Banking, Insurance and Reinsurance: The Market for Risk Transfer

Karlsruhe, 11 December 2002, Dirk Lohmann

© Converium Banking, Insurance and Reinsurance: The Market for Risk Transfer

Important Disclaimer

December 11, 2002 Page 1

Although all reasonable care has been taken to ensure the facts stated herein are accurate and that the opinions contained herein are fair and reasonable, this document is selective in nature and is intended to provide an introduction to, and overview of, the business of Converium. Where any information and statistics are quoted from any external source, such information or statistics should not be interpreted as having been adopted or endorsed by Converium as being accurate. Neither Converium nor any of its directors, officers, employees and advisors nor any other person shall have any liability whatsoever for loss howsoever arising, directly or indirectly, from any use of this presentation. This document contains forward looking statements as defined in the U.S. Private Securities Litigation Reform Act of 1995. It contains forward looking statements and information relating to the Company's financial condition, results of operations, business, strategy and plans, based on currently available information. These statements are often, but not always, made through the use of words or phrases such as 'expects', 'should continue', 'believes', 'anticipates', 'estimated' and 'intends'. The specific forward looking statements cover, among other matters, the improving reinsurance market, the expected losses related to the 11 September attack on the United States, the outcome of insurance regulatory reviews, the Company's operating results, the rating environment and the prospect for improving results and unaudited reports on premium volume developments. Such statements are inherently subject to certain risks and uncertainties. Actual future results and trends could differ materially from those set forth in such statements due to various factors. Such factors include general economic conditions, including in particular economic conditions; the frequency, severity and development of insured loss events arising out of catastrophes; as well as man made disasters such as the 11 September attack on the United States; the ability to exclude and to reinsure the risk of loss from terrorism; fluctuations in interest rates; returns on and fluctuations in the value of fixed income investments, equity investments and properties; fluctuations in foreign currency exchange rates; rating agency actions; changes in laws and regulations and general competitive factors, and other risks and uncertainties, including those detailed in the Company's filings with the U.S. Securities and Exchange Commission and the Swiss Exchange. The Company does not assume any obligation to update any forward looking statements, whether as a result of new information, future events or otherwise.

2002 Page 2 Key differences across sectors highlighted by recent BIS report(*)  How sectors pass on risks to secondary markets  Financial consolidation benefits – a re-evaluation  Risk transfer trends in the (re)insurance industry (*) Basel Committee on Banking Supervision. Insurance and Reinsurance: The Market for Risk Transfer December 11. November 2001 .Talking points  © Converium Banking. Cross-sectoral comparison. „Risk Management Practises and Regulatory Capital“. The Joint Forum.

November 2001 . Cross-sectoral comparison. „Risk Management Practises and Regulatory Capital“. 2002 Page 3 Key differences across sectors highlighted by recent BIS report(*)  How sectors pass on risks to secondary markets  Financial consolidation benefits – a re-evaluation  Risk transfer trends in the (re)insurance industry  If time allows: Consolidation of multiple risks (*) Basel Committee on Banking Supervision. Insurance and Reinsurance: The Market for Risk Transfer December 11.Talking points  © Converium Banking. The Joint Forum.

provisions/reserves . Insurance and Reinsurance: The Market for Risk Transfer December 11. Capital Technical provisions as estimate of foreseeable claims while capital covers unexpected losses Provisions much higher than Capital Commercial Banks Credit risks & funding liquidity risk Medium-term (usually one year) Quantitative models calculate economic capital necessary to absorb unexpected credit loss at target confidence level Asset and Liability management Loan loss reserves to cover expected losses and capital to cover unanticipated losses Capital usually higher than Reserves © Converium Banking. 2002 Page 4 Security Firms Market risk & liquidity risk Typical Time Horizon Risk Measurement Short-term (often 1 to 10 days) Value-at-risk and stress testing methodologies for market & liquidity risk Credit risk minimized through collateral and master netting agreements Holding capital rather than reserves because valuation on a mark-to-market basis Capital much higher than Reserves  Large differences in primary risks.Risk management across sectors Insurance Companies Primary Risks Technical risk (liability risk) & Investment risk (asset risk) Long-term (often multiple years) Quantitative (actuarial) techniques to calculate size of necessary technical provisions Risk limiting and sharing via deductibles. reinsurance & ART Asset and Liability management Provisions / reserves vs. typical time horizon and level of capital vs.

and scope of application of framework (to individual firms. charges applied to individual risks. not just system as a whole Accounting conventions B/S Focus Ratio actual vs. required capital Capital frameworks Variety of different approaches Stability of system as a whole rather than preserving individual banks Historical cost approach Marked-to-market Liability side of balance sheet Actual capital often several times minimum required level Asset side of balance sheet Usually hold no more than 150% of their capital requirement Different definitions of eligible capital.Supervision across sectors Insurance Companies Capital regulation / solvency regime frameworks (1) Risk-Based-Capital (USA. Japan. groups of firms or consolidated groups)  Supervision differs significantly by sector and regions . based on Basel Accord Amendment for market risks Overall concern Soundness of individual insurers. Japan and others) (2) Index based solvency regime (EU and others) Commercial Banks Basel Accord © Converium Banking. and others) (2) EU Capital Adequacy Directive. Canada. 2002 Page 5 Security Firms (1) Net Capital approach (USA. Insurance and Reinsurance: The Market for Risk Transfer December 11. Canada. aggregation methodologies of these charges.

Talking points  © Converium Banking. 2002 Page 6 Key differences across sectors highlighted by recent BIS report(*)  How sectors pass on risks to secondary markets  Financial consolidation benefits – a re-evaluation  Risk transfer trends in the (re)insurance industry (*) Basel Committee on Banking Supervision. „Risk Management Practises and Regulatory Capital“. Cross-sectoral comparison. Insurance and Reinsurance: The Market for Risk Transfer December 11. The Joint Forum. November 2001 .

Security firms: Passing on risk to capital markets © Converium Banking. Insurance and Reinsurance: The Market for Risk Transfer December 11. 2002 Page 7 Secondary Markets Borrower / Issuer Packaging Placement  Security firms usually pass on risk of financial securities immediately to secondary markets rather than holding them on to their own balance sheet .

2002 Page 8 Securisation Client Mgmt / Origination Portfolio Management Syndication Loan Trading Secondary Markets Credit Derivatives  Banks have started to separate origination and management of their loan portfolios Portfolio management optimises the bank’s balance sheet by passing on “undesired” risks to secondary markets  .Banking: Separation of origination and management © Converium Banking. Insurance and Reinsurance: The Market for Risk Transfer December 11.

2002 Page 9 Insured Insurance Companies Reinsurance Reinsurance Companies Secondary Markets ART  Difficulties in packaging insurance risks for secondary markets:  Lack of homogeneity hinders risk standardisation (basis risk)  Moral hazard makes assessment of inherent risk difficult for secondary market Opaqueness of underlying risks can best be mitigated through personal relationships (trust & continuity)  . Insurance and Reinsurance: The Market for Risk Transfer December 11.Insurance: Traditional reinsurance & ART © Converium Banking.

November 2001 .Talking points  © Converium Banking. The Joint Forum. 2002 Page 10 Key differences across sectors highlighted by recent BIS report(*)  How sectors pass on risks to secondary markets  Financial consolidation benefits – a re-evaluation  Risk transfer trends in the (re)insurance industry (*) Basel Committee on Banking Supervision. Cross-sectoral comparison. „Risk Management Practises and Regulatory Capital“. Insurance and Reinsurance: The Market for Risk Transfer December 11.

“One-Stop Global Financial Shopping” – A paradigm of the 1990’s  © Converium Banking.to end 1990’s witnessed broad-based horizontal and vertical integration of financial institutions There was no dominant pattern for horizontal integration. Insurance and Reinsurance: The Market for Risk Transfer December 11. We saw:       Banks acquiring insurers Insurers acquiring banks Insurers and Banks acquiring asset managers Reinsurers venturing into project finance and direct insurance Reinsurers offering third-party asset management  Glass-Steagall Act repeal of 1999 gave additional fuel to expectations about financial consolidation . 2002 Page 11 The mid.

2002 Page 12 Materialized costs and problems of today Integration of controls.Reassessing the costs and benefits of integration in the financial services industry Perceived Benefits in the 90’s Creation of synergies © Converium Banking. legacy systems. Insurance and Reinsurance: The Market for Risk Transfer December 11. they like keeping all their options open Opportunities for cross-selling Scale efficiencies Regulatory arbitrage Economies of scale are not unlimited Regulators and rating agencies are becoming faster at closing the gaps . processes. incentive schemes and culture Customers like their freedom to choose: they like specialists. they like spreading the risk.

Insurance and Reinsurance: The Market for Risk Transfer December 11. 2002 Page 13 Glass Steagall repeal has not sparked a wave of consolidation and integration of financial institutions Recent news highlight a return to financial services de-consolidation:      Citibank spinning off Travelers Property Casualty business CS attributing losses to Winterthur Allianz attributing losses to Dresdner Bank ZFS selling Scudder.“One Stop Global Financial Shopping” – A management fad of the 1990’s?  © Converium Banking. spinning off its reinsurance division and announcing a “strategy of greater focus” on core insurancebased products .

Cross-sectoral comparison. Insurance and Reinsurance: The Market for Risk Transfer December 11. November 2001 . 2002 Page 14 Key differences across sectors highlighted by recent BIS report(*)  How sectors pass on risks to secondary markets  Financial consolidation benefits – a re-evaluation  Risk transfer trends in the (re)insurance industry (*) Basel Committee on Banking Supervision. The Joint Forum.Talking points  © Converium Banking. „Risk Management Practises and Regulatory Capital“.

The logic behind cross-sectoral risk transfers © Converium Banking. Insurance and Reinsurance: The Market for Risk Transfer December 11. 2002 Page 15 Transferor (Sector A) Transferee (Sector B) Transferors  Transferee  Transfer risks that they take on as a part or a consequence of their core business activities Incentive for risk transfer: Cost of transferring or hedging the risk lower than cost of retaining the risk on balance sheet  Incentive for risk acceptance:  Attractive underlying risk-return trade off  Consistency with overall business strategies  Good understanding of risk  Perceived diversification benefits  No legal/regulatory barriers  Low regulatory capital charge  No severe accounting/tax implications .

Insurance and Reinsurance: The Market for Risk Transfer December 11. 2002 Page 16 Insurance Risks Capital Market Risks Insurance / Reinsurance Investment / Hedging (Re)Insurance Markets Capital Markets .The traditional risk transfer avenues © Converium Banking.

Are there feasible diagonal (ART) risk transfer avenues? © Converium Banking. Insurance and Reinsurance: The Market for Risk Transfer December 11. 2002 Page 17 Insurance Risks Capital Market Risks ? (Re)Insurance Markets Capital Markets .

etc. upfront expenses)  Insurance linked securities (CatEPut. (Re)Insurance Markets Capital Markets .One possible direction for ART Securitization © Converium Banking. CAT bonds. Insurance and Reinsurance: The Market for Risk Transfer December 11. CAT risk. Surplus Notes)  Securitization. 2002 Page 18 Insurance Risks Capital Market Risks “Securitization” (i.e.

Another Direction of ART . asset performance risk. business risk.e.“Insuritization” A path littered with failures © Converium Banking. etc. 2002 Page 19 Insurance Risks “Insuritization” Capital Market Risks (i.)  Collateralized bond obligations  Residual value transactions  Credit enhancement transactions  Film Financing (Re)Insurance Markets Capital Markets . Insurance and Reinsurance: The Market for Risk Transfer December 11. credit and credit derivatives risks.

2002 Page 20 Lack of profitability in their traditional reinsurance risk transfer business Slow growth rates in mature non-life reinsurance markets. Insurance and Reinsurance: The Market for Risk Transfer December 11. coupled with a perceived need for top-line growth   Perception of much higher expected ROE’s being earned in the structured finance businesses:  ROE’s shown in banking industry had been misleading through aggressive leveraging practices now exposed in the last 12 months (off-balance-sheet SPV’s) Systemic risk underestimated by re-/insurers and overlooked dependence to own asset side risk  .Why did (re)insurers go into the wrong direction?  © Converium Banking.

rating agency and corporate governance focus leading to greater disclosure and managerial discipline     .What’s happening now?  © Converium Banking. Insurance and Reinsurance: The Market for Risk Transfer December 11. 2002 Page 21 Some of the “new” risks written in the late 90’ are coming home to roost – losses are emerging Recent events such as losses associated with Enron have led to greater reluctance to entertain this business – reputation or explanation risk Financial markets volatility beyond what managers expected – more risk present than perceived Problems from the core business are setting the agenda of management Heightened regulatory.

© Converium Banking. 2002 Page 22 . Insurance and Reinsurance: The Market for Risk Transfer December 11.