Riding the Economic Tsunami: Marine Insurance, Economic Crisis and the Insurance Cycle

1
Riding the Economic TsunamiMarine Insurance,
Economic Crisis and the Insurance Cycle
Board of Marine Underwriters San Francisco,
CA May 1, 2008
Robert P. Hartwig, Ph.D., CPCU,
President Insurance Information Institute ? 110
William Street ? New York, NY 10038 Tel (212)
346-5520 ? Fax [phone] ? bobh_at_iii.org ?
www.iii.org
2
Presentation Outline

• Premium, Profits Growth
• Ocean Marine markets have the upper hand
• Underwriting Trends
• Ocean Marine Outperforms
• The Economic Tsunami Insurance Industry Impacts
• Economic Environment for Marine Insurers
• Marine insurers are riding the tide
• Bubble Trouble
• Top Threats Facing Marine Insurers Today
• Global Economic Review
• Ascendencey of China
• Restructuring of Global Trade Patterns
• Investment Overview
• Catastrophic Loss
• Shifting Legal Liability Tort Environment

3
PREMIUMS, PROFITS GROWTHMarine Market is More
Stable Than Market Overall
4
PREMIUMSOverall Industry Growth Falling, But
Marine Growth Continues
5
Global Marine Hull Premium 2005
Europe and Asia write the majority of marine hull
coverage Just 6.3 was written in the US in 2005.
Source IUMI and Cefor (The Central Union of
Marine Underwriters)
6
Marine Insurance Hull Premiums 2005, Market Share
Europe and Asia write the majority of marine hull
coverage
Source CEFOR (Central Union of Marine
Underwriters Norway).
7
Global Marine Premium 1999-2005 (US Million), as
reported
Aggregate premiums are flat, which is better than
the declines in most commercial segments
Source CEFOR (Central Union of Marine
Underwriters Norway) presented at IUMI
conference Tokyo, September, 2006.
8
Strength of Recent Hard Markets by NWP Growth
1975-78
1984-87
2001-04
Post-Katrina period resembles 1993-97
(post-Andrew)
2007 -0.6 premium growth was the first decline
since 1943
Note Shaded areas denote hard market
periods. Source A.M. Best, Insurance
Information Institute
9
Growth in Net Written Premium, 2000-2008F
P/C insurers are experiencing their slowest
growth rates since 1943 underwriting results are
deteriorating
2008 forecast from A.M. Best. Source A.M.
Best Forecasts from the Insurance Information
Institute.
10
Personal/Commercial Lines Reinsurance NPW
Growth, 2006-2008F
Net written premium growth is expected to be
slower for commercial insurers and reinsurers
Sources A.M. Best Review Preview (historical
and forecast).
11
Net Written Premium GrowthOcean Marine vs. All
Lines
Ocean Marine premium growth has outpaced the
industry overall (5.8 vs. 4.3) since 1990
every year since 2001
Ocean Marine growing faster than almost any other
p/c segment
Source A.M. Best, Insurance Information
Institute 2006/07 Ocean Marine
figure from AIMU.
12
Ocean Marine Lines vs. All P/C Premium Growth,
2006-2007
Ocean Marine is likely the fastest growing major
line in the p/c insurance industry
Most Ocean Marine lines are growing much faster
than the overall p/c insurance industryone of
the few lines showing any growth at all
All P/C lines is net premiums written (A.M.
Best), Ocean Marine coverages are direct basis
(AIMU).
13
Average Commercial Rate Change,All Lines,
(1Q2004 1Q2008)
Magnitude of rate decreases diminished greatly
after Katrina but have grown again
-0.1
KRW Effect
Source Council of Insurance Agents Brokers
Insurance Information Institute
14
Cumulative Commercial Rate Change by Line 4Q99
1Q08
Commercial account pricing has been trending down
for 3 years and is now on par with prices in
late 2001, early 2002
Source Council of Insurance Agents Brokers
15
UNDERWRITINGTRENDS Ocean Marine Markets
Outperform Industry
16
P/C Insurance Combined Ratio, 1970-2008F
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.
17
P/C Insurance Combined Ratio, 2001-2008F
2007/8 deterioration due primarily to falling
rates, but results still strong assuming normal
CAT activity
As recently as 2001, insurers were paying out
nearly 1.16 for every dollar they earned in
premiums
2006 produced the best underwriting result since
the 87.6 combined ratio in 1949
2005 figure benefited from heavy use of
reinsurance which lowered net losses
Sources A.M. Best ISO, III. III estimates for
2008.
18
Ten Lowest P/C Insurance Combined Ratios Since
1920 vs. 2007
2007 was the 20th best since 1920
The 2006 combined ratio of 92.2 was the best
since the 87.6 combined in 1949
The industrys best underwriting years are
associated with periods of low interest rates
Sources Insurance Information Institute research
from A.M. Best data. 2007 III Earlybird survey.
19
Underwriting Gain (Loss)1975-2008F
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.
Billions
Source A.M. Best, Insurance Information
Institute
20
Impact of Reserve Changes on Combined Ratio
Reserve adequacy has improved substantially
Source A.M. Best, Lehman Brothers estimates for
years 2007-2009
21
Combined Ratio Ocean Marine Lines vs. All P/C,
2006-2007
Ocean Marine is among the best performing p/c
lines
All P/C lines is net premiums written (A.M.
Best), Ocean Marine coverages are direct basis
(AIMU). III
22
Combined RatioOcean Marine vs. Commercial Lines
Ocean Marine consistently outperforms Commercial
Lines 1989-2007 Combined Ratios Ocean Marine
104.1 Commercial Lines 108.0
Source A.M. Best, American Institute of Marine
Underwriters 2007 commercial lines est. from
I.I.I.
23
Combined RatioOcean Marine vs. All Lines
Ocean Marine has slightly outperformed the
industry overall (104.1 vs. 105.7) since 1989
Source A.M. Best, American Institute of Marine
Underwriters 2007 commercial lines est. from
I.I.I.
24
Commercial Lines Combined Ratio, 1993-2007E
Outside CAT-affected lines, commercial insurance
is doing fairly well, but premiums are dropping
2006/07 results will benefited from relatively
disciplined underwriting, low CAT losses, reserve
releases
Source A.M. Best Insurance Information
Institute estimate for 2007. .
25
PROFITABILITYProfits in 2006/07 ReachedTheir
Cyclical Peak
26
P/C Net Income After Taxes1991-2008F (
Millions)

• 2001 ROE -1.2
• 2002 ROE 2.2
• 2003 ROE 8.9
• 2004 ROE 9.4
• 2005 ROE 9.6
• 2006 ROE 12.2
• 2007 ROAS1 12.3

Insurer profits peaked in 2006
ROE figures are GAAP 1Return on avg. surplus.
Return on Average Surplus Sources A.M. Best,
ISO, Insurance Information Inst.
27
ROE P/C vs. All Industries 19872008E
P/C profitability is cyclical, volatile and
vulnerable
Sept. 11
Hugo
Katrina, Rita, Wilma
Lowest CAT losses in 15 years
Andrew
Northridge
4 Hurricanes
2008 P/C insurer ROE is I.I.I. estimate. Source
Insurance Information Institute Fortune
28
Personal/Commercial Lines Reinsurance ROEs,
2006-2008F
ROEs are declining as underwriting results
deteriorate
Sources A.M. Best Review Preview (historical
and forecast).
29
Profitability Peaks Troughs in the P/C
Insurance Industry,1975 2008F
197719.0
198717.3
200612.2
10 Years
199711.6
9 Years
10 Years
1975 2.4
1984 1.8
1992 4.5
2001 -1.2
GAAP ROE for all years except 2007 which is
actual ROAS of 12.3. 2008 P/C insurer ROE is
I.I.I. estimate. Source Insurance Information
Institute, ISO Fortune
30
ROE vs. Equity Cost of CapitalUS P/C
Insurance1991-2007
The p/c insurance industry achieved its cost of
capital in 2005/6 for the first time in many years
1.7 pts
2.3 pts
-9.0 pts
-0.1 pts
0.2 pts
-13.2 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
The cost of capital is the rate of return
insurers need to attract and retain capital to
the business
Source The Geneva Association, Ins. Information
Inst.
31
P/C, L/H Stocks Ahead of the SP 500 Index in
2008
Total YTD Returns Through April 11, 2008
P/C insurance stocks not affected as much as the
overall market by credit, subprime concerns
Mortgage Financial Guarantee insurers were down
69 in 2008
Includes Financial Guarantee. Source SNL
Securities, Standard Poors, Insurance
Information Inst.
32
Factors that Will Influence theLength 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
• 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
• Looming reserve deficiencies are not hanging over
  insurers they way they did during the last soft
  market in the late 1990s
• Many companies have been releasing redundant
  reserves, which allows them to boost net income
  even as underwriting results deteriorate
• 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 fall?Contributes
  to discipline
• Realized capital gains are already rising as
  underwriting profits shrink, but like redundant
  reserves, realized capital gains are a finite
  resource
• A sustained equity market decline (and
  potentially a drop in bond prices at some point)
  could reduce policyholder surplus

Source Insurance Information Institute.
33
Factors that Will Influence the Length and Depth
of the Cycle (contd)

• Sarbanes-Oxley Presumably SOX will lead to
  better and more conservative management of
  company finances, including rapid recognition of
  deficient or redundant reserves
• With more eyes on the industry, the theory is
  that cyclical swings should shrink
• Ratings Agencies Focus on Cycle Management
  Quicker to downgrade
• Ratings agencies more concerned with successful
  cycle management strategy
• 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.
• Management has backing of investors of Wall
  Street to remain disciplined
• MA Activity More consolidation implies greater
  discipline
• Liberty Mutual/Safeco deal creates 5th largest
  p/c insurer. More to come?

Source Insurance Information Institute.
34
A STORMY ECONOMIC FORECASTWhat a Weakening
Economy Credit Crunch Mean for the Insurance
Industry
35
Percent Change in GDP By Country,2006-2009F
US growth is among the slowest in 2008
Economic growth is expected to slow globally in
2008, adversely impact global exposure growth and
slowing absorption of excess capital
Best estimates available. In most cases,
actual data for 2007 GDP are not yet available.
Where actual data not available, figures are
consensus forecasts from April 10, 2007 issue of
Blue Chip Economic Indicators. Source Blue Chip
Economic Indicators, April 10, 2008.
36
Real GDP Growth
Economic growth is slowed dramatically in late
2007 into 2008
Yellow bars are Estimates/Forecasts. Source US
Department of Commerce, Blue Economic Indicators
4/08 Insurance Information Institute.
37
Whats Going On With the US and Global Economies
Today?

• Fundamental Factors Affecting Global Economy in
  2008
• Puncture of Two Bubbles Credit and Housing in US
• Burst Bubble?Asset Price Deflation
• Subprime mortgage market was first part of credit
  bubble to burst
• Credit Crunch Some credit markets have
  effectively seized
• Global Contagion Effect Securitization of asset
  back securities, derivatives based on those
  securities amplified via leverage produced
  contagion effect
• Many financial institutions around the world
  found they are exposed
• Many hedge funds, banks caught holding CDOs,
  credit default swaps and other instruments
  against which they borrowed heavily (sometimes
  101)
• Some face margin calls, distressed selling of
  every type of asset except Treasuries
• Global Economic Impacts Global Economic Slowdown
• GDP growth in US down sharply, employment
  falling Deceleration abroad too
• Decoupling theory was naïve
• Crashing dollar is symptom of irresponsible US
  fiscal policy, trade deficits. IOUs are being
  redeemed for hard assets or states in
  corporations
• New bubbles forming in commodities and currencies

Source Insurance Information Institute.
38
Toward a New WorldEconomic Order

• Credit Crunch (incl. Subprime) Issue Will
  Ultimately Cost Hundreds of Billions Globally
  (est. up to 600B)
• Problem exacerbated by leveraged bets taken by
  some financial institutions therefore its reach
  extends beyond simple defaults
• Heavy Toll on Capital Base of Some Large
  Financial Institutions Worldwide (e.g., Bear
  Stearns)
• Cash infusions necessary Sovereign Wealth Funds
  important source
• Federal Reserve forced into playing a larger
  role must improvise
• Most Significant Economic Event in a Generation
• US economy will recover, but will take 18-24
  months
• Shuffling of Global Economic Deck Economic
  Pecking Order Shifting
• China, oil producing countries hold the upper
  hand
• IOUs are Being Redeemed
• Stakes in hard assets/institutions demanded
• Good News No Shortage of Available Capital
• Central banks are (generally) making right
  decisions Dollar sinks

Source Insurance Information Institute
39
Whats Being Done to Fix the Economy??Impacts on
Insurers
Economic Fix Impacts on Insurers
Fed Rate Cuts Reduces bond yields (65 - 80 of portfolio) Potentially contributes to inflation longer run
Fed Debt Swap Fed will swap up to 200B in bank holdings of mortgage back securities for Treasuries up to 28 days Improves bank finances
Fed Bailout of Bear Stearns Fed on 3/14 (via J.P. Morgan) provided Bear with cash after what is effectively a run on the bank Too Big to Fail doctrine is activated Fed acting to prevent broader loss of confidence 3/17 J.P. Morgan buys Bear for 236 million (2/share) Price increased to 10 on 3/24
Source Insurance Information Institute
40
Whats Being Done to Fix the Economy??Impacts on
Insurers (contd)
Economic Fix Impacts on Insurers
Stimulus Package Hope is that 168B plan boosts overall economic activity and employment (by 500,000 jobs) and therefore p/c personal and commercial exposures Contributes to already exploding budget deficitsWashington may expand its search for people and industries to tax
Housing Bailout (?) Keeps more people in their homes and hopefully paying HO insurance premiums Abandoned and neglected homes have demonstrably worse loss performance
Regulatory/ Legislative Action (?) Treasury March 31 Blueprint affects all financial firms For insurers, major recommendation is established of Optional Federal Charter under Office of National Insurance within Treasury
Source Insurance Information Institute
41
Post-Crunch Fundamental Issues To Be Examined
Globally

• Adequacy of Risk Management, Control
  Supervision at Financial Institutions Worldwide
• Colossal failure of risk management (and
  regulation)
• Implications for ERM?
• Includes review of incentives
• Effectiveness and Nature of Regulation
• What sort of oversite is optimal given recent
  experience?
• Credit problems arose under US and European
  (Basel II) regulatory regimes
• Will new regulations be globally consistent?
• Can overreactions be avoided?
• Capital adequacy liquidity
• Accounting Rules
• Problems arose under FAS, IAS
• Asset Valuation, including Mark-to-Market
• Structured Finance Complex Derivatives
• Ratings on Financial Instruments
• New approaches to reflect type of asset, nature
  of risk

Source Insurance Information Institute
42
Summary of Treasury Blueprintfor Financial
Services ModernizationImpacts on Insurers
43
Treasury Regulatory Recommendations Affecting
Insurers

• Establishment of an Optional Federal Charter
  (OFC)
• Would provide system for federal chartering,
  licensing, regulation and supervision of
  insurers, reinsurer and producers (agents
  brokers)
• OFC insurers would still be subject to state
  taxes, provisions for compulsory coverage,
  residual market and guarantee funds
• OFC would specify specific lines covered by
  charter Separate charters needed for P/C and
  Life
• OFC Would Incorporate Several Regulatory Concepts
  
• Ensure safety and soundness
• Enhance competition in national and international
  markets
• Increase efficiency through elimination of price
  controls, promote more rapid technological
  change, encourage product innovation, reduce
  regulatory costs and provide consumer protection

Source Department of Treasury Blueprint for a
Modernized Financial Regulatory System, March
2008.
44
Treasury Regulatory Recommendations Affecting
Insurers (contd)

• Establishment of Office of National Insurance
  (ONI)
• Department within Treasury to regulate insurance
  pursuant to OFC
• Headed by Commissioner of National Insurance
• 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)
• 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
• OIO lead regulatory voice on international
  regulatory policy
• Would have authority to ensure states achieved
  uniform implementation of declared US
  international insurance policy goals
• 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)
• Very similar to OIO

Source Department of Treasury Blueprint for a
Modernized Financial Regulatory System, March
2008.
45
Insurance The EconomyImportant But Somewhat
Muted Impacts
46
A Few Facts About the Relationship Between
Insurance Economy

• Vast Majority of Insurance Business is Tied to
  Renewals
• Approximately 98 of P/C business (units) is
  linked to renewals
• A very large share of p/c insurance premiums are
  statutorily or de facto compulsory (e.g., WC,
  auto liability, surety, usually HO)
• P/C insurers have marginal exposure impact due to
  economy
• Ocean Marine may be volatile because of
  association with global trade flows
• Yachtsluxury for some, necessity for others
• Insurers are Sensitive to Interest Rates
• About 2/3 of P/C invested assets and 75 if Life
  assets are fixed income
• Historically, yield on industry portfolios has
  tracked 10-year note closely
• All else equal, lower total investment gain
  implies greater emphasis on underwriting
• Historically, industrys 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)

Source Insurance Information Institute.
47
Real GDP Growth vs. Real P/C Premium Growth
Modest Association
P/C insurance industrys growth is influenced
modestly by growth in the overall economy
Sources A.M. Best, US Bureau of Economic
Analysis, Blue Chip Economic Indicators, 2/08
Insurance Information Inst.
48
Summary of Economic Risks and Implications for
(Re) Insurers
Economic Concern Risks to Insurers
Subprime Meltdown/ Credit Crunch Some insurers have some asset risk DO/EO exposure for some insurers Client asset management liability for some Bond insurer problems Muni credit quality
Housing Slump Reduced exposure growth Deteriorating loss performance on neglected, abandoned and foreclosed properties
Lower Interest Rates Lower investment income
Stock Market Slump Decreased capital gains (which are usually relied upon more heavily as a source of earnings as underwriting results deteriorate)
General Economic Slowdown/Recession Reduced commercial lines exposure growth Surety slump Increased workers comp frequency
49
New Private Housing Starts,1990-2014F (Millions
of Units)
Exposure growth forecast for HO insurers is dim
for 2008/09 Impacts also for comml. insurers with
construction risk exposure
New home starts plunged 34 from 2005-2007 Drop
through 2008 trough is 53 (est.)a net annual
decline of 1.09 million units
I.I.I. estimates that each incremental 100,000
decline in housing starts costs home insurers
87.5 million in new exposure (gross premium).
The net exposure loss in 2008 vs. 2005 is
estimated at 954 million.
Source US Department of Commerce Blue Chip
Economic Indicators (10/07), except 2008/09
figures from 4/08 edition of BCEF Insurance
Info. Institute
50
Auto/Light Truck Sales,1999-2014F (Millions of
Units)
Weakening economy, credit crunch and high gas
prices are hurting auto sales
New auto/light trick sales are expected to
experience a net drop of 1.4 million units
annually by 2008 compared with 2005, a decline of
9.5
Import sales will suffer too, but foreign auto
makers have more fuel economy experience. Weak
dollar is an incentive to shift more capacity to
US.
Source US Department of Commerce Blue Chip
Economic Indicators (10/07), except 2008/09
figures from 4/08 edition of BCEF Insurance
Info. Institute
51
Inflation Rate (CPI-U, ),1990 2009F
Inflation was just 2.2 in 2007 but is
accelerating. Medical cost inflation, important
in WC, auto liability and other casualty covers
is running far ahead of inflation. Rising
inflation can also lead to rate inadequacy and
adverse reserve development
12-month change Feb. 2008 vs. Feb. 2007
Source US Bureau of Labor Statistics Blue Chip
Economic Indicators, Mar. 10, 2008 Ins. Info.
Institute.
52
Favored Industry Groups for Insurer Exposure
Growth
Industry Rationale
Health Care Economic Necessity?Recession Resistant Demographics aging/immigration?Growth
Energy (incl. Alt.) Fossil, Solar, Wind, Bio-Fuels, Hydro Other
Agriculture Food Processing Consumer Staple?Recession Resistant Grain and land prices high due to global demand, weak dollar (exports) Acreage Growing?Farm Equipment, Transport Benefits many other industries
Export Driven Weak dollar, globalization persist Cuba angle?
Natural Resources Commodities Strong global demand, Supplies remain tightbut beware of bubbles Significant investments in RD, plant equip required
Sources Insurance Information Institute
53
Bubble TroubleDirect Impacts onOcean Marine
Insurers
54
World Crude Oil Prices 1997- April 2008
Dollars per Barrel
Crude oil prices in April 2008 (107.28) are up
605 since January 1998 (15.21) and 106 from
Feb. 2007 (52.11)
As of April 18, 2008 oil prices were a record
107.28 per barrel
All countries spot market price weighted by
estimated export volume. Source Energy
Information Administration http//tonto.eia.doe.
gov/dnav/pet/hist/wtotworldw.htm
55
Dow Jones-AIG Commodity Price Index, 2000-2008
Commodities prices have soared in recent years
doubling since 2002 Sign of demand, weak dollar,
flight to hard assets, speculation
Are commodities experiencing their own price
bubble?
2008 values through April 29. Sources Dow
Jones http//www.djindexes.com/mdsidx/downloads/x
lspages/aigci/djaig_full_hist.xls accessed
1/30/08 I.I.I. calculations based on daily
values.
56
Energy Price Index, 2000-2008
Energy prices in April 2008 were 34 above their
2007 average
Are energy prices in the midst of a bubble?
2008 values through April 29. Sources Dow
Jones-AIG http//www.djindexes.com/mdsidx/downloa
ds/xlspages/aigci/djaig_full_hist.xls accessed
1/30/08 I.I.I. calculations based on daily index
values.
57
Petroleum Price Index,2000-2008
Oil prices are soaring due to weak dollar,
refinery bottlenecks, speculation, flight from
real estate/stocks/low interest rates demand
from emerging economies
Petroleum prices in April 2008 were 49 above
their 2007 average and 283 above 2002 levels
2008 values through April 29. Sources Dow
Jones-AIG http//www.djindexes.com/mdsidx/downloa
ds/xlspages/aigci/djaig_full_hist.xls accessed
1/30/08 I.I.I. calculations based on daily index
values.
58
Grain Price Index, 2000-2008
Grain prices are surging due to speculation,
strong demand, poor harvests, diversion of crops
for biofuels and more recently export quotas
hoarding
Energy prices in April 2008 were 76 above their
2006 level
2008 values through April 29. Sources Dow
Jones-AIG http//www.djindexes.com/mdsidx/downloa
ds/xlspages/aigci/djaig_full_hist.xls accessed
1/30/08 I.I.I. calculations based on daily index
values.
59
Depreciation of Dollar is Partly Responsible for
Rising Energy Prices
Weakening dollar spurs oil producers to try to
maintain purchasing power by keeping oil prices
high. Dollar has dropped 57 relative to Euro
since 2001.
Interest rate cuts will keep downward pressure on
the dollar
As of April 30, 2008. Source Board of
Governors of the Federal Reserve Bank Insurance
Information Institute.
60
Economic Environment for Marine Insurers
Protectionism, Commodities Boom, Economic Bust
Make for Uncertain Future
61
Top Economic Threats toOcean Marine Insurers

• Global Economic Meltdown
• Universal and protracted decline in shipping
  volume
• Protectionism
• Anti-globalization forces, protectionist
  sentiments and xenophobia threaten to undo NAFTA
  and other accords
• Some politicians are fanning these flames
  (election year)
• Few, if any, new accords in the near/mid-term
  future
• Collapse of Commodities Bubble
• Collapse could dramatically slow shipments
  (temporarily)
• Terrorist Attacks
• Attacks on shipping or ports could be devastating
  in terms of hull, cargo, facilities and
  contingent business inter.
• Supply Chain Disruption
• Shift in Tort Environment
• Environmental vulnerabilities loom large
• Higher Taxes on the Wealthy Capital Gains
• Hurts Yacht Sales

Source Insurance Information Institute.
62
Global Economic Outlook Points to Long Run Marine
Insurance Growth

• Global economic growth suggests intl. trade in
  finished products, raw materials as well as
  energy demand and exploration will remain strong.
• Current credit crunch will hurt global growth
  through 2009
• The 21st century is the century of Chinese
  ascendancy. China today is very much like late
  19th century Americaindustrious, rapid growth,
  internationally and militarily ambitious and
  certain of its destiny and primacy over the old
  world order. But inflation looms, country is an
  environmental disaster (incl. waterways)
• Defective products scare wont dent trade much
  or for long
• US dollar is undervalued but not likely to fully
  recover Expect more shipping within regional
  trade zones and blocks (e.g., within Southeast
  Asia, Middle East)

Source Aon III..
63
But Patterns of Global Economic Growth and Trade
May Shift

• Maturation of Chinese Economy
• Implies web of trade will extend further into
  developing world (South Asia, Africa), aiding
  international marine shipping business
• Number and Size of Marine Shipping Growth Zones
  Will Expand
• Intra-Asian trade will expand
• Asia-Africa
• Asia-Australia
• Middle East - World
• Russia World
• Arctic (Transit Resource Hub)
  Europe/Asia/North America

Source Insurance Information Institute.
64
Changes in Global Economy are Pushing Shipping
Industry Changes

• Strong demand for shipping
• Building of ever larger ships
• Creates concentration of risk problem
• Significant number of new ships under
  construction
• Shipyards are building for or have orders for in
  2007/2008 as much as 20 of the current world
  fleet
• Manpower (crew) shortages are more likely
• Port and lock log jams New routes needed
• Expansion of Panama Canal
• Arctic routes
• Eventually shipping industry will see
  overcapacity and falling transport prices

Source Aon Marine Insurance Review, 2006
Insurance Information Institute.
65
Ship Prices RisingBigger Ships, Strong Demand
Millions

• Ship prices are up 50 on average. Builders are
  ramping-up production, cutting production time.
  China is trying to compete with Japan and Korea.
• Cargo/Hull losses for a mage-ship could exceed
  1B - 2 billion.

Source Clarkson Research Services, Insurance
Information Institute
66
Real GDP By Country 1994-2008E( change from
previous year)
Slowdown expected through 2008
Source OECD Economic Outlook No. 81
67
Current Account Balancesas a of GDP
Americas current account deficit continues to
grow and remains one of the biggest risks to
economic stability. It also contributes to the
dollars depreciation which should eventually
lead to export growth.
Forecasts Source OECD Economic Outlook 81
database
68
U.S./CHINA TRADE
69
Chinas Trade With The World( billion)
Billion
Chinas export and import growth rates are
exploding. Chinas total import and export volume
reached 1,761 billion in 2006, a 24 increase on
2005.
Note PRC exports reported on a FOB
basis Sources U.S. China Business Council PRC
General Administration of Customs, Chinas
Customs Statistics and the National Bureau of
Statistics.
70
Chinas Top Trade Partners 2006( billion)
The U.S. is Chinas top trade partner, as are
other major world shipping centers.
Source PRC General Administration of Customs,
Chinas Customs Statistics
71
Top 5 Exports from China 2006(Volume billion)
High-end goods account for majority of Chinas
top exports and contribute to rapidly increasing
cargo values
Source PRC General Administration of Customs,
Chinas Customs Statistics
72
Top 5 U.S. Imports from China 2006(Volume
billion)
High-end goods also account for majority of U.S.
imports from China and contribute to rapidly
increasing cargo values
Source U.S. International Trade Commission, U.S.
Department of Commerce, and U.S. Census Bureau
73
Chinas Trade With The U.S.( billion)
billion
U.S. imports from China grew by 242.2 billion
from 1997 to 2006, while U.S. exports to China
grew by 43.4 billion during the same period
Note U.S. exports reported on FOB basis imports
on a general customs value, CIF basis Sources
U.S. International Trade Commission, U.S.
Department of Commerce and U.S. Census Bureau.
74
Recent Insurer Expansions in China

• Chinas liberalizing market brings opportunities
  in non-life insurance, including marine
• July 2007 AIG subsidiary AIU Insurance Co (AIU)
  granted approval to establish wholly owned
  subsidiary in China. AIG General will expand
  non-life capabilities.
• March 2007 Lloyds receives approval for new
  reinsurance operation Lloyds Reinsurance Co
  China Ltd (LRCCL). Will write onshore reinsurance
  biz throughout China.
• January 2007 Marsh awarded Chinas first Wholly
  Owned Foreign Enterprise insurance broking
  license. Marsh (Beijing) Insurance Brokers will
  expand companys focus on large-scale commercial
  risk, including international marine.
• Zurich gains control of a Chinese broker in Aug.
  2007

Source AIG Marsh Lloyds press releases III
75
KEY INDUSTRY FINANCIALS Factors Affecting the
Industry Behind the Scenes
76
FINANCIAL STRENGTH RATINGS Industry Has
Weathered the Storms Well, But Cycle May Takes
Its Toll
77
P/C Insurer Impairment Frequency vs. Combined
Ratio, 1969-2007E
Impairment rates are highly correlated
underwriting performance and could reach
near-record low in 2007
2006 impairment rate was 0.43, or 1-in-233
companies, half the 0.86 average since 1969
2007 will be lower Record is 0.24 in 1972
Source A.M. Best Insurance Information
Institute
78
Reasons for US P/C Insurer Impairments, 1969-2005
2003-2005
1969-2005
Deficient reserves, CAT losses are more important
factors in recent years
Includes overstatement of assets. Source
A.M. Best P/C Impairments Hit Near-Term Lows
Despite Surging Hurricane Activity, Special
Report, Nov. 2005
79
CAPACITY/SURPLUS Accumulation of Capital/
Surplus Depresses ROEs
80
U.S. Policyholder Surplus 1975-2007
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.
Billions
The premium-to-surplus fell to 0.851 at
year-end 2007, approaching its record low of
0.841 in 1998
Surplus is a measure of underwriting capacity.
It is analogous to Owners Equity or Net Worth
in non-insurance organizations
Source A.M. Best, ISO, Insurance Information
Institute. As of
December 31, 2007
81
Lloyds Insurance Market Capacity, 1998-2008 (
billions)
The capacity of the Lloyds 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.
billions
Beginning of the year. Source Lloyds Members
Services Unit.
82
Annual Catastrophe Bond Transactions Volume,
1997-2007
Catastrophe bond issuance has soared in the wake
of Hurricanes Katrina and the hurricane seasons
of 2004/2005, despite two quiet CAT years
Source MMC Securities Guy Carpenter, A.M. Best
Insurance Information Institute.
83
P/C Insurer Share Repurchases,1987- Through Q4
2007 ( Millions)
2007 share buybacks shattered the 2006 record, up
214

• Reasons Behind Capital Build-Up Repurchase
  Surge
• Strong underwriting results
• Moderate catastrophe losses
• Reasonable investment performance
• Lack of strategic alternatives (MA, 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
Sources Credit Suisse, Company Reports
Insurance Information Inst.
84
MERGER ACQUISITIONCatalysts for P/C
Consolidation Growing in 2008
85
P/C Insurance-Related MA Activity, 1988-2006
MA activity began to accelerate during the
second half of 2007
No model for successful consolidation has emerged
Source Conning Research Consulting.
86
Motivating Factors for Increased P/C Insurer
Consolidation

• Motivating Factors for P/C MAs
• Slow Growth Growth is at its lowest levels since
  the late 1990s
• NWP growth was 0 in 2007 Appears similarly flat
  in 2008
• Prices are falling or flat in most non-coastal
  markets
• Accumulation of Capital Excess capital depresses
  ROEs
• Policyholder Surplus up 6-7 in 2007 and up 80
  since 2002
• Insurers hard pressed to maintain earnings
  momentum
• Options Share Buybacks, Boost Dividends, Invest
  in Operation, Acquire
• Option B Engage in destructive price war and
  destroy capital
• Reserve Adequacy No longer a drag on earnings
• Favorable development in recent years offsets
  pre-2002 adverse develop.
• Favorable Fundamentals/Drop-Off in CAT Activity
• Underlying claims inflation (frequency and
  severity trends) are benign
• Lower CAT activity took some pressure of capital
  base

Source Insurance Information Institute.
87
INVESTMENT OVERVIEW More Pain, Little Gain
88
Property/Casualty Insurance Industry Investment
Gain1
Investment rose in 2007 but are just 9.8 higher
than what they were nearly a decade earlier in
1998
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.
89
Property/Casualty Industry Investment Results,
1994-2007
Realized capital gains rising as underwriting
results slip
63.6
59.2
57.7
57.9
55.8
52.3
48.9
45.6
44.0
35.6
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.
90
US P/C Net Realized Capital Gains,1990-2007 (
Millions)
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
Sources A.M. Best, ISO, Insurance Information
Institute.
91
Total Returns for Large Company Stocks 1970-2008
SP 500 was up 3.5 in 2007, down 5.27 YTD 2008
Markets were up in 2007 for the 5th consecutive
year 2008 could be first down year since 2002
Source Ibbotson Associates, Insurance
Information Institute. Through
April 29, 2008.
92
P/C Investment Income as a of Invested Assets
Follows 10-Year US T-Note
Investment yield historically tracks 10-year
Treasury note quite closely
As of January 2008 month-end. Sources Board of
Governors, Federal Reserve System A.M.Best
Insurance Information Institute.
93
CATASTROPHICLOSS What Will 2008 Bring?
94
Most of US Population Property Has Major CAT
Exposure
Most of the Coast at Risk
95
U.S. Insured Catastrophe Losses
Billions
100 Billion CAT year is coming soon
2006/07 were welcome respites. 2005 was by far
the worst year ever for insured catastrophe
losses in the US, but the worst has yet to come.
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
96
Inflation-Adjusted U.S. Insured Catastrophe
Losses By Cause of Loss, 1987-2006¹
Insured disaster losses totaled 297.3 billion
from 1987-2006 (in 2006 dollars). Wildfires
accounted for approximately 6.6 billion of
these2.2 of the total.
1 Catastrophes are all events causing direct
insured losses to property of 25 million or more
in 2006 dollars. Catastrophe threshold changed
from 5 million to 25 million beginning in 1997.
Adjusted for inflation by the III. 2 Excludes
snow. 3 Includes hurricanes and tropical storms.
4 Includes other geologic events such as volcanic
eruptions and other earth movement. 5 Does not
include flood damage covered by the federally
administered National Flood Insurance Program. 6
Includes wildland fires.
Source Insurance Services Office (ISO)..
97
Insured Offshore Energy Losses for Recent Major
Gulf Storms
Hurricanes Katrina, Rita and Ivan cost energy
insurers at least 7 billion
Sources Insurance Information Institute research
estimates. Midpoint of estimated range for
2.0 to 2.5 billion)
98
Great Natural Disasters Overall Insured Losses,
1950 2007
Insured and total losses surged earlier in this
decade
US Billions
Insured losses
Overall losses
(2007 values)
(2007 values)
Trend insured losses
Trend overall losses
99
Great Natural Disasters 1950 - 2007(Percentage
Distribution Worldwide)
Deaths 1.8 Million
Number of events 283
2
6
7
28
25
55
36
41
Insured losses US 370bn
Overall losses US 1,770bn
4
6
10
5
30
24
40
81
2007 values
100
Natural Catastrophe Insured Lossesby Region,
2002 2007 ( Bill)
North America accounted for 70 of global
catastrophe losses 2001-2007
101
The 2008 Hurricane SeasonPreview to Disaster?
102
Outlook for 2008 Hurricane Season 60 Worse Than
Average
Average 2005 2008F
Named Storms 9.6 28 15
Named Storm Days 49.1 115.5 80
Hurricanes 5.9 14 8
Hurricane Days 24.5 47.5 40
Intense Hurricanes 2.3 7 4
Intense Hurricane Days 5 7 9
Accumulated Cyclone Energy 96.2 NA 150
Net Tropical Cyclone Activity 100 275 160
Average over the period 1950-2000. Source
Philip Klotzbach and Dr. William Gray, Colorado
State University, April 9, 2007.
103
Landfall Probabilities for 2008 Hurricane
Season Above Average
Average 2008F
Entire US East Gulf Coasts 52 69
US East Coast Including Florida Peninsula 31 45
Gulf Coast from Florida Panhandle to Brownsville 30 44
Caribbean NA Above Average
Average over the past century. Source Philip
Klotzbach and Dr. William Gray, Colorado State
University, April 9, 2007.
104
REINSURANCE MARKETSReinsurance Prices are
Falling in Non-Coastal Zones, Casualty Lines
105
Share of Losses Paid by Reinsurers, by Disaster
Reinsurance is playing an increasingly important
role in the financing of mega-CATs Reins. Costs
are skyrocketing
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.
106
US Reinsurer Net Income ROE, 1985-2007
Reinsurer profitability rebounded post-Katrina
but is now falling
Source Reinsurance Association of America.
2007 ROE figure is III estimate based return on
average 2007 surplus.
107
Shifting Legal Liability Tort EnvironmentIs
the Tort PendulumSwinging Against Insurers?
108
Bad Year for Tort Kingpins(Continued)

• 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

Source San Diego Union Tribune, 9/19/07

• 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 firms favor. His
  son/others?guilty on related charges
• Could get 5 years in prison, 250,000 fine

Source Wall Street Journal, 3/15/07
109
Bad Year for Tort Kingpins(Continued)

• King of Class Actions Melvyn Weiss
• Former partner in class action firm Milberg
  Weiss Earned 251 million in legal fees
• Pled guilty to federal charges of racketeering
  and conspiracy for paying kickbacks to
  professional plaintiffs
• Will serve 18-33 months in prison, pay 9.75
  million in restitution 250,000 fine

Source Wall Street Journal, 3/24/07
This Space Available
110
Personal, Commercial Self (Un) Insured Tort
Costs
Total 216.7 Billion
Total 159.6 Billion
Billions
Total 121.0 Billion
Total 39.3 Billion
Excludes medical malpractice Source
Tillinghast-Towers Perrin, 2007 Update on US Tort
Cost Trends.
111
Tort System Costs, 1950-2009E
After a period of rapid escalation, tort system
costs as a of GDP are now falling
Source Tillinghast-Towers Perrin, 2007 Update on
U.S. Tort Costs as of GDP
112
The Nations Judicial Hellholes (2007)
Watch List Madison County, IL St. Clair County,
IL Northern New Mexico Hillsborough County,
FL Delaware California Dishonorable
Mentions District of Columbia MO Supreme Court MI
Legislature GA Supreme Court Oklahoma
Some improvement in Judicial Hellholes in 2007
NEW JERSEY Atlantic County (Atlantic City)
NEVADA Clark County (Las Vegas)
ILLINOIS Cook County
West Virginia
South Florida
Source American Tort Reform Association
Insurance Information Institute
113
Business Leaders Ranking of Liability Systems for
2007
New in 2007 ME, NH, TN, UT, WI Drop-Offs ND, VA,
SD, WY, ID

• Best States
• Delaware
• Minnesota
• Nebraska
• Iowa
• Maine
• New Hampshire
• Tennessee
• Indiana
• Utah
• Wisconsin

• Worst States
• Arkansas
• Hawaii
• Alaska
• Texas
• California
• Illinois
• Alabama
• Louisiana
• Mississippi
• West Virginia

Newly Notorious AK Rising Above FL
Midwest/West has mix of good and bad states
Source US Chamber of Commerce 2007 State
Liability Systems Ranking Study Insurance Info.
Institute.
114
Summary

• Results were excellent in 2006/07 Overall
  profitability reached its highest level (est.
  13-14) since 1988
• Strong 2007 but ROEs slipping Momentum for 2008
• Ocean Marine markets generally outperform overall
  P/C insurance industry
• Low dollar benefiting exporting firms and marine
  transport business
• Restructucting of global trading pattern underway
  as China and other nations become exert more
  economic influence
• Industry growth rates are slowing to their levels
  since WW II
• Rising investment returns insufficient to support
  deep soft market in terms of price, terms
  conditions as in 1990s
• Major Challenges
• Slow Growth Environment Ahead Cyclical
  Economic
• Maintaining price/underwriting discipline
• Managing variability/volatility of results
• Managing regulatory/legislative activism

115
Insurance Information Institute On-Line
WWW.III.ORG
If you would like a copy of this presentation,
please give me your business card with e-mail
address