European Re Insurance

Europe Equity Research 02 September 2010

Life Reinsurance

Unfolding the black box

Insurance

Michael Huttner, CFAAC

(44-20) 7325-9175 [email protected]

J.P. Morgan Securities Ltd.

Vinit Malhotra, CFA (44 20) 7325-5321 [email protected]

J.P. Morgan Securities Ltd.

Dibin Korath (91-22) 6157-3275 [email protected]

J.P. Morgan India Private Limited

See page 91 for analyst certification and important disclosures, including non-US aJ.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, inhave a conflict of interest that could affect the objectivity of this report. Investors should consider this repinvestment decision.

• Life Reinsurance accounts for an average 38% of the premiums of European reinsurers, 34% of our sum of parts. JPMC sees historic association with asset risk during the sub-prime crisis, and current apprehension of underpricing => reinsurers trade at a 24% discount to target prices vs a 19% discount for the total insurance sector.

• Our report shows it actually has a fundamentally stable profile vs non -life (not a broker market, mainly mortality which is conservatively priced), and has relatively high barriers to entry - so this is a business which should earn 10-13% ROE we estimate. We see a strong chance of a return to stabilisation as in the non-life reinsurance post the equity crash 01/03, albeit non-life re also benefited from a lift in pricing following 9/11 and also Hurricane Katrina.

• The accounting is opaque and complex. We believe it is for that reason the market is concerned that life re cannot pay its full share of dividends. Life re does only provide a payback after we estimate 5 years on average, but we believe mature backbooks means this issue is overdone and our dividend forecasts are safe (5.1% average yield vs 4.4% for the insurance sector average) .

• Valuation. Valuation of life reinsurance businesses calculated by backing out life from life primary insurers using the market price if 76% of 10e embedded value. Life insurance assets are currently priced on 3.7x 11e P/E at Hannover, 5.5x at Swiss, 6x at SCOR and Munich Re 9.3x

• Catalysts. Hannover (OW) targets 15% ROE, its life re profits are boosted by its focus on impaired annuities, and offers 29% upside to our Dec11e target price. SCOR (OW) we forecast may announce at its 8 Sept investor day some diversification into longevity life re, raising target ROE from 9% above risk free to 10% above, and offers 25% upside. Swiss Re (N) offers no catalyst and its life re profitability is diluted by underpriced pre 2004 mortality, but offers deep value as it is trading at a 22% discount P/NAV 10e vs 7% re average and wider insurance sector at 47% premium.

Table 1: Reinsurance - Implied valuation for Reinsurers ex Life Re, LCm Implied valuation Munich Swiss $m Hannover SCOR Market cap 18,922 15,387 4,172 3,146 Market cap (ex Life Re) 15,100 7,453 1,629 2,026 Net profit '11e 2,473 1,820 648 478 Net profit '11e (ex Life Re) 1,623 1,281 445 337 MCAP/Net profit - group 7.7x 8.5x 6.4x 6.6x Life Re - 76% of LifeRe EV/profit 4.5x 14.7x 12.5x 7.9x MCAP/Net profit - (ex Life Re) 9.3x 5.8x 3.7x 6.0x Source: J.P. Morgan estimates, MCAP from Bloomberg as on CoB 30th August

Key points and tables:

1. Attraction of life re to the reinsurers – diversification benefit example of Scor Table 2

2. Implicit valuation, after deducting life re at 76% of EV Table 4

3. JPM sum of parts valuation showing life re Error! Reference source not found.

4. Business split of European listed reinsurers in premiums Table 7

5. Accounting and reporting is complex and opaque pp10-11

6. Asset risk is the key source of life re earnings volatility – Scottish Re example Table 8

7. Life re (ex asset risk) is less than half as volatile as non-life re Table 20

8. Life re EV sensitivity is mainly mortality and lapse risk – by contrast primary insurers is mainly interest rate Table 30

9. life re is a relatively concentrated market –the top 5 have 85% share globally figure16, and in US life re Figure 22

10. cash flow profile: in the case of Scor 39% of total cash flow is in first 5 years Table 42

nalyst disclosures. vestors should be aware that the firm may ort as only a single factor in making their

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Michael Huttner, CFA (44-20) 7325-9175 [email protected]

Table of Contents Investment Thesis ....................................................................3 Overview......................................................................................................................3 Valuation gap...............................................................................................................6 High level summary with references ...........................................................................8 Nature of the life reinsurance market...........................................................................9 Five types of risk........................................................................................................10 Summary of Scottish Re profit and loss record 2005-1H10 – asset risk accounted for 85% of the earnings volatility in the period vs just 15% for mortality and other life re operating risks............................................................................................................14 Life reinsurance is relatively stable (apart from asset risk), both under IFRS accounting and US GAAP. ........................................................................................20 Comparison of the accounting standards ...................................................................22 Life re is more stable than non-life except for asset risk............................................27 Comparison of the European life reinsurers...............................................................31 Life reinsurers vs. life primary insurers – we believe the life reinsurance have more attractive risk reward, particularly at current low levels of interest rates...................34 Life reinsurance products...........................................................................................37 RGA read across summary ...................................................40 November 2008 capital issue .....................................................................................41 Capitalisation of reinsurers ........................................................................................47 Key takeaways from the earnings of RGA pre transcript of RGA conference calls 3Q09-2Q10 ................................................................................................................47 Business model: RGA example .................................................................................51 Munich Re .................................................................................................................53 SCOR.........................................................................................................................65 Profitability of a typical life (mortality) reinsurance contract....................................73 Swiss Re.....................................................................................................................75 Life reinsurance – risk products and financing reinsurance.................................................................................................83

Risk Reinsurance .......................................................................................................83 Financing reinsurance ................................................................................................85 Life reinsurance market shares ..................................................................................88 Valuation Methodology and Risks ........................................89 The contents of this report was partially based on conference calls with the main life reinsurers at various levels to understand their business and the accounting, comparison of the reported life re stats from presentations and annual reports. We thank the reinsurers for their help and stress that this report, the views expressed and the conclusions are all our own.



Investment Thesis Overview The life reinsurance market is interesting for a number of reasons: (a) it is not well understood, which presents an opportunity, in our view; (b) it has caused significant earnings volatility, mainly we believe due to asset risk; and (c) it is a focus area for most reinsurers in terms of growth and potentially M&A with the planned disposal by Aegon of TransAmerica Re.

In this report our primary objective is to explain how life reinsurance works, economically and from an accounting perspective. We argue that the market has a fundamentally stable profile vs. non-life, in that it is not a broker market, is mainly mortality where pricing has on the whole been relatively conservative, and has relatively high barriers to entry due to the need to develop specialised underwriting and relationships with cedants.

However, in the past asset risk (associated with the investing of the above highlighted long term cash flows and also assumed asset risk from variable annuities) has caused a problem, and resulted in huge earnings volatility. We conclude that taking on asset risk is not a necessary by-product of the life re business, and thus we see potential for earnings to stabilize just as non-life reinsurance did post the equity crash 2001/03. For example RGA focuses mainly on YRT mortality (ie. pay as you go) and longevity reinsurance is now increasingly on a swap basis with no asset risk assumed.

The accounting dynamics are even more confusing - this is mainly because for US GAAP and IFRS life reserves are set at historic cost on the basis of original pricing and are only reset if the unit turns into loss and the adverse deviation reserves are used up. Dividendable cash flow is still determined by statutory accounting, and while embedded value provides a good view of expected profitability (value of new business) and actual (experience variances) it does not guide to current cash flows.

Valuation. Assuming life is valued at 76% of 2010e embedded value, as is the case for the European listed life primary insurers, then the valuation of the remaining units is lowest at Hannover (3.7x 2011e earnings), next highest at Swiss and SCOR (5.5x/6.0x), and highest at Munich (9.3x). Our unchanged Overweight recommendations are Hannover and SCOR, Hannover for its 15% ROE target, SCOR as we forecast it will lift its target ROE at 8 Sept investor day to 10% from now 9% over risk free.

In our view, life reinsurance is, compared with non-life re, as reported in the accounts of the main listed European life reinsurers, not very transparent, has accounting that is still mainly historic based for liabilities, and reflects neither underlying ‘dividendable’ cash flows (this is statutory earnings), nor true profitability (embedded value does this better).

So we believe when earnings surprises do happen, as they did in the case of RGA at 1Q10 in the case of high adverse mortality, or for Sprofitability for quarterly earnings dropped from a less than SF210m (the equivalent of the stated less

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wiss Re at 1H10 when underlying year earlier SF300m per quarter to than $200m) per quarter, the

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market adjusts downwards quickly and is slower to look forward again to future earnings development.

This note tries to analyse life reinsurance in greater detail and makes three main points:

1. Asset risk We believe that life reinsurance is by nature more stable than non-life, because it consists of more layers of annual business (life reinsurance contracts last up to around 30 years, so in theory excluding lapses, every year’s new business is just 3% of the whole), is mainly directly negotiated so there is less price transparency induced by brokers as in non-life re, and the largest risk is still mortality, which benefits from a consistent improving trend which smoothes out most pricing mistakes.

However, there is asset risk. In two cases, particularly Scottish Re and Swiss Re, we believe that asset risk significantly increases volatility. For Scottish Re, we estimate that 85% of the earnings changes 2004-9 were due to asset risk, just 15% due to mortality and other operating risks. Effectively, Scottish Re’s venture as briefly the fifth largest life reinsurer in the world, following its acquisition of the ING Life Re block of business, ended when the subprime and Alt A investments of its funding structures fell and it had to restructure. The operating business of Scottish Re is now mainly with Hannover Re, where life profits account for an increasing part of group profits.

In the case of Swiss Re we have estimated the impact on life re profitability had the old style accounting continued. So, post 2007, we reallocated the surplus investment returns to the operating units (the new style accounting just allocates risk free, and so by definition removes most asset risk from the operating units). We estimate that life re under the old style reporting would have reported a loss in 2008 due to investment volatility, and that its earnings volatility would have been higher than that of non-life (relative to premiums).

Life re asset risk exists wherever there are reserves and assets and it is only in one business line that it is entirely absent: this is YRT (Yearly Renewable Term), which is like a pay as you go life reinsurance contract, and where there is no asset risk.

2. Accounting Life reinsurance for US GAAP and IFRS accounts for reserves using the original pricing assumptions. There is no change made even if they are seen to be inadequate (only the annual variance) unlike non-life, where reserves are best estimate and constantly adjusted. This means that only if the life re division as a whole is about to go into loss then the reserves are adjusted. It helps explain why Swiss Re explained that part of the reason for the lower run rate of profits going forward is the current dilutive influence of the business written in the US prior to 2004, when price competition was particularly fierce.

Also, US GAAP and IFRS are a compromise form of accounting and all the European reinsurers we spoke with actually rely more on embedded value to steer their business and to set incentive pay (even RGA in the US which does not report embedded value believes that it is a better guide to value). The two indicators most life re units track is new business margin and experience variances.

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And finally the only measure of ‘dividendable’ cash flow comes from statutory earnings, which are different again. Broadly, statutory earnings lead to delayed profit recognition (less capitalisation of deferred acquisition costs), embedded value fronts end more, with much of the value creation linked to the point of sale, and IFRS/US GAAP are compromises.

3. Diversification We believe that part of the attraction of life reinsurance is that, thanks to diversification, a relatively modest outlay of capital in this area can help boost group ROE. Also we believe that reinsurers also see life re as a relatively stable if, on standalone basis, lower margin business compared with non-life re. We estimate that the volatility of operating earnings in life re is 45% that of non-life re for all the European reinsurers, on the basis of the ratio of standard deviation to premiums (the ratio is 6.9% on average for the four listed European reinsurers for non-life, and 3.1% for life. We note that this comparison includes Swiss Re with the reported accounting change in 2007, which now gives life re just the risk free return. We believe this combination of perceived low risk and extra return for little extra capital is the key reason the main European reinsurers all have substantial life reinsurance operations.

Table 2: The attraction of life re is that it brings substantial diversification benefit - SCOR €mn Jan 2009 RBC Jan 2009 RBC Diversification standalone diversified benefit Non-life 2,800 2,400 14% Life 1,900 1,000 47% Total 4,700 3,400 28% Life to total 40% 29% Operating profit 2009 Non-life 188 Life 154 Group 342 2008 pretax ROE Standalone Diversified Non-life 6.7% 7.8% Life 8.1% 15.4% Group 7.3% 10.1% Source: Company reports and J.P. Morgan estimates.

The above table shows how this works for SCOR. On a standalone basis for 2009 non-life earned 6.7% pretax ROE, and life 8.1%. However, when allocating the diversification benefit life re earned 15.4%, and the group's total pretax ROE was lifted from 7.3% to 10.1%.

Split of risk by segment: Example of Munich Re We have shown below the type of risks for each of the products. Mortality accounts for most of the biometric risk for Munich re at 68% (2009). Munich Re mostly focuses on the mortality and morbidity risk.

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Table 3: Type of risks according to products: Munich Re mainly focus on the mortality and morbidity as stated Products Ordinary life Group life Living benefits Annuity Type of risks Mortality Full cover Full cover Morbidity Full cover Longevity Full cover Lapse Selective cover Selective cover Selective cover Investment Selective cover Selective cover Pct of total Ord and group life together 68% 29% 3% Source: Munich Re presentation, Biometric risk portfolio in share of net premium, 2009

Valuation gap We show below the summary valuation of life reinsurance within the four listed European groups. We have used 76% of our forecast 2010e embedded value (EVM in the case of Swiss Re) as a measure of the market value of life embedded value, s this is the average multiple for the listed life insurers we follow.

Among these stocks our two Overweight recommendations are Hannover Re and SCOR. Hannover appears as, implicitly, the most undervalued for the operations other than life re, when life re is valued at 76% of embedded value. SCOR also looks attractively valued. It is above Swiss Re in terms of other than life re valuation multiples, but Swiss Re has a significant portfolio of pre 2004 mortality risks, which were underpriced and which are diluting life reinsurance profitability.

On the assumption that the market would value life reinsurance on the basis of 76% of embedded value, rather than just on reported IFRS/US GAAP earnings, then Hannover Re is still most undervalued, followed by Swiss Re, then SCOR, and finally Munich.

However, we believe that the market which invests in these reinsurers mainly on the basis we believe of their ability to improve their non-life reinsurance and cash flows, may be unwilling to value the life reinsurance on the same basis as standalone life primary insurance groups.

In the case of Swiss Re, we believe this sum of parts approach using life embedded value would be relatively unlikely for now; firstly because we believe that the market cares about US GAAP earnings, where there is still dilution from pre 2004 underpriced mortality business, and secondly because we believe it would be challenging to split life re out of Swiss Re.

There are three reasons we believe it would be challenging to split out life re from Swiss Re, even in theory:

1. Business. Swiss Re runs its life reinsurance business co-mingled with its non-life re unit. This means that in some geographies Swiss Re runs a composite business within the same legal entities.

2. Diversification benefit. On Page 77 of its 2009 annual report Swiss Re shows the capital requirement based on 99% tail VaR. This is SF25.9bn before diversification, SF16.0bn after deducting SF9.9bn of diversification. Diversification comes from all the four risk groups (non-life, life and health, financial market, credit) but if we just allocate to life its share according to gross

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capital, then the capital used by life re as part of the group is we estimate SF5.5bn - SF2.1bn share of diversification, ie SF3.4bn. So the life re unit as a standalone would have to earn 62% more than as part of the group for the same economics.

3. Reporting. There is no separate balance sheet for life reinsurance.

Table 4: Group valuation ex Life Re business - €m and SFm in the case of Swiss Re $m Munich Swiss Hannover SCOR Market cap - from BBG as on cob 30th Aug 18,922 15,387 4,172 3,146 Less 76% of life EV/EVM 2010e -5,391 -7,934 -3,021 -1,486 Add back life re debt 1,569 0 477 366 Market cap excluding life re 15,100 7,453 1,629 2,026 Note 100% of life 2010e EV/EVM is JPMe 7,094 10,440 3,974 1,955 Debt: Total sub debt FY09 4,790 7,172 1,481 629 Less life re sub debt -1,569 na -477 -366 Debt ex Life Re 3,221 7,172 1,004 263 Forecast 2011e net profit 2,473 1,934 648 478 Less life re taxed operating profit -850 -567 -203 -141 Forecast 2011e ex life re 1,623 1,367 445 337 Ratio market to 2011e net profit: Total 7.7x 8.0x 6.4x 6.6x Life re assuming 76% valuation to EV 4.5x 14.0x 12.5x 7.9x Total excluding life re 9.3x 5.5x 3.7x 6.0x Source: Company reports and J.P. Morgan estimates.

We have also shown the split of our price target by line of business below.

Table 5: Reinsurers - Split of JPMe price target by line of business % Split of price target % Life Re % Non Life Re % Asst Mgt % others (incl debt) Hannover Re 35.2% 79.6% 0.0% -14.8% Munich Re 44.1% 62.0% 2.0% -8.1% SCOR 34.1% 83.8% 0.0% -17.9% Swiss Re 24.2% 91.9% 146.3% -162.4% Source: J.P. Morgan estimates.

Summary split of business We show below the split of business of the European listed reinsurers, which includes the premiums and profit from life reinsurance. They all have sizeable life re operations, but in the case of Munich this is diluted by their primary insurance units.

Table 6: Reinsurers - Split of 2010e operating profit by line of business % Life Re Non life Re AM Others Hannover Re 27.9% 69.8% 0.0% 2.3% Munich Re 28.2% 59.5% 1.0% 11.3% SCOR 33.7% 66.3% 0.0% 0.0% Swiss Re 30.5% 68.8% 163.5% -162.8% Source: J.P. Morgan estimates

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Table 7: Reinsurance business split by premiums, 2010e LCm

Life Re Non Life Re Life Primary Health

Primary Non Life Primary Others Total

Hannover 4,202 5,399 9,601 Munich 7,602 13,917 11,949 4,700 4,319 42,487 SCOR 2,744 3,221 5,965 Swiss Re 8,307 10,952 5 19,264

Source: J.P.Morgan estimates

High level summary with references European listed reinsurers have significant life re business All the European listed reinsurers have significant life re businesses, we believe because this way the group as a whole benefits from diversification benefit, and because life re excluding asset risk offers relative stability of earnings relative to P&C. The pricing is stable due to the high entry barrier and the long term nature of the Life Re contracts (in comparison with P&C). As an example, we note the long term stable market share of Munich Re (see Figure 2).

Relative valuations of the remainder look attractive The relative valuations of the remainder (Hannover most attractive, then SwissRe and Scor and finally Munich) look attractive if assume life re valued at 76% of 2010e embedded value (see Table 4).

Low level of transparency for Life Re in Europe, particularly compared with RGA, the US listed pure life reinsurer The Life Re segment has relatively low level of transparency and high degree of accounting complexity, particularly compared with RGA, the US pure life listed reinsurer. We have summarized the three different types of accounting & the way US GAAP and IFRS work in terms of historic based reserves valuation with a buffer for adverse deviation (see Table 17).

Asset risk of Life Re We have summarized the asset risk from Scottish and Swiss Re. For Scottish Re asset risk accounted for 85% of the earnings volatility during 2005-1H10 & just 15% for mortality and other life operating risks (see Table 8). The only year operating risk was significant was in 2006 and this was due to rating downgrades of Scottish Re which started that year and which lead to an accumulation of negative reserve adjustments. Swiss Re switched its accounting from 2007 and now allocates only risk free rates (except for variable annuity & unlit linked) to the operating units. The reason is that this is how the business is priced. We have shown (see Figure 4 & Table 19) the drop in the investment income as well as the lower volatility in the new style against the old style.

Sensitivity comparison Life re is most sensitive to mortality and lapse risk, primary is mainly to interest rate risk (refer Table 28 & Table 30). On an average for primary insurers, MCEV drops by 14.6% for every 1% drop in interest rates and for reinsures increase 20.5% on a 5% drop in mortality/morbidity assumption.

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Swiss Re: uses risk free only to credit life re, has interest rate sensitivity due to being short assets US GAAP gives a relatively poor view of profits as it is mainly focused on baked in assumptions on mortality, lapses and profitability. So has a very stable earnings unwind, but says little about new business. The actual accounting that allocates only the risk free to the operating units, life re’s standard deviation drops to SF0.4bn; in relation to premiums its earnings volatility is now just one third that of non-life, respectively, 2.5% and 7.9% (see Table 19). The main accounting conventions in life are FAS60 (traditional life, constant emergence of margins, relative mainly to premiums) and FAS97. The risk of write downs of the various intangibles (value of acquired business in force, deferred acquisition cost) is low and we believe remote. This is because, under US GAAP, the portfolio as a whole would have to show negative returns (loss recognition is at the aggregated level), for this to happen.

We note that Swiss Re doest not report return on operating revenue (it stopped doing so in 2007) as this is not a very consistent or comparable guide to underlying profitability. We believe the measure that would best help understand profitability is ROE for the life re unit alone, and none of the European listed reinsurers provide this (see Table 54). We also note the comparison of the sensitivity of Swiss Re with peers and primary insurers in Table 31.

Munich Re: positive interest sensitivity in life re Munich’s split of business (as Dec09) in terms of net earned premiums was 68% mortality, 29% living benefits including morbidity, 3% longevity and other (refer to Table 37). Mortality, in particular, has little interest sensitive (morbidity has more as we believe it has relatively more assets). Munich Re also have positive interest rate sensitivity in Life Re (seeTable 28)

SCOR: possible venture into longevity Excluding the equity indexed annuity business, which is a very low risk, high volume and we believe relatively low margin product, and which SCOR has said they would cut back sharply in 2010, life and financing, where the main risks are mortality and lapses, accounted for 71% of total premiums in 2009. We believe this highlights the predominance of traditional and relatively predictable business in SCOR's business life reinsurance business mix (see Table 43)

Hannover Hannover has a relatively high sensitivity to lapse and mortality risk compared with its reinsurance peers. We believe this reflects its business mix, which we believe is structured to use lapse risk and mortality risk to help provide front end commission funding for primary insurers (see Table 31)

Nature of the life reinsurance market • Committed long term partnerships between life insurer and reinsurer

• Strong client network needed

• Extremely knowledge and expertise driven industry

• Lower volatility of profits and higher predictability of results and cashflows

• Almost all business is directly written

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• Long lasting acquisition process for new business of 6 to 12 months

• Demanding regulatory requirements

• Local nature of the business supports the high barriers of entry

• High independencies of risks within homogeneous portfolios

• Correlation to non-life reinsurance only in a very limited number of event scenarios – means high diversification benefit

• Excellent data availability increases statistical certainty

Five types of risk Biometric risk – longevity, mortality, morbidity.

Mortality affects policyholders buying protection for their families or for their mortgage finance, which is generally a younger age group than longevity, which is effectively a risk that pensioners, ie generally older policyholders, live longer. Mortality is often underwritten, particularly the case for RGA, on an YRT (yearly renewable term) basis, which means there is no asset risk for the reinsurer. YRT effectively functions on a pay as you go basis. Mortality, for the past ten years or so, has been reinsured assuming the trend does keep improving, and normally the credit given is 1/3 to 1/2 of the historic trend.

Longevity is mainly a pensions risk, and is present mainly in the US and the UK. Longevity is relatively risky because there are few hedges, which is effectively a risk that pensioners, ie generally older policyholders, live longer. For that reason the most successful longevity reinsurers like Hannover reinsure niches like impaired annuities (this is groups of pensioners who are expected to live shorter than the average) such as typically Glasgow manual workers, in combination with the life company Just Retirement. Despite its riskiness, longevity is becoming more attractive as there is the possibility now to reinsure it on a swap basis, with no asset risk. Also arguably, there is zero and possibly even small negative correlation with mortality risk. For that reason (significant diversification benefit) we believe Swiss Re on 15 Dec 09 entered into a longevity reinsurance agreement with 11,000 in payment pensions (total SF1.7bn liabilities) for civil servants in the County of Berkshire in the UK. The assumption is that, given the size of Swiss Re’s mortality book, there is some offset for increased longevity.

Morbidity can fluctuate with the economy, as this is a category that can be used by employers as a substitute for lay offs or early retirement. Morbidity so far continues to be associated with asset risk.

Financial risk / wherever there is an accumulation of reserves to be invested. The highest risk has been associated with variable annuities including GMDB where the risk for the reinsurer fluctuates as the inverse of the account value (ie the lower the available account value, the higher is the risk covered by the reinsurance premium). Variable annuities in general pose the greatest financial risk as they are difficult to hedge precisely, unless they are equity indexed annuities, where the underlying asset is known and precisely hedgeable. Calculatory risk/behaviourial risk for lapses. This is the risk of getting the behaviour of policyholders wrong. So

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credit life where the risk covered is payment protection against death, disability or illness is a risk, which fluctuates with the economy. Also, long term care, where recently new entrants in the US were affected by losses as they underestimated both the incidence of claims, and also the length of time claimants would need cover.

Protection against catastrophes / pandemics. This is a risk which can partially be hedged in the capital markets, although RGA has found there to be significant basis risk since the capital markets structure is based on general population mortality not the insured population or the actual lives insured by the respective company that purchases the coverage. Swiss Re uses insurance linked securities, SCOR has a swap with JPMorgan as reported by SCOR. . The risk when it is hedged is priced in terms of deviation from normal mortality, with cover starting at 105% of norm, rising to 120% of norm, which would be a very high peak risk.

Accounting risk. Reinsurers in their presentations understate this risk, possibly because life re is such a technical subject with mostly tailor made contracts relatively limited transparency and limited cyclical volatility, that the actuaries who run life re see relatively modest fluctuations in the underlying business and so perceive less need to explain them than in non-life re. But there are three separate accounting / regulatory conventions, which sometimes clash, statutory, IFRS/US GAAP and Embedded value.

Statutory accounting: costs are mainly written off in the first year, or only deferred on a very limited basis (zillmer adjustment in Germany). Statutory sets the distributable cash flows as annual results.

Embedded value discounts these statutory cash flows over the life of the contract, but says little about the amount of cash which can be distributed in the year. It recognizes earnings upfront as the point sale is deemed to be the moment of value creation, and future cash flows from the contracts sold are then discounted back.

IFRS (and also US GAAP) is a compromise solution, which sets the reserves and the profit profile of the policy upfront based on the pricing assumptions of mortality, lapses and investment return, and reports smoothed earnings using the mechanism of deferred acquisition costs to smooth results. These earnings are not automatically distributable and if the company got the pricing wrong, only the annual variance is shown, after offset against adverse deviation reserves.

Part of the reason IFRS accounting for life reinsurance is a poor guide to profits is that there is actually no set rule for the calculation of life liabilities. There is a new IFRS accounting convention being prepared, which, will, we believe, provide a mark to market approach to valuing life re liabilities, but it is still some time away. In the meantime, the approach used is based on US GAAP: life re reserves are calculated using the original pricing assumptions, and are only reset when the adverse deviation reserves are exhausted. This can be for the global account as a whole, or as the case of Swiss Re, for subsegments such as life, health and admin re. So life companies see embedded value as a better guide of profitability. Embedded value is included as available capital in Solvency 2, and so is one of the types of capital against which the insurer can borrow. But the risk with embedded value is that it is highly volatile because the calculation of embedded value under the MCEV convention is reset every year using the point values at the year end of interest rate, yield curve, volatility of interest

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rates and equity prices. Embedded value for primary insurers halved in 2008 and almost doubled in 2009 (however Embedded values for reinsurers were far less volatile).

There are three main points we believe about accounting risk:

a) There is no agreed measure of profitability under IFRS, as for example the combined ratio in non-life. We believe investors would like to know the return on equity, but reinsurers mainly report the ratio of operating profit to premiums (RGA, SCOR, Hannover) or benefit ratio (SwissRe). This is not strictly comparable as when a reinsurer is more exposed to FAS97 contracts then the denominator of premiums is low compared to peers, and the profitability ratio of profit to revenues appears relatively high. FAS97 splits off life reinsurance contracts where there is negligible risk transfer to the insurer/reinsurer, which is the case for universal life or variable annuities. Under FAS97, the accounting is that the premiums are treated like deposits, and the main item of revenues is fees.

Another potential distortion is when there is a lot of growth from acquisitions, as the acquired blocks of business are accounted under purchase GAAP. This means the profits are mainly capitalised upfront with costs amortised over the duration of the contracts, so the annual profitability appears lower than for organically grown business.

b) Transparency is relatively low because life re is shown normally just as one aggregated column in the accounts. The only life reinsurer that reports profitability by type of product/risk is RGA, the specialist US life reinsurer. And even RGA pointed out on the 2Q10 results call that it would improve transparency if variable annuities were reported separately from other annuities in the asset intensive line. All the other reinsurers aggregate all life reinsurance risks as one. This makes understanding and explaining the risks very challenging in our view, as the risks and flows and profit margins under longevity, critical illness, credit life and asset intensive risks like variable annuities are quite different. We believe this is one reason why investors are uncertain how to value life re.

c) The reporting is idiosyncratic. For example, Swiss Re does not allocate the assets acquired for the life reinsurance business to life re, but instead to an Asset Management function, and reallocates to life re the risk free current return, instead of the actual return of the invested GAAP liabilities. As life re, particularly admin re where Swiss Re is particularly active, invests substantially in corporate bonds, this presentation tends to understate the total returns of life re when interest rates are falling, and also tends to understate the volatility of the returns. This presentation reflects pricing of the risk, and also how management is incentivised – life re is not credited with asset risk returns.

Extra source of accounting noise. a further contrary element of financial hedging costs, is that the cost of hedging is calculated for the purpose of the accounts using the reinsurer’s own cost of debt. So, for example, variable annuity liabilities are treated as embedded derivatives, which are measured at fair value. For example, where these are reinsured by Swiss Re, which saw in 2008 its CDS spreads rise sharply, there was an accounting reduction in the value of its liability (the accounting assumes that Swiss Re effectively provides reduced cover due to its reduced implicit credit rating as measured by the CDS spread) and so an increase in earnings. The

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effect is exactly opposite when CDS spreads narrow. Note, the actual hedging cost is set by contract and does not vary.

The last accounting risk (which could also be treated as financial risk) is that on contracts where the reserves are kept and invested by the primary insurer, and the reinsurer operates on a coinsurance basis, the changes in value of the underlying assets appear as mark to markets through the profit and loss account because they are seen as embedded derivatives. This is called Modified Coinsurance or Coinsurance with Funds Withheld. Under modco, liabilities and assets stay with direct company, but under coinsurance with funds withheld, the liabilities move to the reinsurer, while the assets stay with the direct company. Both structures create the embedded liability B36. But if the reinsurer had insisted on taking the assets on its balance sheet, the fluctuations in value would normally have been accounted for as available for sale, ie mark to market through the balance sheet and not the profit and loss account. Effectively, B36 means that the fair value mark to market is linked to the CDS of the counterparty managing the investments.

Whilst statutory reporting is usually linked to explicit capital requirement this does not hold for IFRS and EV. For EV publication purposes, companies usually take statutory rating and economic capital requirements into account in order to take an economic view. We believe that in order to make a like for like comparison, it would be more appropriate to take a similar approach also for statutory and IFRS accounting and compare accounting profits to the same level of capital requirement, possibly adjusted for accounting differences only.

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Summary of Scottish Re profit and loss record 2005-1H10 – asset risk accounted for 85% of the earnings volatility in the period vs just 15% for mortality and other life re operating risks We wrote on the front page that life reinsurance, outside of asset risk, is relatively dull and stable compared with non-life re. But then investors we have spoken to asked, what about Scottish Re, the life reinsurance which for a period in 2008/9 faced such losses that shareholders’ equity turned negative and it operated under direct Order of Supervision of the Insurance Commissioner of Delaware.

The following section summarises the experience of Scottish Re, which we believe supports our point that asset risk is the largest single risk for a life reinsurer, as this accounted for 85% of annual earnings volatility in 2005-1H10. By contrast, mortality, lapses and other operating risks accounted for just 15% on average we estimate.

The following chart shows the experience of Scottish Re in 2005-1H10.

Figure 1: Scottish Re profit/loss and shareholders' equity 2005-1H10 $m

-3,000

-2,000

-1,000

0

1,000

2,000

3,000

2005 2006 2007 2008 2009 1H2010

Shareholders' equityNet income/loss:

Source: company reports

The key events are as follows:

1. Purchase in Oct 04 of the ING Life re book of business in the US for a ceding commission of $560m. In other words, ING paid Scottish Re to take the business off its books. This ceding commission represents $200m for DAC write off (effectively mortality losses), and the remainder was effectively a $360m contribution to the capital required to run this business. In addition, Scottish Re raised $230m to fund the regulatory capital base (RBC) of this business. The issue with the ING life re business is that it was mainly written on level premium terms, which is subject to the Valuation of Life Insurance Policies Regulation XXX (Reg XXX).

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2. 2005 reasonable profit. During 2005 Scottish Re refinanced the collateral finance initially provided by ING mainly by securitising collateral funding through a number of special purpose vehicles. These special purpose vehicles were non recourse and raised collateral funding, which was passed through to Scottish Re. Scottish Re invested the proceeds mainly in Alt A and subprime for the yield pickup (50% of all its investments in Dec06).

3. 2006-8 accelerating write downs on assets, triggered in 2006 by a write off of deferred tax, and leading in 2008 to a very large trading loss on the underlying subprime and Alt A assets.

4. 2009: $0.7bn gain on sale of ING Life Re to Hannover, and another $1.2bn linked to this (Scottish Re effectively deconsolidated a unit whose sole purpose was to provide reinsurance for part of the ING Life Re).

5. 1H10: modest gains on investments and final contingency profits on the sale to Hannover Re.

We have gone through the filed reports of Scottish Re for the period and summarised the main sources of loss below. The key point is that most of the earnings volatility is due to asset risk, and only a relatively modest proportion to operating and mortality.

On average for the period, operating shifts accounted for just 15% of the change in earnings, asset risk for the remaining 85%. The only year where operating risk was a significant factor was 2006, and we believe this was due to the rating downgrades of Scottish Re, which started that year, and which lead to an accumulation of negative reserve adjustments: cedant true ups, experience refunds, premium accruals.

Reserve adjustments under US GAAP for life re only take place when the reporting division as a whole is loss making. Here, the combination of various sources of reserve adjustments did indeed push the earnings to a negative. One factor which also pushed earnings to a negative is a write off of deferred tax as the State of Carolina refused a change of accounting which Scottish Re requested and which would have allowed Scottish Re to recognise the benefit of tax schemes.

Table 8: Scottish Re Net income and shareholders' equity 2005-1H10 $m

2005 2006 2007 2008 2009 1H2010 Average Shareholders' equity 1,272 1,057 347 -2,410 -104 69 Net income/loss: 325 -377 -1,025 -2,710 2,305 178 of which realised and unrealised losses 4 -17 -927 -1,922 243 216 of which trading securities -1,875 of which impairment charge -777 embedded derivatives loss B36 -8 -16 -44 -200 of which gain/loss on sale to Hannover -120 704 60 of which deconsolidation gain Ballantyne 1,150 of which gain on repurchase of debt 20 19 253 of which deferred tax write off -203 sale of Life Re international -31 sale of Wealth Management -5 of which DAC write off -151 of which collateral unwind costs -10 Other (mainly operating) 329 -141 -74 -290 -45 -98 Pct of net profit swing due to operations 67.0% -10.3% 12.8% 4.9% 2.5% 15% Pct of net profit swing due to asset risk 33.0% 110.3% 87.2% 95.1% 97.5% 85% Source: Company reports.

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The interesting point is that as soon as accounting turned negative, then it seemed to trigger in subsequent years an accumulation of further negatives. For example, as the 2006 loss eroded capital, the potential 2007 write down on Alt A and subprime could no longer be argued away as just temporarily impaired, because Scottish Re no longer had enough capital to guarantee that it would be willing and able to hold the underlying assets to maturity. This impairment loss is the $777m item in 2007, the main cause of the $1.0bn net loss in 2007. In 2008, the risky assets were treated as trading instead of available for sale, which meant that the loss was taken direct to earnings, without any review of the impairment logic.

And in 2009 the losses virtually all reversed thanks to the recovery of the value of the subprime and Alt A assets and the sale of ING Life Re to Hannover Re. This in total allowed Scottish Re to book a gain on sale of near $1.9bn, the main factor in the $2.3bn net profit in 2009. We do note that in total for 2005-1H10, the cumulative net loss is -$217m.

Where did these asset losses come from. Effectively, they were the result of an investment policy guided by the need to overfund life reserves to their full statutory level (this is higher than US GAAP due to the regulatory requirement to fund mortality reserves on a very conservative basis, called Regulation XXX). So, in order to pay collateral fees of around 1.5% and still make a profit, Scottish Re invested in risky assets.

We show the investment asset split in the key quarters after the ING life re deal. Mortgages and asset backed rose from 40% of total investments Dec05 to 54% Dec06. At that Dec06 date, Alt A and subprime together accounted for 50% of invested assets. And the yield pick up relative to US treasuries was maintained at 80-90bps, sufficient we estimate to pay collateral fees and also generate a positive margin.

Table 9: Scottish Re Summary investments in $m Dec-05 Mar-06 Jun-06 Sep-06 Dec-06

Treasuries 110 267 180 111 127 Corporates 3,688 3,632 4,378 4,050 4,005 Munis 71 73 80 82 82 Mortgage and asset backed 3,745 4,464 5,408 5,276 5,708 Preferreds 137 135 131 133 136 Commercial mortgage loans 113 108 106 104 99 Cash 1,445 610 1,475 1,134 475 Total 9,309 9,289 11,758 10,890 10,632 Weighted average book yield 5.1% 5.3% 5.5% 5.6% 5.6% Option adjusted duration 3.6 3.5 3.4 3.3 3.3 Yield for US govvies 3 year 4.3% 4.7% 5.1% 4.6% 4.7% Yield pick up 0.8% 0.6% 0.4% 1.0% 0.9% Worth 74 56 47 109 96 Source: Company reports, Bloomberg for govvies yield, JPMe for yield pickup.

We show the structure of Scottish Re’s balance sheet below. The key point is that collateral finance facilities rose from 2% of total liabilities just when the ING Life re closed, to 30% Dec06, from 20% of total capital in Dec04, to 320% in Dec06. And we believe the investment policy for these assets was mainly asset backed, and in particular Alt A and subprime, leading to significant asset volatility, which Scottish Re was not able to offset.

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Table 10: Scottish Re Summary balance sheet in $m and debt to capital ratios Dec-04 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06

Assets Investments own managed 4,328 6,893 6,952 9,883 9,078 8,871 Funds withheld 2,056 2,597 2,610 2,175 2,076 1,942 Total investments 6,384 9,490 9,562 12,058 11,154 10,813 DAC 417 595 620 643 620 619 Reinsurance balances 1,176 987 986 838 994 1,036 Other 192 283 308 289 319 285 Segregated assets 783 761 780 776 739 683 Total 8,952 12,116 12,256 14,604 13,826 13,436 Liabilities and capital Reserves for policies 3,301 3,526 3,539 4,101 3,663 3,919 Interest sensitive contract liabilities 3,181 3,907 3,990 4,089 3,583 3,399 Collateral finance facilities 200 1,986 1,986 3,725 3,745 3,757 Long term debt 245 245 245 245 245 130 Segregated liabilities 783 761 780 776 739 683 Other 227 267 323 328 415 339 Total liabilities 7,937 10,692 10,863 13,264 12,390 12,227 Minorities 10 9 9 9 10 9 Mezzanine equity 142 143 143 143 143 143 Shareholders equity 863 1,272 1,241 1,188 1,283 1,057 Total capital 1,015 1,424 1,393 1,340 1,436 1,209 Total capital and liabilities 8,952 12,116 12,256 14,604 13,826 13,436 Ratio: Capital to liabilities 12.8% 13.3% 12.8% 10.1% 11.6% 9.9% Collateral finance to total liabilities 2.5% 18.6% 18.3% 28.1% 30.2% 30.7% Collateral finance to capital 19.7% 139.5% 142.6% 278.0% 260.8% 310.8% Source: Company reports and J.P. Morgan estimates.

Mortality was indeed negative, as the rise in the benefit ratio (ratio of claims to premiums) shows in the following table.

Table 11: Scottish Re Adverse mortality - benefit ratios 2005 2006

US traditional 74.3% 85.0% Total 70.5% 79.4% Grand total 75.0% 87.0% Source: Company reports

But the cost in terms of earnings was relatively modest, with total mortality variance cost of $30m in 2006 and lapse cost of $27m.

Table 12: Scottish Re Increased mortality costs have a relatively modest impact on 2006 earnings Increase in benefit ratio in 1Q06 in smaller claims by $16m. Mortality also adverse in 4Q06 by $14m Total 2006 mortality was 103% of expected. Lapse assumptions cost $13m in 3Q and $14m in 4Q as lapses rose on contracts with higher margins, fell on those with lower margins. Collateral finance expenses rose 376% in 2006 vs 2005 due to increased facilities. Source: Company reports and J.P. Morgan estimates.

The following table shows more detail of the quarterly change in 2006 earnings, the year that mortality and lapses had their greatest impact on earnings, accounting for 67% of the swing from profit to loss over 2005 to 2006.

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Table 13: Scottish Re Summary operating results quarterly in $m Dec-04 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06

Net operating result 27 51 14 -130 -24 -228 OF which deferred tax valuation allowance -112 -91 The 2006 loss was linked to the ratings downgrades which increased re costs, and the adverse effect of 2006 adjustments to previous estimates. Valuation allowances result from actual results of legal entity statutory income and changes in statutory reserves combined with a reassessment of tax planning. 2006 saw $167m higher collateral finance expenses and $34m goodwill write off. Modco impact was -$8m in 2005 due to change in value of embedded derivatives and Modco impact was +$6m 2006. Modco is consequence of DIG B36 / SFAS133 which requires bifurcation of embedded derivatives as pools of fixed income are deemed to contain embedded derivatives requiring bifurcation. Interest on collateral financing is offset by investment income on fixed maturity assets. Net margin represents the excess of the yield on earnings assets over the interest rate cost Source: Company reports and J.P. Morgan estimates for summary of management discussion in SEC filing.

Our conclusion is that mortality and lapse risks are relatively manageable even as in the case of Scottish Re, which bought a block of business from ING where mortality was a risk due to historic underpricing, and which negotiated a $560m ceding commission (discount) to help fund that risk. But, by comparison, asset risk leads to swings that Scottish Re could only absorb after resort to special conditions from the Insurance Commissioner of Delaware.

As part of the turnaround measures in 2008, Scottish Re obtained approval from the Delaware regulator to limit funding with additional capital of its securitisation units Orkney I and II, which were facing a shortfall due to the fall in the value of their investments in subprime and Alt A. This was linked to an Order of Supervision by the Delaware insurance department set to lapse in April 2009 and obtained authorization to use different mortality tables which boosted capital and surplus by $190m.

Table 14: Scottish Re Funding of the collateral requirements in $m Date Amount Consolidated Comment

HSBCI Jun-04 189 Yes Stingray Jan-05 265 Partly Up to $0.3bn Orkney I Feb-05 850 Yes Orkney II Dec-05 450 Yes HSBC II Dec-05 529 Yes Reinsurance facility Dec-05 n/a n/a Up to $1.0bn Ballantyne Re May-06 1,739 Yes Total 4,022 Total facilities 5,122 Source: Company reports.

The above table shows how the collateral funding was achieved, to replace the facility initially provided by ING at the sale of the business to Scottish Re. The need for collateral funding is because the business was largely Regulation XXX and Scottish Re was aiming to reduce the cost of the funding provided by ING.

This is how Scottish Re describes the collateral funding: at the time of the deal in October 2004 ING was obligated to maintain collateral for the Regulation XXX and AXXX reserve requirement of the acquired business (excluding the business supported by other arrangements) for the duration. Scottish Re paid ING a fee based on the face amount of the collateral.

In 2005 and 2006 Scottish Re completed three securitisations that collectively provided approximately $3.7bn in collateral to fund Reg XXX from part of the ING

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life re business, and used reinsurance to complete the funding. These deals extinguished ING's obligation to provide collateral. They resulted in a refund from ING of fees of $6.2m in 2006 and $6.7m in 205.

Table 15: Summary of Reg XXX reserves for level premium term life (mortality cover

The Valuation of Life Insurance Policies Model Regulation, commonly referred to as Regulation XXX, was implemented in the United States for various types of life insurance business beginning January 1, 2000. Regulation XXX significantly increased the level of reserves that United States life insurance and life reinsurance companies must hold on their statutory financial statements for various types of life insurance business, primarily certain level term life products. The reserve levels required under Regulation XXX increase over time and are normally in excess of reserves required under Generally Accepted Accounting Principles in the United States ("US GAAP"). In situations where primary insurers have reinsured business to reinsurers that are unlicensed and unaccredited in the United States, the reinsurer must provide collateral equal to its reinsurance reserves in order for the ceding company to receive statutory financial statement credit. Reinsurers have historically utilized letters of credit or have placed assets in trust for the benefit of the ceding company as the primary forms of collateral. The increasing nature of the statutory reserves under Regulation XXX will likely require increased levels of collateral from reinsurers in the future to the extent the reinsurer remains unlicensed and unaccredited in the United States. We believe that funding long duration liabilities with shorter-term funding facilities is not suitable or sustainable from a prudent asset liability management perspective because it creates significant refinancing or rollover risk every year.

Source: Company reports

The increasing nature of the statutory reserves required under RegXXX is because under level premium policies the mortality risk rises as the policyholders get older, but the premium stays flat, so the financial risk increases with time.

Scottish Re entered into a number of financing deals in 2004-6 to secure longer term funding for a large portion of our RegXXX collateral needs. .Scottish Re then used this to fund investment in risky assets. It is this combination of leverage and asset risk which we believe was a key factor in Scottish Re’s accumulation of losses in 2007-8.

Other reinsurers avoid the need to fund RegXXX reserves either because they are affiliated, or because they choose to cover only mortality risk, via contracts which are called YRT (yearly renewable term). Here, the premium is increased every year using a pre agreed schedule, and in theory is enough to pay for the expected mortality claims that year. With such a pay as you go system there are no assets and no asset risk either.

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Table 16: Types of mortality cover written by Scottish Re -citation marks refer to the 2009 annual report of Scottish Re

Scottish Re writes in its 2009 report: “we wrote reinsurance generally in the form of yearly renewable term, coinsurance or modified coinsurance. Under yearly renewable term, we share only in the mortality risk for which we receive a premium. In a coinsurance or modified coinsurance arrangement, we generally share proportionately in all material risks inherent in the underlying policies, including mortality, lapses and investments. Under such agreements, we agree to indemnify the primary insurer for all or a portion of the risks associated with the underlying insurance policy in exchange for a proportionate share of premiums. Coinsurance differs from modified coinsurance with respect to the ownership of the assets supporting the reserves. Under our coinsurance arrangements, ownership of these assets is transferred to us, whereas in modified coinsurance arrangements, the ceding company retains ownership of these assets, but we share in the investment income and risk associated with the assets. Modified coinsurance is treated as an embedded derivative under SFAS113 B36 and leads to earnings volatility in the accounts of the reinsurers because changes in the value of these assets come through the profit and loss account”.

Source: Company reports, JPMorgan estimates for description of SFAS113 B36.

The above table explains the asset riskiness of the three main contracts: none under yearly renewable term (YRT) which is like a pay as you go contract, higher under coinsurance in that the asset ownership is to the reinsurer, and available for sale accounting (ie unrealized gains through the balance sheet) is used, and highest under modified coinsurance, as, because of SFAS133 B36, the contract is deemed to be an embedded derivative, and the unrealised gains of the underlying assets go to the profit and loss account of the reinsurer.

Life reinsurance is relatively stable (apart from asset risk), both under IFRS accounting and US GAAP. The reason life reinsurance profitability is relatively stable compared with non-life re is three fold, in our view:

1. Business reason for higher barriers to entry. Life reinsurance is negotiated directly with the primary insurance client for a relationship in mortality which can last for up to 30 years and with pricing which is quite opaque and a life reinsurer sits on an inventory of inforce business from many different pricing eras. So there is less volatility in pricing than in non-life, where the risks are normally 1-2 years, and where around half of total reinsurance is through brokers, with low barriers to entry and relatively transparent pricing. The pricing point is key: in non-life re a slip is prepared, which shows the risk, the pricing agreed by the lead reinsurer, and the proportion of risk taken by each reinsurer, with variations in say the commission rate paid. This is seen by each reinsurer. By contrast, in life re the reinsurer only sees his portion of the pricing and volume, and relies on the primary insurer to say if the pricing or conditions are inline or very different from the other reinsurers.

In the chart below we can see the Munich Re market share in US is stable within the 10% range. The high cession rates in the peak years 2000-05 are, we believe, mainly due to ‘the irrational pricing by reinsurers’ (citation from Munich Re October 2008 life re presentation). In those years competitors which have since exited include ING, and competitors which have significantly repriced include Swiss Re

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Figure 2: Munich Re - market share and cession rate %

42%51% 52%

62% 59% 62% 60% 56%47%

40% 37%

6% 6% 9% 12% 11% 7% 10% 13% 12% 11% 9%0%

10%20%30%40%50%60%70%

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Cession rate Munich Re market share Source: Munich Re Investor day presentation on Life reinsurance 2008

2. Accumulation reason. Life reinsurance contracts typically run for up to thirty years. The reason is that they often have a substantial financing component, where the stream of profits from mortality or morbidity is used to pre-finance an large front end cash advance to the primary insurer, called the reinsurance commission, which the primary insurer uses to fund large front end acquisition costs to sales networks. Alternatively, reinsurance can reduce the statutory strain at the cedant level on a non cash basis. For this pre financing to work without too much strain, the contracts tend to run for well over ten years, and up to thirty years normally for mortality deals. So any one year’s production accounts for around one thirtieth of the total business which is generating profits. SCOR gave the example at its 2008 investor day that the new business of the year 2007 contributed €15m to the 2007 financial life results, ie 9% of €167m. By comparison, in non-life reinsurance where the contracts are for one to two years, one year’s new business accounts for around 40% of the profits of that year (another 40% from the previous year’s new business, and 20% from prior years and in particular reserve releases or additions).

Figure 3: Profit trend lines for new business example Indicative figures in Y axis, X axis is years

-60

-40

-20

0

20

40

60

2007 2012 2017 2022 2027

Distributable cashflow IFRS profits EV profits Source: SCOR investor day presentation, 2008

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3. Accounting reason. Under IFRS and even more so under US GAAP, the profits shown each year are effectively the equivalent of the profits assumed when the contract is priced. So the amortization of the deferred acquisition cost asset depends on the amount of profit expected that year. The financial year profits are therefore the sum of the assumed profit development, and the variances for that year. And there are buffers called adverse deviation reserves to smooth even those variances. So the reported profits are relatively stable.

In addition, there is little adjustment possible to reset the original reserves in life re if the pricing assumptions are seen to be too optimistic. To adjust for this under US GAAP, the adverse deviation reserve for the whole unit’s results should be a loss; under IAS there is more flexibility but it is still relatively limited. So, books of business written under terms which produce low but still positive returns, like US mortality 1997-2004, particularly for Swiss Re, just continue to dilute results going forward. The only way of resetting the results is to sell the business and recognise the difference in expected profit as a gain or loss on sale. Swiss Re reinsured part of its US life re business to Berkshire in January 2010.

We note that Swiss Re has, according to the 2009 EVM reporting, $11bn of reserving margin, which we believe corresponds to the adverse deviation reserves. Swiss Re accounts by segment (life, health and admin re) and would only reset the original reserves if the adverse deviation reserve for that segment is exhausted.

By comparison, in non-life reinsurance the reserves for outstanding claims are constantly reviewed against current payment trends and reset, and this creates a stream of profits or losses from reserve releases or additions.

Comparison of the accounting standards There are three accounting standards under US GAAP 1) FASB60 which is long duration contracts of traditional life; 2) FASB97 which is the universal life where there is no transfer of risk; and 3) FASB113 which has no transfer of risk. We have summarized the standards of each of these below:

FASB60 for long duration contracts of traditional life We have shown the summary of the FAS 60 from the statement of financial accounting standards.

“This Statement extracts the specialized principles and practices from the AICPA insurance industry related Guides and Statements of Position and establishes financial accounting and reporting standards for insurance enterprises other than mutual life insurance enterprises, assessment enterprises, and fraternal benefit societies.

Insurance contracts, for purposes of this Statement, need to be classified as short-duration or long-duration contracts. Long-duration contracts include contracts, such as whole-life, guaranteed renewable term life, endowment, annuity, and title insurance contracts, that are expected to remain in force for an extended period. All other insurance contracts are considered short-duration contracts and include most property and liability insurance contracts.

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Premiums from short-duration contracts ordinarily are recognized as revenue over the period of the contract in proportion to the amount of insurance protection provided. Claim costs, including estimates of costs for claims relating to insured events that have occurred but have not been reported to the insurer, are recognized when insured events occur.

Premiums from long-duration contracts are recognized as revenue when due from policyholders. The present value of estimated future policy benefits to be paid to or on behalf of policyholders less the present value of estimated future net premiums to be collected from policyholders are accrued when premium revenue is recognized. Those estimates are based on assumptions, such as estimates of expected investment yields, mortality, morbidity, terminations, and expenses, applicable at the time the insurance contracts are made. Claim costs are recognized when insured events occur.

Costs that vary with and are primarily related to the acquisition of insurance contracts (acquisition costs) are capitalized and charged to expense in proportion to premium revenue recognized.

Investments are reported as follows: common and nonredeemable preferred stocks at market, bonds and redeemable preferred stocks at amortized cost, mortgage loans at outstanding principal or amortized cost, and real estate at depreciated cost. Realized investment gains and losses are reported in the income statement below operating income and net of applicable income taxes. Unrealized investment gains and losses, net of applicable income taxes, are included in stockholders' (policyholders') equity.”

We have also shown the relevant paragraphs from the FASB60 accounting.

Short term & long term contracts (para 3 & 4): The short term contracts are like the property and liability insurance contracts which cover claims costs only for a short and fixed duration. The insurance company can normally cancel the contract or revise the premium at the beginning of each contract period. Therefore, premiums are earned and recognized as revenue as the protection is provided. For the long term products (including life insurance contracts) the expected policy benefits do not occur evenly over the period. The insurance companies provide insurance protection, sales, premium collection, claim payment, investment & other functions and services. The premiums normally exceed the benefits in the beginning and hence as the premium revenue is recognized a liability for claims costs. Hence, a liability for the expected cost is accrued over each period.

Recognition for long term contracts (para 10): The premiums are recognized when due from the policy holders. From this premiums some amount is accrued as liability for future claims costs which is = the present value of future benefits – present value of future net premiums. Please find the text from the para 10 below

“Premiums from long-duration contracts shall be recognized as revenue when due from policyholders. A liability for expected costs relating to most types of long-duration contracts shall be accrued over the current and expected renewal periods of the contracts. The present value of estimated future policy benefits to be paid to or on behalf of policyholders less the present value of estimated future net premiums to be collected from policyholders (liability for future policy benefits) shall be accrued

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when premium revenue is recognized. Those estimates shall be based on assumptions, such as estimates of expected investment yields, mortality, morbidity, terminations, and expenses, applicable at the time the insurance contracts are made. In addition, liabilities for unpaid claims and claim adjustment expenses shall be accrued when insured events occur”

Acquisition costs (para 11): Acquisition costs are capitalized and charged in proportion to revenue recognized. Other costs are charged as incurred.

Estimation of liability for future policy benefits (para 21): The assumptions used in calculating the liability are applicable at the time insurance contracts are made. These same assumptions shall be used in the subsequent periods as well unless there is premium deficiency. We have shown the text from the standards below.

“A liability for future policy benefits relating to long-duration contracts other than title insurance contracts (paragraph 17) shall be accrued when premium revenue is recognized. The liability, which represents the present value of future benefits to be paid to or on behalf of policyholders and related expenses less the present value of future net premiums (portion of gross premium required to provide for all benefits and expenses), shall be estimated using methods that include assumptions, such as estimates of expected investment yields, mortality, morbidity, terminations, and expenses, applicable at the time the insurance contracts are made. The liability also shall consider other assumptions relating to guaranteed contract benefits, such as coupons, annual endowments, and conversion privileges. The assumptions shall include provision for the risk of adverse deviation. Original assumptions shall continue to be used in subsequent accounting periods to determine changes in the liability for future policy benefits (often referred to as the "lock-in concept") unless a premium deficiency exists (paragraphs 35-37). Changes in the liability for future policy benefits that result from its periodic estimation for financial reporting purposes shall be recognized in income in the period in which the changes”

Premium deficiency shall be recognized and charged to income and either the unamortized cost is reduced or future liability benefits is increased.

FASB 97 We have shown the summary of the FAS 97 below. We have also shown the changes with the FAS 60 as highlighted below.

“This Statement establishes standards of accounting for certain long-duration contracts issued by insurance enterprises, referred to in this Statement as universal life-type contracts, that were not addressed by FASB Statement No. 60, Accounting and Reporting by Insurance Enterprises. The Statement also establishes standards of accounting for limited-payment long-duration insurance contracts and investment contracts and amends Statement 60 to change the reporting of realized gains and losses on investments. New life insurance contracts have evolved since the development of specialized insurance industry accounting principles and practices in the early 1970s. Many of those new life insurance contracts have different provisions than do the life insurance contracts to which Statement 60 applies. Those new life insurance contracts are characterized by flexibility and discretion granted to one or both parties to the contract. Statement 60 identifies but does not address those contracts, noting that the accounting was under study by the insurance industry and the accounting and actuarial professions. This Statement requires that the

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retrospective deposit method be used to account for universal life-type contracts. That accounting method establishes a liability for policy benefits at an amount determined by the account or contract balance that accrues to the benefit of the policyholder. Premium receipts are not reported as revenues when the retrospective deposit method is used. The Statement also requires that capitalized acquisition costs associated with universal life-type contracts be amortized based on a constant percentage of the present value of estimated gross profit amounts from the operation of a "book" of those contracts. Any gain or loss resulting from a policyholder's replacement of other life insurance contracts with universal life-type contracts is recognized in income of the period in which the replacement occurs. This Statement requires that long-duration contracts issued by insurance enterprises that do not subject the enterprise to risks arising from policyholder mortality or morbidity (investment contracts) be accounted for in a manner consistent with the accounting for interest-bearing or other financial instruments. Payments received on those contracts are not reported as revenue

This Statement also addresses limited-payment contracts that subject the insurance enterprise to mortality or morbidity risk over a period that extends beyond the period or periods in which premiums are collected and that have terms that are fixed and guaranteed. This Statement requires that revenue and income from limited-payment contracts be recognized over the period that benefits are provided rather than on collection of premiums. This Statement amends the reporting by insurance enterprises of realized gains and losses on investments. Statement 60 previously required that realized gains and losses be reported in the statement of earnings on a separate line below operating income and net of applicable income taxes. This Statement requires that realized gains and losses now be reported on a pretax basis as a component of other income and precludes the deferral of realized gains and losses to future periods. This Statement is effective for financial statements for fiscal years beginning after December 15, 1988. Accounting changes to adopt the Statement should be applied retroactively through restatement of all previously issued financial statements presented, or if restatement of all years presented is not practicable, the cumulative effect of applying this Statement is to be included in net income of the year of adoption.”

We have shown below an illustrative example of the computation of the estimated gross profit.

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Table 17: Illustration of the computation of estimated gross profit $

Year Surrender

charges

Mortality assessmen

ts

Mortality cost

incurred

Expense Assessmen

ts

Recurring Expenses

incurred

Investment income

related to policy

balances

Interest credited to

policy balances

Estimated gross profit

Revised gross profit

at year 2 1 13,298 17,300 (3,685) 11,700 (12,176) 6,405 (5,490) 27,352 27,352 2 13,169 15,099 (3,541) 9,356 (9,669) 10,571 (9,061) 25,924 34,637 3 7,314 14,104 (3,627) 8,229 (8,476) 14,436 (12,374) 19,606 17,822 4 4,656 13,604 (3,866) 7,566 (7,781) 18,356 (15,734) 16,801 15,273 5 3,645 13,199 (4,107) 7,108 (7,309) 22,405 (19,204) 15,737 14,304 6 2,739 12,791 (4,330) 6,676 (6,866) 26,286 (22,531) 14,765 13,422 7 1,929 12,950 (4,513) 6,270 (6,449) 29,957 (25,677) 14,467 13,151 8 1,208 12,905 (4,690) 5,888 (6,057) 33,447 (28,669) 14,032 12,756 9 567 12,755 (4,865) 5,529 (5,688) 36,779 (31,525) 13,552 12,320 10 0 12,593 (5,003) 5,191 (5,340) 39,965 (34,256) 13,150 11,954 11-20 0 108,164 (55,512) 37,183 (38,270) 551,879 (473,039) 130,405 118,543 21-50 0 140,607 (88,833) 32,577 (33,712) 2,618,726 (2,244,622) 424,743 386,112 Total 48,525 386,071 (186,572) 143,273 (147,793) 3,409,212 (2,922,182) 730,534 677,646 Present value 180,944 176,087 Source: FASB 97 page 27

We have also shown below the illustration of the change in amortization of DAC after the estimation of gross profit.

Table 18: Computation of amortization rate $ Original estimate Revised estimate Present value of estimated gross profit, years one to fifty (from table above)

x 180,944 176,087

Present value of capitalized acquisition costs y 90,986 90,986 Amortization rate (y) / (x) 50.284% 51.671% Source: FASB97 page 28

FASB113 We have shown the summary of the FASB113 from the FASB accounting standard below.

“This Statement specifies the accounting by insurance enterprises for the reinsuring (ceding) of insurance contracts. It amends FASB Statement No. 60, Accounting and Reporting by Insurance Enterprises, to eliminate the practice by insurance enterprises of reporting assets and liabilities relating to reinsured contracts net of the effects of reinsurance. It requires reinsurance receivables (including amounts related to claims incurred but not reported and liabilities for future policy benefits) and prepaid reinsurance premiums to be reported as assets. Estimated reinsurance receivables are recognized in a manner consistent with the liabilities relating to the underlying reinsured contracts.

This Statement establishes the conditions required for a contract with a reinsurer to be accounted for as reinsurance and prescribes accounting and reporting standards for those contracts. The accounting standards depend on whether the contract is long duration or short duration and, if short duration, on whether the contract is prospective or retroactive. For all reinsurance transactions, immediate recognition of gains is precluded unless the ceding enterprise's liability to its policyholder is extinguished. Contracts that do not result in the reasonable possibility that the reinsurer may realize a significant loss from the insurance risk assumed generally do not meet the conditions for reinsurance accounting and are to be accounted for as deposits.

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This Statement requires ceding enterprises to disclose the nature, purpose, and effect of reinsurance transactions, including the premium amounts associated with reinsurance assumed and ceded. It also requires disclosure of concentrations of credit risk associated with reinsurance receivables and prepaid reinsurance premiums under the provisions of FASB Statement No. 105, Disclosure of Information about Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit Risk. This Statement applies to financial statements for fiscal years beginning after December 15, 1992, with earlier application encouraged.”

Life re is more stable than non-life except for asset risk One reinsurer we consulted suggested we check our assertion that life reinsurance is more stable than non-life, except for asset risk.

The first company we checked was Swiss Re, and we believe our analysis there supports our view that:

ASSET RISK IS THE MAIN SOURCE OF VOLATILITY IN LIFE RE

Swiss Re is a good example in our view, because the group switched its accounting in 2008. Previously, investment income was allocated to the individual operating units according to the investments selected by that unit. So if life re invested in corporated bonds, it was credited with the investment return on those corporate bonds.

In 2008, Swiss Re switched its accounting and now allocates only the risk free (except for variable annuities and unit linked) to the GAAP liabilities of its operating units. This means that life re gets credited (except for variable annuities and unit linked) with the investment income of its various vintages of life re assets (ie its gets credited with a weighted average of the risk free according to the age mix of its portfolio).

The reason Swiss Re changed the accounting and now only allocates the risk free return to the operating units is that this is how business is priced. Also, managers of the operating units are incentivised on their pure operating returns, not whether the underlying assets beat the risk free rate.

This means that with Swiss Re we can check how important asset risk is by comparing the earnings volatility of life and non-life re using the two accounting bases. (We estimated the old style reporting for 2008-9 by reallocating out of asset management and legacy investment income to life and non-life re, and the reallocation was on the basis of the invested technical reserves, in an average ratio of 40% non-life: 60% life re).

We show the results below. We estimate that if Swiss Re had continued its old style accounting, allocating investment results according to the underlying assets of the operating units life re and non-life re, then the standard deviation of life re would have been SF1.7bn, non-life re SF2.1bn; to give a better idea we divided the standard deviation by average revenues 2005-9, and this shows that life re had a slightly higher earnings volatility, in relation to the size of its revenues, than non-life (10.6% and 10.2% respectively).

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Table 19: Swiss Re: Average operating profit and their standard deviation by reporting unit in SFm 2004-9 Old style As reported Average SD SD as Average SD SD as Old style Old style pct of revs Reported Reported pct of revs

Non-life 3,333 2,070 10.2% 3,400 1,596 7.9% Life 1,014 1,702 10.6% 1,209 400 2.5% Financial services/asset management 3,925 3,119 60.6% 4,327 3,426 66.5% Legacy n/a n/a n/a -1,209 2,375 -106.8% Group items -1,489 1,080 499.9% -1,472 1,068 494.3% Allocation -4,119 3,551 -86.9% -3,591 2,925 -71.6% Total 2,665 2,704 7.4% 2,665 2,704 7.4% Source: Company reports and J.P. Morgan estimates. Old style is based on actuals 2004-7 and JPMe estimates for 2008=9, where JPMe reallocated investment income from legacy and from asset management to the two main operating units according to their invested technical reserves.

By comparison, using the actual accounting which allocates only the risk free to the operating units, life re’s standard deviation drops to SF0.4bn; in relation to premiums its earnings volatility is now just one third that of non-life, respectively 2.5% and 7.9% (see above table).

We also show this in terms of the operating earnings. The following chart shows the operating earnings as reported, and life re is definitely smoother than non-life, which had a significant dip in 2005.

Figure 4: Swiss Re operating results non-life and life re, 2004-6 old style, 2007-9 new style (only risk free investment return allocated to operating units) SFm

0

1,000

2,000

3,000

4,000

5,000

6,000

2004 2005 2006 2007 2008 2009

Old style Old style Old style New style New style New style

Non-lifeLife

Source: Company reports.

By comparison, under our estimates of the old style operating earnings, where investment income is allocated according to the underlying assets, life re is more volatile, as it had a loss in 2008 under that basis (see following chart).

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Figure 5: Swiss Re operating results of non-life and life re, old style, as reported 2004-7 and JPMe 2008-9 in SFm

-3,000

-2,000

-1,000

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

actual actual actual actual JPMe JPMe

2004 2005 2006 2007 2008 2009

Non-lifeLife

Source: Company reports and J.P. Morgan estimates.

More numbers on earnings volatility of life re vs non-life re – it is consistently lower We show below a comparison of the earnings volatility of life and non-life reinsurance for the European listed reinsurers. For each company we calculated the standard deviation of operating earnings pretax of life re and non-life re, and divided by net earned premiums (gross premiums in the case of SCOR, as net earned premiums data is less readily accessible). In each case, the ratio of standard deviation to premiums is between half and one third in life re as it is in non-life re.

Table 20: Comparison between SCOR, Hannover Re, Swiss Re and Munich Re (2004-09) – on reported basis life re operating earnings volatility is 3% vs 7% non-life re €m, CHFm, % For 2004-09 Hannover Re SCOR Swiss Re Munich ReStandard deviation - operating profit 427 134 2,704 993

Non life 344 103 1,596 821Life 112 51 400 174

Average premiums 7,637 4,920 28,084 36,564Non life 4,216 2,562 16,746 13,765Life 2,708 2,358 11,021 7,508

Standard deviation/avg. premiums 5.6% 2.7% 9.6% 2.7%Non life 8.2% 4.0% 9.5% 6.0%Life 4.1% 2.2% 3.6% 2.3%

Source: Company reports. For SCOR, we have used GEP. Average ratio standard deviation to premiums is 6.9% in non-life, 3.1% in life re.

We show this data in the following two charts. The first shows non-life operating profit in 2004-11e, and the data is relatively volatile with low earnings in 2005 for all, and also relatively low earnings in 2008, particularly for SCOR and Hannover.

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Figure 6: Non life earnings (operating profit) for SCOR, Hannover Re, Munich Re and Swiss Re (2004-11e) €m, CHFm

153 160 331 410 202 213 323 510

2,727

1,025

5,6134,471

2,746

3,820

1,8172,681

463(28)

670 6572

731 692 762

1,9441,284

3,4863,068 2,822 2,989

2,277 2,242

-1,000

-1,000

2,000

3,000

4,0005,000

6,000

2004 2005 2006 2007 2008 2009 2010e 2011e

SCOR Sw iss Re Hannov er Re Munich Re Source: Company reports and J.P. Morgan estimates. Swiss Re in SFm, SCOR, Hannover and Munich in €mn

We show the life operating profits of the same groups over the same period in the chart below, and here the data is much smoother, although all groups did report lower profits in 2008.

Figure 7: Life earnings (operating profit) for SCOR, Hannover Re, Munich Re and Swiss Re (2004-11e) €m, CHFm

46 83 78 167 146 161 165 188

1,304

1,643 1,546

1,320

697 746 805 757

77 93 140230

121

372277 278

698

1,105922

1,091934

1,1751,077

1,334

-200400600800

1,0001,2001,4001,6001,800

2004 2005 2006 2007 2008 2009 2010e 2011e

SCOR Sw iss Re Hannov er Re Munich Re Source: Company reports and J.P. Morgan estimates.

Finally, we show the detailed data for each reinsurer in the next four tables.

Table 21: SCOR - Earnings summary €m 2004 2005 2006 2007 2008 2009 2010e 2011e Gross earned premium 2,728 2,436 2,837 4,739 5,759 6,346 6,452 6,881

ow Non life 1,611 1,394 1,650 2,302 3,068 3,229 3,413 3,583 ow Life 1,117 1,042 1,188 2,437 2,691 3,117 3,039 3,297

Operating profit 199 242 408 577 348 372 488 697 ow Non life 153 160 331 410 202 213 323 510 ow Life 46 83 78 167 146 161 165 188


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Table 22: Swiss Re - Earnings summary CHFm 2004 2005 2006 2007 2008 2009 2010e 2011e Net earned premium 29,439 27,779 29,515 31,664 25,501 24,606 20,278 19,876


Operating profit 3,367 1,973 5,856 5,187 (1,350) 954 2,640 3,158 ow Non life 2,727 1,025 5,613 4,471 2,746 3,820 1,817 2,681 ow Life 1,304 1,643 1,546 1,320 697 746 805 757


Table 23: Hannover Re - Earnings summary €m €m 2004 2005 2006 2007 2008 2009 2010e 2011e Net earned premium 7,575 7,494 7,092 7,293 7,062 9,307 9,601 9,793


Operating profit 539 92 820 928 148 1,140 992 1,063 ow Non life 463 (28) 670 657 2 731 692 762 ow Life 77 93 140 230 121 372 277 278


Table 24: Munich Re - Earnings summary €m €m 2004 2005 2006 2007 2008 2009 2010e 2011e Net earned premium 36,534 36,210 35,714 35,675 35,724 39,526 42,487 44,871


Operating profit 3,025 4,142 5,494 5,078 3,262 4,721 3,825 4,290 ow Non life 1,944 1,284 3,486 3,068 2,822 2,989 2,277 2,242 ow Life 698 1,105 922 1,091 934 1,175 1,077 1,334


Comparison of the European life reinsurers Reinsurance life operating profit margin We have shown in the table below the operating profit margin of the European reinsurance companies for the life segment. We note that the larger reinsurers post higher operating profit margins.

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Table 25: European reinsurers life operating margin LCm, % NEP 2004 2005 2006 2007 2008 2009 Swiss Re 10,205 9,638 10,974 12,665 11,090 10,679 Munich Re 7,294 7,396 7,276 7,024 6,775 9,281 Hannover Re 1,956 2,258 2,373 2,795 2,785 4,079 SCOR 1,080 1,010 1,121 2,191 2,429 2,779 Operating profit Swiss Re (ex gains) 1,222 1,333 1,381 1,320 926 1,291 Munich Re 698 1,105 922 1,091 934 1,175 Hannover Re 77 93 140 230 121 372 SCOR 46 83 78 167 146 161 Operating profit % NEP Swiss Re (ex gains) 12.0% 13.8% 12.6% 10.4% 8.3% 12.1% Munich Re 9.6% 14.9% 12.7% 15.5% 13.8% 12.7% Hannover Re 3.9% 4.1% 5.9% 8.2% 4.3% 9.1% SCOR 4.3% 8.2% 6.9% 7.4% 6.0% 5.8% Source: Company reports, Swiss Re operating profit is excluding gains. Note Munich Re includes life and health re. Note for Swiss Re 2007 onward is the new style accounting where life re gets just credited with the risk free return on its invested assets. 2007, the only year of old and new reporting, had SF2744m life operating profit old style and SF1320m new style.

Reinsurance investment income yield in life We note that the lowest investment yield was in the year 2008 for the life reinsurance segment for the European reinsurers. For Swiss Re, annualised investment yield on our estimates is declining from the 2007 level of 5.2%, reflecting the constant decline in risk free rates since. However, there is accounting noise in the Swiss Re numbers, which we cannot exclude with reported data, as they do include CVA/DVA (CVA is credit valuation adjustment, DVA is debit valuation adjustment) valuation adjustments which reflect the CDS spreads of Swiss Re and its cedants rather than real investment cash flows. We believe this is the main reason why 2Q10 appears strongly positive.

Table 26: Reinsurance investment income yield LCm, %, Swiss Re CHFm during 2004-09 and 1Q10 and 2Q10 (translated back to SF at 0.95) Investment income 2004 2005 2006 2007 2008 2009 1Q 10 2Q 10 Swiss Re 3,400 2,403 2,133 586 737 Munich Re 1,431 1,897 1,617 1,532 1,252 1,570 274 253 Hannover Re 222 275 305 294 246 520 101 128 SCOR 138 175 190 330 259 305 83 95 RGA 581 639 780 908 871 1,123 304 292 Life investments Swiss Re 53,519 62,234 59,519 65,383 52,619 53,073 54,377 50,818 Munich Re 34,030 36,800 33,710 26,108 25,386 23,008 20,591 21,491 Hannover Re 7,600 8,857 10,909 11,351 12,440 15,886 16,728 18,176 SCOR 7,035 7,423 8,474 9,084 9,694 RGA 10,564 12,331 14,613 16,398 15,611 19,224 20,560 21,049 Life inv yield Swiss Re 5.2% 4.6% 4.0% 4.3% 5.8% Munich Re 4.2% 5.2% 4.8% 5.9% 4.9% 6.8% 5.3% 4.7% Hannover Re 2.9% 3.1% 2.8% 2.6% 2.0% 3.3% 2.4% 2.8% SCOR 4.7% 3.5% 3.6% 3.7% 3.9% RGA 5.5% 5.2% 5.3% 5.5% 5.6% 5.8% 5.9% 5.5% Source: Company reports. Note that the accounting split for Munich Re from 1Q10 is just life re, prior was life and health re together. Note fro 2007 onward Swiss Re only credits risk free to its operating units. Investment income as we define it for Swiss Re consists of investment income and net gains on non-participating contracts. However, even this methodology has a weakness, which is that this investment income does include adjustments for Credit Valuation Adjustments and Debit Valuation Adjustments, which mainly reflects the change of CDS costs for Swiss Re and for its cedants where there is Modco business, which is pure accounting and does not reflect a cash cost. With reported data it is not possible to exclude these CVA/DVA adjustments.

33



MCEV (Market Consistent Embedded Value) roll-forward comparison Munich Re contributes maximum as by value of new business with 12.1% of the beginning MCEV driven by the new business. Munich Re 2009 MCEV has also benefited by the economic variances by 15% of the beginning MCEV against 10.6% for Hannover Re.

Table 27: MCEV rollforward comparison of the 3 reinsurers €m, % 2009 2009 2009 2009 2009 2009 2009 2009 2009 €m €m €m % % % Rank Rank Rank MCEV roll forward comparison Munich Hannover SCOR Munich Hannover SCOR Munich Hannover SCOR Opening MCEV 4,657 1,652 1,702 100.0% 100.0% 100.0% 1 1 1

Opening adjustments 306 (25) 0 6.6% -1.5% 0.0% 1 3 2 Adjusted opening MCEV 4,963 1,627 1,702 106.6% 98.5% 100.0% 1 3 2

Value of new business 562 84 113 12.1% 5.1% 6.7% 1 3 2 Expected return at reference rate 196 77 77 4.2% 4.6% 4.5% 3 1 2 Expected return in excess of reference rate 11 0.0% 0.7% 0.0% 2 1 2 Transfers from VIF and required capital to free

surplus 0.0% 0.0% 0.0% 1 1 1 Experience variances 145 (5) 19 3.1% -0.3% 1.1% 1 3 2 Assumption changes 113 41 (19) 2.4% 2.5% -1.1% 2 1 3 Other operating variance (126) (29) -2.7% -1.8% 0.0% 3 2 1

Operating MCEV earnings 891 179 191 19.1% 10.8% 11.2% 1 3 2 Economic variances 712 174 109 15.3% 10.6% 6.4% 1 2 3 Other non operating variance 13 0.3% 0.0% 0.0% 1 2 2 Total MCEV earnings 1,616 353 299 34.7% 21.4% 17.6% 1 2 3

Closing adjustments 194 231 (66) 4.2% 14.0% -3.9% 2 1 3 Closing MCEV 6,773 2,211 1,934 145.4% 133.8% 113.7% 1 2 3 Source: Company reports.

Sensitivity We have shown below the comparison of the 4 reinsurers on the sensitivity of the various assumptions. We also note that the metrics are not exactly comparable since the methodology used by each company is different. We note that Swiss Re EVM is the most sensitive to the drop in interest rates by 1%. The reason was actually the short duration at the end of 2009 and is less linked to the underlying life reinsurance business.

We also note that Munich Re, SCOR & Swiss Re do not adjust the EV for the liquidity premium. And finally we note that the largest exposure to mortality, in terms of sensitivity to the base case embedded value, is Hannover Re at 35% vs 14-20% for its peers.

34



Table 28: Reinsurance sensitivity to assumptions % Year 2009 2009 2009 2009Method MCEV EEV MCEV EVMSensitivity Munich Re SCOR Hannover Re Swiss ReInterest rates & assets

Interest rates –100bp 3.9% 1.1% (3.4%) (3.5%)Discount rate -100 bps NA 6.1% NA 4.2%Equity/property values –10% 0.0% (0.7%) NA (3.1%)Equity/property implied volatilities +25% 0.0% NA 0.0% NA

Expenses and persistency Maintenance expenses –10% 1.1% 1.3% 2.0% NALapse rates –10% (0.8%) 1.5% 15.7% 4.5%

Insurance risk Mortality/morbidity (life business) –5% 19.5% 13.9% 35.0% 13.6%Mortality (annuity business) –5% (0.1%) 0.0% (1.8%) (1.0%)

Liquidity premium None NA None NoneSource: Company reports & J.P.Morgan estimates

MCEV by components: SCOR has the highest free surplus We note that SCOR has the highest % of MCEV as the free surplus and Munich re has the lowest free surplus at 8.3%. We have shown the detailed break up of the segments in the table below.

Table 29: MCEV break up by components €m, % MCEV by components, €m Munich Re SCOR Hannover Re Adjusted net worth 2,835 907 2,093

Free surplus 564 382 794 Required capital 2,271 526 1,299

VIF 3,938 1,027 2,461 PVFP (without options) 2,277 1,507 1,879 CoRNHR 1,252 421 490 FOGs 32 10 7 FCoRC 377 49 84

MCEV 6,773 1,934 4,554 MCEV by components, % Adjusted net worth 41.9% 46.9% 46.0%

Free surplus 8.3% 19.7% 17.4% Required capital 33.5% 27.2% 28.5%

VIF 58.1% 53.1% 54.0% PVFP (without options) 33.6% 77.9% 41.3% CoRNHR 18.5% 21.8% 10.8% FOGs 0.5% 0.5% 0.2% FCoRC 5.6% 2.5% 1.9%

MCEV 100.0% 100.0% 100.0% Source: Company reports

Life reinsurers vs. life primary insurers – we believe the life reinsurance have more attractive risk reward, particularly at current low levels of interest rates We believe that life reinsurance has a more attractive risk reward than life primary insurance, particularly at the current low levels of interest rates. To support our view we make two points. The first is our translation below of a 18 August interview of the Munich Re CEO in the FTD, the second is a comparison of the embedded value sensitivities of life primary insurance and life reinsurers, where the reinsurers have sensitivity mainly to mortality and lapse, the primary insurers to interest rates.

35



Interview with Munich CEO on 18 August in FTD The following is our translation of an interview of Munich Re's CEO, Dr. Nikolaus von Bomhard in the FTD on 18 August, and we have checked the reasonableness of our translation with the company. We cite this interview because it supports our view that life primary insurance is less attractive in terms of risk reward than life reinsurance.

By comparison with life reinsurance, the economics in life primary are in our view less favourable. This is in our view because life reinsurance is more sensitive to mortality and biometric risks, which benefit from generally favourable trends over time, while life primary is more sensitive to interest rate risk and investments, a challenge in the current low interest rate environment.

Munich Re is not particularly concerned with the loss of market share in primary life in Germany. Munich Re set fundamental concerns on the profitability of German life. Seen economically this area is not very profitable. The business model relies on paying long term guaranteed interest rates to clients, which are hard to earn in the current period of low interest rates. Plus, the investment risk is with the insurer - and at least 90% of investment return is to the policyholder.

Munich Re, by contrast, is very satisfied with ERGO's primary non-life which has above average results. As for the life part of ERGO, part has been closed to new business for now (Victoria) as it could not take sufficient investment risk to deliver expected policyholder returns. Munich Re is also very optimistic in reinsurance despite a shrinking topline, with strong regional growth in Asia, CEE and LatAm, and also potential growth in life re.

The following table highlights the differences between reinsurers and primary insurers in terms of embedded value sensitivities. The table is striking in our view in three respects:

1. Asset risk seems mainly with the primary insurers. The interest sensitivity of the reinsurers is on average near zero (this is because it is the average of positive sensitivities for SCOR and Munich, and low negative sensitivities for Hannover and Swiss) whereas on average for the primary insurers it is 15%. The main reason for this sizeable difference we believe is that the primary insurers provide minimum return guarantees to their policyholders (3.3% on average on the back book in Germany, 2.25% for new business), and the reinsurers, except for some small variable annuity shares, provide none.

2. By contrast reinsurers seem to have all the mortality risk. We believe this reflects the reality that reinsurers do focus on mortality as their main offering. And typically reinsurers price their mortality by giving away one third to one half the expected trend improvement in mortality to the primary insurers. So for reinsurers we believe the two main risks on mortality are: a) that the trend improvement slows or stops; b) that there is a pandemic and that mortality for a year is not the 5% worse than the sensitivity calculates, but 10% instead. This is the reason that Swiss Re, for example, has hedged against pandemics via securitisations.

3. Also reinsurers have higher sensitivity to lapse risk. This reflects the business model of reinsurers, which advance a high upfront commission to the primary insurers, to help them pay for their marketing costs. And the reinsurers then try to estimate, using lapse and mortality assumptions, that they will get sufficient

36



premiums back to pay for the upfront commission. So, although the risks are lapses and mortality, the business model is closely tied to making loans to primary insurers, in a way which relieves their liquidity and solvency strain from selling large new business volumes with large front end commissions to sales.

Table 30: Average sensitivities for the reinsurers and primary insurers (2009) % Sensitivity Primary Insurers ReinsurersInterest rates & assets

Interest rates –100bp (14.6%) (0.5%)Discount rate -100 bps 5.2%Equity/property values –10% (4.0%) (1.3%)Equity/property implied volatilities +25% (1.9%)

Expenses and persistency Maintenance expenses –10% 2.7% 1.5%Lapse rates –10% 1.8% 5.2%

Insurance risk Mortality/morbidity (life business) –5% 1.6% 20.5%Mortality (annuity business) –5% (0.9%) (0.7%)

Source: Company reports. Reinsurers is the average for SCOR, Hannover, Munich and Swiss. Primary insurers is the average for Allianz, AXA, Generali and Munich Re primary life.

The following table shows the data in greater detail. We highlight three points:

1. The high interest rate sensitivity in life primary is due mainly to Allianz and Munich Re primary life. This is because they are both significantly exposed to German life, which currently has relatively high average guaranteed rates on old business in Europe, at 3.3% on the backbook. Generali is around half their level, and we believe this is mainly because Generali is less exposed to Germany, and because in Italy the average guaranteed rate is 2%, and this is reduced to 1% after the contractual deduction of 1.2% management fees.

2. Generali has the highest sensitivity to equity and property values at 6%, followed by AXA and Allianz at 4%. Munich Re’s primary sensitivity is relatively modest at 2%. We believe this simply reflects the more conservative investment strategy of Munich, and the more aggressive strategy of Generali. In any case, the numbers are all below 10%, implying that shareholders' net exposure to property and equity values is less than one times life embedded value.

3. Hannover has a relatively high sensitivity to lapse and mortality risk compared with its reinsurance peers. We believe this reflects its business mix, which we believe is structured to use lapse risk and mortality risk to help provide front end commission funding for primary insurers. A significant proportion of this is securitised out using securitisation vehicles (L7 in 1Q09 securitised out €100m of life embedded value, source Hannover website, L6 1Q06 also securitized out €100m life EV)).

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Table 31: Re/Insurance sensitivity to assumptions % Year 2009 2009 2009 2009 2009 2009 2009 2009Method MCEV EEV MCEV EVM MCEV EEV EV MCEVSensitivity Munich Re SCOR Hannover Re Swiss Re Allianz AXA Generali Munich Re primaryInterest rates & assets

Interest rates –100bp 3.9% 1.1% (3.4%) (3.5%) (19.0%) (6.0%) (10.4%) (22.9%)Discount rate -100 bps NA 6.1% NA 4.2% NA NA NA NAEquity/property values –10% (0.0%) (0.7%) NA (3.1%) (4.0%) (4.0%) (6.2%) (1.8%)Equity/property implied volatilities +25% (0.0%) NA (0.0%) NA NA (2.0%) (2.5%) (1.1%)

Expenses and persistency Maintenance expenses –10% 1.1% 1.3% 2.0% NA 3.0% 4.0% 2.4% 1.5%Lapse rates –10% (0.8%) 1.5% 15.7% 4.5% 1.0% 3.0% 2.4% 0.6%

Insurance risk Mortality/morbidity (life business) –5% 19.5% 13.9% 35.0% 13.6% 1.0% 2.0% 2.1% 1.1%Mortality (annuity business) –5% (0.1%) 0.0% (1.8%) (1.0%) (1.0%) (1.0%) (0.7%) (0.9%)

Liquidity premium None NA None None NA NA NA NASource: Company reports.

Life reinsurance products We have summarized the characteristics of the 4 typical Life reinsurance products and the risks associated with each product. Critical Illness is having the longest term generally close to 25 years. Term life and Credit life does not have much interest rate risk since they have low premium reserve.

Table 32: Life reinsurance products characteristics as stated Characteristics Term life Credit Life Financing Critical Illness Biometric risk Constant sum upon death Decreasing sum upon death Typically contains Lump sum on industry standards

Lapse Risk Under reassurance treaty (first year financing)

Under reassurance treaty (No first year financing) Typically contains

Rate covered under reassurance treaty

Interest rate risk None, due to low premium reserves None, due to low premium reserves Major region US Europe Type Individual Individual Individual usually Premiums Stable Long term predictable Long term Approximate term 10 years 20 years 10 years 25 years Source: SCOR investor day presentation, 2008

Term life Term life is a good and steady contributor of the premium and profits as can be seen in the chart below. This is a typical US product sold to individuals. The negative cash flow in the beginning year results from statutory reserve strain and/or a premium commission paid to cedants to help finance the production. This is also a strong EV generator since most of the EV is recognized in the first year.

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Figure 8: Term life: cash flow, IFRS profit & EV profit Indicative figures in Y axis, X axis is years

-8.0-6.0-4.0-2.00.02.04.06.08.0

10.0

1 2 3 4 5 6 7 8 9 10

Distributable cashflow IFRS profits IFRS premiums

EV profits Risk based capital Source: SCOR investor day presentation, 2008

Credit life This is a typical European product sold mainly to individuals for mortgage protection. Also the cash flows and the IFRS profits are identical for these products and are also very much predictable. This is also a strong EV generator. In addition, as can be seen from the figure below the risk based capital is released quickly over time. This product typically does not have negative distributable cash flow at the beginning.

Figure 9: Credit life: cash flow, IFRS profit & EV profit Indicative figures in Y axis, X axis is years

0.0

2.0

4.0

6.0

8.0

10.0

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19

IFRS profits & distributable cash flow IFRS premiums


Financing reinsurance In the financing reinsurance, like for other lines of business, the IFRS profit is spread evenly over the total contract period. This combines traditional life reinsurance and financial components. This usually contains biometric, mortality and lapse risks. Also, all the life and health insurance can be combined with reinsurance.

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Figure 10: Financing reinsurance: cash flow, IFRS profit & EV profit Indicative figures in Y axis, X axis is years

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

1 2 3 4 5 6 7 8 9 10Distributable cashflow IFRS profits IFRS premiums

EV profits Risk based capital Carried-forw ard loss Source: SCOR investor day presentation, 2008

Critical Illness This is a good new business value generator creating EV profits. This product is also often very long term as can be seen in the chart below. Hence this generates steady premiums over the period. This is sold mainly to the individuals with life cover and to protect mortgages.

Figure 11: Critical Illness: cash flow, IFRS profit & EV profit Indicative figures in Y axis, X axis is years

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

Distributable cashflow IFRS profits IFRS premiums


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RGA read across summary We have spent some time analyzing the track record, risks and business model of RGA (Reinsurance Group of America, covered by J.P.Morgan US Life Insurance analyst, Jimmy Bhullar). The reason is that RGA is the only listed pure life reinsurer in the world, it has very granular and transparent accounting and reporting, and we believe its reporting, within the limitations of US GAAP, are a standard for the sector.

The only key weakness in terms of reporting is that RGA does not publish its tracking of embedded value, which it does, however, prepare internally. The reason for so far non disclosure is that the US capital market so far has paid little or no attention to embedded value for the primary life insurers, so there is no peer group nor general understanding. However, we believe following our conversations with RGA that it also (like its European peers) regards embedded value as the better metric to track value creation.

Our analysis of RGA focuses on three areas:

1. The November 2008 $347m capital increase and the reasons for it. We note that although RGA's business is primarily focused on mortality, that its prospectus and SEC filings at the time stressed capital market type risks above other operating risks. We believe this was partly a reflection of the capital markets environment at the time, which was reaching new highs in terms of volatility. But we believe it also highlights the issue that, unless a life reinsurer does just pure mortality business such as YRT (effectively a pay as you go arrangement, with zero investment risk), then investments are an issue and the volatility of investment returns can potentially as in crisis years like 2008 overwhelm the underlying operating profits. This means that, in the case of RGA, investments have an asymmetric effect. They have the potential to be associated with conditions where the company decides to make a capital increase, as was the case in November 2008, whereas in more normal conditions assuming credit risk only has the potential to raise ROE for the group from a 12-13% run rate to a 12-14% level.

2. Profitability track record and US GAAP accounting. Under US GAAP (IFRS is very similar) life re liabilities are valued on the basis of the original pricing assumptions and are only ever reset if the life re division as a whole should fall into loss. We believe this is the reason that, on the 2Q10 the conference call RGA stated that they expect 2010 to be the bottoming out year in terms of profitability, when the weak pricing years of up to 2004 have their maximum impact. We note that in non-life should pricing for any individual risk be understated then an adjustment is made immediately, as the accounting is best estimate, not as life re effectively is, amortised.

3. Business model. We note that RGA is focused mainly on mortality and that it prides itself on gaining market share not so much through pricing, but more in terms of consistency and quality of service. We note also that Canada is significantly more profitable than the US, and we believe this reflects the fact that it is a more concentrated market.

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November 2008 capital issue 4 November 2008 RGA raised $346.9m gross by issuing 10.235million new shares at $34.69 each, raising $331.9m net of $15m fees. Partly thanks to this on the 2Q09 conference call the company said it had over $0.4bn excess capital available for deals, and that number at 2Q10 was over $0.5bn.

Main conclusions are: 1. For RGA reinvestment risk and investment income in general does not drive profits and it uses only modest credit risk to help enhance profitability (ie 5.5% returns). In the mortality risk business, especially YRT, investment income has virtually no impact. RGA’s combined ratio is less than 100% on an expected basis so it is really mortality that drives profitability. Investment income and reinvestment yields affect RGA around the margins slightly. For example, because of the low investment yields right now, RGA would expect to achieve an ROE of 12 to 13% instead of 14-15%.

2. Mortality takes 4-5 years to build up; we believe the reason 2010 is cited as the low point in US profitability by RGA is that this is when the underpriced period 2000-4 has the maximum weight in the portfolio as a whole.

3. The business is very finely analysed in the segments US traditional (mainly mortality), financial and asset based, and even this does not seem enough as on the 2Q10 conference call there were very many questions about variable annuity vs traditional fixed annuity earnings contribution, and RGA said that some break out of VA profitability may be good. International and Asia are a little more homogenous. International is mainly UK, Asia is mainly Australia.

4. The run rate of ROE is below 13% for now due to high mortality and dip in reinvestment rate, trend is 14%. Last ROE low was 11% in 2005 when mortality was high.

5. Swiss Re was very aggressive in the 97-03 period, now much less so (eg closed Taiwan office). The most aggressive is Hannover.

6. Canada is highly concentrated high margin country, the US more fragmented; profitability is adequate.

7. Volatility in US mortality has been in the $1-3m bracket, and has been above expectations. The $250,000-$1,000,000 group is very stable.

8. Expectations of strong growth post 2008 capital markets crisis have not so far materialised. So far very few M&A deals have occurred, which normally would tend to lead to spikes in demand for reinsurance, and session rates are falling as primary insurers have rebuilt their balance sheets and core growth has slowed.

9. The core mortality has baked-in premium growth for stable inforce as the portfolios age and the premiums rise at each anniversary. The so called permanent business (ie mortality is part of the contract and lapses are low) is higher margin and sticky; pure term is more lapse prone.

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10. Mortality contracts run off over around 30 years. This means that the risk of large claims can occur at any time for decades after the contract signing.

11. Underpricing in 2000-03 has the effect of cutting profitability to below 13% ROE from a 14% run rate, and we estimate the relatively underpriced portfolio accounts for around 20% of the total US book of business (assuming 30 year durations); we estimate this means that it was written on ROEs of 5% below the run rate, ie around 7-8%. For more highly capitalised reinsurers like Swiss Re we estimate this means around 5% ROE run rate on that portfolio.

12. Mortality in US seems to have spiked in 2008-1Q10 vs very light in 2006-7.

13. RGA has around $500m capital it has not deployed. This is partly from the 4Q08 capital increase.

Risks as per RGA’s SEC filings around its 4 November 2008 capital rising. We note that the listing of the risks would likely have been influenced by the capital markets environment then, and more priority given to investment risks as a result. The text in italics below is taken from the risk section of the 31/10/08 filing with the SEC.

1. Need for liquidity – this is a key reason given for the capital raising.

2. Volatile capital markets. Results of operations are materially affected by conditions in the global capital markets and the economy generally.

a) These events and the continuing market upheavals may have an adverse effect on us, in part because we have a large investment portfolio and are also dependent upon customer behavior. Revenues may decline in such circumstances and our profit margins may erode.

b) In addition, in the event of extreme prolonged market events, such as the global credit crisis, we could incur significant losses.

c) Even in the absence of a market downturn we are exposed to substantial risk of loss due to market volatility.

3. Collateral: some of our transactions with financial and other institutions specify the circumstances under which the parties are required to post collateral. This may increase under certain circumstances which could adversely affect our liquidity. In addition we may be required to make payments to our counterparties related to any decline in the market value of the specified assets.

4. Defaults on our mortgage loans and volatility in performance may adversely affect our profitability. Mortgage loans are stated on our balance sheet at unpaid principal balance adjusted for any unamortised premium or discount and are net of valuation allocations. Such valuation allowances are based on the excess carrying value of the loan over the present value of expected future cash flows discounted at the loans original effective interest rate.

5. Accounting: Our principal investments are carried as follows.

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Fixed maturities and equities are classified as available for sale and reported at their estimated fair value. Unrealised gains or loses are recorded as OCI.

Short term investments with remaining maturities of one year or less but greater than three months are stated at amoritzed cost which approximates fair value.

Mortgage and policy loans are restated at unpaid principal balance, net of valuation allowances.

Funds withheld at interest represent amounts contractually withheld by ceding companies in accordance with reinsurance agreements. The value of the assets withheld and interest income are recorded in accordance with specific treaty terms. We use the cost method of accounting for investments in real estate joint ventures.

Investments not carried at fair value, principally mortgage loans, policy loans, real estate joint ventures and other limited partnerships may have fair values which are substantially different from the carrying value in our consolidated financial statements. Each of such asset classes is regularly evaluated for impairments.

6. Valuation. Our valuation may include methodologies which are subject to differing interpretations and could result in changes to investment valuations that may materially adversely affect our results of operations. This is relation to level 1, level 2 and level 3 as defined in SFAS 157.

Level 1 is quoted prices in active market for identical assets.

Level 2 are observable inputs such as quoted prices for similar assets, prices in markets that are not active, or valuation methodologies with significant inputs that are observable or can be corroborated from observable market data. This includes primarily US and foreign corporate securities, Canadian provincial government securities, RMBS and CMBS. We value most of these securities using inputs that are market observable.

Level 3 are unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the related assets or liabilities. These unobservable inputs can be based in large part on management judgment or estimation and cannot be supported by reference to market activity. Even though unobservable, management believes these inputs are based on assumptions deemed appropriate given the circumstances and consistent with what other market participants would use when pricing similar assets and liabilities. For our invested assets, this category generally includes U.S. and foreign corporate securities (primarily private placements), asset-backed securities (including those with exposure to sub prime mortgages), and to a lesser extent, certain residential and commercial mortgage-backed securities, among others. Additionally, our embedded derivatives, all of which are associated with reinsurance treaties, are classified in Level 3 since their values include significant unobservable inputs associated with actuarial assumptions regarding policyholder behavior. Embedded derivatives are reported with the host instruments on the condensed consolidated balance sheet.

Risks from October 2008 RGA prospectus The following is a list of risks we extracted from the 29 October 2008 prospectus for the $349m equity increase. We note that this was mainly on investment risks,

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relatively little on insurance and mortality. We believe, as noted above, that part of the reason for the focus on investment risk is the environment in 4Q08, when capital markets volatility rose to new peaks.

1. Adverse capital and credit market conditions may significantly affect our ability to meet liquidity needs, access to capital and cost of capital.

2. Difficult conditions in the global capital markets and the economy generally may materially adversely affect our business and results of operations and we do not expect these conditions to improve in the near future.

3. There can be no assurance that actions of the U.S. Government, Federal Reserve and other governmental and regulatory bodies for the purpose of stabilizing the financial markets will achieve the intended effect.

4. The impairment of other financial institutions could adversely affect us.

5. Our requirements to post collateral or make payments related to declines in market value of specified assets may adversely affect our liquidity and expose us to counterparty credit risk.

6. Defaults on our mortgage loans and volatility in performance may adversely affect our profitability.

7. Our investments are reflected within the consolidated financial statements utilizing different accounting basis and accordingly we may not have recognized differences, which may be significant, between cost and fair value in our consolidated financial statements.

8. Our valuation of fixed maturity and equity securities may include methodologies, estimations and assumptions which are subject to differing interpretations and could result in changes to investment valuations that may materially adversely affect our results of operations or financial condition.

9. Some of our investments are relatively illiquid and are in asset classes that have been experiencing significant market valuation fluctuations.

10. The determination of the amount of allowances and impairments taken on our investments is highly subjective and could materially impact our results of operations or financial position.

11. Gross unrealized losses may be realized or result in future impairments.

12. Defaults, downgrades or other events impairing the value of our fixed maturity securities portfolio may reduce our earnings.

13. The class A common stock is subject to a conversion proposal at a special meeting of our shareholders on November 25, 2008.

Numerous important factors could cause our actual results and events to differ materially from those expressed or implied by forward-looking statements including, without limitation:

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• adverse capital and credit market conditions and their impact on our liquidity, access to capital and cost of capital;

• The impairment of other financial institutions and its effect on our business;

• Requirements to post collateral or make payments due to declines in market value of assets subject to our collateral arrangements;

• The fact that the determination of allowances and impairments taken on our investments is highly subjective;

• Adverse changes in mortality, morbidity, lapsation or claims experience;

• Changes in our financial strength and credit ratings and the effect of such changes on our future results of operations and financial condition;

• Inadequate risk analysis and underwriting;

• General economic conditions or a prolonged economic downturn affecting the demand for insurance and reinsurance in our current and planned markets;

• The availability and cost of collateral necessary for regulatory reserves and capital;

• Market or economic conditions that adversely affect the value of our investment securities or result in the impairment of all or a portion of the value of certain of our investment securities;

• Market or economic conditions that adversely affect our ability to make timely sales of investment securities

• Risks inherent in our risk management and investment strategy, including changes in investment portfolio yields due to interest rate or credit quality changes;

• Fluctuations in U.S. or foreign currency exchange rates, interest rates, or securities and real estate markets;

• Adverse litigation or arbitration results;

• The adequacy of reserves, resources and accurate information relating to settlements, awards and terminated and discontinued lines of business;

• The stability of and actions by governments and economies in the markets in which we operate;

• Competitive factors and competitors' responses to our initiatives;

• The success of our clients;

• Successful execution of our entry into new markets;

• Successful development and introduction of new products and distribution opportunities;

• Our ability to successfully integrate and operate reinsurance businesses that RGA acquires;

• Regulatory action that may be taken by state Departments of Insurance with respect to RGA, or any of its subsidiaries;

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• Our dependence on third parties, including those insurance companies and reinsurers to which we cede some reinsurance, third-party investment managers and others;

• The threat of natural disasters, catastrophes, terrorist attacks, epidemics or pandemics anywhere in the world where we or our clients do business;

• Changes in laws, regulations, and accounting standards applicable to RGA, its subsidiaries, or its business;

• The effect of our status as an insurance holding company and regulatory restrictions on our ability to pay principal of and interest on its debt obligations

US and Canada has higher profit margins We have shown in the chart below the comparison of the profit margin (calculated as operating income % NEP). We note that the US and Canada are having higher margins historically when compared to the Europe and Asia Pacific. Also, the profit margin of Canada has increased over the period 2003 to 2008 and overtook the US in 2009.

Figure 12: Operating income margin by regions for RGA %

6.3% 6.7% 5.8% 6.7% 7.2% 7.5% 7.7% 7.0%

12.0% 12.9%11.2% 12.5% 13.5%

10.8% 12.1%8.4%

12.2% 13.7%

9.5%

15.4%

20.1%

14.3%

4.2%5.7% 6.5%

10.0%7.3%

10.5%6.5%5.1%

1.8%5.9%

8.8%7.1%

8.8% 8.5%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

2003 2004 2005 2006 2007 2008 2009 2010e

Total US Canada Europe and SA Asia pac Source: Company reports & J.P.Morgan estimates, Segment margins are calculated on the pre tax operating income; total margin is calculated on the total operating income.

Premium growth is slowing down The life reinsurance premiums growth has reduced from 27% in 2004 to 7% in 2009. Among the drop the sharpest drop was in Asia Pacific where the growth has reduced from 54% to 0% during the same period. We also note that the growth has increased in 2009 for Canada and Europe/SA. J.P.Morgan estimates (this is drawn from the research of our US colleague Jimmy Bhullar) 15% growth in the premiums in 2010e.

Table 33: Net premium growth is slowing down for the past 6 years % Premium growth 2004 2005 2006 2007 2008 2009 2010eTotal 27% 16% 12% 13% 9% 7% 15%

US 23% 10% 9% 8% 8% 7%Canada 18% 35% 25% 13% 10% 15%Europe and SA 32% 15% 6% 15% 4% 10%Asia pac 54% 34% 26% 29% 16% 0%

Source: Company reports & J.P.Morgan estimates

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Capitalisation of reinsurers Capitalisation of RGA from Sep 2008 RGA has increased its total capital by 47% from Sep 08 and this is mainly driven by the rise in equity as can be seen in the table below. We also note that the current excess capital is over $0.5bn (source: 2Q10 transcript).

Table 34: RGA capitalisation $m, % Sep 08 2Q 10 % change Short term debt 95 - Long term debt 923 1,216 31.8% Prefs and collateralized 1,009 1,009 0.0% Equity 2,607 4,443 70.4% Total capital 4,539 6,668 46.9% Source: Company reports

Key takeaways from the earnings of RGA pre transcript of RGA conference calls 3Q09-2Q10 These are relevant texts parts from the transcripts filed with Bloomberg

2Q10 Results From President & CEO Greig Woodring (in Italics):

Mortality in the US was slightly better than expected with strong mortality in Canada and the UK. ROE was 13% annualised. Capital redundancy exceeded $500m. Competition is ratcheting up in the US where it's a little more competitive. Growth in Canada was mostly in creditor premium and traditional has been more muted. VA business performed OK in the quarter. The new yield is 5.5% down from 5.8% and there is pressure on investing new money and that is reflected in new business pricing.

Pricing in 97-03 was quite a bit off, pricing in late 80s early 90s is very profitable. In primary life the companies are [JPMe: we believe this refers to RGA’s primary life insurance clients] looking for growth at the moment. UK is 80% of the segment which consists of Europe, Africa and India and has strong growth at the moment.

Interest rates matter very little for a typical YRT mortality type quote; it really is not that much of an issue. For the asset intensive businesses there are no new transactions in the last year and that may be reflects our more conservative exposure on investment income among other things. So interest rates have more of an effect on in force business than for new pricing.

RGA has more STOLI stranger originated life insurance. The whole market was not priced correctly for older age issuers. And this is when the market was underpriced and that period ran up to maybe 2005.

For the period of time since say 2003, 2004 and later pricing and expectations are pretty close, because we haven't seen a lot of evolution yet. From say 1997 to 1998 or so to 2003 our expectations today might be a little bit higher than we priced at that time. That was a very competitive period of time and we have reassessed. Prior our expectations are considerably below what we were pricing at because of mortality and claims flows.

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The policies that were written sometime ago we priced at a level X. Mortality has improved considerably. Our expectations would be that it would be less than one times X mortality now. Why haven't they lapsed? Well, a lot of those products remember are permanent products, they are not looking at replacing one set of mortality charges with another, they are basically looking at a whole life level premium or a universal life type product. So the products stay in force for a long time. We have a lot of business in force from eras that precede 2003.

We had a return in 2009 of 13% on that mortality markets business. We expected that to slightly fall in 2010 and that is based on the relative prominence or effect of those more pressured issue years in the overall result that this will be the bottoming out year and overall when we look back over time we will expect decent returns overall.

1Q10 results From President & CEO Greig Woodring (in Italics):

US ROE 10% in 1Q10 vs 13% in 2009; this is expected to fall a bit in 2010 and bottom out (low double digits).We have been expecting that returns would be lower because of the most competitive years from 98-03 having a bigger impact and will bottom out about this year. 2010 we earned 13% on this business. We expect to come maybe a little south of in 2010 and then marginally increase each year going forward. The seasonal component is had more deaths over age 80 than would normally expect. Excess capital at 1Q10 for deployment is $500-600m but we would never want that down to zero. US mortality was about 1% above expected which is about $10m

In 98-03 RGA's natural market share was 12-14% and due to extra competitive market was struggling to capture 5-10%. This is the long cycle of life re. 'We don’t have like the property casualty industry big ups and downs in claims where you swing from positive results to negative results. But you have periods of time where you're more competitive and periods of time where you’re less competitive and margins are a little bit wider. So we blend all those together in each year's experience. The swing in competitive intensity was at the reinsurance level.

FY09 results From President & CEO Greig Woodring (in Italics):

The adverse US claims experience was 15-20m in 4Q09. The variation almost always comes about because of large claims. The mortality by claims amount, by policy count is pretty rock steady. {JPMe:This is around 86% benefits ratio like in 2008 and 2009}. By contrast the 2006-7 level was a lot better. (And of course 1Q10 was high mortality 1% ahead, and 2Q10 was inline, so maybe there is a correlation here with the economy in our view). By comparison 4Q09 mortality in Asia was $5m better than expected. The US business in total in 2009 was performing better than priced. And we get the large claims from business written 20 years ago.

Australia has been a good market, 10% annual growth, and is the leading reinsurer.

Credit life in Canada is written by the banks and is extremely profitable for them. [JPMe: The banks choose to reinsure some of this risk and that help them on their tax

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position. It’s not extremely profitable to RGA in the way it is to the banks that have a very large margin on that business. But it is safer business albeit less margin.]

3Q09 Results From President & CEO Greig Woodring (in Italics):

Mortality was extraordinarily good in 2006-7; mortality on large cases has worsened in the past 6-7 years compared to where it was 7-8 years ago. (ie 2000-1 trough). Asset intensive guidance was up from $10m at 3Q09, then $12m 4Q09, then $16m 1-2Q10.

Net premiums grow faster than inforce because it is mostly YRT mortality and as the policies cross their anniversaries the premiums go up (ie not level premium business). Taiwan Swiss Re closed their office in 2009, the biggest competitor is now GenRe.

Variable annuities: the operating profit we believe is based on the spreads earned on the portfolio of assets. Based on current returns on RGA’s portfolio of investment assets, which includes corporate bonds and structured products, this is very positive; we believe this is why asset intensive business profits (which consist of variable annuities and fixed annuities mainly) keep surprising on the upside. The delta in terms of performance has been over $9m a quarter thanks to higher account values and higher fees. Fixed annuities the spreads are coming in.

Canada session rates are expected over time to fall to US levels (post 2010). In the US it is hard to raise share above the current 20% level.

International growth is around 12%, US below 8%. In 2008-9 mortality in the $1-3m range has been worse than the $250,000 to $1m range. The pricing implemented today gets included in a new primary product with a 6 month lag, and to see the claims rise is a 3-5 year lag. South Africa mortality is more volatile due to more violent deaths but overall good returns on capital. UK is more critical illness but overall good returns including mortality.

Rise of mortality in 1Q 2010 leading to drop in the share price We quote the comments from our US life insurance Jimmy S. Bhullar, CFA (+1-212-622-6397; [email protected]) on the 1Q 2010 and 2Q 2010 results which explains the rise in mortality.

1Q 2010 results

“Reported $1.25 operating EPS vs $1.58 JPMe and consensus $1.59 due to $0.07 negative tax and adverse mortality in the US. On a reported basis 1Q10 ROE was 10% despite high claims. Pricing is expected to remain tight. Mortality has been adverse in the first quarter in the US for the past two years. As recently written business, becomes a greater proportion of the overall book, RGA's margins should improve.”

2Q 2010 results

“2Q10 results affirm our bullish stance on RGA as we expect positive pricing conditions in the US life re market, strong foreign growth and deployment of capital

mailto:[email protected]

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to enable RGA to outperform. Mortality results were inline with expectations which should help concern about mispricing in the business. Pricing to remain firm drive by limited capacity as aggressive underwriters have either raised prices (Swiss Re), exited (Scottish Re, Annuity and Life Re) or been acquired (ING Re, Lincoln Re). Also dislocation in the securitisation markets boosts the appeal of reinsurance. Finally concentration of share should increase, this was 76% in 2009 for the top five, up from 61% 2000, vs 94% for the top three in Canada 2009 up from 69% “

We also note the following from the RGA press release in 2010 1Q.

“Regarding our earnings flow, we experienced the same sort of U.S. mortality seasonality this quarter as we have in the first quarter in each of the last several years, a pattern we expect. The first-quarter reporting period typically presents the unfavorable combination of higher claims flows with the lowest quarterly premium flows. Our U.S. traditional business reported some degree of additional higher-than-expected mortality, while claim levels in Canada were also somewhat higher-than-expected. Despite this claims experience, we still generated a consolidated annualized operating return on equity in excess of 10 percent for the quarter.

We continually update our assessment of mortality trends affecting our business, and use our findings to refine pricing on new business and expected future premium and claims flow for our entire reinsurance portfolio. Though still subject to significant volatility, this ongoing modeling forms the basis for our longer-term expectations.

Our return on the U.S. traditional mortality business was 13 percent in 2009. This return has been somewhat depressed in both 2008 and 2009, due in part to the influence of more competitively priced business and its relative contribution to income. Our projection models indicate returns on the U.S. traditional business will likely remain in low double digits in 2010 before gradually increasing in the following years. That pattern has been anticipated, and we continue to target an enterprise-wide return on equity of 13 percent."

We can note the drop in the share price post 1Q 2010 results in the chart below.

Figure 13: RGA share price drop post 1Q 2010 results Indexed

90.0

95.0

100.0

105.0

110.0

115.0

120.0

Dec 09 Jan 10 Feb 10 Mar 10 Apr 10 May 10 Jun 10 Jul 10

REINSURANCE GROUP OF AMERICA

1Q 10 results

Source: Bloomberg

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Business model: RGA example RGA have five main operational segments segregated primarily by geographic region: United States, Canada, Europe and South Africa, Asia Pacific, and Corporate and other.

1. United States operations provide traditional life reinsurance, reinsurance of asset-intensive products and financial reinsurance, primarily to large U.S. life insurance companies. The focus is very much on mortality risk.

2. Asset-intensive products include reinsurance of annuities and reinsurance of corporate-owned life insurance.

3. Canada operations provide insurers with traditional individual life reinsurance as well as creditor reinsurance, group life and health reinsurance and non-guaranteed critical illness products.

4. Europe and South Africa operations provide primarily reinsurance of traditional life products through yearly renewable terms and coinsurance agreements and the reinsurance of critical illness coverage that provides a benefit in the event of the diagnosis of a pre-defined critical illness.

5. Asia Pacific operations provide life, critical illness, disability income, superannuation, and non-traditional reinsurance.

6. Superannuation is the Australian government mandated compulsory retirement savings program. Superannuation funds accumulate retirement funds for employees, and in addition, offer life and disability.

RGA is number three in US with a 20% market share, and in Canada market leader. North American markets are mature and session rates are actually dropping. RGA is leader in Asia, particularly Taiwan, Australia, Hong Kong. In Asia life insurance is still a growth industry with low reinsurance penetration.

The following are citations from RGA’s transcript on Bloomberg of an investor conference filed on 9 September 2009 on Bloomberg, presented by RGA’s CEO (A. Greig Woodring) & CFO (Jack B. Lay) in Italics.

Operating EPS growth has been 14% CAGR five years. ROEs are in the 14% category, in 2006, 7 and 8 and book value per share growth has been in the 13% - 14% range compounded since the beginning of RGA's history.

The facultative business is about 270,000 hard to underwrite cases, of which 100,000 US and 170,000 outside the US. This is a barrier to entry as it needs substantial actuarial expertise.

Financial reinsurance is a fee business. International life re is a growth area for example in Asia which rebounded first from the recession. RGA is continuing to win

The asset portfolio is primarily investment grade, corporate debt, with some real estate exposure, primarily through CMBS. It has improved significantly during 2009 thanks to spreads coming in. To the extent there are any credit concerns they are well diversified.

Prepared with the kind help of Jimmy Bhullar, covering analyst for RGA, + 212-622-6397, [email protected]

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Note that RGA run capital in the good but not great range relative to ratings, towards the lower end of the acceptable capital levels for the rating agencies and will continue to run the company in such a way that we will not threaten ratings. Of the capital raised in October 2008 only around $20m was used up in block transactions. Some of the demand was from companies looking to acquire parts of AIG, which did not happen, also the AIG subsidiaries which were looking to position themselves for an IPO.

In terms of pricing two years ago the UK was overheated, but not any more. It's not a great market, it's not that bad. In the US the pricing is fine and a little bit better than 2008. No change since the improvement after 2003. In the US the session rates built up to 70% then in 2008-9 trended down to just below 40% again. 2009-10 should trend back up

Credit business in Canada for RGA In 2Q 2010 growth in Canada was mostly in creditor premium. In 4Q 09 Canada creditor business had higher premiums, lower profit margins but more stable profit margins and because there is a lot of small policies it helped the Canada business overall. Experience in Canada has been running for a year over the last several years and 2009 was no exception. In terms of investment took off a little credit risk in 4Q09 and had a bit more liquidity. Creditor insurance in Canada had around 5% margin in 3Q 09.

Reinsurance competitive factors Reinsurers operate in a highly competitive industry, which could limit our ability to gain or maintain market share. The reinsurance industry is highly competitive, and we encounter significant competition in all lines of business from other reinsurance companies, as well as competition from other providers of financial services.

Major players Competitors vary by geographic market. Primary competitors (for RGA) in the North American life reinsurance market are currently the following, or their affiliates: Transamerica Occidental Life Insurance Company, a subsidiary of Aegon, N.V., Swiss Re Life of America and Munich American Reinsurance Company.

Primary competitors in the international life reinsurance markets are Swiss Re Life and Health Ltd., General Re, Munich Reinsurance Company, Hannover Reinsurance and SCOR Global Life.

Factors affecting the competitive position Many of RGA’s competitors have greater financial resources. Ability to compete depends on, among other things,

1. Ability to maintain strong financial strength ratings from rating agencies,

2. Pricing and other terms and conditions of reinsurance agreements, and

3. Reputation,

4. Service, and

5. Experience in the types of business that we underwrite.

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How RGA increases its competitive position? However, competition from other reinsurers could adversely affect our competitive position. RGA’s target market is large life insurers. RGA competes based on the strength of underwriting operations, insights on mortality trends based on large book of business, and responsive service. RGA believes their quick response time to client requests for individual underwriting quotes and our underwriting expertise are important elements to our strategy and lead to other business opportunities with clients. Business will be adversely affected if RGA is unable to maintain these competitive advantages or if our international strategy is not successful

Factors affecting the Reinsurance demand We have noted below the factors that affect the Reinsurance demand. Reinsurance is an arrangement under which an insurance company, the "reinsurer," agrees to indemnify another insurance company, the "ceding company," for all or a portion of the insurance risks underwritten by the ceding company. Reinsurance is designed to:

• reduce the net liability on individual risks, thereby enabling the ceding company to increase the volume of business it can underwrite, as well as increase the maximum risk it can underwrite on a single life or risk;

• stabilize operating results by leveling fluctuations in the ceding company's loss experience;

• assist the ceding company in meeting applicable regulatory requirements; and

• Enhance the ceding company's financial strength and surplus position.

Impact of inflation Inflation is a somewhat better scenario than deflation for us. In spite of unrealised losses that may occur in the invested portfolio it’s - any extra yield that we make on investments flows right to the bottom line. And so, on our mortality on our book of assets supporting our mortality business we don’t have cash call on our assets in a way that would force us to be unable to hold those assets to maturity. So the inflation scenario as long as it’s not too bad is generally beneficial. Some moderate inflation would profitably be good for us.

Munich Re Executive summary - Munich Re life re Munich as at the March 2010 Investor Day shows the split of business Dec09 in terms of net earned premiums was 68% mortality, 29% living benefits including morbidity, 3% longevity and other. Mortality in particular has little interest sensitive (morbidity we believe has more as we believe it has relatively more assets). In particular, mortality is mostly written on YRT basis, which means there is an annual reckoning of claims and premiums, and there is little build up of reserves.

Most reliable indicator of profitability is MCEV earnings, which is the indicator Munich uses and on which it incentivises management. Pricing did dip in mortality in 1997-2003, and this was fully reflected in MCEV earnings in 2008 and 2009. By comparison IFRS accounting has adverse development buffers, and there is no reserve increase until this is used. So this creates smoothing and lags. Life re typically has a relatively low 5-7 year payback, only financing re at on average 3-4 years is quicker.

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Mortality generally displays positive variances (which, however, are declining) because pricing only assumes part of the improvements in mortality that finally come about. Longevity is a very risky business to price because it is future statistics, and there is no hedge. Munich prices it assuming zero correlation with mortality, unlike some peers, where longevity developments have been challenging. There is no clear line between mainly mortality business and mainly balance sheet support business, as long as there is sufficient risk transfer. This is because the reinsurer still needs to make assumptions and take on mortality and lapse risk. Only pure financing re is different, where generally the main risk is lapses on unseasoned new blocks of business.

All business at Munich is priced off risk free. A minimum return on risk allocated capital needs to be achieved. The most stable experience has been in mortality, partly thanks to the positive mortality trend over time (mortality is typically 30 year plus contracts). Recent growth has been mainly in Asia and included deals to support solvency during the capital markets crisis. Solvency 2 and IFRS Phase 2 may also lead in theory to extra life re demand in mature Europe, but Munich is open to all developments.

The IFRS ratio of operating profit to revenues is a relatively poor indicator of profitability, in our view, as reinsurers with a lot of FAS97 business (accounted for as deposits where only fees and not premiums appear as revenues) would have consistently higher profitability ratios, while the return on allocated capital could be the same or even lower.

Life reinsurance at Munich The main indicator is embedded value, from 2001 traditional embedded value, since 2005 European Embedded Value and since 2008 Market Consistent Embedded Value (MCEV). Management incentives in life re are all set relative to MCEV, in particular the creation of new business value, changes in assumptions, and experience gains and losses.

The October 2008 presentation, which shows the emergence of cash from capital invested, is a good guide and the business structure has not changed much since. Life re is very long term; break even is 5-7 years, often 30-40 year contract. This is relatively little sensitivity to interest rates. Payback is only quicker for financial re contracts, 3-4 years. Mortality pricing as observed by RGA dipped in 1997-03, and this has depressed profitability. We believe this was recognised in MCEV in 2008 and 2009 at the latest. Life reinsurance pricing is based on risk free, not corporate bonds, which means some contracts are lost. For MCEV, investment income is neutral as it is based on replicating portfolios. Investment income is not used to accelerate earnings. Of course, if current yields are higher, then MCEV is higher.

A way to assess the reliance on investment income of reinsurance portfolios is to compare the sensitivity to moves in the risk free - the higher the sensitivity the more asset intensive the business. So life re with low interest rate sensitivity would be like Munich Re focused on YRT (pay as you go mortality). By comparison, AdminRe is mainly invested in corporate bonds so is very sensitive to capital market assumptions.

The use of profit-to-revenue as a measure of profitability would inflate businesses which account using FAS 97, ie where there is little risk transfer and it is mainly

55



accounted as deposits rather than premiums. There the revenue line is low, which inflates investment returns. We believe a high share of this type of business is one factor for Swiss Re's structurally higher reported ratio of life re operating profit to revenues.

Life reinsurance is certainly more stable than P&C for example. This is not to say that mortality is fully predictable, but that it tends to smooth out over time. Also in mortality earnings the investment result is relatively modest. Morbidity can also be subject to relatively adverse trends, linked to the economy. There is the example of the hike in morbidity among doctors and dentists in the 1992-4 in the US, when the government was in discussion a health reform which would have cut physicians' income. There is a recent trend for worsening now too, but it is a drop in profitability rather than a loss.

As a reminder, 68% of the business is mortality, 29% living benefits and 3% longevity and other. A typical product has commission upfront, to replicate the payment pattern to sales of the primary insurer. There are extensive checks on underwriting rules and discipline. After 3-5 years there is enough evidence to judge if initial pricing was adequate. If not, then Munich takes a charge against MCEV earnings.

Under IFRS accounting, prudential buffers are set up, so that any adverse development is only seen later in earnings. So for adverse deviation to be reflected in a write off of say capitalised DAC then the adverse deviation has to first exceed these prudential reserves including profit margins.

Mortality pricing up to ten years ago was very conservative, with little or no account taken of the strong and continuous trend in improving mortality. This means that there was steady positive variances from this, which are positive to IFRS earnings, but as these blocks of business become relatively less important, the proportional benefit is lower. More recently, mortality is priced in assuming around 30-50pct of estimated future improvements in mortality. Munich prefers to use conservative assumptions.

Short term mortality fluctuation becomes smoother over longer periods of time. $250k-1m is the band where medical checks start for underwriting. The $10m plus band of mortality risks has relatively few risks and so is statistically more volatile (law of large numbers does not work so well). In mortality, one of Munich Re's competitive advantages is to offer high €50m maximum retention on any one risk, something few competitors can do. This also means that one or two claims in this band will lead to much lower earnings.

Longevity offers not as much diversification as mortality business, as there is no hedge. This means there is a limit on the capital Munich is willing to allocate to longevity, both in absolute terms and relative to the rest of the life re portfolio. Other large reinsurers have been more aggressive on longevity, and this has not necessarily been a success. Longevity pricing is what you forecast 20-30 years from now on vs. Mortality is rather priced on the basis of what you experienced currently.

Negative correlation between mortality and longevity is not proven scientifically, Munich assumes a zero correlation, some peers assume modest negative correlation of up to -0.5 (JPMe).

56



Financing re There are two types, pure liquidity, which is mainly exposed to lapse risk, and is for new blocks of business, and which charges fees which are akin to liquidity financing and balance sheet support.

On balance sheet support, this can be a block of morbidity, also including lapse risk, and is normally a seasoned block, whereas financing is a new block of business with great uncertainty over lapse risk.

But there is no clear distinction between life re, which offers balance sheet support with some financing and that which is pure risk transfer. The main point due to the different accounting regimes (FAS97 deposit accounting, where mainly fees are treated as revenues vs traditional life re which shows premiums as revenues) is that premiums are a relatively poor guide to development of a life re business.

The best benchmark is return on risk capital, in our view. Overall the pricing is set so the returns on each business are subject to the same minimum requirements (mortality, morbidity and financing). In practice, the positive development in mortality means that this has had historically the more stable returns.

In MCEV there is a column for free surplus. However, to appreciate cash flow from life re one should also consider required capital. We believe some groups also have sufficient excess capital like Munich Re to leave excess capital in the life re business until it can be used again.

Businesses which have consistently negative adverse experience are eventually sold or stop writing business. This has, for example, been the case for some writers of long-term care in the US, where all the key indicators turned negative: lower investment returns, higher incidence of loss, longer period of care.

Growth prospects in life re are strongest in Asia. Moreover, the economic crisis 2008-9 helped by leading to demand for capital support and this led to substantial extra business at Munich (€2bn premiums in block transfers). Also, in some markets there is now greater acceptance of deals designed to support solvency. It is not clear whether this will continue beyond the financial crisis. In the more mature markets there is also the expectation that IFRS Phase 2 and Solvency 2 could give a boost to life re business. For now this is not proven and we believe Munich is prepared for all developments.

Munich Re Consolidated results contribution increasing from 2006 onwards The % contribution of the life segment to the reinsurance has increased from 21.0% to 28.5% during the period 2006-2009. In the year 2009 28.5% of the consolidated results of the reinsurance were contributed by the life segment.

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Figure 14: % contribution of life increasing in the reinsurance %

74.0%

30.0%

79.0% 78.0% 75.4% 71.5%

26.0%

70.0%

21.0% 22.0% 24.6% 28.5%

0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

2004 2005 2006 2007 2008 2009

P&C Life Source: Company reports, 2005 P-C negatively influenced by high NatCat claims (Katrina, Rita, Wilma). Note life includes health which since Jan 2010 is separated out in a separate division.

Life reinsurance contributes to the diversification We can note that there is a 9% (21% minus 12%) benefit by including the Life in the reinsurance segment as can be seen in the chart below as per the 2007 data available. The increased diversification is mainly driven by mortality, morbidity and longevity risks, which are mainly uncorrelated to market & P&C risk. This is more important due to the importance of diversification in Solvency II.

Figure 15: Munich re diversification benefit by including the Life in the Re segment %

88% 79%

12% 21%

0%

20%

40%

60%

80%

100%

Ex cl Life, 2007 Incl Life, 2007

Div ersified ERC Div ersification effect Source: Munich Re life investor day presentation 2008

Munich Re economic risk capital (pro rata, JPME) We have estimated the economic risk capital by segments after diversification as shown in the table below. Non-life re would be €7.5bn plus allocate the rest pro rate between non-life re and life re (€3.2bn basic). So, the total would be €8.5bn non-life re and €3.0bn life re. For non-life primary is €2.0bn and life primary €3.9bn.

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Table 35: Munich re capital by segments, 2009 €bn Economic risk capital, 2009 Basic Pro-rata after diversificationReinsurance 13.5 11.5

P&C 8.5Life 3.0

Primary 6.7 5.9P&C 2.0Life 3.9

Total 20.2 17.4Diversification effect (2.8)

Total after diversification 17.4Source: Company reports & J.P.Morgan estimates

Life reinsurance market shares We have shown in the chart below the market shares of the major life reinsurance companies. We note that Munich Re & Swiss Re have a combined market share of 48% (2009 data) and they dominate the life reinsurance market.

Figure 16: Life reinsurance market share, 2009: dominated by top 2 players %

7%

1%1%

5%6%

8%12%

12%21%

27%

0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0%

OtherPartner Re

XL ReTransamerica

GenReSCOR

Hannov er ReRGA

Sw iss ReMunich Re

Life reinsurance - Global market share Source: Munich Re presentation

We have shown the total GWP of life reinsurance in the chart below. The decline 2005 -7 was due to the planned recaptures of three large accounts in Canada and Germany including we estimate Allianz Leben. Excluding this effect, the basic book of business increased steadily during the period 2003-07

59



Figure 17: Munich Re life reinsurance GWP increased in 2009 €m

6,8767,540

7,811 7,6657,299 7,130

9,742

6,000

7,000

8,000

9,000

10,000

2003 2004 2005 2006 2007 2008 2009

Life Re GWP Source: Company reports. Note life includes health which since Jan 2010 is separated out in a separate division. For 2009 life standalone was €6796m, the rest was health, and in 2008 the pure life re premiums was €5284m. The large difference in 2009 was due to the writing of large life and health solvency relief contracts.

Operating EV earnings (as % of beginning EV) has increased in 2009 We can note from the chart below that % contribution of both operating EV earnings as well as the total EV earnings has increased in 2009. This shows the improvement in the profitability in the Life reinsurance segment.

Table 36: Munich Re EV earnings % EV beginning of the year %

13.3% 13.5% 11.3% 8.9%11.8% 9.3%

19.1%

9.0%

16.2% 16.6%9.8%

14.4%7.5%

34.7%

0.0%

10.0%

20.0%

30.0%

40.0%

2003 2004 2005 2006 2007 2008 2009

Operating EV earnings Total EV earnings Source: Company reports, 2003 & 2004 EV are based on Traditional Embedded value; 2005 onwards

Market shares comparison of the Life reinsurance Munich Re has significant market shares in Canada & Germany as can be seen in the chart below. However Munich Re has low market share in Asia and USA and hence scope for further improvement.

60



Figure 18: Market share by regions - Munich Re %

9.0%10.0%

14.0%28.0%

50.0%53.0%

21.0%

0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0%

USARest of europe

AsiaUK

GermanyCanada

Global market

Life Re market shares by region

Source: Munich Re Life investor day presentation 2008

We have shown below the type of risks for each of the products. Mortality accounts for most of the biometric risk for Munich re at 68% (2009). Munich Re mostly focuses on the mortality and morbidity risk.

Table 37: Type of risks according to products: Munich Re mainly focus on the mortality and morbidity as stated Products Ordinary life Group life Living benefits Annuity Type of risks Mortality Full cover Full cover Morbidity Full cover Longevity Full cover Lapse Selective cover Selective cover Selective cover Investment Selective cover Selective cover Pct of total Ord and group life together 68% 29% 3% Source: Munich Re presentation, Biometric risk portfolio in share of net premium, 2009

Munich re life strategic ambition taken to the 2009 VANB, JPME We have taken the Munich re global life ambition of 2006 and assumed that the strategic benefits have occurred in proportion to the year completed. This means that of the 2006-2011 improvements 60% (corresponding to past 3 years) has occurred already and 40% is left now. On this basis, we arrive at the new 2011e (JPME). For the improvements in 11e to 15e we have assumed 100% is still left. So we have added the 100% improvements during this period to get the 2015e JPME forecast.

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Table 38: Munich Re Global life strategic taken to the 2009 actual, JPME €m, %

As of 2006 As of 2009 Global Life, €m Reported JPME Comment VANB 228 562 Less exceptional level of sales 2009 312 VANB normalised 228 250 Improvement by 2011 220 80 40% left

Continuously improve core business 120 40 40% left Grow non-traditional business 40 16 40% left Expand business model 25 10 40% left Superior financial model 35 14 40% left

Additional improvement by 2015 175 120 100% left Continuously improve core business 95 70 100% left Grow non-traditional business 65 40 100% left Expand business model 5 5 100% left Superior financial model 10 5 100% left

JPMe forecast by 2015 623 450 Source: Company reports & J.P.Morgan estimates

We have shown the JPME targets on the basis of the 2006 strategic improvements in the chart below. 2009 Munich Re had an exceptionally strong year due to the solvency relief deals, bringing in €562m value new business. We note that the target for 2011e is unchanged, and merely adjust them for the 2009 change in methodology from EEV to MCEV (change reflects also lower interest rates). The 2011e official target is €330m (€440m previous method) and our forecast for 2015e is €450m.

Figure 19: Munich Re - VANB development €m

228277

356

562

330

0100

200300400

500600

2006 2007 2008 2009 2011e

Munich Re - VANB dev elopment Source: Company reports. Munich Re Investor day presentation on Life reinsurance 2008

Geographic split of the global life reinsurance market We have shown in the chart below the global life reinsurance market by regions for the whole life reinsurance market (not only Munich Re). The US accounts for 50% of the global market for life reinsurance in terms of life premiums and is the largest and most developed market.

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Figure 20: US is the major market for life reinsurance globally, 2007 %

50%6%

10%

7%

27%

USA Germany UK Canada Other Source: Munich Re Life investor day presentation, 2008

Munich Re always had a good market share in Canada but the decline in the premiums and market share is driven by the scheduled termination of one short-term non-traditional business treaty.

Figure 21: Munich Re - Market share in Canada on the basis of GWP %

44%47% 48%

55%

63% 63% 61%

53%

40%

45%

50%

55%

60%

65%

2000 2001 2002 2003 2004 2005 2006 2007

Munich Re - Market share in Canada Source: Munich Re Investor day presentation on Life reinsurance 2008

We have shown below the US market share of the recurring new business in 2009. This is a concentrated market with top 5 players controlling the 85% of the market.

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Figure 22: Market share - US recurring new business assumed (2009) %

0.06%0.07%0.31%

1.20%1.69%1.72%

2.94%3.22%3.25%

11.75%13.52%

18.10%19.26%

22.42%

0.0% 5.0% 10.0% 15.0% 20.0% 25.0%

Employ ers Re CorpRGA Re. CanadaOptimum Re (US)

Wilton ReGeneral Re Life

Ace TempestSCOR Global Life (US)

Canada LifeHannov er Life Re

Generali USA Life ReMunich Re (US)

Transamerica ReSw iss Re

RGA Re. Company

Market share - US recurring new business assumed Source: Munich Re presentation

Differentiation factor for Munich Re The ability to provide large capacity differentiates Munich Re, in our view. We have quoted one innovation example for North America by Munich Re. Munich Re moved to a US$50m per life retention, a limit few competitors can offer. The large case program supports growth and the profit ambitions.

Table 39: Munich Re Innovation example in North America As stated Super pool program: innovation for North America Purpose

Maximise benefits of Munich Re's increased per life capacity Create sustainable competitive advantage for selected clients Control access to larger retention for retention management purposes

Detail Clients get access to increasing levels of Munich Re's US$50m capacity per life Capacity: Tiered based on volume ceded Capacity: Unencumbered by retrocession constraints Program well on track in Canada & US

Source: Munich Re life investor day presentation, 2008

For Munich Re the individual life product is the core, but it also has leading position in other lines of business. The major lines of business are shown in the table below. Another advantage of having different lines of business is the diversification of value added by new business.

Table 40: Munich Re main products As stated Munich Re - life products Individual Life Long term care (LTC) incl. LifePlans Individual disability income Group life and Group LTC Critical illness Source: Munich Re life investor day presentation 2008

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Munich Re holds the no.2 position in the Life reinsurance market in Asia with a 14% share. The market is dominated by the top 3 global players; the domestic reinsurers face tough competition but Korea Re has managed to maintain a strong domestic and regional position.

Figure 23: Market share in Asia, 2008 %

8%7%

15%5%

2%3%

7%8%

12%14%

19%

0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20%

OtherChina ReKorea Re

OtherTransamerica

SCORHannov er Re

Gen ReSw iss Re

Munich ReRGA

Market share in Asia Source: Munich Re Investor day presentation on Life reinsurance, 2008

Key drivers of life reinsurance Munich Re had an underwriting result of €430m in 2007 against a normalized level of ~€300m. The key drivers for the steady increase from the normalized level are given below.

• Steady increase in IFRS results – but slight volatility unavoidable

• Margins flowing through from historical superior business selection

• Exceptionally good mortality and morbidity experience in 2007

• Development in line with portfolio growth and value orientation

Table 41: Munich Re - Underwriting result and IFRS net profit €m Underwriting result incl technical interest IFRS net profit 2004 215 432 2005 140 976 2006 329 561 2007 430 725 2008 238 705 2009 228 728 Source: Company reports. Munich Re Investor day presentation on Life reinsurance 2008. IFRS net profit relates to life and health re which since Jan 2010 report separately. Note €430m is in the life re day presentation for 2007 underwriting profit, 2008-9 are JPMe. The 2008-2009 figures are for life and health.

We have shown in the table below the distributable earnings and the timing in 5 year steps. The present value as at 2007 was €5.8bn.

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Figure 24: Munich Re - Distributable earnings (undiscounted), 5year steps as at 2007 €b

2.42.0 1.9

1.6 1.4 1.20.9 0.8 0.7 0.5 0.4 0.3 0.2 0.1 0.1 0.0

0.00.51.01.52.02.53.0

2008

-12

2013

-17

2018

-22

2023

-27

2028

-32

2033

-37

2038

-42

2043

-47

2048

-52

2053

-57

2058

-62

2063

-67

2068

-72

2073

-77

2078

-82

2083

-87

Distributable earnings Source: Munich Re Investor day presentation on Life reinsurance 2008

SCOR General points for SCOR Current ratio of debt to debt plus equity is 11%, peak was around 40% in the 1999-2002 period. Prior to the repayment of the convertible this ratio was 16% which could be (JPMe) a reasonable level of debt. The issue for this ratio, in our view, is how to raise the debt, and what to do with the proceeds in order to remain value creating.

We believe there is little interest in raising exposure by like Hannover using side cars. The risk appetite of SCOR remains relatively low.

Non-life pricing for SCOR is rising on average because SCOR has a relatively small presence in liability and in the US, both areas where rates are falling. Also because SCOR is still relatively small (€3bn premiums, around one quarter the size of Munich in just non-life re, one third that of Swiss Re) it is able to vary its portfolio more. The A rating means that SCOR is regaining business it had lost, for example in South Africa where it has now opened an office.

The appetite for risk appears relatively low at this stage for SCOR, but we believe there is some appetite for longevity risk at the margin. SCOR's non-life portfolio is very balanced, with no large bets, line sizes (ie premiums per type of risk) of around €200m max. SCOR remains a committed supporter of 8 Lloyds syndicates, and is still considering its strategy whether to 'build or buy' as it said at 1Q10 results presentation.

JPMorgan executive Summary for SCOR on life re • Within life mortality is the main risk driver.

• Writing some more longevity risk will increase diversification

• Rating: we believe the company sees the current rating of A as fully adequate, with A+ offering some extra attraction

• New business analysis is done on a detailed basis, IFRS profits are used more as an early warning system.

• Purchase GAAP (the value of acquired business in force assets) about half of the book is under this: accelerates recognition of profits, means the subsequent profitability in terms of ratio of reported profit to premiums is higher for organic than acquired business.

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• For the industry in general, most recent deals on longevity have been swaps with hardly any reinsurance premium. SCOR has not been active in the longevity market recently

• Pricing - ROE safely above 900bps above risk free

• Financing and annuity business not much above

• Protection businesses generally have higher RoEs

• Services to clients (e.g. medical underwriting product development etc) are at the core of the business model.

Details for SCOR on life re Investment sensitivity SCOR has much lower investment results than a primary insurer. This is because SCOR’s Life business is mostly protection, i.e. biometric and lapse risk. SCOR stays clear of investment related risks embedded in Life reinsurance contracts. SCOR does have a small GMDB variable annuity exposure which is ten years old and was part of the Converium acquisition. The only significant investment income sensitivity is that SCOR has some life business with accumulated reserves (mostly from level premium business) which are invested at low risk and produce investment income.

Diversification between life and non-life is a 28% benefit. This is allocated to both P&C and life, and reduces the capital allocated to the respective business. Life in terms of capital allocated and risk is much smaller than non-life, even though in premium terms they are equal sized. It fluctuates a little, but in a narrow range. Increasing the size of the life re portfolio would modestly but not significantly increase the diversification benefit, we estimate. This is because the maximum increase in diversification happens after adding a small portfolio (life) to a larger portfolio (non-life). When they are equal sized there is no or little extra diversification at the margin. So for example writing more P&C business would actually reduce the diversification benefit. Longevity - this would add diversification within the life re portfolio, as it is negatively correlated with mortality (even if the correlation is very imperfect as they are different cohorts of policyholders). But SCOR would still need to allocate extra capital, it is not as if writing a negatively correlated risk would reduce total capital allocated to life.

SCOR's IFRS profitability is influenced by two factors relative to peers. Firstly, SCOR takes very little investment risk, so compared to say Swiss Re historically, it had one main source of profit margin, biometric risk, compared with two for Swiss Re, biometric and investment risk.

Secondly, around half of SCOR's portfolio comes from acquisitions, half from organic growth. On acquisitions, much of the profit is recognised upfront and the value of business acquired asset created is then amortised. This tends to reduce the ratio of annual profitability to premiums relative to the organic business. In the case of the 2006 Revios deal for example, the recognition of this VOBA asset meant that SCOR accounted for badwill upfront. In other words, purchase accounting limits the reported IFRS profitability as a lot is already recognised and embedded in assumptions.

By comparison, earnings from organic growth are more backended, which means that the average profitability in terms of return on revenues will tend to be higher

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structurally. The accounting under IFRS is similar to US GAAP and is asymmetric. It is possible to recognise worsening profitability and increase reserves set up at the start of the contract, but very difficult to recognise improving profitability with a one off release of reserves. Instead, this flows through over time as positive experience variances. IFRS profitability is used as an early warning tool to recognise variances from plan. For this IFRS is very well suited, in our view.

There is a third level of accounting (other than IFRS or embedded value) which is used for recognition of cash flows and capital for dividends out of the life re division. This is statutory accounting, because only statutory reserves can be released to cash flow and dividends. Changes in IFRS reserves affect reported profits but cannot be released to capital or cash flow. Over time embedded value, which is effectively the discounted future statutory life cash flows, converges with statutory reporting, but embedded value does not identify profits which can be released this year as a point estimate. Only statutory accounting does this (however it is contained in EV reports in the movements of ‘Adjusted Net Worth’ or ‘Adjusted net Asset Value’).

Fungibility and legal structures. Since the 2004 adoption of the EU Reinsurance directive, the benefit of local regulatory regimes, particularly the strict UK FSA environment, has been much reduced. So, primary insurers no longer have a strong preference for any local carrier within the EU. For this reason SCOR has now merged most of its European operations into one legal structure, and this improves capital fungibility. Asia and Canada are accounted for as branches of this one European legal structure, SCOR Global Life SE. The US is still different and there is no prospect that this can be simplified, which means that this is a potential source of capital friction, in our view (for all European Life reinsurers).

In terms of ranking of profitability in terms of profit divided by premium, pure protection is higher than SCOR's average 6-7pct range, financing business is much lower (most savings related are financing),. Overall, 99% of deals are written above 9% ROE, which means that the RGA range of profit to capital of 10-14% is also we believe relevant to SCOR. For SCOR even the pure EIA equity indexed annuities business was at 9%.

There is no split of margin between mortality, investment risk etc. In addition, much of the add on services such as underwriting guidelines for mortality and critical illness and other services such as medical checks by doctors which are actually paid for by the reinsurers, are paid for out of the ROE, which is not just a reward for risk taking, but also a reward for services, which also include claims management in disability, critical illness and long term care. Around 71%of the portfolio is mortality, and this is in terms of generations of contracts (refer Table 43: Split of SCOR business).

Operating profit is a good measure, because the technical result can fluctuate and be offset by opposite fluctuations in investment income. Technical result consists of underwriting plus investment income on funds withheld. That return in Germany can only vary in a range of 2.2-4% as there are very precise regulations to cap it. So it is relatively low volatility. SCOR relies on embedded value for its life business to value it, and many analysts use the same approach. By comparison, IFRS is seen as an early indicator of claims volatility.

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Low life re interest rate sensitivity SCOR’s relatively low interest rate sensitivity is supported by the following extract page 51 of their 2009 reference document (the official annual report). Essentially the point is that: a) in countries with products with minimum guarantees, that is the valuation discount rate. So the liabilities are locked in, and the risk is that the investment portfolio misses that minimum return. And b) for other countries SCOR includes a provision for adverse deviation, which means that the sensitivity is dampened by a relatively large buffer.

We cite below from SCOR’s official 2009 reference document.

Life interest rate sensitivities (2009 SCOR reference document page 251) “Although in general all long term liabilities are discounted, in most cases there is no immediate accounting impact from a 100 basis point change in interest for the following reasons:

1. For the German, Italian, Swiss and Austrian markets, valuation interest rates are typically locked-in at the minimum interest rate guaranteed by the ceding on the deposited assets covering the liabilities.

2. For the business written in the United Kingdom, Scandinavia, United States (traditional, non-savings products) and France (excluding Long Term Care), valuation interest rates are locked-in based on a prudent estimate of the expected rate earned on assets held less a provision for adverse deviation.

The life products with guaranteed minimum death benefits (GMDB) are not materially sensitive to 100 basis point decrease in interest rates. An increase in interest rates would not result in a decrease in the level of reserves as the interest rates are locked-in.

The liabilities recorded for the annuity business would not change materially to a 100 basis point change in interest rates as they are linked to account values. However, the shadow accounting would be impacted.

For Long Term Care products in France, ceding companies use valuation interest rates established by French regulators which are linked to some extent, to market rates. Reserve movements reported by ceding companies are influenced by numerous factors, including interest assumptions, where are not distinguished separately. SCOR does not actively revise the valuation interest rates during its reserving process. Due to lack of direct data, the interest rate sensitivity cannot be precisely analysed.”

Life – also low sensitivity to equity markets (official 2009 reference document page 251-252). “In general, equity movements have no impact on the reported liabilities of the life business as the underlying policies and reinsurance contracts are typically unrelated to equity prices. For some risk premium treaties (where the underlying insurance policies are unit-linked or universal life) the sums at risk and thus the expected claims, vary with the movement of the underlying assets. However, under almost all reinsurance programs, premiums are also linked to the sums at risk such that the liability would not materially change.

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The premiums on the Guaranteed Minimum Death Benefit (GMBD) business underwritten by the SCOR Group in the U.S. market vary with the value of the underlying assets rather than the sum at risk. Thus, premiums would decrease under a decline of the equity values whereas the expected claims would increase thus leading to an increase in the liability. However, included in the reserve calculation is a prudent margin for this fluctuation. Accordingly, the level of reserves recorded for this business would remain unchanged in the event of a 10% decrease in equity values. As the valuation assumptions are locked-in, an increase in equity values, resulting in a decrease in the economic liability, would not impact the level of reserves recorded in the financial statements.”

Distributable cash flow Distributable cash flow (excluding the return of required capital) is less than operating profit. Distributable cash flow expectation from 2009 in force business by SCOR for 2010 is about €150m, which compares with EEV operating profit of €190m for 2009 (which includes inforce block transaction for Ireland and UK protection) and we forecast €160m 2010e (our 2010e forecast assumes the same 4.5% growth in EEV operating profit in 2010 as in 2009; this is conservative as at 1H10 SCOR reported 7.6% growth in underlying premiums excluding low margin equity indexed annuities, and we exclude a repeat of the 2009 new business from exceptional block transactions).

So we estimate distributable cash flow is 25% less than EEV operating profit. We believe this supports our view of the life book, which is that it does produce distributable cash flow, but more slowly than non-life, where the earnings are 100% distributable in our view.

We show below SCOR’s reporting of distributable cash flow. The interesting point is that this fits a curve with an annual decline of 5.8%, which effectively is the implicit cash flow risk discount rate, including the risk free, and the inbuilt margins for lapse risk and for mortality risk.

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Figure 25: Distributable cash flow in €mn

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2005 2010 2015 2020 2025 2030 2035 Source: SCOR EV 2009 presentation. Distributable cash flow excludes free surplus and before release of required capital. €2285m total JPMe.

Of the total €2285m distributable cash flow (and this is based on SCOR's reporting of €1934m Dec09 embedded value), 43% is in the first eight years, 50% within the first ten years, 67% within the first fifteen years, and 94% within the first 24 years.

Table 42: SCOR: Distributable cash flow in €mn, as pct of Dec09 EV €1934m, and as pct of total €2285m JPMe distributable cash flow – 39% of EUR2.3bn total cashflow is in the first 5 years €m Distributable Pct of Pct of total cash Dec-09 EUR2285m flow EUR1934m EV cash flow 2010 150 7.8% 6.6% 2011 141 7.3% 6.2% 2012 132 6.8% 5.8% 2013 125 6.5% 5.5% 2014 118 6.1% 5.2% 2015 111 5.7% 4.9% 2016 105 5.4% 4.6% 2017 99 5.1% 4.3% 2018 94 4.9% 4.1% 2019 88 4.6% 3.9% 2020 83 4.3% 3.6% 2021 78 4.0% 3.4% 2022 73 3.8% 3.2% 2023 69 3.6% 3.0% 2024 65 3.4% 2.8% 2025 61 3.2% 2.7% 2026 58 3.0% 2.5% 2027 55 2.8% 2.4% 2028 52 2.7% 2.3% 2029 49 2.5% 2.1% 2030 47 2.4% 2.1% Source: Company reports and J.P. Morgan estimates.

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71% is traditional mortality and lapse risk The following table shows SCOR’s split of life re business. Excluding the equity indexed annuity business, which is a very low risk, high volume and we believe relatively low margin product, and which SCOR has said they would cut back sharply in 2010, life and financing, where the main risks are mortality and lapses, accounted for 71% of total premiums in 2009. We believe this highlights the predominance of traditional and relatively predictable business in SCOR's business life reinsurance business mix.

Table 43: Split of SCOR business 2009 2008

Life 45% 52% Financing 17% 18% Annuities (equity indexed annuities) 13% 4% Health 8% 7% Disability 7% 7% Long term care 4% 4% Critical illness 4% 3% Personal accident 2% 5% Total 100% 100% Total ex EIA 87% 96% Life and financing 62% 70% Life and financing to adj total 71% 73% Source: SCOR 2009 embedded value slides

Main sensitivities of SCOR life re portfolio The following table shows the main sensitivities of the life re portfolio of SCOR, in terms of EEV. The main points are:

1. The single largest sensitivity is life mortality and morbidity. This shows SCOR’s portfolio has a very traditional life re mortality exposure.

2. the annuities sensitivity to mortality and morbidity is just €0.6m. So far SCOR does almost no longevity risk.

3. The impact of lower interest rates alone on future life earnings, excluding the positive uplift from the use of a lower discount rate, is -€98m ie -5.1% in terms of the base case of €1.9bn embedded value. This is significantly less than the €269m sensitivity to mortality/morbidity, for a 5% worsening (the table gives the effect of a 5% improvement in mortality and we have assumed the reverse).

Table 44: SCOR EEV sensitivities Dec09 €mn Amount Pct of base case Base case 1,934.3 EEV sensitivities: Mortality/morbidity (life) -5% 269.1 13.9% No mortality improvements (180.4) -9.3% Mortality/morbidity (annuities) -5% 0.6 0.0% Lapse rates -10% 28.3 1.5% Maintenance expenses -10% 24.9 1.3% Discount rate -100bps 118.1 6.1% Interest rates -100bps 20.3 1.0% Equity and property capital values -10% (12.8) -0.7% Source: Company reports

We were positively surprised by SCOR’s statement on page 251 of their 2009 official reference document (see above) that although life liabilities are discounted,

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there is little accounting impact in IFRS of a change in interest rates because: a) in countries with minimum guaranteed rate, that is the discounting rate used at inception, and not change; and b) in other countries there is a sizeable margin for adverse deviation in the reserves to protect against this.

Table 45: SCOR Dec09 Investment Portfolio in €m Pct of total €mn

Real estate 2% 399 Equities 4% 799 Alternatives 2% 399 Govvies and assimilated 23% 4,593 Covered and agency 5% 998 Corporate 13% 2,596 Structured products 4% 799 Funds withheld 39% 7,788 Cash 8% 1,598 Total 100% 19,969 Source: Company reports.

To double check our understanding we compared the interest rate sensitivity of SCOR’s fixed income assets to the reported IFRS sensitivity of a 100bps change in interest rates.

We estimate the impact of a 100bps fall in interest rates on shareholders' equity at €226m (see following table).

By comparison SCOR reports a sensitivity of €+204m to a 100bps fall in interest rates for IFRS.

We believe the accounting reserve adjustment is the difference, and it is relatively modest at €24m.

Table 46: JPMe estimate of interest rate sensitivity - our €226m estimate is only modestly above the €204m reported, which we believe means the IFRS sensitivity of life reserves to interest rates is relatively low (ie the difference of €22m) €m Fixed income 8,986 Duration 3.6 Tax 30% Net 226 Source: Company reports and J.P. Morgan estimates.

High mortality sensitivity, but low investment risk Compared with primary life insurers, SCOR’s EEV has low sensitivity to investment risk, and high sensitivity to mortality risk.

The following table shows that 100bps lower interest rates boosts EEV at SCOR by 1%, at Munich by 4%, and the peer group average is a negative -10% fall. This is mainly due to the very high negative interest sensitivity of the German life insurers Allianz and ERGO, where the combination of very long duration of the life contracts, high guaranteed rates on the back book, and low current interest rates, means that this is the single largest risk they face.

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SCOR’s +1% consists of a +6% positive due to the use of a 100bps lower discount rate more than offsetting a -5% pure impact of lower interest rates on future investment income and future cash flows.

And on mortality, a 5% drop in mortality would add 14% to SCOR’s EEV, 19% to that of Munich, but just 1.5% for the primary life insurers.

The fact that reinsurers focus on mortality risk is supported by the sensitivity to the assumption of no mortality improvement. As the reinsurers have priced in their products assuming some continuing mortality improvement, no mortality improvement would cut their embedded value (-9% at SCOR, -37% at Munich). By comparison mortality is priced at current best estimates at the primary insurers, so there is no sensitivity to this. This means that when primary insurers reinsure, they lock in a particular rate of mortality improvement (around 50% of the historic trend we estimate).

Table 47: SCOR and Munich Re have low investment risk compared with primary life insurers Pct of base case 2009 EEV

Average SCOR MunichRe primaries Generali ERGO Allianz AXA

Mortality/morbidity (life) -5% 13.9% 19.5% 1.5% 2.1% 1.1% 1.0% 2.0% No mortality improvements -9.3% -37.1% not av not av 0.0% not av not av Mortality/morbidity (annuities) -5% 0.0% -0.1% -0.9% -0.7% -0.9% -1.0% -1.0% Lapse rates -10% 1.5% -0.8% 1.8% 2.4% 0.6% 1.0% 3.0% 100bps lower interest rates 1.1% 3.9% -14.6% -10.4% -22.9% -19.0% -6.0% Equity and property capital values -10% -0.7% 0.0% -4.0% -6.2% -1.8% -4.0% -4.0% Source: Company reports.

Profitability of a typical life (mortality) reinsurance contract The following table summarises the profitability of a typical life contract, whose main feature is to provide financing to the primary insurer equal to the premium in the first year, and to 5% of the annual premiums after.

There are three points to make:

1. Reported profits are reported last under statutory, most upfront in embedded value, where the new business value allocates most of the return to the point of sale, and there is a midway solution for IFRS, which smoothes profits using deferral and amortization of acquisition costs..

2. Total profit is the same. There is some rounding in the model, but the numbers add up to €516m for statutory, €479m for IFRS, €483m for embedded value.

3. ROE is highest on average under statutory, lower under embedded value, midway under IFRS.

Table 48: Summary profitability under three different accounting regimes: statutory, embedded value and IFRS €mn

Statutory EEV IFRS Average capital 52 48 48 Average annual profit 328 627 521 Average ROE 15.7% 7.7% 9.2% Source: Company reports and J.P. Morgan estimates. Profits should be same in all three, some rounding differences.

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We show the allocated capital under the three approaches (statutory, EEV and IFRS in the below chart. The main reason that the profitability under statutory is so much higher than IFRS or EEV, is that statutory, although it requires capital upfront, requires the least amount of capital on average. So the return on capital is the highest under statutory. The total profit in all three regimes is the same, as they are the same underlying cash flows.

Figure 26: Chart of allocated capital under statutory, embedded value and IFRS €m

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StatutoryEEVIFRS (capped at 1/5x statutory)

Source: SCOR investor day 2009 contract simulation and JPMe for capping the IFRS capital at 1.5x statutory. The dividends our are deducted from both embedded value and IFRS capital.

In the model with IFRS capital detailed above and which we detail below we have assumed that under IFRS cash can be ‘dividended’ out as soon as the IFRS accumulated capital (initial capital plus profit for year) reaches 1.5x statutory capital, which we estimate is sufficient for a rating range A-AA. We have deducted these dividends from EEV capital and from IFRS capital.

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Table 49: Estimated ROE under statutory, EEV and IFRS accounting €m

Average 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 ROE

Statutory: Premium 1,000 900 828 770 724 688 653 621 590 560 Claims -310 -418 -481 -514 -532 -545 -560 -574 -589 -604 Commission (100% plus 5% renewal) -1,000 -45 -41 -39 -36 -34 -33 -31 -30 -28 Change in reserves -386 -213 -102 -30 20 61 101 142 183 224 Investment income 0 12 18 21 22 21 19 16 12 7 Pretax treaty profit -696 236 222 209 198 191 180 174 167 159 After tax treaty profit after 35% tax -452 153 144 136 129 124 117 113 108 103 Expenses pretax -40 -36 -33 -33 -31 -29 -28 -26 -24 -22 After tax expenses -26 -23 -22 -20 -19 -18 -17 16 -15 -15 Net profit -478 130 122 116 110 106 100 129 93 88 Required capital: insurance risk 321 338 343 344 336 324 310 295 279 262 ALM risk 10 15 18 18 18 16 14 10 6 0 operational risk 0 21 20 18 17 16 16 15 14 13 Total 331 374 381 380 371 356 340 320 299 275 Statutory ROE -144.5% 36.6% 33.7% 31.9% 31.0% 31.1% 30.8% 42.0% 32.3% 32.9% 15.7% EEV: EEV operating profit 176 53 49 44 39 35 30 24 19 14 Embedded value: Opening 478 654 707 756 800 839 874 904 928 947 EEV operating profit 176 53 49 44 39 35 30 24 19 14 Dividend 48 54 62 70 66 71 70 485 Closing 654 708 698 675 641 604 557 506 35 708 EEV ROE 31.1% 7.8% 6.9% 6.3% 5.7% 5.3% 4.8% 4.1% 3.6% 5.2% 7.7% IFRS: Statutory pretax -696 236 222 209 198 191 180 174 167 159 Less expenses -40 -36 -33 -33 -31 -29 -28 -26 -24 -22 Subtotal -736 200 189 176 167 162 152 148 143 137 DAC amortisation 816 -104 -99 -95 -92 -89 -87 -85 -83 -81 Operating result 80 96 90 81 75 73 65 63 60 56 Operating result to premiums 8.0% 10.7% 10.8% 10.5% 10.3% 10.6% 10.0% 10.1% 10.1% 10.0% Taxed profit 52 62 58 52 49 47 42 41 39 36 IFRS capital (capped at 1.5x statutory) Opening 478 497 561 572 570 557 534 510 480 449 Taxed IFRS profit 52 62 58 52 49 47 42 41 39 36 Dividend -2 48 54 62 70 66 71 70 485 Closing 497 561 572 570 557 534 510 480 449 0 IFRS ROE 10.7% 11.8% 10.3% 9.2% 8.6% 8.7% 8.1% 8.3% 8.3% 7.8% 9.2% Source: Company reports from SCOR 2009 investor day slides and J.P. Morgan estimates. JPMorgan assumption for dividendable profit is that IFRS profit is capped at 1.5x statutory capital..

Swiss Re The following is JPMorgan’s interpretation of Swiss Re’s view of life reinsurance

1a). Accounting - US GAAP is not very informative as it reflects mainly historic assumptions US GAAP gives a relatively poor view of profits as it is mainly about baked in assumptions on mortality, lapses and profitability. So has a very stable earnings unwind, but says little about new business.

By comparison EVM gives a complete picture of profitability, both value added by new business and also experience variances and assumption changes. The part of EVM which leads to high volatility is economic assumptions.

Finally dividends are still paid out of statutory earnings and there are three main accounting conventions for this. Firstly in the US amortised cost is used for both

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reserves and assets, so sensitivities are moderate. UK in theory is market value on both sides, but in times of volatility and stress FSA does exercise its influence to moderate impacts, as in 2008 when it allowed the use of liquidity premiums. Finally in Switzerland statutory is now consistent with Swiss Solvency Test, ie uses risk free for both sides, assumes zero extra risk return on risky assets.

1b). Reported earnings vs cash flow – this is JPMorgan’s view of the reported profits vs statutory earnings which set’ dividendable’ cash flows In general, we believe that statutory earnings will be higher than Swiss Re's convention of allocating just the risk free to life, as long as returns on risky assets are positive, as they were in 2Q10 when corporate bond returns were strongly positive, which means that the cash flow will be higher. This will reflect the superior cash flow of admin re. Admin re cash flow in the first 6-12 months is a return of a large part, we estimate around 30%, of the capital invested; so for example on the Barclays Life £750m deal in November 2008 around £250m of the capital was expected to be returned by May 2009. And admin re is more geared to asset values due to the value of the unit linked accounts; as these are flat on November 2008, this means that the fee income is less than expected, and this is not hedged. Whereas for mortality, US GAAP gives about the same figure for profits as statutory cash flow, cash flow on Triple x reserves business is negative compared with positive US GAAP profitability.

Note that Swiss Re has no intention of changing this convention of just allocating the risk free to life. The objective was to focus its underwriters on underwriting, where they believe thanks to their proprietary LMS model that they have superior returns in the US, and away from asset management, where the track record is poor. The risk free rate in the currency is for the duration of the actual reserves. This understates a little the profitability of admin re, as the last major admin re deal was Barclays Life November 2008, and there have been no deals since.

1c) The main accounting conventions in life are FAS60 (traditional life, constant emergence of margins, relative mainly to premiums) and FAS97 (mainly universal life but also contracts where there is no risk to Swiss Re like unit linked, with smooth emergence of economic margins, but more volatile emergence of US GAAP margins relative to the underlying investment performance including the change in unit linked account values).

2. Write down risk is remote we believe Swiss Re explained that the risk of write downs of the various intangibles (value of acquired business in force, deferred acquisition cost) is low and we believe remote. This is because under US GAAP the portfolio as a whole would have to show negative returns (loss recognition is at the aggregated level), for this to happen. Swiss Re does it by choice across subsegment, life, health and admin re, all on a global basis.

The mechanism is that Swiss Re checks actual variances against its Adverse Deviation reserve, and when this is exhausted writes off intangibles and resets reserves completely, segment by segment. And Swiss Re has stated that the underlying return of the pre 2004 mortality book of business was relatively low but still positive.

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Swiss Re has stated that the main way to check on profitability is to review the uplift on the transition from US GAAP balance sheet to EVM. In 2008 at the peak of the crisis this was a positive SF3.2bn for life, SF8.3bn in 2009. For the group in 2008 the uplift was a negative SF1.9bn, a positive SF2.3bn in 2009.

Table 50: Swiss Re: EVM uplift from life reinsurance in Sbn 2007 2008 2009

Additional discounting -3.1 -3.7 1.4 Reserving basis: GAAP margins 12.8 10.3 12.2 Other -0.3 -1.1 -1.0 Recognition differences 0.3 0.5 0.3 Extra tax -1.6 0.1 -0.9 Other 0.1 0.1 Frictional capital costs -4.2 -3.0 -3.7 Total EVM adjustments 4.0 3.2 8.3

Source: Company reports.

In particular, the EVM 2009 presentation on slide 21 shows that the uplift from revaluing reserves from US GAAP to EVM is SF12.2bn, which is the main positive source of the SF8.3bn uplift of life EVM vs US GAAP. That figure was SF10.3bn in 2008 accounting again for the main positives underlying the net SF3.2bn uplift from US GAAP to EVM capital in life.

Slide 11 from the 1Q09 Appendix slides highlights that the reserves are relatively robust: the US GAAP life reserves contain SF10bn of uplift of which 2/3 is traditional life (rest is equally health and admin re). These reserves can withstand as a sensitivity 105% mortality vs assumptions, 100bps lower investment returns across all segments, 10% higher lapses. By contrast, and this highlights the sensitivity of FAS97 accounting (premiums treated as deposits, relates mainly to unit linked) PVFP amortization, which negatively affects profit recognition, is accelerated by SF0.1bn for 20% fall in equities, and by SF0.4bn for 20% one off lapse shock.

3. Key business factors for profitability The key factor is risk free interest rates. This is a bigger factor than we had previously thought, when Swiss Re gave figures of underlying which were based on year earlier rates. So at 2Q09 when Swiss Re said the normalized profit figure for that quarter was SF300m, this was based on 2008 risk free, which was 2.8% average for the year for 5 year US government bonds. At 2Q10 when Swiss Re said the normalised profit figure for that quarter was $200m (say SF200m, ie 33% less than a year earlier) this was based on the rolling average risk free year yields which had dropped significantly (the duration of the life book is 8-9 years we estimate). This sensitivity implies that Swiss Re life margins are based on invested life assets of around SF57bn, ie $54bn (SF100m quarterly earnings difference, SF400m for the year / 70bps = SF57bn x 0.95 FX = $54bn). A cross check is that at 1Q10 Swiss Re gave a figure of $240m per quarter ie SF250m, and this was based on 2009 risk free rates. These were 2.5% for 5 year US government bonds at Dec09, ie just 30bps lower; this would imply interest sensitive assets of SF66bn or $63bn. We believe this provides a consistent view of the interest rate sensitivities. So equally, should the 5 year US government bond yield recover to say 4%, then profitability would be significantly higher, we estimate around SF400m per quarter, ie double the 2Q10 run rate of we estimate SF200m.

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Swiss Re has stated that the return on risky assets is less of a factor, as it has no intention of re-risking other than adding around 1-2pct allocation to equities and 1-2pct to bonds to be funded out of the cash of $36bn (short term plus cash is $50bn). We do note that admin re's earnings are only positive if we allocate their share of return on risky assets, which is most of the $18.6bn corporate bonds at 2Q10 (ie around $3540m annualised uplift we estimate).

The other factors which Swiss Re tracks are mortality, lapses, and the distribution of risks in the primary insurers' portfolios (age distribution, male/female distribution, behaviour distribution, and association with different trends in terms of mortality and lapses).

Swiss Re makes continuous assumptions about distribution (are risks male or female, what age, what cohort in terms of mortality and lapses?) and we believe it took negative model assumptions in 2Q10. This volatility was made worse in 2Q10 by cedant changes in reserves, which are taken as they are communicated and are not managed in any way.

The 2Q10 results reflect volatility due to cedant updates on reserves and accounting for CVA (credit value adjustment) and DVA (debit value adjustment), which is the volatility due to changes in the CDS of Swiss Re and its cedants, and Swiss Re is determined to provide more transparency of life re, without, however, changing the accounting, which is that life re only gets allocated the return on equivalent vintage risk free assets, not the return on the actual underlying risky assets like the $17bn corporate bond portfolio.

4. Actions taken in 2009 to deal with the crisis and which affected life re profitability a) Swiss Re repriced Triple X reserve business, where effectively Swiss Re now charges a higher cost of funding (ie the cedant’s effective cost of funding) whereas previously it had offered a cost of funding based on estimated cost of letters of credit, the main alternative form of finance, and these were set relatively low. So Swiss Re as a result is writing slightly shorter duration business as its rates are not attractive to cedants for thirty year durations.

b) Swiss Re refocused on mortality business. This is positive for profitability longer term we believe (new business has a only a gradual impact on the average of the portfolio).

c) Swiss Re did no new admin re business, as did not find attractive business at its pricing level. The likelihood, however, of some smaller $100-200m admin re deals being closed now is higher. Negative for profitability we believe, as admin re has a very quick payback, at least in terms of statutory earnings. This may have been the miss factor which affected 2Q10 life earnings as Swiss Re had still signed no admin re deals then.

d) In January 2010, Swiss Re reinsured part of their US life re backbook, with 2010 premiums of SF1.7bn, to Berkshire. This was because on the Swiss Re model of investing at risk free rates profitability was very low, whereas the cash flow was potentially worth more to Berkshire. The deal frees SF300m capital for Swiss Re, and is small positive in terms of profitability as there is no loss recognised on the

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deal and the business reinsured had, we estimate, well below 6% ROE on the assumption that the reserves are invested at the risk free rate.

5. Ranking of profitability. Swiss Re's EVM based model shows that at the moment profitability is highest in property non-life, next highest in admin re if we credit return on risky assets, next highest (and least volatile) for traditional mortality, and lowest for casualty.

Swiss Re: general points about profitability and the 12% ROE target

Swiss Re's target 12% ROE assumes the following:

1. repayment of the Berkshire convertible at March 2011;

2. Also some capital management; Swiss Re’s priority is to return to a normal dividend policy as soon as possible, and then, if there is still excess capital, it said it would potentially consider other options.

3. Interest rates rise 100bps from their Dec09 levels, ie 140-150bps from now. Swiss Re assumes that the annual cash flow from operations and from maturing assets is reinvested at the higher yields. We assume, to simplify our models, that there is a one off reinvestment of $10-11bn, which we estimate corresponds to the short duration mismatch, as assets are 90% of the duration of liabilities (this is for the group as a whole, and the mismatch is mainly in life). Plus, there the benefit of 1-2pct each extra allocation for equities and corporate bonds, ie 2-4pct or $4-6bn. So in total we believe the 12% target ROE assumes uplift in investment income from current levels of we estimate $14-17bn x 140-150bps, ie $200m-$270m extra.

4. Increasing the allocation of casualty from currently 16% of total group premiums to we estimate 24% (but below the 28% peak of 2007). Casualty is potentially a higher ROE business than property if premium rates recover and interest rates rise. We estimate this adds $240m to profitability (assuming the capital allocated rises by $1bn from we estimate $2bn to $3bn and the return on casualty rises from we estimate 6% now to 12% ROE, ie from $120m to $360m ie an extra $240m).

5. We estimate expected profits rise excluding the Berkshire Convertible by $440-510m to $2.4bn from $1.9-2.0bn previously. As for S&P, Swiss Re said that it had done all to merit a higher rating, including freeing up rating capital during 2Q10 by reducing the ALM duration mismatch to just 10% (90% asset to liability duration ratio). Swiss Re stressed that buying back the Berkshire convertible was a full commitment, whatever natural catastrophes may cost in the next six months.

6. Organic growth in life and health follows the economic cycle and in particular the housing market, which is when households buy more life insurance cover. Longevity is assumed to increase gradually, but under the IFRS convention of spreading earnings over the life of the contract this is not a significant contributor to life profits.

7. Expense control is to remain below inflation, so improving operational leverage.

8. Swiss Re makes no assumption about positive reserve run off in non-life.

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View on the industry cycle:

1. Swiss Re hopes and expects premiums rates to rise end 2011, particularly in casualty.

2. We believe the worse case for Swiss Re is more of the same, which means sluggish growth, low interest rates, low reinsurance margins. Swiss Re is at a disadvantage vs its peers in such a low inflation environment, in our view, because the reserve run off profits up to the first SF2bn go to Berkshire.

Better than the current environment we believe would be a fall in interest rates, as this would force a return to underwriting, where Swiss Re can compete with a good track record, or a rise in interest rates, which would allow Swiss Re to return to casualty which is currently just 16% of total group premiums down from a 28% peak in 2007, and would boost the profitability of casualty from currently we estimate just 5% ROE.

Swiss re insurance risk stress test We have shown below the Swiss Re’s exposure to major nat cat events net of retrocession and securitization. The difference with 2009 and 2008 is due to higher retrocession & securitization in California earthquake and decrease in the European windstorm and Japanese earthquake.

The SF3.6bn figure for pandemic risks shows that peak mortality risk is a bigger risk for Swiss Re than natural catastrophes: SF3.6bn risk from pandemic vs SF3.2bn for the largest natural catastrophe.

Table 51: Insurance risk stress tests CHF billion, % Significant events with a 200 year return period 2008 2009 Change in % Natural catastrophes

Atlantic hurricane -3.5 -3.2 -9% Californian earthquake -3.9 -3.2 -18% European windstorm -2.1 -2.7 29% Japanese earthquake -1.7 -1.9 12%

Life insurance

Lethal pandemic -3.5 -3.6 3% Source: Company reports

We show the history of EVM 2006-9 together with our forecast for 2010e. We assume for our 2010e forecast:

1. the natural catastrophes and large claims in non-life reduce the EVM profit as much (EVM and US GAAP are closest in non-life).

2. for asset management a small positive from a modest narrowing of spreads, more than offset by a negative as SwissRe is short duration and interest rates are down. Asset management is measured relative to benchmarks, so the normal run rate we believe should be zero before capital costs and 2009 was quite exceptional.

3. legacy a relatively modest contribution as the run off is almost complete.

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As a result, our 2010e forecast of EVM profit before capital costs is much lower than 2009, which benefitted from a significant tightening of spreads in the asset management unit.

Table 52: EVM reporting (the Swiss Re equivalent of embedded value) 2006-10e – before capital costs SFm 2010e 2010e Non-life Life Asset mgmt Legacy Group Total New business profit 300 280 -700 60 -60 Previous years' profit/loss 370 300 -100 50 620 Total profit after capital costs 670 580 -700 -40 50 560 Release of capital costs 550 260 700 100 -100 1,510 Income before capital costs 1,220 840 0 60 -50 2,070 2009 2009 Non-life Life Asset mgmt Legacy Group Total New business profit 1,002 311 4,162 213 432 6,120 Previous years' profit/loss 370 401 -309 498 960 Total profit after capital costs 1,372 712 4,162 -96 930 7,080 Release of capital costs 552 261 1,677 304 20 2,814 Income before capital costs 1,924 973 5,839 208 950 9,894 2008 2008 Non-life Life Asset mgmt Legacy Group Total New business profit 658 595 -12,366 -2,396 -2,782 -16,291 Previous years' profit/loss 618 -141 -2,624 -296 -2,443 Total profit after capital costs 1,276 454 -12,366 -5,020 -3,078 -18,734 Release of capital costs 978 666 1,213 488 2,265 5,610 Income before capital costs 2,254 1,120 -11,153 -4,532 -813 -13,124 2007 2007 Non-life Life Asset mgmt Legacy Group Total New business profit 1,787 1,247 -761 -1,534 45 784 Previous years' profit/loss 851 -42 0 0 100 909 Total profit after capital costs 2,638 1,205 -761 -1,534 145 1,693 Release of capital costs 1,601 1,136 728 69 -338 3,196 Income before capital costs 4,239 2,341 -33 -1,465 -193 4,889 2006 2006 Non-life Life Asset mgmt Legacy Group Total New business profit 1,695 391 995 -71 3,010 Previous years' profit/loss 137 328 0 225 690 Total profit after capital costs 1,832 719 995 154 3,700 Release of capital costs 1,578 1,007 857 99 3,541 Income before capital costs 3,410 1,726 1,852 253 7,241 Source: Company reports and J.P. Morgan estimates.

We show the relation between changes in total EVM net worth and EVM income in the following table.

Table 53: Swiss Re change in life re economic net worth SFm ENW 2005 2006 2007 2008 2009 2010e Brought forward 17,059 20,065 39,200 38,400 18,600 28,494 GEIS deal 1,989 Opening adjustments 161 -1,000 2,300 Income 1,720 2,367 4,900 -13,124 9,894 2,070 Dividend -785 -1,257 -1,200 -1,300 -340 Mandatory convertible and buybacks -1,300 -600 300 0 FX and other 1,910 -526 -2,200 -7,100 -300 -1,500 Carried forward 20,065 22,638 38,400 18,576 28,494 28,724 Source: Company reports and J.P. Morgan estimates.

Finally we show the track record of Swiss Re life re profits in 1999-2009. We note that Swiss Re doest not report return on operating revenue (it stopped doing so in 2007) as this is not a very consistent or comparable guide to underlying profitability.

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We believe the measure that would best help understand profitability is ROE for the life re unit alone, and none of the European listed reinsurers provide this.

Table 54: Swiss Re reported life profits in SFm 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Life premiums 7311 8330 8922 11275 10229 10205 9638 10974 12665 11090 10679 Life fees 881 879 955 808 916 Life claims -6119 -7448 -8502 -10084 -9085 -9331 -8669 -9594 -11112 -9065 -9348 Acquisition costs -1732 -1912 -2077 -2582 -2479 -2177 -2221 -2256 -2665 -2626 -2488 Investment income 2494 2983 3903 3448 3140 3311 5799 5353 6304 -1374 6654 Of which non-participating inv inc.

1839 2530 3388 3476 3085 3178 3249 3016 4692 2632 2678

Of which non-participating gains

312 165 354 -229 -545

Unit linked investment income/ gains and losses

9150 3019 2827 2120 -2822 4823

Other -741 -587 -704 -764 -983 -1308 -958 -844 Life operating profit 1505 1447 1682 1316 1643 1645 1645 1682 1320 697 746 Life operating result ex gains

850 994 1167 1344 1163 1222 1333 1381 2744 926 1291

Allocated of overheads

-48 -208 -184 -135 -105 -165 -213 -452 -301 -368

Life operating result ex gains after costs pretax

946 959 1160 1028 1117 1168 1168 2292 625 923

Life reserves 30339 40432 53851 51043 51041 54687 77851 102353 106723 87137 79223 Of which unit linked 1688 1964 1943 1799 2448 12629 14692 42834 41340 34518 37931 Estimate of capital required (4% trad, 1% UL, 2X health prems)

4856 5583 6098 5745 5262 6830 7682 8771 7139 6023

Net of tax and of central costs ROE

14.6% 12.9% 14.3% 13.4% 15.9% 12.8% 11.4% 19.6% 6.6% 11.5%

Return on operating revenue

9.3% 9.2% 9.5% 9.1% 8.7% 9.1% 9.6% 9.2% 16.5% 6.4% 9.0%

Return on reserves 2.8% 2.5% 2.2% 2.6% 2.3% 2.2% 1.7% 1.3% 2.6% 1.1% 1.6% Return on premiums after allocation

11.4% 10.7% 10.3% 10.0% 10.9% 12.1% 10.6% 18.1% 5.6% 8.6%

Source: Company reports and J.P. Morgan estimates for expenses allocation and capital allocated

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Life reinsurance – risk products and financing reinsurance The life reinsurance product is one of two kinds: either: a) risk reinsurance or, b) Financing reinsurance. The Risk reinsurance product makes money for the reinsurer due to an information advantage, as the reinsurer can see data across several primary insurers. The financing reinsurance product helps the primary insurer meet acquisition costs, or as an alternative to securitization markets, particularly for smaller insurers.

In this section we include a summary of discussions with Hannover Re and discuss in some more detail the various kinds of life reinsurance products like YRT, Modco (and the accounting of the B36 derivative).

Risk Reinsurance The purpose of the buyer here is to transfer insurance risk to a third party, in this case a reinsurer. These are mostly biometric risk factors – mortality, longevity etc. The primary insurer may feel that they are too exposed to mortality risk so enters into a reinsurance agreement, either in an excess of loss or a quota share basis.

Here the risk/reward profile is quite simple to understand – the reinsurer will determine its price for the risks assumed in-line with mortality risks in-line with other mortality exposures etc. Let’s assume the reinsurer charges 100 and the expected claims cost is 90 if the expected claims cost materializes here then earns 10% of premium. If mortality is higher then the margin is less, and vice versa.

Reinsurers have established a fair amount of extra data and clients are in many cases smaller companies, so there is an information advantage. They can compare the data of one company with data in another company in same market which gives data greater credibility. Primary insurers are also benefiting from a significant solvency relief from the business reinsured, and that’s because the solvency margin is on the net retained portfolio, not on the assumed written portfolio.

Risk reinsurance profits tend to tail off due to selection effect In risk reinsurance, the mortality profits or risk profits of the reinsurers tail off over the years and this has to do with the underwriting or selection process of the primary insurance company. If we consider the case of a male aged 40 and let’s assume with a typical mortality of 100% (i.e. average of all persons who have reached aged 40). If the reinsurer then underwrites a person who is just turning 40 then the primary insurer would have weeded out those who are about to die quickly. So the mortality on the people who are reinsured is better than others, and this comes through.

YRT One of the widely used methods of risk transfer reinsurance, particularly in the US market is the Yearly Renewable Term (YRT) product.

The first concept we define here is the 'Net Amount at Risk': which is basically the difference of the value of claim (in event of death) over the reserve which the

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insurance company has set up. The YRT agreement splits this net amount at risk between the insurance company and the reinsurer.

This product is called the Yearly Renewable Term as the ceding company prepares a schedule of ‘net amount at risk’ for every year of the policy and accordingly the reinsurer develops a schedule of the premiums it will charge ever year.

It is interesting to note here that although the net amount at risk does decline steadily every year, the insurer and the reinsurer agree to adjust the premium only at agreed intervals to keep costs under control.

Coinsurance The Coinsurance basis of reinsurance is the most comprehensive cover, as it transfers all risks (either proportional or excess of loss basis). Typically, the reinsurer receives a premium, and sets up a reserve, and then pays not just its share of claim, but also any other benefits, along with commissions.

Coinsurance with funds withheld Here the ceding company retains the assets which back the reserves of the ceded portion of business and pays interest to the reinsurer on this book of reserves. There could be two reasons why a ceding company chooses to retain the reserves.

a) it can attempt to maximise its investment income

b) this reduces its counterparty credit risk (removes the risk the reinsurer may not be able to pay the claim when due).

Modified Coinsurance The key difference between modified coinsurance (Modco) and the coinsurance with funds withheld (above) is that the reinsurer only pays the ceding company for any change in reserves after deducting the interest it would have otherwise received, thus, implying that the ceding company is responsible for any changes in reserves simply due to interest earned while all other changes belong to the reinsurer.

Interestingly, this ‘reserve adjustment’ interest rate is a key part of the negotiations between the reinsurer and the cedant.

MODCO treaties were in focus when Hannover last year reported large unrealised gains (and losses) on these treaties and recently changed the basis of calculation to CDS from previous Option adjusted swaps (OAS) which did indeed reduce the volatility on this line.

These unrealized gains or losses are due to the recognition of an ‘embedded derivative’ and appear in the P&L due to the famous ‘B 36’ accounting rule (Statement 133 Implementation Issue No. B36) which we discuss briefly below:

We discussed above that the interest rate that the ceding company pays to the reinsurer on the ceded reserves is part of the negotiation and is in the reinsurance agreement. This interest rate is typically based on a specified portion of the ceding company’s return on its assets (or a specific book of cedant's assets).

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Thus the ability of the ceding company to pay interest (from the reinsurer's point of view) is not linked directly to the risk profile of the ceding company, but rather on the investment return the ceding company can earn on its assets. This introduces a disconnect, which leads to the formation of the embedded derivative.

UK Enhanced annuities market The UK protection market is the largest European reinsurance market, and the primary insurers tender and re-tender their products every 12-18 months, which means that the barriers to entry for re-insurers into this market are very low, which means you get competition from new players, and even incumbents have become aggressive recently.

Enhanced annuities market – Hannover Re is the only company which has credible data. This covers only 25% of the population that is purchasing an annuity. This is the population with the shortest longevity. They can predict clusters of annuities ranging from illnesses, territorial distribution. Longevity in the UK is very different in the North compared to the South. This is single premium immediate annuities – the customer hands over a lump sum to the insurer and the price is quoted jointly by the primary insurer with the reinsurer. There is no risk of lapse or persistency. Also there is no risk of anti-selection going forward (in that good risks leave the portfolio and bad risks remain). Not participating in the investment risk at all – in most cases have arrangement with clients that guarantee certain interest rate.

In Germany the primary insurers charge 54% above actual mortality experience.

Further, on the accounting of life reinsurance, we flag off a key difference between IFRS and US GAAP:

In IFRS you are forced every year to compare actual to expected and to immediately reflect any deviation in your balance sheet and you have to prove to auditors that the DAC asset is a real asset. Under US GAAP, if you receive 100 premium, you expect 90 of mortality but real claims experience in first year is 95, you are still able to show this treaty with a profit of 10, because the underlying assumption in US GAAP is correct and any short term deviation is just a random fluctuation.

Financing reinsurance The demand here is driven not by consideration of offloading insurance risk but here it is to manage the financials. Managing financials has a number of dimensions: protect your solvency; protect your liquidity; protect your earnings under either statutory or IFRS. Whatever they do companies have to include transfer of underlying risk in order for it to qualify as insurance.

The typical financing reinsurance treaty is where the reinsurer helps the primary company to meet the acquisition costs. You assume a life company is producing new individual life business and this business creates a very substantial strain in the balance sheet and also in the liquidity. The easiest to understand is the liquidity strain – agents etc want cash up-front. There are also substantial internal acquisition costs – policy issuance, compliance, etc – that only occur in Year 1. There are also solvency costs – this triggers solvency requirements that have to be financed. This creates a very substantial acquisition cost in Year 1. In this context, the primary insurer looks for assistance from a reinsurer and in many of these

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The reinsurer participates in the cost structure of the primary insurance company. The reinsurer puts money on the table to finance the acquisition of a life insurance portfolio. They help the primary company to finance the acquisition of such a portfolio. They share the initial expenses. This portfolio will generate future earnings.

These cash flows are recovered pro-rata with the primary insurer. Many of the treaties have terms and conditions that allow them to recover more than their share in the early years. The main risk factor in financing business is the persistency risk – the key is to keep the product on the books. We believe this is why lapse risk appears as a significant factor in the embedded value sensitivities of the life reinsurers.

Financing reinsurance treaties also have a tailing off effect like the risk treaties, as is evident from the IFRS profits of a financial re treaty, sourced from Hannover Re’s Investor Day 2007.

Figure 27: IFRS profits of financing reassurance treaty 4.0

3.6 3.3 3 2.7 2.5 2.2 2.1 1.91.6 1.4 1.2 1.1 0.9 0.7 0.6 0.5 0.4 0.3 0.3 0.3 0.2 0.2 0.2 0.1

0.0

1.0

2.0

3.0

4.0

5.0

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

IFRS result Source: Company reports

If we compare financing reinsurance to alternative forms of ‘monetising' like securitising, we see that the small and medium sized insurers (which make up the bulk of the number of insurers worldwide) find it easier to use a financial reinsurance product vs. tying up with the securitisation markets.

Block transfers Another product of the financing reinsurance is the Block assumption transfer (BAT) where Hannover assumes existing blocks of policies which are closed to new business via quota share reinsurance. Hannover has indicated that demand for monetizing the EV in this manner continues to remain strong and even in 2Q 10 helped towards the strong 7% growth seen in forex adjusted life re premiums.

We have shown below the example of the IFRS result of a block assumption transaction. Year 3 and following years will look similar to the second year.

Table 55:Hannover’s example of block assumption transaction on traditional individual Life biz from Germany, IFRS Year 1 Year 2 Year 3+ Gross written premium 93.7 85.7 Similar to Year 2 Reinsurance commission (74.2) (1.6) Similar to Year 2 Change in DAC 64.1 (7.0) Similar to Year 2 IFRS result 4.0 3.6 Similar to Year 2 Source: Company reports (Hannover Re investor day presentation 2007 slide 122)

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Risk business is almost twice as profitable as Financing re Overall, from a profitability point of view, we look at the IFRS new business margin, as defined by Hannover: (IFRS results year 0 + present value of IFRS results)/ (IFRS premiums year 0 + PV of IFRS premiums) and note that the risk reinsurance has a 9.8% margin vs. a 4.24% (Hannover Re data). Hannover does point out that its Financial re business has an IRR of 11.5% so is still a profitable product.

Appendix I: Executive summary • We believe life re has been under-researched by the market and under-reported in

terms of granularity and transparency by the listed European reinsurers. We believe this is because by comparison with non-life re, life re is complex and opaque.

• Non-life reinsurance is immediate and transparent: this year’s renewals affect profits this and next year, negative claims trends have to be reserved immediately, nat cats have an immediate effect, and because it is part a broker market, pricing is relatively transparent. And finally the main annual reinsurance conference is in glamorous Monte-Carlo.

• By contrast, life reinsurance is like treacle: long lasting, slow to change (new business accounts for 3-10% of this year's profits), and with sticky accounting (IFRS and US GAAP reserves are mainly historic). But, and this is the main positive, in our view, in the main mortality business life re rarely produces losses. This is because mortality tends to improve with time, so pricing errors tend to be offset by positive variances, and we assume that companies have been reasonably conservative in their pricing assumptions.

• The one exception to this is asset risk on the invested assets, which we believe was a key factor in the upset at Swiss Re in 2008-9, which we believe caused Scottish Re’s losses and forced closure, and which causes unusual volatility in results on a quarterly basis elsewhere (eg ModCo at Hannover).

• This report goes through the main forms of life re, the different accounting and reporting rules (IFRS, US GAAP, embedded value and statutory), the main trends of each of the main life reinsurers in Europe. As a benchmark for reporting, trends and profitability, we have used the example of RGA in the US, which is the only company to report the main segments of life re: mortality, longevity, asset intensive, Canada, other markets.

• Given our view that life re is a less volatile business, we should argue that life re should be revalued. The difficulty is that investors who are used to non-life reinsurance cycles, reporting and accounting, may be unwilling to pay up for life reinsurance embedded value, particularly if there is the perception that life re earnings are based on reserves which under different accounting would be restated. We believe for example that the valuation discount of say Swiss Re arising in life re may need a catalyst to be crystallized.

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Life reinsurance market shares Munich Re & Swiss Re has a combined market share of 48% (2009 data) and they dominate the life reinsurance market. The US accounts for 50% of the gross premiums written and is the largest and most developed market.

Figure 28: Life reinsurance market share, 2009: dominated by top 2 players %

7%1%1%

5%6%

8%12%12%

21% 27%

0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0%

OtherPartner Re

XL ReTransameric

GenReSCOR

Hannov er ReRGA

Sw iss ReMunich Re

Life reinsurance - Global market share

Source: Munich Re life investor day presentation

Figure 29: US is the major market for life reinsurance, 2007 %

50%6%

10%

7%

27%

USA Germany UK Canada Other

Source: Munich Re Life investor day presentation, 2008

We have shown below the US market share of the recurring new business in 2007. This is a concentrated market with top 5 players controlling the 85% of the market.

Figure 30: Market share - US recurring new business assumed (2009) %

0.1%0.1%0.3%

1.2%1.7%1.7%

2.9%3.2%3.3%

11.8%13.5%

18.1%19.3% 22.4%

0.0% 5.0% 10.0% 15.0% 20.0% 25.0%

Employ ers Re CorpRGA Re. CanadaOptimum Re (US)

Wilton ReGeneral Re Life

Ace TempestSCOR Global Life (US)

Canada LifeHannov er Life Re

Generali USA Life ReMunich Re (US)

Transamerica ReSw iss Re

RGA Re. Company

Market share - US recurring new business assumed Source: Munich Re Investor day presentation on Life reinsurance

Key points on the life re:

1) Lower earnings volatility: Life reinsurance has lower earnings volatility than Non life reinsurance. However the asset risk could be high, for example 85% Scottish Re earnings fluctuations were due to asset risk.

2) Relatively opaque accounting: Life reinsurance accounting is relatively opaque in comparison with Non life Re.

3) Diversification: Life re provides attractive diversification due to low correlation of mortality & other life risks with Non life.

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Valuation Methodology and Risks Hannover Re (Overweight; Price Target €45.70) Valuation Methodology We establish a Dec 11 SoTP based PT of €45.7. Our valuation is based on valuation multiples of 8.7x for P&C and 9.1x for L&H representing a cost of equity of 11.5% for P&C (1/11.5% = 8.7x) and 11.0% for Life (1/11% = 9.1x). We have changed the cost of equity assumption for the life reinsurance unit to 11.0% vs. previously 10.0% to reflect in our view investor concerns about impact of life reinsurance business from low interest rates. We highlight we use net profit including realised gains which we believe is appropriate given the low equity holdings at Hannover. We deduct the face value of debt from the total value for our valuation. Risks to Our View Key downside risk to our OW rating and PT is continued softness in reinsurance pricing leading to a deterioration in combined ratio in 2011 and 2012. Every 1% worse 2012e COR impacts our PT by -5.6% (current Dec 11 PT of €45.7). Another potential risk is continued pressure on earnings from nat cat losses, eg the increased loss of €89m for the Deepwater Horizon oil rig.

SCOR (Overweight; Price Target €21.40) Valuation Methodology Our sum of parts valuation uses the same methodology as for peers. We value non-life using an 11.5% cost of capital which is equivalent to an 8.7x valuation PE, and life 11.0% (as it is slightly lower risk) and this is equivalent to an 9.1x valuation PE. We exclude from the non-life earnings we value the realised gains (we leave them in the life valuation as our forecast is based on a total sustainable life margin) of we forecast 6.65% as pct of net earned premiums (1H10 was 6.0%, part depressed by the lower margin equity indexed annuity business). We deduct the debt at face value, and we deduct both the €499m sub debt and the €196m financial debt, ie €695m in total. Risks to Our View The downside risks to our overweight recommendation are mainly two. The first is deal risk, as SCOR has said that it is looking to build or buy in the Lloyds market, and this could potentially could lead to dilution risk (albeit relatively modest as we estimate SCOR has potential €0.55bn internal financing capacity, consisting of €0.3bn potential extra debt and €0.25bn we estimate excess capital). The second is that the non-life combined ratio disappoints due to high European natural catastrophes, despite the improvement in pricing due to the January and July 2010 renewals.

Swiss Re (Neutral; Price Target SF 57.00) Valuation Methodology Valuation: New SF57 Dec 11 SoTP based price target (previously SF61 Dec 2010) Our Dec 2011 SOTP based price target is SF57. Our sum-of-parts valuation values our forecast 2012E earnings on P/E valuation multiples of 8.3x for cyclical reinsurance, life reinsurance and asset management. We also deduct -SF600m pre tax, $430m net of tax (@95.5% FX rate and 25% tax rate) as the Berkshire redemption penalty from our valuation. The valuation is based on our forecast

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operating earnings excluding realised gains and realised losses. The P/E multiple of 8.3x assumes a 12.0% cost of capital. Risks to Our View The upside risk is that Swiss Re remains very undervalued in terms of price to book value of we estimate SF78 per share year end 2010 with a 39% discount and that it starts a buyback earlier than the for now indicated earliest deadline of March 2011. The downside risks are that non-life combined ratio, the competitive edge of the group (we show in the chart below how Swiss Re is consistently since 2003 at or below Munich Re), misses the new below 93% guidance going forward. The other downside risk is that life reinsurance triggers a large assumption provision, which we estimate could be up to around $1.6bn. .

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Companies Recommended in This Report (all prices in this report as of market close on 31 August 2010, unless otherwise indicated) Hannover Re (HNRGn.DE/€34.87/Overweight), SCOR (SCOR.PA/€17.16/Overweight), Swiss Re (RUKN.VX/SF 43.55 [01-September-2010]/Neutral)

Analyst Certification: The research analyst(s) denoted by an “AC” on the cover of this report certifies (or, where multiple research analysts are primarily responsible for this report, the research analyst denoted by an “AC” on the cover or within the document individually certifies, with respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research analyst’s compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report.

Important Disclosures

• Market Maker/ Liquidity Provider: J.P. Morgan Securities Ltd. is a market maker and/or liquidity provider in Hannover Re, SCOR, Swiss Re.

• Lead or Co-manager: J.P. Morgan acted as lead or co-manager in a public offering of equity and/or debt securities for Hannover Re within the past 12 months.

• Beneficial Ownership (1% or more): J.P. Morgan beneficially owns 1% or more of a class of common equity securities of Swiss Re.

• Client of the Firm: Hannover Re is or was in the past 12 months a client of JPM; during the past 12 months, JPM provided to the company investment banking services, non-investment banking securities-related service and non-securities-related services. SCOR is or was in the past 12 months a client of JPM; during the past 12 months, JPM provided to the company investment banking services, non-investment banking securities-related service and non-securities-related services. Swiss Re is or was in the past 12 months a client of JPM; during the past 12 months, JPM provided to the company investment banking services, non-investment banking securities-related service and non-securities-related services.

• Investment Banking (past 12 months): J.P. Morgan received, in the past 12 months, compensation for investment banking services from Hannover Re, SCOR, Swiss Re.

• Investment Banking (next 3 months): J.P. Morgan expects to receive, or intends to seek, compensation for investment banking services in the next three months from Hannover Re, SCOR, Swiss Re.

• Non-Investment Banking Compensation: JPMS has received compensation in the past 12 months for products or services other than investment banking from Hannover Re, SCOR, Swiss Re. An affiliate of JPMS has received compensation in the past 12 months for products or services other than investment banking from Hannover Re, SCOR, Swiss Re.

0

12

24

36

48

60

Price(€)

Sep06

Jun07

Mar08

Dec08

Sep09

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Hannover Re (HNRGn.DE) Price Chart

N €37.7 N €41.3 N €24.1

N €38.8 OW €43.3 N €23.2 N €38.9 OW €45.7

N €38.1 N €43.3 N €38.4 UW €26.5UW €26.9UW €36.4 OW €43.4

Source: Bloomberg and J.P. Morgan; price data adjusted for stock splits and dividends.This chart shows J.P. Morgan's continuing coverage of this stock; the current analyst may or may not have covered itover the entire period.J.P. Morgan ratings: OW = Overweight, N = Neutral, UW = Underweight.

Date Rating Share Price (€)

Price Target (€)

15-Nov-06 N 32.85 38.10 19-Dec-06 N 34.48 38.80 19-Mar-07 N 32.30 37.70 06-Jul-07 N 36.53 43.30 10-Jul-07 OW 36.18 43.30 05-Oct-07 N 36.71 41.30 11-Aug-08 N 29.60 38.40 29-Oct-08 N 15.70 23.20 04-Dec-08 N 19.60 24.10 16-Mar-09 UW 23.55 26.50 03-Jul-09 UW 26.38 26.90 19-Oct-09 UW 33.92 36.40 09-Nov-09 N 33.15 38.90 05-Mar-10 OW 33.01 43.40 05-May-10 OW 32.60 45.70

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0

8

16

24

32

40

Price(€)

Sep06

Jun07

Mar08

Dec08

Sep09

Jun10

SCOR (SCOR.PA) Price Chart

OW €23.638 OW €23.3 N €21.1

OW €2.45 OW €20 OW €18 N €21.4 N €23

N €2.2 OW €18.7 OW €16.2OW €19.6 OW €21.4 N €22.6 OW €21.4

Source: Bloomberg and J.P. Morgan; price data adjusted for stock splits and dividends.Break in coverage Feb 26, 2004 - Oct 17, 2006. This chart shows J.P. Morgan's continuing coverage of this stock; thecurrent analyst may or may not have covered it over the entire period.J.P. Morgan ratings: OW = Overweight, N = Neutral, UW = Underweight.

Date Rating Share Price (€)

Price Target (€)

18-Oct-06 N 19.45 2.20 14-Nov-06 OW 20.89 2.45 12-Feb-07 OW 21.73 23.64 11-Mar-08 OW 13.89 18.70 25-Mar-08 OW 14.75 20.00 29-Oct-08 OW 11.04 16.20 17-Nov-08 OW 14.79 18.00 04-Dec-08 OW 14.93 23.30 12-Feb-09 OW 15.55 19.60 10-Jul-09 OW 14.58 21.40 07-Sep-09 N 18.20 21.40 13-Oct-09 N 18.96 21.10 15-Feb-10 N 17.45 22.60 04-Mar-10 N 18.45 23.00 27-Aug-10 OW 16.28 21.40

0

37

74

111

148

185

Price(SwF)

Sep06

Jun07

Mar08

Dec08

Sep09

Jun10

Swiss Re (RUKN.VX) Price Chart

N SwF131 OW SwF130 OW SwF85UW SwF26OW SwF48 OW SwF57

N SwF122 OW SwF141 OW SwF90UW SwF55 N SwF37OW SwF53

N SwF117 N SwF137 OW SwF120OW SwF66 N SwF28OW SwF50 OW SwF61N SwF57

Source: Bloomberg and J.P. Morgan; price data adjusted for stock splits and dividends.This chart shows J.P. Morgan's continuing coverage of this stock; the current analyst may or may not have covered itover the entire period.J.P. Morgan ratings: OW = Overweight, N = Neutral, UW = Underweight.

Date Rating Share Price (SwF)

Price Target (SwF)

21-Nov-06 N 105.50 117.00 20-Feb-07 N 103.80 122.00 01-Mar-07 N 107.50 131.00 09-Jul-07 N 111.10 137.00 05-Oct-07 OW 106.50 141.00 20-Nov-07 OW 85.10 130.00 06-May-08 OW 87.65 120.00 12-Aug-08 OW 70.25 90.00 10-Oct-08 OW 43.02 85.00 21-Oct-08 OW 47.50 66.00 25-Nov-08 UW 44.00 55.00 06-Feb-09 UW 18.60 26.00 09-Apr-09 N 23.20 28.00 08-May-09 N 38.52 37.00 13-May-09 OW 38.68 48.00 12-Aug-09 OW 45.26 50.00 25-Aug-09 OW 47.90 53.00 04-Nov-09 OW 45.10 57.00 22-Feb-10 OW 48.70 61.00 06-Aug-10 N 48.94 57.00

Explanation of Equity Research Ratings and Analyst(s) Coverage Universe: J.P. Morgan uses the following rating system: Overweight [Over the next six to twelve months, we expect this stock will outperform the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Neutral [Over the next six to twelve months, we expect this stock will perform in line with the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Underweight [Over the next six to twelve months, we expect this stock will underperform the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] J.P. Morgan Cazenove’s UK Small/Mid-Cap dedicated research analysts use the same rating categories; however, each stock’s expected total return is compared to the expected total return of the FTSE All Share Index, not to those analysts’ coverage universe. A list of these analysts is available on request. The analyst or analyst’s team’s coverage universe is the sector and/or country shown on the cover of each publication. See below for the specific stocks in the certifying analyst(s) coverage universe.

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Coverage Universe: Michael Huttner, CFA: Allianz (ALVG.DE), CNP (CNPP.PA), Euler Hermes (ELER.PA), Generali Deutschland (GE1G.DE), MLP (MLPG.F), Munich Re (MUVGn.DE), OVB Holding AG (O4BG.F), PZU (PZU.WA), SCOR (SCOR.PA), Swiss Re (RUKN.VX), Zurich Financial Services (ZURN.VX)

J.P. Morgan Equity Research Ratings Distribution, as of June 30, 2010

Overweight (buy)

Neutral (hold)

Underweight (sell)

J.P. Morgan Global Equity Research Coverage

46% 42% 12%

IB clients* 49% 46% 31% JPMS Equity Research Coverage 44% 48% 9% IB clients* 68% 61% 53%

*Percentage of investment banking clients in each rating category. For purposes only of FINRA/NYSE ratings distribution rules, our Overweight rating falls into a buy rating category; our Neutral rating falls into a hold rating category; and our Underweight rating falls into a sell rating category.

Valuation and Risks: Please see the most recent company-specific research report for an analysis of valuation methodology and risks on any securities recommended herein. Research is available at http://www.morganmarkets.com , or you can contact the analyst named on the front of this note or your J.P. Morgan representative.

Analysts’ Compensation: The equity research analysts responsible for the preparation of this report receive compensation based upon various factors, including the quality and accuracy of research, client feedback, competitive factors, and overall firm revenues, which include revenues from, among other business units, Institutional Equities and Investment Banking.

Registration of non-US Analysts: Unless otherwise noted, the non-US analysts listed on the front of this report are employees of non-US affiliates of JPMS, are not registered/qualified as research analysts under FINRA/NYSE rules, may not be associated persons of JPMS, and may not be subject to FINRA Rule 2711 and NYSE Rule 472 restrictions on communications with covered companies, public appearances, and trading securities held by a research analyst account.

Other Disclosures

J.P. Morgan ("JPM") is the global brand name for J.P. Morgan Securities LLC ("JPMS") and its affiliates worldwide. J.P. Morgan Cazenove is a marketing name for the U.K. investment banking businesses and EMEA cash equities and equity research businesses of JPMorgan Chase & Co. and its subsidiaries.

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http://www.morganmarkets.com/

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publicly available information. Clients should contact analysts and execute transactions through a J.P. Morgan subsidiary or affiliate in their home jurisdiction unless governing law permits otherwise.

“Other Disclosures” last revised September 1, 2010.

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