A Changing “World” of Risk Presented to American Risk and Insurance

1. 7 August 2007 A Changing “World” of RiskPresented to American Risk and Insurance Joan Lamm-Tennant, PhD Global Chief Economist and Risk Strategist Guy Carpenter

2. Changing “World” of Risk • Drivers of Change • Seeing the Landscape • Focusing on the Totality of Risk • Linking Risk to Capital Management • Varying Strategies

3. Changing “World” of RiskDrivers of Change • Recent Shock to Capital • And awareness of new risks • Scrutiny of Corporate America • And new regulatory/rating agency hurdles • New code of behavior • New role of governance • Awakening the Capital Markets to Insurable Risk • Is it the last horizon? • Has pricing adjusted to whet the appetite of the titans? • Is it about diversification of risk?

4. Changing “World” of RiskSeeing the Landscape • Holistic or Enterprise Models of Risk • And products/strategies for managing enterprise risk • Linking Risk Management to Capital Management • Capital Adequacy • Capital Allocation • Capital Structure

5. Duration/Maturity Credit Asset Class Proxies C O R R E L A T E D EC ON O M I C FACTORSs Correlated Loss Events Frequency and Severity Distributions Reserve Adjustments Severity Distributions Reinsurance Default Credit Ratings Recoveries Seeing the LandscapeEnterprise Risk Models T I M E L I N E S I M U L A T I O N Enterprise Risk/Return Economic Capital Catastrophe Event Tables Aggregated Losses Aggregated Losses Operational Risk Event Tables

6. Framing Reinsurance In “ERM” Vernacular

7. Framing Reinsurance In “Earnings” Vernacular Net Income – All Lines XYZ’s Expected Net Income

8. $3M Cat $2.5M Cat $2M Cat $3M Cat $2.5M Cat $3M Cat $2M Cat $2.5M Cat $2M Cat $3M Cat $2.5M Cat $2M Cat Framing Reinsurance In “Capital” Vernacular Return / Risk Profile Economic Capital Released vs. Capital-at-Risk $8,500 $300K Treaty$25,000,000 xs $10,000,000 $8,300 $8,100 $200,000 Treaty $25,000,000 xs $10,000,000 $7,900 $7,700 $300,000 Treaty Aggregate Economic Capital Released (Return) $7,500 $7,300 $200,000 Treaty Aggregate $7,100 $6,900 $6,700 $6,500 ($4,800) ($5,000) ($5,200) ($5,400) ($5,600) ($5,800) ($6,000) ($6,200) ($6,400) Capital-at-Risk CaR (5%) (Risk)

9. Capital Structure Reinsurance, Debt, Equity… Capital Allocation Pricing Risk-Adjusted Returns Capital Adequacy Economic Capital Risk Tolerance Risk Aggregation ERM Models Risk Modeling Asset Volatility Catastrophe Models Reserve Volatility Frequency / Severity Seeing the LandscapeLinking Risk Management to Capital Management

10. Seeing the LandscapeLinking ERM to Capital Management • Manage the Adequacy of Capital • How much capital does the firm require? • Too much capital will lower the ROEs … too little capital will increase the cost of capital and impose frictional costs of regulation • Maximize Return on Capital • Allocate capital to drive growth in lines yielding the highest return on risk-adjusted capital • RORAC, return on risk-adjusted capital • Often referred to as RAROC, risk-adjusted return on capital • Minimize the Cost of Capital • Achieve the optimal capital structure … balance the various sources of capital • Innovations in sources of capital • Surplus Notes, Catastrophe Bonds, Side Cars, ILWs, And more EVA: ROC – Cost of Capital

11. Changing “World” of RiskVarying Strategies • Reframing products • From Reinsurance to Contingent Capital • Repositioning expertise • From Broking to Capital Advisors with Transactional Excellence • Focus in on Economic Value Creation

12. Conclusion Change is Both Behavioral and Empirical

13. Re

14. Catastrophe Bond ConsiderationsMarket Update • 2007 has already set a new record in terms of risk capital issued • 19 transactions • $5.1 billion of risk capital placed • Nine first time sponsors • Balance of the year expected to be active with more deals involving Euro wind than in the first half of the year

15. Catastrophe Bond Market – Primary Pricing Experience U.S. Wind Peril, May 2006 – Present, Exp. Loss < 3.0%