ALIRT PC Review Year End 2010.pdf - Adobe Reader

8/7/2019 ALIRT PC Review Year End 2010.pdf - Adobe Reader

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ALIRT Insurance Research Page 1 March 16, 2011

Year End 2010 P&C Industry Review (March 16, 2011)

Surplus for the ALIRT P&C Composite 1 rose marginally in 2010 as somewhat weaker underwritingand operating income was offset by substantial shareholder dividends paid to parent companies.Accident year underwriting results continued to underperform reported results though the gapbetween the two underwriting profitability measures narrowed as prior year reserve redundanciesshrank. Direct and net premiums written were flat as soft market conditions persist in the face of weak economic conditions and abundant capital.

State of the Underwriting Cycle: ALIRT Capacity Quadrant

In recent months we have been asked more often about when commercial pricing might hardenand/or what kind of capital hit could move the market. As we enter the 7 th year of the current softmarket cycle, these questions are only natural.

We reiterate first the important distinction between capital and capacity , as they are not the samething. Capital (or surplus in the statutory reporting world) is technically the difference betweenassets and liabilities and represents the financial cushion available to insurers to absorb operatinglosses (among other things). Capacity reflects this financial capability (capital/surplus) to writebusiness, but also the willingness to do so. It is the removal of this willingness to write businesswhich will ultimately lead to a market turn. This is a very human element and involves the dailydecisions of thousands of market participants, from insurance management, underwriters, andactuaries to insurance producers to end insureds. This is also the element that makes predicting amarket turn so difficult.

Below we provide a visual The ALIRT Capacity Quadrant - which charts the interaction of capitaland willingness to write business and how this dynamic impacts capacity and ultimately the price of property & casualty insurance.

As both capital and the willingness to write business rise,prices tend to get soft (upper right hand quadrant). Thisis where the market resides currently. As both capitaland willingness to write business decline, the markettends to get hard (bottom left hand quadrant). Thethatched area represents a condition of marketequilibrium, where rates should be relatively stable.

There are several directions we could go from here:

1. Both capital and willingness to underwrite remainrelatively high as profitability/capital positions donot deteriorate. Pricing remains soft. An alternativeto this is that the market moves into the thatchedarea = prices are flat for an extended period of time.

1 The ALIRT P&C Composite is comprised of 50 large U.S. P&C insurers, representing about 53% of total industry net written premium.

Hig her

Capital

Lo we r

Lo we r Willingness Hig her

HardeningMarket

SoftMarket

ALIRT Capacity Quadrant

HardMarket

SofteningMarket


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2. Capital levels remain high but willingness to write business starts to flounder as soft marketexhaustion sets in, in which case we would move into the upper left hand quadrant. In thisscenario, prices would harden but perhaps not appreciably and/or swiftly;

3. A large catastrophe loss and/or rapidly deteriorating underwriting results lead to deterioratingcapital and the willingness to write business is sharply reduced. This would push the marketinto the lower left hand quadrant = rapidly hardening prices = hard market.

Brian Dupperault, CEO of Marsh, recently remarked that market psychology is very important atthis stage of the pricing cycle. In a presentation to an industry gathering, he stated that underwritersare tired and that one cant underestimate the importance of market psyche. Although capitalremains plentiful, insurers could latch on to a near term excuse to begin firming pricing. If this istrue, it may be an important factor impacting future willingness to write business.

Insured losses from the tragic events in Japan are currently estimated at between $15-$35 billion,with these preliminary figures taking into account only the earthquake damage. While these insuredlosses will be disproportionately absorbed by the Japanese insurance market, global reinsurers willalso suffer losses. These losses, combined with other large global catastrophes thus far in the firstquarter, could serve to tighten reinsurance pricing in the U.S. come mid-year renewals. Some arebeginning to ask whether this potential tightening of reinsurance rates could act as a catalyst to pushprimary rates up somewhat in the U.S. or at least halt their decline.

Executive Summary: ALIRT P&C Composite Results Below we provide 2010 financial highlights for the ALIRT P&C Composite, based on insurersstatutory financial statements.

ALIRT Composite surplus rose 2.5% in 2010 , as operating earnings of $18.8 billion andcapital gains of $8.6 billion were offset by sizeable shareholder dividends of $21.5 billion andother one-time changes of almost $2.0 billion.

The ALIRT Composite reported a 2010 combined ratio of 102.6%, a 2.4 percentage pointdeterioration from the 2009 result. Reported underwriting results were aided by $2.4 billionof prior year reserve releases. These redundancies were well below the $7.8 billion of net

prior year reserve releases as of 9/30/2010, as a number of Chartis Commercial Linessubsidiaries strengthened reserves substantially in the 4 th quarter.

The composite accident year combined ratio (which excludes the impact of prior year reservedevelopment), rose 1.8 percentage points to 103.7% in 2010 on the continuation of softmarket pricing. The accident year results have underperformed reported results fornineteen consecutive quarters, a reflection of reserve releases into earnings and anindication of a soft market.

Pretax operating income of $21.1 billion in 2010 was 11.6% lower than in the prior yearperiod, reflecting weaker underwriting results as prior year reserve redundancies eased.Composite pretax ROE declined 150 basis points to 7.3% (annualized) when compared to the

2009 ROE of 8.8%.

In 2010, net investment yield rose 38 basis points to 4.44% from 4.06% in 2009, helped bylarge one-time dividends paid to a composite insurer. Total return declined 11 basis points to5.87% in 2010 despite continued strong equity market performance in the fourth quarter.

Direct and net premiums were flat year over year (0.0% and 0.3%, respectively). Thisrepresents an improvement vs. prior figures, which were negative, though it continued a weak trend reaching back to 2008.


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Gross and net underwriting leverage ratios were also flat when compared to 2009 results andremain historically low at 1.17 times (gross) and 0.75 times (net) as of 12/31/2010. The lownet underwriting leverage is an expression of the relatively abundant capital in the currentP&C market.

Company Highlights

In February 2011, AIG announced that its Chartis commercial lines pool strengthened itsreserves substantially, which resulted in a 4 th quarter GAAP net charge of $4.1 billion. Tohelp offset this loss, AIG entered into an agreement with the U.S. Treasury to retain $2 billionof funds from the recently closed sale of overseas business. Chartis reported that the reservestrengthening was for four classes of long-tail liability business, with the majority comingfrom accident years 2005 and prior.

Liberty Mutual Insurance Company (LMIC) took $2.4 billion in shareholder dividends fromfour of its regional P&C subsidiaries (Liberty Mutual Agency Corp. = LMAC) in 2010,which resulted in sharp surplus declines for General Ins. Co. of America, Ohio Casualty,Peerless Ins. Co., and Safeco Ins. Co. of America. These dividends boosted net investmentincome considerably for LMIC (and hence for the composite).

In September, Liberty Mutual postponed its previously announced IPO of LMAC, whichmanagement stated was due to an unfavorable environment for receiving appropriatevalue for the business. Management has announced that it may re-attempt this IPO inthe not too distant future.

In February 2010, Motors Insurance Corporation (MIC) completed the sale of its U.S.personal lines P&C business to a joint venture backed by American Capital AcquisitionCorporation and AmTrust Financial. The transaction included the sale of ten poolsubsidiaries which resulted in a sharp decline in MICs net premium written.

In the third quarter 2010, OneBeacon Insurance Group sold its traditional personal lines

business to Tower Group, Inc. This necessitated the termination of an intercompanyreinsurance agreement between One Beacon Insurance Company (OBIC) and twosubsidiaries sold to Tower Group, as well as the cession of additional personal lines businesswritten by other One Beacon subsidiaries. This reduced net premiums written at OBIC, thelead member of the One Beacon Pool.


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Capital and Surplus

Surplus for the ALIRT P&C Composite rose 2.5% in 2010, a much lower increase than the 11.5%reported in 2009, which largely offset the reduction in surplus in 2008. Thus, surplus is only up1% from year end 2007 levels (the previous high level mark), which indicates a substantialslowing of capital growth looking over the period since 2003.

As can be seen in the graph below, the decline in surplus growth is due to both: 1) diminishingoperating earnings, and 2) substantially higher shareholder dividends paid in 2010. The large

dividend payments are likely an expression of a perceived lack of opportunity to put excesscapital funds to profitable use, as we enter the 7 th year of a protracted soft market. On balance,this is a positive sign for a potential market turn as capital is stripped away from the industry,putting potential support under pricing.

We do note, however, that net premium leverage (net premium to surplus) fell to a cyclically lowof 0.75 times in 2010. This shows that even with the industrys low capital growth, the amount of premium being written against that base remains at conservative levels. This reflects thecontinued impact of weak exposure bases due to economic struggles and weak pricing, the latterexpressing an elevated willingness to write business.

Surplus Development: ALIRT P&C Composite(Data in $ Millions) 2003 2004 2005 2006 2007 2008 2009 2010

Surplus Beginning of Period 151,644 184,882 208,276 226,664 268,200 290,216 256,779 286,003

Operating Earnings 12,070 17,235 17,278 31,532 32,018 20,298 20,315 18,764

Net Capital Gains or (Losses) 20,037 14,634 6,899 19,781 10,628 (40,405) 11,268 8,559

Surplus Paid-In 5,008 4,741 4,539 769 590 5,3122,161 3,232

Shareholder Dividends (6,904) (9,184) (9,247) (9,706) (18,891) (17,410) (9,062) (21,489)

All Other Changes to Surplus 3,027 (1,254) (1,081) (840) (2,330) (1,232) 4,542 (2,008)

Surplus End of Period 184,882 208,276 226,664 268,200 290,216 256,779 286,003 293,061

Change in Surplus 21.9% 12.6% 8.8% 18.1% 8.2% -11.5% 11.5% 2.5%

Individual Company Results

Thirty-four composite companies reported an increase in surplus during 2010, led by EmployersInsurance Co. of Wausau (22%), American Home Assurance (14%, aided by a $1.9 billion capitalinfusion in the fourth quarter), Factory Mutual Ins. Co. (12%), Erie Insurance Exchange (12%),Nationwide Mutual Ins. Co. (12%), Liberty Mutual Ins. Co. (10%, helped by a $500 millioncapital infusion), and Chubb subsidiary Pacific Indemnity Company (10%).

Twelve composite companies incurred surplus declines exceeding 10% in 2010, all of which paid

substantial shareholder dividends to their parent companies. Of these, four are theaforementioned Liberty Mutual subsidiaries within the Liberty Mutual Agency Corp.intercompany pool. These include Safeco Insurance Company of America (-26%), PeerlessInsurance Company (-26%), General Insurance Company of America (-25%), and Ohio CasualtyInsurance Company (-16%). Also reporting hefty surplus declines were Onebeacon InsuranceCompany (-32%, $513 million in dividends), Commerce & Industry (-31%), Motors InsuranceCorporation (-26%, $850 million dividend), and Travelers subsidiaries Travelers IndemnityCompany (-15%, $2.3 billion dividend) and Travelers Casualty and Surety Company (-12%, $2.0billion dividend).


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Underwriting Profitability

The ALIRT P&C Composite reported a combined ratio of 102.6% in 2010, a 240 basis pointdeterioration from 2009 results. As we will discuss later, this deterioration was due in part tosubstantial reserve strengthening on the part of several Chartis commercial lines subsidiaries.The operating ratio, which takes into account both underwriting and investment earnings,deteriorated by 70 basis points vs. the prior years result. This reflects considerable netinvestment income growth, though investment income was distorted somewhat by large dividendspaid to Liberty Mutual Insurance Company from a number of its regional subsidiaries.

The accident year combined ratio of 103.7% was appreciably higher than the prior years results,likely reflecting the impact of weaker current pricing as 2010 as estimated catastrophe lossesappear to be in-line with the prior year result (see chart on page 8). As shown below, excludingthe larger catastrophe-impacted years 2005 and 2008, accident year profitability has deterioratedsequentially since 2004.

Underwriting Results: ALIRT P&C Industry Composite

2004 2005 2006 2007 2008 2009 2010

Changefrom 9/09(points)

Loss/LAE Ratio 73.4%

77.0% 66.7% 68.5% 75.7% 73.4% 75.4% +2.0Expense Ratio 23.9% 23.8% 25.0% 25.5% 25.9% 26.3% 26.6% +0.3

Combined Ratio 97.8% 101.2% 92.7% 94.5% 102.0% 100.2% 102.6% +2.4

AY Comb. Ratio* 95.4% 99.2% 94.0% 96.0% 104.5% 101.8% 103.7% +1.9

Operating Ratio 88.0% 90.1% 81.4% 82.2% 90.1% 89.6% 90.1% +0.7* Accident year combined ratios remove the impact of prior year reserve adjustments, thereby reflecting the profitability of businesswritten only in the current year.


Only two composite companies reported combined ratios below 90% in 2010, both of which wereaided by substantial prior year reserve releases: Factory Mutual (78.4%) and Great AmericanInsurance Company (86.0%). The next strongest combined ratios were reported by AceAmerican Insurance Company (90.4%, 8 points of reserve release), and two lead Chubbsubsidiaries Pacific Indemnity and Federal Insurance Company (91.0% and 91.3%, respectively,5 points of reserve release). All five of these top performing companies are commercial linespredominant, although of the 20 companies with the strongest underwriting performance, 15 areeither personal lines predominant or multi-line carriers (such as Travelers, Chubb, and Hartford),indicating the relative strength of the personal lines segment at present.

Twenty-seven companies reported combined ratios that exceeded 100% in 2010, with sevenreporting ratios in excess of 110%, including lead Chartis commercial lines pool subsidiariesCommerce & Industry (142%), National Union Fire (138%), and American Home Assurance(138%), due to substantial 4 th quarter 2010 reserve increases which added approximately 38points to the reported combined ratio (on which, see more below). Also reporting weak underwriting profitability were lead Crum & Forster pool member United States Fire (114%),Continental Casualty Company (113%), and New Jersey Manufacturers (112%).

Again, we note that the poorest underwriting results were concentrated among commercial linespredominant carriers, reflecting the longer tail/greater volatility in those lines of business.


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Loss Reserve Adequacy

The table below tracks prior year loss reserve development for the ALIRT P&C Composite overthe past 10 years. As the far right hand column illustrates, aggregate reserve releases as of 12/31/2010 were the largest for accident year 2004 (= $12.9 billion) and trailed off sequentiallyfor accident years 2005-2009. Total reserve releases fell to $2.4 billion for calendar year 2010,substantially below the $7.8 billion reported in 2009. This is largely due to the substantialstrengthening of prior year reserves in the Chartis commercial lines pool in the 4 th quarter 2010,as National Union Fire and American Home Assurance Company together boosted prior year

reserves by almost $4 billion.

PRIOR YEAR RESERVE DEVELOPMENTALIRT P&C COMPOSITE (2001 2010) Data in $Millions

Acc. YearCY

2001CY

2002CY

2003CY

2004CY

2005CY

2006CY

2007CY

2008CY

2009CY

2010 Total

Prior Yrs.* 4,618 7,946 9,696 8,420 8,626 3,808 3,339 1,906 3,176 3,260 54,795

2001 -- -369 602 1,371 1,803 406 435 123 325 190 4,886

2002 -- -- -2,909 795 1,835 475 127 159 -52 98 528

2003 -- -- -- -5,609 -1,129 -200 -165 38 -232 -1 -7,298

2004 -- -- -- -- -7,377 -2,290 -1,417 -1,109 -518 -237 -12,948

2005 -- -- -- -- -- -5,553 -2,081 -1,755 -947 -633 -10,9692006 -- -- -- -- -- -- -3,815 -2,550 -1,335 -874 -8,574

2007 -- -- -- -- -- -- -- -2,658 -2,095 -637 -5,390

2008 -1,992 -939 -2,931

2009 -2,590 -2,590

Total Dev. 4,618 7,577 7,389 4,977 3,758 -3,354 -3,577 -5,846 -3,670 -2,363 9,509

Due to the outsized impact of the Chartis commercial lines pool prior year reserve strengthening,we take a look at the size and character of this action. Below we detail the total charges taken byeach of the six participating pool members. As shown, the lines disproportionally impacted bythe reserve charges were Workers Compensation and Other Liability Occurrence, where thebulk of Asbestos & Environmental (A&E) liabilities reside. These two lines together comprised90% of the total $5.2 billion of net statutory reserve strengthening.

Chartis Commercial Lines PoolPrior Year Reserve Strengthening 2010

By Major Line of Business (Data in $MM)

Company

Total PriorYr. ReserveAdditions

WorkersComp.

OtherLiability

Occurrence

American Home Assur. 1,904 651 995

Chartis P&C Co. 261 91 138

Commerce & Industry 575 199 304

Insurance Co. in State of PA 261 91 138

National Union Fire 1,986 688 1,051

New Hampshire Ins. Co. 261 91 138

Chartis Comml Lines Pool 5,248 1,811 2,764

% of Total Reserve Addition 100% 35% 53%


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The chart below shows the accident years in which the majority of the reserve strengtheningoccurred. Of the $5.2 billion reserve action, 45% occurred in accident years prior to 2001, whichwould reflect the bulk if not all of the A&E charges. While AIG, in its initial releaseregarding these reserve charges, indicated that the majority of charges were for older accidentyears, we note that 28% of the total actually came in accident years 2007-2009.

There was some concern during the credit crisis that AIG subsidiaries were aggressively pricingbusiness to protect their renewal base. While this reserve action is not conclusive one way or theother, it is interesting to note that the composite released reserves for accident years 2008-2009

and that not one of Chartis commercial lines peers reported comparable strengthening in either of those years (only Continental Casualty and Firemans Fund among national lines peers reportedstrengthening in both 2008 and 2009).

It could also be argued that Chartis is a proverbial canary in the coal mine, taking necessaryaction to strengthen near-term accident years before most of its peers. If this is so, we mightexpect to see deteriorating reserve quality for these accident years over the coming reportingperiods for other insurers, perhaps marking the beginning of a pain cycle which could movepricing higher.

Chartis Commercial Lines PoolPrior Year Reserve Strengthening 2010

By Accident Year

Acc. Year Total% of Total

WorkersComp

% of Total

OtherLiabilityOccur.

% of Total

Prior Yrs. 2,371 45% 826 46% 1,217 44%2001 271 5% 99 5% 179 6%

2002 259 5% 92 5% 130 5%

2003 247 5% 43 2% 92 3%

2004 198 4% 23 1% 108 4%

2005 154 3% 39 2% -10 0%

2006 282 5% 80 4% 131 5%

2007 668 13% 135 7% 407 15%2008 478 9% 301 17% 288 10%

2009 321 6% 173 10% 224 8%

Total Dev. 5,248 100% 1,811 100% 2,766 100%


Companies reporting the largest prior year reserve releases in 2010 were State Farm Mutual Auto($849 million), lead GEICO subsidiary Government Employees Ins. Co. ($499 million),Nationwide Mutual Ins. Co. ($453 million), Continental Casualty Company($431 million), and Federal Insurance Co. ($319 million). Of the 10 companies with the largest

releases, 8 were personal lines predominant or multi-line carriers. Only two ContinentalCasualty and Factory Mutual were commercial lines specialists.

Only five insurers strengthened reserves in 2010, of which the top three are the lead Chartiscommercial pool carriers discussed above. Additionally, Firemans Fund boosted prior yearreserves by $209 million in 2010, largely reflecting the strengthening of legacy A&E liabilities inthe 2 nd quarter, while Allstate Insurance Company boosted reserves by $16 million, withstrengthening of $306 million for accident years prior to 2001 largely offset by releases in recentaccident years.


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Year 1Q 2Q 3Q 4QFullYear

1999 1.9 3.5 2.72 0.27 8.36

2000 1.2 1.5 0.3 0.8 3.82001 0.7 6.2 19.1 0.5 26.52002 0.6 2.8 0.7 1.7 5.82003 1.5 5.1 3.7 2.6 12.92004 1 2.3 23.7 0.5 27.52005 2.1 0.9 48.4 10.8 62.22006 1.5 5 1.3 1.5 9.32007 1.3 2.2 1.1 1.7 6.32008 3.4 6 13.3 2.5 25.22009 3.5 5.2 2.6 0.2 11.52010 2.7 5.6 1.9 ?? 9.2*

Net Cat Losses for P&C Industry (Data in $Billions)

Source: ISO Propert y Claim Service quarterly estimates

Net Lo ss and Loss Adj. Expenses (aft er reinsurance)

* 4th quarter 2010 cat losses not yet available from ISO

Operating Earnings

Pretax and after-tax operating earnings 4 and returns in 2010 declined slightly when compared toresults over the last two years. Had 2005 and 2008 not been disproportionately impacted bycatastrophe losses, we would see a smoother rise and fall in earnings metrics since 2001 -expected given the cyclical nature of P&C pricing. Underwriting profitability over the last twoyears has been helped by the relative lack of major catastrophes (see catastrophe loss tablebelow), as well as by continued prior year reserve redundancies, which appear however to bedrying up.

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

'9 6 '9 7 '9 8 '9 9 '0 0 '0 1 '0 2 '0 3 '0 4 '0 5 '0 6 '0 7 '0 8 '0 9 '1 0

ALIRT P&C Composite Return on Equity

PT ROE AT ROE15 Year Av erage Pretax ROE

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

'9 6 '9 7 '9 8 '9 9 '0 0 '0 1 '0 2 '0 3 '0 4 '0 5 '0 6 '0 7 '0 8 '0 9 '1 0

ALIRT P&C Composite Return on Earned Premium

PT ROR AT ROR15 Year Av erage Pretax ROR

As for how this gradual decline in operating earnings could affect industry pricing, we note themuch weaker profitability in the period 1998-2000 before the last hard market turn. With capitalpositions strong and industry profitability just beginning to fall below 15 year averages (see black lines in graphs above), willingness to write business is probably unlikely to fall away rapidly barring an extremely large catastrophe or capital market shock.


Fifteen companies reported annualized pretaxreturns on earned premium (ROP) exceeding 20%

in 2010. The top five companies include nationalmulti-line insurers Travelers Indemnity andTravelers Casualty & Surety (38.7% and 33.8%,respectively), Liberty Mutual Ins. Co. (35.2%,large dividends received from subsidiaries),Federal Insurance Company (35.0%), and AceAmerican Ins. Co. (34.0%).

Also reporting strong results were OneBeacon Ins.Co. (33.4%) and Motors Insurance Corporation(31.1%), both helped by sizeable transactions,along with specialty insurers Great American Ins.

Co. (29.3%) and Factory Mutual Ins. Co. (28.3%).

Only seven composite companies reported operating losses in 2010, including the three Chartissubsidiaries discussed at length above, American Home (-21.5%), Commerce & Industry (-21.4%), andNational Union Fire (-13.3%). The remaining four insurers with 2010 operating losses were FarmersInsurance Exchange (-6.6%), United States Fire (-2.5%), New Jersey Manufacturers (-0.3%), and StateFarm Fire & Casualty (-0.2%).

4 Excludes the impact of net capital gains/losses.


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Premium Income

Direct and net premiums for the ALIRT P&C Composite were essentially flat in 2010 versus theprior year period. Premiums are a function of both pure rate and the amount of insurance written(exposure units & any changes in deductibles/limits). Somewhat more difficult to measure arechanges in terms and conditions which may result in more/less coverage for a static level of premium. Such policy changes could result in higher/lower future losses.

As the chart below shows, this is the first time since year end 2007 that annual net written

premium growth was positive, if only by less than half a percentage point. This may reflect agradual increase in economic activity in 2010, which would expand exposure units even if underlying pricing remains soft (as indicated in the second graph below). Additionally andlikely - companies may be keeping more net business, even with weak pricing, as a way to utilizeexcess surplus.

$232 $58 $117 $178 $233 $57 $115 $175 $227 $55 $110 $168 $220 $54 $110 $168 $221

5.6%

3.5%2.5% 2.8%

0.4%

-1.4% -1.3% -1.4%

-2.5%

-4.0%-4.5%

-3.8%-3.1%

-1.8%

-0.4% -0.1%0.3%

-9%

-6%

-3%

0%

3%

6%

0

50

100

150

200

250

300

YE06 3/07 6/07 9/07 YE07 3/08 6/08 9/08 YE08 3/09 6/09 9/09 YE09 3/10 6/10 9/10 YE10

Y O Y C h a ng e i n N WP N

WP -$ in Billions

Composite Net Written Premium Change by Quarter

NWP $ in Billions YOY % Chng.

The graph below depicts the quarterly average of three, largely commercial lines pricing surveys 6.The last soft market commenced in the third quarter of 2004 and has followed a wavelike patternover the last six years. Since mid 2008, broad price decreases have moderated and appear to haveleveled off starting in mid-2009. We point out that as pricing becomes ever weaker, large year-over-year declines become less likely. The fact that price decreases have remained steady arguesfor the tenacity of the current soft market cycle, exacerbated by weak macro economic conditions.

8.2%

4.4% 1.4%

-1.7%-2.6%

-5.3%

-4.9%

-5.2%

-3.5%

-4.0%

-3.1%

-4.2%-6.5%

-7.9%-9.5%

-10.1%

-10.1%

-10.5%

-9.3%-8.0%

-5.5%-4.0%

-2.8%

-3.0%

-3.0%

-3.2%

-3.5%

-3.0%

-3.1%

-15%-12%

-9%

-6%

-3%

0%

3%

6%

9%

12%

Q4:03

Q1:04

Q2:04

Q3:04

Q4:04

Q1:05

Q2:05

Q3:05

Q4:05

Q1:06

Q2:06

Q3:06

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Q1:07

Q2:07

Q3:07

Q4:07

Q1:08

Q2:08

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Q4:08

Q1:09

Q2:09

Q3:09

Q4:09

Q1:10

Q2:10

Q3:10

Q4:10

W

eighted Avg. Rate Change

P&C Industry Commercial Lines Rate Changes (per Market Surveys*)(* Weight ed Average of CIAB, CLIPS [Q2:05 & subsequent] and MarketScout Surveys)

6 The CLIPs survey is estimated based on average prior quarters results as the 4Q report will likely not be released until April.


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Seven composite companies reported net premium growth exceeding 10% in 2010, led byFarmers subsidiaries Farmers Insurance Exchange and Mid-Century Insurance Company (31.3%,due in part to an amendment of a quota share reinsurance agreement in 2Q). Other companieswith strong net premium growth include Hanover Insurance Company (19.5%), LexingtonInsurance Company (19.5%; Chartis Surplus Lines Pool expanded with the inclusion of ChartisSpecialty Insurance Company), Liberty Mutual subsidiary Employers Insurance of Wausau(16.8%, due to revisions to its intercompany pool at 1/1/2010), Ace American Insurance

Company (15.2%), and Progressive Direct (10.9%).

In contrast, seven companies reported net premium declines in excess of 10%, with the largestdeclines reported by Motors Insurance Corporation (-76.2%; sale of personal lines business in1Q). Other companies with large net premium declines include Onebeacon Insurance Company(-40.1%, sale of traditional personal lines business), the three Chartis pool members, in part onchanges to intercompany pooling arrangements: Commerce & Industry (-18.0%,), National UnionFire (-18.0%), and American Home Assurance (-14.3%), as well as Firemans Fund InsuranceCompany (-15.2%) and Geico Indemnity Company (-11.6%).

Investment Mix

Invested assets for the ALIRT Composite rose 2.6% in 2010, as net premium flow was flat butnet investment income was up 14%, in part on large one-time dividends paid to Liberty MutualInsurance Company in anticipation of an IPO which was subsequently put on hold (seeintroductory comments).

Distribution of Invested AssetsALIRT P&C Composite

12/31/05 12/31/06 12/31/07 12/31/08 12/31/09 12/31/10 Chng.in 2010 Bonds 58.8% 57.5% 57.1% 58.7% 59.6% 59.3% -0.3%

Unaffiliated Stocks 14.7% 15.6% 15.2% 10.6% 11.6% 11.4% -0.2%

Affiliated Stocks 16.6% 16.6% 17.3% 18.8% 18.2% 18.1% -0.1%

Mortgage Loans & Real Estate 1.4% 1.4% 1.6% 1.7% 1.5% 1.4% -0.1%

Cash & Short-Term 4.2% 4.5% 3.8% 4.1% 3.4% 3.3% -0.1%

Schedule BA 3.6% 3.9% 4.9% 5.6% 5.4% 5.9% +0.5%

Other 0.7% 0.5% 0.2% 0.5% 0.3% 0.6% +0.3%

Change in Inv. Assets 8.1% 11.1% 4.9% -7.4% 5.6% 1.9% N/M

As shown above, the mix of invested assets stayed relatively steady in 2010 after some sizeablechanges in 2008 and 2009. Since year end 2007, the mix of bonds has risen by over 2 percentagepoints while unaffiliated stocks have declined by almost 4 percentage points, likely due tocontinued depressed market values as equity markets remain well below year end 2007 levels.The mix of cash & short-term investments holdings also continues to trend lower, likelyreflecting growing comfort with capital market recovery, while the holding of Schedule BA assets(= hedge funds, private equity, REITs, and other alternative type investments) increased, perhapsan expression of insurers trying to boost investment returns.


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In recent months, analysts Meredith Whitney and Nouriel Roubini created a media stir byestimating that municipal bond losses could range from between $100 billion (Roubini) tohundreds of billions (Whitney). Other prominent asset managers have since disputed this thesisand the discussions continue.

Whatever the merits of the various arguments, it remains true that P&C insurers are largeinvestors in municipal bonds and that some of these bonds could come under pressure givenlower tax and other fee revenues in some cities and states, as well as sizeable challengesassociated with current and future budget deficits. As shown below, just under half of the

composites year end 2010 bond portfolio was invested in these securities. The exposure to thisclass of bonds, however, declined by almost 8 percentage points over the last two years, offset byholdings of U.S. federal and corporate bonds.

6.1% 6.9% 9.5% 10.3%3.6% 2.1%

2.7% 3.7%

54.6% 55.3% 51.4% 47.6%

31.5% 31.6% 34.0% 36.0%

2.3% 2.0% 0.6% 0.5%1.9% 2.1% 1.9% 1.9%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2007 2008 2009 2010

% of Portfolio

P&C Composite - Bond Portfolio Composition Comparison

Affil. Securities

Other

Corporate Bonds

Municipal Bonds

Foreign Gov.

U.S. Bonds

In a recent release, Moodys estimated potential municipal bond related losses of $500 million forthe industry under current credit conditions, though this figure could rise to $3 billion, understress test scenarios, if there is further deterioration in the market. P&C insurers could likelyabsorb such losses even in the higher range of these estimates with little trouble. Of course,individual insurers might face disproportionate losses, though a look at the holdings of thecomposite carriers does not indicate a large number of outliers (see Appendix A).

Investment Results

Net Investment Yield

Net investment yield for the Composite rose 38 basis points to 4.44% in 2010 vs. 4.06% in 2009.These results, however, were distorted to the upside by a large one-time gain in net investmentincome at Liberty Mutual Insurance Company (LMIC) as a number of subsidiaries upstreamedlarge dividend payments. LMICs yield jumped to 12.29% in 2010 from just 2.27% in 2009 onnet investment income of $3.4 billion in 2010. Also receiving extraordinary large dividendpayments was OneBeacon Insurance Company, likely tied in part to the sale of a number of subsidiaries to Tower Insurance Group in mid year 2010.

5.68%

5.07%

5.07% 5.23%

5.50%

4.62%4.98%

4.51%4.29%

4.59% 4.59% 4.67%

4.55%

4.06%4.44%

9.44%

15.05%

10.32%

7.97%

3.64%1.75%

0.76%

9.60%7.52%

5.92%8.26%

6.49%

-2.18%

5.90% 5.87%

-6.00%

-2.00%

2.00%

6.00%

10.00%

14.00%

18.00%

3.00%

3.50%

4.00%

4.50%

5.00%

5.50%

6.00%

6.50%

7.00%

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

T ot a l R e t ur n

Net Yield

Net Investment Yield and Total Return - 50 Company Composite

Net Yield

Total Return


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Although improved, net yield for the composite remains at a near 15 year low as the FederalReserve currently targets its Federal Funds rate at near 0% and both government (includingmunicipal bonds) and investment grade corporate bonds offer relatively low yields, especially inthe shorter maturity issues that P&C insurers favor. These historically weak investment yieldsplace additional focus on underwriting results, as carriers cannot depend on investment income tohelp offset poor underwriting decisions, as has happened in the past. All things equal, these weak investment yields could help support a market turn when it comes.

Total Investment Return

Total Return of 5.87% for 2010 was in line with 2009 results of 5.90%, despite the fact thatequity markets reported another strong year of growth (see graph below). This was due, in part,to lower composite net capital gains (-23% in 2010), as several large companies reported muchlower gains (or net capital losses) year over year, including Federal Insurance Company,Government Employees, Liberty Mutual and State Farm Auto.

Equity markets have been extremely volatile thus far in the 1 st quarter 2011, up only slightly inaggregate (after sizeable gains in earlier months), in part due to uncertainty regarding thedurability of the global economic recovery, the impact of political unrest in the Middle East, andthe recent catastrophic events in Japan.

2004 2005 2006 2007 2008 2009 2010 1Q11*DJIA +3.1% -0.6% +16.3% +6.4% -33.8% +17.9% +11.0% +0.8%S&P 500 +9.0% +3.0% +13.6% +3.5% -38.5% +21.3% +12.8% +0.4%NASDAQ +8.6% +1.4% +9.5% +9.8% -40.5% +36.0% +16.9% -0.8%

Avg. % Change +6.9% +1.3% +13.1% +6.6% -37.6% +25.1% +13.6% +0.1%* First quarter equity index results are through midday March 16, 2011.

Conclusion

Financial results for the ALIRT P&C Composite are beginning to show signs of wear and tear aswe enter the 7 th year of the current soft market cycle. Surplus rose only slightly as insurers made

sizeable shareholder dividend payments to parent organizations, while both reported and accidentyear combined ratios deteriorated and prior year reserve releases slowed. Premium growth, onboth a direct and net basis, remains flat.

As discussed earlier, capacity is a product of the interaction between insurer capital levels and thewillingness to place business. At some point, especially if industry financial deteriorationcontinues, some catalyst could move carriers to dial back their appetite to place business. Thiswould lead to harder pricing and a market turn.

Examples of catalysts could include large catastrophe losses impacting reinsurance capacity (thestring of global catastrophe events thus far in the first quarter?), additional dramatic increases inprior year reserves (a la AIG/Chartis in the 4 th quarter), or a marked deterioration in economic

conditions/global capital markets. Even continued sideways investment results might be enoughto push insurers to the brink of psychological exhaustion.

Lastly, ALIRT notes the regulatory action taken against three insurers over the last month (twowere placed in liquidation). While these insurers are small, the companies ALIRT trendsidentified them as laggards up to several years before. As we continue to sift through and analyzethe financials of many property & casualty insurers every quarter, we are likely to turn up othercarriers to watch closely, especially after such a long stretch of soft market pricing.


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APPENDIX A COMPOSITE MUNI BOND HOLDINGS(Sorted High to Low By % of YE2010 Surplus)

(Data in $MM)

States & % Tot. Political % Tot. Special % Tot. % YE2010 % YE2010COMPANY GROUP Territory Munis Subdivision Munis Revenue Munis Total Bonds Surplus

Commerce & Industry Insurance Co AIG 751 19% 746 19% 2,363 61% 3,859 69% 205%

Lexington Insurance Company AIG 1,929 18% 2,441 23% 6,158 58% 10,528 69% 190%

General Insurance Co of America Liberty Mutual 25 3% 81 11% 628 86% 734 48% 179%

American Home Assurance Company AIG 2,097 19% 2,809 25% 6,239 56% 11,145 63% 167%

Pacific Indemnity Company Chubb Corp. 608 15% 484 12% 2,862 72% 3,954 80% 163%Sta te Farm F ire a nd C asua lty C o Sta te Farm Mutual 1,5 67 12% 5,343 41% 6,249 47% 13,160 67% 150%

Metropolitan Property & Cas Ins Co MetLife Inc. 27 1% 110 5% 2,295 94% 2,432 90% 132%

Travele rs Casua lty & Sure ty Company Trave le rs Cos. 1 ,300 19% 2,359 34% 3,255 47% 6,913 75% 127%

Berkley Regional Insurance Company WR Berkley 80 9% 70 8% 724 83% 874 58% 127%

Safeco Insurance Co of America Liberty Mutual 94 9% 80 8% 863 83% 1,037 43% 123%

Ohio Casualty Insurance Co Liberty Mutual 152 11% 155 11% 1,049 77% 1,355 42% 121%

Travelers Indemnity Company Travelers Cos. 1,414 17% 2,874 34% 4,086 49% 8,374 64% 118%

Berkley Ins Co WR Berkley 275 9% 144 5% 2,603 86% 3,021 62% 115%

Peerless Insurance Company Liberty Mutual 283 15% 230 12% 1,375 73% 1,887 47% 106%

Ace American Ins Co ACE Ltd. 156 8% 145 7% 1,750 85% 2,051 34% 104%

Country Mutual Insurance Co Country Mutual 139 8% 649 38% 914 54% 1,703 74% 104%

St Paul Fi re & Marine Insurance Co Travelers Cos. 1,200 20% 2,672 44% 2,146 36% 6,018 55% 103%

Mid-Century Insurance Co Zurich Financial 98 12% 125 15% 627 74% 850 33% 102%

Continental Casualty Co C.N.A. 582 6% 1,330 14% 7,371 79% 9,282 32% 95%

Ne w Jersey Ma nufacturers Ins C o New Je rsey Ma nuf. 1 ,153 54% 997 46% 0 0% 2,150 50% 90%

Employers Ins of Wausau Liberty Mutual 154 13% 131 11% 895 76% 1,180 50% 90%

Federated Mutual Insurance Co Federated Mutual 84 4% 776 41% 1,010 54% 1,870 66% 85%

Ha rtfo rd Acci dent & Inde mni ty C o Hartford Fi nanci al 2 92 12% 340 13% 1,888 75% 2,519 30% 79%

Firemans Fund Insurance Co Allianz 246 11% 317 15% 1,580 74% 2,143 39% 79%

Farmers Insurance Exchange Zurich Financial 316 11% 417 15% 2,118 74% 2,851 39% 77%

Federal Insurance Company Chubb Corp. 1,614 15% 1,328 12% 7,731 72% 10,673 71% 75%

Cincinnati Insurance Co Cincinnati Fin'l 3 0% 1,587 62% 952 37% 2,543 52% 67%

USAA Casualty Insurance Co USAA 137 6% 0 0% 2,325 94% 2,462 44% 67%

Nationwide Mutua l Fi re Insurance Co Nationwide Mutua l 202 14% 400 27% 890 60% 1,491 48% 67%

Great American Insurance Co American Fin'l Corp. 147 15% 123 13% 713 73% 983 36% 67%

Allstate Insurance Company Allstate Corp. 183 2% 1,527 15% 8,166 83% 9,876 44% 64%

United States Fire Ins Co Fairfax Financial 79 14% 0 0% 491 86% 570 63% 63%

National Union Fire Ins Co of Pitts AIG 1,297 19% 1,706 25% 3,856 56% 6,859 44% 54%

Hanover Insurance Company Hanover Ins. Grp. 53 6% 133 15% 708 79% 893 31% 51%

Zurich American Ins Co Zurich Financial 0 0% 0 0% 3,558 100% 3,559 19% 48%

Liberty Mutual Insurance Co Liberty Mutual 779 13% 686 12% 4,402 75% 5,867 42% 43%

Amica Mutual Insurance Company Amica Mutual 248 25% 194 20% 550 55% 992 53% 42%

State Farm Mutual Auto Ins Co State Farm Mutual 3,307 13% 10,739 42% 11,503 45% 25,549 64% 42%

Sentry Insurance A Mutual Co Sentry Ins. Group 8 1% 401 33% 818 67% 1,227 56% 36%

Government Employees Insurance Co Berkshi re Hathaway 0 0% 5 0% 2,153 100% 2,158 24% 33%

Nationwide Mutual Insurance Co Nationwide Mutual 389 12% 631 19% 2,280 69% 3,299 33% 31%

Progressive Direct Ins Co Progressive Corp. 69 21% 5 1% 262 78% 337 13% 28%

Erie Insurance Exchange Erie Indemnity Co. 195 14% 301 21% 919 65% 1,415 29% 28%

Factory Mut Ins Co FM Global 235 13% 148 8% 1,494 80% 1,877 56% 27%

Onebeacon Ins Co White Mountains 10%

00%

246100%

247 23% 27%Motors Insurance Corp GMAC Inc. 0 0% 0 0% 316 100% 316 12% 22%

Progressi ve Casualty Insurance Co Progressive Corp. 2 1% 0 0% 172 99% 173 13% 13%

Hartford Fire Insurance Co Hartford Financial 202 11% 211 12% 1,372 77% 1,785 13% 13%

Usaa USAA 62 7% 0 0% 808 93% 871 16% 5%

GEICO Indemnity Company Berkshire Hathaway 0 0% 0 0% 24 100% 24 1% 1%

50 Company Composite 24,233 13% 45,947 24% 117,759 63% 187,939 48% 64%

MUNI BONDS


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We note above that 64% of composite municipal bond holdings at 12/31/2010 were held in SpecialRevenue/Special Assessment Obligations, which derive their interest and principal payments fromspecial revenue streams and do not depend on a municipalitys ability to levy taxes and/or controlgeneral operating expenses. These types of bonds represent by far the largest holding of muni-related securities for both property & casualty as well as life/annuity insurers.

Three of the four composite insurers with the highest surplus exposures to municipal bonds areAIG subsidiaries: Commerce & Industry (205%), Lexington Ins. Co. (190%), and AmericanHome Assurance Company (167%), while several Liberty Mutual and WR Berkley subsidiaries

also report higher than composite average surplus exposure to municipal bonds

Only New Jersey Manufacturers and Cincinnati Insurance Company had well above compositeaverage municipal bond exposure to States & Territory/Political Subdivision holdings (see inyellow), though neither insurer had an overall outsized surplus exposure to municipal bonds.

This review is prepared by ALIRT Insurance Research, an independent insurance industry financial analysis firm. ALIRT provides its ALIRT (AnaLysis of Insurer Risk Trends) Services to institutionalclients responsible for monitoring exposures to insurance company financial deterioration. This review is for the specific internal use of our clients, and may not be redistributed without the express written

permission of ALIRT Insurance Research.

While this review is prepared for your personal use, it is not a substitute for an impartial and thorough investigation of insurance company relative financial strength, and does not satisfy federal and statemandated fiduciary due diligence. Financial information contained in this review is obtained from public sources we consider reliable, but we cannot guarantee as accurate. This review should not be

considered complete, includes expressions of our opinion, and must be accepted without responsibility to ALIRT.

ALIRT Insurance Research, LLC - 200 Day Hill Road, Ste. 220, Windsor, CT 06095Phone: (860) 683-2070 Fax: (860) 683-4020

Email: [email protected] Website: www.alirtresearch.com

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