II- Capital and Capital Management

1. II- Capital and Capital Management Presented by Michel M. Dacorogna Moscow, Russia, April 23-24,2008

2. Important disclaimer Although all reasonable care has been taken to ensure the facts stated herein are accurate and that the opinions contained herein are fair and reasonable, this document is selective in nature and is intended to provide an introduction to, and overview of, the business of Converium. Where any information and statistics are quoted from any external source, such information or statistics should not be interpreted as having been adopted or endorsed by Converium as being accurate. Neither Converium nor any of its directors, officers, employees and advisors nor any other person shall have any liability whatsoever for loss howsoever arising, directly or indirectly, from any use of this presentation. The content of this document should not be seen in isolation but should be read and understood in the context of any other material or explanations given in conjunction with the subject matter. This document contains forward-looking statements as defined in the US Private Securities Litigation Reform Act of 1995. It contains forward-looking statements and information relating to the Company's financial condition, results of operations, business, strategy and plans, based on currently available information. These statements are often, but not always, made through the use of words or phrases such as 'expects', 'should continue', 'believes', 'anticipates', 'estimated' and 'intends'. The specific forward-looking statements cover, among other matters, the reinsurance market, the outcome of insurance regulatory reviews, the Company's operating results, the rating environment and the prospect for improving results, the amount of capital required and impact of our capital improvement measures and our reserve position. Such statements are inherently subject to certain risks and uncertainties. Actual future results and trends could differ materially from those set forth in such statements due to various factors. Such factors include general economic conditions, including in particular economic conditions; the frequency, severity and development of insured loss events arising out of catastrophes; as well as man-made disasters; the outcome of our regular quarterly reserve reviews, our ability to raise capital and the success of our capital improvement measures, the ability to exclude and to reinsure the risk of loss from terrorism; fluctuations in interest rates; returns on and fluctuations in the value of fixed income investments, equity investments and properties; fluctuations in foreign currency exchange rates; rating agency actions; the effect on us and the insurance industry as a result of the investigations being carried out by US and international regulatory authorities including the US Securities and Exchange Commission and New York’s Attorney General; changes in laws and regulations and general competitive factors, and other risks and uncertainties, including those detailed in the Company's filings with the US Securities and Exchange Commission and the SWX Swiss Exchange. The Company does not assume any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. Please further note that the Company has made it a policy not to provide any quarterly or annual earnings guidance and it will not update any past outlook for full year earnings. It will however provide investors with perspective on its value drivers, its strategic initiatives and those factors critical to understanding its business and operating environment. This document does not constitute, or form a part of, an offer, or solicitation of an offer, or invitation to subscribe for or purchase any securities of the Company. Any securities to be offered as part of a capital raising will not be registered under the US securities laws and may not be offered or sold in the United States absent registration or an applicable exemption from the registration requirements of the US securities laws.

3. Agenda

4. The need for capital • We have seen that beyond the expected loss, the insurer needs to make sure that he can pay his liability. • For this, he uses the capital he got from his shareholders to guarantee that he will pay up to a certain probability. • Then the first question to ask is: how much capital the company is willing to risk within a given time horizon (usually 1 year)? • It is helpful to clearly distinguish between the available capital: equity, long-term debts, unrealized gains, discount in loss reserves, latent taxes, …, which is called the economic capital. • And the minimal amount of capital the insurer would technically need in order to cover the risk it has taken: the risk-based capital (RBC).

5. The two dimensions of capital:available versus required capital Economic resources available to develop the business or take on more risk Economic Adjustments: discount in loss reserves(+) miscellaneous other discounts...(+/-) Less reinsurance More reinsurance Capital as reported in financial statement RBC for underwriting risk: New business Reserves RBC for investment risks RBC for other risks Economically adjusted capital: Available Capital Capital required given management’s risk appetite: Risk-Based Capital

6. Risk-Based Capital • Let us define, as in the previous presentation, the underwriting result (UWR) as: UWR = Premium – Losses – Expenses (everything discounted according to their payout patterns). • Risk Based Capital depends on: • The risk measure chosen (s, VaR, ES,), • The risk tolerance level a. • We define Risk Based Capital (RBC) as a function of the risk measure and the risk tolerance.

7. Three possible definitions ofRisk Based Capital UW Result Distribution Expected UW Result Solvency Requirement Capital needed to insure against Bankruptcy RBC1 Capital needed to insure Solvency RBC2 Capital needed to insure UW Result RBC3 Premium Bankruptcy Level UW Result 0 Cost Losses

8. Each definition plays a role • Given our definition of risk, which is the probability of not meeting a certain expectation (different for customers, regulators and investors), we can define the following notions of RBC: • RBC1 is used when pricing. We want to make sure that the business is well written: The more premium for the same risk, the less capital. • RBC2 is needed to satisfy the regulators. We want to keep the business running. • RBC3 is needed to meet investors’ expectation. They expect our business to be profitable. • The optimal deployment of capital as the shareholders expect must be implemented through the business strategy (and not through the definition of capital itself).

9. Capital and allocation of capital as foundation of the Risk / Reward strategy • In financial institutions the primary focus of capital is not to provide finance, but to absorb the risks undertaken • It is thus the “commodity” to produce the company business • Its allocation is not ancillary to the business processes; it must be at the heart of them • It is a precondition for the optimisation of shareholder value • The heart of a risk / reward strategy is thus the proper definition and allocation of capital

10. What is economic capital?Different people have different views • For shareholders: • Capital is the monetary “value” of a firm for its “owners” • It is employed to generate future profits and should stay as small as possible (target capital) to avoid agency problems • For regulators and policyholders: • Capital is the guarantee of the ability to make liability payment beyond the expectation • It should be as large as possible • For rating agencies: • Capital equals the monetary value of a company from which some creditworthiness is derived for risk assessment of the company • They conduct an assessment of “sufficient” capital levels • For management and employees: • Capital is their core means to generate profit • It needs to be managed to satisfy all stakeholders

11. (Potential) stakeholders of capitaland their business interests • Current shareholders: risk – return perception, i.e. invested capital to be adequately rewarded within defined limits • Potential investors: risk – return perception, similar to shareholders • Policyholders/bondholders: seek value protection, no direct risk / reward perception • Employees/Management/Board of Directors: more complex picture • Agents: • Employees/Management/Board of Directors: agents of shareholders • Regulatory bodies: agents of policyholders, demand “sufficient” lower capital limit • Rating agencies: agents of investors and clients, assessment of “sufficient” economic capital levels for different credit levels

12. What is “sufficient” capital? • “Sufficient” capital equals the monetary value of a company that it has to have, given the risk assessment of the company by a stakeholder or his agents (rating agencies, regulators, investors, management). • How much is the investor prepared to lose in return for the profit expectation? (How well is a policyholder protected?) • This is basically Risk-Based Capital (RBC) + some “buffer capital” on top • The various stakeholders use different definitions regarding RBC depending on: • The risk tolerance of the stakeholder • The depth of knowledge about the risks and their dependencies regarding the concrete company • SCOR measures its Risk-Based Capital based on the expected shortfall of the firm’s economic profit. This measure is in general also used by the Swiss Solvency Test (SST).

13. Accommodating the differentviews in capital • The art of capital management is to accommodate these very different views in order to achieve both an adequate return on equity and a stable rating for the company • Finally, model uncertainty should also enter in the equation

14. Capital allocation and performance • Concepts of capital are crucial within the company when it comes to investing profitably the capacity across the different lines of business and for the investment risk. • Optimal “allocation of capital” to a line of business or a treaty is related to the risk contribution of the line of business or the treaty to the overall expected shortfall • The allocated capital has to be profitable, i.e. generate adequate profit The pricing tool must take care of this at treaty level

15. Underwriting RBC and Pricing:Capital allocation down to a treaty level • Risk- based performance indicators per treaty: • Capital (TRAC) • RoRAC • Performance excess against Hurdle and Target rates Market … … P/NP Our EPI NPV TRAC RoRAC Perf. Perf. Name Excess Excess Hurdle Target Eastern Europe Prop 118‘679 18‘638 105‘804 17.6% 6‘808 3‘385

16. Agenda

17. Drivers Key Questions Capital management framework (1/2) Industry peers • How much capital does a company need and what should it do with excess capital? • What type of capital should it have? • How should it reward capital on an ongoing basis? Regulators Rating Agencies Management/Economic Capital Capital Markets

18. Capital Management Framework (2/2) 2,900 ??? Signaling Capital 2,200 Key challenge: determine appropriate buffer (see next page) 1,600 700 Internal model Regulatory model* A-range Rating model Risk Based Capital In € million, the numbers are illustrative 2,200 ??? Take the maximum of the three definitions to satisfy allstakeholders Available Capital* Required Capital (RBC) Buffer Capital Target Capital * All the other capital are computed at t1 while available capital is computed at t0

19. Determining the size ofthe capital buffer (1/2) • A capital buffer is required for two reasons: • Need for a safety margin to avoid having to go to the capital market every year • Model uncertainty • Internal models give as a result the probability distribution of the shareholders’ equity after one year • To determine the buffer we add to the required capital the quantile of the distribution corresponding to a probability of being exhausted of 10 to 13% • The buffer plus the required capital constitute the target capital of the company

20. Determining the sizeof the capital buffer (2/2) • Such a buffer gives a probability to hit the required capital not more than once every 7.5 to 10 years • This means a safety margin to avoid frequent capital increases • The threshold at which to determine the buffer will depend on the risk appetite and the access to financial markets of the company as well as its target ROE

21. Buffer capital limitsprobability of a capital increase S&P CAR: 140% Recapitalization probability 25% (1 in 4 years) 80 Net income exceeds expectations 20% (1 in 5 years) 150 Net income below expectations Expected Net Income 300 13% (1 in 7.5 years) 300 Negative net income partially reduces buffer 300 -400 Buffer Capital 10% (1 in 10 years) 400 Required capital Capital raising necessary 2,200 5% (1 in 20 years) 600 10 -13% probability S&P CAR: 150% In million EUR Scenarios: Consider capital return transaction Revise business model Profit/loss distribution determines probabilities for recapitalization necessity Proposed Buffer capital range

22. Risk-return tradeoff for different recapitalization probabilities Proposed Target Capital range Next Year ROE • The mathematical relation between target ROE and buffer is as follows: Buffer / Required Capital = (Market Risk Premium – Target ROE) / Target ROE • In this case 9% above the risk free rate corresponds more or less to 1/10 years buffer (should be the result of the internal model) 15.5% 14.6% 14.1% 13.4% 12.9% Consider capital return transaction Revise business model 12.0% Recapitalization every x years (probability) 3 (33%) 4 (25%) 5 (20%) 7,5 (13%) 10 (10%) 20 (5%) • Lower recapitalization probability requires more buffer capital • The more target capital, the less ROE at given profit • There is a natural trade-off between safety and profitability

23. Buffer capital - model uncertaintysingle worst-case scenarios (examples) Capitalincrease necessary Equity: +300 Equity: 0 In million EUR Probability 0.4% US earthquake 100 Single peril scenarios US hurricane 0.4% 180 EU windstorm 0.4% 280 All currencies down 20% vs. EUR N.A. 320 Capital market scenarios All equity, real estate and hedge funds down 30% 1.7% 325 All interest rate parallel up by 300 bp 0.4% 345 Global pandemic 0.7% 350 Tokyo earthquake of 1923 incl. capital market effects Multi risk driver scenarios 0.2% 620 Severe adverse development in reserves 0.2% 705

24. Capital position over a three year period In million EUR Neutral excess capital range Neutral target capital range Target Capital Available Capital Neutral Range Required Capital Buffer Capital Excess Capital S&P CAR Y1 2.200 400 2.600 2.900* 300 +-130 161% Y2 2.240 410 2.650 2.850* 200 +-133 154% Y3 2.280 420 2.700 2.870* 170 +-135 152%

25. Excess capital return framework

26. Agenda

27. Equity versus long term debt (1/2) • Equity is the most flexible form of economic capital and very much liked by regulators and rating agencies, but disliked by shareholders • For companies, equity is the most expensive form of capital because they are required to pay the cost of equity on it • Long term debt is usually less expensive than equity. Particularly, for companies that have a good credit rating, which is the case for reinsurances • Long term debt is thus a way to reduce the cost of capital and increase the return on equity

28. Equity versus long term debt (2/2) • Long term debt is however quite inflexible: contrary to dividends, costs must always be paid to avoid bankruptcy • This is why a company must carefully decide by how much it should leverage its capital • All the return and risk considerations must be taken into account (Enterprise Risk Management) • The ratio between long term debt and equity is called leverage • Often a peer review would help assess the reasonableness of the chosen leverage

29. The various forms of capital Increasing equity characteristics Rating agencies generally treat hybrid as capital up to 25% of total adjusted capital

30. Leverage constraints Maximum hybrid capital exposure set by rating agencies serves as a good proxy for leverage constraints 3,920 1 in 7.5 years In million EUR 3,410 3.410 • Only Required Capital is leveraged by 25% • Buffer Capital and Excess Capital are not leveraged at all since they are kept for absorbing adverse events 980 980 25% 29% 850 S&P available TAC + hybrid capacity S&P model required TAC at 125% + hybrid capacity S&P available TAC after 1 in 7.5 year loss + hybrid capacity

31. Then confirmed by a peer analysis Capital Structure of the major European re(insurance) companies in 2007 Source: JP Morgan

32. Authorized and Contingent Capitalmust be first defined by the ERM approach Example: Loss of Required Capital, given complete loss of Buffer Capital Conditional Probability 100% Figures derived from internal RBC model • Authorized capital of EUR 250 million would enable the company to relatively quickly re-establish the Required Capital in about 55% of these negative scenarios • Contingent capital of EUR million on top would enable quick re-establishment of Required capital in another 25% of these negative scenarios • Only 1 in 37.5 to 50 years would it be necessary for the company to raise more than EUR 500 million in capital to re-establish the Required Capital 75% 50% 25% Loss of required capital 125 250 375 500

33. Agenda

34. Wrap-up Capital Management (1/2) • In a modern reinsurance company, capital allocation is used to optimize the risk / reward strategy • Capital allocation to all business units will steer the portfolio towards better diversification and profitability • A clear capital management framework is appealing to all stakeholders of the company • A company should aim its capital to be within a Target Capital range consisting of two elements: • Required Capital must be held at any time and is defined so that requirements of all relevant stakeholders are met • A Buffer Capital range is defined on top of Required Capital in order to manage the probability with which the company has to get additional capital

35. Wrap-up Capital Management (2/2) • When available capital is (consistently) above the upper end of the Target Capital range the company should give it back to the shareholders • When available capital is (consistently) below the lower end of the Target Capital range the company should rethink its business model including a possible capital injection • The use of hybrid capital should be limited by the amount that can be fully used from a rating agencies’ perspective even in a crisis situation and in line with the company’s peers • A prudent capital management requires sufficient authorized/contingent capital to enable management to quickly regain Required Capital in about 80% of all recapitalization scenarios

36. Appendix

37. Glossary (1/2) • Economic Capital: The difference between the marked-to-market value of the assets and the market consistent value of the liabilities • Available Capital: The economic capital deduced from the balance sheet at t0 • Risk-Based-Capital (RBC): the quantity computed by the various models (internal, rating agency, solvency) for t1*. For the internal model, we suggest using the difference between the expected value and the 1% expected shortfall of the economic capital at t1. • *The RBC at t1 for the internal model and the SST model allows for planned new business, expected claims, lapses (life) and non-renewed business between t0 and t1

38. Glossary (2/2) • Required Capital: The maximum of the internal model RBC, the capital requirements of the rating agencies model, and the solvency model, all computed for t1, at t0*. • Buffer Capital: The monetary amount above the required capital which has an X% probability (we choose 10%) of being exhausted, as calculated from the internal model computed for t1, at t0. • Target Capital: The monetary amount of capital the company needs to have at t0 in order to be able to meet its obligations at t1. In our definition, this is the required plus buffer capital. • Signalling Capital: The difference between the required capital and the available capital. It can be different from the buffer capital if the company wants to grow the business in a multi-step period. • *because it is needed at t0!