1) The document discusses IRS audits of P&C insurance companies and summarizes industry reserve development trends from 1996-2010. 2) Major reserve deficiencies have occurred, totaling over $100 billion currently. Deficiencies are greater for prior accident years and larger, less financially strong companies. 3) Automobile insurance lines, especially bodily injury liability, have seen major deficiencies, along with other lines like general liability.

1. IRS Audit Activity
P&C Insurance Companies
A.M. Best Review & Preview Conference
March 23, 2011
Moderated by: Brian Z. Brown, FCAS, MAAA
Principal & Consulting Actuary
262-796-3391
brian.brown@milliman.com
Presented by: Susan J. Forray, FCAS, MAAA
Principal & Consulting Actuary
262-796-3328
susan.forray@milliman.com
Richard F. Riley, Jr.
Partner
Foley & Lardner LLP
202-295-4712
RRiley@foley.com

2. Outline
§ Macroeconomic Context
§ Industry Reserve Development
– By Calendar Year
– By Statement Year
§ Typical Characteristics of Audited Companies
§ “Isn’t This Just a Timing Issue?”
§ Summary Observations
§ Other Considerations
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3. MACROECONOMIC CONTEXT
3

4. Federal Deficit
(In Billions)
$400
$236.24
$200 $128.24
$0
-$200 ($157.76) ($160.70)
($248.18)
-$400 ($318.35)
($377.59) ($412.73)
($458.55)
-$600
-$800
-$1,000
-$1,200
-$1,400 ($1,294.07)
($1,412.69)
-$1,600
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Source: Congressional Budget Office
4

5. Property & Casualty Industry
RESERVE DEVELOPMENT
5

6. Industry Reserve Development
Excluding Mortgage & Financial Guaranty
Net Loss & ALAE (In Billions), by Calendar Year
$30
$25 $22.8
$20
$14.2
$15 $11.9 $10.5
$10
$5 $1.1 $0.8
$0
-$5 ($3.7)
-$10 ($6.3) ($6.8)
($8.8) ($9.4) ($9.5) ($10.3)
-$15 ($11.5)
($14.5)
-$20
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Source: Milliman analysis of Property & Casualty Statutory Annual Statements
6 Excludes Mortgage & Financial Guaranty

7. Industry Reserve Development
Net Loss & ALAE (In Billions), by Calendar Year
Split Between “Prior” and “Recent” Accident Years
$35
$25 $21.2
$16.7 $16.7
$15 $12.4
$11.9
$7.3 $7.6
$3.2 $4.8 $5.0
$5
$0.0 $1.6
-$5 ($2.5)
($6.2)
Accident Years 2000 & Prior
($11.6)
-$15
($14.1) ($15.3)
Accident Years 2001 & ($17.1) ($17.7) ($16.3)
Subsequent
-$25
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Source: Milliman analysis of Property & Casualty Statutory Annual Statements
7 Excludes Mortgage & Financial Guaranty

8. Statement Year Development
By Calendar Period, as of December 31, 2010
Net Loss & ALAE (In Billions)
$120
$100
$80
$60
$40
$20
$0
-$20
-$40
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
1st 2nd 3rd 4th 5th 6th 7th 8th 9th 10th
Source: Milliman analysis of Property & Casualty Statutory Annual Statements
8 Excludes Mortgage & Financial Guaranty

9. Development by Statement Year
Net Loss & ALAE (In Billions)
As of December 31, 2010
$120
$106.8$105.7
$100
$80.2 $83.9
$80
$60 $51.7 $52.7
$40
$27.3
$20 $11.7 $15.4
$5.3
$0.0
$0
($8.3) ($10.3)
-$20 ($16.4)
($28.6)($26.0)
-$40
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Source: Milliman analysis of Property & Casualty Statutory Annual Statements
9 Excludes Mortgage & Financial Guaranty

10. Property & Casualty Industry – Audited Companies
TYPICAL CHARACTERISTICS
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11. Reserve Development by Company Size
2006 – 2010
(Net, In Billions)
($23.1)
($14.4)
($13.1)
($2.2)
Largest 2nd Largest
3rd Largest Smallest
Source: Milliman analysis of Property & Casualty Statutory Annual Statements
11 Excludes Mortgage & Financial Guaranty

12. Comm Auto MPL
Line of Business ($2.9) ($9.8)
Other
2006 – 2010 CMP
($9.4)
($5.1)
(Net, In Billions) Work
Comp
($0.4) Personal Auto
Reserve GL
Auto Phys
Dam
($10.5)
Development ($2.5)
($8.5)
Comm Auto MPL
Work Comp $90.2 $47.7 Homeowners
$183.3 CMP ($3.6)
$151.0
GL Other
$203.7 $341.5
Homeowners
$293.1
Auto Phys
Personal Auto
$474.7
Earned
Dam
$349.3
Premium
Source: Milliman analysis of Property & Casualty Statutory Annual Statements
12 Excludes Mortgage & Financial Guaranty

13. A
Financial Strength ($10.1)
A- Other
2006 – 2010 ($6.1) $0.2
Not
(Net, In Billions) A+ Rated
($18.7) ($2.0)
Reserve A++
Development ($16.0)
A
$785.0 Other
A- $62.7
$147.6
Not
Rated
$54.1
A++
A+ $393.6 Earned
$691.3 Premium
Source: Milliman analysis of Property & Casualty Statutory Annual Statements
13 Excludes Mortgage & Financial Guaranty

14. Mutual Companies Only
Calendar Year Reserve Development
Net Loss and ALAE, In Billions
$1
$0.3 $0.4
$0
-$1
($1.2) ($1.1)
($1.6)
-$2
($2.1)
($2.3)
($2.7) ($2.6) ($2.6)
-$3 ($2.8)
($3.5)
-$4 ($3.7)
($4.2) ($4.2)
-$5
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Source: Milliman analysis of Property & Casualty Statutory Annual Statements
14 Excludes Mortgage & Financial Guaranty

15. Mutual Companies Only
Statement Year Reserve Development
Net Loss and ALAE, In Billions, as of December 31, 2010
$6
$4.2
$4
$3.1
$2.4
$2
$0.8
$0.0
$0
($0.4)
-$2 ($1.6)
($2.6)
-$4 ($3.5)
($4.2)
($4.8) ($4.7) ($4.8)
-$6 ($5.3)
($5.9) ($6.0)
-$8
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Source: Milliman analysis of Property & Casualty Statutory Annual Statements
15 Excludes Mortgage & Financial Guaranty

16. “ISN’T THIS JUST A TIMING
ISSUE?”
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17. “Isn’t this Just a Timing Issue?”
In Some Ways, Yes
§ Eventually, reserves develop to ultimate
– Over the long term, income will be recognized
§ Settlements with IRS affect subsequent tax years
– Example: settlement of 2006 will affect 2007 tax
• 2006 income increases, 2007 income decreases
– However…
• Requires claiming a refund
• Can continue to audit subsequent years
• IRS unlikely to settle subsequent years immediately
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18. “Isn’t this Just a Timing Issue?”
In Other Ways, No
§ High interest rate on deficiencies
– Currently 5% for “large corporate underpayments”
– Increasing to 6% next quarter
– Has been as high as 10% for 2006 tax year
§ IRS wasn’t actively auditing reserves in prior years
– Can’t collect interest on prior year “overpayments”
– Even if you could…
• Interest rate on overpayments 4.5% less
• So currently 0.5%
– And reserve audits will likely slow again
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19. SUMMARY OBSERVATIONS
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20. Summary Observations
§ P&C Industry Likely Not Over-Reserved
– In hindsight, 1995 – 2004 statement years under-reserved
– 2005 & subsequent statement years
• Have run off favorably to date
• But will likely develop adversely due to tail liabilities
§ Typical Characteristics of Audited Companies
– Medium size
– Mutual structure
– Financially sound
– Medical professional liability (sometimes)
§ Not Simply a Timing Issue
– High interest rate on underpayments
– Reserves audited selectively
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21. OTHER CONSIDERATIONS
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22. Other Considerations
§ Accompanying Oral Discussion
– This document is not complete without the accompanying oral discussion and
explanation of the underlying information and concepts as well as any interpretational
limitations.
§ Limited Distribution
– This document should not be distributed, disclosed or otherwise furnished, in whole
or in part, without the express written consent of Milliman.
§ Data Reliance
– We have relied upon data and other background information provided by the
Congressional Budget Office and A.M. Best without audit or independent verification.
We have performed a limited review of the data for reasonableness and consistency
and have not found material defects in the data. If there are material defects in the
data, it is possible that they would be uncovered by a detailed, systematic review and
comparison of the data to search for data values that are questionable or
relationships that are materially inconsistent. Such a review was beyond the scope
of our assignment.
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