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Preliminary 2008 Financial Results

2008 was a very tough year for AEGIS. The unprecedented crisis of the financial markets only deepened since our last mass email where we reported our results through September of last year. We just reviewed our preliminary unaudited financial results for all of 2008 with our Board of Directors. We would now like to share these results and plans with you, our member/owners.

Since September 30, the deteriorating capital markets caused our total return on investments to decrease by another -3.6%, producing a total pretax return for the year of -7.52% (-$296 million). Having concluded our preliminary discussions with our internal and two independent actuaries (Towers Perrin and Deloitte & Touche), we estimate our overall combined loss and expense ratio for the year to be approximately 120%, producing a pretax underwriting loss of $178 million. This worse than expected level is due to the larger than anticipated 2008 losses in excess liability and property. As a result, surplus will decrease during 2008 from $1,081 million to approximately $750 million after taking into account the fair valuing of our workers' compensation reserves as AEGIS elected in 2007.

Obviously, AEGIS is not alone among property/casualty insurers affected by the crisis. According to recent estimates by some industry observers, the property/casualty industry overall will show a loss of approximately 15-20% of its surplus in 2008 due to poor investment performance as well as its difficult loss experience. AEGIS has experienced a somewhat larger drop in surplus because our 25% allocation to equities was about twice the industry average. For the past thirteen years, this allocation had proven superior to those of the large majority of insurers and was more consistent with our goal of a long-term total return investment strategy commensurate with our long-term mutual underwriting philosophy. At this time, however, we do not believe accepting further equity asset volatility is prudent.

In addition to the capital market's meltdown, 2008 will go down in history as the fourth worst year in the last 20 for catastrophic losses. These losses hit our members particularly hard. After estimated reinsurance recoveries, AEGIS suffered approximately $50 million in losses from Hurricane Ike, $20 million from the Midwest floods and $100 million from California wildfires, which, as you know, are now being blamed on some of your fellow members.

Nonetheless, AEGIS has emerged from 2008 ready to continue to fulfill its mission for you in 2009. We have also taken several steps to reduce stress on our surplus going forward. First, as we discussed in our previous letter, we have reduced our equity and high yield bond allocations to further decrease volatility from capital market gyrations and provide a foundation for asset preservation and measured growth. In addition, our Investment Committee and Board of Directors recently approved our recommended allocation for 2009 to 93% fixed income and 7% in fund of funds, which traditionally have not been as volatile as pure equity holdings.

Second, although we believe we are prudently reserved, at year-end we purchased a substantial adverse development reinsurance program designed to reduce potential volatility in our previously incurred reserves, and improve the rating agencies' views of our capital adequacy. As you may know, potential reserve volatility is one of the prime factors in the agencies' capital models.

Third, we will reduce our overall premium revenues by $50 million by cutting back our participation in our alliance with Liberty Mutual. In addition, we plan to write about $50 million less in our Lloyd's operation, although this reduction will largely be non-member related. These actions will decrease the capital required to write this business while allowing us to continue to provide these products to you.

Fourth, we have expanded our reinsurance program for 2009 to further reduce loss volatility and capital stress on our ongoing business. In particular, we have purchased additional reinsurance coverage in our $10 x 25 million layer which has been particularly volatile in recent years. We will, however, continue to focus on top line underwriting with a continuation of our practice not to allow reinsurers to dictate our underwriting strategy.

What do we expect in 2009? Based on current interest rate levels and forecasts from our external and internal investment managers, we expect investment returns to be less than 5% during 2009. With less investment return to fall back on, we will have to be sure that we collect enough premiums to produce positive overall results.

As you know, for the past several years we have been pressing for increases in premium to more adequately reflect the way the losses of the energy industry have been evolving, particularly in excess liability. For the past three years, our excess liability loss ratios have been 135%, 170% and 177%. This is the major reason our overall combined ratio for 2007 was 110%, and for 2008 is approximately 120%. Obviously, overall premiums will have to increase to fund losses. In some cases, a change in the terms of coverage will also be necessary, for example, to control wildfire exposures. Based on our underwriting renewals with you since November of last year, we are happy to report that our members and brokers have been very understanding of the need for these actions and have been able to support these increases despite your own difficult budgetary constraints. So far, nearly every member has renewed its excess liability program with AEGIS.

We trust that all of our members will embrace these strategies to repair the financial damage of the past year. As always, we will not promote across-the-board rate increases. We will underwrite each account individually according to the characteristics that make up each member's unique risk profile. We will contact each of you early in the renewal process to discuss the specifics.

Lastly, I would like to comment on continuity credits. As you know, our continuity credits are based on an annual renewal cycle, beginning each July. Your Board of Directors will consider our recommendation for a continuity credit declaration in April. Based on the preliminary 2008 financials discussed above, we believe that it will be prudent for continuity credits to be substantially reduced if not entirely suspended for this year. A successful 2009 should allow us to resume declarations of credits in 2010. Management of our continuity credits is, of course, one of our primary tools to preserve and restore surplus for the long-term benefit of the Company and our member/owners. Our willingness to adjust the continuity credits according to our financial results is always considered by our rating agencies in their evaluation of our business plans. We have begun our annual dialogue with both the Fitch and A. M. Best rating agencies and we will, of course, advise you of the results of their review in due course.

AEGIS has had a number of financial ups and downs over the past 34 years: some related to losses, some to investments – this year due to both. But with your constant support, we always have emerged thriving and growing. I am confident that we will do this yet again in 2009. I am very encouraged by the numerous expressions of support many of you have offered for AEGIS to take whatever steps are necessary to preserve the Company you have grown so that it can continue to be the cornerstone of your insurance programs. As always, we will balance the inflows of our premium revenues and investment returns against the outflows of our losses, expenses and continuity credits to achieve a positive equilibrium. And we promise to do this fairly across the membership.

I look forward to working with all of you in 2009 as together we manage your risk management needs, and those of AEGIS.

Sincerely,

Alan J. Maguire
President & CEO