Making Money from This Year's Hurricane Season - Use Options!
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Making Money from This Year's Hurricane Season - Use Options!

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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

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Making Money from This Year's Hurricane Season - Use Options! Making Money from This Year's Hurricane Season - Use Options! Document Transcript

  • EQUITY RESEARCHMay 23, 2006 North America Financial ServicesInsurance/Non-Life Insurance/Non-Life Jay Gelb, CFA Ryan RenickerIndustry Overview 1.212.526.1561 1.212.526.9425Hurricane Option Strategy jgelb@lehman.com rrenicke@lehman.comSector View:New: 1-PositiveOld: 1-PositiveInvestment conclusion We expect P&C insurance stocks could be volatile in anticipation of an active 2006 hurricane season. As a result, we believe investors could position themselves to benefit from this volatility through the options market. In this note we propose a straddle opportunity, in which investors could benefit from certain P&C stocks meaningfully rising or falling.Summary 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. We believe this potential volatility in P&C insurance stocks could provide an attractive opportunity for investors to purchase at-the-money straddles. However, because hurricane intensity and location of hurricane landfall are not possible to predict and these factors can have significant impact on which (re)insurers incur larger loss, we recommend investors purchase a basket of at-the-money straddles. The P&C insurance stocks that have either moderate or large exposure to hurricanes and relatively liquid options are: MRH, RE, ALL, ACE, and CB. While CB has limited exposure to hurricanes, it could be affected if any hurricanes hit the Northeastern U.S. MRH Oct 15 straddles can be purchased for $3.35 and finish in the money if the stock closes above $18.35 or below $11.65 (+/-23%). RE Oct 90 straddles were offered at $10.80 as of last night’s close and the position breaks even if the stock finishes above $100.80 or below $79.20 as of the October 20 expiration (+/-12%). ALL Oct 55 straddles can be purchased for $5.80 and would be profitable if ALL closes above $60.80 or below $49.20 at expiration (+/- 10%). Investors can also purchase ACE Nov 55 straddles for $7.30. These would finish in the money if the stock closes above $62.30 or below $47.70 on October 20 (+/-14%). In case of CB, the Nov 50 straddles could be purchased for $5.30 and would lose money only if CB remains range-bound between $44.70 and $55.30 (+/-11%).Hurricane Volatility. Hurricanes represent risk to book value to P&C insurers and reinsurers. Recent forecasts for 2006indicate expectations for an active hurricane season. We believe concern over losses from an active 2006 hurricane seasoncould 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 (the volatility implied for a six-month period)at the beginning of the hurricane season with the “ex-post 6-month realized volatility” (the volatility actually realized during therespective six month period) at the end of these hurricane seasons to identify instances when it would have been profitable tobe long gamma in 2004 and 2005 (Figure 1). While the lack of listed options having 6 month maturities for several of the P&CLehman Brothers does and seeks to do business with companies covered in its research reports. As a result, investors shouldbe aware that the firm may have a conflict of interest 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 companiescovered in this report, at no cost to them, where such research is available. Customers can access this independent research atwww.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(S) ON PAGE 6 AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 7 1
  • EQUITY RESEARCHnames prevents comparison across the universe, we find that P&C stocks with moderate to high exposure to hurricanestended to have higher realized volatility over the six months of the hurricane season than what was originally implied at thebeginning of the period.Figure 1. Implied vs Subsequent Realized Volatility in 2004-05 Implied Implied Realized Current 6- Hurricane Realized Vol Ticker Vol Vol Vol month Exposure (11/30/05) (5/31/05) (5/28/04) (11/30/04) ImpliedMRH Highest N/A 46.7% N/A 15.5% N/APRE Highest N/A 22.4% N/A 15.2% 19.0%RE Highest 18.8% 20.5% 22.1% 20.6% N/ARNR Highest 21.8% 32.0% N/A 23.0% N/AXL Moderate 18.4% 27.5% 23.0% 18.6% 19.2%ACE Moderate 22.7% 22.2% N/A 27.0% 23.7%ACGL Moderate N/A 22.1% N/A 20.2% 18.8%ALL Moderate 14.8% 17.6% 20.4% 16.1% 16.8%AIG Least 24.5% 15.2% 22.4% 26.4% 27.3%CB Least 18.5% 17.7% 22.3% 20.3% 19.3%HIG Least 20.4% 17.5% 25.2% 22.7% 22.2%PGR Least N/A 21.8% N/A 18.0% 21.8%SAFC Least 18.5% 16.0% 21.6% 17.9% 18.9%STA Least 19.6% 18.2% 22.7% 24.0% 20.6%Source: Lehman Brothers, OptionMetricsSince the beginning of 2006, price-to-book multiples for P&C insurers have been under pressure, possibly a reflection ofinvestor concern over hurricane losses. In the event that there are fewer property losses this year, there is a possibility ofmultiple expansion in these names. We believe this factor, coupled with the stocks’ relatively low implied volatility, implies thatstraddles purchased ahead of this year’s hurricane season could be a profitable strategy as the stocks could have substantialmoves in either direction. This could occur in the event of either an active hurricane season or one that causes significantlylower losses than expected.Figure 2. Multiple Compression in 2006 1.60 1.55 P&C Composite Multiple (P/B) 1.50 1.45 1.40 1.35 6 06 06 6 -0 r-0 n- b- ar Ap Ja Fe MSource: Lehman Brothers, FactsetUpcoming Catalysts. There are several possible catalysts in the near term, which could draw investor attention to the 2006hurricane season. May 31: The CSU team updates its 2006 Hurricane Forecast June: Hurricane season beginsInvestment 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 spaceremains a constraint, MRH, RE, ALL, ACE, and CB are P&C stocks we identify as having relatively liquid options. While CBhas limited exposure to hurricanes, it could be affected if any hurricanes hit the Northeastern U.S., which are at “high risk” thisyear, according to Accuweather meteorologists. Since the impact (or lack of impact) of the 2006 hurricane season varies dueto unique geographic exposures – and the magnitude and location of hurricane landfalls is uncertain – we recommendinvestors 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 orbelow $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 2
  • EQUITY RESEARCHfinishes above $100.70 or below $79.30 as of the October 20th expiration date (which follows the most active portion of thehurricane 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 atexpiration. Investors can also purchase ACE Nov 55 straddles for $7.20. These would finish in the money if the stock closesabove $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-boundbetween $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 in2005, straddles purchased at these prices would have broken even as the average absolute return for these stocks over theentire 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 Nov05MRH 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, BloombergBackgroundReview 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 represented13% 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) in ai IP (b) Be A y rR e F i C Re St Re up f) l O oyd al ric su (a) ire (a) (a) ha ) A l Re e ce rd ec s Ax pe y ua C i) r R at a) St hite m ( (f) nc rw e P a A Re es l no Tra cia al C u rs pl rog Sa )(f) du Un nc e e (a Ltd Ev ap ) ey ) ic )( c au ou (g) rk IG irf Ar Ma te ra ain rk Re ive o H a) er AC a ita er ita at h C i ss (f a Sp iter As ialt un (a ti ie R Q XL e ( ra de e R is n ( Be yer ess fec En um ssa R is Gr (d)( t n it A h R e)( H (e)( ta H Ch ele ve ns l ( tfo W Far )(c) e y( w M e lan Ll api h ran dy s . P M a) el PX nt ap (a na ap l T nt rtn W e Zu In bb ax ch x t C ls R r ar Th le v C s o R r e tp R C 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 rateSource: Company data, Lehman Brothers 3
  • EQUITY RESEARCHRealized Volatility Relatively Low in 2004, High in 2005. We use absolute one-day returns of insurance stocks to gaugethe magnitude of the impact the 2005 hurricanes had on these companies’ shares. In addition, the average of the dailyabsolute returns over each month can be used as an estimate of the profitability of an options strategy whereby investorswould have gone long volatility in insurance names by purchasing options on each stock, and delta-hedging their positions atthe close of each day (long gamma). We find insurers did not experience exceptionally high volatility in response to the 2004hurricane season (Figure 5), which was a rather active season – particularly for Florida – with four major hurricanes (Cat 3 orhigher) making landfall (hurricanes Charley, Frances, Ivan, Jeanne). The only month with unusually high volatility wasOctober, owing to the Spitzer investigation into insurance brokers. However, the 2005 hurricane season generated muchhigher realized volatility for insurance stocks having high exposure to hurricanes, given the significantly larger damage toinsured properties in the Gulf of Mexico coastal regions (hurricanes Dennis, Katrina, Rita, Wilma).Figure 5. Average Absolute Returns For P&C Insurers 2.5% Daily Absolute Return - Highest Exposure 2.0% Daily Absolute Return - Moderate Exposure 1.5% 1.0% 0.5% 0.0% 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 MSource: Lehman Brothers, BloombergHeightened Risk Expectations Post Katrina. We use the change in short term implied volatility for options on P&C insurersas an index of the level of risk expectations priced in by the options market. The spread of the weighted average impliedvolatilities of P&C insurers over S&P 500 implied volatility is a measure of the incremental risk specific to stocks with exposureto hurricanes. In 2005, we find that implied volatility for P&C stocks relative to the market reached its trough at the end ofAugust. However, following hurricane Katrina’s landfall, there was a re-pricing of risk expectations for P&C options across theboard (Figure 6). In fact, implied volatility for insurers with the highest exposure to hurricanes began to trade at a premiumrelative to the implied volatility for insurers having a moderate exposure. We caveat that the information content of impliedvolatility for stocks with the highest exposure to hurricanes be taken with the proverbial pinch of salt, given the lack of liquidityin these options.Figure 6. P&C Insurer Implied Volatility Relative to S&P 500 25% 20% 15% 10% 5% 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 Implied Vol Spread to Market - Highest Exposure Implied Vol Spread to Market - Moderate ExposureSource: Lehman Brothers, BloombergIn recent months, the implied volatility spread for insurers with the highest risk exposure has been declining, which couldindicate that the options market is not pricing in hurricane risk sufficiently. As the onset of the 2006 hurricane seasonapproaches, with outlooks released (and increasing media attention or headline risks surfacing), there is likely to be elevated 4
  • EQUITY RESEARCHinvestor attention to this risk and, we believe, another re-pricing of implied volatility, even in the absence of an immediatechange in realized vols.Hurricane Forecasts for 2006. NOAA (National Oceanic and Atmospheric Administration) released its 2006 hurricaneforecast yesterday (May 22), saying it expects the 2006 hurricane season to be more active than average, but less active than2005. 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 thatcollectively 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 activethan 2005. The NOAA and CSU forecasts are mostly in line. (Figure 7). NOAA does not predict the probability of hurricanesmaking 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 conservativein their forecasts. Figure 8 shows the NOAA and CSU forecasts versus the actual number of hurricanes and major hurricanesfrom 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 research.Figure 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 recalibratingtheir catastrophe models to include assumptions for increased frequency and severity of hurricanes. RMS, a catastrophemodeling firm, expects that updates to its 2006 hurricane model could result in at least a 50% increase in Atlantic hurricaneloss expectations following the devastating 2005 storm results. EQECAT, another catastrophe modeler, adjusted itscatastrophe model increasing expected loss frequency in the U.S. from Atlantic hurricanes by 40%. EQECAT’s severityassumptions increased 25% for both a 1 in 50 year event and a 1 in 100 year event; however, adjustments to EQECAT’sassumptions varied by region (Figure 9). Both EQECAT and RMS expect at least another five years of increased hurricaneactivity.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 NYIncreases 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 BrothersDr. William Gray (CSU) is considered one of the leading experts on patterns of hurricane activity. The Colorado StateUniversity 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- 5
  • EQUITY RESEARCHmonth season, which officially begins on June 1. The team expects nine of these storms to become hurricanes, with five ofthem intense hurricanes (category 3 or higher). The CSU team provided probabilities of at least one major storm (category 3or 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.Analyst Certification:We, Jay Gelb, CFA and Ryan Renicker, hereby certify (1) that the views expressed in this research Industry Note accurately reflect ourpersonal views about any or all of the subject securities or issuers referred to in this Industry Note and (2) no part of our compensation was,is or will be directly or indirectly related to the specific recommendations or views expressed in this Industry Note.Other Team Members:Hawken, Brennan 1.212.526.8190 bhawken@lehman.comPagluica, Sarah 1.212.526.9947 spagluic@lehman.comMallick, Devapriya 1.212.526.5429 dmallik@lehman.com 6
  • EQUITY RESEARCHImportant Disclosures:ACE Limited (ACE) $ 52.51 (19-May-2006) 2-Equal weight / 1-PositiveRating and Price Target Chart: ACE LIMITED As of 16-May-2006 Currency = USD 60.00 56.00 52.00 48.00 44.00 40.00 36.00 32.00 28.00 24.00 20.00 16.00 12.00 8.00 4.00 0.00 1-03 4-03 7-03 10-03 1-04 4-04 7-04 10-04 1-05 4-05 7-05 10-05 1-06 4-06 7-06 10-06 Closing Price Price Target Recommendation Change Drop Coverage Source: FactSetCurrency=$Date Closing Price Rating Price Target Date Closing Price Rating Price Target03-Jan-06 54.54 57.00 01-Feb-05 43.87 0.0014-Nov-05 56.57 57.00 01-Feb-05 43.87 Dropped07-Oct-05 47.96 48.00 16-Jul-04 42.28 42.0030-Jun-05 44.85 44.00 10-Jun-04 41.98 40.0013-Apr-05 40.06 42.00 10-Jun-04 41.98 3-Underweight13-Apr-05 40.06 2-Equal weight FOR EXPLANATIONS OF RATINGS REFER TO THE STOCK RATING KEYS LOCATED ON THE PAGE FOLLOWING THE LAST PRICE CHART.Lehman Brothers Inc. and/or an affiliate expects to receive or intends to seek compensation for investment banking services from ACELimited within the next 3 months.Lehman Brothers Inc and/or an affiliate trade regularly in the shares of ACE Limited.Lehman Brothers Inc. has received non-investment banking related compensation from ACE Limited within the last 12 months.ACE Limited is or during the past 12 months has been an investment banking client of Lehman Brothers Inc. and/or an affiliate.ACE Limited is or during the last 12 months has been a non-investment banking client (securities related services) of Lehman Brothers Inc.Risks Which May Impede the Achievement of the Price Target: Similar to other property/casualty insurers, ACE Limited faces risks froma return to a soft property/casualty market, catastrophes and other large losses, and rising interest rates. Risks to ACE that could impedethe stock from achieving our price target include further adverse loss development in its asbestos reserves. The company also could sufferfrom uncollectible reinsurance balances. 7
  • EQUITY RESEARCHImportant Disclosures Continued:Allstate Corp. (ALL) $ 56.39 (19-May-2006) 1-Overweight / 1-PositiveRating and Price Target Chart: ALLSTATE CORP. As of 16-May-2006 Currency = USD 72.00 68.00 64.00 60.00 56.00 52.00 48.00 44.00 40.00 36.00 32.00 28.00 24.00 20.00 16.00 12.00 8.00 4.00 0.00 1-03 4-03 7-03 10-03 1-04 4-04 7-04 10-04 1-05 4-05 7-05 10-05 1-06 4-06 7-06 10-06 Closing Price Price Target Recommendation Change Drop Coverage Source: FactSetCurrency=$Date Closing Price Rating Price Target Date Closing Price Rating Price Target11-Jan-06 55.55 65.00 01-Feb-05 50.93 Dropped03-Jan-06 54.73 65.00 22-Oct-04 46.83 54.0020-Oct-05 53.02 65.00 09-Sep-04 46.50 2-Equal weight21-Jul-05 61.20 70.00 27-Aug-04 47.69 2-Equal weight30-Jun-05 59.75 66.00 17-Oct-03 40.05 52.0013-Apr-05 54.50 63.00 17-Oct-03 40.05 1-Overweight13-Apr-05 54.50 1-Overweight 13-Aug-03 35.89 50.0001-Feb-05 50.93 0.00 13-Aug-03 35.89 2-Equal weight FOR EXPLANATIONS OF RATINGS REFER TO THE STOCK RATING KEYS LOCATED ON THE PAGE FOLLOWING THE LAST PRICE CHART.Lehman Brothers Inc. and/or an affiliate has managed or co-managed within the past 12 months a 144A and/or public offering of securitiesfor Allstate Corp..Lehman Brothers Inc. and/or an affiliate has received compensation for investment banking services from Allstate Corp. in the past 12months.Lehman Brothers Inc. and/or an affiliate expects to receive or intends to seek compensation for investment banking services from AllstateCorp. within the next 3 months.Lehman Brothers Inc and/or an affiliate trade regularly in the shares of Allstate Corp..Lehman Brothers Inc. has received non-investment banking related compensation from Allstate Corp. within the last 12 months.Allstate Corp. is or during the past 12 months has been an investment banking client of Lehman Brothers Inc. and/or an affiliate.Allstate Corp. is or during the last 12 months has been a non-investment banking client (securities related services) of Lehman Brothers Inc.Risks Which May Impede the Achievement of the Price Target: There are several risks that could prevent Allstate from achieving ourprice target. The major risk for the stock is a return to a soft personal lines insurance market, which could cause a contraction in the stocksmultiple. Second, the company has substantial exposure to 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 a large, highly visible corporation. 8
  • EQUITY RESEARCHImportant Disclosures Continued:Chubb Corp. (CB) $ 50.36 (19-May-2006) 1-Overweight / 1-PositiveRating and Price Target Chart: CHUBB CORP. As of 16-May-2006 Currency = USD 60.00 56.00 52.00 48.00 44.00 40.00 36.00 32.00 28.00 24.00 20.00 16.00 12.00 8.00 4.00 0.00 1-03 4-03 7-03 10-03 1-04 4-04 7-04 10-04 1-05 4-05 7-05 10-05 1-06 4-06 7-06 10-06 Closing Price Price Target Recommendation Change Drop Coverage Source: FactSetCurrency=$Date Closing Price Rating Price Target Date Closing Price Rating Price Target25-Apr-06 50.97 58.00 13-Apr-05 39.77 45.0019-Apr-06 49.50 55.00 13-Apr-05 39.77 1-Overweight03-Jan-06 48.90 55.00 01-Feb-05 38.27 0.0014-Nov-05 49.06 55.00 01-Feb-05 38.27 Dropped27-Jul-05 44.63 47.50 13-Aug-03 32.85 41.0030-Jun-05 42.80 46.00 13-Aug-03 32.85 1-Overweight FOR EXPLANATIONS OF RATINGS REFER TO THE STOCK RATING KEYS LOCATED ON THE PAGE FOLLOWING THE LAST PRICE CHART.Lehman Brothers Inc and/or an affiliate trade regularly in the shares of Chubb Corp..Risks Which May Impede the Achievement of the Price Target: Similar to other property/casualty insurers, Chubb faces risks from areturn to a soft property/casualty market, catastrophes and other large losses, and rising interest rates. Risks to Chubb that could impedethe stock from achieving our price target include adverse prior-period loss-reserve development in areas such as its homeowners, directorsand officers, and errors and omissions lines, as well as asbestos. In addition, Chubb Financial Solutions could suffer operating losses as thecompany exits this business. 9
  • EQUITY RESEARCHImportant Disclosures Continued:Everest Re Group (RE) $ 91.04 (19-May-2006) 1-Overweight / 1-PositiveRating and Price Target Chart: EVEREST RE GROUP As of 16-May-2006 Currency = USD 128.00 120.00 112.00 104.00 96.00 88.00 80.00 72.00 64.00 56.00 48.00 40.00 32.00 24.00 16.00 8.00 0.00 1-03 4-03 7-03 10-03 1-04 4-04 7-04 10-04 1-05 4-05 7-05 10-05 1-06 4-06 7-06 10-06 Closing Price Price Target Recommendation Change Drop Coverage Source: FactSetCurrency=$Date Closing Price Rating Price Target Date Closing Price Rating Price Target25-Apr-06 90.00 105.00 19-Apr-05 84.11 90.0003-Jan-06 100.81 120.00 13-Apr-05 84.75 92.0014-Nov-05 107.34 120.00 22-Nov-04 83.97 101.0014-Nov-05 107.34 1-Overweight 22-Nov-04 83.97 2-Equal weight25-Jul-05 94.68 95.00 10-Nov-04 82.46 0.0030-Jun-05 93.00 92.00 FOR EXPLANATIONS OF RATINGS REFER TO THE STOCK RATING KEYS LOCATED ON THE PAGE FOLLOWING THE LAST PRICE CHART.Lehman Brothers Inc and/or an affiliate trade regularly in the shares of Everest Re Group.Risks Which May Impede the Achievement of the Price Target: The risks for RE include asbestos exposure and the company notreserving adequately for unexpected future losses; weather and non-weather catastrophes; future terrorist acts; regulatory fines andsanctions; and prices falling faster than expected. 10
  • EQUITY RESEARCHImportant Disclosures Continued:Montpelier Re Holdings (MRH) $ 15.12 (19-May-2006) 2-Equal weight / 1-PositiveRating and Price Target Chart: MONTPELIER RE HOLDINGS As of 16-May-2006 Currency = USD 44.00 40.00 36.00 32.00 28.00 24.00 20.00 16.00 12.00 8.00 4.00 0.00 5-03 8-03 11-03 2-04 5-04 8-04 11-04 2-05 5-05 8-05 11-05 2-06 5-06 Closing Price Price Target Recommendation Change Drop Coverage Source: FactSetCurrency=$Date Closing Price Rating Price Target Date Closing Price Rating Price Target14-Mar-06 16.43 17.00 09-Dec-05 17.31 0.0014-Mar-06 16.43 2-Equal weight FOR EXPLANATIONS OF RATINGS REFER TO THE STOCK RATING KEYS LOCATED ON THE PAGE FOLLOWING THE LAST PRICE CHART.Lehman Brothers Inc. and/or an affiliate has managed or co-managed within the past 12 months a 144A and/or public offering of securitiesfor Montpelier Re Holdings.Lehman Brothers Inc. and/or its affiliates beneficially owns 1% or more of any class of common equity securities of Montpelier Re Holdingsas of the end of last month.Lehman Brothers Inc and/or an affiliate trade regularly in the shares of Montpelier Re Holdings.Risks Which May Impede the Achievement of the Price Target: The risks for MRH include the company not reserving adequately forunexpected future losses; weather and non-weather catastrophes; future terrorist acts; regulatory fines and sanctions; interest-ratefluctuations; and prices falling faster than expected.Other Material Conflicts: Lehman Brothers Inc. or an affiliate has received compensation for investment banking services from the subjectcompany within the past 12 months.Lehman Brothers Inc. or an affiliate expects to receive or intends to seek compensation for investment banking services from the subjectcompany within the next three months.The subject company is or during the past 12 months has been an investment banking client of Lehman Brothers Inc. 11
  • EQUITY RESEARCHImportant Disclosures Continued:The analysts responsible for preparing this report have received compensation based upon various factors including the firms totalrevenues, a portion of which is generated by investment banking activitiesCompany Name Ticker Price (19-May-2006) Stock / Sector RatingACE Limited ACE $ 52.51 2-Equal weight / 1-PositiveAllstate Corp. ALL $ 56.39 1-Overweight / 1-PositiveChubb Corp. CB $ 50.36 1-Overweight / 1-PositiveEverest Re Group RE $ 91.04 1-Overweight / 1-PositiveMontpelier Re Holdings MRH $ 15.12 2-Equal weight / 1-PositiveSector Coverage UniverseBelow is the list of companies that constitute the sector coverage universe:ACE Limited (ACE) Allstate Corp. (ALL)American International Group (AIG) Aon Corporation (AOC)Arch Capital Group Ltd. (ACGL) Arthur J. Gallagher & Co. (AJG)Aspen Insurance Holdings (AHL) Chubb Corp. (CB)Everest Re Group (RE) Marsh & McLennan Cos. (MMC)Montpelier Re Holdings (MRH) PartnerRe Ltd. (PRE)Progressive Corp. (PGR) RenaissanceRe Holdings (RNR)SAFECO Corp (SAFC) St. Paul Travelers Cos. (STA)Willis Group Holdings Ltd. (WSH) XL Capital Ltd. (XL)Guide to Lehman Brothers Equity Research Rating System:Our coverage analysts use a relative rating system in which they rate stocks as 1-Overweight, 2-Equal weight or 3-Underweight (seedefinitions below) relative to other companies covered by the analyst or a team of analysts that are deemed to be in the same industrysector (the “sector coverage universe”). To see a list of the companies that comprise a particular sector coverage universe, please go towww.lehman.com/disclosuresIn 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 the definitions 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-monthinvestment horizon.2-Equal weight - The stock is expected to perform in line with the unweighted expected total return of the sector coverage universe over a12- 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 firmpolicies in certain circumstances including when Lehman Brothers is acting in an advisory capacity in a merger or strategic transactioninvolving the company.Sector View1-Positive - sector coverage universe fundamentals/valuations are improving.2-Neutral - sector coverage universe fundamentals/valuations are steady, neither improving nor deteriorating.3-Negative - sector coverage universe fundamentals/valuations are deteriorating.Distribution of Ratings:Lehman Brothers Equity Research has 1832 companies under coverage.43% have been assigned a 1-Overweight rating which, for purposes of mandatory regulatory disclosures, is classified as Buy rating, 32% ofcompanies with this rating are investment banking clients of the Firm.40% have been assigned a 2-Equal weight rating which, for purposes of mandatory regulatory disclosures, is classified as Hold rating, 6%of companies with this rating are investment banking clients of the Firm.17% have been assigned a 3-Underweight rating which, for purposes of mandatory regulatory disclosures, is classified as Sell rating, 61%of companies with this rating are investment 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 beenapproved by Lehman Brothers International (Europe), authorized and regulated by the Financial Services Authority, in connection with its distribution in theEuropean Economic Area. This material is distributed in Japan by Lehman Brothers Japan Inc., and in Hong Kong by Lehman Brothers Asia Limited. Thismaterial is distributed in Australia by Lehman Brothers Australia Pty Limited, and in Singapore by Lehman Brothers Inc., Singapore Branch (“LBIS”). Wherethis material is distributed by LBIS, please note that it is intended for general circulation only and the recommendations contained herein does not take intoaccount the specific investment objectives, financial situation or particular needs of any particular person. An investor should consult his Lehman Brothers’representative regarding the suitability of the product and take into account his specific investment objectives, financial situation or particular needs before hemakes a commitment to purchase the investment product. This material is distributed in Korea by Lehman Brothers International (Europe) Seoul Branch. 12
  • EQUITY RESEARCHThis document is for information purposes only and it should not be regarded as an offer to sell or as a solicitation of an offer to buy the securities or otherinstruments mentioned in it. No part of this document may be reproduced in any manner without the written permission of Lehman Brothers. With theexception of disclosures relating to Lehman Brothers, this research report is based on current public information that Lehman Brothers considers reliable, butwe make no representation that it is accurate or complete, and it should not be relied on as such. In the case of any disclosure to the effect that LehmanBrothers Inc. or its affiliates beneficially own 1% or more of any class of common equity securities of the subject company, the computation of beneficialownership of securities is based upon the methodology used to compute ownership under Section 13(d) of the United States Securities Exchange Act of1934. 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 outstanding sharecapital 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 thatLehman Brothers may otherwise have, or which may accrue in the future, with respect to such ordinary share capital. Similarly such calculation does notinclude any shares held or owned by Lehman Brothers where such shares are held under a wider agreement or arrangement (be it with a client or acounterparty) concerning the shares of such company (e.g. prime broking and/or stock lending activity). Any such disclosure represents the position ofLehman Brothers as of the last business day of the calendar 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 ofLehman Brothers 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 not be suitable for all types of investors. If an investor has any doubts about product suitability, he should consult his Lehman Brothersrepresentative. The value of and the income produced by products may fluctuate, so that an investor may get back less than he invested. Value and incomemay be adversely affected by exchange rates, interest rates, or other factors. Past performance is not necessarily indicative of future results. If a product isincome producing, part of the capital invested may be used to pay that income. © 2006 Lehman Brothers. All rights reserved. Additional information isavailable on request. Please contact a Lehman Brothers entity in your home 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. 13