Build FremontPresentation to Fremont Management

6/29/2009, 3:00 PM BDO Seidman offices, 99 Monroe Avenue, NW, Suite 800

Grand Rapids, Michigan 49503.

Agenda:Personal Lines

•A lack of underwriting discipline in personal lines•No clearly defined risk management policy•Top executives in a state of denial•A blatant disregard for industry best practices•Culture of fear which discourages dissent•Brown-nosing rather than arguing with bad strategy

A Lack of Underwriting Discipline inPersonal Lines

• 2006 underwriting gain of $4,129,003•2007 underwriting gain of $2,687•2008 underwriting loss of $ (806,725 )•Simultaneously, net premiums earned in personal lines wentfrom $ 25,752,956 in 2006 to $ 33,452,206 in 2008.•There is a clear pattern here: massive growth, then losses.

A Lack of Underwriting Discipline inPersonal Lines

• When you lose money, hit the brakes—not the gas pedal.

• Has there been any change in behavior after losses? No.

•Underwriting loss for Q1 2009: ($442,258 )

•Underwriting gain for Q1 2008: $280,284

•Net Premiums earned grew from $ 7,864,128 in Q1 2008  to $9,351,382 in Q1 2009

• Do you see a pattern emerging here?

A Lack of Underwriting Discipline inPersonal Lines

• Occasional underwriting losses at an insurancecompany are excusable.

•However, growing net premiums earned at adouble digit clip in the face of underwriting losses isabsolutely inexcusable cowboy risk managementwhich investors have no patience for.

No Clearly Defined Risk Management Policy

• When I ask about risk management in personal lines, Iget vague, muddled, unclear, undisciplined responses.• For instance, “We are examining the situation closelyand analyzing the losses to improve underwriting.”•What is a Risk Management Policy in underwriting?

The Risk Management Policy FremontMust Employ

• 7 major elements: I. Trigger (underwriting losses in personal lines) II. Cooling off Period (contract premiums for 1 year) III. Analysis of problems (what are the drivers of loss?) IV. Corrective Action (I have some ideas) V. Objective standard of success (combined ratio below 95 for 2 years) VI. Warm up period (resumption of premium growth after step Vsuccessful) VII. Total Discipline and Adherence to strict, rational risk control

Top Executives in a State of Denial• Me: You have a real problem in personal lines.•Kevin Kaastra (CFO): That is your opinion.•Me: You are experiencing underwriting losses in personal lines. That is a fact, notan opinion.•Kevin Kaastra: We take a long term view of the success of our strategies.•Me: This is a long term problem. The situation has been deteriorating for twoyears.•Kevin Kaastra: This is a cyclical business, there will be underwriting losses fromtime to time.•Me: The issue is not underwriting losses. The issue is the company’s irrationalresponse to underwriting losses, which is to grow, rather than contract premiums inthe face of losses. That is cowboy risk management, and it is unacceptable.

A Few Words on Life and Insurance

“When the facts change, I change my mind. What do you do, sir?”--Lord Keynes

• Insurance and life are not based upon opinions, feelings, emotions, biases,hope, wishes, or “magical thinking.”• They are based upon facts, rational analysis, and a hard-headedexamination of cause and effect relationships.• The key to success is the mental ability to quickly admit when you arewrong and to change course swiftly when the facts demand it.•False pride, vanity, and arrogance have no place at a public company.•Management is paid to correct mistakes quickly, not to be perfect.

What stage is Fremont management at?

•Like the addict, the first step in the program is admitting you have aproblem.

•The results in personal lines are driven by a lack of rationally designed andimplemented systems. Bad results are a result of bad processes.

A State of Denial: Truth Only Hurts WhenYou Ignore It

Changes in the relationship between variables:I. Brutal political environment for the pricing of personal linesII. Credit scoring makes it harder for the company to raise ratesIII. Long term increase in weather volatilityIV. Inflation in the cost of repairs is hideous.V. Social inflationVI. The economic environment

Any countervailing forces?If you think a 4% price increase in personal line pricing will counteract the abovedrivers of loss, you are delusional.

The Truth in DetailBrutal political environment for the pricing of personal lines. The Governor asked for a price freeze. How much moreobvious can you get? She practically declared war on the insurance industry.

Credit scoring makes it harder for the company to raise rates. The use of credit scoring, is like waving a red cape in front ofan angry bull, hitting it on the nose, and doing an Irish jig when it comes to regulators

Inflation in the cost of repairs is hideous. My sources in the transportation industry have told me the price forreplacement parts and repairs has gone way up in a way that is not reflected in government reported headlineinflation numbers. The same thing may or may not be happening with the cost of repairing homes. Repairingvehicles is a major cost for Fremont, given its growing auto business. Rate increases would reflect that. If thecompany wants rate increases, please refer to the first two problems listed above.

Social inflation. The creep of "social inflation" is continuous. Lawsuits become more expensive every year and juriesaward ever-larger payouts. Pricing, therefore, should increase at a rate commensurate with this burden.

The economic environment. People become more aggressive about reporting claims when the economy deteriorates. Toa large degree, this may change the relationship between variables that may not be reflected in historical data fromthe recent past.

Questions for ManagementI. Do you have an outside firm that analyzes and determines reserving practices andreserving adequacy?

II. What are your goals/practices to reduce the Premium to Surplus ratio?

III. You constantly brag about automation, but do you have an adequate number of trained,experienced Underwriters and Claims people to handle growth and to provide adequateservice?

IV. As fraud becomes more rampant in Michigan what are your plans to combat this withyour heavy book of Personal Lines business?

Burying your head in the sand is not a formof risk control, nor is it a well-regarded

management technique.

The Bottom Line

•Fremont cannot afford to grow any line which is inthe midst of underwriting losses.

•Those who advocate profitless growth irresponsiblyjeopardize Fremont’s financial viability.

SolutionsI. Fremont should rank insurance agencies by historical loss performance (perhapsadjusted to reflect their ranking in their geographic area). Then, Fremont should dispatchemployees by telephone, and when necessary, in person, to ask underperforming agencies tovoluntarily cancel their contracts with the company.

II. Fremont needs to promptly stop using credit scoring. It is a fine quantitativemethod. However, due to the political environment, it hurts the company when it tries toraise rates. If the use of credit scoring keeps the company from getting its rates raised byregulators, its success at predicting loss performance is a moot point.

III. Fremont needs to accept the inconvenient truth that the political environment inMichigan has become hostile to the adequate pricing of personal lines

IV. Fremont needs to expand outside of Michigan. Indiana would be an excellentstate for expansion. The regulatory environment is rational, the economy is better than astate such as Ohio, and the weather environment is mathematically modelable.

A Practical Roadmap forExpansion

Fremont executives have told me that they are not sure how they would find the capitalnecessary to expand. Here are some ideas:

I. Fremont could easily do a sale-and-leaseback of its headquarters property to free up cash.It is owned free and clear, with no mortgage indebtedness. What could be easier?

II. The money could be used to purchase an Indiana insurance company.

III. The company could sell all or part of its Michigan book of business in personal lines. Ifthis is impossible due to its poor performance, the company could heavily reinsure the lineand take steps which would approach run-off, while staying within the bounds of theMichigan Essential Insurance Act.

If a line has no future, do everything you can to minimize the pain and to expand inplaces where Fremont can make, as opposed to lose, money.

The Pillars of Shareholder Value

Transparency and Corporate Governance

Conservative Underwriting

FMIC as a Beacon for Fremont and the MidwesternCommunity