Risk Securitization vs. Traditional Reinsurance

1. Patrick Sullivan Vice President Marsh & McLennan Securities Corp. Risk Securitization vs. Traditional Reinsurance Gary Prestia Senior Vice President, Property Zurich Re (North America) October 23, 1998

2. Agenda • Insurance and the Financial Markets • Convergence of insurance/reinsurance and financial markets • Narrowing the many choices available (traditional reinsurance, CBOT, contingent surplus notes, CATEX, BCOE) • Complimentary solutions of traditional reinsurance and securitizations • Case Study • Company profile of product lines, geographic spread and loss experience • Catastrophe modeling analysis based on 5 digit zip unicede information. Discussion of expected loss curve profile • Traditional and Non-Traditional Solutions

3. Key Risk Problem with Case Study • Primarly Exposed to Texas Gulf • Possibility of loss from very large, but very rare event • Is single-year insurance the best choice? • Price stability over time • Capacity stability over time • Credit risk of counterparties

4. Risk ProfileCatastrophe Protection Analysis Est Dollar Loss Return Period Year Limits (in millions) 1250 1.22 b 250 1.13 b 200 980 m 150 912 m 100 541 m 50 50 1998

5. Possible Solutions Options Reason Quota Share Surplus relief & ground-up risk & cat loss sharing Aggregate Excess of Loss Reduce frequency of losses Catastrophe Excess Reduce moderate to severe cat of loss losses Top end catastrophe coverage in form of Cat Bond Securitization or Contingent Surplus Note Reduce severe cat loss activity

6. Traditional Reinsurance SolutionCatastrophe Protection Analysis Est Dollar Loss Return Period Year Limits (in millions) 1250 1.22 b 250 Traditional Cat Reinsurance $1b xs $250m (3 layers) 1.13 b 200 980 m 150 912 m 100 541 m 50 250 250 m 20 50% QS Aggregate Catastrophe $65m xs $60m Franchise Deductible - $30m 1998 50% Net Retention

7. Traditional Reinsurance • Advantages • Traditional solution, easy to understand and explain. Accustomed to traditional approaches • Less complicated, generally more quickly accomplished • When supply is plentiful, pricing/terms will be very attractive • Known regulatory and accounting treatment • Broad coverage (WC, ECO/XPL, reinstatement) • Historical track record and known entities. Longevity of commitment by professional reinsurers to the insurance marketplace • Disadvantages • Credit quality • May not be best solution for sophisticated/complex or large risks • Market cycles • When demand exceeds supply, pricing/terms may be unattractive • Limited size of reinsurance market capacity

8. Risk Profile and Capital Markets SolutionsObjectives • Integrate with other risk management methods, e.g. insurance, mitigation • Capacity (size and new sources) • Cost effective • Credit quality • Stability over time

9. Forms of Insurance Securitization • Exchange-traded derivative contracts • Over-the-counter derivatives (swaps) • Catastrophe bonds

10. Exchange Traded Derivative Contracts Contracts - Exchange Traded • Key considerations • Exchange volumes: (6/1-10/15 at risk) • CBOT: $10.8 mm • BCOE: $12.5 mm • Basis risk • Credit quality • Open price discovery

11. Collateral or Guarantee Premium Cedent Swap Counterparty Premium Insurance Swap SwapBasic Structure Insurance Transformer

12. Swap Counterparty Highly Rated Short-term Investments in trust Investment Income LIBOR Remaining Funds Investors $’s LIBOR Premium at maturity & liquidation Insurance Premiums Insured Investors Interest Payments Insurance Par Amount Catastrophe BondsBasic Structure SPV

13. SummaryStructures and Issues Cat Bond USAA Trinity Re Parametric Re Issues Higher cost No credit risk No investor leverage Larger investor group Swap vs. Mitsui XL Mid Ocean Issues Credit risk Enforceability More flexible Provides potential leverage for investor More limited investor group

14. SummaryStructures and Issues UNL-linked vs. USAA Trinity Re XL Mid Ocean Issues Heavy disclosure Custom hedge Investor concerns • Index-linked • Parametric • SR Earthquake Fund • Mitsui • Issues • Little disclosure • Basis risk • Indexes • Attractive to investors

15. Basis Risk/Transparency Tradeoff Event Parameter Standard Index Custom Index Transparency Reference Loss Ult. Net Loss Basis Risk

16. SummaryStructures and Issues • Single year vs. • Cost of issuance • Expense • Time • Multi-year • Changing exposure profile • Reset mechanisms • Amortize cost of issuance • Lock in price and capacity

17. Capital Markets SolutionRecommended Structure • Bond or Swap • large capacity • regulatory issues • High-level attachment • Maximize investor pool • Competes most effectively with insurance • Risk metric: actual loss • Index not appropriate

18. Capital Markets SolutionRecommended Structure (cont.) • Term: multiple years • Price and capacity stabilized • Transaction costs minimized • Expected loss value for bond held constant • Annual modeled resets • Model version held in escrow at inception • Price stays constant

19. Capital Markets SolutionCatastrophe Protection Analysis Est Dollar Loss Return Period Year Limits (in millions) 10 % Co 1250 Capital Markets Solution 1.22 b 250 1.13 b 200 980 m 150 912 m 100 Traditional Cat Reinsurance $650m xs $250m (3 layers) 541 m 50 250 250 m 20 50% QS Aggregate Catastrophe $65m xs $60m Franchise Deductible - $30m 1998 50% Net Retention

20. Capital Markets SolutionStructure highlights (cont.) • Integrated with insurance program • Insurance program designed to change with reset • Co-participation • Issued through an offshore SPV • Tax deductible insurance premium • Funds held in trust • Not issued directly as corporate debt

21. Capital Markets SolutionBenefits of this Structure • Simple • Maximizes investor interest • Cost • Cost effective • Multi-year amortizes cost over time • Reduced management time

22. Securitization GeneralAdvantages • High credit quality • Integrates well with insurance structure • Low correlation - attractive investment • Huge potential capacity • No insurance market cycles • Pricing driven by exposure analysis • Intangible benefits

23. SecuritizationGeneralDisadvantages • Untested market – no loyalty • Costs - size constraints • Often complicated structure • Effect of market turmoil? • Statutory accounting and regulatory issues

24. Conclusions • No single right answer - a myriad of choices available today that should be explored • Search for the best fit based on your needs, risk appetite and ability to afford reinsurance • Complimentary solution of a mix of traditional reinsurance and risk securitization

25. Marsh & McLennan Securities CorpWho we are • An investment bank focused on the insurance industry and insurance related risk transfer products • Primary lines of business • Corporate Finance Advisory • Capital Markets • NASD Licensed Broker - Dealer

26. Zurich Financial Services Group Who we are • Zurich Reinsurance (North America) Inc., with $809 million of Statutory Surplus (as of 12/31/97), is the North American Reinsurance arm of Zurich Financial Services, a global financial services company. We are rated “A” by A.M. Best • Within ZRNA, traditional property/casualty reinsurance is written, and through the Centre Re Division we write non-traditional and financial products • ZRNA Treaty Property Division is a leading reinsurer in Property Catastrophe, Specialty Property Lines and weather related products

27. This information was prepared by Marsh McLennan Securities Corp. (MMSC) & Zurich Re for use in marketing presentations. It is intended for the exclusive use of the recipients and not for dissemination. Information contained herein is believed to be reliable, but MMSC & Zurich Re do not warrant its completeness or accuracy. Opinions and estimates constitute our judgment and are subject to change without notice. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. MMSC & Zurich Re may have a business relationship with any of the companies described herein.