Financial Performance Analysis of the US P&C industry by Sutherland Global Services

Financial Performance Analysis of the US P&C industry January, 2012

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Financial Performance Analysis of the US P&C industry Client • The client is a leading provider of P&C Insurance based out of the Europe with a need for market assessment of the US P&C insurance industry in terms of financial performance, to help them know the market dynamics of US. insurance industry

Project Scope • Key objectives of the study were: o Understand the U.S. P&C insurance industry o Identify key financial performance of the U.S. P&C insurance industry o Provide key insights regarding the financial performance

Sutherland’s Solution • SGS conducted extensive secondary research to size the U.S. P&C insurance industry, identified major players, along with major trends and challenges in U.S. market, and also identified views of P&C Insurance sector executives. Key bottom-line and top-line performance parameters were also identified • All financial and qualitative databases to which SGS holds subscription, were extensively used to identify key markets in the P&C insurance industry across the U.S. as well as to collate the financial information for them

• Benefits to the Client • The project provided significant and exclusive intelligence to the client with regards to the financial performance and trends of the P&C insurance market in U.S. • After reading the report, the client proceeded to the next step in designing its “Go To Market” Strategy in the U.S. market

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P&C premiums have seen some decline over the last few years, and the outlook is expected to remain similar for the next year Net Earned Premiums (Yearly) $500

$454

$448

$450

Comments

$433

$429

•

$400 $300 $200

•

$100

• $0 2006

2007

2008

2009

2010

• US P&C Market Structure – DPW, 2010 ($bn) US P&C Insurance Market ~$477bn

Standard ~$370–$405bn

A Specialty Insurance

Specialty Admitted

Non-admitted (E&S)

~$40–70bn

~$33bn

1. Note Specialty insurance generally includes person and commercial lines. 2. E&S = Excess and surplus lines 3. DPW = Direct Premiums written Source: Insurance Information Institute, NAIC, Highline Data

•

Personal/Commercial lines split has been about 50/50 for many years; Personal Lines overtook Commercial Lines Commercial Lines in 2010 • Pvt. Passenger Auto is by far the largest line of insurance The specialty insurance segment is also fast growing, and now forms about 18% of the overall P&C market The P&C market is expected to continue to produce underwriting losses with returns on capital below historical averages for the foreseeable future. Recent expansion of underwriting losses has promoted a recent shift in market pricing after years of softening rates. This positive premium rate movement remains in an early stage, but market competition remains fierce • Outside of the U.S., global (re)insurers were hit by significant losses around the world, led by the Japanese earthquake and tsunami in March. As a result, reinsurance pricing for property catastrophe-exposed business is expected to increase at double-digit levels for renewals Industry is expected to see further improvements in pricing as low investment yields, rising property reinsurance costs and stabilizing industry capital positions will make it difficult for the insurers to continue pricing the business below cost.

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Commercial lines have out-performed Personal lines in terms of growth over the last few quarters. However, this does not appear sustainable Top P&C Companies by Direct Premiums Written (2008 & 2010 USD Bn) 0

State Farm

Breakup of US P&C Insurance Industry (DPW, 2010) Pvt. Passenger Auto $165 Bn / 36%

Zurich

Commercial Lines $226 Bn / 49%

Allstate AIG

Liberty Mutual Travelers 2008 2010

Berkshire Hathaway

Homeowners $68.2 Bn / 15%

Nationwide

Net Written Premium Growth (YoY)

Progressive USAA

7.5%

Hartford Financial

5.0%

Chubb

2.5%

Ace 0.0%

C.N.A

-2.5%

Comments •

Premiums from Commercial Lines have grown significantly in the last few years • However, commercial lines are likely to shift to a negative outlook in the near term relative to personal lines, given the fundamental pricing trends. • Commercial insurance rates are at inadequate levels

Source: Insurance Information Institute, NAIC, Bloomberg

-5.0% -7.5% -10.0% 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 07 07 07 07 08 08 08 08 09 09 09 09 10 10 10 10 11 11 Personal Lines Primary Commercial Lines All Lines

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Bottom lines of insurers are impacted because Combined Ratios are at significantly high levels, largely driven by higher loss ratios Expense Ratio & Loss Ratio (Yearly) 120% 100%

105.2%

Comments

100.6%

102.3%

77.4%

72.4%

73.5%

92.7%

95.6%

65.5%

68.1%

27.2%

27.5%

27.8%

28.2%

28.8%

2006

2007

2008

2009

2010

80% 60% 40% 20% 0%

Expense Ratio

Loss Ratio

• Combined ratios in 2Q11 was at 110%, while the Combined Ratio for overall FY11 is expected to be around108% • This increase is driven by continued deterioration of current accident year loss ratios and the sharp increase in catastrophe-related losses. • These factors are partially offset by: • Better than anticipated favourable prior year loss reserve development • A modest expense ratio improvement.

Note: Expense Ratio contains dividend ratio in the range of 0.6% to 0.9%

Combined Ratio (Quarterly) 120% 100% 80% 60% 40% 20% 0%

95.4%

93.9%

64.8% 61.8%

99.0%

98.7%

68.2% 68.0%

96.4% 66.0%

Combined Ratio (Forecast) 101.6%

93.8%

71.0%

63.2%

110.5%

30.5%

31.3%

30.8%

30.6%

30.4%

31.1%

30.6%

3Q09

4Q09

1Q10

2Q10

3Q10

4Q10

1Q11

2Q11

Loss Ratio

Expense Ratio

Actual 2010

81.5%

Forecast 2011

Projection 2012

Loss Ratio

73.6

79.6

74.4

Exp. Ratio

28.3

28.1

27.8

Div. Ratio

0.6

0.4

0.5

102.5

108.1

102.7

Combined Ratio

Source: Insurance Information Institute, NAIC, Bloomberg, SGS Desk Research

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Industry income levels have dropped significantly in the last few quarters, driven by higher losses, low prices, and low investment yields Net Premiums Earned (QoQ, %)

Underwriting Gain (Loss) – 2000 to 2010

20% 14.5%

14.5%

13.7%

12.3%

15%

15.0%

10.2%

10.0%

10% 5%

0.2%

2.3%

0.4%

3.2%

2.0%

1.0%

0% -3.8% 1Q10 2Q10

-5% 3Q09

4Q09

Net Premiums Earned

-0.1% 3Q10

4Q10

-2.0% 1Q11

2Q11

50% -30.4% -36.6%

0% -50%

31.4% -7.8%

-23.6% 32.9%

-30.0% -23.3%

-100%

•

3.7% 1.0%

-18.0%

-134.4%

-150% -177.5%

-200% 3Q09

4Q09

1Q10

Net Income

2Q10

19 $2 -5

3Q10

4Q10

1Q11

Pre Tax Operating Income

-3

-$6 -21

-32

-10 -24.1

-32

-53 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011E

Comments

56.1%

52.4% 54.4%

Operating Margin

Industry Income (QoQ, %) 100%

40 30 20 10 0 -10 -20 -30 -40 -50 -60

2Q11

Catastrophe losses in the first half of 2011 were more than double the level in the first half of 2010, making 2011 already the second-worst year on record Industry underwriting losses resumed in 2008 after achieving two years of profitability • Underwriting losses and combined ratios expected to worsen in 2011, reflecting high level of natural catastrophe activity in first half year • Investment income recovered significantly in 2010 due to realized investment gains, but expect future impact from low interest rate environment • This is putting significant pressure on bottom-lines of companies

Source: Insurance Information Institute, NAIC, Bloomberg, E&Y, SGS Desk Research

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While investments are increasing, investment yields are under pressure. On an average, it takes 3-4% reduction in Combined Ratio to offset 1% decline in Investment yield Net Investment Yield (%)

P&C Industry Total Cash & Investments vs. Net Investment Yield 13,50,000 13,00,000 12,50,000 12,00,000 11,50,000 2006

2007

2008

2009

$ billion

2010

4.6%

4.4%

4.2%

4.0%

3.8%

3.6%

3.4%

3.2%

-2

Jun 11 LTM

% Growth

11.0

8.8

7.8 4.1

4.1

3.6

3.7

3.8

3.9

3.7

-0.7 3Q09

4Q09

1Q10

2Q10

3Q10

4Q10

1Q11

2Q11

Net Investment Yield

Reinsurance

Med Mal

Surplus Lines

Warranty

Fidelity/Surety

Comm Cas

Comm Prop

Credit

Comml Auto

Commercial

Pers Prop

Pvt Pass Auto

Personal Lines 0% -1% -3% -4% -5% -6%

-1.8%-1.8%-2.0%

-1.9%-2.1%

-3.6%

-3.1%-3.3%-3.3% -3.7% -4.3% -5.2% -5.7%

-7% -8%

-7.3%

8.1

8.0

6.0

Reduction in Combined Ratio Necessary to Offset 1% Decline in Investment Yield to Maintain Constant ROE

-2%

10.2

ROE

Comments •

P&C insurers’ investment performance continues to be challenged by low interest rates and lower invested asset leverage, given declines in industry premium volume in recent years • Industry’s portfolio yield has declined significantly over the last 15 years, moving from 5.7% in 1996 to less than 3.8%. Portfolio yields are expected to decline further in near term as new money yields are currently considerably less than that for maturing bonds. • Despite yield pressures, insurers generally have resisted the urge to meaningfully add asset risk to their portfolios in the near term.

Source: Insurance Information Institute, NAIC, Bloomberg, E&Y, SGS Desk Research

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In the last few years, reserve releases have helped significantly to offset underwriting losses. However, the reserve redundancies are expected to be depleted in 2 to 3 years if reserve releases continue at the pace of 2007 to 2010.

Premium to Surplus (%)

Comments •

110 105 100 95 90 85 80 75 70 65 60

96.6 87.3

87.1

86.3 78.9

79.0

• 2006

2007

2008

2009

2010

Jun 11 LTM

Industry Reserve Development 25 20 15 10 5 0 -5 -10 -15 -20 -25

•

18.5 7.2

10.5

8.3 2.0

-0.7 -11.0

-10.2 -14.0

-22.0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

•

Premium-to-surplus ratios have decreased from 91% in 2006 to 78% in June 2011 • Given the slow premium growth outlook and the industry’s adequate reserve levels, these ratios are expected to continue the downward trend in 2011, with surplus growing faster than premium • In addition, excess capital continues to hinder improvement in pricing US property/casualty insurers who are struggling with sluggish organic growth because of the soft pricing environment and the weak economy, look to deploy their excess capital in: • Expanding their businesses (inorganically) • Making share repurchases • Technology and infrastructure improvements, with sustainable long-term benefits Premium rate trends have been positive in 3Q11 with insurers suggesting they expect the rate rises to continue • However, the trends on rates offered by insurers pertain to renewals only - Typically new business tends to require a 10 15% rate reduction from the existing insurer to win business. The P&C insurance industry is estimated to have released $46bn of reserves since 2006. • It is estimated that there are roughly $22bn of excess reserves across all lines of business, and the reserve redundancies are expected to be depleted in 2 to 3 years if reserve releases continue at the pace of 2007 to 2010.

Source: Insurance Information Institute, NAIC, Bloomberg, E&Y, SGS Desk Research

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The recent economic downturn has made the insurance market very attractive for M&A, with valuations at fairly lower values as compared to pre-2008 levels Five year history of significant M&A transactions in the P&C industry

Source: E&Y

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Thank You.