1. 1 Presented by: Steve Goldberg SVP, P&C Underwriting & Pricing USAA Presentation to: The CAS Seminar on Catastrophes October 23, 1998 Implications Of The First and Second Successful Large Scale Securitizations of Catastrophe Risk

2. 2 Objective of Briefing To summarize the Residential Re transaction and its implications for USAA, the P&C Insurance Industry and investors. and investors.

3. 3 How will USAA insulate itself from the next mega-hurricane?

4. 4 Hurricane Andrew made landfall in South Dade County Florida devastating Homestead Air Force Base.

5. 5 1992 Hurricane Andrew USAA$600,000,000 Industry$16,500,000,000

6. 6 A storm the size of Andrew just 40 mi. north would have resulted in insured losses of over $50 billion HAFB Miami 40 miles north Miami 40 miles north

7. 7 Exposure to Mega-Hurricane Estimated U.S. Insured Losses (1/500 Yr.) $22 Billion HurricaneHouston-Galveston $21 Billion Hurricane Northeast Region $17 Billion Hurricane Southeast Region $76 Billion Hurricane Florida Region Source: Risk Management Solutions, Inc.; Insurance Services Office, Inc.

8. 8 Strategic Challenge: Industry Perspective l Since 1989, a series of natural disasters has resulted in variability in insurance losses. l Prior to Hurricane Hugo, the insurance industry had never suffered losses from a single disaster over $1 Billion. l Since then, 11 natural disasters have exceeded this amount. l Traditional reinsurance mechanisms are limited in capacity. l Recent events have caused the insurance industry to reconsider its approach in handling low frequency, high severity occurrences. l The questions have centered around the following: — What steps can we take to reduce losses from future disasters? — What steps can we take to reduce variability in insurer results from future disasters?

9. 9 l Serving members who live in catastrophe- prone areas requires maintenance of a high level of capitalization and liquidity. l If such exposures could be mitigated, then transferred or separately securitized, USAA could more efficiently deploy its capital resources. Strategic Challenge: USAA Perspective

10. 10 Options Considered By USAA To Address The Strategic Challenge Options Considered By USAA To Address The Strategic Challenge l Expanded Traditional Reinsurance l Catastrophe Bonds l Catastrophe Options l Surplus Notes and Contingent Surplus Notes l Contingent Equity l Catastrophe Swaps

11. 11 Options’ Issue: Financing vs. Hedging FinancingHedging Impact on: PML PMLNoYes Surplus SurplusYesYes Liquidity LiquidityYesYes Balance Sheet Balance Sheet Yes * Yes * Contingent type can be kept off balance sheet until exercised. * Contingent type can be kept off balance sheet until exercised. Risk Transfer NoYes Instrument Surplus Notes Reinsurance Cat Bonds CBOT Contingent Surplus Notes Contingent Equity

12. 12 - Competitive. - Financially Strong. - Highly Rated. - No regulatory concerns. R USAA Capacity Cost Security Permanence Risk Transfer CapitalMarkets ReinsuranceMarkets USAA Preferred Hedging Strategy Strategy USAA Preferred Hedging Strategy Strategy

13. 13 Hedging Design Field Re-insurance C. B. O. T. Cat Bond Indemnity Index Source: “Financial Risk Management For Catastrophes”- Neil Doherty Credit Risk Moral Hazard Basis Risk

14. 14 Selected Hedging Instruments l Expanded Traditional Reinsurance l Catastrophe Bonds

15. 15 Characteristics Of Catastrophe Bonds l Rated security l Renewable process l Supplement to traditional reinsurance l Objective risk assessment l Potentially attractive to investors

16. 16 Special Purpose Reinsurer How it Works Company SPRReinsurancePremium Investor To secure obligations under the Reinsurance Agreement Reg 114 Trust Account

17. 17 The Reinsurance Agreement l Obligates Residential Reinsurance to pay USAA for the claims in the layer between $1.0 billion and $1.5 billion resulting from a single Class 3, 4 or 5 hurricane in the Covered States during a 12 month claims period. l USAA will retain not less than 10% of the risk.

18. 18 Catastrophe Bond Transaction Timeline Catastrophe Bond Transaction Timeline June 15, 1998 - May 31, 1999 June 15, 1998 - May 31, 1999 June 1, 1999 - June 1, 1999 - Dec 1, 1999 Dec 1, 1999 Dec 1, 1999 Dec 1, 2009 Risk Period ExtendedClaimsPeriod Class A-1 Principal Extension Period June 1 Dec 1 June 1 Dec 1 Typical Hurricane Season

19. 19 Key Issues Encountered l Federal Tax – SPR off-shore – Debt vs. equity interest l Regulatory – Recognition that investors are not in the business of insurance l Securities – Public vs. private offering l Bond Structure – Principal at risk vs. principal protected – Single year vs. multi-year transaction

20. 20 The Investor’s Perspective

21. 21 Why Do I Buy? l Increase Yield l Reduce Portfolio Variability

22. 22 What Do I Need To Know? Questions that need to be answered from Investor’s Perspective l How do I assess the risk ? l How credible is the risk assessment ? l When do I feel that I have become educated enough to buy ? l Is this the first transaction of this kind? l Is there a pipeline of future deals to further increase diversification ? l Why have they bypassed the reinsurance market ? l Can I afford to lose all my principal ? l What are the regulatory impacts (especially for life insurers and pensions funds) ? l Isn’t one year too short; wouldn’t a multi-year commitment improve the utility of this instrument ?

23. 23 Who Are The Investors? Bottom line: 90 - 95% of the money is new to the P&C Insurance Industry. This is “found money”; capital that would never have been applied to the problem of catastrophe protection through either investment in primary insurers or reinsurers.

24. 24 Categories Of Investors: This is a Global Market l Life Insurers l Pension Funds l Reinsurers l Hedge Funds l Banks l Investment Advisors

25. 25 Wall Street Journal June 18, 1997 Wall Street Journal June 18, 1997

26. 26 Even Nature Can Be Turned Into a Security Into a Security High Yield and Big Risk With Catastrophe Bonds Even Nature Can Be Turned Into a Security Into a Security High Yield and Big Risk With Catastrophe Bonds THE NEW YORK TIMES AUGUST 6, 1997 THE NEW YORK TIMES AUGUST 6, 1997

27. 27 ImplicationsImplications l Transaction will be the evidence that securitization of catastrophe risk on a large scale is possible. l Renewing transaction will improve cost and efficiency. l Soft reinsurance market may deter rapid growth. l Multi-year periods could be negotiable. l New risk capital available. l Fundamental change in the game.

28. 28 Final Observations l USAA is driven by the need to serve our members. l Traditional reinsurance capacity is limited. l Reinsurance market must be supplemented to increase capacity. l Capital markets offer the potential to supply this additional capacity. l Improving efficiency and cost will be a major objective as we renew the process.

29. 29 ConclusionConclusion l This pioneering (and now renewed), mutually beneficial transaction fulfills the strategic purposes of: –Tapping into the vast pool of capital for capacity. –Introducing a new asset class which supplements reinsurance. –Providing a vehicle for investors to increase yield, while reducing portfolio risk through diversification.

30. 30 Insulating USAA from the Financial Impact of a Mega-Catastrophe