• Like
  • Save
Options Not Fully Pricing in Hurricane Risks
Upcoming SlideShare
Loading in...5
×
 

Options Not Fully Pricing in Hurricane Risks

on

  • 319 views

Actionable trade ideas for stock market investors and traders seeking alpha by overlaying their portfolios with options, other derivatives, ETFs, and disciplined and applied Game Theory for hedge fund ...

Actionable trade ideas for stock market investors and traders seeking alpha by overlaying their portfolios with options, other derivatives, ETFs, and disciplined and applied Game Theory for hedge fund managers and other active fund managers worldwide. Ryan Renicker, CFA

Statistics

Views

Total Views
319
Views on SlideShare
319
Embed Views
0

Actions

Likes
0
Downloads
4
Comments
0

0 Embeds 0

No embeds

Accessibility

Categories

Upload Details

Uploaded via as Adobe PDF

Usage Rights

© All Rights Reserved

Report content

Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

Cancel
  • Full Name Full Name Comment goes here.
    Are you sure you want to
    Your message goes here
    Processing…
Post Comment
Edit your comment

    Options Not Fully Pricing in Hurricane Risks Options Not Fully Pricing in Hurricane Risks Document Transcript

    • May 22, 2006 Options Not Fully Pricing in 2006 Hurricane Equity Derivatives Risks for P&C Stocks Strategy Ryan Renicker, CFA • P&C insurers experienced higher implied and realized volatility in response to the 2005 hurricane 1.212.526.9425 season.ryan.renicker@lehman.com Devapriya Mallick 1.212.526.5429 • Since several independent weather forecasters are predicting another active hurricane season this dmallik@lehman.com year, we believe stocks within this industry could experience higher volatility, which the options market has yet to fully price in, in our opinion. Insurance/Non-Life Jay Gelb, CFA • Since medium-term implied volatility in the P&C space continues to be low relative to the market, 1.212.526.1561 jgelb@lehman.com and has generally been on a declining trend for much of this year, we recommend purchasing at- the-money straddles on insurers with exposure to hurricanes, such as MRH, RE, ALL, ACE, and CB. Brennan Hawken, CPA 1.212.526.8190 bhawken@lehman.com Sarah Pagluica 1.212.526.9947 spagluic@lehman.comLehman Brothers does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict ofinterest that could affect the objectivity of this report.Customers of Lehman Brothers in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost to them,where such research is available. Customers can access this independent research at www.lehmanlive.com or can call 1-800-2LEHMAN to request a copy of this research.Investors should consider this report as only a single factor in making their investment decision.PLEASE SEE ANALYST(S) CERTIFICATION AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 8.
    • Equity Derivatives Strategy | Options Not Fully Pricing in 2006 Hurricane Risks for P&C Stocks P&C Insurance Volatility Hurricanes represent risk to book value to P&C insurers and reinsurers. Recent forecasts for 2006 indicate expectations for another active hurricane season. We believe concern over losses from an active 2006 hurricane season could cause P&C insurance stocks to pull back, in the short-term. Alternatively, if hurricane losses in 2006 are not severe, P&C insurance stocks could rally, based on larger than expected preservation of book value. Insurers we cover with exposure relative to book value from Atlantic hurricanes in our view: • Most exposure: RNR, PRE, RE, and MRH. • Moderate exposure: ALL, ACGL, AHL, XL, and ACE. • Least exposure: STA, PGR, SAFC, CB, and AIG. The Case for Higher Realized Volatility We compare 6-month implied volatility at the beginning of the hurricane season with the “ex-post 6- month realized volatility” (the volatility actually realized during the corresponding six month period, after the fact) at the end of these hurricane seasons to identify instances when it would have been profitable to be long gamma in 2004 and 2005 (Figure 1). While the lack of listed options having 6 month maturities for several of the P&C names prevents comparison across the universe, we find that P&C stocks with moderate to high exposure to hurricanes tended to have higher realized volatility over the six months of the hurricane season than what was originally implied at the beginning of the period. Since the beginning of 2006, price-to-book multiples for P&C insurers have been under pressure, possibly a reflection of investor concern over potential hurricane losses this season (Figure 2). In the event there are fewer property losses this year, there is a possibility, however, of multiple expansion in these names. We believe this factor, coupled with the stocks’ relatively low implied volatility, implies that straddles purchased ahead of this year’s hurricane season could be a profitable strategy – as the stocks could have substantial moves in either direction. This could occur in the event of either an active hurricane season (negative for stocks) or one that causes significantly lower losses than expected (positive for stocks).Figure 1: Implied vs Subsequent Realized Volatility in 2004-05 Figure 2: Multiple Compression in 2006 Hurricane Implied Vol Realized Vol Implied Vol Realized Vol 1.60 Ticker Exposure (5/31/05) (11/30/05) (5/28/04) (11/30/04)MRH Highest N/A 46.7% N/A 15.5% 1.55 P&C Composite Multiple (P/B)PRE Highest N/A 22.4% N/A 15.2%RE Highest 18.8% 20.5% 22.1% 20.6%RNR Highest 21.8% 32.0% N/A 23.0% 1.50XL Moderate 18.4% 27.5% 23.0% 18.6%ACE Moderate 22.7% 22.2% N/A 27.0% 1.45ACGL Moderate N/A 22.1% N/A 20.2%ALL Moderate 14.8% 17.6% 20.4% 16.1%AIG Least 24.5% 15.2% 22.4% 26.4% 1.40CB Least 18.5% 17.7% 22.3% 20.3%HIG Least 20.4% 17.5% 25.2% 22.7%PGR Least N/A 21.8% N/A 18.0% 1.35SAFC Least 18.5% 16.0% 21.6% 17.9% 6 06 06 6 -0 r-0 n- b-STA Least 19.6% 18.2% 22.7% 24.0% ar Ap Ja Fe MSource: Lehman Brothers, OptionMetrics Source: Lehman Brothers May 22, 2006 2
    • Equity Derivatives Strategy | Options Not Fully Pricing in 2006 Hurricane Risks for P&C Stocks Upcoming Catalysts There are several possible catalysts in the near term, which could draw investor attention to the 2006 hurricane season. May 31: The CSU team updates its 2006 Hurricane Forecast June 1: Hurricane season begins Investment Conclusion We believe average implied volatility on P&C insurers is not pricing in hurricane risk sufficiently, providing an attractive opportunity for investors to purchase at-the-money straddles. While option liquidity in this space remains a constraint, MRH, RE, ALL, ACE, and CB are P&C stocks we identify as having relatively liquid options. While CB has limited exposure to hurricanes on aggregate, it could be affected if any hurricanes hit the Northeastern U.S., which are at “high risk” this year, according to Accuweather meteorologists. Since the impact (or lack of impact) of the 2006 hurricane season varies due to unique geographic exposures – and the magnitude and location of hurricane landfalls is uncertain – we recommend investors take a long volatility position on all of these stocks. For instance, MRH Oct 15 straddles can be purchased for $3.40 and finish in the money if the stock closes above $18.40 or below $11.60. RE Oct 90 straddles were offered at $10.70 as of last night’s close and the position is profitable if the stock finishes above $100.70 or below $79.30 as of th the October 20 expiration date (which follows the most active portion of the hurricane season). The ALL Oct 55 straddles can be purchased for $5.75 and would be profitable if ALL closes above $60.75 or below $49.25 at expiration. Investors can also purchase ACE Nov 55 straddles for $7.20. These would finish in the money if the stock closes above $62.20 or below $47.80 on October 20. In case of CB, the Nov 50 straddles could be purchased for $5.35 and would lose money only if CB remains range-bound between $44.65 and $55.35. Figure 3 summarizes the strikes and break-even prices as of last night’s close. With the exception of ALL, we find that in 2005, straddles purchased at these prices would have broken even as the average absolute return for these stocks over the entire hurricane season was 21.5%. Figure 3: Recommended Strikes and Straddle Costs Straddle Return from Price Hurricane Straddle Lower Upper Ticker Name Strike Cost as % May05 to (5/22) Exposure Cost (5/22) Breakeven Breakeven of Spot Nov05 MRH MONTPELIER RE HOLDINGS LTD 14.83 Highest 15 3.40 11.60 18.40 22.9% -42.9% RE EVEREST RE GROUP LTD 91.00 Highest 90 10.70 79.30 100.70 11.8% 17.5% ALL ALLSTATE CORP 56.18 Moderate 55 5.75 49.25 60.75 10.2% -3.6% ACE ACE LTD 52.19 Moderate 55 7.20 47.80 62.20 13.8% 28.4% CB CHUBB CORP 50.81 Least 50 5.35 44.65 55.35 10.5% 15.0% Source: Lehman Brothers, Bloomberg May 22, 2006 3
    • Equity Derivatives Strategy | Options Not Fully Pricing in 2006 Hurricane Risks for P&C Stocks Review of 2005 Hurricane Season The hurricanes of 2005 caused about $50 billion to $80 billion in insured losses, according to catastrophe modelers (12%-19% of total U.S. industry surplus). Median losses to P&C insurers represented 13% of book value (Figure 4). Losses varied from 1% of book value to over 100% of book value. Figure 4: 2005 After Tax Hurricanes Losses as a Percentage of 2Q05 Book Value 100% Hi: 106% Hurricane Losses (% of 2Q05 BV) Low: 1% 80% Median: 13% 60% 40% 20% 0% Sw ce e d) Fi C Re Be A y rR e in ai IP b) St Re up f) ric su (a) ire (a) (a) ha ) C ital O oy d al A l Re ec s A x pe y r R a t a) St hite m ( (f) e ce rd es l nc rw e Pa A Re ua C (i) ey ) pl rog Sa (f) C u rs no Tra cia al U nc e E v ap ) e (a Ltd ic )( c au ou (g) ra ain irf Ar Ma te er AC rk Re ive o Th rkle IG H a) er ita at h ss (f C i a Sp iter As ialt un (a ti lie XR r a de e R is n ( En um ssa R is Gr (d)( Be yer ess fec Ll apit n it A h R e)( ( ta H Ch ele H (e)( ve ns l ( tfo W Far )(c) e y( ) w M e lan h r an Q XL e dy s . P M a) nt ap (a na ap l T nt rtn W e Zu In bb ax c h x t C ls R r pe P ar v s o R a r e du n R C t at n on sh W at Pl Re Em P M o Fa an H (a) Tax adjusted at 35% tax rate (b) Tax adjusted at 0% tax rate (c) Reported in CHF, converted into USD @ 0.7731 (d) reported in Euros coverted into USD @ 1.218 (e) Not developed (f) Shareholders Equity used instead of Common Equity (g) Net worth as of 12/31/04 used instead of Common Equity (h) Impact calculated as most recently available book value (i) Average tax rate used to tax adjust (j) Tax adjusted at 30% tax rate Source: Company data, Lehman Brothers Realized Volatility Relatively Low in ’04, High in ‘05 We use absolute one-day returns of insurance stocks to gauge the magnitude of the impact the 2005 hurricanes had on these companies’ shares. In addition, the average of the daily absolute returns over each month can be used as an estimate of the profitability of an options strategy whereby investors would have gone long volatility in insurance names by purchasing options on each stock, and delta- hedging their positions at the close of each day (long gamma). We find insurers did not experience exceptionally high volatility in response to the 2004 hurricane season (Figure 5), which was a rather active season – particularly for Florida – with four major hurricanes (Cat 3 or higher) making landfall (hurricanes Charley, Frances, Ivan, Jeanne). The only month with unusually high volatility was October, owing to the Spitzer investigation into insurance brokers. However, the 2005 hurricane season generated much higher realized volatility for insurance stocks having high exposure to hurricanes, given the significantly larger damage to insured properties in the Gulf of Mexico coastal regions (hurricanes Dennis, Katrina, Rita, Wilma). May 22, 2006 4
    • Equity Derivatives Strategy | Options Not Fully Pricing in 2006 Hurricane Risks for P&C Stocks Heightened Risk Expectations Post Katrina We use the change in short term implied volatility for options on P&C insurers as an index of the level of risk expectations priced in by the options market. The spread of the weighted average implied volatilities of P&C insurers over S&P 500 implied volatility is a measure of the incremental risk specific to stocks with exposure to hurricanes. In 2005, we find that implied volatility for P&C stocks relative to the market reached its trough at the end of August. However, following hurricane Katrina’s landfall, there was a re-pricing of risk expectations for P&C options across the board (Figure 6). In fact, implied volatility for insurers with the highest exposure to hurricanes began to trade at a premium relative to the implied volatility for insurers having a moderate exposure. We caveat that the information content of implied volatility for stocks with the highest exposure to hurricanes be taken with the proverbial pinch of salt, given the lack of liquidity in these options. In recent months, the implied volatility spread for insurers with the highest risk exposure has been declining, which could indicate that the options market is not pricing in hurricane risk sufficiently. As the onset of the 2006 hurricane season approaches, with outlooks released (and increasing media attention or headline risks surfacing), there is likely to be elevated investor attention to this risk and, we believe, another re-pricing of implied volatility, even in the absence of an immediate change in realized vols.Figure 5: Average Absolute Returns For P&C Insurers Figure 6: P&C Insurer Implied Volatility Relative to S&P 500 2.5% 25% Daily Absolute Return - Highest Exposure 2.0% Daily Absolute Return - Moderate Exposure 20% 15% 1.5% 10% 1.0% 5% 0.5% 0% 0.0% 4 4 5 5 6 04 05 06 4 04 4 5 05 5 6 -0 l-0 -0 l-0 -0 -0 -0 -0 -0 -0 p- p- n- n- n- ov ov ay ay ay ar ar ar Ju Ju Ja Ja Ja Se Se M M M N N M M M 4 4 5 5 04 05 06 4 04 4 5 05 5 6 l-0 l-0 -0 -0 -0 -0 -0 -0 -0 p- p- n- n- n- ov ov ay ay ar ar ar Ju Ju Ja Ja Ja Se Se M M M N N M M Implied Vol Spread to Market - Highest Exposure Implied Vol Spread to Market - Moderate ExposureSource: Lehman Brothers, Bloomberg Source: Lehman Brothers, OptionMetrics May 22, 2006 5
    • Equity Derivatives Strategy | Options Not Fully Pricing in 2006 Hurricane Risks for P&C Stocks Hurricane Forecasts for 2006 NOAA (National Oceanic and Atmospheric Administration) released its 2006 hurricane forecast yesterday (May 22), saying it expects the 2006 hurricane season to be more active than average, but less active than 2005. The NOAA forecasts 13-16 named storms (average=11) to form in the Atlantic basin during the six-month season, which officially begins on June 1. The NOAA expects 8- 10 of these storms to become hurricanes (average=6), with 4-6 (average= 2) of them intense hurricanes (category 3 or higher). NOAA expects an above average active hurricane season due to warmer ocean water combined with lower wind shear, weaker easterly trade winds, and a more favorable wind pattern in the mid- levels of the atmosphere are the factors that collectively will favor the development of storms in greater numbers and to greater intensity. The Colorado State University (CSU) team led by Dr. William Gray also expects the 2006 hurricane season to be more active than average, but less active than 2005. The NOAA and CSU forecasts are mostly in line. (Figure 7). NOAA does not predict the probability of hurricanes making landfall because this depends on short-term factors that can not be predicted. However, based on historical statistics, NOAA estimates 2-4 hurricanes could make landfall in the U.S in 2006. Notably, the NOAA and CSU tend to be conservative in their forecasts. Figure 8 shows the NOAA and CSU forecasts versus the actual number of hurricanes and major hurricanes from 2003-2005.Figure 7: 2006 Hurricane Season Outlook Vs 2005 2005 NOAA CSU ActualNumber Named Storms 13-16 17 28Number Hurricanes 8-10 9 15Numerb Major Hurricanes (Cat 3 or higher) 4-6 5 7Source: NOAA, Colorado State University, Lehman Brothers researchFigure 8: NOAA And CSU Forecasts Vs Actual NOAA Prediction CSU April Prediction Actual Atlantic Hurricanes Major Hurricanes Atlantic HurricanesMajor Hurricanes Atlantic Hurricanes Major Hurricanes2005 7-9 3-5 7 3 15 72004 6-8 2-4 8 3 9 62003 6-9 2-4 8 3 7 2Source: NOAA, Colorado State University, Lehman Brothers research As a result of increased expected hurricane activity, many insurers as well as catastrophe modeling firms are recalibrating their catastrophe models to include assumptions for increased frequency and severity of hurricanes. RMS, a catastrophe modeling firm, expects that updates to its 2006 hurricane model could result in at least a 50% increase in Atlantic hurricane loss expectations following the devastating 2005 storm results. EQECAT, another catastrophe modeler, adjusted its catastrophe model increasing expected loss frequency in the U.S. from Atlantic hurricanes by 40%. EQECAT’s severity assumptions increased 25% for both a 1 in 50 year event and a 1 in 100 year event; however, adjustments to EQECAT’s assumptions varied by region (Figure 9). Both EQECAT and RMS expect at least another five years of increased hurricane activity. May 22, 2006 6
    • Equity Derivatives Strategy | Options Not Fully Pricing in 2006 Hurricane Risks for P&C Stocks Figure 9: Changes to EQECAT’s Catastrophe Models, By Region Gulf of Mexico, Total Average FL Only excluding FL GA, NC, and SC VA to NY Increases in Frequency 40% 60% 20% 40% 30% Increases in Severity: 1 in 50 year event 25% 40% 15% 25% 15% 1 in 100 year event 25% 25% 10% 25% 10% Source: EQECAT, Lehman Brothers Dr. William Gray (CSU) is considered one of the leading experts on patterns of hurricane activity. The Colorado State University team’s most recent hurricane forecast (April) expects the 2006 hurricane season to be more active than average, but less active than 2005. The team forecasts 17 named storms (average 9.6) to form in the Atlantic basin during the six-month season, which officially begins on June 1. The team expects nine of these storms to become hurricanes, with five of them intense hurricanes (category 3 or higher). The CSU team provided probabilities of at least one major storm (category 3 or higher) making landfall in a coastal region in 2006: • U.S. coastline: 81% (average for last century is 52%); • U.S. east coast and Florida: 64% (average for last century is 31%); • U.S. Gulf coast from Florida panhandle: 47% (average for last century is 30%); and • Caribbean: above average risk. May 22, 2006 7
    • Equity Derivatives Strategy | Options Not Fully Pricing in 2006 Hurricane Risks for P&C StocksAnalyst Certification:The respective research analysts responsible for the fundamental ratings hereby certify (1) that the views expressed in this research email accurately reflect ourpersonal views about any or all of the subject securities or issuers referred to in this email and (2) no part of our compensation was, is or will be directly or indirectlyrelated to the specific recommendations or views expressed in this email.I, Ryan Renicker, hereby certify (1) that the views expressed in this research email accurately reflect my personal views about any or all of the subject securities orissuers referred to in this email and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressedin this email.To the extent that any of the conclusions are based on a quantitative model, Lehman Brothers hereby certifies (1) that the views expressed in this research emailaccurately reflect the firms quantitative research model (2) no part of the firms compensation was, is or will be directly or indirectly related to the specificrecommendations or views expressed in this research report.Important DisclosuresLehman Brothers does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have aconflict of interest that could affect the objectivity of this email communication.Customers of Lehman Brothers in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost tothem, where such research is available. Customers can access this independent research at www.lehmanlive.com or can call 1-800-2-LEHMAN to request a copy ofthis research.Investors should consider this communication as only a single factor in making their investment decision.The analysts responsible for preparing this report have received compensation based upon various factors including the Firm’s total revenues, a portion of which isgenerated by investment banking activities.Stock price and ratings history charts along with other important disclosures are available on our disclosure website at www.lehman.com/disclosuresAnd may also be obtained by sending a written request to: LEHMAN BROTHERS CONTROL ROOM , 745 SEVENTH AVENUE, 19TH FLOOR NEW YORK, NY10019Mentioned StocksACE Limited (ACE - USD52.51) 2-Equal weight / Positive E/J/K/L/MRisks Which May Impede the Achievement of the Price Target: Similar to other property/casualty insurers, ACE Limited faces risks from a return to a softproperty/casualty market, catastrophes and other large losses, and rising interest rates. Risks to ACE that could impede the stock from achieving our price targetinclude further adverse loss development in its asbestos reserves. The company also could suffer from uncollectible reinsurance balances.Allstate Corp. (ALL - USD56.39) 1-Overweight / Positive A/D/E/J/K/L/MRisks Which May Impede the Achievement of the Price Target: There are several risks that could prevent Allstate from achieving our price target. The major risk forthe stock is a return to a soft personal lines insurance market, which could cause a contraction in the stocks multiple. Second, the company has substantial exposureto natural catastrophe losses, owing to its large homeowners insurance business. Also, Allstate is subject to numerous lawsuits that we attribute in part to it being alarge, highly visible corporation.Chubb Corp. (CB - USD50.36) 1-Overweight / Positive JRisks Which May Impede the Achievement of the Price Target: Similar to other property/casualty insurers, Chubb faces risks from a return to a soft property/casualtymarket, catastrophes and other large losses, and rising interest rates. Risks to Chubb that could impede the stock from achieving our price target include adverseprior-period loss-reserve development in areas such as its homeowners, directors and officers, and errors and omissions lines, as well as asbestos. In addition, ChubbFinancial Solutions could suffer operating losses as the company exits this business.Montpelier Re Holdings (MRH - USD15.12) 2-Equal weight / Positive A/F/JRisks Which May Impede the Achievement of the Price Target: The risks for MRH include the company not reserving adequately for unexpected future losses; weatherand non-weather catastrophes; future terrorist acts; regulatory fines and sanctions; interest-rate fluctuations; and prices falling faster than expected.Everest Re Group (RE - USD91.04) 1-Overweight / Positive JRisks Which May Impede the Achievement of the Price Target: The risks for RE include asbestos exposure and the company not reserving adequately for unexpectedfuture losses; weather and non-weather catastrophes; future terrorist acts; regulatory fines and sanctions; and prices falling faster than expected. May 22, 2006 8
    • Equity Derivatives Strategy | Options Not Fully Pricing in 2006 Hurricane Risks for P&C StocksDisclosure Legend:A: Lehman Brothers Inc. and /or an affiliate managed or co-managed within the past 12 months a 144A and/or public offering of securities for this company.D: Lehman Brothers Inc. or an affiliate has received compensation for investment banking services from the subject company within the past 12 months.E: Lehman Brothers Inc. or an affiliate expects to receive or intends to seek compensation for investment banking services from the subject company within the nextthree months.F: Lehman Brothers Inc. and/or its affiliates beneficially own(s) 1% or more of any class of common equity securities of the subject company as of the end of the lastmonth.J: Lehman Brothers Inc. or an affiliate trade(s) regularly in the shares of the subject company.K: Lehman Brothers Inc. has received non-investment banking related compensation from the subject company within the last 12 months.L: The subject company is or during the past 12 months has been an investment banking client of Lehman Brothers Inc. and/or an affiliate.M: The subject company is or during the last 12 months has been a non-investment banking client (securities related services) of Lehman Brothers Inc.Options are not suitable for all investors and the risks of option trading should be weighed against the potential rewards.Supporting documents that form the basis of the recommendations are available on request. Please note that the trade ideas withinthis report in no way relate to the fundamental ratings applied to European stocks by Lehman Brothers Equity Research.Guide to Lehman Brothers Equity Research Rating SystemOur coverage analysts use a relative rating system in which they rate stocks as 1-Overweight, 2- Equal weight or 3-Underweight (see definitions below) relative to othercompanies covered by the analyst or a team of analysts that are deemed to be in the same industry sector (“the sector coverage universe”). To see a list of companies thatcomprise a particular sector coverage universe, please go to www.lehman.com/disclosures.In addition to the stock rating, we provide sector views which rate the outlook for the sector coverage universe as 1-Positive, 2-Neutral or 3-Negative (see definitions below).A rating system using terms such as buy, hold and sell is not the equivalent of our rating system. Investors should carefully read the entire research report including thedefinitions of all ratings and not infer its contents from ratings alone.Stock Rating1-Overweight - The stock is expected to outperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.2-Equal weight - The stock is expected to perform in line with the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.3-Underweight - The stock is expected to underperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.RS-Rating Suspended - The rating and target price have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstancesincluding when Lehman Brothers is acting in an advisory capacity on a merger or strategic transaction involving the company.Sector View1-Positive - sector coverage universe fundamentals are improving.2-Neutral - sector coverage universe fundamentals are steady, neither improving nor deteriorating.3-Negative - sector coverage universe fundamentals are deteriorating. May 22, 2006 9
    • Equity Derivatives Strategy | Options Not Fully Pricing in 2006 Hurricane Risks for P&C StocksDistribution of Ratings:Lehman Brothers Equity Research has 1832 companies under coverage.43% have been assigned a 1-Overweight rating which, for purposes of mandatory disclosures, is classified as a Buy rating, 32% of companies with this rating are investmentbanking clients of the Firm.40% have been assigned a 2-Equal weight rating which, for purposes of mandatory disclosures, is classified as a Hold rating, 6% of companies with this rating areinvestment banking clients of the Firm.17% have been assigned a 3-Underweight rating which, for purposes of mandatory disclosures, is classified as a Sell rating, 61% of companies with this rating areinvestment banking clients of the Firm.This material has been prepared and/or issued by Lehman Brothers Inc., member SIPC, and/or one of its affiliates (“Lehman Brothers”) and has been approved byLehman Brothers International (Europe), authorized and regulated by the Financial Services Authority, in connection with its distribution in the European EconomicArea. This material is distributed in Japan by Lehman Brothers Japan Inc., and in Hong Kong by Lehman Brothers Asia Limited. This material is distributed in Australiaby Lehman Brothers Australia Pty Limited, and in Singapore by Lehman Brothers Inc., Singapore Branch. (“LBIS”). Where this material is distributed by LBIS, pleasenote that it is intended for general circulation only and the recommendations contained herein does not take into account the specific investment objectives, financialsituation or particular needs of any particular person. An investor should consult his Lehman Brothers’ representative regarding the suitability of the product and takeinto account his specific investment objectives, financial situation or particular needs before he makes a commitment to purchase the investment product. This materialis distributed in Korea by Lehman Brothers International (Europe) Seoul Branch. This document is for information purposes only and it should not be regarded as anoffer to sell or as a solicitation of an offer to buy the securities or other instruments mentioned in it. No part of this document may be reproduced in any mannerwithout the written permission of Lehman Brothers. With the exception of disclosures relating to Lehman Brothers, this research report is based on current publicinformation that Lehman Brothers considers reliable, but we make no representation that it is accurate or complete, and it should not be relied on as such. In the caseof any disclosure to the effect that Lehman Brothers Inc. or its affiliates beneficially own 1% or more of any class of common equity securities of the subject company,the computation of beneficial ownership of securities is based upon the methodology used to compute ownership under Section 13(d) of the United States SecuritiesExchange Act of 1934. In the case of any disclosure to the effect that Lehman Brothers Inc. and/or its affiliates hold a short position of at least 1% of the outstandingshare capital of a particular company, such disclosure relates solely to the ordinary share capital of the company. Accordingly, while such calculation representsLehman Brothers’ holdings net of any long position in the ordinary share capital of the company, such calculation excludes any rights or obligations that LehmanBrothers may otherwise have, or which may accrue in the future, with respect to such ordinary share capital. Similarly such calculation does not include any sharesheld or owned by Lehman Brothers where such shares are held under a wider agreement or arrangement (be it with a client or a counterparty) concerning the sharesof such company (e.g. prime broking and/or stock lending activity). Any such disclosure represents the position of Lehman Brothers as of the last business day of thecalendar month preceding the date of this report.This material is provided with the understanding that Lehman Brothers is not acting in a fiduciary capacity. Opinions expressed herein reflect the opinion of LehmanBrothers and are subject to change without notice. The products mentioned in this document may not be eligible for sale in some states or countries, and they may notbe suitable for all types of investors. If an investor has any doubts about product suitability, he should consult his Lehman Brothers representative. The value of and theincome produced by products may fluctuate, so that an investor may get back less than he invested. Value and income may be adversely affected by exchange rates,interest rates, or other factors. Past performance is not necessarily indicative of future results. If a product is income producing, part of the capital invested may beused to pay that income. © 2006 Lehman Brothers. All rights reserved. Additional information is available on request. Please contact a Lehman Brothers entity in yourhome jurisdiction.Lehman Brothers policy for managing conflicts of interest in connection with investment research is available at www.lehman.com/researchconflictspolicy. Ratings,earnings per share forecasts and price targets contained in the Firms equity research reports covering U.S. companies are available atwww.lehman.com/disclosures.Complete disclosure information on companies covered by Lehman Brothers Equity Research is available at www.lehman.com/disclosures. May 22, 2006 10