Managing Risk in Global Insurance:

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
What will I do, the meeting is tomorrow?

• How do I know
• what the Rating Agencies will think about all of
  this?

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 organizations ability to execute
  chosen strategy
• Managements expertise in operating each of the
  companys 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 companys competitive
  advantage?
• Does the companys 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 firms 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
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Standard Poors Objective
Risk management is at the heart of what Standard
Poors does. Standard Poors 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
ERM Evaluation Components
19
ERM Quality Classifications
20
Global Findings through 2006
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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
insurers 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 Poors 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 Poors can incorporate benefits of
uncorrelated risks (diversification)
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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 firms 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
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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 ManagementSP 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 sponsors 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 ILWs
• 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 ILWs 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
• Motor or 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 Poors Criteria

• Capital Model Credit for Securitisation and Risk
  Transfer
• SP increasingly willing to grant quantitative
  credit for risk transfer in ILS
• Credit can be given for non-indemnity structures
  based on SPs 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 SP 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