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NAIC. Taoufik Gharib, Associate Director Thomas Upton, Managing Director Standard & Poor’s. December 1, 2007. Agenda. S&P’s approach to catastrophe risk: Major rating factors Catastrophe risk in the rating process (quantitative & qualitative) S&P’s property catastrophe criteria:

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  1. NAIC Taoufik Gharib, Associate Director Thomas Upton, Managing Director Standard & Poor’s December 1, 2007

  2. Agenda • S&P’s approach to catastrophe risk: • Major rating factors • Catastrophe risk in the rating process (quantitative & qualitative) • S&P’s property catastrophe criteria: • Primary insurance criteria changed in April 2006 • Reinsurance criteria remains unchanged as published in June 2005

  3. The Eight Pillars Of Insurance Analysis • Industry Risk (macro - economic factors) • Potential threat of new entrants, substitute products or services, regulatory risk. • Competitive Position (micro - economic factors) • Competitive advantage: distribution channel, underwriting, pricing power, scale, diversification (sector & line of business). • Management & Corporate Strategy • Enterprise Risk Management (ERM) • Risk controls, optimization of earnings and capital. • Operating Performance (incl. quality of earnings) • Capitalization (incl. reinsurance & reserves & RBC model & quality of capital) • Investments & Liquidity • Financial Flexibility

  4. Catastrophe Risk In The Rating Process CapitalRatio Cat Risk

  5. Catastrophe Risk • Catastrophe Risk is incorporated in the major rating factors, with varying degrees of importance, depending on each company’s risk profile. • A concentrated monoline property catastrophe reinsurer - catastrophe risk may be the most important rating factor. • A significantly diversified casualty writer - catastrophe risk may be less important. • Catastrophe risk is incorporated in our ratings on quantitative and qualitative bases. • Catastrophic loss activity can have a significant impact on a company's overall financial strength.

  6. Catastrophe Risk: Quantitative Basis • Capitalization: S&P typically allocates capital according to premiums and reserves, with adjustments for asset quality. • However, S&P does not believe that catastrophe premiums provide a consistent and adequate indication of exposure and risk. • Therefore, S&P assesses capital requirements for property catastrophe risk based on exposure. • S&P’s catastrophe capital model uses company's own modeled exposures - that is, the exceedence probability (EP) curve. • S&P’s capital charge for catastrophe risk is based on the company-specific net expected aggregate losses at the 1-in-250-year level.

  7. Catastrophe Risk: Qualitative Basis • Competitive Position: Some companies have a competitive advantage based on a leadership position in underwriting and catastrophe modeling. • Enterprise Risk Management: A company with strong ERM, and robust processes to identify and evaluate catastrophe risk, will highly unlikely experience losses outside its tolerances. • Operating Performance: (earnings volatility) • A re/insurer may have a strong capital base that can withstand a large catastrophe loss (10%-30% of its equity). • However, the loss of two to three years of earnings in one event is viewed as a negative rating factor. • Financial Flexibility:is also important and determines if a company can renew all its current business and take advantage of prospective price increases after an event.

  8. Catastrophe Risk: Qualitative Basis (continued) • Through S&P’s property catastrophe survey, we collect additional data to better understand each company’s specific catastrophe risk profile. The survey includes some of the following questions: • Exposure by zone (globally) and peril (it is always earthquake season), highlights concentration risk. • Historical impact of catastrophe events on the loss ratio. • What catastrophe models are used - significant variance between models and versions. • Detail on model assumptions: demand surge, storm surge, fire following, etc… • Detail on exposure assumptions: year built, construction type, building condition, etc... • Description and credit quality of reinsurance protection.

  9. Catastrophe Risk: Frequency & Severity • Year 2005 in review: (According to Swiss Re, sigma No. 2/2006) Global natural catastrophe economic losses totaled more than $220b: • Katrina $135b 61% • Wilma $20b 9% • Rita $15b 7% • Insured property losses: • Katrina $45b (or 11% of U.S. P/C net premiums written) • Wilma $10b • Rita $10b • Versus $48b insured property losses in 2004 (Charley, Frances, Ivan, and Jeanne) • 2005 had a very active hurricane season: • 27 named storms (previous record was 21 in 1933) • 15 hurricanes (previous record was 12 in 1969) • Highest number of category 5 hurricanes – at three

  10. Property Catastrophe Primary Companies Criteria: • The net aggregate 1/250-year property PML is reduced by a premium offset to not double-count required capital. • The premium offset will also be company specific, but within boundaries to maintain rating consistency. • The premium offset is based on the risk profile of each insurer: • Globally or nationally diversified insurers: 10%–30% • Geographically concentrated insurers: 0%-50% • If an insurer is unable to prove a specific catastrophe load or premium offset as within pricing and/or rate filings - the default will be a premium offset of 5%.

  11. Property Catastrophe Reinsurance Companies Criteria: • The criteria outlined for primary insurers is consistent with the one that is in place for reinsurers. • S&P applies the same net aggregate 1/250-year property PML and premium offset to reinsurers. • The premium offset for reinsurers is for programs that only have natural catastrophe risk. • The criteria for reinsurers has not changed following Hurricanes Katrina, Rita, and Wilma, and remains as published in June 2005.

  12. Property Catastrophe Insurer & Reinsurer Criteria: • The capital charge covers property (personal & commercial) catastrophe exposures on a global basis, covering all perils: wind, earthquake, tornado, hail, and flood (outside the U.S.), and all zones combined. • Both insurers and reinsurers benefit from another premium offset (in addition to C3), which is applied directly to the PML to reflect the short-tail nature of property risk, less a 30% expense ratio. • This is to reflect that premiums collected would reduce a potential PML loss in the same year • The net aggregate 1/250-year PML is tax adjusted

  13. Property Catastrophe Conclusion: • It is very likely that insured losses due to natural catastrophes will increase over the next 10 years because of climate and socio-economic changes. • This higher risk will be imbedded in our ratings.

  14. NAIC Taoufik Gharib, Associate Director Thomas Upton, Managing Director Standard & Poor’s December 1, 2007

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