To Our Shareholders

MARK RAM
President and Chief Executive Officer

2007 marked another year of solid results for Northbridge. I am very proud that we have once again exceeded our goal of a 15% return on equity over the long term, achieving a 22.2% ROE in 2007 – results that could not have been achieved without the continuing dedication and hard work of each and every employee across the Northbridge family.

Even so, we are not content with the status quo. As our industry continues to evolve, shifting opportunities and challenges demand that we constantly examine our businesses and practices to ensure that Northbridge continues to be the commercial P&C insurance leader of not just today, but of tomorrow as well. Continuous improvement, one of our core values, will continue to play an important role into 2008 and beyond.

RESULTS

Over the past year, downward pressure on pricing increased across the Canadian commercial P&C industry as competitors sought to increase or preserve market share, most dramatically affecting our large complex property accounts and niche markets such as long-haul trucking. However, pricing also weakened across the small to mid-sized commercial segments (which represents the largest proportion of our business), a clear sign that the soft market is upon us. Increased commercial auto loss frequency compounded the competitive pressures in our transportation-related lines, while additional large losses impacted the exited niche lines of business at Commonwealth. On the other side of the equation, the stronger Canadian dollar reduced the impact of U.S. dollar-denominated claims reserves, providing a 4.3 percentage point favourable impact on our combined ratio, while our investment portfolio recorded substantial gains. Despite softening market conditions for the industry in general, combined ratios across our group for 2007 held up well overall, with ratios of 93.7% at Lombard, 95.2% at Markel, 77.0% at Commonwealth, and 94.1% at Federated. These results translated into a 92.3% combined ratio for the group in 2007, along with a 22.2% return on equity.

Operations in 2007

Although we had many successes in 2007, I would like to take a moment to highlight a few that are particularly notable:

• Reinsurance Program Restructuring: During 2007, we took a group approach to reinsurance and employed significant resources to analyze and restructure our reinsurance programs in anticipation of 2008 renewals. As a result of that effort, we’ve significantly simplified our reinsurance structure across the company, increasing our efficiencies, synergies and risk management controls. We’ve also deepened our relationships with highly-rated reinsurers and expect the changes we’ve made to realize meaningful cost savings, with increased protection and reduced reinsurance utilization, making Northbridge an even stronger company going forward.

• Commonwealth Re-Engineering: As I wrote at this time last year, substantial changes were underway at our Commonwealth subsidiary, including winding down the majority of our Energy and International lines, taking aggressive steps to mitigate our exposure to these segments and reduce our overall volatility. During 2007, our actions bore fruit as most in-force policies in exited business lines expired; we believe Commonwealth is now well positioned going forward.

• Rating Upgrades: In a toughening marketplace, where rating increases are rare, we are extremely proud that A.M. Best and Standard & Poor’s, the industry’s preeminent independent rating agencies, decided to upgrade the ratings of Northbridge companies in 2007. We see this as validation of our overall strategy, direction and risk management initiatives we’ve undertaken over the past few years.

• Conservative Claims Reserving: Inadequate claims reserving is the leading cause of insolvencies in our business. Although surprises will always be a part of the P&C industry, we pride ourselves on the efforts we employ in continually and conservatively managing our outstanding claims. Over the 12 years that we have owned all four of our operating subsidiaries, our claims provisions have developed favourably by 4.6% on average, a track record that we believe is one of the best in the industry.

Industry Challenges

I expect the downward momentum of the soft market in the Canadian P&C insurance industry to persist in 2008. The outlook for underwriting profitability will become progressively weaker if competition for market share continues to fuel aggressive pricing from our competitors, particularly in the small to medium-sized enterprise segment, the largest part of the Canadian commercial market. Although industry returns should move toward more historical levels, this trend could be moderated somewhat by low investment returns and continued scrutiny from regulators, independent rating agencies and shareholders.

In the large account segments, we are already seeing some unfortunate parallels with the deep price discounting of the last soft market, and are alarmed at the apparent deterioration of reserve strength at some insurers. On its own, inadequate pricing can be very dangerous in an industry where the true cost of goods sold is not known for years to come, but becomes a recipe for disaster when reserves are weak. It’s very easy to grow in our industry, but doing so profitably is a much rarer skill.

Over the next decade, I expect considerable consolidation not only of insurance companies but of distribution channels as well. Although not to the extent seen in Canadian banking and life insurance, we will nonetheless likely see considerable contraction of the currently fragmented Canadian P&C industry, where many small and mid-size insurers may ultimately be acquired or squeezed-out. On the distribution side, direct sales will see increasing market share in personal lines, while the truly independent broker channel will continue to shrink as more and more brokers are acquired by consolidators and insurance companies.

Equally important, and often overlooked, is the increasing industry-wide shortage of qualified insurance professionals. I believe our industry is simply not doing an adequate job of attracting enough of today’s sharp young minds into the business, and we could end up paying the price tomorrow.

Against this backdrop, we believe we are better positioned overall than most of our competitors to hold on to our business at proper rates in the near term. However, if and when pricing drops below adequate levels, we are prepared to let business go, as evidenced by the underwriting actions taken by Markel and Commonwealth in 2007. Over the next decade, we believe the keys to success in our consolidating industry will be superior rate adequacy and pricing segmentation, the ability to differentiate products and brands in the eyes of insureds and brokers, prudent claims reserving, and the attraction, development and retention of tomorrow’s commercial insurance leaders.

Culture of Continuous Improvement

Our achievements at Northbridge to date are a direct result of our focus on the core values we believe will continue to drive our long term success. If I had to single out one value to encompass all others, it would be our unrelenting commitment to continuous improvement. Being the leader of today does not guarantee leadership tomorrow. To truly excel over the long term, we must continuously seek out new ideas and be willing to challenge, with open minds, all aspects of how we do business.

In the P&C industry, it takes years of vision, planning and hard work to bring any major success to fruition, which means that a good management team must always be living at least five years in the future. If management is focused only on today, there may not be a pleasant tomorrow. At Northbridge, we take both the opportunities and challenges of the future very seriously. Our responsibility to build long term sustainability and value for our shareholders, brokers, reinsurers and our 1,500+ employees and their families is of paramount importance.

Our companies each enjoy many individual talents and we plan to continue to work closely together to leverage those talents across our group, in areas such as distribution and broker relations, differentiation, data analytics, product alignment, and employee training and development, to name a few. At the same time, we will continue to capitalize on Northbridge’s presence in the industry with our broker and reinsurance partners, and with our customers, rating agencies and investors. Quite simply, the road to success must always be under construction.

Although the realities of a weakening insurance market will increasingly challenge the Canadian P&C industry in the short term, I firmly believe that Northbridge’s distinct strategy and positioning will reward our stakeholders over the long term. When I look across our company, I see a team that exemplifies the focus, expertise and leadership that I believe will drive us to future success. I would like to express my sincere appreciation to everyone in our group who dedicated themselves to delivering another solid year in 2007, and to our independent brokers, insureds and reinsurance partners for their continuing support. Thank you.

Mark Ram
President and Chief Executive Officer

  • Largest Commercial P&C Writer in Canada
  • $5.5 Billion in assets
  • $1.7 Billion Premiums Written
  • 20.5% Average 5 yr ROE
  • 89% Commercial Lines
  • Canadian owned and operated
  • 4.6% Favourable Claims Development