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Luxembourg, October 16, 2007 ALAC Conference

Munich Re Group – Risk Trading Unit. Trading risk into value. Securitisation of insurance risks Risk management instrument for insurers and alternative asset class. Luxembourg, October 16, 2007 ALAC Conference. Agenda. Market development and functional areas

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Luxembourg, October 16, 2007 ALAC Conference

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  1. Munich Re Group – Risk Trading Unit Trading risk into value Securitisation of insurance risksRisk management instrument for insurers andalternative asset class Luxembourg, October 16, 2007ALAC Conference

  2. Agenda • Market development and functional areas • Examining the needs of insurers and investors • Operating structures – assessing required elements • Case study • Risk trading at Munich Re Agenda

  3. 1. Market development and functional areas

  4. Market development and functional areas Munich Re Group Issues OutstandingCat Bonds Issued Cat Bonds in USD bn * and prior Source: Goldman Sachs Market Development and functional areas

  5. Market development and functional areas Munich Re Track Record • In USD mn; **Munich Re of America, formerly American Re

  6. Market development and functional areas • The cat bond market has further matured in 2005, 2006, 2007 • Record issuance in 2006 • Large pipeline in 2007 • New risks transferred to capital markets (industrial 3rd party liability, motor portfolio, trade credit, Mexico EQ, Mediterranian EQ, cat mortality) allow investors to diversify into new risk classes • Cat bond spreads widened substantially after Hurricane Katrina after tightening before Katrina • Storm resulted in first total loss, i.e. Kamp Re • Spread widening in particular for critical exposure zones (e.g. US Hurricane) • No detaching of capital markets from reinsurance cycle • Strong differences in prices for risks with identical expected loss level • Spreads tightening again (but higher than pre-Katrina level) Market development and functional areas

  7. Market development and functional areas • Diversified investor market (cat funds, hedge funds, traditional asset managers) • Higher risk/return layers placed • Competition through „Sidecars“ (private equity, bonds) • Issuance at USD 7,7 bn • Convergence of capital markets and reinsurance markets (ILWs, Swaps, • Munich Re reentered the cat bond market • European windstorm bond (Aiolos) over EUR 110mn (USD 128mn) • Hurricane cat bond shelf program in June 2006 (Carillon) • Second series in Mai 2007 (USD 150mn, B rating) • Cat bond transaction for Zurich in December 2006 (Lakeside) Market development and functional areas

  8. Market development and functional areas • Concentration on Peak Exposures • Tight capacities • High premium level • Diversification still limited • Traditional reinsurance without competition for diversifying risks • Price • Capacity Market development and functional areas

  9. Market development and functional areas • Embedded Value securitizations (Issuance over USD 8 bn) • Monetization of future cash flows from life insurance book of business (immediate liquidity, capital optimization) • Admin Re business model with potential for capital markets refinancing and risk transfer • Arbitrage opportunities (trade off between purchase/value of life blocks and refinancing) • XXX solutions • Capital markets financing of regulatory reserves (around USD 8.5 bn) • Risk transfer limited (credit wraps) • Traditional investors (money managers) Market development and functional areas

  10. Market development and functional areas Investors’ comfort with regard to owning insurance risk will increase due to • Proven track record of past transactions • Better model availability leading to reduced asymmetric information Sponsors’ net benefit will rise due to • Lower transaction costs per annum because of increased volumes, multi-year transactions and prevailing best practice methods; use of unissued shelf registrations which allow several takedowns • Less risk discounts demanded by investors • Decrease in basis risk as modeling capability is improved  Even without much interference from outside, the market for capital markets risk transfer solutions is likely to grow further with at least slowly increasing growth rates Market development and functional areas

  11. 2. Examining the needs of insurers and investors

  12. Advantages Capacity in tighter markets Additional and alternative capacity Diversification Collateralization Immediate liquidity Transparency Multi year cover Disadvantages Basis risk Decreases with improvements of modelling capabilities Transaction costs Risk transfer costs Tightening of prices between reinsurance and capital markets for Peak Exposures Complexity Dependence on investor preferences Needs of insurers and investors – insurer’s view Needs of insurers and investors – insurer’s view

  13. Needs of insurers and investors – investor’s view Advantages • High yield • Compared to credit markets • Track Record • One default • Uncorrelated asset class • Investment in pure insurance risks • Not possible in insurance stocks Expected Loss 0,23 1,6 2,7 2,8 3,6 8,5 Needs of insurers and investors – insurer’s view

  14. Needs of insurers and investors – investor’s view Comparison of BB rated CMBS with a BB rated cat bond (Lakeside) Needs of insurers and investors – insurer’s view

  15. Needs of insurers and investors – issues for investors • Liquidity • High bid/offer spreads • Secondary market write downs (after issuance) • Risk assessment • Rating and pricing based on risk modelling • Different modelling approaches of the Modelling Agencies • Modelling arbitrage • Change in modelling approach • E.g. US Hurricane • Doubling of industry losses • Downgrade of outstanding Hurricane Bonds Needs of insurers and investors – insurer’s view

  16. Investor market Excess demand for hurricane protection first half 2006 Secondary market pricing Write down of new issues Change in investor appetite Preference for one year deals Regional covers instead of whole market Exclusions (flood) MR requirements High volume Fair price Multi year cover Whole market protection No exclusions Needs of insurers and investors – conflict of interest Example US Hurricane – MR cat bond 2006 (Carillon I) Needs of insurers and investors – insurer’s view

  17. 3. Operating structures – assessing required elements

  18. Operating structures – assessing required elements Efficient protection Compliance with regulations Costs Success of placement Operating structures – assessing required elements

  19. Operating structures – assessing required elements Structural considerations • Determine risk to be securitized (peak exposure) • Determine expected loss (EL) probability of securitisation • Select the EL range offering the best economics (protection vs. price) • The lower the EL, the higher the multiple to be paid as spread • The higher the EL the lower the multiple • Increasing investor appetite for higher EL ranges • Fit in overall reinsurance program Operating structures – assessing required elements

  20. Operating structures – assessing required elements Selection of trigger type • Parametric (based on event generation) • Industry loss (based on damage caused) • Modelled loss (reference portfolio) • Indemnity (based on financial loss of sponsor) Modelling Risk Investor Parametric Modelled Loss Indemnity Basis RiskSponsor Operating structures – assessing required elements

  21. Operating structures – assessing required elements Selection of trigger type • Indemnity trigger • Best for sponsor (no basis risk) • Availability of exposure data • Publication of exposure data • Challenging to sell to investors (moral hazard) • Synthetic trigger (parametric, modelled loss, market loss) • Wide market acceptance (clarity & transparency) • Assessment of basis risk essential • Availability of internal know how Operating structures – assessing required elements

  22. Operating structures – assessing required elements Clarity on accounting and taxation • Balance sheet consolidation to be avoided • Close coordination with auditors • No financial leverage • Use reinsurer as fronter and legal sponsor • Taxation regime • No unfavourable taxation of collateral trust assets and premium cash flows (excise tax) • SPV location decisive • Double tax treaties in place Operating structures – assessing required elements

  23. Operating structures – assessing required elements Selection of service providers • Modelling Agency (inc. loss verification) • Credibility of model crucial for rating and success of transaction • SPV administrator • Indenture trustee • Legal • Limited number of law firms active • Placement (one placement bank sufficient) • Beauty contest • Rating agency (one agency sufficient) Operating structures – assessing required elements

  24. Operating structures – assessing required elements Form of issuance • 144A private placement standard „Principal at Risk“ • Tranching • Currency SPV • Off Shore (Cayman or Bermuda, Ireland) • Minimal capitalization provided by Charitable Trust • Consolidation with sponsor unlikely Operating structures – assessing required elements

  25. Operating structures – assessing required elements Project management (responsible for execution and success) • Conceptual design • Internal coordination • Internal submission • Engagement of service providers (organization of beauty contests) • Manage internal and external interfaces and service providers • Manage costs • Control time schedule • Controlling Operating structures – assessing required elements

  26. 4. Case Study

  27. Case study I – Lakeside Re • Executive summary • Covered Territory: California • Risk: Earthquake • Modeling Agent: RMS • USD 190mn principal at risk bonds • 3-year EQ cover for Zurich American • Dual Trigger based on PCS industry loss and Zurich ultimate net loss (UNL) • Rating S&P: BB+ • Spread: 650bps above LIBOR Case study

  28. Case study I – Lakeside Re Issuer Lakeside Re Ltd., a Cayman Islands exempted company licensed as a Class B insurer Reinsurer Münchener Rückversicherungs-Gesellschaft Aktiengesellschaft (“Munich Re”) Ceding Insurer Zurich American Insurance Company (“Zurich”), for itself and its Pool Members (“ZAIC Pool”) Ceding Insurer Affiliates Certain branches and affiliates of the Zurich Insurance Company other than the ZAIC Pool Securities Offered US$ 190,000,000 Principal At-Risk Variable Rate Notes Closing Date December 20, 2006 Risk Period December 21, 2006 to December 23, 2009 Scheduled Redemption Date December 31, 2009 Triggers(i)Industry Loss threshold based on PCS Reports (ii) Ultimate Net Loss based on actual claims Covered Territory The United States state of California Named Peril Earthquake S&P Rating On the Closing Date, the Notes are expected to be rated “[BB+]” Distribution144A Private Placement to Qualified Institutional Buyers in Permitted Jurisdictions who, for U.S. Persons, are also Qualified Purchasers and residents of and purchasing in a Permitted U.S. Jurisdiction or a Permitted Non-U.S. Jurisdiction Case study

  29. Case study I – Lakeside Re ZurichAmerica $ 190mn Reinsurance Agreement Premiums Munich Re $ 190mn Retrocession Agreement Premiums Lakeside Re Ltd. Deposit Bank $ 190mn Principal At-Risk Variable Rate Noteholders Outstanding Principal Amount at Redemption $ 190,mn Bank Deposit LIBOR + 650bps Collateral Account $ 190mn LIBOR - Eligible Bank Fee $ 190mn Note Proceeds Case study

  30. Case study I – Lakeside Re For the indemnity layer, the expected loss is 0,43% Case study

  31. Volume • Issue size of US$ 190mn • Deal over subscribed Spread • 650bps above 3m-LIBOR • In line with reinsurance pricing • 21 Investors Investors Cat Fund Reinsurer Institutional Hedge Fund Use of Balance Sheet • Expiring Redwood V and VI • Total “bridge financing” of US$ 42.5mn Case study I – Lakeside Re Case study

  32. Case Study II – Carillon 2 • Covered Area: US East Coast • Risk: Hurricanes • Modeling Agent: AIR • USD 150mn cat bond for Munich Re • Hurricane cover over four wind seasons • Trigger based on PCS industry loss (Attachment USD 35 bn; Exhaustion USD 45 bn) • Rating S&P: B • Spread: 1525bps above LIBOR for 3 2/3 years; seasonalized: 1400bps above LIBOR • Attracted new cat bond investors • Executive summary Covered Area Non-Covered Area Case study

  33. Case Study II – Carillon 2 • Transaction structure Munich Re Carillon Ltd. Capital Markets Investors Payment Equal to Sum of Interest Spread and Swap Spread Return of Original Principal Amount at Maturity (if no trigger event) Interest: 3M LIBOR +Interest Spread Cayman Island SPV AA-/Aa3/AA- (1) Class E Principal At-Risk Variable Rate Notes PCS Index-triggeredUS HurricaneFinancial Contract Proceeds (USD) 3M LIBOR – Swap Spread + Principal at Maturity Proceeds Morgan Stanley Capital Services Inc. 3M LIBOR – Swap Spread and Return of par on Permitted Investments Collateral Account Contingent Security Interest The Bank of New York Trustee Guaranteed by Morgan StanleyA+/Aa3 (2) Investment Income on Permitted Investments + any gain • Notes • S&P (Financial Strength), Moody’s (Insurance Financial Strength) and Fitch (Insurer Financial Strength) ratings respectively • S&P (Long Term Issuer Credit) and Moody’s (Senior Unsecured Debt) ratings respectively Case study

  34. Case Study II – Carillon 2 • Trigger mechanism Generalized Class Payout Functions Principal Reduction Formula • Principal written down according to Property Claims Services’ (PCS) loss estimates Principal Reduction(%) Principal reduction affecting the Notes will be applied linearly between the applicable Event Attachment Amount and the applicable Event Exhaustion Amount using the formula below: Event AttachmentAmount (USD 35bn) Event Amount – EventExhaustionAmount OriginalPrincipalAmount X Event ExhaustionAmount(USD 45bn) Event AttachmentAmount (USD 35bn) EventAttachmentAmount – Any principal reduction is limited to the Outstanding Principal Amount for the Class PCS Index Case study

  35. Case Study II – Carillon 2 • Risk metrics • Notes • Source: AIR Worldwide Case study

  36. Volume • Issue size of USD 150mn • Largest single B rated cat bond ever placed Spread • 1525 bps above 3m-LIBOR (annualized) • 1400 bps seasonalized • 17 Investors Investors Switzerland Cayman Bermuda Canada Germany Others U.K. U.S. Use of Balance Sheet • Munich Re bought USD 1.5mn to round up to USD 150mn Case Study II – Carillon 2 • Transaction outcome Hedge Fund Cat Fund I Bank Reinsurer Pension Fund Insurer Case study

  37. 5. Risk trading at Munich Re

  38. Risk Trading – Key considerations for Munich Re Attractive market conditions Attractive market conditions Pricing “multiples“* (right axis) Average expected loss* (left axis in %) in bn 2001 2002 2003 2004 2005 2006 * and prior; ** to date *For outstanding cat bonds only Source: Goldman Sachs Source: Lane Financial L.L.C. 2006 Optimal moment to increase our activity in this market segmentbenefiting from a well developed infrastructure and maturing markets Opportunities for portfolio optimization, increase of capital efficiency and additional earnings with a minimum of launching costs for MR Risk Trading – Key considerations for Munich Re

  39. Risk Trading – Active use of capital markets Munich Re’s Risk Trading approach Managing our own risks Managing our clients’ risks • Optimise portfolio • Use of additional capacity • Consulting, structuring, project management and placement support • Risk fronting / transformation and (interim) capacity provider Improve our risk/return profile and save costs Fee and risk-based income Risk warehousing Restructuring and reselling • Retain risks • Be active player in primary and secondary market • Extension of “buy and hold” strategy • Combine and restructure risks • Sell at favourable terms and conditions Risk-based, investment and arbitrage income Fee and arbitrage income Risk Trading – Active use of capital markets

  40. Outlook Dynamic market development • Doubling of market volume until 2008 • Securitization market 10% of reinsurance market • Retrocession predominantly via capital markets • New investors (high net worth individuals) • New risk classes Risk Linked Securities integral part of risk management spectrum Outlook

  41. Contacts: Munich Reinsurance Company 107 Königinstrasse 80802 Munich, Germany Dr. Marcel Grandi Senior Manger Structuring Risk Trading Unit +49 89 3891 4114 mgrandi@munichre.com

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