Managing Risk in Global Insurance: A Rating Agency Perspective Rodney Clark, FSA

1. Managing Risk in Global Insurance: A Rating Agency Perspective Rodney Clark, FSA Director, Insurance Ratings Insurance Ratings Criteria Officer, North America 10 July 2007

2. Agenda • Key Insurance Ratings Drivers • Enterprise Risk Management • Economic Capital Models • Insurance Linked Securities as a Risk Management Tool • Questions and answers

3. Memo From the CEO To: Planning Group Re: Planning Process for 2008 – 2010 Here are the assignments for the Offsite Planning Retreat next month: 1. Plans for major Business Units and Investments President Jim (with BU Heads & CIO) 2. Proposals for Major Financial activitiesCFO Alicia 3. Possibilities for Major Strategic AlternativesVP Strategy Alex 4. Potential Rating ImplicationsTreasurer Kris

4. Business Unit Plans Risk/Reward of Business as Usual • Developing sustainable, profitable growth • Maintenance of margins • Establishing competitive differentiation • Degree of investment in ERM • Managing volatility

5. Financial Strategies • Capital structure – Degree of financial leverage – Degree of operational leverage • Dividend strategy • Share repurchases • New issuances • Reinsurance strategy

6. Strategic Management Decisions Great Idea! • Acquisitions • Major Change in Investment Portfolio • Entering New Market/Exiting Market • Change to Management • Organizational Restructuring • Changing Risk Tolerance

7. Key Ratings Implications “How do I know what the Rating Agencies will think about all of this? What will I do, the meeting is tomorrow?”

8. Company Ratings Drivers

9. Strategic Positioning • The planning process • The strategy • How developed & updated • Strategy consistent with organizational capabilities • Strategy that makes sense in the marketplace • Planning & compensation systems • Do they support the strategic goals of the organization?

10. Operational Skills • Evaluating an organization’s ability to execute chosen strategy • Managements’ expertise in operating each of the company’s lines of business • Adequacy of audit & control systems • IT capabilities • Organizational fit with chosen strategy

11. Financial Risk Tolerance • Specific financial goals • Predetermined limits for levels of risk it will accept • Level of leverage employed (operating & financial) • Guidelines applied to many areas of operation or just a few • Operate “on the edge” or conservatively: – Accounting, investments, controls – Risk governance – Board Of Director involvement

12. Competitive Position Key Questions • What are the sources of the company’s competitive advantage? • Does the company’s characteristics fit the strategy? • Does the company possess what it currently takes to be viable over the long run? • Does the company have the ability to generate a reasonableamount of business profitably?

13. Full Benefits of an ERM Program Once a firm’s enterprise wide risks are identified andobjectives are set, an ERM Program should… • Develop and maintain systems to periodically measure thecapital needed to support the retained risks of the company • Reflect the risk capital in: • – Strategic decision making • – Product design and pricing • – Strategic and tactical investment selection • – Financial performance evaluation The product of a fully-realized ERM Program is the optimization of enterprise risk adjusted return

14. Enterprise Risk Management

15. Standard & Poor’s Objective Risk management is at the heart of what Standard & Poor’s does. Standard & Poor’s assesses insurers’ risks and how risks are managed. Objective: Enhance ratings process by increasing our analytical focus on insurers’ risk management practices • Previously, only qualitative credit given to risk management practices and models • Ultimately, may give some quantitative recognition to risk models, but only where models are robust and underlying risk management framework is sound

16. ERM & Ratings • ERM Quality Evaluation is based on the risks of the company • Importance of ERM in the company rating is based on:- Capacity to absorb losses- Complexity of risks • A insurer with tight capital and complex risks- ERM is very important • A insurer with excess capital and ordinary risks- ERM is not as important

17. ERM Evaluation – Focus Quality of Risk Controls High ------------------------------- Low

18. Strategic Risk Management Risk & Economic Capital Models Risk Control Processes Emerging Risks Mgmt Risk Management Culture ERM Evaluation Components

19. ERM Quality Classifications

20. Global Findings through 2006

21. Insurance ERM Key Points 1. ERM is a new organizing concept– For looking at a collection of issues we have always covered 2. ERM applies to all insurers globally 3. ERM evaluation will be tailored to the risks of each insurer 4. ERM recognizes all the risk management of the insurer – Even if the company does not do “ERM”!!! 5. ERM is reflected in insurer ratings– Importance of ERM will vary among companies – just as every other factor does 6. ERM is a new section in the ratings report 7. ERM is not a new Capital Model– ERM is not primarily concerned with looking at an insurer’s Economic Capital Model Risk & Capital Risk Control Emerging RM

22. Economic Capital Models

23. Economic Capital Review For Insurers with Strong or Excellent ERM • Standard & Poor’s will develop robust processes for evaluating insurers' internal economic capital models • To be performed only for companies with effective ERM • Evaluations of economic capital will be used in conjunction with existing static, risk-based measures • Dynamic approach will enhance our existing and prospective view of capital adequacy Standard & Poor’s can incorporate benefits of uncorrelated risks (diversification)

24. Evaluating Economic Capital Models Process for Evaluation: • Framework of assumptions to review- For each risk- Establish a range for each assumption to be stressed • Remote events analyzed, using realistic disaster scenario analysis/tail event stress analysis • Model mechanics reviewed and standardized, where possible • Testing procedures employed- To evaluate the consistency of one firm’s model output for a given set of data with that of its peers Findings will be incorporated into the companies’ ratings

25. An Economic Capital Model & Strategic Risk Management How an economic capital model supports strategic risk management: • Consistent view across all risks • Capability to assess trade-offs between different risk types • Assessment of risk adjusted returns • Capital budgeting • Strategic investment allocation Strategic Risk Management Risk and Economic Capital Models Objective: To Optimize Risk-adjusted Returns An Economic Capital Model is One Tool to Support that Objective

26. Economic Capital Models Major Review Considerations: 1. Risk Quantum 2. General level of risks 3. Company specific variations in level of risks. 4. Company specific exposures & offsets 5. Diversification effects 6. Model robustness 7. Model execution • Model usage – specific • Stress Tests

27. Economic Capital Model Criteria Development Timeline • Request For Comment Released to Market. Discussion focused on the major ECM review considerations – January 2007 • Receive feedback from industry – March 2007 • Conduct small number of initial reviews/discussions with volunteer insurers – Second Quarter 2007 • Release preliminary draft of final review criteria for comments – Summer 2007 • Receive feedback from industry – Late Summer / Fall 2007 • Publish final ECM review criteria and process – Fall 2007 • Perform ECM reviews – Fourth Quarter 2007

28. Strategic Risk ManagementS&P Ratings Criteria: • View across all risks to make decisions about optimizing risk-adjusted returns • Capability to assess trade-offs between different risk types • Capital budgeting • Strategic investment allocation Strategic Risk Management is the UPSIDE of Risk Management, providing the tools to maximize the risk/return relationship.

29. Insurance-Linked Securitizations as a Risk Management Tool

30. Driving Forces Behind Insurance-Linked Securitisations Natural Catastrophes Competition IFRS Insurance Industry: • Capital intensive industry • Pressures from regulators, rating agenciesand shareholders • Threat of costly catastrophes Cost of Capital Higher Cost of Claims Solvency II Pandemics Capital Markets today: • Appetite for high yielding assets classes • Desire for diversification • Role of hedge funds and private equity and other sophisticated investors

31. Issuer Motivations • Risk Transfer • Property catastrophe risks • Extreme level of casualty risks • Extreme mortality risks • Credit & surety risks • Motor insurance risks • Capital Raising • Closed blocks • Releasing embedded value (monetising VIF) • Reserve Funding • XXX and AXXX reserve requirements for U.S. domiciled life insurers • Pricing Arbitrage • Investor-owned life insurance (e.g. Life Insurance vs. Annuity arbitrage notes transactions in the US)

32. Rated Securitisations & selected Capital Solutions

33. Rated Transactions by Region* and Year of Issue US$ m * By domicile of sponsor

34. Rated transactions by Type and Year of Issue US$ m

35. Rating Methodology – Issue Rating • Insurance Considerations • Underwriting, claims and risk management processes • Premium and persistency patterns • Mortality, morbidity, lapsation, interest rate sensitivities • Development of stress tests to analyze the vulnerabilities of the insurance blocks being securitized • Structural and Legal Analyses • Structured Finance criteria regarding: • Special purpose entity • Indenture trustee and accounts • Priority of funds/ flow of funds/ events of default • Swaps – No termination for non-credit related events • Legal opinions on authority, enforceability of agreements, security interest and taxation • Ratings of cedants, swap counterparties, guarantors • Servicer evaluations • Review of investment criteria

36. Rating Methodology – Issuer Rating • Rating Impact • Additional funding sources can enhance financial flexibility • Give qualitative credit under relevant rating factors • Aim to understand the economic benefit of transaction • Quantitative credit possible • Analytical Team • Ensure consistency between criteria used and rating assigned • Joint rating analysis – Structured Finance and Insurance analysts • Involve sponsor’s primary rating analyst • Able to draw on further expertise where required • Actuarial • Legal • Accounting

37. Identify Changing Trends • Property catastrophe bonds • Increased use of parametric and indexed bonds - investor preference • Expansion of geographic location and type of risk exposures – e.g. Australian typhoon and quake, U.K. flood, U.S. tornado • Issues typically linked to single events and rated in the ‘BB’ range, though third event notes can be rated ‘A+’ and fifth event notes rated ‘AA’ – e.g. Bay Haven • Motor securitizations • Increased market interest but quality and volume of data remains an issue • Indicative rating on first multi-portfolio motor securitisation • High frequency/low severity nature of risk allow rating up to ‘AAA’ • Reinsurance recoverables • Rated first synthetic transaction • Securitisation of asset remains difficult • Common to all new risks being securitized • “Novelty” premium demanded by investors; mitigated if wrapped

38. New Cat Bond Structures • Bay Haven Limited • Covers worldwide perils • Series of ILW’s • Parametric and Index triggers • Senior Class rated ‘AA’ – first CAT bond to be rated at this level • Gamut Reinsurance Limited • Covers worldwide perils • Insurer can – write ILW’s and traditional reinsurance, purchase cat bonds in the market • Combine cat bond and CDO criteria • Reliance on collateral manager, Nephila Capital Ltd. • Senior class rated ‘A-’

39. European Developments • Regulatory pressures • Insurance Groups and Financial Groups solvency directives • Consolidated group picture of solvency • Eliminate any capital relief for senior debt down-streamed as equity • Solvency I • Phase out traditional forms of qualifying capital by 2009 (implicit items, financial reinsurance) • New funding sources required • Hybrid debt: Limited source • Securitisation: Tax-deductible core Tier I capital • UK: developing framework for securitisation • Embedded Value and Premium securitisations • Rest of Europe to follow with or before Solvency II

40. Securitizations Likely To Increase • New asset classes and structures will emerge • Natural catastrophe • Aim to increase liquidity in market – introduction of traded indices • More complex structures • Longevity • Great demand in market to transfer risk • High expectation to find capital market solution • Completion of private transactions to date • Reinsurance capacity increasing • Motoror other property insurance classes • Capital markets alternative to reinsurance • Driven by protection of earnings rather than capital • Increased tranching of the risk • More unwrapped transactions Investor appetite for these transactions will likely exceed supply

41. Evolving Standard & Poor’s Criteria • Capital Model Credit for Securitisation and Risk Transfer • S&P increasingly willing to grant quantitative credit for risk transfer in ILS • Credit can be given for non-indemnity structures based on S&P’s understanding of the economic benefits of a transactions and if basis risk can be adequately modeled • New capital model presents increased opportunity to reflect risk transfer • Further opportunity for qualitative credit in Capitalisation and Financial Flexibility analysis • More credit likely under ERM analysis of Economic Capital Models for insurers assessed by S&P as ‘Strong’ or ‘Excellent’

42. Managing Risk in Global Insurance: A Rating Agency Perspective Rodney Clark, FSA Director, Insurance Ratings Insurance Ratings Criteria Officer, North America 10 July 2007