WEATHER RISK MANAGEMENT LYNDA CLEMMONS ELEMENT RE ISDA

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WEATHER RISK MANAGEMENT LYNDA CLEMMONS ELEMENT RE ISDA Annual General Meeting Washington D. C.

WEATHER RISK MANAGEMENT LYNDA CLEMMONS ELEMENT RE ISDA Annual General Meeting Washington D. C. Developing Products Panel - April 5, 2001 at 2: 15 PM

THE WEATHER MARKET – SOME FLAVOR

THE WEATHER MARKET – SOME FLAVOR

WEATHER RISK IS EVERYWHERE! “ 70% of US Companies are affected by weather” -US

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 3

TWO DISTINCT TYPES OF WEATHER RISK NON-CATASTROPHIC COMMON VARIABLES TEMPERATURE PRECIPITATION HURRICANES EARTHQUAKES TARGET

TWO DISTINCT TYPES OF WEATHER RISK NON-CATASTROPHIC COMMON VARIABLES TEMPERATURE PRECIPITATION HURRICANES EARTHQUAKES TARGET PROFITS PROPERTY FREQUENCY REGULAR RARE IMPACT INCREMENTAL IMMEDIATE EFFECT 0% TO 30% HUGE TRADITIONAL MANAGEMENT RETAIN INSURE MARKET PERSPECTIVE NORMAL EXTRAORDINARY MARKET REACTION PUNISH FORGIVE 4

NON-CAT WEATHER IMPACTS VOLUMES PRICE RISK MANAGEMENT x VOLUME + WEATHER RISK MANAGEMENT 5

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

MARKET DIMENSIONS l Since 1997, an estimated $10 B in limit has been transferred

MARKET DIMENSIONS l Since 1997, an estimated $10 B in limit has been transferred Ø l Average Rate On Line of 20% = $2. 0 B in premium Average US utility end-user deal is ~$50, 000/HDD with a limit of $20 MM per season l Average secondary market deal is $5, 000/$1 MM l There is a need for greater capacity 6

MARKET MAKERS, SHAPERS AND SOURCES OF GROWTH

MARKET MAKERS, SHAPERS AND SOURCES OF GROWTH

DISTINCT MARKET PHASE I: 1997 TO 1998 l Geographic Risk Spread Ø l End

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

DISTINCT MARKET PHASE II: 1999 TO 2000 l Geographic Risk Spread Ø l End

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

CUT TO: CURRENT MARKET 2001 l Geographic Risk Spread Ø l End Users Ø

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

CUT TO: CURRENT MARKET 2001 • Capacity Providers Ø Ø • Fallen Providers Ø

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

WHAT THE FUTURE HOLDS l Geographic Risk Spread Ø l End Users Ø l

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

CHALLENGES TO FUTURE GROWTH l Availability of reliable global data Ø l Ability to

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

PRODUCTS AND APPLICATIONS

PRODUCTS AND APPLICATIONS

NON-CAT RISKS COVERED l Degree Days Ø l Heating, Cooling, Specialized Temperature Ø Minimum,

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

TYPES OF INDICES l Aggregate Ø l l Indices that are additive, i. e.

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

FINANCIAL RISK MANAGEMENT GOALS l Reduce earnings volatility due to the weather l Minimize

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

PRICING CONSTRUCTS l “Burn” Analysis aka Actuarial Analysis Ø l Portfolio Analysis Ø l

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

SUMMARY l The weather market is coming into its own Ø Ø l Weather

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

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

CONTACT INFO Lynda R. Clemmons (00)1 -203 -356 -3577 [email protected] com Coming soon: www. elementre. com 20