Banking, Insurance and Reinsurance: The Market for Risk Transfer

Banking, Insurance and Reinsurance: The Market for Risk Transfer Karlsruhe, 11 December 2002, Dirk Lohmann

Important Disclaimer Although all reasonable care has been taken to ensure the facts stated herein are accurate and that the opinions contained herein are fair and reasonable, this document is selective in nature and is intended to provide an introduction to, and overview of, the business of Converium. Where any information and statistics are quoted from any external source, such information or statistics should not be interpreted as having been adopted or endorsed by Converium as being accurate. Neither Converium nor any of its directors, officers, employees and advisors nor any other person shall have any liability whatsoever for loss howsoever arising, directly or indirectly, from any use of this presentation. This document contains forward looking statements as defined in the U.S. Private Securities Litigation Reform Act of 1995. It contains forward looking statements and information relating to the Company's financial condition, results of operations, business, strategy and plans, based on currently available information. These statements are often, but not always, made through the use of words or phrases such as 'expects', 'should continue', 'believes', 'anticipates', 'estimated' and 'intends'. The specific forward looking statements cover, among other matters, the improving reinsurance market, the expected losses related to the 11 September attack on the United States, the outcome of insurance regulatory reviews, the Company's operating results, the rating environment and the prospect for improving results and unaudited reports on premium volume developments. Such statements are inherently subject to certain risks and uncertainties. Actual future results and trends could differ materially from those set forth in such statements due to various factors. Such factors include general economic conditions, including in particular economic conditions; the frequency, severity and development of insured loss events arising out of catastrophes; as well as man made disasters such as the 11 September attack on the United States; the ability to exclude and to reinsure the risk of loss from terrorism; fluctuations in interest rates; returns on and fluctuations in the value of fixed income investments, equity investments and properties; fluctuations in foreign currency exchange rates; rating agency actions; changes in laws and regulations and general competitive factors, and other risks and uncertainties, including those detailed in the Company's filings with the U.S. Securities and Exchange Commission and the Swiss Exchange. The Company does not assume any obligation to update any forward looking statements, whether as a result of new information, future events or otherwise.

Talking points • Key differences across sectors highlighted by recent BIS report(*) • How sectors pass on risks to secondary markets • Financial consolidation benefits – a re-evaluation • Risk transfer trends in the (re)insurance industry (*) Basel Committee on Banking Supervision, The Joint Forum, „Risk Management Practises and Regulatory Capital“, Cross-sectoral comparison, November 2001

Talking points • Key differences across sectors highlighted by recent BIS report(*) • How sectors pass on risks to secondary markets • Financial consolidation benefits – a re-evaluation • Risk transfer trends in the (re)insurance industry • If time allows: Consolidation of multiple risks (*) Basel Committee on Banking Supervision, The Joint Forum, „Risk Management Practises and Regulatory Capital“, Cross-sectoral comparison, November 2001

Risk management across sectors • Large differences in primary risks, typical time horizon and level of capital vs. provisions/reserves

Supervision across sectors • Supervision differs significantly by sector and regions

Security firms: Passing on risk to capital markets • Security firms usually pass on risk of financial securities immediately to secondary markets rather than holding them on to their own balance sheet

Banking: Separation of origination and management Securisation Client Mgmt / Origination Portfolio Management Syndication Secondary Markets Borrowers Loan Trading Credit Derivatives • Banks have started to separate origination and management of their loan portfolios • Portfolio management optimises the bank’s balance sheet by passing on “undesired” risks to secondary markets

Insurance: Traditional reinsurance & ART • Difficulties in packaging insurance risks for secondary markets: • Lack of homogeneity hinders risk standardisation (basis risk) • Moral hazard makes assessment of inherent risk difficult for secondary market • Opaqueness of underlying risks can best be mitigated through personal relationships (trust & continuity)

“One-Stop Global Financial Shopping” –A paradigm of the 1990’s • The mid- to end 1990’s witnessed broad-based horizontal and vertical integration of financial institutions • There was no dominant pattern for horizontal integration. We saw: • Banks acquiring insurers • Insurers acquiring banks • Insurers and Banks acquiring asset managers • Reinsurers venturing into project finance and direct insurance • Reinsurers offering third-party asset management • Glass-Steagall Act repeal of 1999 gave additional fuel to expectations about financial consolidation

Reassessing the costs and benefits of integration in the financial services industry

“One Stop Global Financial Shopping” –A management fad of the 1990’s? • Glass Steagall repeal has not sparked a wave of consolidation and integration of financial institutions • Recent news highlight a return to financial services de-consolidation: • Citibank spinning off Travelers Property Casualty business • CS attributing losses to Winterthur • Allianz attributing losses to Dresdner Bank • ZFS selling Scudder, spinning off its reinsurance division and announcing a “strategy of greater focus” on core insurance-based products

The logic behind cross-sectoral risk transfers Transferors • Transfer risks that they take on as a part or a consequence of their core business activities • Incentive for risk transfer: Cost of transferring or hedging the risk lower than cost of retaining the risk on balance sheet Transferor(Sector A) Transferee(Sector B) Transferee • Incentive for risk acceptance: • Attractive underlying risk-return trade off • Consistency with overall business strategies • Good understanding of risk • Perceived diversification benefits • No legal/regulatory barriers • Low regulatory capital charge • No severe accounting/tax implications

The traditional risk transfer avenues Insurance / Reinsurance Insurance Risks Capital Market Risks Investment / Hedging (Re)Insurance Markets Capital Markets

Capital Markets (Re)Insurance Markets Capital Market Risks Are there feasible diagonal (ART) risk transfer avenues? Insurance Risks ?

Capital Markets (Re)Insurance Markets Capital Market Risks One possible direction for ART - Securitization Insurance Risks “Securitization” (i.e. CAT risk, upfront expenses) • Insurance linked securities (CatEPut, Surplus Notes) • Securitization, CAT bonds, etc.

Capital Markets (Re)Insurance Markets Capital Market Risks Another Direction of ART - “Insuritization”A path littered with failures Insurance Risks “Insuritization” (i.e. credit and credit derivatives risks, asset performance risk, business risk, etc.) • Collateralized bond obligations • Residual value transactions • Credit enhancement transactions • Film Financing

Why did (re)insurers go into the wrong direction? • Lack of profitability in their traditional reinsurance risk transfer business • Slow growth rates in mature non-life reinsurance markets, coupled with a perceived need for top-line growth • Perception of much higher expected ROE’s being earned in the structured finance businesses: • ROE’s shown in banking industry had been misleading through aggressive leveraging practices now exposed in the last 12 months (off-balance-sheet SPV’s) • Systemic risk underestimated by re-/insurers and overlooked dependence to own asset side risk

What’s happening now? • Some of the “new” risks written in the late 90’ are coming home to roost – losses are emerging • Recent events such as losses associated with Enron have led to greater reluctance to entertain this business – reputation or explanation risk • Financial markets volatility beyond what managers expected – more risk present than perceived • Problems from the core business are setting the agenda of management • Heightened regulatory, rating agency and corporate governance focus leading to greater disclosure and managerial discipline

Banking, Insurance and Reinsurance: The Market for Risk Transfer