Finite Risk in 2003 ...It Isn’t 1998 Anymore

1. Finite Risk in 2003...It Isn’t 1998 Anymore Edward S. Hochberg, CPA, CPCU Mark Callahan, FCAS, MAAA David Koegel, ACAS, MAAA

2. Finite Risk in 2003 Edward S. Hochberg - SVP Pegasus Advisors PMA Re, Deloitte&Touche Mark Callahan - SVP XL Re M&R, Scruggs David Koegel - SVP Enterprise/Imagine Deloitte&Touche, Gil&Roeser, Am Re, AIG, ISO

3. Finite Risk in 2003 Topics to be covered: • Finite Risk Market Overview • The Buyer’s Perspective • The Seller’s Perspective • Example Transactions

4. Finite Risk in 2003Market Overview • Underwriting environment-traditional • Underwriting environment-finite • Interest rate environment • Accounting and disclosure issues…post-Enron

5. The world in 1998… VERY soft pricing and terms No lack of capacity Virtually anything could get done at attractive (buying) pricing and terms The world in 2003… Market much harder post 9/11 While there is often ample capacity, it comes at high (often unattractive) prices Difficult to get coverage for certain lines, classes, and exposures Finite Risk in 2003Market Overview-Traditional Environment

6. The world in 1998… VERY soft pricing and terms No lack of capacity Virtually anything could get done at attractive (buying) pricing and terms-everything had a price Adverse selection and risk aggregation Many active market participants Reputation risk rarely considered Finite Risk in 2003Market Overview-Finite Environment • The world in 2003… • Market much harder post 9/11…pricing and terms • Several very active markets have exited the business (e.g. Stockton, Scandinavian, OPL, Commercial Risk) • Not everything has a price • Market much more intelligent about risk aggregation, credit risk, and other exposures • Reputation risk considered

7. The world in 1998… The 10-year US Treasury was 5.80% (4/28/98) Time value of money was a significant/dominant component of many finite risk transactions Finite Risk in 2003Market Overview-Interest Rate Environment • The world in 2003… • The 10-year US Treasury was 3.90% (4/28/03) • Significantly changes the economics of many finite risk transactions…much less reliance on time value of money

8. The world in 1998… “Enron” had not yet occurred Relatively few scandals involving reinsurance Relatively less stringent focus on application of reinsurance accounting standards Less focus from rating agencies and analysts Finite Risk in 2003Market Overview-Accounting and Disclosure • The world in 2003… • Post-Enron…Sarbanes-enough said • Scandals/Insolvencies: Independent, HIH, PHICO, Reciprocal Group • Very stringent application of accounting standards and auditing thereof; specific focus on accrual issues and quota share reinsurance • Analysts and rating agencies increased focus…end of “in-the-money” transactions

9. The world in 1998…Buyer Motivation Discounting of losses Spreading of catastrophe losses Y2K Unusual exposures…e.g. credit, “integrated risk”, etc. The world in 1998…Product Expectations Inexpensive, with loose terms, plenty of capacity Lack of attention to credit risk and other issues Relatively few accounting issues Finite Risk in 2003Buyer Perspective

10. The world of buying finite risk in 2003 Accounting issues More scrutiny—rating agencies, analysts, auditors More expensive—stricter terms and conditions Less benefit from time value of money WHY IS DEMAND INCREASING? Finite Risk in 2003Buyer Perspective

11. Increase in Demand The main reason finite risk is used (reconciliation of accounting models to underlying economics still exists) Better underwriting environment is pressuring leverage limits for many companies Significant increases in cost for many classes of traditional reinsurance are making finite risk structures a cost-effective solution for many companies (e.g. workers’ compensation, medical malpractice) May be the only cost-effective way to deal with certain exposures (e.g. terrorism, mold, others) Finite Risk in 2003Buyer Perspective