Drop through2009 trough is65% (est.)a

net annual

decline of1.35 million

units

I.I.I. estimates that each incremental100,000 decline in housing starts costs

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

exposure loss in 2009 vs. 2005 isestimated at about $1.2 billion.

Source: US Department of Commerce; Blue Chip Economic Indicators (1/09); Insurance Information Inst.


11/70

16.916.916.617.1

17.517.8

17.4

16.516.1

13.2

11.2

13.1

11

12

13

14

15

16

17

18

19

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

Weakening economy, creditcrunch are hurting auto sales;Gas prices less of a factor now.

New auto/light trick sales areexpected to experience a net

drop of 5.7 million unitsannually by 2009 compared

with 2005, a decline of 20.7%

Impacts of falling auto sales willhave a less pronounced effect onauto insurance exposure growth

than problems in the housingmarket will on home insurers

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

Source: US Department of Commerce; Blue Chip Economic Indicators (1/09); Insurance Information Inst.

W & S l Di b


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$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

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

$0

$5

$10

$15

$20

$25

$30

$35

$40

$45Wage & SalaryDisbursementsWC NPW

*9-month data for 2008Source: US Bureau of Economic Analysis; Federal Reserve Bank of St. Louis at

http://research.stlouisfed.org/fred2/series/WASCUR;I.I.I. Fact Books

Wage & Salary Disbursements(Payroll Base) vs. Workers Comp

Net Written Premiums

7/90-3/91

Shaded areas indicate recessions

3/01-11/01

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

12/07-?

Weakening wageand salarygrowth is

expected to causea deceleration inworkers comp

exposure growth
http://research.stlouisfed.org/fred2/series/WASCURhttp://research.stlouisfed.org/fred2/series/WASCUR


13/70

Total Industrial Production,(2007:Q1 to 2010:Q4F)

1.5%

3.2%3.6%

0.3% 0.4%

-3.4%

-8.9%-8.6%

-6.1%

-2.6%

2.9%3.3%

3.8% 3.7%

0.5%

2.0%

-10.0%

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

07:Q

1

07:Q

2

07:Q

3

07:Q

4

08:Q

1

08:Q

2

08:Q

3

08:Q

4

09:Q

1

09:Q

2

09:Q

3

09:Q

4

10:Q

1

10:Q

2

10:Q

3

10:Q

4

Sources: US Bureau of Labor Statistics; Blue Chip Economic Indicators (1/09); Insurance Info. Inst.

Industrialproduction began

to contract sharplyduring H2 2008 and

is expected toshrink through the

first half of 2009

Obama stimulus program is expected benefitimpact industrial production and therefore

insurance exposure both directly and indirectly

Figures for H2:09and 2010 revised

sharply upwards toreflect expected

impact of Obamastimulus program

U S $825B E i S i l


14/70

$214.5

$124.0

$77.7$68.4

$49.4$26.8 $19.2

$0

$100

$200

$300

Public sectorjobs and v ital

services

Help workershurt by theeconomy

Transportation,Infrastructure

Education Energy Lower healthcare

costs

Science,technology

U.S. $825B Economic Stimulus

Package, By Category

Sources: House Appropriations Committee; Wall Street Journal, January 16, 2009

$ BillionsCommercial insurance lines

that will benefit from theObama stimulus plan

include workers comp,commercial property,

commercial auto, surety,inland marine and others

l G G h l /C


15/70

5.2%

-0.9%

-7.4%

-6.5%

-1.5%

1.8%4

.3%

18.6%20.3%

5.8%

0.3%

-1.6%

-1.0%

-1.8%

-1.0%

3.1%

1.1%

0.8%

0.4%

0.6%

-0.4%

-0.3%

1.6%

5.6%

13.7%

7.7%

1.2%

-2.9%-0

.5%

-3.4%

-4.9%

-10%

-5%

0%

5%

10%

15%

20%

25%

787980818283848586878889909192939495969798990001020304050607

08F

RealNWPGrowth

-4%

-2%

0%

2%

4%

6%

8%

RealGDPGrowth

Real NWP Growth Real GDP

Real GDP Growth vs. Real P/C

Premium Growth: Modest Association

P/C insurance industrys growthis influenced modestly by growth

in the overall economy

Sources: A.M. Best, US Bureau of Economic Analysis, Blue Chip Economic Indicators, 8/08; Insurance Information Inst.


16/70

FINANCIAL

STRENGTH &RATINGS

Industry Has Weathered

the Storms Well


17/70

P/C Insurer Impairment Frequency

vs. Combined Ratio, 1969-2007

90

95

100

105

110

115

120

697071727374757677787980818283848586878889909192939495969798990001020304050607

CombinedRati

0

0.2

0.40.6

0.8

1

1.2

1.4

1.6

1.8

2

ImpairmentRat

Combined Ratio after DivP/C Impairment Frequency

Impairment ratesare highlycorrelated

underwritingperformance andcould reached a

record low in 2007

Source: A.M. Best; Insurance Information Institute

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

record was 0.24% in 1972

S f A M B P/C I


18/70

Summary of A.M. Bests P/C Insurer

Ratings Actions in 2008*

Under Review, 63 ,

4.3%

Upgraded, 59 , 4.0%

Initial, 41 , 2.8%

Other, 59 , 4.0%

Affirm, 1,183 , 81.0%

Downgraded, 55 ,

3.8%

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

21

Despite financial marketturmoil, high cat losses

and a soft market in2008, 81% of ratingsactions by A.M. Best

were affirmations; just3.8% were downgrades

and 4.0% upgrades

P/C insurance is bydesign a resilient inbusiness. The dualthreat of financial

disasters andcatastrophic losses are

anticipated in theindustrys riskmanagement strategy.

R f US P/C I


19/70

Reasons for US P/C Insurer

Impairments, 1969-2005

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

Catastrophe

Losses

8.6%

Alleged

Fraud

11.4%

Deficient

Loss

Reserves/In-

adequate

Pricing62.8%

Affiliate

Problems

8.6%

Rapid

Growth

8.6%

2003-2005 1969-2005

Deficientreserves,CAT lossesare more

importantfactors in

recent years

Reinsurance

Failure

3.5%

Rapid

Growth

16.5%

Misc.

9.2%

Affiliate

Problems

5.6%

Sig. Change

in Business

4.6%

Deficient

Loss

Reserves/In-

adequate

Pricing38.2%

Investment

Problems*

7.3%

Alleged

Fraud

8.6%

Catastrophe

Losses

6.5%

CONSUMER POLL


20/70

CONSUMER POLL:2008 I.I.I. PULSE SURVEY

Source: Insurance Information Institute, 2008 Pulse Survey, November 2008.

Q. DO YOU THINK THAT THESE PROBLEMS (THE MORTGAGE PROBLEMS SOME AMERICANS FACE,

THE DROP IN THE STOCK MARKET AND JOB LAYOFFS) AFFECT THE ABILITY OF INSURANCE

COMPANIES TO PAY THEIR CLAIMS, TO SELL MORE INSURANCE, BOTH, NONE OF THESE (DOESNT

AFFECT ABILITY TO PAY CLAIMS OR SELL INSURANCE) OR DONT KNOW?

95% Americans thinkthat the downturn inthe economy affectsthe basic business of

the insuranceindustry: the abilityto pay claims and/or

sell insurance

To payclaims

7%

To sell

insurance10%

Doesn'taffect abilityto pay

claims orsell

insurance3%

Don't know2%

To payclaims AND

sellinsurance

78%

C iti l Diff


21/70

Critical Differences

Between P/CInsurers and Banks

Superior Risk Management Model& Low Leverage Make

a Big Difference

H I I d t St bilit


22/70

How Insurance Industry Stability

Has Benefitted Consumers

BOTTOM LINE: Insurance MarketsUnlike BankingAre Operating

Normally

The Basic Function of Insurancethe Orderly Transfer

of Risk from Client to InsurerContinues Uninterrupted This Means that Insurers Continue to:

Pay claims (whereas 25 banks have gone under) The Promise is Being Ful f i l led

Renew existing policies (banks are reducing and eliminatinglines of credit)

Write new policies (banks are turning away people who wantor need to borrow)

Develop new products (banks are scaling back the productsthey offer)

Source: Insurance Information Institute25

Reasons Why P/C Insurers Have Fewer


23/70

Emphasis on Underwri ting 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 secur i tize, sever ing the link between r iskunderwr it ing and r isk bearing, with (predictably) disastrous consequencesstraightforwardmoral hazard problem from Econ 101

Low Leverage Insurers do not rely on borrowed money to underwrite insurance or pay claimsThere is no

credit or l iquidity crisis in the insurance industry

Conservative Investment Phi losophy High quality portfolio that is relatively less volatile and more liquid

Comprehensive Regulation of I nsurance 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., hedgefunds, private equity, complex securitized instruments, credit derivativesCDSs)

Greater Transparency

Insurance companies are an open book to regulators and the public

Source: Insurance Information Institute26

Reasons Why P/C Insurers Have FewerProblems Than Banks:

A Superior Risk Management Model


24/70

The Financial Crisisin Perspective

Bank vs. Insurer Impacts


25/70

$600

$106

$780

$205

$0

$100

$200

$300

$400

$500

$600

$700

$800

Banks Insurers

Losses as of Sept 2008

Total expected losses

Financial Institutions Globally FacingHuge Losses from the Credit Crunch*

*Global losses since the beginning of 2007.

Source: IMF Global Financial Stability Report, October 2008, IIF, Bloomberg, cited in a presentation by ThomasHess (Chief Economist, Swiss Re) October 23, 2008, accessed via Geneva Association web site.

Billions

The IMF estimates total credit-turmoil-related losses will

eventually amount to $1.4 trillion$205B or 20.8% of estimated total

(bank+insurer) losses will besustained by insurers worldwide

28

US Bank Failures:*


26/70

US Bank Failures:*

1995-2009**

86

13

8 7

4

11

3 4

0 0

3

25

2

0

5

10

15

20

25

30

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09**

Through January 23, 2009

Remarkably, as recentlyas 2005 and 2006, no

banks failedthe firsttime this had happened in

FDIC history (datingback to 1934)

*Includes all commercial banking and savings institutions. **Through Jan. 23.Source: FDIC: http://www.fdic.gov/bank/historical/bank/index.html ; Insurance Info. Institute

Bank failures are up sharply. 27banks (but no p/c or life

insurers) failed in 2008/09 due tothe financial crisis, including thelargest in historyWashington

Mutual with $307B in assets.

30

T 10 P/C I l i B d
http://www.fdic.gov/bank/historical/bank/index.htmlhttp://www.fdic.gov/bank/historical/bank/index.htmlhttp://www.fdic.gov/bank/historical/bank/index.html


27/70

Top 10 P/C Insolvencies, BasedUpon Guaranty Fund Payments*

$2,265.8

$1,272.7

$1,049.7

$843.4$699.4

$566.5 $555.8 $543.1 $531.6 $516.8

$0

$500

$1,000

$1,500

$2,000

$2,500

Relia

nceI

nsura

nce

Legio

nIns

uranc

e

Calif

ornia

Comp

ensat

ionIn

s.

Frem

ontI

ndem

nityI

ns.

PHIC

OIns

.

Tran

sitCasu

altyI

ns.

Supe

riorN

ation

alIns

.

Ameri

canM

utual

Liab

ilityI

ns.

Midl

andI

nsuran

ce

South

ernFa

mily

Ins.

* Disclaimer: This is not a complete picture. If anything the numbers are understated as some states have not reported in cer tain years.

Source: National Conference of Insurance Guaranty Funds, as of September 17, 2008.

$ MillionsThe 2001 bankruptcyof Reliance Insurancewas the largest ever

among p/c insurers

32


28/70

Top 5 ThreatsFacing P/C Insurers

Amid FinancialCrisis

Top 5 Threats Facing


29/70


P/C Insurers in 2009

Source: Insurance Information Inst.

1. Ability to Reload Capital Continued asset price erosion coupled with major capital event could

lead to significant shortage of capital P/C have come to assume that large amounts of capital can be raised

quickly and cheaply after major events (post-9/11, Katrina). Thisassumption is probably incorrect in the current environment.

Cost of capital is much higher today Implications: 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 Return 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 Insurers have not adjusted to this new investment paradigm Regulators will not readily accept it; Many will reject it Implication 1: Industry must be prepared to operate in environment

with investment earnings accounting for only small fraction of profits Implication 2: Implies underwriting discipline of a magnitude not

witnessed in this industry in more than 30 years Lessons from the period 1920-1975



30/70


P/C Insurers in 2009


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

subjected to inappropriate , duplicative and costly regulation

4. Tort Threat No tort reform (or protection of recent reforms) is forthcoming from

the current Congress or Administration Erosion of recent reforms is a certainty (already happening) Innumerable legislative initiatives will create opportunities to

undermine existing reforms and develop new theories and channels ofliability

Historically extremely costly to p/c insurance industry

5. Disintermediation Alternative forms of risk transfer are taking an ever-larger share of

the (commercial) p/c insurance pie Soft market did not bring it back; Hard market could hasten trend

Trend toward state-sponsored insurance and reinsurance drainspremium out of private insurance markets

AFTERSHOCK


31/70

AFTERSHOCK:

Regulatory ResponseCould Be Harsh

All Financial SegmentsIncluding InsurersWill Be Impacted

P t C h F d t l


32/70

Post-Crunch: Fundamental

Issues To Be Examined Globally

Source: Ins.Info. Inst.

Failure of Risk Management, Control & Supervision atFinancial Institutions Worldwide: Global Impact Colossal failure of risk management (and regulation) Counterparty risk and collateral management were systemic failure points Implications 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 expanded Non-Depository Financial Institutions in for major regulation Changes likely under US and European regulatory regimes

Will new regulations be globally consistent? Can overreactions be avoided?

Accounting Rule Changes?? Problems arose under FAS, IAS Asset Valuation, including Mark-to-Market Structured Finance & Complex Derivatives

Ratings on Financial Instruments New a roaches to reflect t e of asset nature of risk

P ibl R l t S i f


33/70

Possible Regulatory Scenarios for

P/C Insurers as of Year-End 2009


Status Quo: P/C Insurers Remain Entirely UnderRegulatory Supervision of the States Unlikely, but some segments of the industry might welcome this

outcome above all others

Federal Regulation: Everything is Regulated by Feds Unlikely that states will be left totally in the cold

Optional Federal Charter (OFC):Insurers Could ChooseBetween Federal and State Regulation Unlikely to be implemented as envisioned for past several years by

OFC supporters

Dual Regulation:Federal Regulation Layer Above State Feds assume solvency regulation, states retain rate/form regulation

Hybrid Regulation:Feds Assume Regulation of LargeInsurers at the Holding Company Level

Systemic Risk Regulator: Feds Focus on Regulation ofSystemic Risk Points in Financial Services Sector What are these points for insurers? P/C vs. Life?

P/C INSURANCE


34/70

P/C INSURANCE

FINANCIALPERFORMANCE

A Resilient Industry in

Challenging Times


35/70

Profitability

Historically Volatile

P/C N t I Aft T


36/70

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

$14

,178

$5

,840

$19

,316

$10

,870

$20

,598

$24

,404 $

36

,819

$30,7

73

$21

,865

$3

,046

$30,0

29

$61

,940

$5

,421

-$6,970

$65

,777

$44

,155

$20

,559

$38

,501

-$10,000

$0

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

$70,000

91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08F

*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.

2001 ROE = -1.2%2002 ROE = 2.2%2003 ROE = 8.9%2004 ROE = 9.4%2005 ROE= 9.4%2006 ROE = 12.2%2007 ROAS1= 12.3%2008 ROAS = 1.1%*

Insurer profitspeaked in 2006.

45

P/C Insurance Industry ROEs


37/70

-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

06

08F

09F

10F

1975: 2.4%

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

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

Note: 2009 figure is actual 9-month result.

Sources: ISO;

Insurance Information Institute.

2008F: 1.1%

P/C Insurance Industry ROEs,19752010F*

2010F: 6.0%

2009F: 4.5%

46

ROE vs Equity Cost of Capital:


38/70

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

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

ROE Cost of Capital

ROE vs. Equity Cost of Capital:

US P/C Insurance:1991-2008:Q3

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

The p/c insurance industry fell wellshort of is cost of capital in 2008

-13.2pts

US P/C insurers missed their

cost of capital by an average 6.7

points from 1991 to 2002, but on

target or better 2003-07

-1.7pts

+2.3pts

-9.0pts

The cost of capital

is the rate of returninsurers need toattract and retain

capital to thebusiness

-9.7pts

47


39/70

Presidential Politics

& P/C Insurance

How is Prof itabil i ty Affected by thPresidents Political Party?

P/C Insurance Industry ROE by


40/70

15.10%

10.13%

8.93%

8.65%

8.35%

7.98%

7.68%

6.98%

6.97%

5.43%

5.03%4.83%

4.43%

3.55%

16.43%

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

Carter

Reagan II

G.W. Bush II

Nixon

Clinton I

G.H.W. Bush

Clinton II

Reagan I

Nixon/Ford

Truman

Eisenhower I

Eisenhower II

G.W. Bush I

Johnson

Kennedy/Johnson

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

OVERALL RECORD:1950-2008*

Democrats 8.05%

Republicans 8.02%

Party of President has

marginal bearing onprofitability of P/Cinsurance industry

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


41/70

Profitability in

Washington State

Mixed Performance

Relative to US Overall

R t f R t N t W th f


42/70

6.6%

3.3%

9.5% 10.0%

5.3%5.0%

7.3% 8.0%

14.1%15.2%

18.0%

8.8%

14.4%

6.5%

12.5%

-0.5%

11.9%

13.5%

-0.5%

8.4%

-5%

0%

5%

10%

15%

20%

98 99 00 01 02 03 04 05 06 07

US WA

Rates of Return on Net Worth for

All Lines: US vs. WA, 19982007*

Source: NAIC. *Latest available.

Washington State hashistorically been somewhatmore profitable than the USoverall, due in part to lower

cat losses



43/70

10.1%

2.2% 2.0%

9.4%

13.3%

11.0%

12.1%

8.0% 8.4%

3.3%

7.0%

4.5%

11.2%

12.6%

9.8%

7.9%

9.3%8.8%

7.7%

4.1%

0%

2%

4%

6%

8%

10%

12%

14%

98 99 00 01 02 03 04 05 06 07

US WA


PPA: US vs. WA, 19982007*


Washington Statesauto insurance ROE

has been mixedrelative to the US

overall



44/70

3.8%

-7.2%

1.4%

9.7%

3.7%

-2.8%

18.5%

0.2%

7.5% 7.6%

13.4%

21.2%

25.8%

31.2%

3.9%

16.0%

5.4% 5.4%

12.4%

4.4%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

98 99 00 01 02 03 04 05 06 07

US WA


HO: US vs. WA, 19982007*


Until recently,Washington States

homeowners insuranceROE had been abovethat of the US overall



45/70

3.5%1.6%

6.7%

-5.5%

7.4%

11.2%

8.8%

5.7%

-4.0% -4.0%

10.4%

-8.7%

-0.7%

2.9%

6.2%

17.9%15.1%15.6%

14.2%14.6%

-15%

-10%

-5%

0%

5%

10%

15%

20%

98 99 00 01 02 03 04 05 06 07

US WA


Comm. M-P: US vs. WA, 19982007*


Washington Statescommercial

multiperil ROE hasbeen mixed relative

to the US overall

I t t


46/70

Investment

Performance

I nvestments are the PrincipleSource of DecliningProfitability

Distribution of P/C Insurance


47/70

Distribution of P/C Insurance

Industrys Investment Portfolio

Cash & Short-

Term Investments

7.2%

Common Stock

17.9%

Bonds

66.7%

Preferred Stock

1.5%

Real Estate

0.8%

Other

5.9%

Portfolio Facts

Invested assets totaled$1.3 trillion as of12/31/07

Insurers are generallyconservatively invested,with 2/3 of assetsinvested in bonds as of12/31/07

Only about 18% ofassets were invested in

common stock as of12/31/07

Even the mostconservative of portfolioswas hit hard in 2008

Source: NAIC; Insurance Information Institute research;.

As of December 31, 2007

57

Property/Casualty Insurance Industry


48/70

Property/Casualty Insurance IndustryInvestment Gain:1994- 2008:Q3 1

$ Billions

$35.4

$42.8$47.2

$52.3

$44.4

$36.0

$45.3$48.9

$59.4$55.7

$63.6

$28.3

$56.9$51.9

$57.9

$0

$10

$20

$30

$40

$50

$60

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

06 07

08:Q3

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 are off sharplyin 2008 due to lower yields and

poor equity market conditions.

58

P/C Insurer Net Realized


49/70

P/C Insurer Net RealizedCapital Gains, 1990-2008:Q3

$2.88

$4.81

$9.89

$1.66

$6.00

$9.24$10.81

$13.02

$16.21

$6.63

-$1.21

$6.61

$8.97

-$9.71

$18.02

$3.52

$9.70$9.13

$9.82

-$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:Q

3

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

Realized capital gains exceeded $9billion in 2004/5 but fell sharply in2006 despite a strong stock market.Nearly $9 billion again in 2007, but

$-9.7billion in 2008 through Q3.

$ Billions

59


50/70

UnderwritingTrends

Financial Crisis Does NotDirectlyImpact Underwriting

Performance: Cycle, CatastrophesWere 2008s Drivers

P/C Insurance Combined Ratio


51/70

90

95

100

105

110

115

120

70

71

72

73

74

75

76

77

78

79

80

81

82

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

0

8F

Combined Ratios1970s: 100.3

1980s: 109.2

1990s: 107.8

2000s: 102.0*

Sources: A.M. Best; ISO, III *A.M. Best year end estimate of 103.2; Actual 9-mos. result was 105.6.

P/C Insurance Combined Ratio,

1970-2008F*

65

P/C Insurance Industry Combined


52/70

115.8

107.5

100.198.4

100.8

92.6

101

103.3

101.2

95.7

90

100

110

120

2001 2002 2003 2004 2005 2006 2007 2008 2008* 2009F

P/C Insurance Industry CombinedRatio, 2001-2009E

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

Best combinedratio since 1949

(87.6)

As recently as 2001, insurerspaid out nearly $1.16 for every

$1 in earned premiums

Relativelylow CATlosses,reservereleases

IncludingMortgage

& Fin.Guaranteeinsurers

Cyclical

Deterioration

66

2005 ratio benefited fromheavy use of reinsurancewhich lowered net losses

Underwriting Gain (Loss)


53/70

-55-50-45-40-35-30

-25-20-15-10-505

101520253035

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

$Billions

Insurers earned a record underwriting profit of$31.7 billion in 2006, the largest ever but only the

second since 1978. Cumulative underwriting deficit

from 1975 through 2007 is $422 billion.

Underwriting Gain (Loss)

1975-2008:Q3*

$19.877 Billunderwritingloss in 08:9Mincl. mort. &FG insurers

67

Number of Years With Underwriting


54/70

Number of Years With UnderwritingProfits by Decade, 1920s2000s

6

7

10

8

4

5

0 0

3

0

2

4

6

8

10

1920s 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.

Number of Years with Underwriting ProfitsUnderwriting profits were commonbefore the 1980s (40 of the 60 years

before 1980 had combined ratiosbelow 100)but then they vanished.Not a single underwriting profit was

recorded in the 25 years from 1979through 2003.

68

Personal Lines


55/70

103

.9

10

4.5

103

.5

10

4.9

99

.8 102.7

10

4.5

109

.9

110

.9

105

.3

98

.4

94

.3 96

.4

93

.9 97

.6

103

.3

97

.6

85

90

95

100

105

110

115

93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08E 09FSource: A.M. Best (historical and forecast).

Improvement in 2009 assumesreasonable degree of underwritingdiscipline and average CAT

activity ($10 B -$12B)

Personal Lines

Combined Ratio, 1993-2009F

2008deteriorationdue to price

competition andhigher CAT

losses. Trends

reverse in 2009.

Monthly Change in Auto


56/70

0.8

%

0.8

%

0.5

%

0.4%

0.3%0.3%0.5

%

0.6

%

0.5

%

0.1

% 0.5

% 0.9

%1.1

%1.3

% 1.7

%

2

.6%

2

.6%

2.7

% 3.0

%3.1

% 3.4

% 3.7

% 4.0

%

0.2

%

0%

1%

1%

2%

2%

3%

3%

4%

4%

5%

Jan-07

Feb-07

Mar-07

Apr-07

May-07

Jun-07

Jul-07

Aug-07

Sep-07

Oct-07

Nov-07

Dec-07

Jan-08

Feb-08

Mar-08

Apr-08

May-08

Jun-08

Jul-08

Aug-08

Sep-08

Oct-08

Nov-08

Dec-08

Monthly Change in AutoInsurance Prices*

*Percentage change from same month in prior year.Source: US Bureau of Labor Statistics

Auto insuranceprices have clearly

begun to rise inrecent months

Commercial Lines Combined


57/70

110

.3

110

.2

107.6

103

.9 109

.7

112

.3

111

.1

122

.3

110

.2

102

.5 105

.4

91

.1 95

.1

106

.5

105

.1

102

.0

112

.5

85

90

95

100

105

110

115

120

125

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

2006/07 benefited from favorable loss cost

trends, improved tort environment, low CATlosses, WC reforms and reserve releases.Most of these trends reversed in 2008 and

mortgage and financial guarantee segmentshave big influence. 2009 is transition year.

Commercial coverageshave exhibited significant

variability over time.

Commercial Lines Combined

Ratio, 1993-2009F

Mortgage and financialguarantee may account for upto 4 points on the commercial

combined ratio in 2008

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

Average Commercial Rate Change


58/70

Average Commercial Rate Change,

All Lines, (1Q:2004 4Q:2008)

-3.2

%

-5.9%

-7.0

%

-9.4

%

-9.7

% -8.2

%

-4.6

% -2

.7%

-3.0

%

-5.3

%

-9.6

%

-11.3

%

-11.8%

-13

.3%

-12.0%

-13

.5%

-12

.9% -11

.0%

-6.0%

-16%

-14%

-12%

-10%

-8%

-6%

-4%

-2%

0%

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

KRW Effect

-0.1

% Magnitude of price

declines is nowshrinking. Reflectsshrinking capital,

reduced investmentgains, deteriorating

underwritingperformance andcostlier reinsurance

Personal/Commercial Lines &


59/70

Personal/Commercial Lines &Reinsurance NPW Growth,2006-2009F

2.0

%3

.5%

2.5

%5

.0%

28.1%

-0.3

%

0.0

%

-11.9%-3.8

%

1.0

% 7.6

%

-1.4

%

-15%

-10%

-5%

0%

5%

10%

15%20%

25%

30%

35%

Personal Commercial Reinsurance

2006 2007 2008E 2009F

Sources: A.M. Best Review & Preview (historical and revised year-end 2008 forecast as of 1/20/09

Declines in premiumgrowth began to stabilize

in later 2008 and arefirming to some extent as

we move into 2009

Advertising Expenditures by P/C


60/70

Advertising Expenditures by P/CInsurance Industry,1999-2007

$ Billions

$1.736 $1.737 $1.803 $1.708

$3.426

$4.102

$2.975

$2.111$1.882

$1.5

$2.0

$2.5

$3.0

$3.5

$4.0

$4.5

99 00 01 02 03 04 05 06 07Source: Insurance Information Institute from consolidated P/C Annual Statement data.

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

increased competition


61/70

Catastrophe Losses

Impacting UnderwritingResults and the Bottom Line

U S I d C t t h L *


62/70

U.S. Insured Catastrophe Losses*

$

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 $25

.2

$100.0

$

61

.9

$

9.2

$0

$20

$40

$60

$80

$100

$120

89

90

91

92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08**

20??

*Excludes $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

$ Billions2008 CAT losses exceeded

2006/07 combined. 2005 was byfar the worst year ever for

insured catastrophe losses in the

US, but the worst has yet to come.

$100 BillionCAT year iscoming soon

80

ap tal


63/70

ap tal

PolicyholderSurplus

Shrinkage, butCapital is Within

Historic Norms

U.S. Policyholder Surplus:


64/70

$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 08

U.S. Policyholder Surplus:1975-2008*

Source: A.M. Best, ISO, Insurance Information Institute. *Towers Perrin estimate as of 12/31/08

$Billions

Surplus is a measure of

underwriti ng capacity. I t isanalogous to Owners

Equity or Net Worth in

non-i nsurance organizations

Actual capacity as of 9/30/08 was $478.5, down 7.6%from 12/31/07 at $517.9B, but 68% above its 2002

trough. Recent peak was $521.8 as of 9/30/07. Estimateas of 12/31/08 is $438B is 16% below 2007 peak.

The premium-to-surplusratio stood at $0.94:$1 at

year end 2008, up from

near record low of $0.85:$1

at year-end 2007

83

Policyholder Surplus


65/70

Policyholder Surplus,2006:Q42008:Q4(Est.)

$ Billions

$487.1

$496.6

$512.8$521.8

$478.5

$438.0

$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

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

Declines Since 2007:Q3 Peak

Q2: -$16.6B (-3.2%)Q3E: -$43.3B (-8.3%)Q4E: -$84B (-16.1%)

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

84

Historically, Hard Markets Follow


66/70

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

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*

NWP % changeSurplus % change

*Actual 9-month 2008 result.

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

y,

When Surplus Growth is Negative

Sharp decline in capacity is anecessary but not sufficientcondition for a true hard market

P/C P i


67/70

P/C Premium

GrowthPrimarily Driven by the

Industrys UnderwritingCycle, Not the Economy

Strength of Recent Hard Markets


68/70

-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

2

008F

2

009F

2

010F

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

g fby NWP Growth

1975-78 1984-87 2000-03

Shaded areasdenote hard

market periodsNegativegrowth in

2008 beforeturning

positive in2009

In 2007 net writtenpremiums fell1.0%, the first

decline since 1943

88

Year-to-Year Change in Net


69/70

gWritten Premium, 2000-2010F*

*2008 figure is 9-month actual result from ISO.Source: A.M. Best (historical); I.I.I. estimates for 2009-2010.

5.0%

8.4%

15.3%

10.0%

3.9%

0.5%

4.2%

-1.0%-0.4%

1.0%

3.0%

2000 2001 2002 2003 2004 2005 2006 2007 2008F 2009F 2010F

P/C insurers areexperiencing their

slowest growth ratessince 1943

Slow growth meansretention is cri tical

Protractedperiod of

negative orslow growthis possibledue to soft

markets and

sloweconomy

89

Insurance Information


70/70

f

Institute On-Line

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YOUR ATTENTI ON!

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