FPK Small/Mid-Cap Bank and Insurance Conference Investor Presentation June 2008
Forward-looking Statements This presentation may include forward-looking statements. These forward-looking statements include comments with respect to our objectives and strategies, and the results of our operations and business. By their nature, however, these forward-looking statements involve numerous assumptions, risks, uncertainties and opportunities, both general and specific. The risk exists that these statements may not be fulfilled. Investors should not place undue reliance on these forward-looking statements as a number of factors could cause future company results to differ materially from these statements. Potential risks and uncertainties include fluctuations in interest rates and stock indices; cyclical changes in our business; increased competition on the basis of pricing, coverage or other factors; developments in the financial or capital markets; the loss of key personnel or the inability to recruit additional personnel; changes in the availability, cost or quality of reinsurance or failure of our reinsurers to pay claims timely; severe weather conditions; changes in our relationships with the agencies and agents that distribute our products; and a decline in our financial ratings. The foregoing list is not exhaustive. When relying on forward-looking statements to make decisions, investors should carefully consider the aforementioned factors as well as other uncertainties and events including those discussed in the Forward-Looking Statements and Risk Factors sections of the Company s 10-K for the year ended December 31, 2007, and most recent 10-Q, for the quarter ended March 31, 2008, which is on file with the SEC. 2
Business Overview Platform Strategic Advantage Financial Review Concluding Remarks
First Mercury s Business Provide insurance products and services in specialty commercial insurance markets, focusing on niche and underserved customers Operate as an Excess & Surplus lines company (rated A- by A.M. Best) in 49 states, the District of Columbia, and the Virgin Islands, underwriting primarily general liability coverage Long-term track record of success proven over 35 years across various market cycles Diversified product lines and distribution platform positions us well to respond to the current market environment Superior financial results reflected in a three year average combined ratio of 70.3% and 2007 ROAE of 20.8% Targeting 20%+ premiums produced growth and 16.5% to 18.0% ROAE in 2008 Market capitalization of approximately $320 million with inside ownership of 19.6% 4
Differentiated Operating Platforms CoverX Contract Underwriting First Mercury Emerald Insurance Services ( FM Emerald ) Legend: Risk-bearing entity Non risk-bearing entity (fee income) ARPCO American Management Corporation ( AMC ) 5
Key Investment Highlights Generate excellent underwriting results through a disciplined, data-driven approach Sustainable superior ROE throughout the underwriting cycle Cost-efficient operating structure drives overall profitability Growth strategy fueled by existing pipeline of underwriting opportunities Well positioned in the surplus lines market, driven by strength of CoverX brand Admitted specialty underwriting opportunity through acquisition of AMC Management team closely aligned with shareholders 6
Growth and Underwriting Performance Premiums Produced ($ mm) GAAP underwriting ratios Premiums produced $300 $250 $200 $150 $100 $50 $0 21% CAGR $276 $230 $189 2005 2006 2007 100% 75% 50% 25% 0% 89.9% 70.7% 67.7% 72.5% 75.0% 73.7% 29.4% 14.3% 16.9% 20.4% 21.2% 20.4% 56.4% 50.8% 52.1% 60.5% 53.8% 53.3% 2005 2006 2007 3 yr. peer avg. YTD Mar 2008 YTD Mar 2007 Loss Ratio Expense Ratio Peer group comparison YTD March 2008 GAAP underwriting ratios 100% 75% 50% 25% 75.0% 21.2% 53.8% 84.3% 89.2% 90.2% 83.7% 95.9% 89.2% 92.0% 84.9% 22.7% 38.3% 29.4% 24.3% 35.8% 32.4% 36.0% 30.4% 61.6% 50.9% 60.8% 59.4% 60.1% 56.8% 56.0% 54.5% 0% First Mercury National Interstate RLI W.R. Berkley HCC Argo Group Navigators Markel Tower Group Loss Ratio Expense Ratio 7
Business Overview Platform Strategic Advantage Financial Review Concluding Remarks
Premiums Produced and Gross Written Premiums by Source Premiums Produced ($ in millions) $400 $350 $350 $300 $300 $250 $250 $200 $150 $150 $100 $100 $50 $50 $0 $0 $146.9 $97.2 $78.6 $69.9 $68.3 $8.8 20%+ CAGR $188.5 $12.9 $59.5 $41.2 $101.4 $74.2 $5.0 $8.1 $138.2 $5.4 $71.9 $230.1 $20.0 $138.2 $1.3 $91.1 $46.4 $276.0 $52.1 $155.9 $71.9 $66.7 $1.3 20%+ Growth Over 2007 $47.6 $0.3 $155.9 $66.7 $93.4 $39.0 9 $22.9 $7.0 $300 $50.0 $250 $71.4 $161.2 $150 $68.4 $50 $6.5 $13.7 $39.9 $128.4 $50.9 $1.5 $5.6 $16.3 $39.9 $17.9 $69.9 $1.5 $10.2 $1.7 $31.5 $13.6 $71.9 $66.7 GWP NWP GWP NWP GWP NWP GWP NWP GWP NWP 2004 2005 2006 2007 2008 Projected Gross Written Premiums ($ in millions) Security Specialty Contract Underwriting FM Emerald $350 $200 $100 $0 $48.7 $43.0 $0.4 $8.8 $97.2 $8.1 $138.2 $47.6 $155.9 2004 2005 2006 2007 2008 Projected Growth in 2008 driven by Contract Underwriting, FM Emerald and New Initiatives $92.1 35%+ CAGR $175.9 $218.2 $271.5 $1.3 20%+ Growth Over 2007
Security Classes 2007 premiums by class through 12/31 125% 100% 75% 50% 25% 0% Alarm 30% Safety Equipment 29% Total 2007 premiums = $66.7mm Historical loss & ALAE ratio 1987 1991 1995 1999 2003 2007 1 Cumulative loss ratio since 1987 Security Guard 41% 59% 1 Overview General liability coverages, each policy individually underwritten Customized policy forms and exclusions Analyze data and results intensely to drive underwriting decisions 13 underwriters; senior underwriter has 17 years experience Policy limits generally $1mm Target account premium $50,000 and below; average account size $7,300 in 2007 Approximately 800 production sources in 49 states and 2 jurisdictions in 2007 Top 5 producers represented 29% of premium in 2007 Since 1987, across all industry cycles, achieved a cumulative loss and ALAE ratio of 59% 10
Security Premium by State 2007 Top 20 States Represent Approximately 91% of CoverX Security premium Washington Oregon Idaho Montana Wyoming North Dakota South Dakota Minnesota Wisconsin Michigan 3.3% 10.3% Maine Vermont New Hampshire New York Massachusetts Rhode Island Connecticut Hawaii 30.0% California Nevada Utah Arizona Colorado New Mexico Nebraska Kansas Oklahoma Iowa Illinois Missouri Arkansas Pennsylvania New Jersey Ohio Maryland Delaware Indiana West Virginia Virginia Kentucky North Carolina Tennessee South Carolina Texas Alabama Georgia Mississippi Alaska 15.2% Louisiana Florida 5.8% State DPW ($mm) % of total California $20.0 30.0% Texas 10.1 15.2 New York 6.8 10.3 Florida 3.9 5.8 Pennsylvania 2.2 3.3 Total top 5 $43.0 64.6% 11 > 10% <10%, >5% <5%, >1% <1% = CoverX Office
Specialty Classes 2007 premiums by class through 12/31 Historical loss & ALAE ratio 75% 50% 25% 45.4% Other 45% Carpentry Habitational Masonry 8% 2% Drywall 7% 3% Total 2007 premiums = $155.9mm 48.9% 37.2% 38.3% 51.8% 2003 2004 2005 2006 2007 1 Cumulative loss ratio since 2003 Roofers 35% 45% 1 Overview All general liability coverages; similar fundamental underwriting characteristics and targets as Security classes Customize policy forms and exclusions Focus on underserved accounts Manage claims handling & jurisdictional issues Analyze data and results 14 underwriters; senior underwriters average over 20 years of experience Target account premium $50,000 and below; average account size $32,300 in 2007 Policy limits generally $1mm Approximately 500 production sources in 2007 Since 2003, achieved cumulative Loss and ALAE ratio of 45% 12
Specialty Premium by State 2007 Top 20 States Represent Approximately 93% of CoverX Specialty Premium 17.7% Washington Oregon Idaho Montana Wyoming North Dakota South Dakota Minnesota Wisconsin Michigan 10.3% Maine Vermont New Hampshire New York Massachusetts Connecticut Rhode Island Hawaii California Nevada Utah Arizona 11.4% Colorado New Mexico Nebraska Kansas Oklahoma Iowa Illinois Missouri Arkansas Pennsylvania New Jersey Ohio Maryland Indiana Delaware West Virginia Virginia Kentucky North Carolina Tennessee South Carolina Alabama Georgia Alaska Texas Mississippi 13.8% Louisiana 9.5% Florida State DPW ($mm) % of total Washington $27.5 17.7% Texas 21.6 13.8 Arizona 17.8 11.4 New York 16.0 10.3 Florida 14.8 9.5 Total top 5 $97.7 62.7% 13 > 10% <10%, >5% <5%, >1% <1% = CoverX Office
Specialty Class Contractor Book 2007 premiums by class through 12/31 Other 38% Total 2007 premiums = $142.3mm Excavation 2% Plumbing 3% Metal Works 3% Drywall/Plaster 6% Masonry 6% Roofing 33% Carpentry 9% 2007 contractor premiums by state Other 28% CA 8% FL 10% NY 10% WA 19% AZ 12% TX 13% 14
First Mercury Emerald Insurance Services Business consists of 3 units: Excess/Umbrella Casualty product E&S Property Primary Casualty for heavier E&S risks Operation commenced in July 2007 Hired 30 underwriting professionals, with an average of 20 years experience led by Kevin Brooks Offices in New York, Atlanta, Los Angeles and Chicago Business is heavily reinsured to manage exposure TARGET premiums by class Underwriting Rationale Primary Casualty 40% E&S Property 20% Excess/ Umbrella 40% Complementary product lines to Security and Specialty underwriting Leadership team worked together at GenStar unit of GenRe for many years First year premiums anticipated to be $40-50 million Net retention expected to be less than 30% in 2008 15
Contract Underwriting Programs Programs Program 1: Lawyers Professional Liability Program 2: Hospitality / Habitational Small Accounts Program 3: GL Habitational / Premises Liability Program 4: Texas Non-Subscriber Worker s Comp Program 5: Outdoor Recreation E&S 2007 premiums by class through 12/31 Program 3 7% Program 2 40% Program 4 11% Program 5 3% Total 2007 premiums = $52.1mm Program 1 39% 16 Opportunities Approach to adding new programs: Due diligence and personnel background checks Data verification and loss experience analysis Actuarial, claims and underwriting reviews IT / technology systems in place Heavily reinsured to manage exposure o 2008 retention of less than 50% for programs added in 2007 Rollover capabilities: Existing books with proven histories Established distribution networks Solid ownership and management Complementary to FMIC existing product line-up Niche products by class and/or distribution Low limits / smaller accounts Primary only Smaller deductibles or SIRs No excess attachments Pilot program goal: $10mm premium potential by 18 months
American Management Corporation Acquired in February 2008 Leading experienced MGA focused on niche fuel related marketplace for over 20 years 87% of 2007 premiums written on an admitted basis Currently written on third-party paper with the opportunity to renew on FMR paper over time Source of fee based income 2007 Production Trucking 2% E&S 13% Service Stations 10% Personal Lines 9% Work Comp <1% Total 2007 premiums = $94.3mm Jobbers 66% Transaction Rationale Definable niche market Best-in-class underwriting franchise with unmatched experience and historical data that provides a significant competitive advantage Strong, established relationships with insureds and sub-producers Specialty admitted nature of business enhances our ability to adapt to market cycles 17
Business Overview Platform Strategic Advantage Financial Review Concluding Remarks
Positioned for Profitable Growth Across Market Cycles Premium Premium growth growth in in 2008 2008 will will be be driven driven by by strategic strategic initiatives initiatives undertaken undertaken in in 2006 2006 and and 2007 2007 CoverX Premium production is expected to be flat as we maintain our commitment to underwriting discipline Small account focus insulates us from the broader market trends, but we are not immune Flexibility to manage the cycle by increasing or decreasing net retentions Platform Overview FM Emerald Contract Underwriting Proven team with large book of business will be a driver of profitable premium growth in 2008 and beyond Leadership team hired in late July 2007; currently 32 dedicated employees Opportunity to underwrite complimentary product lines with an experienced, cohesive leadership team Realize full year of production from specialty programs initiated in mid-2007 Limit production to 15%-20% of total book Small amount of premium from selected new pilot programs in 2008 AMC Fee income in 2008 with the opportunity to take risk on FMR paper as we get comfortable with the book $90mm+ of controlled premium Potential to realize operating synergies as business is integrated onto our technology platform 19
Embedded Growth Opportunities $300 $271.5 $1.3 $250 $200 $150 $100 $50 $0 $218.2 $47.6 $8.1 $175.9 $155.6 $8.8 $142.9 $155.9 $5.4 $138.2 $22.9 $105.7 $97.2 $5.0 $91.1 $93.4 $59.5 $69.9 $71.9 $66.7 $41.2 $46.4 $39.0 GWP NWP GWP NWP GWP NWP 2005 2006 2007 Security Specialty Contract Underwriting FM Emerald 20 $0.3
Approach to Growth Strategic Approach Hire experienced underwriters Representative Execution 7 additional underwriters hired in 2007 Expand geographically in specialty classes Opened office in Irvine, California (December 2006) Consolidated Southeast underwriting operations in Atlanta, GA Opened office in Seattle, Washington (January 2008) Focus on entering definable niche markets Habitational (2007) Hospitality (2007) Employer general liability (2007) Hired an experienced E&S specialty underwriting team (2007) Selectively evaluate M&A opportunities Acquired American Management Corporation Pursue new product opportunities Entered into 3 pilot program relationships in 2007 and 1 in 2008 Retain more premium produced Reduced quota share on Jan 1, 2007 to 35% from 50% in 2006 Reduced quota share on Oct 1, 2007 to 25% from 35% Reduced quota share on Apr 1, 2008 to 15% from 25% in 2007 21
Business Overview Platform Strategic Advantage Financial Review Concluding Remarks
Financial Overview Summary $ in millions For the three months ended For the year ended March 31, December 31, 2008 2007 % change 2007 2006 % change Premiums produced $ 81.3 $ 64.3 26 % $ 276.0 $ 230.1 20 % Net premiums earned 43.6 44.9 (3) 169.1 110.6 53 Net investment income 4.9 3.3 48 16.3 9.7 68 Operating net income 1 $ 10.0 $ 9.9 1 % $ 41.7 $ 21.5 94 % Loss ratio 53.8 % 53.3 % 52.1 % 50.8 % Net expense ratio 2 21.2 20.4 20.4 16.9 Combined ratio 75.0 % 73.7 % 72.5 % 67.7 % Total investments $ 473.9 $ 459.3 $ 297.8 Long-term debt 67.0 67.0 46.4 Total stockholders equity 239.5 229.4 172.7 Book value per outstanding share $ 13.10 $ 12.76 $ 9.98 Return on average equity 16.6 % 20.8 % 23.6 % Operating leverage 3 1.2x 0.8x 1.0x Investment leverage 4 2.0 2.0 1.7 Financial leverage 5 21.9 % 22.6 % 21.2 % 1 Adjusted to exclude the impact of net gains (losses) on 2 Does not consider impact of insurance services revenue 4 Total investments / total capital investments and the change in fair value of derivative 3 Net written premium / statutory surplus 5 Debt / total capital instruments and taxes related to these adjustments 23
Prudent Loss Reserve Philosophy Extensive monthly in-house loss experience monitoring Expanded actuarial team to include two credentialed actuaries in 2007 and a FCAS in June 2008 Quarterly internal and semi-annual external actuarial reviews Case vs. IBNR reserves, net of reinsurance 100% 75% 50% 25% 0% 49.5% 42.1% 35.7% 30.1% 29.1% 30.2% 50.5% 57.9% 64.3% 69.9% 70.9% 69.8% 2003 2004 2005 2006 2007 Q1 2008 IBNR & ULAE Case 24
Investment Portfolio Characteristics Investment portfolio is actively managed by advisors AAM, JP Morgan, MD Sass and Zazove Associates S&P weighted average credit quality of AA+ for fixed income portfolio Tax-effected duration of 2.7 years $ in millions $500.0 $450.0 $400.0 $350.0 $300.0 $250.0 $200.0 $150.0 $100.0 $50.0 $223.2 $248.8 $297.8 $360.0 $395.9 $429.1 $459.3 $473.9 ABS & CMBS 9.3% Corporates & Preferreds 12.1% Money Market 6.8% BBB 5.2% A 10.1% Portfolio Composition Convertible Securities 7.2% BB 1.3% Other 4.8% Mortgages 14.1% Asset Quality CCC 0.1% B 2.2% NR 0.7% Municipal Bonds 45.7% $0.0 Q2 2006 Q3 2006 Q4 2006 Q1 2007 Q2 2007 Q3 2007 Q4 2007 Q1 2008 AA 14.7% AAA 65.7% 25
Structured Products Analysis as of 3/31/2008 23.4% of portfolio in Mortgage and Asset backed securities 97% are AAA rated $3.3 million rated below AAA have significant credit support and low delinquency and foreclosure rates Residential Mortgage Backed Securities and Home Equity Asset Backed Securities Average credit quality of AAA 72.6% are Agency Backed Securities Approximately $0.1 million are subprime % Market Value $ in millions Mortgage Backed Securities Agency Passthroughs & Collateralized Mortgage Obligations 10.5% $ 49.5 Non-Agency Passthroughs & Collateralized Mortgage Obligations 3.6% $ 17.2 14.1% $ 66.7 Asset Backed Securities Asset Backed Securities (including Home Equity) 3.5% 16.8 AA 1.9% A 1.1% Commercial Mortgage Backed Securities 5.8% 27.3 9.3% $ 44.1 AAA 97.0% Total Portfolio 23.4% $ 110.8 26
Reinsurance Program / Mainframe Treaties Overview Mainframe Mainframe reinsurance reinsurance structure structure as as of of April April 2008 2008 Umbrella policies only Primary policies per occurrence policy limits $5,000,000 $500,000 $500,000 FMIC: 10% Retention $5,000,000 xs $1,000,000 Munich Re: 76.5% Swiss Re USA: 13.5% $500,000 xs $500,000 Swiss Re: 40% QBE: 35% Liberty: 25% FMIC Retention: 85% Ace Tempest Re USA: 10% Swiss Re: 5% High High quality quality reinsurance reinsurance partners partners Reinsurance Name A.M. Best rating Recoverables ($MM)* Ace Ltd. A+ $72.1 Swiss Re America A+ $49.6 Others NA $28.0 Substantially all of reinsurer credit exposure is rated A or better by A.M. Best There are no disputed reinsurance recoverable amounts Quarterly reset available for increased Quota Share % ceded to reinsurers in 2008 Added Swiss Re for 5% on April 1, 2008 * Balance as of 12/31/07 Maintain higher retentions on more seasoned business 15% quota share of $500,000 Control net earned exposure growth for new initiatives e.g., FM Emerald and Contract Underwriting 27
Business Overview Platform Strategic Advantage Financial Review Concluding Remarks
Concluding Remarks Proven track record over 35 years High quality management team closely aligned with shareholders Business model designed for profitable growth across market cycles Highly disciplined underwriting approach using data-driven analysis to generate superior loss ratios Cost-efficient operating platform provides a competitive advantage Deploying capital efficiently while maintaining A- A.M. Best rating Disciplined growth strategy ROEs outperform peer group across all market cycles 29