NCREIF/PREA Conference 2005

Jeffrey Alpaugh Marsh Boston October 19, 2005

Marsh

Agenda

 Insurance Market Update   Insurance and Reinsurance Market Impact Affects of Katrina and Rita  Market Outlook  Terrorism  TRIA update  Stand-alone Market 2

Insurance and Reinsurance Market Impact

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US Property Casualty Insurance Industry

 Surplus increased by $111 billion in 2003 and 2004, to $402 billion  In 2004 the US industry reported its first net underwriting profit since 1978 (Jimmy Carter was President).

 Even with 2.3 points on a combined ratio in adverse loss development  It is conceivable that the US industry could report

net income

and

increase its surplus

in 2005, despite Katrina and Rita  AM Best had estimated industry’s 2005 net income would be $32.5 billion before Katrina.

 A lot of reinsured losses will be borne by foreign reinsurers 4

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Underwriting Gain (Loss) 1975-2005E*

$25 $15 $5 ($5) ($15) ($25) ($35) ($45) ($55) Before Katrina, p/c insurers were on track for only the second underwriting profit in 26 years

*2005 estimate is based on annualized actual 05Q1 underwriting profit of $7.1 billion.

Source: A.M. Best, Insurance Information Institute

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US Reinsurers: Change in Policyholder Surplus

($ Billions)

$55 $50 $45 $40 $75 $70 $65 $60 $60.9

1998 Reinsurer PHS fell 20% from 1998 2002. Capacity today similar to 1998. Same story globally $58.9

1999 $57.9

2000 $46.8

2001 $48.8

2002 $64.8

2003 $73.0

2004

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U.S. Policyholder Surplus

1975-2005

YE 2004 PHS was 20% above its mid 1999 peak $450 $400 $350 $300 $250 $200 $150 $100 $50 $0

Surplus increased by $68B or 24% to $354B in 2003 and 13% in 2004 to $402B

PHS backs all lines of insurance in all states. PHS is not fungible and is frequently misunderstood and misused

“Surplus” is a measure of underwriting capacity. It is analogous to “Owners Equity” or “Net Worth” in non insurance organizations

75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 0405E Source: A.M. Best, ISO, Insurance Information Institute *2005 Figures based on A.M. Best

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120 115

P/C Industry Combined Ratio

2001 = 115.7

2002 = 107.2

2003 = 100.1

2004 = 97.9

2005E = 97.3*

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Combined Ratios 1970s: 100.3

1980s: 109.2

1990s: 107.8

2000-04: 106.2

105 100 95

Marsh Sources: A.M. Best; ISO, III *2005 figure based on A.M. Best estimates pre Katrina 8

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2004 Net Investment Income Nears Peak Levels

16% 14% 12% 10% 8% 6% 4% 2% 3-Month T-Bill 1-Yr. T-Bill 10-Year T-Note 0% 9 1 0 8 9 1 1 8 9 1 2 8 9 1 3 8 9 1 4 8 9 1 5 8 9 1 6 8 9 1 7 8 9 1 8 8 9 1 9 8 9 1 0 9 9 1 1 9 9 1 2 9 9 1 3 9 9 1 4 9 9 1 5 9 9 1 6 9 9 1 7 9 9 1 8 9 9 1 9 9 0 2 0 0 0 2 1 0 0 2 2 0 0 2 3 0 0 2 4 0 0 2 5 0 * Source: A.M. Best, ISO, Insurance Information Institute

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Combined Ratio

Reinsurance vs. P/C Industry

Reinsurance All Lines Combined Ratio

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170 160 150 140 130 120 110 100 90

 2001: Combined ratio was the worst-ever for reinsurers; 2002 results were also poor  2003: Big improvement in all lines and reinsurer segments  2004: Reinsurance combined ratio increases

Hurricane Andrew 91 92 93 94 95 96 97 98 99 00 01

* 2005 figures based upon A.M. Best estimates 5/2005 Source: A.M. Best, ISO, Reinsurance Association of America, Insurance Information Institute

02 03 04 05E

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Reinsurance Prices are Only at 1995 Levels, Despite Increased Risk

40%

US cat reinsurance price index: 1994 = 100

120 30% 20% 16% 21% 11% 10% 2% 0% -10% -5% -11% -9% -8% -4% -4% -6% -20% 94 95 96 97 98 99 '00 '01 '02 '03 '04 05E Sources: Swiss Re, Cat Market Research Marsh rate changes [left] index level [right] 100 80 60 40 20 0 11

Hurricane Katrina - Reinsurers

 Reinsurance market to bear the brunt of losses, just like 9-11  Could put ratings at risk  No new reinsurers being formed  Some bit-players will exit reinsurance  Some bigger players to exit certain lines  12 reinsurers announced capital strengthening plans*  Generally attempting to recoup losses and retain ratings  Potential difficulties attracting new capital now vs. post 9-11  Premium rates in many lines flat or declining  Conservatism required for high rating prevents high ROE Marsh * - As of 10-6-05 12

Marsh

Trouble Concentrated In Commercial Lines and Reinsurance

   Katrina losses to be 60%-70% borne by commercial lines insurers (vs. personal lines insurers) per Dowling & Partners  These deficiencies are in commercial lines and reinsurance  Personal lines reserves redundant per Best Estimated 2004 PHS of U.S. commercial insurers and reinsurers: $205 billion  AM Best: U.S. Industry is over $45 billion under-reserved at year end 2004  Includes reserve deficiency for asbestos and environmental losses  Based on 2003 estimate plus 2004 development.

 Other rating agencies have similar opinions What new mass tort issues will emerge? 13

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A Profitable Industry with Some Vulnerable Companies

 Premium rates had been declining in most lines of business  Now insurers have much less confidence in their ability to price their product properly  Will the market learn from the past or repeat its mistakes?

 In 2003 market security was the most important issue for risk managers. What about now?   Will price and coverage mean more than financial strength? Will this impact insurer/reinsurer underwriting decisions?

 Reinsurance rates expected to increase, at least in certain lines  If nothing else, this will be passed on to primary insurance rates 14

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It Is Only October 19th

 Wilma  Alpha, Beta, Gamma…  How many insurers have more reinstatements?

 What about next year?

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And Everything Was Going So Well…

Impact of Katrina and Rita Property Market

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Property Market Rates – Key Points

July 2 – Aug. 1, 2005

 86% of 87 accounts sampled obtained rate reductions, with a median reduction of 10.1%.

 Companies with TIV between $500m and $1b had a median rate reduction of 12%, while the medians for the other TIV groupings were each 9.9%.

 Over 20% of the accounts increased their limits by more than 5%, while only four changed their deductibles – three reductions and one increase.

 Real Estate risks obtained median rate reductions of 11.5% between January – August 2005.

 StarrTech and CNA have provided the highest median rate reductions in 2005, while Fireman’s Fund, Lloyds and FM Global have had the lowest.

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Renewal Rates as of Aug. 1, 2005

Pct. of Accounts with Rate Reductions

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88.0% 87.0% 86.0% 85.0% 84.0% 83.0% 82.0% 81.0% 80.0% 79.0% 86.3% 85.5% 82.3% 87.2% 87.4% 3rd Qtr 04 4th Qtr 04 1st Qtr 05 2nd Qtr 05 July 1 05 Pct Accounts with Reductions 85.7% Aug 1 05

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0.00% -2.00% -4.00% -6.00% -8.00% -10.00% -12.00% -14.00% -16.00% -18.00%

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Renewal Rates Comparison 2004 to 2005 (January – Aug)

Selected Industries Median Pct Rate Change

Jan - Aug 04 Jan - Aug 05

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Hurricane Katrina

 Estimates of $26 billion to $60 billion and growing*  The high end is more than double the cost of any previous catastrophe year ($27 billion in 2004)  (Re)Insurers announced aggregate estimates of $22 billion*  S&P downgraded 2 ratings, placed 10 on negative watch including Lloyds & Swiss Re*  Best downgraded 2 ratings, placed 23 Under Review: Negative*  Note: After 9/11 some early loss estimates were too high Marsh * - As of 10-6-05 20

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Hurricane Katrina

 Scale and scope never before encountered  Business Interruption and Contingent BI coverage  Flood versus Wind  Valued Property Law in Louisiana could surprise insurers  Political Issues  In Louisiana  In Mississippi  Demand surge will increase repair costs and repair times dramatically  The higher the costs, the more likely costs will blow through reinsurance coverage, placing burden on primary insurers 21

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Client Segments/Industries Most Affected by Katrina

 Gaming  Healthcare  Hospitality  Marine  Oil& Gas/Energy  Public Entities  Real Estate  Retail  Transportation 22

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Market Segments Impacted By Loss

 Excess & Surplus Lines  Oil & Gas/Energy  On-Shore  Off-Shore  Small Commercial  Federal Flood Program  Primary/Layered Underwriters  Home Owners  State Farm   Allstate St. Paul - Travelers 23

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Hurricane Rita

 Estimates of $2.5 billion to $10 billion  May have been one of the ten costliest U.S. catastrophes to the insurance industry.

 Substantial damage to oil refineries and offshore oil rigs 24

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Hurricanes Katrina and Rita

 Proved, once again, that catastrophe models are flawed  Industry losses still unknown in main renewal season  Withered financial reinsurance market limits ability to defer losses  Raising premium rates in property catastrophe, marine and marine energy  Should help future profitability  Expect coverage disputes between direct insurers and reinsurers  These aren’t rounding errors  Reinsurers get no political gain from paying uncovered claims 25

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Major Markets Reporting Losses

        Lloyd’s Munich Re Swiss Re AIG ACE Group Montpelier Re AXIS Factory Mutual

*Net of Reinsurance

 $2.55 Billion  $1.60 Billion  $1.20 Billion  $900 Million*  $700 Million  $675 Million  $600 Million  $300 Million* 26

3,000

Distribution of Announced

Hurricane Katrina Losses ($ Millions)

(As of September 23, 2005) 2,500 2,000 1,500 As of September 23, 37 companies had announced pre-tax losses totaling between $14.3 and $15.5 billion, almost 40% of a mid-range industry loss estimate of $40 billion 1,000 500

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0 Ll oy S ds w is s R e A S P Tra IG ve * le rs A ** c e X Lt L M C d.

on api tpe ta lie A l x r is R C e api ta A l ll M ia nz un ic E R e h nd R na e ura is nc sa e nc E e R ve e re st R e P ar tne r H R a e nn W ov hi te er M A X ou A nt Tra ai ns

Note: If company gave range of estimates, upper end is used.

ns a tl ant ic P X R E Fa ir fa x A s P pe la n ti num A lf a Zu O dy ri s ch se y R R M oy e ax al R S e un H A C lli C anc C e inc S C inn O R at i Fi nl Ze W R ni B th er C ke on ly v er A ium M m idl er and ic an 21 st N

*After-tax figure. $900 million after reinsurance recoverables.

a C tl ent K ury ing sw a y

Sources: Morgan Stanley, Company Reports **After-tax figure, net of reinsurance recoverables. Gross figure is $2.5 billion.

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Historical Comparison

Previous Catastrophic Property Events

 A comparison of market conditions prior to other catastrophes, the extent of those catastrophes, and the property insurance marketplace’s responses may help us understand how insurers will respond to Katrina and why.

 The previous catastrophes compared are:  Hurricane Andrew – 1992   Terrorist Attacks – Sept. 11, 2001 Hurricanes Charley, Francis, Ivan, and Jeanne – 2004  This comparison is certainly not all encompassing and is only intended to highlight a few of the key factors that determine market rates.

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Historical Comparisons

U.S. Property Catastrophes

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Andrew 1992 9/11 2001 Hurricanes 2004 Katrina 2005

Market Profitability Rates Prior Insured Loss Size Segment Impacted Insurer/Reins.

Geog. Breadth Industry Breadth Rate Change Coverage Changes $21b Residential Reinsurers Limited Limited 1 year spike Raise deductibles $32b Commercial Reinsurers $20b Residential Insurers Limited Limited 1 year spike Wide Limited Minimal Exclude Terr Use Insurer Forms Raise deductibles $40 - $60b (?) Commercial TBA Wide Wide TBA TBA 29

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Historical Indicators for Why Katrina Could Change Market Direction

 Size of loss $40 - $60 billion  Commercial sector heavily impacted  Wide geographic and industry breadth of damage  Rating agency and investor demands for sufficient capitalization and profits. S & P’s ratings of 10 insurer/reinsurer groups on watch for potential downgrades*  If the reinsurers are hit hard by Katrina, they will raise prices and insurers will likely pass these increased costs on to policyholders

* Includes Lloyds of London, Montpelier Re, Swiss Re, ACE, Oil Casualty Ins. Ltd.

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Historical Indicators Which May Moderate Katrina’s Impact

 Strong Market Capitalization  Market has been profitable the last two years  Major commercial insurers may have been impacted disproportionately, thus reactions may differ  Due to market over-supply, property rates were on the decline prior to the loss, although that decline was beginning to slow  If the reinsurers are not hit too hard, the excess capacity in the reinsurance marketplace will hold down price increases 31

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Reinsurance Indications

 Estimated US CAT premium is $8b – Katrina losses far exceed that.

 Katrina may not just reduce earnings – it could take capital out of the market.

 Reinsurers will likely seek highest rate increases from those with substantial Katrina losses and those with similar types of accumulations in CAT zones.

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Early Indications

 Several insurers reinstated their treaties and will be passing those costs on to policyholders.

 Insurers are reevaluating their accumulations and modeling, and adjusting their quotes accordingly. Faith in modeling has been shaken.  Insurers are continuing to quote business and so far rate adjustments have been evaluated on a risk by risk basis.  Many insurers are indicating we may see radical change in market pricing; this is particularly acute in “CAT” risk areas.

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Potential Impact on Property Terms & Conditions

 Pricing – Cat vs. Non Cat  Increased % Deductible on CAT Perils  Rationing of CAT capacity  Aggregated Limits for the Peril of Wind  Manuscript Form Restrictions  Insurer Quotations could be Delayed  Degradation of Solvency Ratings of Insurers/Reinsurers (Need for credit enhancements) 34

Terrorism Market Update

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TRIA

 When does TRIA end ?

 What is the future of TRIA ?

 Factors that will determine the future of TRIA  Stand-alone Terrorism Market 36

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When Does TRIA End?

 Insurers must “make available” terrorism coverage through 3rd year of program and until December 31, 2005  TRIA is not a risk-attaching reinsurance vehicle - in other words - it will end on December 31, 2005 and will not follow the terms of P&C insurance policy  Sunset Clauses – Mid term cancellation of TRIA Terrorism coverage for policies incepting in 2005 and providing property coverage until expiration in 2006 37

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What is Future of TRIA?

 June 30, 2005 the Secretary of the Treasury submitted a report to Congress regarding the effectiveness of the TRIA program  Developments in Insurers ability to model and quantify terrorism loss exposure  Developments in the insurance industry’s financial status since September 11th 2001  The implications of eliminating TRIA for insurance markets and for the economy more generally  TRIA has satisfied the temporary demands of commercial and consumer buyers of insurance during the period in which it has been in force 38

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What is Future of TRIA?

 TRIA has achieved its goals of supporting the insurance industry during a transitional period and stabilizing the private insurance market  TRIA is considered as having been effective in its goals, extending TRIA would have little impact on the economy given its current strength   In the opinion of the Treasury, the continuation of the program in its current form is likely to hinder the further development of the insurance market by crowding out innovation and capacity building  Overall the Administration opposes the extension of TRIA in its current form The Administration would only accept an extension of TRIA should the qualifying Terrorism event size for TRIA coverage to be triggered be increased from $5 million to $500 million, increases the dollar deductibles and percentage co-payments borne by Insurers, and eliminates certain lines of insurance 39

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Factors That Will Determine the Future of TRIA

 Political Climate  Availability of Reinsurance  Results of Surveys  Competitiveness of Property Market  Take-up Rates –

exceeds 60% for Real Estate Risks

 Events and Losses - in US and Globally  Any Government Alternatives to TRIA?

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The Stand-alone Terrorism Market and Property Terrorism Solutions

 Stand-alone Terrorism market capacity  Market Overview for Stand-alone Terrorism  Factors impacting the pricing and availability of Stand-alone Terrorism market capacity  Stand-alone Terrorism vs. Property TRIA cover 41

Stand-Alone Terrorism Market Capacity Maximum $1.5B

$400 $50 $100 $100 $150 AIG ACE USA AXIS Specialty Berkshire Lloyd's Montpelier Re $700 Marsh *Carrier Capacity in millions 42

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Factors Impacting the Pricing and Availability of Stand-Alone Terrorism Market Capacity

 

Capacity

 Location of risk Insurers accumulation of exposure Concentration of exposure    

Pricing

 Location of risk  Insurer’s accumulation of aggregate exposure in specific areas  Limit / amount of coverage required Insured’s TIV Extent of requests to broaden the standard coverage conditions Insured’s profile and ownership Perception as to whether the company is a target  Nature of tenants, such as government agencies  Terrorism loss history 43

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The Stand-Alone Market Provides an Alternative Source of Cover to TRIA

   

Stand-alone terrorism – T3/T3A

 Acts of foreign and domestic terrorism  Locations in the US and outside of the US  Limits are typically aggregated or with one reinstatement Location and schedule specific Non-cancelable policy available Long-term (up to 3 years) available Select markets    

TRIA as part of All Risk Property

 Covers foreign acts only US locations only Per occurrence limits that match property policy  Coverage for all locations, including unscheduled, depending on terms of the property policy  Cancellation terms follow property policy Typically one year All markets that meet insurer definition under the Act 44

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Key Points:

Stand-Alone Terrorism insurance

     Aggregate limits; can sometimes obtain occurrence limits from Lexington only Typically higher deductibles Worldwide locations (a few limitations) Cancelable or Non-cancelable Scheduled locations (not blanket) & amounts for each location (co-insurance penalty). Typically require Underwriter approval for new locations  Coverage:  Wide Terrorism definition: includes foreign & domestic acts   Direct PD, BI / Rents / EE Excludes CBI, Supply Interruption, Civil Authority, Ingress / Egress   Excludes War, Nuclear, Chemical, Biological (NCB) + cyber Non concurrencies within layers when combined with “All Risk” programs  Pricing is client specific 45

Key Points:

Property Program TRIA Cover

Marsh  Per occurrence limits  Typically lower deductibles  U.S. locations only  Cancelable  Not typically scheduled or restricted for new locations  Coverage:  Certified TRIA acts; a few markets quoting non-certified (domestic) acts   Direct PD, BI / Rents / EE Sub-limits for CBI, Supply Interruption; + Civil Authority, Ingress / Egress  Excludes War, NCB  Price variations commonplace 46

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Conclusions

 Katrina/Rita Market Impact – What Extent?

 Quality Risk Information – Differentiation will be Key  The Future of TRIA – “Extended” subject to Modifications  Strategizing in an Uncertain Environment – Explore all Options 47