Inland Marine: More Than Meets the Eye

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1 Inland Marine: More Than Meets the Eye Placeholder for Head Shot if desired Presented by Jerry Theodorou, Vice President, Conning

2 About Conning Long History in Financial Services Founded in Specialist in insurance industry research, advisory services, and investment management services Headquartered in Hartford, with offices in New York, Hong Kong, Cologne, Dublin, and London Top three asset manager in U.S. insurance assets under management Research coverage of Property-Casualty, Life, Annuity, and Health 2

Conning s Published Insurance Industry Research Insurance Segment Series 30 Industry Segments Covered Lines of Business, Distribution, Reinsurance Landscape Report State of the Segment

3 Conning s Published Insurance Industry Research Insurance Segment Series 30 Industry Segments Covered Lines of Business, Distribution, Reinsurance Landscape Report State of the Segment Forecasts & Analyses Three-Year Forecast of Industry Segments Analyzing Key Industry Performance Drivers Strategic Studies Identifying and Analyzing Industry-Critical Issues and Trends 3

4 Agenda Inland Marine Performance: A Peek Under the Covers Inland Marine Challenges = P/C Challenges Performance Drivers for Inland Marine Insurers 4

5 Inland Marine Has Outperformed P-C Industry Inland Marine Combined Ratio Typically 15 Points Lower than Industry Source: Conning Research & Consulting analysis 5

6 Long History of Favorable Inland Marine Performance Sub-100% Combined Ratio of Inland Marine has Long History Historical Inland Marine Net Combined Ratio, Calendar Year Source: Conning Research & Consulting analysis, A.M. Best 6

7 Three Reasons Inland Marine Numbers Are Outta Sight 1. Personal Lines Inland Marine Insurers Report Superior Results 2. Reporting Anomalies at Some Companies Skew Overall Numbers: Net-to-direct ratios unusually low for some insurers Idiosyncratic expense reporting 3. The Specialty Lines Superior Margin Factor 7

8 Inland Marine Reporting Anomalies Negative or de minimis reported commissions at companies with low net-to-direct ratios pull overall IM commission ratio down by 7% - 8% points 2010 reported commission ratio is 10.5%; 10.4% in 2009 from impact of few large writers General expense ratio 1% - 2% for some significant writers in 2009; 30% for another (reported $250M in general expenses) 8

9 Inland Marine Writers with Personal Lines Focus Reported Inland Marine combined ratios of Insurers with personal lines focus State Farm 94.5% 80.0% 81.1% 84.4% 85.2% 84.3% Progressive 118.1% 66.6% 68.1% 87.1% 74.2% 75.2% Allstate 93.4% 59.8% 71.1% 66.4% 69.2% 71.5% USAA 85.7% 80.0% 81.7% 78.1% 72.2% 77.2% Amex 60.2% 60.0% 61.4% 64.8% Auto Owners 70.6% 71.5% 77.4% 72.6% 70.7% 77.3% Ohio Farmers 73.8% 72.3% 69.7% 77.9% 75.6% 78.2% Average 89.4% 71.7% 72.8% 75.2% 72.6% 75.5% Source: Company reports, Conning Research & Consulting Analysis 9

10 Personal Lines Companies Taken Out of Analysis State Farm Ohio Farmers Assurant Farmers Progressive Met Life P-C Allstate Motorists Mutual USAA State Auto Amex Securian Auto Owners Blue Cross Blue Shield of South Carolina 10

11 Analysis Focused on Top 40 Commercial IM Insurers 1-10 Liberty Mutual Travelers Hanover FM Global ACE USA TIG Chubb Zurich CNA XL Re Allianz Munich Re W. R. Berkley Harleysville AIG Stonebridge Casualty Cincinnati Financial American National American Financial Jewelers Mutual Crum & Forster Navigators Hartford Old Republic Sentry RLI Fireman s Fund QBE Selective Transatlantic Re Nationwide OneBeacon Employers Mutual Repwest Ins Co Markel Underwriters at Lloyds Axa Ins Grp Alleghany Acuity Erie 11

12 Normal Expense Allocation $100 million NPW 20 K fully loaded = $3M K fully loaded = $2M T&E = $1M line managers = $0.8M Total General Expense = $7.8M Allocated Other Acquisition: Sr. Mgt, HR, IT, Bldg, Insurance = $8M Acquisition (commission) =$17M Total Expense Ratio = 32.8% 12

13 Normalized Inland Marine Numbers 1. Imputing 18% commission ratio for outlyer commissions 2. Other acquisition expense ratio brought to 8% when highly anomalous 3. General expense ratio brought to 8.5% when highly anomalous 4. Result of normalization data scrubbing brought expense ratio to approx. 34.5% 5. Anomalies are understandable: Allocation keys according to line are typically battled, negotiated, imposed, or not understood Three reporting regimes statutory, GAAP and internal company administrative guarantee lack of consistency 13

14 Normalizing IM Numbers Dulls Industry Shine Year Statutory Inland Marine Combined Ratio, as Reported Combined Ratio of Top 40 Commercial Inland Marine Insurers, with Anomalies Adjusted Difference % 94.8% -4.4% % 78.3% -5.5% % 85.7% -6.2% % 101.4% -8.6% % 95.9% -9.2% % 97.6% -11.6% 6-year avg. 84.7% 92.3% -7.6% Source: Company reports, Conning Research & Consulting Analysis 14

15 Normalized IM Better Than Standard Lines and Wet Year Ocean Marine Private Passenger Auto HO Com l IM top 40, Adj % 95.1% 100.3% 94.8% % 95.5% 88.9% 78.3% % 98.3% 95.6% 85.7% % 100.2% 116.8% 101.4% % 101.3% 105.7% 95.9% % 101.0% 106.7% 97.6% 6-yr avg. 98.3% 98.6% 102.3% 92.3% Source: Company reports, Conning Research & Consulting Analysis 15

16 But on Par or Behind other Commercial Lines Year Crop Fire CMP Fire Com l Auto PD Med Prof Com l IM top 40, Adj % 82.4% 93.8% 88.3% 100.9% 94.8% % 76.4% 83.8% 87.7% 91.1% 78.3% % 86.3% 89.8% 91.0% 84.3% 85.7% % 92.5% 108.4% 94.7% 77.4% 101.4% % 78.4% 98.6% 96.8% 83.4% 95.9% % 79.7% 102.5% 101.4% 80.6% 97.6% 6-yr avg 81.3% 82.6% 96.2% 93.3% 86.3% 92.3% Source: Company reports, Conning Research & Consulting Analysis 16

17 If We re Like P/C Industry, What s Driving the Industry? Sluggish, volatile economic outlook depresses premium exposure Disappointing economic growth Cost drivers: inflation, disinflation, sector differences, claim behavior Investment environment: income and risk Insurance market conditions posing strong challenges Soft rates Frequency of severity catastrophe losses Rising expenses Investment income limited from low interest rates Keen competitive conditions But not enough fear for a violent market turn 17

18 Economic Overview: Feeble and Volatile Economic growth and outlook being revised downward and delayed Recovery could build insurance exposures disproportionately Interest rates being kept at historic lows now extended Headline inflation indicates real interest rates are negative Sectors of inflation may be more important to insurance Inflation or Deflation still in the cards Regional differences may be important Real GDP Growth Year Action Eco Philly Fed % 1.8% % 2.4% % 2.7% Source: Action Economics, Federal Reserve Bank of Philadelphia 18

19 Economic Projections a Year Ago: Moderate Recovery Annual Data F 2012F Real GDP Growth 1.9% 0.0% (2.6%) 2.7% 3.1% 4.1% Nominal GDP Growth 4.9% 2.2% (1.7%) 3.7% 4.6% 5.7% CPI 2.9% 3.8% (0.3%) 1.6% 1.7% 2.2% Capacity Util. 81.3% 77.9% 70.0% 74.2% 77.5% 79.6% Fed Funds (EOY) 4.92% 1.88% 0.16% 0.16% 0.49% 2.69% 2-Year T-Note 4.27% 1.94% 0.95% 0.74% 1.55% 3.19% 10-Year T-Note 4.58% 3.61% 3.29% 3.13% 3.42% 3.98% Source: Action Economics 19

20 Economic Projections Today: Recovery Delayed Annual Data F 2012F 2013F 2014F Real GDP Growth 1.9% (0.3%) (3.5%) 3.0% 1.7% 2.5% 3.5% 3.8% Nominal GDP Growth 4.9% 1.9% (2.5%) 4.2% 3.9% 4.8% 6.1% 6.8% CPI 2.9% 3.8% (0.3%) 1.6% 3.2% 2.5% 3.1% 3.1% Capacity Util. 81.0% 77.8% 69.2% 74.5% 77.2% 78.9% 80.4% 81.5% Fed Funds (EOY) 4.92% 1.88% 0.16% 0.16% 0.10% 0.10% 0.48% 2.56% 2-Year T-Note 4.27% 1.94% 0.95% 0.65% 0.43% 0.65% 1.72% 3.41% 10-Year T-Note 4.58% 3.61% 3.29% 3.14% 2.76% 2.65% 3.63% 4.18% Source: Action Economics 20

21 Outlook for Interest Rates Revised Downward Historical and Projected Average Annual Yields 6% 2 yr 11/09 2 yr 12/11 10 yr 11/09 10 yr 12/11 5% 4% 3% 2% 1% 0% F 2012F 2013 Source: Action Economics, Conning Research analysis 21

22 Uncertain Outcomes U.S. Ten Year Treasuries 100 Paths of Simulation 12% 10% 8% 6% 4% 2% 0% Source: GEMS: 100 paths selected from 1000 runs 22

23 Both Inflation and Deflation Possible Probability range of prospective (CPI) inflation from GEMS 20% % 10% 5% 0% -5% -10% Year 1 Year 3 Year 5 Volatility of economic, fiscal and monetary structural conditions currently unfolding Source: GEMS 23

24 Geographic Differences: States Matter Conning s economic outlook indicator ranking, as of 2011Q2 Rising are Massachusett s Virginia, New Hampshire, and Wyoming Falling are California, North Carolina, South Carolina, Nebraska, Minnesota 24

25 Top Five Challenges for P-C Industry 1. Low interest rate/investment yield environment 2. Increasing regulatory uncertainty and encroachment Global, federal, state competing for relevance Financial and operational regulation affecting distribution, risk selection, pricing 3. Economic volatility and uncertainty Impact on exposures, demand, employment, inflation, deflation 4. Demographics and the pace of change Aging, behavioral factors, healthcare, technology and demand for services 5. Challenges of substitution Government safety net, globalization, self funding or risk retention 25

26 Top Five Opportunities for P-C Industry 1. Technology and the power of segmentation Underwriting efficiency and expanding capital markets solutions Predictive modeling and data mining 2. Globalization and convergence Diversification across economies Operational and Investment opportunities 3. Improved risk/return understanding and effectiveness Impact on exposures, demand, employment, inflation, deflation 4. Growing marketplace need for new forms of protection Catastrophes, retirement, emerging risks, need for stability Risk transfer and risk mitigation 5. New opportunities in distribution and customer contact Social networks, segmentation and specialization 26

P&C Industry Outlook: Falling Projections Projected Growth in Net Premiums Written for Commercial Lines (Primarily Exposure), Personal Lines (Primarily Price) Premium growth slightly lower on lower

27 P&C Industry Outlook: Falling Projections Projected Growth in Net Premiums Written for Commercial Lines (Primarily Exposure), Personal Lines (Primarily Price) Premium growth slightly lower on lower exposures, ROE lower on falling yields Industry growth has been affected by the recession and a soft pricing environment. Source: Conning Property-Casualty Forecast & Analysis by Line of Insurance, 2011Q3 Edition 27

28 Modeling Current Expectations vs. Inflation 7.0% 7.0% Inflation - CPI 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 2010 (A) 2011 (E) 2012 (E) 2013 (E) 2014 (E) 2015 (E) Baseline Alternative 10-year Gov't Yield (EOY) Real GDP Growth 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 2010 (A) 2011 (E) 2012 (E) 2013 (E) 2014 (E) 2015 (E) 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% 2010 (A) 2011 (E) 2012 (E) 2013 (E) 2014 (E) 2015 (E) Source: Scenario developed through AFFIRM 28

29 Falling Portfolio Yields as Maturing Bonds Roll Over Insurance Industry Portfolio Book Yield Rates, P&C 6.5% 6.0% 5.5% 5.0% 4.5% 4.0% 3.5% 3.0% Source: Company statutory filings, AFFIRM analysis assuming cash flow rebalancing of investments 29

30 Inflation Impacts on P-C Performance Indicators Total Industry model results Measurement Scenario Premium Change Base 2.9% 4.6% 5.0% 5.1% 5.2% Alternative 3.4% 6.6% 7.7% 7.1% 6.8% Incurred Loss Ratio (CY) Base 73.6% 77.8% 75.8% 75.6% 75.2% 74.8% Alternative 83.2% 83.5% 81.6% 78.9% 77.3% Operating Ratio Base 90.8% 97.0% 95.5% 95.2% 94.5% 93.8% Alternative 102.4% 102.8% 100.3% 97.2% 95.1% Investment Gain to Base 13.3% 8.8% 8.5% 8.3% 8.4% 8.5% Premiums Earned Alternative 9.0% 8.5% 9.0% 9.4% 9.7% Surplus Change Base 8.9% 5.5% 3.6% 3.6% 4.1% 4.6% Alternative 1.8% 4.1% 0.9% 2.5% 4.9% GAAP ROE Base 6.1% 1.4% 2.3% 2.5% 2.9% 3.4% Alternative 0.9% 1.5% 0.1% 2.0% 3.5% NPW/Surplus Base Alternative Loss Reserve/Surplus Base Alternative Source: Conning model and analysis 30

31 Cyclical Patterns in P-C Loss Reserve Development Changes in Accident-Year Incurred Loss Ratio, Total All Lines 5 Year 2 to Year 5 Year 5 to Year 7 Year 7 to Year Source: Company statutory filings, Conning Research & Consulting analysis 31

catastrophes unusually severe 2011Q2 Over $34 billion in 2011 2011 expected at $15 billion

32 Cats: Beware the Second Quarter U.S. catastrophes unusually severe 2011Q2 Over $34 billion in expected at $15 billion above annual average Average annual natural catastrophe losses near $20 billion for 2012 and 2013, adjusted for estimated property exposure growth Insured Catastrophe Losses by Quarter & Year ($ in millions) Source: Property Claim Services 32

33 Rising Expenses a Growing Concern Increasing costs Commissions Up 1.4% 2010/04 Same percentage of DPW Other Acquisition Up 25% 2010/04 Up 1.3 points as percent of DPW General Expense Up 29% 2010/04 Up 1.2 points as percent of DPW Property-Casualty Direct Underwriting Expenses by Category ($ in billions) $50 $45 $40 $35 $30 $25 $20 $15 Commission Other Acquisition General $10 $5 $ Source: Company statutory filings, Conning Research & Consulting analysis 33

34 Commercial Lines Rates Declined in Soft Market Source: Council of Insurance Agents & Brokers agent/broker pricing surveys 34

35 Numerous New Recent Entrants 35

36 Performance Driver 1: Predictive Modeling 36

37 Where s the Sports Car? 37

38 We Think We Know, But Door 1 Door 2 Door 3 Scenario 1 Win Lose Scenario 2 Lose Win Scenario 3 Lose Win 38

39 Performance Driver 2: Expense, Commission Discipline Average Expense Ratio and Commission Ratio for Top Inland Marine Performers, Average Combined Ratio Average Expense Ratio Average Commission Ratio Alleghany 40.6% 23.5% 10.4% XL Re 55.4% 24.2% (17.0%) Farmers 57.3% 30.2% 10.4% Allianz 60.6% 28.4% (45.8%) Amex Assurance 61.6% 15.4% N/A Travelers 63.4% 32.3% 17.4% Chubb 65.3% 30.6% 17.2% Allstate 67.6% 23.6% 11.6% MetLife Property Casualty 68.6% 33.7% 13.5% Nationwide 73.5% 35.3% 18.2% Auto-Owners 73.9% 27.8% 19.2% Progressive 74.2% 20.6% 7.7% Westfield 74.7% 38.6% 21.6% Selective 74.7% 39.3% 21.3% State Auto 75.0% 38.7% 20.5% Employers Mutual 75.2% 39.7% 22.4% USAA 77.9% 26.9% 0.0% Old Republic 78.3% 26.5% 12.7% QBE 80.0% 35.7% 19.9% Hartford 80.0% 40.0% 18.4% Source: Statutory company filings, Conning Research & Consulting analysis 39

40 Performance Driver 3: Specialization 40

41 Performance Driver 3: Specialization Long-Term Average Reinsurance Combined Ratio, , or Since Founding, by Type Hybrid 95.9% Pure 89.2% Generalist 98.5% Specialist 76.5% Source: Company reports, Conning Research & Consulting analysis 41

42 Performance Driver 3: Specialization U.S. Transactions Involving a Specialty Insurance Target, Property-Casualty Sector, 2011 Acquirer Target Description of Target Tokio Marine Holdings, Inc. Delphi Financial Group, Inc. Self-insured and high deductible worker's compensation, and excess casualty through Safety National Insurance. Allstate Corp. White Mountains, Inc. d/b/a Esurance Insurance Services, Inc., and Answer Financial Web-based automobile insurance QBE Insurance Group Ltd. Balboa Insurance Group Balboa Insurance writes lender-placed homeowners, reported in fire & allied, traditionally a profitable line. Balboa also includes Newport, an E&S writer, with E&S typically more profitable than standard lines. Berkshire Hathaway, Inc. Wesco Financial Corp. The main insurance unit of Wesco is Kansas Bankers Surety, which writes surety business. Wesco has been owned by Berkshire for 30 years, and this transaction represents the completion of ownership. WRM America Holdings LLC Fidelity National Indemnity Insurance Co. and Fidelity National Insurance Services, Inc. CNA Financial Corp. CNA Surety Corp. Surety business Doctors Co. FPIC Insurance Group, Inc. Medical professional NORCAL Mutual Insurance Co. Medicus Insurance Holdings, Inc. WRM America, a specialty lines property-casualty insurance holding company, focused on the education market and not-for-profit and municipal markets. It was formed in 2008 with private equity backing from Aquiline Capital Partners. Medical professional Medical Protective Princeton Insurance Co. Medical professional Emergency Medicine Professional Medical Insurance Underwriter RRG Medical professional ACE Penn Millers Agribusiness Source: Public announcements, Conning Research & Consulting analysis 42

43 Takeaways 1. Inland Marine Numbers Not Necessarily What They Appear To Be. Know Your Performance. 2. Normalization Exercise Suggests Inland Marine May Not Be All That Different From Other P/C Lines. 3. Need to Focus on Performance Drivers: Predictive modeling Expense, Commission Discipline Specialization 43

44 Thank You! Questions? ABOUT CONNING As a knowledge leader for the insurance industry, Conning serves clients with a unique combination of asset management, insurance research and strategic advisory services. Conning is headquartered in Hartford, CT, with offices in New York, Hong Kong, London and Dublin. Conning Research & Consulting is a Hartford, CT-based insurance industry publisher and consulting group with 50 years of industry experience in the insurance market. Conning s team of analysts bring a wealth of industry knowledge from their prior operating roles in insurance. For more information on Conning Research & Consulting and its services, please call or visit All rights reserved. This presentation is produced by Conning and may not be reproduced or disseminated in any form without the express permission of Conning. This presentation is intended only to inform readers about general developments of interest and does not constitute investment advice. While every effort has been made to ensure the accuracy of the information contained herein, Conning does not guarantee such accuracy and cannot be held liable for any errors in or any reliance upon this information. Conning does not guarantee that this presentation is complete. Opinions expressed herein are subject to change without notice. Past performance is no indication of future results. Conning is a portfolio company of the funds managed by Aquiline Capital Partners LLC ( Aquiline ), a New York-based private equity firm. Conning has offices in Hartford, New York, Hong Kong, Dublin and London. 44

South Carolina Wind and Hail Underwriting Association

South Carolina Wind and Hail Underwriting Association Page 1 of 6 ACE USA GROUP 0.4788% 0.5914% AEGIS SECURITY INSURANCE COMPANY 0.7279% 0.8990% AFFILIATED FM INSURANCE COMPANY 0.1471% 0.1817% ALEA NORTH AMERICA INSURANCE COMPANY 0.0198% 0.0245% ALLIANZ GLOBAL