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1. 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.com
Lehman 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 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 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.

2. 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% 1.50
XL Moderate 18.4% 27.5% 23.0% 18.6%
ACE Moderate 22.7% 22.2% N/A 27.0%
1.45
ACGL 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% 1.40
CB 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% 1.35
SAFC Least 18.5% 16.0% 21.6% 17.9%
6
06
06
6
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n-
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STA Least 19.6% 18.2% 22.7% 24.0%
ar
Ap
Ja
Fe
M
Source: Lehman Brothers, OptionMetrics Source: Lehman Brothers
May 22, 2006 2

3. 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

4. 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%
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(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

5. 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
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N
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Implied Vol Spread to Market - Highest Exposure
Implied Vol Spread to Market - Moderate Exposure
Source: Lehman Brothers, Bloomberg Source: Lehman Brothers, OptionMetrics
May 22, 2006 5

6. 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 Actual
Number Named Storms 13-16 17 28
Number Hurricanes 8-10 9 15
Numerb Major Hurricanes (Cat 3 or higher) 4-6 5 7
Source: 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 Hurricanes
2005 7-9 3-5 7 3 15 7
2004 6-8 2-4 8 3 9 6
2003 6-9 2-4 8 3 7 2
Source: 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

7. 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

8. Equity Derivatives Strategy | Options Not Fully Pricing in 2006 Hurricane Risks for P&C Stocks
Analyst Certification:
The respective research analysts responsible for the fundamental ratings hereby certify (1) that the views expressed in this research email accurately reflect our
personal 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 indirectly
related 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 or
issuers 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 expressed
in 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 email
accurately reflect the firm's quantitative research model (2) no part of the firm's compensation was, is or will be directly or indirectly related to the specific
recommendations or views expressed in this research report.
Important Disclosures
Lehman 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 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 to
them, 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 of
this 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 is
generated 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/disclosures
And may also be obtained by sending a written request to: LEHMAN BROTHERS CONTROL ROOM , 745 SEVENTH AVENUE, 19TH FLOOR NEW YORK, NY
10019
Mentioned Stocks
ACE Limited (ACE - USD52.51) 2-Equal weight / Positive E/J/K/L/M
Risks Which May Impede the Achievement of the Price Target: Similar to other property/casualty insurers, ACE Limited faces risks from a return to a soft
property/casualty market, catastrophes and other large losses, and rising interest rates. Risks to ACE that could impede the stock from achieving our price target
include 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/M
Risks 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 for
the stock is a return to a soft personal lines insurance market, which could cause a contraction in the stock's multiple. 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.
Chubb Corp. (CB - USD50.36) 1-Overweight / Positive J
Risks 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/casualty
market, catastrophes and other large losses, and rising interest rates. Risks to Chubb that could impede the stock from achieving our price target include adverse
prior-period loss-reserve development in areas such as its homeowners, directors and officers, and errors and omissions lines, as well as asbestos. In addition, Chubb
Financial Solutions could suffer operating losses as the company exits this business.
Montpelier Re Holdings (MRH - USD15.12) 2-Equal weight / Positive A/F/J
Risks Which May Impede the Achievement of the Price Target: The risks for MRH include the company not reserving adequately for unexpected future losses; weather
and 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 J
Risks Which May Impede the Achievement of the Price Target: The risks for RE include asbestos exposure and the company not reserving adequately for unexpected
future losses; weather and non-weather catastrophes; future terrorist acts; regulatory fines and sanctions; and prices falling faster than expected.
May 22, 2006 8

9. Equity Derivatives Strategy | Options Not Fully Pricing in 2006 Hurricane Risks for P&C Stocks
Disclosure Legend:
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Supporting documents that form the basis of the recommendations are available on request. Please note that the trade ideas within
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Our 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 other
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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).
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Stock Rating
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1-Positive - sector coverage universe fundamentals are improving.
2-Neutral - sector coverage universe fundamentals are steady, neither improving nor deteriorating.
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May 22, 2006 9

10. Equity Derivatives Strategy | Options Not Fully Pricing in 2006 Hurricane Risks for P&C Stocks
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 disclosures, is classified as a Buy rating, 32% of companies with this rating are investment
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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 are
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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 are
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