Reinsurance Matters Steve Adams Senior Vice President Houston Marine Insurance Seminar September 23 rd 2003

2003, XL Capital Ltd, All rights reservedPage 2 _4-Jun-16 The White Knuckle Ride

2003, XL Capital Ltd, All rights reservedPage 3 _4-Jun-16 Agenda — Reinsurance matters — Where we’ve been — Where we are now — Where we might be going — Why reinsurance matters

2003, XL Capital Ltd, All rights reservedPage 4 _4-Jun-16 Reinsurance according to Kiln — "What is reinsurance? Insuring insurers is a short and as good a description as any. That is to say, it is: — the business of insuring an insurance company or underwriter against suffering too great a loss from their insurance operations; and — allowing an insurance company or Underwriter to lay off or pass on part of their liability to another Insurer on a given insurance which they have accepted."

2003, XL Capital Ltd, All rights reservedPage 5 _4-Jun-16 Where we’ve been — Pre-Spiral days — The age of innocence — The Spiral — The $2bn boys — Post Piper Alpha — Fundamental problem ignored — 1993 to 1997 — Halcyon Days — 1998 to 2000 — Plumbing the depths — 2001 — The year to end all years

2003, XL Capital Ltd, All rights reservedPage 6 _4-Jun-16 Pre-Spiral Days The age of innocence — The eighties — Lowering retentions — Benign period for losses — More cover — …..and more cover — ….and more cover — The first clue - 87J — Piper Alpha 6 th July 1988

2003, XL Capital Ltd, All rights reservedPage 7 _4-Jun-16 The Spiral The $2bn Boys — Original loss $1.4bn — Spiral loss by 1992 was $14bn — They stopped counting

2003, XL Capital Ltd, All rights reservedPage 8 _4-Jun-16 Insurer XL DirectXL on XL (1st Tier) XL on XL (2nd Tier) XL on XL (3rd Tier)

2003, XL Capital Ltd, All rights reservedPage 9 _4-Jun-16 The Spiral The $2bn Boys — Each company buys as follows: — ABC Ins Co - $95,000 xs $5,000 from DEF Ins Co — DEF Ins Co - $85,000 xs $5,000 from GHI Ins Co — GHI Ins Co - $95,000 xs $5,000 from ABC Ins Co

2003, XL Capital Ltd, All rights reservedPage 10 _4-Jun-16 — ABC Ins Co - $5,000 loss (retained) — DEF Ins Co - nil — GHI Ins Co - nil The Spiral The $2bn Boys

2003, XL Capital Ltd, All rights reservedPage 11 _4-Jun-16 The Spiral The $2bn Boys — ABC Ins Co - $10,000 loss ($5,000 retained, $5,000 reinsured with DEF) — DEF Ins Co - $5,000 loss (retained) — GHI Ins Co - nil

2003, XL Capital Ltd, All rights reservedPage 12 _4-Jun-16 The Spiral The $2bn Boys — ABC Ins Co - $15,000 loss ($5,000 retained, $10,000 reinsured with DEF) — DEF Ins Co - $10,000 loss ($5,000 retained, $5,000 reinsured with GHI) — GHI Ins Co - $5,000 loss (retained)

2003, XL Capital Ltd, All rights reservedPage 13 _4-Jun-16 The Spiral The $2bn Boys — ABC Ins Co - $20,000 loss ($5,000 retained, $15,000 reinsured with DEF) — DEF Ins Co - $15,000 loss ($5,000 retained, $10,000 reinsured with GHI) — GHI Ins Co - $10,000 loss ($5,000 retained, $5,000 reinsured with ABC)

2003, XL Capital Ltd, All rights reservedPage 14 _4-Jun-16 The Spiral The $2bn Boys — ABC Ins Co - $25,000 loss ($5,000 retained, $20,000 reinsured with DEF) — DEF Ins Co - $20,000 loss ($5,000 retained, $15,000 reinsured with GHI) — GHI Ins Co - $15,000 loss ($5,000 retained, $10,000 reinsured with ABC)

2003, XL Capital Ltd, All rights reservedPage 15 _4-Jun-16 The Spiral The $2bn Boys — ABC Ins Co - $30,000 loss ($5,000 retained, $25,000 reinsured with DEF) — DEF Ins Co - $25,000 loss ($5,000 retained, $20,000 reinsured with GHI) — GHI Ins Co - $20,000 loss ($5,000 retained, $15,000 reinsured with ABC)

2003, XL Capital Ltd, All rights reservedPage 16 _4-Jun-16 The Spiral The $2bn Boys — ABC Ins Co - $35,000 loss ($5,000 retained, $30,000 reinsured with DEF) — DEF Ins Co - $30,000 loss ($5,000 retained, $25,000 reinsured with GHI) — GHI Ins Co - $25,000 loss ($5,000 retained, $20,000 reinsured with ABC)

2003, XL Capital Ltd, All rights reservedPage 17 _4-Jun-16 The Spiral The $2bn Boys — ABC Ins Co - $40,000 loss ($5,000 retained, $35,000 reinsured with DEF) — DEF Ins Co - $35,000 loss ($5,000 retained, $30,000 reinsured with GHI) — GHI Ins Co - $30,000 loss ($5,000 retained, $25,000 reinsured with ABC)

2003, XL Capital Ltd, All rights reservedPage 18 _4-Jun-16 The Spiral The $2bn Boys — ABC Ins Co - $45,000 loss ($5,000 retained, $40,000 reinsured with DEF) — DEF Ins Co - $40,000 loss ($5,000 retained, $35,000 reinsured with GHI) — GHI Ins Co - $35,000 loss ($5,000 retained, $30,000 reinsured with ABC)

2003, XL Capital Ltd, All rights reservedPage 19 _4-Jun-16 The Spiral The $2bn Boys — ABC Ins Co - $100,000 loss ($5,000 retained, $95,000 reinsured with DEF) — DEF Ins Co - $95,000 loss ($10,000 retained, $85,000 reinsured with GHI) — GHI Ins Co - $85,000 loss ($5,000 retained, $80,000 reinsured with ABC) Original loss: $20,000 Spiral loss: $280,000 The $2bn Boys

2003, XL Capital Ltd, All rights reservedPage 20 _4-Jun-16 Post Piper Alpha The fundamental problem ignored — Prices were tripled — Retentions raised — Losses — Hugo — Phillips Petroleum — Exxon Valdez — 90A — The fundamental problem wasn’t addressed

2003, XL Capital Ltd, All rights reservedPage 21 _4-Jun to 1997 Halcyon Days — The penny dropped — Prices went through the roof — Specifics to maximum line — Generals

2003, XL Capital Ltd, All rights reservedPage 22 _4-Jun to 2000 Plumbing the depths — International business — Packaging layers — Lower retentions — Composite business — Political Risk — Onshore Energy — Aviation War — Property

2003, XL Capital Ltd, All rights reservedPage 23 _4-Jun The year to end all years

2003, XL Capital Ltd, All rights reservedPage 24 _4-Jun-16 Where we are now — Coverage issues — Less for more — Original risk pricing — Not as good as expected — Marine reinsurance — Factors to flatten the cycle — Underwriters and brokers — The friendly enemy — Security — The fabled “flight to quality!” — Technical pricing — Modelling marine business

2003, XL Capital Ltd, All rights reservedPage 25 _4-Jun-16 Coverage issues Less for more — General principle — More money, higher retentions and exclude everything that gave the market losses — Coverage — PREC — REC — Aviation War — Composite — Terrorism — Arguments for: A risk not an event Tighter security It is rated for — Arguments against: Most property classes exclude it Potential aggregation of cruise ships Olympics Miami

2003, XL Capital Ltd, All rights reservedPage 26 _4-Jun-16 Original risk pricing Not as good as expected — Hull — Market levelling — Market Franchise Board — Cargo — As before — Energy — Reductions — Expenses — Reinsurance costs Source: Lloyd’s

2003, XL Capital Ltd, All rights reservedPage 27 _4-Jun-16 Original risk pricing Not as good as expected Source: Lloyd’s

2003, XL Capital Ltd, All rights reservedPage 28 _4-Jun-16 Marine reinsurance Factors to flatten the cycle — ROE requirements — With low investment returns, reinsurers need low 90's combined ratios to generate 10% ROE — Swiss Re Report — Capital Gained $26bn in 2001 Gained $19bn in 2002 Since 2000 the market has lost $200bn of capital — Non-marine management — In the past, the marine market has always given them evidence of how dumb they can be — Coverage and retention — “Wetter” book with reinsured retaining an interest in his results

2003, XL Capital Ltd, All rights reservedPage 29 _4-Jun-16 Underwriters and brokers The friendly enemy — The sad truth — Man for man, in my view, brokers are More innovative More proactive and Underwriters tend to be reactive — Still the way for London to prosper — Face to face — Brokers can no longer afford to wipe out a market — Close to losing critical mass

2003, XL Capital Ltd, All rights reservedPage 30 _4-Jun-16 Security The fabled “flight to quality!” — Standard & Poors / Bests — The ultimate powers — Downgrade clauses negate security concerns — We should have resisted these — A premium for superior security — Not yet — Hardly anybody has caught the flight yet

2003, XL Capital Ltd, All rights reservedPage 31 _4-Jun-16 Technical pricing Modelling marine business — Technical rate v Computer-generated rate — Experience Model — Simple burning cost calculation with “extras” — Exposure Model — A snapshot in time — Risk profiles to take our share of exposed premium — Cat loading — Dangers — Different models — Underwriter’s judgement — Soon, the “technical price” will be the price — The property market Above and below the line — Benefits — Discipline — Consistency of approach — Transparency

2003, XL Capital Ltd, All rights reservedPage 32 _4-Jun-16 Technical pricing Modelling marine business

2003, XL Capital Ltd, All rights reservedPage 33 _4-Jun-16 The future — Somebody will eventually catch the “flight to quality” — Brokers will continue to drive the business — Reducing client base — Technical underwriting will become mandatory — If the marine market is not careful it could end up as a specialist section of a property account

2003, XL Capital Ltd, All rights reservedPage 34 _4-Jun-16 Why reinsurance matters — The tail, has always, and will continue to wag the dog — Reinsurers provide the direct market with the capacity to do their business — It provides balance in the proper control and management of a marine account — Reinsurance has the characteristics necessary to provide an excellent ROE