State Farm Insurance CompaniesState Farm Insurance Companies

Agenda

• State Farm Overview

• State Farm Investment Department

• State Farm Fixed Income

State Farm Overview

Company Evolution

George J. Mecherle

Auto Health

Life Fire

SF Bank &Mutual Funds

“About State Farm”

State Farm’s mission is to: •help people manage the risks of everyday life,

•recover from the unexpected, •and realize their dreams.

State Farm Data

• 23 Affiliated Companies• 16,900 Agents• 68,000 Employees• 76.2 Million Policies & Accounts• $ 59.2 Billion Revenue (12/31/05)• $159.7 Billion in Assets (12/31/05)• $ 50.2 Billion Net Worth (12/31/05)• Ranked #22 within Fortune 500 • Ranked #1 in Illinois

Industry Positions

• #1 U.S. Auto insurer since 1942• 17.7% Market Share at end of 2005• Over 40 million Auto policies

• #1 U.S. Home insurer since 1964• 22.2% Market Share at end of 2005• Over 25 million Fire policies

•SF Bank•$12.2 billion in total assets (12/2005)•Top 5% of banks nationwide

•Mutual Funds•$2.8 billion in assets (12/2005)

State Farm Investment Department

Investment Department Invested Assets* ($ Billions)

Cash & equivalent xxx

Bonds xxx

Stocks xxx

Mortgages & Real Estate xxx

Total $ xxx

* (12/31/2006)

Why does State Farm have an Investment Department?

• Amount of “float” the business generates– Premiums – Reserves

• Cost of the float – Claims – Operating expenses

• Long-term outlook for both these factors – Write more policies

Property/Casualty Company Change in Adjusted Surplus

Underwriting Losses including Policyholders’ Dividends (25.0) %

Stock Portfolio Appreciation 30.0 %

Net Investment Income 55.0 %

Other (3.0) %

Net Increase to Surplus 57.0 %

Example: XYZ Property Casualty Company (5-year period)

Structure Investment Policy to Withstand Worse Case Scenario

• Major underwriting losses

• Discovery of gross underestimation of cost of unpaid claims

• Collapse in stock and long-term bond prices

Insurance Company Financial Adequacy Ratios

• Premiums / surplus – tests adequacy of capital to prolonged poor underwriting results

• Loss reserves / surplus – tests potential for estimation error relative to capital

• Equities / surplus – tests potential for stock market declines to reduce capital

State Farm’s Top 10 Catastrophe Pay-outs (Auto & Fire Combined)

Investment Department Goals

• Support insurance & financial service operations

• Invest long-term

Support Insurance and Financial Service Operations

• State Farm Companies are first and foremost insurance companies with growing financial service operations

• Make investment decisions for investment reasons first

Long Term Investing

Long-term investors have earned higher returns over the years from equity investments versus any other asset class

Equities: Goal: Maximize shareholder value Return: Potentially unlimited

Fixed Income: Goal: Capital preservation Return: Generally limited to coupon or yield

Risk vs. Return, 1926 – 2005 (nominal returns)

Asset Class

Compound

Return %

Holding

Period

Simple

Average Max Min Range

Small

Company

Stocks

12.6

5

10

20

13.7

14.2

14.7

45.9

30.4

21.1

-27.5

-5.7

5.7

73.4

36.1

15.4

Large

Company

Stocks

10.4

5

10

20

10.5

11.2

11.4

28.6

20.0

17.9

-12.5

-0.9

3.1

41.0

21.0

14.8

Long-Term

Corporate

Bonds

5.9

5

10

20

6.0

5.9

5.5

22.5

16.3

12.1

-2.2

1.0

1.3

24.7

15.3

10.8

Long-Term

Government

Bonds

5.5

5

10

20

5.5

5.4

5.1

21.6

15.6

12.1

-2.1

-0.1

0.7

23.8

15.6

11.4

Treasury

Bills 3.7

5

10

20

3.8

3.9

4.0

11.1

9.2

7.7

0.1

0.1

0.4

11.0

9.0

7.3

Consumer

Price

Index

3.0

5

10

20

3.2

3.5

3.8

10.1

8.7

6.4

-5.4

-2.6

0.1

15.5

11.2

6.3

Data Source: Stocks, Bonds, Bills and Inflation 2006 Yearbook, Ibbotson Associates, Inc., Chicago, Illinois

State Farm Fixed Income

Global Major Marketsmarket value of invested assets

$ 43.6 trillion

$ 58.4 trillion

Stocks Bonds

Corporate Bonds

$ 6.7 trillion

$ 17.0 trillion

$ 24.1 trillion

Stocks, U.S. Bonds, U.S.

Corporate Bonds

$ 3.1 trillion

U.S. Major Marketsmarket value of invested assets

Major Market Indices

• $ 13.1 trillion market value

• Capitalization-weighted Index

S&P 500 Index stocks

Lehman Aggregate Index bonds

• 994 issuers• 7,158 issues• $ 8.8 trillion par outstanding• Asset Classes

– U.S. Government (35.7%)• Treasury bonds• Agencies

– Corporate Bonds (23.1%) – Mortgage-Backed (35.1%)– Asset-Backed (1.2%)– Commercial Mortgage-Backed

(5.0%) – Taxable Municipals

(new as of Oct. 1, 2003)

Bonds* – 12/31/2006

U.S. Treasuries

Other U.S.-Government-Backed

Agencies

Mortgage-Backed Securities

Asset-Backed Securities

Corporate Bonds

Canadian Pay Bonds

Taxable Municipal Bonds

Municipal Bonds (Tax-Advantaged)

Community Investments

Total

* Insurance Company Portfolios

State Farm Investment Philosophies and Disciplines:

• Buy and Hold

• Dollar-Cost Average

• Portfolio Ladder

• Duration Target

Corporate Bonds

• Private vs. Public

• Analyzing and investing in corporate bonds

• Pricing corporate bonds

Fundamental Credit Analysis

• Industry Analysis – Porter’s 5 Forces

• Business Risk Analysis

• Financial Risk Analysis

Porter’s Five Forces of Competition

• Barriers to Entry

• Threat of Substitute Products

• Power of Suppliers

• Power of Buyers

• Rivalry among Existing Competitors

Source: Michael Porter, Competitive Strategy

Business Risk Analysis

• Industry Characteristics

• Competitive Position

• Management

Financial Risk Analysis

• Financial Characteristics

• Financial Policy

• Profitability

• Capital Structure

• Cash Flow Protection

• Financial Flexibility

Common Financial Ratios

• EBIT / Interest – tests the adequacy of operations to meet interest payments

• CA / CL – tests liquidity• Debt / Cap – tests leverage (loan to

value)• Funds from Operations / Debt – tests

cash flow adequacy to repay debt

Idiosyncratic

Risk

Systematic Credit

Risk

Yield Curve

T-Bill

Credit Spread

Risk-Free Rate

{{

= Yield

Corporate Bond Pricing

Why can’t I find a quote for Duke Energy bonds –

herein lies the answer:

Trace Data:

This is how we keep track of bond prices:

Example of 10-Year AT&T bond yield:

Idiosyncratic

Risk

Systematic Credit

Risk *

Yield Curve

T-Bill

10-year Credit Spread

10-yr Risk-Free Rate

{

{ = Yield7.40%

1.70 %

0.70 %

3.00 %

2.00 %

2.40 %

5.00 %

* Swap Spreads or Agencies

Example of 10-Year AT&T bond prices:

• 6% coupon 10-year AT&T corporate bond trading at a yield of 7.4% = $90.23 (discount)

• 8% coupon 10-year AT&T corporate bond trading at a yield of 7.4% = $104.19 (premium)

The coupons are different but both bonds trade at the same yield, 7.4%.

Example of 10-Year AT&T bond bid/ask yields:

Bid (yield at which you can sell)

Assume 10-Year Treasury is 5.00%

2.45%

Yield on Bid Side 7.45%

Offer (yield at which you can buy)

Assume 10-Year Treasury is 5.00%

2.40%

Yield on Offer Side 7.40%

Remember from finance class – bond prices and yields are inversely related – a lower yield means a higher price.

Think of bid/ask spread for stocks. You have to buy at a higher price than you can sell. The same holds true for bonds.

Investing in a New Public Corporate Bond Issue

New deal isannounced

Perform fundamental credit analysis

Road shows, Conference calls, Red-herring prospectus

Price guidance Determine relative value

Submit order

Deal goes “subject”

Receive allocation and final spread

Price the deal, bill & deliver

Questions?

Contact Information

State Farm Insurance

Human Resources

Three State Farm Plaza South, K-1

Bloomington, IL 61791

Need more information? Visit our website!

www.statefarm.com

E-mail: jobopps.corpsouth@statefarm.com