Modeling Catastrophe Risk to Marine and Energy Exposure

Modeling Catastrophe Risk to Marine and Energy Exposure in the Gulf of Mexico Houston Marine Insurance Energy Seminar Hemant Shah, CEO Risk Management Solutions September 18, 2006 TM Bringing Science to the Art of Underwriting™

New Orleans, September 3 2005 q 70 -80% of New Orleans flooded, q 55% of the city’s 147, 000 properties inundated by more than 4 feet q Maximum flood depths 18 feet. © 2006 Risk Management Solutions, Inc. CONFIDENTIAL TM 2

New Orleans Before the Pumps, 1888 TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 3

The Expansion into the Floodplain n Pumps initially deployed from 1913 -1928 TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 4

1915 “New Orleans” Hurricane n Cat 4 Hurricane, 20 miles east of New Orleans (Grand Isle) – “Whole country between Poydras and Buras inundated. Levees gone, property loss appalling. Life toll probably heavy. Conditions estimated worse than ever before. Relief needed. No Communications. . . " n Storm struck before the construction of the Industrial Canal n On the Mississippi River below New Orleans storm surge overtopped the levees below New Orleans and rose to 15 -20 feet above sea level. – Swells rolled up the river in New Orleans 10 -12 feet above high water. n Water was carried into Lake Pontchartrain and overflowed the existing levees to flood western part of the city – From the Old Basin canal (parallel to Orleans Avenue) to Broadway and from Claiborne Avenue to Lake Pontchartrain – Flooding 1 -8 feet n After the passage of the storm the surge receded rapidly but the flood waters stayed in place for 3 -4 days in New Orleans and had to be removed by the drainage system (from 1915 Monthly Weather Review). TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 5

The Expansion into the Floodplain q Second generation of pumps elevated to be able to function after a flood Bayou St. Jean at Lake Pontchartrain TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 6

1947 Hurricane n Cat 3 directly over the City n Surge overtopped Lake Pontchartrain levees n 17 th St Canal wall failed n Up to 6 feet of water in parts of Jefferson parish n Standing water for weeks – Removed through cutting and blasting holes in the levees TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 7

Growth of New Orleans TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 8

New Orleans Canals Developed after 1945 Industrial Canal (link between Lake Pontchartrain and Mississippi R) 1923 Misssippi River Gulf Outlet 1965 Drainage Canals Mid 19 th Century Inner Harbor Navigation Canal 1923 TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 9

1965 Hurricane Betsy n Cat 3 Hurricane n 12 foot storm surge n 60, 000 homeless TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 10

1965 Hurricane Betsy - Presidential Response TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 11

2005 Hurricane Katrina - Presidential Response TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 12

100 Years of Storm Surge Flooding 1915 1947 1965 2005 TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 13

One Disaster Sets The Terms For The Next TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 14

Mayor Pomfh’s Vision… “I want to give positive assurance that our friends will find Miami this winter the same enjoyable, hospitable, comfortable vacation city it has always been. I predict that Miami will make a world record come-back…we are ready to resume our place as the playground of the world” -Miami Mayor E. C. Pomfh …speaking six days after the September 18, 1926 storm struck south Florida TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 15

Mayor Pomfh’s Vision…Realized n 1990 Population of Dade and Broward alone exceed that of all 109 coastal counties (TX – VA) in 1930 – Of 67 coastal counties in LA ->FL, pop. density is 2. 5 X national average n During the Florida construction boom from 1970 – 1990: – 70% of buildings in Broward and Palm Beach counties built in this period – 75% increase in the population density in SE Florida – Commercial values almost tripled in value n The trend continues; from 1990 to 2000: – The population of Broward County increased by 29%, – and Collier County by 65% n Currently, 1, 540 building permits issued in coastal counties every day TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 16

Probability U. S. Hurricane Risk, Risk. Link v 6. 0 “Tail” (Hurricane) $40 – 60 B Katrina $120 – 250 B Miami Cat 5, NYC Cat 4 $300 – 350 B “Worst Case” Loss TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 17

The Capital Crunch will Catalyze Change 90 $82 billion 80 Loss ($billion) 70 60 Personal lines $55 billion 50 Personal lines 40 • Capital markets alternatives? • Shortage of cover 30 20 • New capital entering the market? Commercial lines 10 • Change in market architecture? Increase in one-in-250 -year loss Capital increase TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 18

What is a Catastrophe Model? TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 19

Utility of a Catastrophe Model Geography of Risk Demographics of of Risk (Gross/Net) Probability of Risk (EP Curve) TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL

Offshore Platform Modeling Framework RMS Risk. Link v 6. 0, Released May, 2006 Define Hurricane n n n Claiming Storm parameters n Time-stepping windfield n Physical damage (PD) calculations Basin-wide tracks, n Loss of production realistic time histories n Windspeed and wave n BI, CBI, OEE height Onshore and offshore “clash” n Submarine landslide TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL

Recent Storms to Impact the Offshore GOM Plot of maximum windspeeds - 2002 to 2005 Lili, Ivan, Katrina & Rita TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 22

Recent Storms to Impact the Offshore Region n 94% of the 4, 200 offshore platforms in GOM experienced Cat 1 winds or greater from 2002 -2005 Category % Platforms 1 5% 2 24% 3 33% 4 27% 5 5% Total 94% TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 23

Hurricane Losses to Offshore Exposure Ivan (’ 04), Katrina and Rita (’ 05) Event Loss ($M) Ivan Total Insured 2, 700 Platform PD 550 -600 Katrina Total Insured 6, 000 Platform PD 3, 000 -3, 200 Total Insured 5, 000 Platform PD 2, 400 -2, 600 Rita Obtained from various industry sources TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 24

Lessons Learned of Relevance to Offshore Energy n Frequency and intensity of hurricane activity – Likely to face elevated levels of hurricane activity over at least the medium term – Prior modeling practice, based on long-term historical averages, underestimated the occurrence of intense storms n Vulnerability to damage and insured loss – Physical damageability of platforms (et al) greater than previous expectation – Time element risks are significant, and must be modeled – Greater variability in risk to various classes of exposure n Making the transition from 1 st to 2 nd generation models TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 25

Frequency of Hurricane Activity TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 26

A Conspiracy Between Mother Nature and Developers? Category 3 -5 Atlantic Basin Hurricanes 1901 -2005 and 5 -year running average Sustained period in population growth and economic development of coastal Gulf and SE regions of the U. S. TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 27

US Landfalling Cat 3 -5 Hurricanes 0. 9 = Ave. from 1995 - 2005 0. 6 = Average from 1900 - 2003 Decadal moving average TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 28

Tropical Atlantic Sea Surface Temperature Departures (ºC) During Aug-Oct (1951 -2000 Base Line) 0. 8 0. 6 o C o 0. 5 C 0. 4 0. 2 0 -0. 2 -0. 4 -0. 6 -0. 8 1950 1960 1970 1980 1990 2000 TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 29

Hurricane Activity on the Rise? Average 1950 -2005 Named Storms 2004 2005 Initial 06 Forecast “Very Active” 11 15 28 13 -16 Hurricanes 6 9 15 8 -10 Cat 3 -5 2 6 7 4 -6 Cat 5 0. 4 1 4 N/A US Hurricanes 1. 6 6 5 88% US Cat 3 -5 0. 7 3 4 81% Other factors, including temporal and geographic expansion of the basin; and sustained intensity of storm TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 30

NOAA Declares the Onset of an El Niño n September 10 th, 2006 “Scientists at the NOAA Climate Prediction Center reported that El Niño conditions have developed in the tropical Pacific and are likely to continue into early 2007…Ocean temperatures increased remarkably in the equatorial Pacific during the last two weeks. ” "Currently, weak El Niño conditions exist, but there is a potential for this event to strengthen into a moderate event by winter…also, the development of weak El Niño conditions helps explain why this Atlantic hurricane season has been less active than was previously expected. ” “El Niño typically acts to suppress hurricane activity by increasing the vertical wind shear over the Caribbean Sea region. However, at this time the El Niño impacts on Atlantic hurricanes are small. We are still in the peak months of the Atlantic hurricane season, and conditions remain generally conducive for hurricane formation. ” TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 31

Expansion of the Atlantic Basin? Hurricane Alex (Cat 3) most intense N of 38 N Aug 3 rd - 5 th 2004 Tropical Cyclone Catarina Brazil March 26 th – 27 th 2004 First S. Atlantic Hurricane? Hurricane Wilma (Cat 5) most intense Atlantic Hurricane – 882 mb Oct 18 th – 25 th 2005 Hurricane Ivan (Cat 5) Longest lasting Intense Hurricane Sept 5 th – 16 th 2004 TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 32

Vigorous & Visible Debate on Climate TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 33

Climate Change Debate and Hurricane Activity n The WMO (World Meteorological Organization) has released a statement on the current state of debate – “The division in the community is not as to whether Global Warming can cause a trend in tropical cyclone intensities. Rather it is on whether such a signal can be detected in the historical data base. ” – “Whilst the existence of a large multi-decadal oscillation in Atlantic tropical cyclones is still generally accepted, some scientists believe that a trend towards more intense cyclones is emerging. ” – “No single high impact tropical cyclone event of 2004 and 2005 can be directly attributed to global warming, though there may be an impact on the group as a whole. ” Prepared by the WMO/CAS Tropical Meteorology Research Program, Steering Committee for Project TC-2: Scientific Assessment of Climate Change Effects on Tropical Cyclones. February 2006 TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 34

RMS Expert Elicitation, October 2005 Jim Elsner Kerry Emanuel Professor Florida State Tom Knutson Professor, MIT GFDL, NOAA, Princeton, NJ Mark Saunders Professor, University College London The Climate Change Trend The Multidecadal Cycle activity v 1930 1950 1970 1990 2010 2030 TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 35

Geography of Hurricane Activity Increase Changes in CAT 3 -5 Activity vs. 1900 -2005 Cat 1 -2: 21% increase in activity Cat 3 -5: 36% increase in activity 20% OP increase in rates + + 15 - 20% 20 - 30% 30 - 45% > 45% TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 36

Vulnerability to Damage and Insured Loss TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 37

Comparison of Industry Platform PD Losses to Modeled Estimates TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 38

Development of Vulnerability Curves n Approach – Analytical damage assessment • Detailed platform hurricane damage analysis reports • Evaluation of structural response to wind and wave action • Design guidelines – Detailed analyses of historical claims data n Vulnerability curves are functions of: – New construction classes – Modeling of OEE – New year-built ranges – Modeling of CBI – New occupancy classes – OP specific loss amplification TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 39

New Construction Classes Risk. Link® 5. 0 n Shallow Water n Fixed { n Jackups n Caissons/Well Protectors – Up to 1971 – Post 1971 Risk. Link® 6. 0 – Up to 1971 – Post 1971 n Fixed n Deepwater – Up to 1971 – 1972 – 1980 – 1981 - 1993 { – Post 1993 n TLP/Spar n Semi-submersibles n Drillship © 2006 Risk Management Solutions, Inc. CONFIDENTIAL TM 40

Mobiles Jackups 6. 0: Jackups n Used for drilling new wells – move from location to location 5. 0: Shallow Water n Design Requirements – 10 -Yr API Design MDR • Wind (1 -min): 78 mph • Significant wave height: 26 ft n Typical damage mechanisms – Failure of legs and separation of hull Ocean Warwick after Katrina Wind Speed/Wave TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 41

Mobiles Semi-Submersibles n Used for drilling new wells – move from location to location 6. 0: Semis 5. 0: Deep Water n Design requirements MDR – Mooring line design criteria: similar to Jackups – Rig itself designed to more stringent criteria n Typical damage mechanisms – Mooring lines break – Anchors dragged Wind Speed TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 42

Platforms in Shallower Water Caisson/Well Protector 6. 0: Caisson Up to '71 n – No design guidelines pre-1971 6. 0: Caisson - Post '71 – Typically 100 -yr winter storms/sudden hurricanes 5. 0: Shallow Water n MDR Design requirements Typical damage mechanisms – Damage to deck and rails – Bending of well jacket Wind Speed TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 43

Platforms in Shallower Water Fixed Platforms 6. 0: 5. 0: Fixed-Pre '71 Fixed-'72 - '80 Fixed-'81 - '93 Fixed-Post '93 Fixed - Structure Upto 1971 Fixed - Structure Post 1971 n – No design guidelines pre-1971 – Typically 100 -yr design criteria – Further changes in 1980 and 1993 n MDR Design requirements Typical damage mechanisms – Wave-in-deck – Buckling of legs Wind Speed TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 44

Platforms in Deeper Water Drill Ship 6. 0: Drillships Used for drilling new wells – move from location to location n Typically of modest risk since drill ships can be moved away from path of inbound storms MDR 5. 0: Deep Water n Wind Speed TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 45

Platforms in Deeper Water TLP/Spar n 6. 0: TLP/Spars Design requirements – Stringent design guidelines – Designed for deeper waters 5. 0: Deep Water n Typical damage mechanisms MDR – Wave-in-deck – Wind damage to topsides Damage to Mars during Katrina Wind Speed TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 46

Loss of Production Income (Lo. PI) Modeling n Business Interruption (BI) – Direct physical damage caused to the platform – Modeled through effective downtime n Contingent BI (CBI) – Damage to upstream facilities typically not owned by assured – Pipeline • Mudslide • Falling objects such as collapsed platforms • Anchor drags – Other platforms that serve as collection/processing hubs – Damage to onshore facilities TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 47

Operator’s Extra Expense (OEE) Modeling n Coverage includes: – Control of well n Modeled for: – Caisson/Well Protectors – Fixed platforms n Platform needs to be severely damaged/ collapsed n OEE vulnerability functions based on the probability of severe platform damage Number of Wells Lost – Redrill costs Reported Modeled n Validated on MMS Well information Ivan Katrina Rita TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 50

Change in Modeled PD Risk, Industry Aggregate 2006 IED TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 51

Evolution in Re/insurer Modeling and Risk Management Practice TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 52

Insurance Industry Dynamics in Flux n Risk increasing (modeled risk, more risks) n Capital requirements increasing (even for same risk) n Re/insurance rates increasing n Insurers are taking action to manage their exposures n Insureds retaining more risk n New capital entering the market, and ART “We remain of the opinion the amount of capital required by a re/insurer in peak zones will increase by 50%+. We believe that demand for coverage will increase as the new models are introduced, new PMLs are calculated, and rating agencies require more capital” - Dowling and Partners TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 53

Integrated Decision Making Under “Deep” Uncertainty Risk Management Approach • Risk Transfer • Capital efficiency Frequency High • Pricing • Control • Capital adequacy Non-CAT Risk Low not material SUPER-CAT Low High Extreme • Per-risk models / scoring • Probabilistic portfolio models • Scenarios • Accumulation frontier of modelability Severity / Correlation Risk Measurement Techniques TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 54

Modeling and Underwriting, Together “The most important factor in improving underwriting is better information on risks…executives say believe that they need more granular risk assessments than traditional approaches” - Economist & Deloitte Insurance Survey 2003 “Whether they misclassify risk or allow risk pricing to be driven by the market instead of underwriting discipline. . . is the fundamental driver of low returns in this industry” - Mc. Kinsey & Company, The Journey Revisited 2004 “Disciplined underwriting will continue that highlights exposure data, related loss modeling and pertinent underwriting information” - 2005 Insurance Market Overview “There is one certainty amid all this confusion. We are in a period of increased frequency and severity of hurricane activity. The sooner the industry accepts this and adapts its underwriting, the better off it will be” - 2006 U. S. Insurer, Editorial Page TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 55

We Live in a Quantum World TM © 2006 Risk Management Solutions, Inc. CONFIDENTIAL 56