HOULIHAN LOKEY HOWARD ZUKIN Mergers Acquisitions in the

HOULIHAN LOKEY HOWARD & ZUKIN Mergers & Acquisitions in the Property/Casualty Insurance Market Casualty Actuaries of Greater New York Spring 2004 Meeting June 3, 2004 685 Third Avenue • New York, New York 10017 • (212) 497 -4100 • www. hlhz. com Los Angeles • New York • Chicago • San Francisco • Washington D. C. • Minneapolis • Dallas • Atlanta • London

Agenda – Property & Casualty Insurance • Industry Fundamentals • Historical M&A Trends • Recent M&A Trends • M&A Outlook 2

Overview • P&C consolidation has declined markedly and relatively steadily over the past five years • Transformational deals are out of favor – St. Paul / Travelers is the exception, not the rule • Going forward, P&C acquisition activity should increase as rates soften and organic growth is more challenging – However, M&A activity will be more thoughtful, as quality insurers consolidate and diversify with smaller niche acquisitions 3

Industry Fundamentals 4

Story of 2000 – 2004 The Race Between Premium Prices and Development 5

Decelerating Hard Market • Property & Casualty companies enjoyed an extended run of rate increases beginning in 2000 • Overall rates have begun to fall back to the levels last seen in late 1999, the end of the last soft market cycle – Increases began to decelerate in 2003 – Property has softened (large account) – D&O and Med Mal still rising • Question is whether the casualty lines have caught up after years of under-reserving 6

Decelerating Hard Market Average Commercial and Personal Lines Rate Changes 30. 0% 25. 0% 20. 0% 15. 0% 10. 0% 5. 0% 0. 0% Fall 98 Spring 99 Fall 99 Spring 00 Fall 00 Spring 01 Fall 01 Spring 02 Fall 02 Spring 03 Fall 03 -5. 0% -10. 0% -15. 0% Personal Auto Homeowners Commercial Lines 7

Adverse Reserve Development • The rating agencies are skeptical of the capital position of many insurers – Fitch estimates the reserving shortfall to be $77 billion • Asbestos – no trust fund and no end in sight • M&A Impact: Given the magnitude of the downside, prudence has dictated caution among would-be acquirors given sellers’ natural information advantage 8

Capital Turning the Corner • The tragedy of September 11 th, adverse loss development and the equity markets devastated the P&C sector’s surplus • Thanks to the hard market, the industry is now generating a torrent of cash flow and surplus has surpassed 1999 levels, assuming proper reserving 22% 9

Capital Management What to do with the build up of surplus? • Increase Dividends – With the new tax laws, dividending is an attractive option – Montpelier Re increased its dividend yield to nearly 4% in 2003 • Growth through Acquisitions – Buyers may be able to take advantage of smaller insurers which have been weakened by capital pressures and rating agency actions – Many of the Bermuda players have picked off liability-free business from weakened peers 10

Historical M&A Trends 11

M&A Drivers M&A Driver Technological Change Financial Markets Management/Personality Regulatory / Political Focus / Diversification P&C Insurance Applicability 12

Fragmented P&C Insurance Market 13

Deal Volume – Relatively Cyclical • Not surprisingly, P&C insurance M&A deal volume is reasonably cyclical 14

P&C M&A Activity • Generally, deal volume is inversely correlated with P&C rates 15

Valuations and the Cycle • The interplay between interest rates and P&C rates impacts P&C company valuations as well as deal volume Asbestos; Product Liab. Hurricane Andrew 9/11 P&C rates 16

Recent M&A Trends 17

Is Hank right? “…[T]wo drunks helping one another home…” - Hank Greenberg on P&C acquisitions 18

Recent M&A Activity: A Look Back • Large transactions on the decline – Bifurcation – strong grow and weak pare back or run-off – Renewal rights deals flourish as buyers have the upper hand • Bermuda Class of 2001 – Filling the capacity shortfall – Cash flowing and surplus spiking… • Focus and rationalization – Pendulum swings away from diversification – Sponsored spin-offs rise in popularity 19

The Death of the Mega-Deal? • There have been 44 P&C mergers valued at $500 million or more since 1997 but all but five occurred in the 1997 – 2001 period Source: SNL Data. Source 20

Deal Valuations Decline • Median multiples have declined drastically over the last few years but may be on the rise again 21

The Rise of Renewal Rights Transactions • Renewal rights deals have become increasingly popular given market skepticism regarding the adequacy of reserves • Competition for growth in soft cycle should cause a decline in renewal rights deals 22

Bermuda: Consolidation? • Newer Bermuda players focused on secondary offerings, providing original venture investors a chance to reduce positions • To date in 2004, a total of 15 insurance offerings have priced, raising $4. 9 billion with selling shareholders receiving 77% of those proceeds. • Starting in 2005, the Bermuda players will contend with slowing growth • Some of the Bermuda insurers have already begun to participate on the M&A front by purchasing the renewal rights of weaker competitors 23

Past as Prelude: Bermuda Class of 1993 IPO Stage M&A Stage Cumulative Capital Raised ($mm) 4, 000 Partner Re. Ltd. IPO Nov. 1993 3, 500 3, 000 Global Capital Reinsurance Ltd. Sold to Exel Ltd. Jun. 1997 Global Capital Reinsurance Ltd. IPO Dec. 1995 2, 500 La. Salle Re Merged with Trenwick Oct. 2000 La. Salle Re. Ltd. IPO Nov. 1995 2, 000 1, 500 Tempest Reinsurance Co. Sold to Ace Ltd. Jul. 1996 1, 000 500 Mid Ocean Ltd. IPO Aug. 1993 IPC Holdings Ltd. IPO Mar. 1996 Renaissance. Re Holdings Ltd. IPO Jul. 1995 Centre Cat Ltd. Sold to Ace Ltd. Apr. 1998 Mid Ocean Ltd. Sold to Exel Ltd. 1998 0 1993 1994 1995 1996 1997 1998 Companies that went public and later were acquired Companies that went public and expanded beyond their original mandate Companies that remained private until acquired Source: A. M. Best, Bermudan Business, Aon Capital Markets 24

Rationalization • Verdict: focus is the safe bet – Management is heeding the Street and divesting – Examples: Safeco, CNA, RSA and Zurich • Contra-case – Diversification: risky but necessary? 25

Divestiture Mechanism: The Spinoff • As profitability and competition have become increasingly challenging, many insurers are focusing on core markets • In addition to divestitures, insurers have taken advantage of the capital markets by spinning off more profitable businesses 26

M&A Outlook 27

Outlook • Soft Cycle Spurs M&A activity – Bermuda consolidates again… – Diversification returns? – New hybrid capital – prolonging the inevitable? • Russian Roulette Returns? – Sellers gain leverage and liabilities back on the table • Specialty consolidation and the return of the roll-up – WC, E&S and NSA • Focus on expenses in downturn – Outsourcing? • Europeans bargain shoppers – Weak dollar could tempt buyers 28