WEATHER RISK MANAGEMENT LYNDA CLEMMONS ELEMENT RE ISDA

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

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 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 = REVENUE LOWER EARNINGS VOLATILITY

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

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 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 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 • 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 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 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

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. 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 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 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 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. elementre. com 20