2. Market Cycle Update Personal Lines Greg Ciezadlo, FCAS, MAAA Farmers Insurance Group Casualty Actuarial Society Spring Meeting 2002 – San Diego, California

3. Today’s Topics Historical Overview –Past cycles –The current downturn –Why cycles? Insurer reaction to the current cycle –Pricing –Product –Market availability –Segmentation Future outlook for personal lines insurers

4. …worst year ever in 2001 as the industry recorded an after-tax loss for the first time in history.

5. P/C Net Income After Taxes 1993-2001 ($ Millions) Sources: A.M. Best, ISO, Insurance Information Institute. 2001 was the first year ever with a full year net loss

6. Key Drivers Confluence of events – Insurance cycles – Capital markets – Investment yields – TORTure – Mold – WTC/Catastrophes

7. *Estimate from I.I.I. Groundhog Survey. Source: A.M. Best, Insurance Information Institute Growth in Net Premiums Written (All P/C Lines) 2000: 5.1% 2001: 8.1% 2002 Forecast: 14.7%* The underwriting cycle went AWOL in the 1990s. It’s Back!

8. Auto Repair Costs

9. Construction Material Costs

10. HO insurance costs & cost of home repairs *2001 Estimate

11. Investment environment -19% -31% March 2000 – December 2001

12. Net Investment Income Facts 1997 Peak = $41.5B 1998 = $39.9B 1999 = $38.9B 2000= $40.7B 2001 = $37.1E Source: A.M. Best, Insurance Information Institute Billions (US$) Pricing & underwriting problems were exacerbated by declining investment income Short-term interest rates are under 2%!

13. TORT-ure Asbestos “Toxic” Mold Aftermarket Parts Lead Arsenic Treated Lumber Construction Defects Guns What’s Next? September 11!!!

14. Average Jury Awards 1994 vs. 2000 Source: Jury Verdict Research; Insurance Information Institute.

15. Stachybotrys

16. Source: Texas Department of Insurance * 2001 (estimate based on Jan. - Mar. data) Texas: Paid Losses for Water Damage Claims In Millions

17. 9/11/2001

18. U.S. insured catastrophe losses $ Billions

19. P/C Industry Combined Ratio 2000 = 110.1 2001 Estimate = 116.0 2002 Forecast* = 108.0 Combined Ratios 1970s: 100.3 1980s: 109.2 1990s: 107.7 Sources: A.M. Best; III * Based on III 2002 Groundhog Forecast

20. Personal Lines Combined Ratios *Breakeven Ratio: Reflects AY results, includes investment income; assumes 4% interest rate. Source: A.M. Best 97 98 99 00 01E BE* PERSONAL AUTOHOMEOWNERS

21. Policyholder Surplus: 1975-2001 Source: A.M. Best, Insurance Information Institute Billions (US$) Surplus Peaked at $336.3 Billion in 1999 Surplus decreased 8.7% in 2001 to $289.6 Billion. Surplus is now lower than at year-end 1997.

22. Why do we still have cycles? Lag between emerging trends and insurers’ ability to react in the market Continued reliance on investment income to offset underwriting losses Reluctance to lead the pack Incentives in place based on the past, not on the future New and unusual events or coverage –Tort liability crises in the 70’s and 80’s –High inflation in the 70’s –Mold Catastrophes

23. The Industry’s Reaction Price increases New business limitations Coverage modifications and/or exclusions More sophisticated segmentation systems –Insurance scoring using credit information –Complex tiering plans using scoring plus other variables –Introduction of rating plans in HO focused on the individual not the property

24. Average Price Change of Personal Lines Renewals *III estimates Source: Conning, III

25. The Texas Result: A Lesson to be Learned 4 out of the 5 top insurers stopped writing homeowners HOB insurance policies due to the mold impact on business

26. Market Restrictions Tighter new business underwriting rules New business quotas Highly segmented rate changes Weaker nonstandard auto market Stop writing new business Withdrawal from the line Mold exclusions and water damage limitations Use of insurance scoring models for acceptance or retention PERSONAL AUTOHOMEOWNERS

27. Mold-Induced Rate Increases Will Impact Affordability in TX* *As a % of the median family of 4’s income. Source: NAIC, Insurance Information Institute

28. In summary:

29. Reasons Why Market Will Remain Hard Price increases by market leaders The Homeowners line has a long, tough road ahead to return to profitability –Large price increases –Catastrophes remain problematic –Will product suffer from affordability or availability issues? Auto is in better shape, but … –Cost pressures from Diminished Value, OEM, etc. –Influence of legislation and court decisions on liability cases Uncertain investment future Wall Street pressure for short-term profits

30. Where we are heading… …conditions are set for improved results in 2002 as: pricing environment continues to harden appreciably policy coverage terms and conditions become more restrictive.

31. Outlook for 2002: Personal Lines *Breakeven Ratio: Reflects AY results, includes investment income; assumes 4% interest rate. Source: A.M. Best 97 98 99 00 01E 02E BE* PERSONAL AUTOHOMEOWNERS

32. Market Cycle Update Personal Lines Greg Ciezadlo, FCAS, MAAA Farmers Insurance Group Casualty Actuarial Society Spring Meeting 2002 – San Diego, California