1. Risk Securitization vs. Traditional Reinsurance
Patrick Sullivan
Vice President
Marsh & McLennan Securities Corp.
Gary Prestia
Senior Vice President, Property
Zurich Re (North America)
October 23, 1998

2. Agenda Insurance and the Financial Markets
Convergence of insurance/reinsurance and financial markets
Narrowing the many choices available (traditional reinsurance, CBOT, contingent surplus notes, CATEX, BCOE)
Complimentary solutions of traditional reinsurance and securitizations
Case Study
Company profile of product lines, geographic spread and loss experience
Catastrophe modeling analysis based on 5 digit zip unicede information. Discussion of expected loss curve profile
Traditional and Non-Traditional Solutions

3. Key Risk Problem with Case Study
Primarly Exposed to Texas Gulf
Possibility of loss from very large, but very rare event
Is single-year insurance the best choice?
Price stability over time
Capacity stability over time
Credit risk of counterparties

4. Risk Profile Catastrophe Protection Analysis
Est Dollar Loss
Return Period Year
Limits
(in millions)
1250
1.22 b
250
1.13 b
200
980 m
150
912 m
100
541 m 50 50
1998

5. Possible Solutions Options Reason
Quota Share Surplus relief & ground-up risk & cat loss sharing
Aggregate Excess
of Loss Reduce frequency of losses
Catastrophe Excess Reduce moderate to severe cat
of loss losses
Top end catastrophe
coverage in form of Cat
Bond Securitization or
Contingent Surplus Note Reduce severe cat loss activity

6. Traditional Reinsurance Solution Catastrophe Protection Analysis
Est Dollar Loss
Return Period Year
Limits
(in millions)
1250
1.22 b
250
Traditional Cat
Reinsurance
$1b xs $250m
(3 layers)
1.13 b
200
980 m
150
912 m
100
541 m 50
250
250 m 20
50% QS
Aggregate Catastrophe $65m xs $60m Franchise Deductible - $30m
1998
50% Net Retention

7. Traditional Reinsurance
Advantages
Traditional solution, easy to understand and explain. Accustomed to traditional approaches
Less complicated, generally more quickly accomplished
When supply is plentiful, pricing/terms will be very attractive
Known regulatory and accounting treatment
Broad coverage (WC, ECO/XPL, reinstatement)
Historical track record and known entities. Longevity of commitment by professional reinsurers to the insurance marketplace
Disadvantages
Credit quality
May not be best solution for sophisticated/complex or large risks
Market cycles
When demand exceeds supply, pricing/terms may be unattractive
Limited size of reinsurance market capacity

8. Risk Profile and Capital Markets Solutions Objectives
Integrate with other risk management methods, e.g. insurance, mitigation
Capacity (size and new sources)
Cost effective
Credit quality
Stability over time

9. Forms of Insurance Securitization
Exchange-traded derivative contracts
Over-the-counter derivatives (swaps)
Catastrophe bonds

10. Exchange Traded Derivative Contracts Contracts - Exchange Traded
Key considerations
Exchange volumes: (6/1-10/15 at risk)
CBOT: $10.8 mm
BCOE: $12.5 mm
Basis risk
Credit quality
Open price discovery

11. Insurance Transformer
Swap Basic Structure
Collateral or
Guarantee
Premium
Swap
Insurance
Cedent
Swap Counterparty
Insurance Transformer

12. Catastrophe Bonds Basic Structure
Swap Counterparty
LIBOR
Investment Income
Highly Rated
Short-term
Investments
in trust
Investors
$’s
LIBOR
Remaining
Funds
Par Amount
Interest Payments
Premium at maturity
& liquidation
Investors
Insured
Insurance
Premiums
SPV

13. Summary Structures and Issues
Swap vs.
Mitsui
XL Mid Ocean
Issues
Credit risk
Enforceability
More flexible
Provides potential leverage for investor
More limited investor group
Cat Bond
USAA
Trinity Re
Parametric Re
Issues
Higher cost
No credit risk
No investor leverage
Larger investor group

14. Summary Structures and Issues
UNL-linked vs.
USAA
Trinity Re
XL Mid Ocean
Issues
Heavy disclosure
Custom hedge
Investor concerns
Index-linked
Parametric
SR Earthquake Fund
Mitsui
Issues
Little disclosure
Basis risk
Indexes
Attractive to investors

15. Basis Risk/Transparency Tradeoff
Event
Parameter
Standard
Index
Custom
Index
Transparency
Reference
Loss
Ult. Net
Loss
Basis Risk

16. Summary Structures and Issues
Single year vs.
Cost of issuance
Expense
Time
Multi-year
Changing exposure profile
Reset mechanisms
Amortize cost of issuance
Lock in price and capacity

17. Capital Markets Solution Recommended Structure
Bond or Swap
large capacity
regulatory issues
High-level attachment
Maximize investor pool
Competes most effectively with insurance
Risk metric: actual loss
Index not appropriate

18. Capital Markets Solution Recommended Structure (cont.)
Term: multiple years
Price and capacity stabilized
Transaction costs minimized
Expected loss value for bond held constant
Annual modeled resets
Model version held in escrow at inception
Price stays constant

19. Capital Markets Solution Catastrophe Protection Analysis
Est Dollar Loss
Return Period Year
Limits
(in millions)
10 % Co
1250
Capital
Markets
Solution
1.22 b
250
1.13 b
200
980 m
150
912 m
100
Traditional Cat
Reinsurance
$650m xs $250m
(3 layers)
541 m 50
250
250 m 20
50% QS
Aggregate Catastrophe $65m xs $60m Franchise Deductible - $30m
1998
50% Net Retention

20. Capital Markets Solution Structure highlights (cont.)
Integrated with insurance program
Insurance program designed to change with reset
Co-participation
Issued through an offshore SPV
Tax deductible insurance premium
Funds held in trust
Not issued directly as corporate debt

21. Capital Markets Solution Benefits of this Structure
Simple
Maximizes investor interest
Cost
Cost effective
Multi-year amortizes cost over time
Reduced management time

22. Securitization General Advantages
High credit quality
Integrates well with insurance structure
Low correlation - attractive investment
Huge potential capacity
No insurance market cycles
Pricing driven by exposure analysis
Intangible benefits

23. Securitization General Disadvantages
Untested market – no loyalty
Costs - size constraints
Often complicated structure
Effect of market turmoil?
Statutory accounting and regulatory issues

24. Conclusions
No single right answer - a myriad of choices available today that should be explored
Search for the best fit based on your needs, risk appetite and ability to afford reinsurance
Complimentary solution of a mix of traditional reinsurance and risk securitization

25. Marsh & McLennan Securities Corp Who we are
An investment bank focused on the insurance industry and insurance related risk transfer products
Primary lines of business
Corporate Finance Advisory
Capital Markets
NASD Licensed Broker - Dealer

26. Zurich Financial Services Group Who we are
Zurich Reinsurance (North America) Inc., with $809 million of Statutory Surplus (as of 12/31/97), is the North American Reinsurance arm of Zurich Financial Services, a global financial services company. We are rated “A” by A.M. Best
Within ZRNA, traditional property/casualty reinsurance is written, and through the Centre Re Division we write non-traditional and financial products
ZRNA Treaty Property Division is a leading reinsurer in Property Catastrophe, Specialty Property Lines and weather related products

27. This information was prepared by Marsh McLennan Securities Corp
This information was prepared by Marsh McLennan Securities Corp. (MMSC) & Zurich Re for use in marketing presentations. It is intended for the exclusive use of the recipients and not for dissemination. Information contained herein is believed to be reliable, but MMSC & Zurich Re do not warrant its completeness or accuracy. Opinions and estimates constitute our judgment and are subject to change without notice. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. MMSC & Zurich Re may have a business relationship with any of the companies described herein.