Table of Contents
Executive Summary........................................................................... 2
Inflation spreading its tentacles ................................................................................................2
Finity ................................................................................................... 4
Finity Consulting – who are they? .............................................................................................4
Tomorrow: What’s in store? ............................................................. 5
How will GI perform for the next three years?..........................................................................5
Projection approach outlined ....................................................................................................5
Three core assumptions – simple and logical ...........................................................................7
How did we fare in 2007?.......................................................................................................10
2008 to 2010...........................................................................................................................11
Scenario analysis – sizing up the bulls and bears....................................................................13
Value creation in GI (Finity) ............................................................ 16
Synopsis ................................................................................................................................16
Introduction............................................................................................................................16
Growth – some recent industry metrics..................................................................................16
Profit – some recent industry metrics.....................................................................................18
Profit versus growth – the trade-off ........................................................................................19
Applying an Intrinsic Value (IV) approach ................................................................................20
An illustration of IV at work .....................................................................................................21
Strategies for increasing IV .....................................................................................................22
Some final thoughts................................................................................................................24
Insight into claims trends (Finity) .................................................. 25
Introduction and main observations........................................................................................25
Personal lines..........................................................................................................................27
Personal lines - Motor .............................................................................................................28
Personal lines - Householders.................................................................................................30
Compulsory Third Party...........................................................................................................34
Liability ...................................................................................................................................36
Professional Indemnity / Directors & Officers.........................................................................38
Commercial property (Fire and ISR) ........................................................................................40
Today: GI Snapshot (Finity) ............................................................ 42
Introduction............................................................................................................................42
Overview of Recent Experience..............................................................................................43
Industry focus by type of insurer ............................................................................................44
Industry focus by class of business ........................................................................................50
Yesterday: The past 30 years.......................................................... 52
Overview................................................................................................................................52
Premium growth over time.....................................................................................................52
Profitability changes over time................................................................................................54
Reserving and capital over time..............................................................................................58
Implications for listed sector.......................................................... 59
Soft cycle turning, although inflation is stifling the benefits....................................................59
Valuation and Risks .................................................................................................................60
Sector summary and running the numbers.............................................................................61
Appendices....................................................................................... 65
Note: Finity has contributed three sections to “Pendulum” as highlighted above (“Value
Creation in GI”, “Insight into claims trends” and “Today: GI Snapshot”)

Executive Summary
Inflation spreading its tentacles
This is the second publication of “Pendulum”, our annual review of the state of General
Insurance in Australia, published in conjunction with Finity Consulting Pty Limited (“Finity”).
􀂄 Pendulum’s foundation is a detailed industry P&L, including key balance sheet drivers,
from data in regulatory releases. This is one of the most comprehensive data sets
available, we believe. It stretches back to 1977 and covers thirty classes of business
(COBs) that we have simplified into four main categories.
􀂄 Finity has provided analysis of the state of the industry in APRA’s latest detailed
release, the final year in our P&L data series. Finity has also provided a series of articles
that provide insight into claims developments across key COBs and a thematic piece
that appropriately considers how insurers should be balancing the challenge of growth
and margin preservation at the current delicate stage of the pricing cycle.
􀂄 We have refined and updated our projection model, first rolled out in “20/10 Vision”,
July 2005, and modified extensively in our inaugural publication of Pendulum last year.
We present a three year industry forecast, highlighting key drivers that will shape
financial performance over the medium term, which allows us to readily assess possible
scenarios for IAG, QBE and SUN as industry events unfold.
In both “20/10 Vision” and Pendulum’s inaugural publication last year we highlighted the risk
to unsustainably high insurance margins posed by rate reductions. Although Pendulum
2007 noted encouraging early indications that rate reductions could moderate in 2008, we
have become increasingly apprehensive about intensifying margin pressure from a
variety of sources. Indeed, claims inflation above normal assumptions is in our view
developing as one of the key industry themes in 2008/09. While insurers are acknowledging
this through rating actions across a number of classes, particularly Personal Lines (PER) and
CTP, the benefits are only likely to emerge well into 2009, and quite possibly only in 2010.
Our views are best captured in the chart below, depicting the inevitable drag on margins in
future years that will be brought on from a range of drivers.

We still believe GI will earn healthy ROEs (~15% in 2009/10 after sub-10% in 2008 due
mainly to equities) and margins will not collapse to pre-2002 levels. However, a number of
changes in recent months have impacted claims costs at a faster pace than many have
been anticipating. Storms have played a part, but other changes that are more enduring in
nature are working through the supply chain for both short-tail and long-tail products.
􀂄 Claims inflation spreading its tentacles. Across both PER and Commercial short-tail, a
significant deterioration in claims cost per policy (CPP) was evident in 2007 – based on
industry anecdotes this has continued into 2008. Householders Buildings and Contents,
for example, experienced CPP inflation of 32% and 27% respectively. While a portion of
this was related to large storm events which is difficult to isolate, there is evidence of
non-weather claims inflation well above CPI in certain classes, as shown below.

􀂄 Inflation not confined to short-tail classes. The recent acceleration of superimposed
inflation trends across certain liability classes, particularly QLD CTP, and more recently in
NSW, suggest the post tort reform honeymoon period is over. With many class actions
in the pipeline for PI and D&O, these classes could also be making headlines in 2008/09.
􀂄 Superimposed inflation in liability classes should curtail reserve releases. We’ve
drawn on a recent APRA publication on reserve releases to add greater rigour to our
industry predictions. We were surprised to observe that releases made up 8.5% of the
industry’s 21.3% ITR margin in 2007. While general liability claims trends still appear
favourable, we believe actuaries will need to acknowledge the risk to these trends in a
tougher economic climate, with implications for lower releases in coming years.
􀂄 What about the weather? In “Rain Check” Feb 2008 we highlighted the cyclical nature
of storm frequency and intensity around La Nina events. While La Nina has retreated as
predicted and could clearly positively impact catastrophic claims, we estimate
moderating reserve releases will have a greater impact. We also note that the factors
driving up inflation for the broader economy - trade skills shortage, fuel prices and
commodities prices - are particularly relevant for claims costs, regardless of storms.
􀂄 GWP growth should start improving though. GWP grew by 3.4% in 2007, similar to
growth in 2006. With rate rises now the flavour of the month across numerous classes,
pricing should more than offset slower volume growth. We expect reasonable growth in
2008 and strong top-line growth of 7-9% over 2009/10 as rate reductions reverse.
While there weren’t too many places to hide in the listed GIs over the past year, there are
now some compelling defensive and valuation arguments to own the sector. However, a
fresh look at the margin compression risks highlighted in Pendulum 2008 leave us reluctant
to adopt a more positive view on the domestics until visibility for medium-term margins
improves. QBE remains our preferred exposure and only Buy rated stock in the sector (detail
on views, risks and valuation in “Implications for listed sector”)

Finity
Finity Consulting – who are they?
Finity Consulting Pty Limited is an independently owned Australian firm of general insurance
specialists. It provides actuarial and broader consulting services to many stakeholders in the
General Insurance industry and (with its predecessor firms) has been providing advice to the
insurance industry for around 20 years.
In 2006, and again in 2007, Finity was named as Service Provider of the Year in the Australian
and New Zealand Insurance Industry’s annual awards; and both in 2007 and 2008 Finity was
a finalist in the annual BRW Client Choice awards.
Finity started business on 24 March 2005 as a specialist consulting practice of some 60 staff.
After three years of expansion Finity now has over 70 staff, based in Sydney and Melbourne.
During the last 12 months, Finity served more than 130 clients, primarily in Australia and New
Zealand. Finity holds Appointed Actuary roles with over 30 APRA-regulated insurers.
The types of institutions Finity advise include:
􀂄 general insurance companies
􀂄 reinsurance and specialist insurance companies
􀂄 accident compensation authorities
􀂄 government regulators and agencies
􀂄 industry associations
􀂄 corporations with significant insurance or self-insured liabilities
Finity works with their clients on many strategic, operational and technical aspects of their
businesses. Specific areas of expertise include:
􀂄 premium rating and pricing strategies
􀂄 reinsurance planning and strategies
􀂄 profit measurement and capital management
􀂄 business planning and distribution strategies
􀂄 assessment of insurance liabilities
􀂄 stochastic modelling and dynamic financial analysis
􀂄 claims outcome improvement
􀂄 accident compensation scheme design and performance monitoring
􀂄 customer insights/analytics

Tomorrow: What’s in store?
How will GI perform for the next three years?
While M&A for QBE and IAG and Banking for SUN have dominated stock price performance
more recently, the outlook for GI growth and profitability in Australia remains a central issue
for their prospects. Inflationary pressures, the impact of recent storms, the rate at which
reserve releases compress and the duration of the soft Commercial cycle are the most
critical issues that will shape their fortunes over the medium-term.
Pendulum presents our best estimates of how the industry could look over the next three
years. We acknowledge the numerous unpredictable drivers, particularly those that lack
consistent disclosure across the industry, such as reserve releases. The point of forecasting
the industry is not to get embroiled in a detailed debate on these complex drivers, but rather
to provide a robust forward-looking framework that we can recalibrate to actual industry
performance every year. This will allow us to readily assess possible scenarios for GI’s
prospects as events unfold over time.
Projection approach outlined
Our three year view of the industry uses the latest cut of detailed APRA data (June 2007
rolled forward to December 2007), with the reported classes of business grouped into four
major categories. As we outline below, our projections integrate volume, rate and claims
assumptions for each COB into future premium and profitability forecasts.