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WEATHER RISK MANAGEMENT ELEMENT RE ISDA Annual General Meeting Washington D.C. April 5, 2001

WEATHER RISK MANAGEMENT ELEMENT RE ISDA Annual General Meeting Washington D.C. April 5, 2001. THE WEATHER MARKET – SOME FLAVOR. WEATHER RISK IS EVERYWHERE!. “70% of US Companies are affected by weather” -US Department of Commerce

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WEATHER RISK MANAGEMENT ELEMENT RE ISDA Annual General Meeting Washington D.C. April 5, 2001

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  1. WEATHER RISK MANAGEMENT ELEMENT RE ISDA Annual General Meeting Washington D.C. April 5, 2001

  2. THE WEATHER MARKET – SOME FLAVOR

  3. WEATHER RISK IS EVERYWHERE! “70% of US Companies are affected by weather” -US Department of Commerce “An era is coming when businesses will be required to manage weather-linked risks as a matter of common sense” -official at Industrial Bank of Japan

  4. TWO DISTINCT TYPES OF WEATHER RISK

  5. NON-CAT WEATHER IMPACTS VOLUMES PRICE x VOLUME = REVENUE PRICE RISK MANAGEMENT WEATHER RISK MANAGEMENT LOWER EARNINGS VOLATILITY +

  6. MARKET DIMENSIONS • Since 1997, an estimated $10B in limit has been transferred • Average Rate On Line of 20% = $2.0B in premium • Average US utility end-user deal is ~$50,000/HDD with a limit of $20MM per season • Average secondary market deal is $5,000/$1MM • There is a need for greater capacity

  7. MARKET MAKERS, SHAPERS AND SOURCES OF GROWTH

  8. DISTINCT MARKET PHASE I: 1997 TO 1998 • Geographic Risk Spread • US only • End Users • Few, predominantly energy • Market Makers • Few, mostly energy (Enron, Koch, Aquila, Southern, Castlebridge) • Capacity Providers • None

  9. DISTINCT MARKET PHASE II: 1999 TO 2000 • Geographic Risk Spread • US, Canada, some Europe, Japan and Australia • End Users • Still mostly energy - add retailers, transportation, entertainment • Market Makers • … plus CME, Tempest Re, El Paso, Enron OnLine • Capacity Providers • Insurance - Swiss Re, AIG, St Paul, PX Re, WWWeather • Capital Markets - Kelvin (Koch), Barep, Mercury AM • WRMA • Industry trade group formed - www.wrma.org

  10. CUT TO: CURRENT MARKET 2001 • Geographic Risk Spread • US, Canada, growing Europe, Japan and Australia, discussion of South America • End Users • … Energy, Beverage companies, Agriculture, Municipals • Market Makers • … plus Element Re, Hetco, Dynegy, BNPParibas, Reliant, Louis Dreyfus, Chubb, Commercial Risk • Originating Banks • Royal Bank of Scotland, HypoVereinsBank, Industrial Bank of Japan, Bank of Tokyo-Mitsubishi

  11. CUT TO: CURRENT MARKET 2001 • Capacity Providers • 2nd Wave - AXA, AGF, Sorema, Hannover, Tokyo Marine & Fire, Mitsui Marine, Lloyd’s syndicates • Capital Markets - Barep, Merrill Lynch Investment Mgrs, Societe Generale SPVs • Fallen Providers • Castlebridge (American Re), AIG, Palladium, WorldWide Weather, TransAtlantic, PXRe • Work Slowdown • CME, Swiss Re, Duke

  12. WHAT THE FUTURE HOLDS • Geographic Risk Spread • Fully global market • End Users • Comprehensive - All exposed industries reporting • Market Makers • Energy, Banks, Insurance • Originating Banks • Originating deals from strong corporate lending and project finance relationships • Capacity Providers • Full access to insurance and reinsurance capacity • Active pension and hedge fund involvement

  13. CHALLENGES TO FUTURE GROWTH • Availability of reliable global data • No data, no deal! • Ability to quantify end-user exposures • Must define the risk in order to define the solution • Management of end-user pricing expectations • Often unrealistic: expect non-catastrophic protection at catastrophic prices • Expansion of market risk-taking capacity • (Re)insurers need renewed comfort with weather risk • Weather (alternative risk) must be included in traditional capital markets investment indices

  14. PRODUCTS AND APPLICATIONS

  15. NON-CAT RISKS COVERED • Degree Days • Heating, Cooling, Specialized • Temperature • Minimum, Maximum, Average, Heat Index • Rainfall • Snowfall • Wind Speed • Hurricanes • Frequency, Storm Track • Streamflow

  16. TYPES OF INDICES • Aggregate • Indices that are additive, i.e. degree days • Events • Sum of events over a period • Events defined by criteria being satisfied, i.e. days with more than two inches of rain • Average • Indices that are not generally additive, i.e. temperature

  17. FINANCIAL RISK MANAGEMENT GOALS • Reduce earnings volatility due to the weather • Minimize premium outlay • Risk retention, symmetry of protection • Optimize for taxes • Insurance vs. Derivatives • Consider timing of payment/recovery • Quarter-end, Year-end

  18. PRICING CONSTRUCTS • “Burn” Analysis aka Actuarial Analysis • Historical financial performance • Portfolio Analysis • Valuation of deal with entire book • Stochastic Analysis • Monte Carlo simulations • Meteorological Forecasts • Both short- and long-term • Implied Market Pricing • Active swap and option markets

  19. SUMMARY • The weather market is coming into its own • More players, traders, end-users • Respect and understanding of the risk • Weather risk management is multi-faceted • Applications exist for defensive risk management, aggressive marketing or innovative financing • Weather will no longer be tolerated as an excuse for diminished earnings • Equity analysts, investors and creditors are aware of weather risk management products • A less volatile company is a more valuable company!

  20. CONTACT INFO Lynda R. Clemmons (00)1-203-356-3577 Lclemmons@elementre.com Coming soon: www.elementre.com

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