1. DFA and Securitization Presentation to the Casualty Actuarial Society July 13, 1998

2. Global New Derivatives Agenda  The “Non-” Construction  Capital Markets Context  Uses of DFA  Developments in Securitization

3. Global New Derivatives Capital Markets Context  Measuring Risk and Return  Psychology  History  Defining “Beta”  Trading in Low Beta Risks  Range of Risks  Appeal to Investors  Benefits to Issuers

4. Global New Derivatives Volatility of Earnings

5. Global New Derivatives Risk and Return S&P 500 Life Cosmetics P&C Restaurant Oil Well Services Metals Steel Airlines Drugs Soft Drinks Railroads Retail Food Chains Machine Tools

6. Global New Derivatives Defining Beta Y =  +  x  = Cov(xy) / SD(x) 2 Ra = Rf +  (Rm - Ra)

7. Global New Derivatives Defining Beta

8. Global New Derivatives Low Beta Risks  Natural Catastrophes  earthquake, volcano, tsunami, flood, landslide, subsidence  hurricane, windstorm, tornado, brush fire  Weather  degree-days, freeze, precipitation  Industry  infrastructure and project finance  drilling, mining, aviation, satellite, nuclear efficacy  maintenance, obsolescence, residual value  GDP

9. Global New Derivatives Data Used: S&P 500, Merrill Lynch Bond Index B0A0, Historical Reinsurance Industry Returns for Low Beta Asset

10. Global New Derivatives Issuer Perspective  Efficient Markets  Match risks to investor preferences  Aggregate “basket” / avoid over-hedging  Tax  Deductibility  Leverage  Firm partitions  Ratings and Regulation

11. Global New Derivatives Issuer Perspective  Deadweight Cost of Ruin  Capacity  Additional capacity for conventional risks  Handle unconventional risks  Integrated View of Capital

12. Global New Derivatives Uses of DFA  Price an individual risk  Price a portfolio of liabilities  Allocate assets  Optimize the capitalization  equate a pound of equity, a yard of debt, a gallon of reinsurance  Trade individual and aggregate risks

13. Global New Derivatives DFA: Outcomes Model all the risks to get the full profile Potential Loss of Ratings Expected Gain

14. Global New Derivatives Challenges to Insurers  Paradox of Capital  Disintermediation  Clients’ perspective - articulate the benefits  Non-intermediation  12% / 88%  The risks already exist, but fall to the common equity  Mission  Underwriting is the real value-added  Handle a much wider range of risks, adopt a trading perspective  Cost of capital is key

15. Global New Derivatives Retrospective Pre 1994 1994199519961997/8 “Alternate Risk” “Financial Reinsurance” Surplus notes ABS Market Innovations “Contingent” Surplus Notes Cat Swaps & Bonds “Contingent” Equity Premium Trust “Cat Note” Indemnity Cat Bond Non-Cat Swaps

16. Global New Derivatives Historical Context åLate 1970’s start of the mortgage-backed securities market åDerivatives warehouses in early 80’s åHigh yield securities bring trading to commercial banking åFirst credit card and automobile loan securitizations in 1985-6 åDerivatives extend to commodities, credit, and other categories in early 90’s åMBS, ABS, and high yield all as established asset classes. In 1998, each will be several hundred billion dollars in the US public markets The development of the market for Low Beta risks is part of the broader sweep of events. Viewed in historical context, the future is part of a trend and may well be predictable.

17. Global New Derivatives Vision of the Future The transformation that has occurred in the US financial services sector may well occur in the insurance and reinsurance industries. å Broad investor familiarity with the insurance business å New equity market valuations, optimized capital å Warehousing joint ventures with Wall Street firms å Combinations with institutional money managers å Proliferation of start-up reinsurers with access to public capital å Increase in competition from other financial intermediaries å Growth of sophisticated analytics and a new trading perspective å Commoditization of some products, disintermediation of some participants