Medical Professional Liability & the P/C Insurance Industry

Medical Malpractice

Insurance & The

Insurance Cycle

Medical Professional Liability

& the P/C Insurance Industry

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

Insurance Information Institute ♦ 110 William Street ♦ New York, NY 10038

Tel: (212) 346-5520 ♦ Fax: (212) 732-1916 ♦ bobh@iii.org ♦ www.iii.org

31

Annual Physician Insurance

Association of America Meeting

Philadelphia, PA

Presentation Outline

•

P/C Operating Overview & Outlook

¾

Profitability

¾

Underwriting Trends

¾

Premium Growth & Price Drivers

¾

Capacity & Surplus

•

Medical Professional Liability Insurance Overview

¾

Medical & Health Care Cost Inflation

¾

Med Mal Operating Results

¾

Med Mal Investment Performance

•

Med Mal Tort Environment

•

P/C Investment Overview & Outlook

•

Weakening Economy: Insurance Impacts & Implications

¾

Implications of Treasury reform “Blueprint” for insurers

•

Catastrophic Loss: Spillover Effects?

P/C INSURANCE

OPERATING

OVERVIEW

PROFITABILITY

Insurer Profits in 2006/07

Reached Their Cyclical Peak

P/C Net Income After Taxes

1991-2008F ($ Millions)*

*ROE figures are GAAP; 1Return on avg. surplus. **Return on Average Surplus; Sources: A.M. Best, ISO,

Insurance Information Inst.

y2001 ROE = -1.2% y2002 ROE = 2.2% y2003 ROE = 8.9% y2004 ROE = 9.4% y2005 ROE= 9.6% y2006 ROE = 12.2% y2007 ROAS1 _{= 12.3%**}

Insurer profits

peaked in 2006

-5% 0% 5% 10% 15% 20% 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08F

US P/C Insurers

All US Industries

ROE: P/C vs. All Industries

1987–2008E

2008 P/C insurer ROE is I.I.I. estimate.

Source: Insurance Information Institute; Fortune

Andrew

Northridge

Hugo _{Lowest CAT}

losses in 15 years

Sept. 11

4 Hurricanes

Katrina, Rita, Wilma

-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 07E 08F

Profitability Peaks & Troughs in the

P/C Insurance Industry,

1975 – 2008F*

*GAAP ROE for all years except 2007 which is actual ROAS of 12.3%. 2008 P/C insurer ROE is I.I.I. estimate.

-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

ROE

Cost of Capital

ROE vs. Equity Cost of Capital:

US P/C Insurance:1991-2007

Source: The Geneva Association, Ins. Information Inst.

The p/c insurance industry achieved its cost of

capital in 2005/6 for the first time in many years

-13.2 pts

+0.2 pts

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

-0.1 pts

+1.7 pts

-9.0 pts

The cost of capital is the rate of return

insurers need to attract and retain

capital to the business

P/C, L/H Stocks: Lagging the

S&P 500 Index in 2008

*Includes Financial Guarantee.

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

Total YTD Returns Through May 9, 2008

P/C, Life insurance stocks underperforming S&P— concerns about soft market, credit/subprime exposure of

some companies

Mortgage & Financial Guarantee insurers were

Factors that Will Influence the

Length and Depth of the Cycle

• Capacity: Rapid surplus growth in recent years has left the industry with between $85 billion and $100 billion in excess capital, according to analysts

¾ All else equal, rising capital leads to greater price competition and a liberalization of terms and conditions

• Reserves: Reserves are in the best shape (in terms of adequacy) in decades, which could extend the depth and length of the cycle

¾ Looming reserve deficiencies are not hanging over insurers they way they did during the last soft market in the late 1990s

¾ Many companies have been releasing redundant reserves, which allows them to boost net income even as underwriting results deteriorate

¾ Reserve releases will diminish in 2008; Even more so in 2009

• Investment Gains: 2007 was the 5th _{consecutive up year on Wall Street. With} sharp declines in stock prices and falling interest rates, portfolio yields are

certain to fallÆContributes to discipline

¾ Realized capital gains are already rising as underwriting profits shrink, but like redundant reserves, realized capital gains are a finite resource

¾ A sustained equity market decline (and potentially a drop in bond prices at some point) could reduce policyholder surplus

Factors that Will Influence the

Length and Depth of the Cycle

(cont’d)

• Sarbanes-Oxley: Presumably SOX will lead to better and more conservative management of company finances, including rapid recognition of deficient or redundant reserves

¾ With more “eyes” on the industry, the theory is that cyclical swings should shrink

• Ratings Agencies: Focus on Cycle Management; Quicker to downgrade

¾ Ratings agencies more concerned with successful cycle management strategy

¾ Many insurers have already had ratings “haircut” over the last several years they way they did during the last soft market in the late 1990s; Less of a margin today

• Finite Reinsurance: Had smoothing effect on earnings; Finite market is gone

• Information Systems: Management has more and better tools that allow faster adjustments to price, underwriting and changing market conditions than it had during previous soft markets

• Analysts/Investors: Less fixated on growth, more on ROE through soft mkt.

¾ Management has backing of investors of Wall Street to remain disciplined

• M&A Activity: More consolidation implies greater discipline

¾ Liberty Mutual/Safeco deal creates 5th _{largest p/c insurer. More to come?}

FINANCIAL

STRENGTH &

RATINGS

Industry Has Weathered

the Storms Well, But Cycle

P/C Insurer Impairment Frequency

vs. Combined Ratio, 1969-2007E

90 95 100 105 110 115 120 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07E Co m b in e d Ra ti o 0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8 2 Im p a ir m e n t Ra te

Combined Ratio after Div P/C Impairment Frequency Impairment rates are highly correlated underwriting performance and could reach near-record low in 2007

Source: A.M. Best; Insurance Information Institute

2006 impairment rate was 0.43%, or 1-in-233 companies, half the 0.86% average since 1969;

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 Pricing 62.8% Affiliate Problems 8.6% Rapid Growth 8.6%

2003-2005

1969-2005

UNDERWRITING

TRENDS

Extremely Strong 2006/07;

Relying on Momentum &

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 08F Combined Ratios 1970s: 100.3 1980s: 109.2 1990s: 107.8 2000s: 102.0*

Sources: A.M. Best; ISO, III *Full year 2008 estimates from III.

P/C Insurance Combined Ratio,

1970-2008F*

115.8 107.4 100.1 98.3 100.7 92.4 98.6 95.6 90 100 110 120 01 02 03 04 05 06 07 08F

P/C Insurance Combined Ratio,

2001-2008F

Sources: A.M. Best; ISO, III. *III estimates for 2008.

2005 figure benefited from

heavy use of reinsurance

which lowered net losses

2006 produced the best underwriting result since the 87.6 combined

ratio in 1949

As recently as 2001,

insurers were paying

out nearly $1.16 for

every dollar they

earned in premiums

2007/8 deterioration due primarily to falling rates, but

results still strong assuming normal CAT activity

87.6 91.2 92.1 92.3 92.4 92.4 93.1 93.1 93.3 95.6 93.0 85 87 89 91 93 95 97 1949 1948 1943 1937 2006 1935 1950 1939 1953 1936 2007

Ten Lowest P/C Insurance Combined

Ratios Since 1920 vs. 2007

Sources: Insurance Information Institute research from A.M. Best data. *2007: III Earlybird survey.

2007 was the 20

best since 1920

The industry’s best

underwriting years

are associated with

periods of low

interest rates

The 2006 combined

ratio of 92.2 was the

best since the 87.6

combined in 1949

-55 -50 -45 -40 -35 -30 -25 -20 -15 -10 -5 0 5 10 15 20 25 30 35 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, Insurance Information Institute

$ 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)

1975-2008F*

110.3 110.2 107.6 103.9 109.7 112.3 _111.1 122.3 110.2 102.5 105.4 91.2 94.7 97.5 102.0 112.5 85 90 95 100 105 110 115 120 125 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07E 08F

Recent results benefited from favorable loss cost trends, improved

tort environment, low CAT losses, WC reforms and reserve releases

Commercial coverages

have exhibited significant

variability over time.

Commercial Lines Combined

Ratio, 1993-2008F

Outside CAT-affected lines, commercial insurance is doing fairly well. Caution is required in

underwriting long-tail commercial lines.

$10. 8 _$22. 8 _$33. 4 $36. 9 $18. 9 ($5.0) ($6.0) ($5.3) $0.4 ($7.0) 8.9 -1.1 -1.3 -1.6 4.5 -1.2 0.1 3.5 8.6 6.5 ($10) ($5) $0 $5 $10 $15 $20 $25 $30 $35 $40 00 01 02 03 04 05 06 07F 08F 09F R eser ve D evel o p m en t ( $ B ) (3) (2) (1) 0 1 2 3 4 5 6 7 8 9 10 C o m b in e d R a ti o P o in ts PY Reserve Development Combined Ratio Points

Impact of Reserve Changes on

Combined Ratio

Source: A.M. Best, Lehman Brothers estimates for years 2007-2009

Reserve

adequacy has

improved

substantially

PREMIUM

GROWTH

At a Virtual Standstill

in 2007/08

-10% -5% 0% 5% 10% 15% 20% 25% 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 2007F 2008F

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

Strength of Recent Hard Markets

by NWP Growth*

Growth in Net Written

Premium, 2000-2008F

*2008 forecast from A.M. Best.

Source: A.M. Best; Forecasts from the Insurance Information Institute.

5.0%

8.4%

15.3%

10.0%

3.9%

0.5%

4.3%

-0.6% -1.0%

P/C insurers are experiencing

their slowest growth rates

since 1943… underwriting

WEAK PRICING

Under Pressure in

2007/08, Especially

Average Commercial Rate Change,

All Lines,

(1Q:2004 – 1Q:2008)

-16%

-14%

-12%

-10%

-8%

-6%

-4%

-2%

0%

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

Magnitude of rate decreases diminished

greatly after Katrina but have grown again

KRW Effect

Cumulative Commercial Rate Change

by Line: 4Q99 – 1Q08

Source: Council of Insurance Agents & Brokers

Commercial account pricing has been trending down for 3+

years and is now on par with prices in late 2001, early 2002

CAPACITY/

SURPLUS

Accumulation of Capital/

Surplus Depresses ROEs

$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

U.S. Policyholder Surplus:

1975-2007*

Source: A.M. Best, ISO, Insurance Information Institute. *As of December 31, 2007

$ Billions

“Surplus” is a measure of underwriting capacity. It is analogous to “Owners

Equity” or “Net Worth” in non-insurance organizations

Capacity as of 12/31/07 was $517.9B, 6.5% above year-end 2006, 81% above its 2002 trough

and 55% above its 1999 peak.

The premium-to-surplus

fell to $0.85:$1 at

year-end 2007, approaching

its record low of

$0.84:$1 in 1998

Annual Catastrophe Bond

Transactions Volume, 1997-2007

Risk Capital Issued Number of Issuances

Source: MMC Securities Guy Carpenter, A.M. Best; Insurance Information Institute.

Catastrophe bond issuance has

soared in the wake of

Hurricanes Katrina and the

hurricane seasons of 2004/2005,

Lloyd’s Insurance Market

Capacity, 1998-2008 (

£ billions)*

*Beginning of the year.

Source: Lloyd’s Members’ Services Unit.

The capacity of the Lloyd’s market rose significantly during the period 2001 to 2004. In 2005, capacity reduced but increased again in 2006 and 2007 due to the impact of the U.S. hurricane season. Capacity reduced to £15.95 billion ($32 billion) in 2008.

£15.95 £16.1 £14.8 £13.7 £14.9 £14.4 £12.2 £11.3 £10.1 £9.9 £10.2 0 2 4 6 8 10 12 14 16 18 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 £ b illions

P/C Insurer Share Repurchases,

1987- Through Q4 2007 ($ Millions)

Sources: Credit Suisse, Company Reports; Insurance Information Inst.

2007 share buybacks shattered

the 2006 record, up 214%

Build-Up & Repurchase Surge

•Strong underwriting results

•Moderate catastrophe losses

•Reasonable investment

performance

•Lack of strategic alternatives

(M&A, large-scale expansion)

Returning capital owners (shareholders) is one of the

few options available

2007 repurchases to

date equate to 3.9% of

industry surplus, the

highest in 20 years

MEDICAL

PROFESSIONAL

LIABILITY

OVERVIEW

MEDICAL &

HEALTH CARE

COST INFLATION

National Problem &

Insurer Cost Driver

Consumer Price Index for Medical

Care vs. All Items, 1960-2007

207.3 351.1 0 100 200 300 400 60 61 62 63 64 65 66 67 68 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

All Items Medical Care

Source: Department of Labor (Bureau of Labor Statistics).

(Base: 1982-84=100)

Inflation for Medical Care

has been surging ahead of

general inflation (CPI) for

25 years. Since 1982-84,

the cost of medical care

National Health Expenditures and Health

Expenditures as a Share of GDP,

1960-2017F ($ Billions)

07E 08E 09E 10E 11E 12E 13E 14E 15E 16E 17E

N a ti on al H e al th Exp s 0% 5% 10% 15% 20% 25% N a ti on al H e al th Exp . as % of G D P

National Health Expenditures National Health Expenditures as % of GDP

Health care expenditures will consumed 16.6% of GDP in 2008 and are expected to rise

to 19.5% by 2017

National Health Expenditures

Per Capita, 1960-2017E

($Bill)

$4, 523 $4, 7 90 $5, 1 48 $5, 5 60 $5, 9 52 $6, 301 $6, 6 49 $7, 0 26 $7, 439 $7, 868 $8, 3 29 $8, 8 16 $9, 3 22 $9, 8 62 $10, 439 $11, 043 $11, 684 $12, 369 $13, 101 $356 $2, 8 13 $1, 1 00 $148 $3, 4 69 $4, 1 04 $4, 2 97 $0 $1,000 $2,000 $3,000 $4,000 $5,000 $6,000 $7,000 $8,000 $9,000 $10,000 $11,000 $12,000 $13,000 $14,000 $15,000

60 70 80 90 93 97 98 99 00 01 02 03 04 05 _{06 07E 08E 09E 10}E ₁₁E _{12E 13E 14E 15E 16E 17E}

Source: Centers for Medicare & Medicaid Services, Office of the Actuary; Insurance Information Institute.

Health costs on a per capita

basis continue to rise rapidly, as

health expenditures rise faster

than population growth

Average Annual Growth in US Per

Capital Health Care Costs,

1960-2017F

14.1%

20.9%

15.6%

7.0%

7.9%

7.6%

The 1970s were the most inflationary decade for

medical costs at nearly 21% per year

Over the net decade health care expenditures will likely

increase well ahead of economic growth and the

general pace of inflation

Source: Insurance Information Institute calculations based on data from the Centers for Medicare & Medicaid Services, Office of the Actuary.

4.5% 3.6% 2.8% 3.2% 3.5% 4.1% 4.6% 4.7% _4.0% 4.4% 4.2% 4.0% 5.1% 7.4% 10.1% 8.3% 10.6% 8.2% 14.0% 7.4% 9.0% 6.8% 11.7% 7.5% 0% 2% 4% 6% 8% 10% 12% 14% 16% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Change in Medical CPI

Change Med Cost per Lost Time Claim

WC Medical Severity Rising Far

Faster than Medical CPI

Sources: Med CPI from US Bureau of Labor Statistics, WC med severity from NCCI based on NCCI states.

3.5 pts

WC medical severity rose more than twice as fast as the

medical CPI (8.8% vs. 4.0%) from 1995 through 2006

Med Costs Share of Total

Costs is Increasing Steadily

Indemnity 55%

Medical 45%

Source: NCCI (based on states where NCCI provides ratemaking services).

Indemnity 52% Medical 48% Indemnity 41% Medical 59%

1986

1996

2006p

Auto Claim Costs Rise Faster

than CPI or Health Care Costs

9%

4%

8%

6%

3%

4%

Sources: Insurance Research Council, Auto Insurance Claims: Countrywide Patterns in Treatment,

Cost and Compensation, 2008 Edition; Insurance Information Institute.

Inflation in auto

insurance claims is a

significant and

long-term cost driver

MEDICAL

MALPRACTICE

OPERATING

ENVIRONMENT

Improved, But

Still Vulnerable

103.7 108. 0 96. 4 99.8 106. 6 107. 9 115.7 129. 7 133. 7 154. 7 142. 5 137. 5 111. 0 101. 0 91.2 83. 0 94.5 108. 8 115.7 107. 0 108.3 _106. 7 106.0 102. 0 105.9 108. 0 110. 1 _115.8 107. 5 100. 1 98.4 100.8 92. 5 95. 6 98.6 127. 9 80 90 100 110 120 130 140 150 160 170 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07P 08E

Medical Malpractice All Lines Combined Ratio

Medical Malpractice

Combined Ratio

Source: AM Best, Insurance Information Institute

Insurers in 2007 paid out an

estimated $0.83 for every $1

they earned in premiums.

As recently as 2002, med mal insurers paid out $1.55 for every dollar earned

The dramatic improvement has

restored med mal’s viability

Medical Malpractice: Losses &

Expenses Paid vs. Premiums Earned

$ Billions

Earned Premiums Losses & Expenses Paid

Source: Computed from A.M. Best data by the Insurance Information Institute

Before reforms took hold in the mid-2000s, premium earned rose 54% while

losses and expenses rose 125% over the period from 1990 through 2003,

Medical Malpractice:

Underwriting Loss/Profit,

1990-2007p

$ Millions

Source: Insurance Information Institute calculations based on data from A.M. Best.

Med Mal underwriting losses

exploded by $3.1 billion or 1059%

between 1996 and 2001

Medical Malpractice:

Cumulative Underwriting Losses

$ Millions

The cumulative

underwriting loss in Med

Mal from 1990-2003 totaled

more than $17 billion

Outlook for MPLI

Operating Environment

•

Short-Term: Soft market persists, driven by relatively

good underlying underwriting performance

•

Intermediate Term: Cyclical deterioration in

profitability as underwriting begins to deteriorate under

soft market conditions

•

Long-Run: Erosion of reforms of recent years begins to

take toll, further damaging results

•

Conclusion: Underwriting Cycle can’t be banished, but

its depth and length can be moderated via disciplined

underwriting and pricing

•

Tort Cycle: Med Mal tends to experience a tort crisis

every 10-15 years. If history is any guide, the next crisis

will be evident around 2012-2015

Investment Component

of Medical Malpractice

Investment Gain: Med Mal vs.

All Commercial Lines*

*As a % of net earned premium. Investment gains consists primarily of interest, dividends and realized capital gains and losses.

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

12. 5 % 14. 3 % 14. 1 % 16. 8 % 16. 9 % 15. 1% 16. 8 % 14. 3 % 9. 6% 8. 9% 9. 4% _10.3 % 10. 2% 27. 4 % 29. 3% 30. 2 % 30. 0 % 28. 0 % 23. 7 % _27. 9 % 19. 1% 12. 8 % 15. 5 % 15. 1% 14. 0% 18. 9% 0% 5% 10% 15% 20% 25% 30% 35% 94 95 96 97 98 99 00 01 02 03 04 05 06

Commercial Lines Med Mal

Investment returns have generally shrunk since 2000, but are still important. “Heavy Lifting” must be done through underwriting & pricing

Medical Malpractice Investment Gain*

$ Billions

*Imputed from investment gain data as a % of net earned premium. Investment gains consists primarily of interest, dividends and realized capital gains and losses.

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

Investment returns have risen, but poor investment environment today implies “Heavy Lifting” must be done through

Medical

Malpractice Tort

Environment

Harvesting the Fruits

of Reform

Medical Malpractice Tort Cost:

Growth Continues, Though Modestly

$ Billions

Sources: Tillinghast-Towers Perrin, US Bureau of Labor Statistics, Insurance Information Institute

•Over the period from 1990 through 2006, medical

malpractice tort costs rose 229%, more than double the 90% increase in tort costs generally over the same period.

•Over the period from 1975 through 2006, medical

malpractice tort costs have increased at an annual rate of 11.1 percent, versus 8.2 percent for all other tort costs.

ME NH MA CT PA WV VA NC LA TX OK NE ND MN MI IL IA ID WA OR AZ HI NJ RI MD DE AL VT NY DC SC GA TN AL FL MS AR NM KY MO KS SD WI IN OH MT CA NV UT WY CO

Medical Crises across the U.S.*

Crisis states at height of 2000s

AMA: Crises reached in 22 states in the 2000s

PR AK

*The AMA is no longer categorizing states as crisis states. Source: American Medical Association, February 2008

2007 Top Ten Verdicts

Source: LawyersWeekly USA, January 22, 2008.

Florida Auto Crash, Death

$45 Million New Jersey Vioxx $47.5 Million Nevada Prempro $47.6 Million Alabama Product Liability, Death

$50 Million

Florida DUI Crash

$50 Million

New Mexico Nursing Home, Death

$54 Million

Florida Private Air Crash

$54 Million

California Product Liability, Death

$55.2 Million

Florida Premises Liability, Death

$102.7 Million New York Medical Malpractice $109 Million State Issue Value

2002 Top Ten Verdicts

Source: LawyersWeekly USA, January 2003.

New York Med Mal (Birth Injury)

$80 Million

Missouri Prod. Liab/Personal Inj. (Auto)

$80 Million

New York Medical Malpractice

$91 Million

New York Med Mal (Birth Injury)

$95.2 Million

California Business Fraud

$97.2 Million

Virginia Product Liab. (Auto Accident)

$122 Million

Oregon Tobacco (Product Liability)

$150 Million

Texas Product Liability (Rollover)

$225 Million

Kentucky Personal Injury (Burn)

$270 Million

Missouri Negligence (Pharmacy Mal)

$2.2 Billion

Florida Tobacco (Product Liability)

$28 Billion

State Issue

2001 Top Ten Verdicts

Source: LawyersWeekly USA, January 2002.

California Real Estate $94.5 Million New York Medical Malpractice $107.8 Million Texas Inheritance Dispute $108.2 Million New York Medical Malpractice $114.9 Million Virginia Intellectual Property Theft

$116 Million

Colorado Police Auto Crash

$ 256 Million

Texas Nursing Home

$312.8 Million

Florida Private Airplane Crash

$480 Million Louisiana Land Contamination $1 Billion California Tobacco $3 Billion State Issue Value

Average Jury Award in

Medical Malpractice Cases*

$ Millions

*Ultimate award may be reduced by judge or upon appeal.

Source: Jury Verdict Research; Insurance Information Institute.

The average med mal jury

award more than tripled

between 1994 and 2005, but

Trends in Million Dollar Verdicts*

*Verdicts of $1 million or more.

Source: Jury Verdict Research; Insurance Information Institute.

Sharp jumps in multi-million dollar

awards in recent years across most types of defendants. In med mal, million

dollar-plus awards rose from 36% of all awards from 1996-98 to 55% in 2004-05, well above most other categories.

MERGER &

ACQUISITION

Catalysts for P/C

Consolidation Growing

in 2008

P/C Insurance-Related M&A

Activity, 1988-2006

$0

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06

0

20

40

60

80

100

120

140

Transaction Values Number of Transactions

Source: Conning Research & Consulting.

M&A activity began to accelerate

during the second half of 2007

No model for successful consolidation

Motivating Factors for Increased

P/C Insurer Consolidation

Motivating Factors for P/C M&As

•

Slow Growth:

Growth is at its lowest levels since the late 1990s

¾ NWP growth was 0% in 2007; Appears similarly flat in 2008

¾ Prices are falling or flat in most non-coastal markets

•

Accumulation of Capital:

Excess capital depresses ROEs

¾ Policyholder Surplus up 6-7%% in 2007 and up 80% since 2002

¾ Insurers hard pressed to maintain earnings momentum

¾ Options: Share Buybacks, Boost Dividends, Invest in Operation, Acquire

¾ Option B: Engage in destructive price war and destroy capital

•

Reserve Adequacy:

No longer a drag on earnings

¾ Favorable development in recent years offsets pre-2002 adverse develop.

•

Favorable Fundamentals/Drop-Off in CAT Activity

¾ Underlying claims inflation (frequency and severity trends) are benign

¾ Lower CAT activity took some pressure of capital base

P/C INVESTMENT

OVERVIEW

More Pain,

Little Gain

Property/Casualty Insurance

Industry Investment Gain

1

$ Billions

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 rose in 2007 but are just

9.8% higher than what they were

Property/Casualty Industry

Investment Results, 1994-2007

*Primarily interest, stock dividends, and realized capital gains and losses. **Not shown: $1.1B capital loss in 2002.

2005 figure includes special one-time dividend of $3.2B. Sources: ISO; Insurance Information Institute.

$52.3 $57.7 $44.0 $35.6 $45.6 $48.9 $59.2 $55.8 $63.6 Realized capital gains rising as underwriting results slip $57.9

US P/C Net Realized Capital Gains,

1990-2007 ($ Millions)

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

Realized capital gains rebounded strongly in 2004/5

but fell sharply in 2006 despite strong stock market

as insurers “bank” their gains. Rising again in 2007 as underwriting results slip

-30% -20% -10% 0% 10% 20% 30% 40% 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Source: Ibbotson Associates, Insurance Information Institute. *Through May 9, 2008.

Total Returns for Large

Company Stocks: 1970-2008*

S&P 500 was up 3.5% in 2007, down 5.45% YTD 2008*

Markets were up in 2007 for

the 5

consecutive year;

2008 could be first down

2% 3% 4% 5% 6% 7% 8% 9% 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08*

P-C Inv Income/Inv Assets 10-Year Treasury Note

P/C Investment Income as a % of Invested

Assets Follows 10-Year US T-Note

*As of January 2008 month-end.

Sources: Board of Governors, Federal Reserve System; A.M.Best; Insurance Information Institute.

Investment yield

historically tracks

10-year Treasury

note quite closely

Investment Outlook

•

Short-Term: Low interest rates, poor equity market

performance will reduce investment gains and depress

profitability

•

Intermediate Term: Fed likely to begin raising rates as

early as late 2008, if credit market conditions continue

to improve

¾

Stock markets could begin recovery from first quarter lows

•

Long-Run: Interest rates and stock market returns are

modest

•

Conclusion: Insurers (including long-tail carriers

offering MPLI) cannot count on investment gains to

offset underwriting losses

•

Implication: Insurers Must Remain Disciplined in Terms

REINSURANCE

MARKETS

Reinsurance Prices are

Falling in Non-Coastal

Share of Losses Paid by

Reinsurers, by Disaster*

30%

25%

60%

20%

45%

*Excludes losses paid by the Florida Hurricane Catastrophe Fund, a FL-only windstorm reinsurer, which was established in 1994 after Hurricane Andrew. FHCF payments to insurers are estimated at $3.85 billion for 2004 and $4.5 billion for 2005.

Sources: Wharton Risk Center, Disaster Insurance Project; Insurance Information Institute.

Reinsurance is playing

an increasingly

important role in the

financing of

mega-CATs; Reins. Costs

US Reinsurer Net Income

& ROE, 1985-2007*

Net Income ROE

Source: Reinsurance Association of America. *2007 ROE figure is III estimate based return on average 2007 surplus.

Reinsurer profitability

rebounded post-Katrina

Reinsurer Market Share Comparison:

1990 vs. 2006

1990

2006

Sources: Reinsurance Association of America; Insurance Information Institute.

U.S. Reinsurer 46.9% Offshore Reinsurer 53.1%

U.S. Reinsurer market

share fell precipitously

between 1990 and 2006

Regional Distribution of

Reinsurers by NWP, 2006

Source: Standard & Poor’s, Global Reinsurance Highlights, 2007 Edition

International reinsurers from

Germany, Switzerland and France account for 40 percent of global reinsurance volume.

Bermuda is a growing market, with a 10 percent share. Lloyd’s and

London-based reinsurers account for 6 percent of the

world market.

Eight countries account for 89 percent of global reinsurance volume.

A STORMY

ECONOMIC

FORECAST

What a Weakening Economy

& Credit Crunch Mean for

3. 7% 0.8% 1. 6% 2.5% 3. 6% 3. 1% 2.9% 0. 6% 3. 8% 4.9% 0. 6% 2. 1% 1.9% 2. 0% 2.6% 2.8% 2.9% 0. 6% 0.1% 0% 1% 2% 3% 4% 5% 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

Real GDP Growth*

*Yellow bars are Estimates/Forecasts.

Source: US Department of Commerce, Blue Economic Indicators 4/08; Insurance Information Institute.

Economic growth has

slowed dramatically

A Few Facts About the Relationship

Between Insurance & Economy

•

Vast Majority of Insurance Business is Tied to Renewals

¾ Approximately 98+% of P/C business (units) is linked to renewals

¾ A very large share of p/c insurance premiums are statutorily or de facto

compulsory (e.g., WC, auto liability, surety, usually HO…)

¾ P/C insurers have marginal exposure impact due to economy

¾ Most life revenues and units are renewals, but some products (e.g.,

variable annuities are sensitive to market volatility)

¾ Life insurers who manage 401(k) assets seeing more loans and hardship

withdrawals;

•

Insurers are Sensitive to Interest Rates

¾ About 2/3 of P/C invested assets and 75% if Life assets are fixed income

¾ Historically, yield on industry portfolios has tracked 10-year note closely

¾ All else equal, lower total investment gain implies greater emphasis on

underwriting

¾ Historically, industry’s best underwriting performances are rooted in

periods when interests rates were low and/or equity market performance poor (1930s – 1950s, early 2000s gave rise to strong 2006/07)

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 % -2 .9 % -2 .7 % -10% -5% 0% 5% 10% 15% 20% 25% 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 R eal N W P Gr o w th -4% -2% 0% 2% 4% 6% 8% Re a l G D P G ro w th

Real NWP Growth Real GDP

Real GDP Growth vs. Real P/C

Premium Growth: Modest Association

P/C insurance industry’s growth

is influenced modestly by growth

in the overall economy

Summary of Treasury

“Blueprint”for

Financial Services

Modernization

Treasury Regulatory

Recommendations Affecting Insurers

Source: Department of Treasury Blueprint for a Modernized Financial Regulatory System, March 2008.

•

Establishment of an Optional Federal Charter (OFC)

¾

Would provide system for federal chartering, licensing,

regulation and supervision of insurers, reinsurer and

producers (agents & brokers)

¾

OFC insurers would still be subject to state taxes,

provisions for compulsory coverage, residual market and

guarantee funds

¾

OFC would specify specific lines covered by charter;

Separate charters needed for P/C and Life

•

OFC Would Incorporate Several Regulatory Concepts

¾

Ensure safety and soundness

¾

Enhance competition in national and international markets

¾

Increase efficiency through elimination of price controls,

promote more rapid technological change, encourage

product innovation, reduce regulatory costs and provide

consumer protection

•

Establishment of Office of National Insurance (ONI)

¾ Department within Treasury to regulate insurance pursuant to OFC

¾ Headed by Commissioner of National Insurance

¾ Commissioner has regulatory, supervisory, enforcement and

rehabilitative powers to oversee organization, incorporation, operation, regulation of national insurers and national agencies

•

Establishment of Office of Insurance Oversight (OIO)

¾ Department within Treasury to handle issues needing immediate

attention such “reinsurance collateral”; OIO could focus immediately on “key areas of federal interest in the insurance sector”

¾ OIO: lead regulatory voice on international regulatory policy

¾ Would have authority to ensure states achieved uniform

implementation of declared US international insurance policy goals

¾ OIO would also serve as advisor to Treasury Secretary on major

domestic and international policy issues

•

UPDATE

: HR 5840 Introduced April 17 Would Establish

Office of Insurance Information (OII)

¾ Very similar to OIO

Source: Department of Treasury Blueprint for a Modernized Financial Regulatory System, March 2008.

Treasury Regulatory Recommendations

Affecting Insurers (cont’d)

CATASTROPHIC

LOSS

No Appreciable

Spillover Effects

U.S. Insured Catastrophe Losses*

*Excludes $4B-$6b offshore energy losses from Hurricanes Katrina & Rita.

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

$ Billions

2006/07 were welcome

respites. 2005 was by far the

worst year ever for insured

catastrophe losses in the US.

Few “spillover effects” into

non-property lines

$100 Billion

CAT year is

coming soon

Shifting Legal

Liability & Tort

Environment

Is the Tort Pendulum

Bad Year for Tort Kingpins*

“King of Class Actions” Bill Lerach

•

Former partner in class action firm Milberg

Weiss

•

Admitted felon. Guilty of paying 3 plaintiffs

$11.4 million in 150+ cases over 25 years &

lying about it repeatedly to courts

•

Will serves 1-2 years in prison and forfeit

$7.75 million; $250,000 fine

“King of Torts” Dickie Scruggs

•

Won billions in tobacco, asbestos and

Katrina litigation

•

Pleaded guilty for attempting to offer a judge

$40,000 bribe to resolve attorney fee allocation

from Katrina litigation in his firm’s favor.

His son/others

Æ

guilty on related charges

•

Could get 5 years in prison, $250,000 fine

Source: San Diego Un

ion Tribune, 9/19/07

Source: Wa

ll

$17.0 $49.6 $58.7 $85.6 $17.1 $51.0 $70.9 $85.6 $5.2 $20.4 $30.0 $45.5 $0 $50 $100 $150 $200 $250 1980 1990 2000 2006

Commercial Lines Personal Lines Self (Un)Insured

Billions

Total = $39.3 Billion

*Excludes medical malpractice

Source: Tillinghast-Towers Perrin, 2007 Update on US Tort Cost Trends. Total = $121.0 Billion

Total = $159.6 Billion

Total = $216.7 Billion

Personal, Commercial &

Self (Un) Insured Tort Costs*

Tort System Costs,

1950-2009E

Tort Sytem Costs Tort Costs as % of GDP

Source: Tillinghast-Towers Perrin, 2007 Update on U.S. Tort Costs as % of GDP

After a period of rapid escalation, tort system costs as

a % of GDP are now falling

The Nation’s Judicial

Hellholes (2007)

Source: American Tort Reform Association; Insurance Information Institute

TEXAS Rio Grande Valley and Gulf Coast South Florida ILLINOIS

Cook County West Virginia

Some improvement

in “Judicial

Hellholes” in 2007

Watch List

Dishonorable

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