Marsh 2005 Technology Conference

1. Marsh 2005 Technology Conference The Value and Limitations Of Business Interruption Insurance ForTechnology Companies – And A Few Ideas On How To Improve ItUrs Nussbaum, Swiss Re

2. Purpose "Not everything that is faced can be changed, but nothing can be changed until it is faced."  --  James Baldwin • Critical review of present practices • Provide ideas to develop alternatives • Win a few people to pursue the discussion after the conference • Empower all stakeholders to take a leap of faith "Not everything that is faced can be changed, but nothing can be changed until it is faced."  --  James Baldwin

3. Select General Thoughts On The Nature Of Insurance • Historic Dimension • Insurance laws hardly change (x finite) • Products essentially the same • Broadening/tightening of coverage cycle-driven • World around insurance has changed • Tangible to intangible (services, Intellectual Property) • Analogue to digital • Specialization and value chain focus, outsourcing • Significant progress in financial risk management (hedges) • Capital markets as a potent and capable risk taker for all kinds of risks -> How could insurance survive?

4. Select General Thoughts On The Nature Of Insurance • High level of abstraction – some level of self-adjustment • Not specific to industries and consumers • Broad definitions and descriptions (event, insured interest/activities) • Contains hidden options – previously inexistent events • Semi-finished product – continuously applied • Risk manager/broker: exposure evaluation & effectiveness of protection • Underwriter: exposure evaluation and pricing • Loss adjuster/lawyer: claims settlement process

5. Summary of Pros and Cons Of Insurance • Pros For Insured • Broad coverage incl. hidden risks – “luxury” option • No basis risk between actual loss and payout • Cons For Insured • Needs specifying and applying to individual circumstances • Ex-post loss quantification • Continuous negotiation process • (No liquid market  no price transparency) • Pros For Insurer • Ability to sell “same” service to variety of different consumers • Low product cost • Cons For Insurer • Hidden options • Settlement value determined by third party • Moral risk management needed

6. Implications For Business Interruption • Exposure Assessment • Information about business process • Values • Limits • Loss Settlement Issues • Extra Expense/Increased Cost of doing business -> Interest alignment & moral risk management, collaboration Insured with Insurer (overtime, repair, use of other facilities) • Overcompensation -> exclude: variable expenses, making up for lost production • Basis of comparison: 12 months before

7. Summary Of Issues • Uncertainty and imprecision remain even ex-post • Judgement and interpretation inherent in implied service/process • Implied Joint Venture between Insured and Insurer (exposure evaluation and loss settlement). Note, interests are not always aligned • Continuous process of negotiation necessitates third party, carries risks of disagreement • Slow, expensive and possibly leads to mutual disappointment

8. Features Of A Solution Address the disadvantages of the status quo • Specific industry and individual business needs must be reflected in the structure and in the policy to a higher level • Continued negotiation and resulting unpredictability and high level of judgement must be replaced with pre-determined processes/agreements • Post-event loss quantification must be replaced with pre-determined payments under defined conditions to the extent possible • Recoverable must be booked and paid quickly

9. Unplanned Outage Strike Price Comparable Product ELPRO Example Contingent Price Option for power utilities Payment In case of production shortfall due to occurrence of NERC/FERC triggers Min(Max (Shortfall- Deductible,O) * Max(Price-Strike,0), or Limit Effect Reimbursement for production shortfall under market price and production cost calculation/projections

10. Application of the ELPRO Model Trigger events • Defined list of acceptable “named perils” including non-physical damage reflecting risk retention level and industry-specific issues Loss payments (per time unit) • Determination of fixed operating cost, deductible based on risk retention level and available accounting information • Determination of profit component beyond fixed cost (a) capital market projections (stock market index or ratio) or (b) historic profitability based on available accounting information Loss settlement • Upon verification of trigger event Specificity, Pre-determined events Pre-determined amounts Faster, cheaper settlement

11. Example Of Alternative Structure Semiconductor Company • Trigger Event (replace FERC/NERC definitions) • Fire and other key hazard risk, additionally, key supplier credit default and/or information system breakdown at specified locations under consideration of present characteristics • Loss Payment (Replace electricity volume and market price risk) • Fixed cost – deductible • Gross profit pegged to historic performance but determined by Philadelphia Semiconductor Index • Strike Price: Index exceeds defined value (e.g. Phlx > 399) • Payment: $x for each point that Phlx > 399, per day • Assumption: Correlation between Phlx and BI value

12. Summary of Pros and Cons Of Alternative Structure • Exposure and accounting information provide proxy. Accuracy of pre-loss estimate not significantly inferior to post-loss estimate. Reliability will vary with industry • Tech world is too intangible and too unpredictable to quantify the “true” BI loss • Loss settlement process faster and cheaper • Insurance recovery can be booked fast • Service performance generally more predictable • Basis risk - Danger of under/overcompensation • Underwriting process may take longer • Adverse selection, unprofitable business may find undue attraction • Regulatory muster

13. Open Questions • Regulation/Accounting (insurance vs derivative, SOX) • Quantifying and getting comfortable with the basis risk (Ability to evaluate/model the scenarios) • Internal • Market demand

14. Questions For Discussion • Value of certainty of BI payments • Ability to book insurance recovery quickly • Comfort level with basis risk – ability to (reliably) quantify BI ex-ante • Regulatory comfort level • Value of extending BI cover beyond physical damage • Value of “hidden options”