How Investment Bankers

Value Insurance Companies

Valuation of Insurance Operations

April 10

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In Today’s Market

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Two Approaches
 Market Approach
 Fundamental Approach
 Traditional Approach
 Non-traditional Approach

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Market Approach
 Research Analyst
 Buy-side Analyst
 Investor Community

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Market Approach
 Valuations for property casualty insurance companies
have declined significantly during the past year
 The decline in the property casualty sector is the
result of deterioration in the industry fundamentals
that drive value
Historical Relative Performance
120%

110%
Percentage of Base Price

100%

90%

80%

70%

60%

50%
03/31/1999 05/31/1999 07/31/1999 09/30/1999 11/30/1999 01/31/2000 03/31/2000

S&P 500 S&P P&C

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 Market Approach
 Volatility of the industry’s results has declined over
the last twenty years

Volatility of Property & Casualty Earnings

4.0x
3.5x
3.0x
2.5x
Standard Deviation 2.0x
1.5x
1.0x
0.5x
0.0x
1942- 1947- 1952- 1957- 1962- 1967- 1972- 1977- 1982- 1987- 1992-
46 51 56 61 66 71 76 81 86 91 96
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Which operating factors drive
stock market values?
 Profitability, as measured by return on equity
 Profit margin
 Operating leverage
 Earnings consistency
 Standard deviation of change in earnings
 Reserve development
 In other words, the market rewards risk
adjusted returns on capital

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 Value Drivers
Price/Book
Baldwin & Lyons, Inc. 0.79x
W.R. Berkley Corporation 0.65
Return on Equity Capitol Transamerica Corp.
HCC Insurance Holdings, Inc.
1.00
1.31
Markel Corporation 1.74
Earnings Consistency Medical Assurance, Inc. 1.40
NYMAGIC, Inc. 0.52
Penn-America Group, Inc. 0.78
Earnings Growth Philadelphia Cons. Holding Co. 1.13
RLI Corp. 0.93

Market Cap 1999

Company ($ in ROE
Baldwin & Lyons, Inc. $226.1
millions) 6.5%
W.R. Berkley Corporation 384.3 -5.5
Capitol Transamerica Corp. 133.1 12.1
HCC Insurance Holdings 610.5 15.9
Markel Corporation 667.6 9.9
Medical Assurance, Inc. 456.3 14.4
NYMAGIC, Inc. 121.1 7.1
Penn-American Group, Inc. 63.0 2.3
Philadelphia Cons. Holding Co. 181.8 10.4
RLI Corp. 272.9 10.6 Casualty Actuarial Society
Value Drivers
2
R = 0.3554
2.00
1.75 MKL
1.50 MAI
Price/Book (x)

1.25 PHLY
HCC
1.00 PNG BWINB CATA
0.75 RLI
0.50
0.25
NYM

0.00
2.0% 5.0% 8.0% 11.0% 14.0% 17.0%
ROE

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 Value Drivers
Current Premium Growth Rate Net Income Growth Rate BV/Share Growth Rate
P/E 1996-1998 1996-1999 1996-1998 1996-1999 1996-1998 1996-1999

Baldwin & Lyons, Inc. 12.7 x 8.3% 5.6% -11.7% -5.0% 3.7% 3.4%
W.R. Berkley Corporation NM 14.1% 13.0% -22.8% N/A 7.1% -2.8%
Capitol Transamerica Corporation 8.3 7.0% 2.3% 2.9% -3.1% 9.5% 4.0%
HCC Insurance Holdings, Inc. 13.4 -9.7% -6.9% 37.0% -13.3% 16.5% 11.4%
Markel Corporation 16.6 4.1% 12.5% 10.8% -4.5% 25.2% 11.7%
Medical Assurance, Inc. 10.0 16.3% 16.3% 23.4% 14.5% 16.2% 12.3%
NYMAGIC, Inc. 8.0 -11.5% -16.7% -9.5% -10.1% 12.5% 8.6%
Penn-America Group, Inc. 37.3 13.8% 7.4% 12.7% -33.7% 59.1% 33.2%
Philadelphia Consolidated Holding Corp. 12.0 30.5% 31.8% 22.4% 12.1% 26.1% 21.8%
RLI Corp. 9.0 4.4% 14.3% 4.8% 7.0% 17.5% 13.2%

Mean 14.1 x 7.7% 8.0% 7.0% -4.0% 19.3% 11.7%

Median 12.0 7.7% 9.9% 7.8% -4.5% 16.3% 11.6%

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 Value Drivers
YE 1996 YE 1997 YE 1998 YE 1999 % Change P/E
P/E P/E P/E P/E 1998-1999

Baldwin & Lyons, Inc. 12.4 x 13.8 x 20.3 x 16.0 x -21.0%

W.R. Berkley Corporation 13.4 14.5 19.4 N/M N/M
Capitol Transamerica Corporation 12.7 15.8 10.9 6.8 -37.4%
HCC Insurance Holdings, Inc. 27.6 19.9 11.8 25.9 118.7%
Markel Corporation 10.8 17.5 17.8 21.5 21.0%
Medical Assurance, Inc. 10.1 15.5 16.5 10.3 -37.2%
NYMAGIC, Inc. 8.4 10.3 10.9 7.8 -28.2%
Penn-America Group, Inc. 15.6 17.5 10.1 32.3 220.7%
Philadelphia Consolidated Holding Corp. 12.4 15.7 16.9 11.6 -31.3%
RLI Corp. 11.7 15.0 12.5 11.0 -12.0%

Mean 13.5 15.5 14.7 15.9 21.5%

Median 12.4 15.6 14.5 11.6 -21.0%

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Who Cares about the
Actuaries

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 Frontier Chart
Frontier Stock History

$40 Reserve Adjustment

$35 of $40 Million Reserve Adjustment
$30 of $150 Million

$25
Reserve Adjustment
$20 of $136 Million
$15
$10
$5
$0
01/02/1997 07/02/1997 01/02/1998 07/02/1998 01/02/1999 07/02/1999 01/02/2000

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 Meadowbrook Chart
Meadowbrook Stock History
Reserve Adjustment
$40 of $7.3 Million
$35 Reserve Adjustment
$30 of $2.7 Million
$25 Reserve Adjustment
$20 of $4 Million
$15
$10
$5
$0
01/02/1997 07/02/1997 01/02/1998 07/02/1998 01/02/1999 07/02/1999 01/02/2000

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Consolidation and the Need for
Economies of Scale
 Opportunities for convergence
 Need for multiple distribution channels
 Need for broader line of products
 Need to achieve greater efficiencies
 Need to minimize rating pressures
 Need for improved access to capital

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Increased Consumer
Awareness
 Consumers more informed through
internet
 More product choices and distribution
methods increase awareness
 Privacy issues becoming more significant
 Consumers becoming informed about
structural alternatives (such as
demutualization)

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Margin Erosion
 Commodity products (e.g. term
insurance, auto)
 New entrants
 Widespread consumer information
 Competitive pressures – increasing loss
ratios
 High cost distribution systems

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Rating Pressures and Capital
Requirements
 Eroding profits or growth rates put
pressure on ratings
 Low rates of return on equity
 Some companies have high loss ratios –
reserves need strengthening

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Fundamental Analysis
 We traditionally base our valuation of
insurance companies on four valuation
methodologies:
 Analysis of public market comparables
 Private and public market M&A transactions
 Discounted cash flow analysis
 Additional areas of value that must be
developed with potential buyers

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Comparable Company Analysis
 We focus our multiple analysis on
Price/Earnings and Price/Book multiples.
In analyzing these multiples, we
consider the following factors:
 Core earnings power of the Company
 Earnings growth compared to the
comparable companies
 Relationship between price to book value
and return on equity

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M&A Transactions Analysis
 Additionally, we analyze recent private
and public market transactions for
companies within comparable sectors
 We look closely at the specific
characteristics of each transaction in
order to find the most comparable
multiples

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Multiple Analysis
Multiple Valuation
(Dollars in thousands) Selected Multiples
Low High
Net Income Valuation
Adjusted 1999 Net Income $1,935 $1,935
Selected Multiple (1) 12.0 x 14.0 x
Implied Value $23,224 $27,095
Projected 2000 Net Income $1,766 $1,766
Selected Multiple (1) 10.0 x 12.0 x
Implied Value $17,664 $21,197
Book Value Valuation
Current Book Value $16,274 $16,274
Selected Multiple (1) 1.00 x 1.25 x
Implied Value $16,274 $20,342
Required Book Value (4) $7,233 $7,233
Selected Multiple (1) 1.25 x 1.50 x
Implied Value 9,041 10,849
Excess Book Value 9,041 9,041
Selected Multiple 1.00 x 1.00 x
Implied Value 9,041 9,041
Total Implied Value $18,082 $19,890
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Discounted Cash Flow Analysis
 A discounted cash flow approach offers
a good proxy for value due to the
following:
 Multiple analyses may be too weighted to
the historical performance, which in some
cases is limited
 Discounted cash flow approach captures
both growth and operating profitability

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Discounted Cash Flow Analysis
 The discounted cash flow analysis
captures the value of both the value of
the existing balance sheet and the
value of new business.

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Discounted Cash Flow Analysis
 In valuing the existing balance sheet,
we focus on the following components:
 The existing surplus (pro forma for any
reserve strengthening or other
adjustments)
 The value of the runoff of the reserves
(actuarially determined payout pattern)
 Any value/equity in the unearned premium
reserve (value of deferred acquisition cost)

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Discounted Cash Flow Analysis
 In valuing the new business, we focus
on the following factors:
 The premium growth potential
 The potential to introduce new products
 The projected combined ratio for the
business
 The expected payout of the future reserves
and associated investment income

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Valuation Summary
DCF Valuation

Terminal Multiples
Discount 1.75 x 11.0 x
Rate Book Value Net Income Average

13.0% $44,886 $45,832 $45,359

14.0% 42,957 43,862 43,409

15.0% 41,126 41,992 41,559

16.0% 39,388 40,218 39,803

17.0% 37,738 38,533 38,135

Low High
Selected Valuation Range $40,000 $45,000
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Non-traditional Approach
 Due to the uncertainty of the quality of
the Company's earnings, We value
some of the Companies based on an
analysis of the various components of
the company

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Non-traditional Approach -
Example
 The Company stock has not recovered
since its 2nd Quarter earnings
announcement
One-Year Stock Price History
$60.00

50% drop after second quarter

$50.00 earnings showed significant
reserve redundancies were used to
manufacture earnings.
$40.00
Share Price

$30.00

$20.00

$10.00
03/31/1999 05/31/1999 07/31/1999 09/30/1999 11/30/1999 01/31/2000 03/31/2000

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Non-traditional Approach
 As a starting point we attempt to
determine the tangible book value of
the company:
 Eliminated the goodwill from previous
transactions
 Estimated the current adequacy of loss
reserves

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Non-traditional Approach
 We add to the current book value an
estimate of the value of the premium
using two approaches:
 Value based on projected cash flows from
the in-force book of business
 Estimated cost to purchase a book of
business of that size

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Non-traditional Approach
 We also attempt to assess the value of
the runoff of the loss reserves by
estimating the payout of the liabilities
and the associated investment income
earned on the runoff.

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Non-traditional Approach
 The final component of value that we
included was the value of any non-risk
bearing segments
 Value of service businesses are sometimes
incorporated in the book value of the
company
 Estimated value from future earnings on the
business or estimated sale value of the
business

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Non-traditional Approach
9/30/99 Book Value $166,826
Goodwill (76,604)
Tangible Book Value $90,222
Low High
Other Adjustments
Tangible Book Value 90,222 90,222
Reserve Adjustment (26,000) (13,000)
Adjusted Book Value 64,222 77,222
Low High
Valuation Summary
Adjusted Book Value $64,222 $77,222
Estimated Value of Premium 27,000 37,000
Estimated Value of Reserve Run-off 25,000 27,000
Estimated Value of TPA & Service Segment 35,000 40,000
Transaction Costs (2,500) (1,500)
Total Valuation $148,722 $179,722
Value per Share $15.33 $18.53
Current Price $18.13 $18.13
Premium to Current Price -15.4% 2.2%

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 Non-traditional Approach
Paid Losses as a % of Initial Reserves

80%

70% Prior
1989
60% 1990
1991
50%
1992
40% 1993
1994
30%
1995
20% 1996
1997
10% 1998

0%
1 2 3 4 5 6 7 8 9 10
Accident Year

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Non-traditional Approach
 The value of new business was
projected out over 30 years. The
underwriting performance assumptions
were as follows:
 Base Case:
 118% combined ratio, decreasing to 117% in
2002
 Loss ratio of 95%
 Expense ratio of 23%

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Non-traditional Approach
 Case 2:
 115.7% combined ratio, decreasing to 114.7%
in 2002
 Loss ratio of 95%, decreasing to 94% in 2002
 Expense ratio of 20.7%

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Non-traditional Approach
 Gross written premium is projected to
decrease 20% in 2000, increase at an annual
rate of 5% from 2001 to 2004, slow to a
growth rate of 2.5% from 2005 to 2009, and
then grow at a rate of 1% for each year
thereafter
 A valuation range was obtained by applying
discount rates to both scenarios

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 Non-traditional Approach
DCF Valuation - New Business Selected Valuation Range
($ in thousands) High $37,000
Low 27,000
Discount
Rate Base Case Case 2
10% $42,758 $52,070
11% 36,890 44,902
12% 32,003 38,943
13% 27,909 33,959
14% 24,460 29,767
15% 21,539 26,219
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 Non-traditional Approach
 An estimated valuation range was generated by selecting a
discount rate of 7-10% and calculating the implied NPV.
(Dollars in thousands)
Year
1 2 3 4 5 6 7 8 9 10

Assumed Payout Pattern 30.0% 22.5% 15.0% 10.0% 5.0% 5.0% 5.0% 2.5% 2.5% 2.5%

Loss Reserves Outstanding

Beginning of Year $266,012 $186,209 $126,356 $86,454 $59,853 $46,552 $33,252 $19,951 $13,301 $6,650
Loss Reserves Paid (79,804) (59,853) (39,902) (26,601) (13,301) (13,301) (13,301) (6,650) (6,650) (6,650)
End of Year 186,209 126,356 86,454 59,853 46,552 33,252 19,951 13,301 6,650 0

Average Reserves O/S 226,111 156,282 106,405 73,153 53,202 39,902 26,601 16,626 9,975 3,325
Net Investment Yield 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0%
Net Investment Income 15,828 10,940 7,448 5,121 3,724 2,793 1,862 1,164 698 233

Net Investment Income 15,828 10,940 7,448 5,121 3,724 2,793 1,862 1,164 698 233
Assumed Tax Rate 35.0% 35.0% 35.0% 35.0% 35.0% 35.0% 35.0% 35.0% 35.0% 35.0%

After-Tax Income $10,288 $7,111 $4,841 $3,328 $2,421 $1,816 $1,210 $756 $454 $151

NPV Calculation
Implied Selected Valuation Range
Discount Rate Value
High $27,000
6.0% $27,457
Low 25,000
7.0% 26,771
8.0% 26,116
9.0% 25,491
10.0% 24,893
11.0% 24,322

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Non-traditional Approach
 A valuation range was selected by applying current multiples of
public companies and multiples from M&A transactions to the
projected results of the company
($ in thousands)
Selected Multiples
Low High
1999 Projected Revenue $31,128 $31,128
Selected Multiple (1) 1.00 x 1.25 x
Implied Value $31,128 $38,910

1999 Projected Net Income $3,174 $3,174

Selected Multiple (1) 11.00 x 13.00 x
Implied Value $34,913 $41,260

Selected Value $35,000 $40,000

Notes:
(1) Based on the public market trading multiples for selected comparable companies.

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Conclusion
 Why are you doing the valuation?
 For whom are you doing the valuation?
 What changes may occur at the target
or the investment?
 Everybody has an opinion, that’s what
makes a market

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