Property and Casualty Reinsurance Issues from a Midwestern Buyers Perspective February 9, 2004 Marty Orth, ACAS, MAAA Farm Bureau Financial Services Farm Bureau Mutual Insurance Company Vice President Research and Development

Speech Style There are many issues Who can predict the next major issue? Therefore, this is an interactive speech Your participation appreciated

Lets take a sampling What is your Reinsurance Knowledge? 1.Never Involved…know very little 2.Work with infrequently 3.Part of current responsibilities 4.Primary responsibility

Participation and Discussion What do you think the reinsurance issues are in 2004? What do you think the long-term reinsurance issues will be over the next 10 years?

LESSON 1: Reinsurance Purposes Limit liability of specific risks Stabilize loss experience Protect against catastrophes Increase capacity Other –Entry into a new line –Cut off exposure on an existing line –Gain reinsurers expertise

LESSON 2: Reinsurance Does NOT Change the inherent nature of the risk Make a bad risk insurable Make an exposure more predictable or desirable Alter the total risk exposure

Types of Reinsurance General Types FacultativeTreatyFinancialAlso Proportional or Pro rata Excess reinsurance or non-proportional

Reinsurance Examples FACExcess –Property Per Risk –Excess Per Occurrence Property Catastrophe Aggregate Excess of Loss Funded Programs LPT

Property Facultative Obligatory Reinsurance Treaty (FOT) Characteristics Capacity to write larger risks Stability by limiting exposure on an individual risk Degree of catastrophe protection from major loss on an individual risk Vehicle to protect other reinsurance results Limits ceding companys exposure on risks not normally written by the company

Excess of Loss

Combination Per Risk Excess and Surplus Treaty Second Surplus Share Layer $7,500,000 First Surplus Share Layer $2,000,000 Per Risk Excess $400,000 xs $100,000 Retention $40,000,000 $10,000,000 $ 2,500,000 $ 500,000 $ 100,000 Third Surplus Share Layer $30,000,000

Property Surplus Share Example

Surplus Share Program Example Risk Size = $1,000,000 Retention = $200,000 Company retains 20%

Fundamentals of Reinsurance

Overview Current Market Overview Reinsurance Issues Midwestern Buyers View

2001 Combined Ratios Source: Reinsurance Association of America – Reinsurance Underwriting Report

2002 Combined Ratios Source: Reinsurance Association of America – Reinsurance Underwriting Report

Month Combined Ratios Source: Reinsurance Association of America – Reinsurance Underwriting Report

Historical Combined Ratios Source: Reinsurance Association of America – Reinsurance Underwriting Report

RAA Industry Results – U.S. Reinsurers Source: Reinsurance Association of America – Reinsurance Underwriting Report

Reinsurance Bits and Pieces Reinsurance outlook Reserve Charge Example YIELD

Reinsurance Outlook Continuous reserve development? Financial Rating Issues Capitalization –Is Bermuda overcapitalized? –Will there be additional capital entering? Continued reinsurer exits and consolidations?

XL Capital Ltd – 2004 Example January 13 –XL Capital Ltd Completes Previously Announced Claims Audit Review and Year End Reserve Review Expects fourth quarter charge of $647 million after taxes –Majority due to adverse development in Companys North American reinsurance operations for casualty business written during underwriting years Company to raise at least $750 million of new capital

XL Capital Ltd – 2004 Example January 14 –A.M. Best Downgraded all debt ratings of XL Capital Ltd. (Cayman Islands) Placed ratings of A+ (superior) under review with negative outlook for XL Capital Group (Hamilton, Bermuda) and its affiliated companies –S&P Cuts XL Capital Rating to AA- vs. AA

XL Capital Ltd – 2004 Example January 22 –XL Capital Ltd Announces Retirement Of Insurance Operations Chief Executive

XL Capital Ltd – 2004 Example January 22 –XL Capital Ltd Announces Management Changes Within Its Global Reinsurance Operations

Special Termination Language Special Termination Language or Downgrading Clauses –Dont Rely on it –Do the Due Diligence –Reinsurers beginning to resist –Could allow run on the bank due to return premiums

Legacy Issues Mold Construction Defects AsbestosEnvironmental9/11 Professional Liability/ Med Mal Others???

New / Evolving Issues Terrorism Mad Cow GMOsObesitySARS? Soft Market? Others?

Terrorism Risk Insurance Act (TRIA) Update A.M. Best SRQ What are your potential targets? TRIA Flow Chart Update

A. M. Best SRQ VI. Terrorism Section –41. Terrorism Exposure Management –42. Largest Single Insurance At Risk –43. Largest Single Insured TIV –44. Zonal Aggregate Exposure

TRIA Update AIR landmark database includes over 300,000 Potential Targets

Terrorism Risk Insurance Act of 2002 Coverage Flowchart LOSS OCCURS Is it a Certified Act? Yes Terrorism Risk Insurance Act of 2002 sunsets on December 31, The Act only applies to Commercial insurance which includes Farmowners. Department of Treasury is sole authority on terrorism act certification. Not Covered by Policy Covered by Policy Pay & Submit to Treasury No Does underlying policy have a Terrorism Exclusion? Yes Deny Claim No Pay loss – Collect against the Terrorists Deny Claim

TRIA Update Treasury survey –How is the industry handling Will the industry have enough capacity to handle itself? Will TRIA be allowed to sunset?

Mad Cow What is a Mad Cow –Bovine Spongiform Encephalopathy What does this have to do with reinsurance?

Mad Cow USDAs Risk Management Agency (RMA) –Offers Livestock Risk Protection Market-based price protection policy Mad Cow Disease found in Washington State Results –Sold more policies on that day as compared to life-to-date of program

GMOs What are they? –Genetically Modified Organisms Issues –Potential Liability? Cross pollination Loss of market value HealthOther –Reinsurance Issues?

Hard Market Is the Primary market softening What are the Reinsurance Issues Best Rating Issues

So whats a company to do?

Midwestern Issues and View Regional isolation Cat Placement –Models –Data Issues –Pricing Future Events / Issues

FBM

Regional Isolation Its what you dont see –Earthquake –Coastal Midwestern Issues –Its all about the CAT

Midwestern Cat Definition Event occurs over a 72 hour period: Wind/hail etc

Cat Model Issues Models –AIR: straight wind/tornado/hail –RMS: no straight wind –EQE: no tornado/hail Data Issues Where is the property located –County, zip, policy Other Issues

Use of Reinsurance Brokers Pros –Expertise and service –Modeling and pricing –An intermediary Cons –Access to directs

Cat Placement Number one questions asked –Deductibles Number two questions asked –TIV

Open Discussion What are the reinsurance issues to watch out for in 2004 and beyond?

Summary Understand your exposures Do your homework Look for long-term relationships Seek advice of experts if needed –Contract attorneys –Reinsurers –Brokers Monitor Results…Monitor Results…

Contact Information Marty Orth (515)