1. Prepared for: Casualty Actuarial Society Reinsurance and Rating Agency Models May 8, 2007 Susan Witcraft

2. 1 Capital Adequacy Models Complexity & Risk Sensitivity Regulatory System Rating Agency System S&P A.M. Best Moody’s U.S. Canada EU Japan Australia Agency Stress Testing Ratio Risk Based Capital Quantitative | Analyst Judgment IRIS Tests Solvency 1 Rules Basic Ratio And Peer Comparisons ECR/QIS 3 MCR Calculation SMR Calculation MCT Calculation RBC Calculation S&P Capital Adequacy Ratio (SPCAR) A.M. Best Capital Adequacy Ratio (BCAR) DCAT Internal Model Option ICAS/QIS 3 Moody’s MRAC Fitch Fitch PRISM

3. 2 Dual Effect of Reinsurance on Capital Adequacy Reinsurance Reduces required capital Increases expected value of ratio of reported capital to required capital Reduces risk of loss of reported capital Reduces probability of reduction in ratio of reported capital to required capital

4. 3 Best Capital Adequacy Ratio (BCAR): Example of Risk-Based Model Secure Ratings Vulnerable Ratings A++>175%B-/B>80% A+>160%C+/C++>60% A>145%C-/C>40% A->130% B++>115% B+>100% BCAR = Adjusted Surplus / Required Capital

5. 4 BCAR Base Formula Adjusted statutory capital is reported surplus adjusted for after-tax impact of: + equity in unearned premium reserves + equity (discount amount) in the loss reserves + or - redundancy or deficiency in loss reserves + or - market vs. book value of fixed income portfolio - one net catastrophe PML

6. 5 BCAR Required Capital  Invested asset risk  Interest rate risk  Credit risk  Reserve risk  Premium risk

7. 6 BCAR Invested Asset Risk Asset StatementRiskRequired ValueFactor %Capital Mortgage & Collateralized Loans- 5.0%- Real Estate - Owner Occupied- 10.0%- Real Estate - Investment- 20.0%- Contract Loans- 5.0%- Cash5,667 0.3%17 Short Term Investments- 1.0%- Other Investments- 20.0%- Title Plants- 10.0%- EDP and Other Tangible Assets- 20.0%- Foreign Exchange Rate Asset- 20.0%- Aggregate Write-Ins- 20.0%- Sub Totals99,036 2,021 Multiply: Spread of Risk Factor1.259 Company Totals99,036 2,544

8. 7 BCAR Credit Risk

9. 8 BCAR Reserve Risk StatementDeficiencyDiscountAdjustedCapitalAdj' Req'd ReservesFactor ReservesFactorCapital Homeowners/Farmowners Multi-Peril01.00 0.9500.370 Private Passenger Auto Liability01.00 0.9300.380 Commercial Auto Liability01.00 0.8900.380 Workers' Compensation63,0961.00 0.7949,8450.3919,440 Commercial Multi-Peril01.17 0.8500.280 Medical Malpractice: Occurrence01.00 0.8500.500 Medical Malpractice: Claims-Made01.00 0.8900.440 Special Liability01.00 0.9200.450 Other Liability: Occurrence01.00 0.8200.450 Other Liability: Claims-Made01.00 0.8600.420 Products Liability: Occurrence01.00 0.8000.500 Products Liability: Claims-Made01.00 0.8400.430 Special Property01.00 0.9500.440 Auto Physical Damage01.00 0.9400.440 Fidelity/Surety/Fin Guar/Mtg Guar01.00 0.9500.440 Other (Credit, A&H, Agg Write-ins)01.00 0.9000.440 International01.00 0.9000.590 Reinsurance: Property01.00 0.9500.450 Reinsurance: Liability01.00 0.8700.510 Reinsurance: Financial01.00 0.9000.500 Total63,0961.000.7949,8450.3919,440 Growth Factor 1.00 Diversification Factor1.00 19,440

10. 9 BCAR Premium Risk

11. 10 BCAR Required Capital & BCAR Required Capital Asset Risk (B1)Fixed Income Securities1,016 (B2)Equity Securities1,529 Subtotal2,544 (B3)Interest Rate1,185 Total Investment Risk3,730 (B4)Credit3,203 Total Asset Risk6,932 Underwriting Risk (B5)Loss and LAE Reserves19,440 (B6)Net Premiums Written17,115 Total Underwriting Risk36,555 (B7)Business Risk- Gross Required Capital (GRC)43,487 Less: Covariance Adjustment16,229 Net Required Capital (NRC)27,258 Adjusted Surplus (APHS)39,639 BCAR % (APHS/NRC)1.454

12. 11 BCAR: Reinsurance Impact  Excess of Loss –Reduces  Written premium risk  Reserve risk  Invested asset risk –Increases credit risk –Net impact is usually increase in BCAR –Often greater benefit over time as ceded reserves build

13. 12 BCAR: Reinsurance Impact  Quota share –Reduces  Written premium risk  Reserve risk  Invested asset risk –Increases credit risk –Little or no ceding commission impact due to adjustment for DAC asset –Adjustments made for risk retained due to caps, corridors and sliding scale commissions –Net impact is usually increase in BCAR –Impact often bigger than reduced excess retention due to greater premium cession

14. 13 BCAR: Reinsurance Impact Required CapitalHigh RetentionLow RetentionHigh w/ QS Asset Risk (B1)Fixed Income Securities1,016 996 900 (B2)Equity Securities1,529 4,304 3,890 Subtotal2,544 5,299 4,790 (B3)Interest Rate1,185 947 856 Total Investment Risk3,730 6,246 5,645 (B4)Credit3,203 3,742 4,539 Total Asset Risk6,932 9,988 10,184 Underwriting Risk (B5)Loss and LAE Reserves19,440 18,141 16,439 (B6)Net Premiums Written17,115 13,091 10,654 Total Underwriting Risk36,555 31,232 27,093 (B7)Business Risk- - - Gross Required Capital (GRC)43,487 41,220 37,277 Less: Covariance Adjustment16,229 16,812 15,247 Net Required Capital (NRC)27,258 24,408 22,030 Adjusted Surplus (APHS)39,639 37,339 37,390 BCAR % (APHS/NRC)1.454 1.530 1.697

15. 14 BCAR Impact Risk Limiting Features Expected Losses Risk Charge Ceded Losses Corridor/Slide Retention XS Cap Overlap between Retention and Risk Charge Added To Premium Risk Charge

16. 15 BCAR: Reinsurance Impact Long Term

17. 16 Dual Effect of Reinsurance on Capital Adequacy Reinsurance Reduces required capital Increases expected value of ratio of reported capital to required capital Reduces risk of loss of reported capital Reduces probability of reduction in ratio of reported capital to required capital

18. 17 Reinsurance Protects Against Surplus Reduction

19. 18 Reinsurance Protects Against BCAR Decline

20. Prepared for: Casualty Actuarial Society Reinsurance and Rating Agency Models May 8, 2007 Susan Witcraft